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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, 2004 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, 2005 was as follows:
Common Shares, without par value: 433,605,559
Page 1
CARDINAL HEALTH, INC. AND SUBSIDIARIES
Index *
Page No.
--------
Part I. Financial Information:
Item 1. Financial Statements:
Condensed Consolidated Statements of Earnings for the Three and Six Months
Ended December 31, 2004 and 2003 (unaudited)....................................... 3
Condensed Consolidated Balance Sheets at December 31, 2004 and
June 30, 2004 (unaudited).......................................................... 4
Condensed Consolidated Statements of Cash Flows for the Six Months Ended
December 31, 2004 and 2003 (unaudited)............................................. 5
Notes to Condensed Consolidated Financial Statements............................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.............................................................. 30
Item 3. Quantitative and Qualitative Disclosures about Market Risk......................... 38
Item 4. Controls and Procedures............................................................ 39
Part II. Other Information:
Item 1. Legal Proceedings.................................................................. 40
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds........................ 43
Item 4. Submission of Matters to a Vote of Security Holders................................ 43
Item 5. Other Information.................................................................. 44
Item 6. Exhibits........................................................................... 44
* Items not listed are inapplicable.
Page 2
PART I. FINANCIAL INFORMATION; ITEM 1. FINANCIAL STATEMENTS
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,
2004 2003 2004 2003
------------- ------------ ------------- -------------
Revenue $ 18,554.6 $ 16,350.8 $ 36,350.6 $ 31,739.0
Cost of products sold 17,348.1 15,189.8 34,057.6 29,505.2
------------- ------------ ------------- -------------
Gross margin 1,206.5 1,161.0 2,293.0 2,233.8
Selling, general and administrative expenses 699.6 588.0 1,392.7 1,135.6
Impairment charges and other 83.0 (8.1) 86.8 (6.4)
Special items - restructuring charges 105.1 12.9 112.6 20.2
- merger charges 10.2 7.8 27.1 16.4
- other (12.2) (24.2) (4.7) (26.9)
------------- ------------ ------------- -------------
Operating earnings 320.8 584.6 678.5 1,094.9
Interest expense and other 16.9 27.6 54.3 53.9
------------- ------------ ------------- -------------
Earnings before income taxes, discontinued operations
and cumulative effect of change in accounting 303.9 557.0 624.2 1,041.0
Provision for income taxes 100.1 183.4 202.6 343.9
------------- ------------ ------------- -------------
Earnings from continuing operations before
cumulative effect of change in accounting 203.8 373.6 421.6 697.1
Earnings/(loss) from discontinued operations
(net of tax ($6.5) and $3.1, respectively, for the
three months ended December 31, 2004 and 2003,
and ($3.7) and $4.2, respectively, for the
six months ended December 31, 2004 and 2003 10.2 (5.1) 5.7 (6.9)
Cumulative effect of change in accounting - - - (38.5)
------------- ------------ ------------- -------------
Net earnings $ 214.0 $ 368.5 $ 427.3 $ 651.7
============= ============ ============= =============
Basic earnings per Common Share:
Continuing operations $ 0.47 $ 0.86 $ 0.98 $ 1.60
Discontinued operations 0.02 (0.01) 0.01 (0.02)
Cumulative effect of change in accounting - - - (0.09)
------------- ------------ ------------- -------------
Net basic earnings per Common Share $ 0.49 $ 0.85 $ 0.99 $ 1.49
============= ============ ============= =============
Diluted earnings per Common Share:
Continuing operations $ 0.47 $ 0.85 $ 0.97 $ 1.58
Discontinued operations 0.02 (0.01) 0.01 (0.02)
Cumulative effect of change in accounting - - - (0.09)
------------- ------------ ------------- -------------
Net diluted earnings per Common Share $ 0.49 $ 0.84 $ 0.98 $ 1.47
============= ============ ============= =============
Weighted average number of Common Shares outstanding:
Basic 432.1 433.2 431.7 436.8
Diluted 437.1 438.7 436.3 442.5
Cash dividends declared per Common Share $ 0.030 $ 0.030 $ 0.060 $ 0.060
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,
2004 2004
--------------- ----------------
ASSETS
Current assets:
Cash and equivalents $ 1,273.7 $ 1,096.0
Trade receivables, net 2,821.9 3,432.7
Current portion of net investment in sales-type leases 211.5 202.1
Inventories 8,177.5 7,471.3
Prepaid expenses and other 794.3 795.4
Assets held for sale from discontinued operations 32.1 60.4
--------------- ----------------
Total current assets 13,311.0 13,057.9
--------------- ----------------
Property and equipment, at cost 4,484.2 4,300.1
Accumulated depreciation and amortization (2,091.1) (1,936.1)
--------------- ----------------
Property and equipment, net 2,393.1 2,364.0
Other assets:
Net investment in sales-type leases, less current portion 631.9 546.0
Goodwill and other intangibles, net 5,040.0 4,938.8
Other 413.0 462.4
--------------- ----------------
Total $ 21,789.0 $ 21,369.1
=============== ================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Notes payable and other short-term borrowings $ 79.0 $ 5.6
Current portion of long-term obligations 356.4 855.0
Accounts payable 7,231.9 6,432.4
Other accrued liabilities 1,968.5 2,021.3
Liabilities from discontinued operations 53.5 55.1
--------------- ----------------
Total current liabilities 9,689.3 9,369.4
--------------- ----------------
Long-term obligations, less current portion 2,384.6 2,834.7
Deferred income taxes and other liabilities 1,155.6 1,188.7
Shareholders' equity:
Preferred Shares, without par value
Authorized - 0.5 million shares, Issued - none - -
Common Shares, without par value
Authorized - 755.0 million shares, Issued - 474.9
million shares and 473.1 million shares,
respectively, at December 31, 2004 and June 30, 2004 2,708.3 2,653.8
Retained earnings 8,289.8 7,888.0
Common Shares in treasury, at cost, 41.9 million shares
and 42.2 million shares, respectively, at December 31,
2004 and June 30, 2004 (2,565.2) (2,588.1)
Other comprehensive income 151.3 28.9
Other (24.7) (6.3)
--------------- ----------------
Total shareholders' equity 8,559.5 7,976.3
--------------- ----------------
Total $ 21,789.0 $ 21,369.1
=============== ================
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,
2004 2003
--------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Earnings from continuing operations before
cumulative effect of change in accounting $ 421.6 $ 697.1
Adjustments to reconcile earnings from continuing
operations before cumulative effect of change
in accounting to net cash from operations:
Depreciation and amortization 198.2 143.2
Asset impairments 155.8 4.8
Provision for bad debts 0.8 (2.7)
Change in operating assets and liabilities, net of
effects from acquisitions:
Decrease/(increase) in trade receivables 622.3 (488.3)
Increase in inventories (707.5) (841.4)
Decrease/(increase) in net investment in sales-type leases (95.3) 22.0
Increase in accounts payable 794.1 964.3
Other accrued liabilities and operating items, net 129.2 49.4
--------------- -------------
Net cash provided by operating activities 1,519.2 548.4
--------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of subsidiaries, net of cash acquired (273.2) (499.1)
Proceeds from sale of property, equipment and other assets 4.2 5.2
Additions to property and equipment (214.6) (164.1)
Proceeds from sale of discontinued operations 39.5 -
--------------- -------------
Net cash used in investing activities (444.1) (658.0)
--------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net change in commercial paper and short-term debt (562.7) 0.6
Reduction of long-term obligations (1,621.4) (202.8)
Proceeds from long-term obligations, net of issuance costs 1,264.8 78.5
Proceeds from issuance of Common Shares 47.8 80.0
Purchase of treasury shares - (1,000.0)
Dividends on Common Shares (25.9) (26.4)
--------------- -------------
Net cash used in financing activities (897.4) (1,070.1)
--------------- -------------
NET INCREASE/(DECREASE) IN CASH AND EQUIVALENTS 177.7 (1,179.7)
CASH AND EQUIVALENTS AT BEGINNING OF PERIOD 1,096.0 1,724.0
--------------- -------------
CASH AND EQUIVALENTS AT END OF PERIOD $ 1,273.7 $ 544.3
=============== =============
See notes to condensed consolidated financial statements.
Page 5
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. ACCOUNTING INVESTIGATIONS AND RESTATEMENTS
As more fully described in the Form 10-K for the fiscal year ended June
30, 2004 (the "2004 Form 10-K") in October 2003, the Securities and Exchange
Commission (the "SEC") initiated an informal inquiry regarding Cardinal Health,
Inc. (the "Company"). The SEC's request sought historical financial and related
information including but not limited to the accounting treatment of certain
recoveries from vitamin manufacturers. The SEC's request sought a variety of
documentation, including the Company's accounting records for fiscal 2001
through fiscal 2003, as well as notes, memoranda, presentations, e-mail and
other correspondence, budgets, forecasts and estimates. In connection with the
SEC's informal inquiry, the Audit Committee of the Board of Directors of the
Company commenced its own internal review in April 2004, assisted by independent
counsel. On May 6, 2004, the Company was notified that the SEC had converted the
informal inquiry into a formal investigation. On June 21, 2004, as part of the
SEC's formal investigation, the Company received an additional SEC subpoena that
included a request for the production of documents relating to revenue
classification, and the methods used for such classification, in the Company's
Pharmaceutical Distribution business as either "Operating Revenue" or "Bulk
Deliveries to Customer Warehouses and Other." In addition, the Company learned
that the U.S. Attorney for the Southern District of New York had also commenced
an inquiry with respect to the Company that the Company understands relates to
the revenue classification issue. On October 12, 2004, in connection with the
SEC's formal investigation, the Company received a subpoena from the SEC
requesting the production of documents relating to compensation information for
specific current and former employees and officers. The Company continues to
respond to the SEC's investigation and the Audit Committee's internal review and
provide all information required.
During September and October 2004, the Audit Committee reached certain
conclusions with respect to findings from its internal review as of the date of
the determination. These conclusions regarding certain items that impact revenue
and earnings relate to four primary areas of focus: (1) classification of sales
to customer warehouses between "Operating Revenue" and "Bulk Deliveries to
Customer Warehouses and Other" within the Company's Pharmaceutical Distribution
and Provider Services segment; (2) disclosure of the Company's practice, in
certain reporting periods, of accelerating its receipt and recognition of cash
discounts earned from suppliers for prompt payment; (3) timing of revenue
recognition within the Company's former Automation and Information Services
segment; and (4) certain balance sheet reserve and accrual adjustments that had
been identified in the internal review. These conclusions are detailed in the
2004 Form 10-K. The Audit Committee's internal review with respect to the
financial statement impact of the matters reviewed to date is substantially
complete. In connection with these conclusions, the Audit Committee determined
that the financial statements of the Company with respect to fiscal 2000, 2001,
2002 and 2003 as well as the first three quarters of fiscal 2004 should be
restated to reflect the conclusions from its internal review to date. These
restatements were reflected in the 2004 Form 10-K.
Following the conclusions reached by the Audit Committee in September and
October 2004, the Audit Committee began the task of assigning responsibility for
the financial statement matters described above which were reflected in the 2004
Form 10-K and has determined to take disciplinary actions with respect to the
Company's employees who it determined bore responsibility for these matters,
other than with respect to the accounting treatment of certain recoveries from
vitamin manufacturers for which there is an ongoing separate Board committee
internal review (discussed below). The disciplinary actions ranged from
terminations or resignations of employment to required repayments of some or all
of fiscal 2003 bonuses from certain employees to letters of reprimand. These
disciplinary actions affect senior financial and managerial personnel, as well
as other personnel, at the corporate level and in four business segments. None
of the Company's current corporate executive officers (who are identified at
www.cardinal.com) were the subject of disciplinary action by the Audit
Committee. All affected employees have been notified. In connection with the
determinations made by the Audit Committee, Gary S. Jensen, the Company's
controller, has resigned, which resignation will be effective on February 15,
2005. The Audit Committee has completed its determinations of responsibility for
the financial statement matters described above which were reflected in the 2004
Form 10-K, with the exception of conclusions concerning the responsibility for
matters relating to the Company's accounting treatment of certain recoveries
from vitamins manufacturers which are being addressed by a separate committee of
the Board.
As the Company continues to respond to the SEC's investigation, the U.S.
Attorney's inquiry and the Audit Committee's internal review, there can be no
assurance that additional restatements will not be required, that the historical
financial statements included in the 2004 Form 10-K, the Form 10-Q for the
period ended September 30, 2004 or this Form 10-Q will not change or require
amendment, or that additional disciplinary actions would not be required in such
circumstances. In addition, as the SEC's investigation, the U.S. Attorney's
inquiry
Page 6
and the Audit Committee's internal review continue, the Audit Committee may
identify new issues, or make additional findings if it receives additional
information, that may impact the Company's financial statements and the scope of
the restatements described in the 2004 Form 10-K, the Form 10-Q for the period
ended September 30, 2004 and this Form 10-Q.
In connection with the SEC's formal investigation, a committee of the
Board of Directors, with the assistance of independent counsel, is separately
conducting an internal review to assign responsibility for matters relating to
the Company's accounting treatment of certain recoveries from vitamin
manufacturers. In the 2004 Form 10-K, as part of the Audit Committee's internal
review, the Company reversed its previous recognition of estimated recoveries
from vitamin manufacturers for amounts overcharged in prior years and recognized
the income from such recoveries as a special item in the period cash was
received from the manufacturers. The SEC staff had previously advised the
Company that, in its view, the Company did not have an appropriate basis for
recognizing the income in advance of receiving the cash. The Company is
responding to the separate committee internal review and providing all
information required.
The conclusions of the Audit Committee's internal review to date with
respect to financial statement matters are set forth in Notes 1 and 2 of "Notes
to the Consolidated Financial Statements" included in the 2004 Form 10-K.
Additional information with respect to the Audit Committee's second, third and
fourth areas of focus described in the second paragraph above, which impact the
reporting periods discussed in this Form 10-Q, is set forth below. There was no
first or second quarter fiscal 2004 impact with respect to the first area of
focus.
UNDISCLOSED EARNINGS IMPACT: Disclosure of the Company's Practice, in
Certain Reporting Periods, of Accelerating Its Receipt and Recognition of
Cash Discounts Earned From Suppliers for Prompt Payment
Historically, the Company recognized cash discounts as a reduction of cost
of products sold primarily upon payment of vendor invoices. Cash discounts are
discounts the Company receives from some vendors for timely payment of invoices.
The Company had a practice of accelerating payment of vendor invoices at the end
of certain reporting periods in order to accelerate the recognition of cash
discounts, which had the effect of improving operating results for those
reporting periods. Although the effect of these accelerated payments was
properly included in the Company's reported earnings, the impact of this
acceleration practice was not separately quantified and disclosed in the periods
in which the Company benefited from this practice. The net increase/(decrease)
in net earnings in the first and second quarters of fiscal 2004 as a result of
this practice was as follows:
(in millions) Net Earnings
FISCAL 2004 ------------
- --------------
First Quarter $(0.2)
Second Quarter 3.0
-----
Year-To-Date $ 2.8
=====
For additional information regarding the net increase/(decrease) in net
earnings as a result of this practice for fiscal 2004, 2003 and 2002, see Note 1
of "Notes to Consolidated Financial Statements" in the 2004 Form 10-K.
During the fourth quarter of fiscal 2004, the Company changed its
accounting method for recognizing cash discounts from recognition primarily upon
payment of vendor invoices to recording cash discounts as a component of
inventory cost and recognizing such discounts as a reduction to cost of products
sold upon sale by the Company of the purchased inventory. The Company believes
the change in accounting method provides a more objectively determinable method
of recognizing cash discounts and a better matching of inventory cost to
revenues. This change was made retroactively effective to the beginning of
fiscal 2004. As a result, the Company restated its previously reported fiscal
2004 quarterly results to reflect this change. See Note 13 below for further
discussion of this change in accounting.
REVENUE AND EARNINGS IMPACT: Timing of Revenue Recognition Within the
Company's Former Automation and Information Services Segment
Within its former Automation and Information Services segment (which is
now included in the Clinical Technologies and Services segment; see Note 7
below), the Company's revenue recognition policy for equipment systems installed
at a customer's site is to recognize revenue once the Company's installation
obligations are complete and the equipment is functioning according to the
material specifications of the user's manual and the customer has accepted the
equipment as evidenced by signing an equipment confirmation document. As more
fully described in the 2004 Form 10-K, the Company learned of concerns during
the Audit Committee's internal review
Page 7
that some equipment confirmation documents were being executed prior to the time
when installations were complete and revenue could be recognized. In order to
assess the implications of any premature execution of equipment confirmations
and corresponding revenue recognition, the Audit Committee review included: (a)
document and process reviews, including a sample of equipment confirmation
forms; (b) certifications for selected employees involved in the installation
process; (c) interviews of selected employees across regions within the U.S. and
at various levels of the Company; (d) interviews of certain former employees of
the Company; and (e) interviews of selected customers across all regions within
the U.S.
This inquiry indicated some equipment confirmations, particularly in some
sales regions, had been prematurely executed by customers at the request of
certain Company employees, including certain situations where inducements to the
customer (such as deferral of payments) were offered to obtain premature
execution. As a result, it was determined that a material weakness in the
Company's internal controls existed with respect to the timing of revenue
recognition within this segment. The Company concluded the following in
connection with its review of premature revenue recognition:
- Equipment confirmations in the last several weeks of a quarter were
the most likely to be executed early by the customer due to requests
from certain Company employees.
- No evidence was discovered of fictitious sales being recorded by the
Company.
- Revenue was recognized early primarily by one quarter. In most
cases, installations were completed in the following quarter.
- Impact on the Company's financial results was not deemed material
for any individual quarter or annually.
The net impact of this premature revenue recognition was assessed as of
June 30, 2004 based upon interviews of customers representing a substantial
percentage of the segment's end of quarter reported revenue. As a result, it was
determined that approximately 10.8% of revenue in the last 10 days of the fourth
quarter of fiscal 2004 was being recognized prematurely (based upon an
extrapolation). The Company recorded an $8.3 million reduction of revenue and a
$5.3 million reduction of operating earnings during the fourth quarter of fiscal
2004 to adjust for premature revenue recognition that was determined to have
occurred within that quarter. These revenues and operating earnings were
recognized in the first quarter of fiscal 2005 upon completion of the applicable
installation process.
The Company does not maintain accounting records that allow it to
determine the precise impact of this matter on prior quarters. However, during
the investigation there was sufficient data accumulated independent of the
accounting systems to estimate the impact using a variety of methods. These
estimation methods were utilized solely to test the materiality of prior periods
and are not necessarily indicative of what the actual results would have been.
If the results of the June 30, 2004 interviews were applied to all quarters of
fiscal 2004 (i.e., utilizing the 10.8% exception rate) the net increase in
revenue and operating earnings for the first and second quarters of fiscal 2004,
and the related percentage of the former Automation and Information Services
segment's reported amounts, would have been as follows:
Operating
($ in millions) Revenue % Change Earnings % Change
FISCAL 2004 ------- -------- --------- --------
- ---------------
First Quarter $ 3.7 2.6% $ 2.4 4.5%
Second Quarter 0.1 0.0% - 0.0%
------- ---------
Year-To-Date $ 3.8 1.2% $ 2.4 1.8%
======= =========
For additional information regarding the estimated net increase/(decrease)
in revenue and operating earnings for fiscal 2002 and each previously reported
quarter of fiscal 2003 and 2004, and the related percentage of the former
Automation and Information Services segment's reported amounts, see Note 1 of
"Notes to Consolidated Financial Statements" in the 2004 Form 10-K. Using
different estimation methods than the methodology used to derive the table
above, the percentage change in operating earnings for the first and second
quarters of fiscal 2004 would be 2.1% and 0.7%, respectively. The Company
believes the impact of the adjustments resulting from the estimation methods is
not material to previously reported results as such estimated adjustments do not
distort trends in revenue and operating earnings growth that were previously
reported and would not alter the Company's previous disclosures related to the
former Automation and Information Services segment.
Given the premature revenue recognition practices identified at June 30,
2004, the Company completed a similar review of the installation process during
the first quarter of fiscal 2005, including interviews with selected customers
representing a substantial percentage of the former Automation and Information
Services segment's end of quarter reported revenue. While the results from the
interviews performed in the first quarter of fiscal 2005 suggested a lower
incidence of premature revenue recognition than at June 30, 2004, the sample of
customers interviewed was more limited than was completed at June 30, 2004. In
addition, the Company's efforts to improve its system of
Page 8
internal controls were in the early stages. As a result, the Company in
conjunction with the Audit Committee decided to adjust reported revenue
utilizing the same error rate, 10.8%, as was utilized at June 30, 2004.
Utilizing the same 10.8% assumed error rate, the Company recorded a $4.2 million
reduction in revenue and a $2.5 million reduction in operating earnings during
the first quarter of fiscal 2005. This adjustment is exclusive of the
recognition of the $8.3 million in revenue and $5.3 million of operating
earnings in the first quarter of fiscal 2005 described above.
Following the completion of the first quarter of fiscal 2005, the Company
reiterated the revenue recognition policy for equipment systems installed at a
customer's site for its former Automation and Information Services segment, and
instructed all employees to strictly adhere to this policy. The Company
continues to implement corrective actions in response to these findings
regarding its revenue recognition practices within its former Automation and
Information Services segment, as more fully described in Note 1 of "Notes to
Consolidated Financial Statements" in the 2004 Form 10-K and in "Part I, Item 4"
of this Form 10-Q. During the second quarter of fiscal 2005, the Company
completed a review of revenue recognition practices associated with the
equipment installation process for its former Automation and Information
Services segment, including interviews with selected customers and site visits
to related customer locations representing a substantial percentage of the
former Automation and Information Services segment's end of quarter reported
revenue. The results of the interviews and site visits performed did not
indicate an incidence of premature revenue recognition during the second quarter
of fiscal 2005.
RESTATED EARNINGS: Certain Balance Sheet Reserve and Accrual Adjustments
The Audit Committee's internal review included a review to determine if
period-end adjustments to balance sheet reserve accounts and other accruals
recorded in fiscal 2000 through fiscal 2004 were properly recorded in accordance
with generally accepted accounting principles ("GAAP"). Based upon the Audit
Committee's internal review, the Company determined there were various
situations where (a) the amount of reserve, (b) the timing of reserve
recognition, or (c) the timing of reserve adjustments could not be substantiated
or was in error. As a result, as more fully described in the 2004 Form 10-K, the
financial statements for certain prior fiscal quarters and years have been
restated by the Company.
Some of the types of balance sheet reserves and accrual adjustments that
were restated consist of the following:
1. Errors arising from misapplication of GAAP. These errors primarily
include (a) reductions in reserve accounts made in periods subsequent to
the period in which the excess had been identified by the Company, (b) a
last-in, first-out("LIFO"), inventory adjustment, and (c) a change in
accounting policy for dividends to recognition when declared versus when
paid. The net impact of these errors on the first and second quarters of
fiscal 2004 is reflected in the table below.
2. Errors made in previous periods that were identified and
appropriately corrected in a subsequent period when discovered. These
items were not reported as prior period corrections at the time of their
discovery because they were deemed immaterial. At this time, however, the
Company has restated its prior financial statements to correct for such
items identified during the internal review. The net impact of these
errors on the first and second quarters of fiscal 2004 is reflected in the
table below.
The following table summarizes the restatement impact on previously
reported net earnings as defined above for the first and second quarters of
fiscal 2004:
Misapplication of Total
(in millions) GAAP Errors Restatement
- -------------- ----------------- ------ -----------
FISCAL 2004
First Quarter $(0.3) $ (4.5) $(4.8)
Second Quarter (0.4) (4.5) (4.9)
----- ------ -----
Year-To-Date $(0.7) $ (9.0) $(9.7)
===== ====== =====
The impact of these restatements on both basic and diluted earnings per
Common Share from continuing operations for the three and six months ended
December 31, 2003 was a decrease of $0.01 and $0.02, respectively.
For additional information regarding the restatement impact on previously
reported net earnings for fiscal 2004, 2003 and 2002, see Note 1 of "Notes to
Consolidated Financial Statements" in the 2004 Form 10-K.
Page 9
The SEC investigation, the U.S. Attorney inquiry, the Audit Committee
internal review and the separate committee internal review remain ongoing. While
the Company is continuing in its efforts to respond to these inquiries and
provide all information required, the Company cannot predict the outcome of the
SEC investigation, the U.S. Attorney inquiry, the Audit Committee internal
review or the separate committee internal review. The outcome of the SEC
investigation, the U.S. Attorney inquiry and any related legal and
administrative proceedings could include the institution of administrative,
civil injunctive or criminal proceedings involving the Company and/or current or
former Company employees, officers and/or directors, as well as the imposition
of fines and other penalties, remedies and sanctions.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION. The condensed consolidated financial statements of
the Company include the accounts of all majority-owned subsidiaries, and all
significant inter-company amounts have been eliminated. Certain
reclassifications have been made to conform prior period amounts to the current
presentation.
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 GAAP for interim reporting. In the opinion of
management, all adjustments necessary for a fair presentation have been
included. Except as disclosed elsewhere in this Form 10-Q, all such adjustments
are of a normal and recurring nature.
Effective the second quarter of fiscal 2005, the Company presented
non-restructuring operating asset impairments and gains and losses from the sale
of operating and corporate assets in "impairment charges and other" as a
separate component of operating earnings on the Company's consolidated
statements of earnings. Prior period financial results were reclassified to
conform to this change in presentation. See Note 11 for additional information
regarding "impairment charges and other."
The condensed consolidated financial statements included in this Form 10-Q
should be read in conjunction with the audited consolidated financial statements
and related notes contained in the 2004 Form 10-K. Without limiting the
generality of the foregoing, Note 3 of the "Notes to Consolidated Financial
Statements" from the 2004 Form 10-K is specifically incorporated in this Form
10-Q by reference.
RECENT FINANCIAL ACCOUNTING STANDARDS. In May 2004, the Financial
Accounting Standards Board ("FASB") issued FASB Staff Position Statement of
Financial Accounting Standards ("SFAS") 106-2, "Accounting and Disclosure
Requirements Related to the Medicare Prescription Drug, Improvement and
Modernization Act of 2003." This statement provides guidance on the accounting,
disclosure, effective date and transition requirements related to the Medicare
Prescription Drug, Improvement and Modernization Act of 2003. FASB Staff
Position SFAS 106-2 is effective for interim or annual periods beginning after
June 15, 2004. The adoption of this pronouncement did not have a material impact
on the Company's financial position or results of operations.
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs-an
amendment of ARB No. 43, Chapter 4." The statement requires abnormal amounts of
idle capacity and spoilage costs be excluded from the cost of inventory and
expensed when incurred. SFAS No. 151 is applicable to inventory costs incurred
during fiscal years beginning after June 15, 2005. The Company is currently
assessing the impact of this statement on its financial position and results of
operations; however, the adoption of this statement is not anticipated to have a
material impact on the Company's financial position or results of operations.
In December 2004, the FASB issued SFAS No. 153, "Exchanges of Nonmonetary
Assets-an amendment of APB Opinion No. 29." This statement requires exchanges of
productive assets to be accounted for at fair value, rather than at carryover
basis, unless (a) neither the asset received nor the asset surrendered has a
fair value that is determinable within reasonable limits, or (b) the
transactions lack commercial substance. SFAS No. 153 is effective for
nonmonetary asset exchanges occurring in fiscal periods beginning after June 15,
2005. The adoption of this statement is not anticipated to have a material
impact on the Company's financial position or results of operations.
In December 2004, the FASB also issued FASB Staff Position SFAS 109-1,
"Application of FASB Statement No. 109, Accounting for Income Taxes, for the Tax
Deduction Provided to U.S.-Based Manufacturers by the American Jobs Creation Act
of 2004." This statement clarifies that the tax deduction for domestic
manufacturers under the American Jobs Creation Act of 2004 should be accounted
for as a special deduction in accordance with FASB Statement No. 109,
"Accounting for Income Taxes." FASB Staff Position SFAS 109-1 was effective upon
issuance. The adoption of this pronouncement did not have a material impact on
the Company's financial position or results of operations.
Page 10
In December 2004, the FASB also issued FASB Staff Position SFAS 109-2,
"Accounting and Disclosure Guidance for the Foreign Earnings Repatriation
Provision within the American Jobs Creation Act of 2004." This statement
provides entities more time to evaluate the impact of the American Jobs Creation
Act of 2004 on the entity's plan for reinvestment or repatriation of certain
foreign earnings for purposes of applying SFAS No. 109, "Accounting for Income
Taxes." FASB Staff Position SFAS 109-2 was effective upon issuance. The Company
is currently evaluating the effect this new act might have on its foreign
reinvestment plans as well as on its worldwide tax position.
In December 2004, the FASB also issued SFAS No. 123(R), "Share-Based
Payment," which revises SFAS No. 123, "Accounting for Stock-Based Compensation."
SFAS No. 123(R) supersedes Accounting Principles Bulletin ("APB") Opinion No.
25, "Accounting for Stock Issued to Employees" and amends SFAS No. 95,
"Statement of Cash Flows." This statement requires that a public entity measure
the cost of equity-based service awards based on the grant-date fair value of
the award. All share-based payments to employees, including grants of employee
stock options, are required to be recognized in the income statement based on
their fair value. SFAS No. 123(R) is effective for public companies that do not
file as small business issuers as of the beginning of the first interim or
annual reporting period after June 15, 2005. The Company will adopt this
statement on July 1, 2005.
SFAS No. 123(R) allows public companies to adopt its requirement using one
of the following transition methods: (1) a "modified prospective" method in
which compensation cost for all share-based payments granted after the effective
date is recognized based on the requirements of SFAS No. 123(R) and compensation
cost for all awards granted to employees prior to the effective date that are
unvested as of the effective date of SFAS No. 123(R) is recognized based on SFAS
No. 123, or (2) a "modified retrospective" method which includes the
requirements of the modified prospective method and also permits entities to
restate prior periods presented or prior interim periods of the year of adoption
based on the amounts previously recognized in its SFAS No. 123 pro forma
disclosures. The Company has not yet determined which transition method it will
adopt.
The Company currently accounts for share-based payments to employees under
APB Opinion No. 25's intrinsic value method. As such, the Company generally does
not recognize compensation cost for stock options granted to employees. The
adoption of SFAS No. 123(R) is expected to have a significant impact on the
Company's results of operations; however, it is not expected to have a material
impact on the Company's overall financial position. The Company cannot determine
the impact of SFAS No. 123(R) at this time as it will depend on share-based
payments granted in the future. However, if the Company had adopted SFAS
No.123(R) in prior periods, the impact would have approximated the impact of
SFAS No. 123 as described below in the "Accounting for Stock-Based Compensation"
disclosure of pro forma net income and earnings per share. SFAS No.123(R) also
requires the benefits of excess tax deductions in excess of recognized
compensation cost be reported as a financing cash flow rather than as operating
cash flow as is currently required. As such, in the periods after adoption, this
requirement of SFAS No. 123(R) will reduce net operating cash flows and increase
net financing cash flow. The Company cannot estimate what the future tax
benefits will be as the amounts depend on, among other items, future employee
stock option exercises. However, the amount of operating cash flows recognized
in the six months ended December 31, 2004 and 2003 for such excess tax
deductions were $5.9 million and $24.6 million, respectively.
Page 11
ACCOUNTING FOR STOCK-BASED COMPENSATION. At December 31, 2004, the Company
maintained several stock incentive plans for the benefit of certain employees.
The Company accounts for these plans in accordance with APB Opinion No. 25, and
related interpretations. Except for costs related to restricted shares,
restricted share units and an insignificant number of options amended requiring
a new measurement date, 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 share if the Company had adopted the
fair value recognition provisions of SFAS No. 123, "Accounting for Stock-Based
Compensation":
For the Three Months For the Six Months
Ended Ended
December 31, December 31,
-------------------- --------------------
(in millions) 2004 2003 2004 2003
--------- --------- --------- ---------
Net earnings, as reported $ 214.0 $ 368.5 $ 427.3 $ 651.7
Stock-based employee compensation expense
included in net earnings, net of related tax effects 1.8 0.5 3.1 0.9
Total stock-based employee compensation expense
determined under fair value method for all awards,
net of related tax effects (1) (35.2) (28.5) (70.6) (53.3)
--------- --------- --------- ---------
Pro Forma Net Earnings $ 180.6 $ 340.5 $ 359.8 $ 599.3
========= ========= ========= =========
For the Three Months For the Six Months
Ended Ended
December 31, December 31,
-------------------- -------------------
2004 2003 2004 2003
-------- --------- -------- --------
Basic earnings per Common Share:
As reported $ 0.49 $ 0.85 $ 0.99 $ 1.49
Pro forma basic earnings per Common Share $ 0.42 $ 0.79 $ 0.83 $ 1.37
Diluted earnings per Common Share:
As reported $ 0.49 $ 0.84 $ 0.98 $ 1.47
Pro forma diluted earnings per Common Share $ 0.42 $ 0.78 $ 0.83 $ 1.36
(1) The total stock-based employee compensation expense was adjusted to
include employee stock purchase plan expense of $2.9 million and $3.6
million, respectively, for the three months ended December 31, 2004 and
2003 and $5.8 million and $7.2 million, respectively, for the six months
ended December 31, 2004 and 2003.
(2) The Company uses the treasury stock method when calculating diluted
earnings per Common Share as presented in the table above. Under the
treasury stock method, diluted shares outstanding is adjusted for the
weighted-average unrecognized compensation component should the Company
adopt SFAS No. 123.
Page 12
3. 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
and unvested restricted shares, 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, 2004
and 2003:
For the Three Months Ended For the Six Months Ended
December 31, December 31,
-------------------------- ------------------------
(in millions) 2004 2003 2004 2003
- ---------------------------------------- ----- ----- ----- -----
Weighted-average Common Shares - basic 432.1 433.2 431.7 436.8
Effect of dilutive securities:
Employee stock options and unvested
restricted shares 5.0 5.5 4.6 5.7
----- ----- ----- -----
Weighted-average Common Shares - diluted 437.1 438.7 436.3 442.5
===== ===== ===== =====
The potentially dilutive employee stock options that were antidilutive for
the three months ended December 31, 2004 and 2003 were 29.4 million and 32.5
million, respectively, and for the six months ended December 31, 2004 and 2003
were 29.5 million and 32.5 million, respectively.
4. COMPREHENSIVE INCOME
The following is a summary of the Company's comprehensive income for the
three and six months ended December 31, 2004 and 2003:
For the Three Months Ended For the Six Months Ended
December 31, December 31,
-------------------------- ------------------------
(in millions) 2004 2003 2004 2003
-------- -------- -------- ---------
Net earnings $ 214.0 $ 368.5 $ 427.3 $ 651.7
Foreign currency translation adjustment 110.0 58.8 119.1 49.9
Net unrealized gain/(loss) on derivative
instruments 2.5 (3.2) 3.3 -
-------- -------- -------- ---------
Total comprehensive income $ 326.5 $ 424.1 $ 549.7 701.6
======== ======== ======== =========
5. SPECIAL ITEMS
The following is a summary of the special items for the three and six
months ended December 31, 2004 and 2003.
Three Months Ended Six Months Ended
December 31, December 31,
-------------------------- ------------------------------
(in millions, except for Diluted EPS amounts) 2004 2003 2004 2003
- -------------------------------------------- --------- ---------- ----------- -----------
Restructuring costs $ 105.1 $ 12.9 $ 112.6 $ 20.2
Merger-related costs 10.2 7.8 27.1 16.4
Litigation settlements, net (21.2) (24.2) (21.2) (26.9)
Other special items 9.0 - 16.5 -
--------- ---------- ----------- -----------
Total special items $ 103.1 $ (3.5) $ 135.0 $ 9.7
Tax effect of special items (1) (32.0) 0.2 (43.9) (4.3)
--------- ---------- ----------- -----------
Net earnings effect of special items $ 71.1 $ (3.3) $ 91.1 $ 5.4
========= ========== =========== ===========
Net decrease/(increase) on Diluted EPS $ 0.16 $ (0.01) $ 0.21 $ 0.01
========= ========== =========== ===========
Page 13
(1) The Company applies varying tax rates to its special items depending upon
the tax jurisdiction where the item was incurred. The overall effective
tax rate varies each period depending upon the unique nature of the
Company's special items and the tax jurisdictions where the items were
incurred.
RESTRUCTURING COSTS
The following table segregates the Company's restructuring costs into the
various reportable segments impacted by the restructuring projects. See the
paragraphs that follow for additional information regarding the Company's
restructuring plans.
Three Months Ended Six Months Ended
December 31, December 31,
--------------------- --------------------
in millions) 2004 2003 2004 2003
- ------------------------------------------------------ --------- ------- ---------- -------
Restructuring costs:
Global restructuring program:
Pharmaceutical Distribution and Provider Services $ 3.2 $ - $ 3.4 $ -
Medical Products and Services 18.8 - 19.4 -
Pharmaceutical Technologies and Services 71.6 - 73.0 -
Clinical Technologies and Services 0.7 - 0.7 -
Other 8.2 - 8.5 -
Other restructuring programs:
Medical Products and Services 2.1 0.4 2.8 5.3
Pharmaceutical Technologies and Services - 11.6 4.0 13.3
Other 0.5 0.9 0.8 1.6
--------- ------- ---------- -------
Total restructuring costs $ 105.1 $ 12.9 $ 112.6 $ 20.2
========= ======= ========== =======
GLOBAL RESTRUCTURING PROGRAM. As previously announced, the Company has
launched a global restructuring program with a goal of increasing the value the
Company provides its customers through better integration of existing businesses
and improved efficiency from a more disciplined approach to procurement and
resource allocation. The Company expects the program to be implemented in two
phases over a three-year period. See the Form 8-K filed by the Company on
December 14, 2004 for a description of the costs the Company expects to incur in
connection with the first phase of this global restructuring program ("Phase
I"). The following summarizes the significant costs recorded within special
items for the three and six months ended December 31, 2004 in connection with
Phase I.
The Company incurred costs of $3.2 million and $3.4 million, respectively,
related to restructuring projects associated with Phase I initiated within the
Pharmaceutical Distribution and Provider Services segment during the three and
six months ended December 31, 2004. The costs for the three months ended
December 31, 2004 consist of $1.2 million of employee-related costs, primarily
severance accrued upon communication of terms to employees. The costs for the
three and six months ended December 31, 2004 also include $2.0 million and $2.2
million, respectively, of facility exit and other costs, primarily project
consulting fees incurred during reviews of certain business operations and
accelerated depreciation due to consolidation of distribution sites. These
restructuring projects are expected to be completed during fiscal 2005 and 2006.
Overall, the restructuring projects within this segment associated with Phase I
will result in termination of approximately 90 employees, of whom approximately
25 had been terminated as of December 31, 2004.
The Company incurred costs of $18.8 million and $19.4 million,
respectively, related to restructuring projects associated with Phase I
initiated within the Medical Products and Services segment during the three and
six months ended December 31, 2004. The costs for the three and six months ended
December 31, 2004 consist of $16.2 million and $16.8 million, respectively, of
employee-related costs, primarily severance accrued upon either (a)
communication of terms to specific employees or (b) upon management's commitment
to the restructuring plan when a defined benefit plan exists. In addition, the
costs for the three months ended December 31, 2004 include $2.6 million of
facility exit and other costs, primarily due to the transfer of production
between Company facilities or the outsourcing of production. These restructuring
projects will be completed during fiscal years 2005 through 2008. Overall, the
restructuring projects within this segment associated with Phase I will result
in termination of approximately 2,675 employees, of whom approximately 100 had
been terminated as of December 31, 2004.
The Company incurred costs of $71.6 million and $73.0 million,
respectively, related to restructuring projects associated with Phase I
initiated within the Pharmaceutical Technologies and Services segment during the
three and six months ended December 31, 2004. The costs for the three months
ended December 31, 2004 include $67.5 million of asset impairment charges and
$0.3 million of facility exit and other costs.
Page 14
In addition, the costs for the three and six months ended December 31, 2004
include $3.8 million and $5.2 million, respectively, of employee related costs,
the majority of which includes severance accrued upon communication of terms to
employees. These restructuring projects will be completed during fiscal years
2005 through 2007. Overall, the restructuring projects within this segment
associated with Phase I will result in termination of approximately 850
employees, of whom approximately 330 had been terminated as of December 31,
2004.
Of the $67.5 million in asset impairments described above, the Company
incurred costs of approximately $67.2 million during the three months ended
December 31, 2004 related to its plan to sell two facilities and transfer
business from a third facility within the Pharmaceutical Technologies and
Services segment. The Company plans to transfer portions of each of the
businesses to be sold to other existing Company facilities and intends to sell
the remaining portions. The Company expects to complete the sales no later than
December 2005. The carrying amount of the asset groups being sold is $64.6
million, which includes $15.4 million of goodwill allocated in accordance with
SFAS No. 142, "Goodwill and Other Intangible Assets." As the Company determined
that the plan of sale criteria in SFAS No. 144, "Accounting for the Impairment
or Disposal of Long-Lived Assets," had been met during the three months ended
December 31, 2004, the carrying value of the asset groups being sold was
adjusted to $22.0 million, the estimated fair market values less costs to sell.
As a result, the Company recognized asset impairment charges of $42.6 million
associated with the two businesses during the three months ended December 31,
2004. The Company also committed to a plan to transfer production from one of
its Pharmaceutical Technologies and Services facilities to another existing
Company facility during the three months ended December 31, 2004. Production is
expected to continue at the facility through fiscal 2007. The Company recorded
an asset impairment of $24.6 million based on an analysis of discounted cash
flows in accordance with SFAS No. 144.
The Company incurred costs of $0.7 million related to a restructuring
project associated with Phase I initiated within the Clinical Technologies and
Services segment during the three months ended December 31, 2004. Such costs are
employee-related costs, the majority of which represent severance accrued upon
communication of terms to employees within this segment. This restructuring
project is expected to be completed during fiscal 2005. The restructuring
project within this segment associated with Phase I will result in termination
of approximately 20 employees, of whom approximately 15 had been terminated as
of December 31, 2004.
During the three and six months ended December 31, 2004, the Company
incurred costs of $8.2 million and $8.5 million, respectively, related to
restructuring projects associated with Phase I that impacted multiple segments.
These costs related primarily to project consulting fees and restructuring the
Company's delivery of information technology infrastructure services. These
restructuring projects are expected to be completed in fiscal 2005 and 2006.
OTHER RESTRUCTURING PROGRAMS. Separate from the global restructuring
program discussed above, during the three and six months ended December 31,
2004, the Company incurred costs of $2.1 million and $2.8 million, respectively,
as compared to $0.4 million and $5.3 million, respectively, in the same periods
of 2003 to restructure operations (both domestically and internationally) within
the Medical Products and Services segment. The Company also incurred costs of
$4.0 million during the six months ended December 31, 2004, as compared to $11.6
million and $13.3 million, respectively, for the three and six months ended
December 31, 2003 to restructure operations (both domestically and
internationally) within the Pharmaceutical Technologies and Services segment.
Included in these costs for the three and six months ended December 31, 2003 was
a $10.9 million asset impairment related to the Company's decision to exit
certain North American commodity operations within the Pharmaceutical
Technologies and Services segment. The restructuring plans within both segments
focused on various aspects of operations, including closing and consolidating
certain manufacturing operations, rationalizing headcount both domestically and
internationally, and aligning operations in the most strategic and
cost-efficient structure.
In connection with implementing these restructuring plans, the Company
incurred costs that included, but were not limited to, the following: (1)
employee-related costs, the majority of which represents severance accrued upon
either communication of terms to employees or management's commitment to the
restructuring plan when a defined benefit plan exists; and (2) exit costs,
including asset impairment charges, costs incurred to relocate physical assets
and project management costs. The earliest of these restructuring plans was
initiated during fiscal 2001, with others being implemented throughout fiscal
2002, 2003 and 2004. Some of these restructuring plans were completed during
fiscal 2003 and 2004, while other plans will be completed throughout fiscal
2005. Overall, these restructuring plans within the Medical Products and
Services segment will result in the termination of approximately 2,200
employees, of whom approximately 2,050 had been terminated as of December 31,
2004. The restructuring plans within the Pharmaceutical Technologies and
Services segment overall has resulted in the termination of approximately 1,000
employees, all of whom were terminated as of December 31, 2004.
Page 15
During the three and six months ended December 31, 2004 the Company
incurred costs of $0.5 million and $0.8 million, respectively, as compared to
$0.9 million and $1.6 million, respectively, from the comparable periods of 2003
related to restructuring plans that impacted more than one segment. The costs
incurred in 2004 related to a plan to restructure the Company's delivery of
information technology infrastructure services and restructuring activity within
the Clinical Technologies and Services segment. The costs incurred in 2003
related to the plan to restructure the Company's delivery of information
technology infrastructure services. The information technology infrastructure
restructuring plan resulted in the termination of approximately 20 employees,
all of whom were terminated as of December 31, 2004.
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, 2004 were
primarily a result of the acquisitions of ALARIS Medical Systems, Inc. (which
has been given the legal designation of Cardinal Health 303, Inc. and is
referred to in this Form 10-Q as "ALARIS") and Syncor International Corporation
(which has been given the legal designation of Cardinal Health 414, Inc. and is
referred to in this Form 10-Q as "Syncor"). The merger-related costs recognized
during the three and six months ended December 31, 2003 were primarily a result
of the Syncor acquisition. The following table and paragraphs provide additional
detail regarding the types of merger-related costs incurred by the Company.
Three Months Ended Six Months Ended
December 31, December 31,
------------------- -----------------
(in millions) 2004 2003 2004 2003
- ---------------------------------------- -------- -------- -------- ------
Merger-related costs:
Employee-related costs $ 4.4 $ 5.5 $ 9.0 $ 7.1
Asset impairments and other exit costs 0.2 0.3 0.6 0.5
Debt issuance cost writeoff 0.1 - 8.8 -
Integration costs and other 5.5 2.0 8.7 8.8
-------- -------- -------- ------
Total merger-related costs $ 10.2 $ 7.8 $ 27.1 $ 16.4
======== ======== ======== ======
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, 2004,
the Company incurred employee-related costs of $4.4 million and $9.0 million,
respectively. The costs incurred in the three months ended December 31, 2004
consisted primarily of severance and retention bonuses accrued over the service
period as a result of the ALARIS acquisition. The costs incurred in the six
months ended December 31, 2004 consisted primarily of severance and retention
bonuses paid as a result of the ALARIS and Syncor acquisitions. 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 severance and
retention bonuses paid as a result of the Syncor acquisition.
ASSET IMPAIRMENTS AND OTHER EXIT COSTS. During the three and six months
ended December 31, 2004, the Company incurred asset impairments and other exit
costs of $0.2 million and $0.6 million, respectively, as compared to $0.3
million and $0.5 million, respectively, during the comparable periods in 2003.
The asset impairment costs incurred during the three and six months ended
December 31, 2004 related primarily to facility closures associated with the
Syncor acquisition and fixed asset disposals as a result of the ALARIS
acquisition. 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.
DEBT ISSUANCE COST WRITEOFF. During the three and six months ended
December 31, 2004, the Company incurred charges of $0.1 million and $8.8
million, respectively, related to the writeoff of debt issuance costs and other
debt tender offer costs related to the Company's decision to retire certain
ALARIS debt instruments that carried higher interest rates than the Company's
cost of debt. As a result, the Company retired such debt instruments in advance
of their original maturity dates.
INTEGRATION COSTS AND OTHER. The Company incurred integration and other
costs during the three and six months ended December 31, 2004 of $5.5 million
and $8.7 million, respectively, as compared to $2.0 million and $8.8 million,
respectively, during the comparable periods in 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-
Page 16
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. These costs were offset
during the three and six months ended December 31, 2003 by income of
approximately $3.0 million related to two foreign currency hedges purchased in
connection with the acquisition of The Intercare Group, plc ("Intercare") in
December 2003. 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 three months
ended December 31, 2003, and resulted in a gain for the Company of approximately
$4.1 million.
LITIGATION SETTLEMENTS, NET
The following table summarizes the Company's net litigation settlements
during the three and six months ended December 31, 2004 and 2003.
Three Months Ended Six Months Ended
December 31, December 31,
------------------ ----------------
(in millions) 2004 2003 2004 2003
- ------------- ------- ------ -------- ------
Litigation settlements, net:
Vitamin litigation $ (0.6) - $ (0.6) (2.7)
Pharmaceutical manufacturer antitrust litigation (20.6) (24.2) (20.6) (24.2)
======= ===== ======= =====
Total litigation settlements, net $ (21.2) (24.2) $ (21.2) (26.9)
======= ===== ======= =====
VITAMIN LITIGATION. During the three and six months ended December 31,
2004 the Company recorded income of $0.6 million resulting from the recovery of
antitrust claims against certain vitamin manufacturers for amounts overcharged
in prior years. During the six months ended December 31, 2003, the Company
recorded income of $2.7 million resulting from the recovery of such claims. The
total recovery of antitrust claims against certain vitamin manufacturers through
December 31, 2004 was $145.3 million (net of attorney fees, payments due to
other interested parties and expenses withheld). The defendants have settled all
claims with the Company related to this litigation as of December 31, 2004.
PHARMACEUTICAL MANUFACTURER ANTITRUST LITIGATION. During the three and six
months ended December 31, 2004, the Company recorded income of $20.6 million, as
compared to income of $24.2 million in the comparable periods ending December
31, 2003, related to settlement of pharmaceutical manufacturer antitrust claims
alleging certain prescription drug manufacturers took improper actions to delay
or prevent generic drug competition. The total recovery of antitrust claims
against certain prescription drug manufacturers through December 31, 2004 was
$76.5 million (net of attorney fees, payments due to other interested parties
and expenses withheld).
OTHER SPECIAL ITEMS
During the three and six months ended December 31, 2004 the Company
incurred costs recorded within other special items totaling $9.0 million and
$16.5 million, respectively. These costs primarily relate to legal fees and
document preservation and production costs incurred in the SEC investigation and
the Audit Committee internal review. For further information regarding the SEC
investigation and the Audit Committee internal review, see Note 1.
SPECIAL ITEMS ACCRUAL ROLLFORWARD
The following table summarizes activity related to the liabilities
associated with the Company's special items during the six months ended December
31, 2004.
Six Months Ended
(in millions) December 31, 2004
- ------------- -----------------
Balance at June 30, 2004 $ 39.9
Additions (1) 156.2
Payments (76.8)
--------
Balance at December 31, 2004 $ 119.3
========
(1) Amount represents items that have been either expensed as incurred or
accrued according to GAAP. These amounts do not include gross litigation
settlement income of $21.2 million recorded as a special item during the six
months ended December 31, 2004.
PURCHASE ACCOUNTING ACCRUALS
In connection with restructuring and integration plans related to the
Intercare acquisition, the Company accrued, as part of its acquisition
adjustments, a liability of $10.4 million related to employee termination and
relocation costs
Page 17
and $11.0 million related to closing of certain facilities. As of December 31,
2004, the Company had paid $2.7 million of employee-related costs. No payments
were made associated with the facility closures.
In connection with 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, 2004, the
Company had paid $12.8 million of employee related costs, $2.3 million
associated with the facility closures and $1.6 million of other restructuring
costs.
SUMMARY OF ESTIMATED FUTURE COSTS
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 if recorded amounts exceed costs, such changes
in estimates will be recorded as 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 $226 million (approximately $147 million net of tax).
These estimated costs are primarily associated with the first phase of the
Company's previously-announced global restructuring program and the ALARIS
acquisition. The Company believes it will incur these costs to properly
restructure, integrate and rationalize operations, a portion of which represent
facility rationalizations and implementing efficiencies regarding information
systems, customer systems, marketing programs and administrative functions,
among other things. Such amounts will be expensed as special items when
incurred.
6. NOTES PAYABLE AND LONG-TERM OBLIGATIONS
The Company has two unsecured $750 million bank revolving credit
facilities, which provide for an aggregate $1.5 billion in borrowings. One of
these facilities expires on March 24, 2008, and the other expires on March 23,
2009. At expiration, these revolving credit facilities can be extended upon
mutual consent of the Company and the lending institutions. These revolving
credit facilities exist largely to support issuances of commercial paper as well
as other short-term borrowings. During the first quarter of fiscal 2005, the
Company borrowed $500 million in aggregate on the revolving credit facilities.
The proceeds of this borrowing were utilized to repay a portion of the Company's
commercial paper and for general corporate purposes, including the establishment
of pharmaceutical inventory at the Pharmaceutical Distribution business'
National Logistics Center in Groveport, Ohio. During the second quarter of
fiscal 2005, the Company borrowed an additional $750 million in the aggregate on
the revolving credit facilities, with the proceeds being utilized primarily for
the establishment of the National Logistics Center. Prior to December 31, 2004,
the Company repaid in full its $1.25 billion in borrowings in the aggregate
under the revolving credit facilities due to stabilization in its short-term
liquidity requirements in light of, among other things, the Company having
substantially completed the initial establishment of inventory for the National
Logistics Center. Also outstanding under these facilities at December 31, 2004
was $43.4 million of standby letters of credit issued on behalf of the Company.
For additional information regarding notes payable and long-term
obligations, see Note 6 of "Notes to Consolidated Financial Statements" in the
2004 Form 10-K.
7. 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 Clinical Technologies and
Services (formed during the first quarter of fiscal 2005). Clinical Technologies
and Services includes ALARIS, which was acquired in a transaction completed in
early July 2004, the Company's businesses formerly within the Automation and
Information Services segment and the Company's Clinical Services and Consulting
business, which was formerly reported under the Pharmaceutical Distribution and
Provider Services segment. Also during the first quarter of fiscal 2005, the
Company transferred its Specialty Pharmaceutical Distribution business,
previously included within the Pharmaceutical Distribution and Provider Services
segment, to the Medical Products and Services segment. These transfers were
effected to better align business operations with the current management and
reporting structure. Prior period financial results were adjusted to reflect
these changes.
Page 18
The Pharmaceutical Distribution and Provider Services segment distributes
a broad line of pharmaceuticals, health care products and other items typically
sold by hospitals, retail drug stores and other health care providers. Through
the acquisition of Intercare, this segment also operates a distribution network
within the United Kingdom offering a specialized range of branded and generic
pharmaceutical products. This segment also provides support services
complementing its distribution activities. In addition, this segment provides
services to the health care industry through the franchising of apothecary-style
retail pharmacies.
The Medical Products and Services segment manufactures medical, surgical
and laboratory products and distributes these self-manufactured products as well
as products manufactured by other suppliers to hospitals, physician offices,
surgery centers and other health care providers. In addition, the segment
distributes oncology, therapeutic plasma and other specialty pharmaceutical and
biotechnology products to hospitals, clinics and other managed-care facilities.
The Pharmaceutical Technologies and Services segment provides products and
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. This segment also provides comprehensive packaging,
radiopharmaceutical manufacturing, pharmaceutical development and analytical
science expertise and scientific and regulatory consulting, as well as medical
education, marketing and contract sales services. It also manufactures and
markets generic injectible pharmaceutical products for sale to pharmacies in the
United Kingdom and provides manufacturing services for oral potent drugs and
sterile dose forms in Europe.
The Clinical Technologies and Services segment provides products and
services to hospitals and other health care providers that focus on patient
safety. This segment designs, develops and markets intravenous medication safety
and infusion therapy delivery systems and develops, manufactures, leases, sells
and services point-of-use systems that automate the distribution and management
of medications and supplies in hospitals and other health care facilities. In
addition, this segment provides services to the health care industry through
integrated pharmacy management, temporary pharmacy staffing and the gathering
and recording of clinical information for review, analysis and interpretation.
The Company evaluates the performance of the segments based on operating
earnings after the corporate allocation of certain administrative expenses.
Information about interest income and expense and income taxes is not provided
on a segment level. In addition, special charges and non-restructuring
impairment charges are not allocated to the segments. See Note 5 above for
further discussion of the Company's special items and Note 11 below for
additional information regarding non-restructuring impairment charges. The
accounting policies of the segments are the same as those described in the
summary of significant accounting policies.
Page 19
The following tables include revenue and operating earnings for the three
and six months ended December 31, 2004 and 2003 for each segment and reconciling
items necessary to agree to amounts reported in the condensed consolidated
financial statements:
For the Three Months Ended For the Six Months Ended
December 31, December 31,
-------------------------- -------------------------
(in millions) 2004 2003 2004 2003
- ------------- ----------- ------------ ----------- -----------
Revenue:
Pharmaceutical Distribution and Provider Services $ 15,058.5 $ 13,150.0 $ 29,460.4 $ 25,591.9
Medical Products and Services 2,426.8 2,286.3 4,819.9 4,434.6
Pharmaceutical Technologies and Services (1) 759.9 707.7 1,465.4 1,354.5
Clinical Technologies and Services (2) (3) 546.6 396.5 1,070.9 731.2
Corporate (4) (237.2) (189.7) (466.0) (373.2)
----------- ----------- ----------- -----------
Total revenue $ 18,554.6 $ 16,350.8 $ 36,350.6 $ 31,739.0
=========== =========== =========== ===========
For the Three Months Ended For the Six Months Ended
December 31, December 31,
-------------------------- ------------------------
(in millions) 2004 2003 2004 2003
- ------------- --------- --------- -------- -----------
Operating earnings:
Pharmaceutical Distribution and Provider Services $ 213.3 $ 233.8 $ 376.7 $ 464.7
Medical Products and Services 169.8 170.4 308.2 330.8
Pharmaceutical Technologies and Services (1) 88.8 113.4 169.7 219.8
Clinical Technologies and Services (2) (3) 75.9 95.9 121.9 163.5
Corporate (5) (227.0) (28.9) (298.0) (83.9)
-------- -------- -------- ----------
Total operating earnings $ 320.8 $ 584.6 $ 678.5 $ 1,094.9
======== ======== ======== ==========
The following table includes total assets at December 31, 2004 and June 30, 2004
for each segment as well as reconciling items necessary to total the amounts
reported in the condensed consolidated financial statements:
At December 31, At June 30,
(in millions) 2004 2004
- ------------- -------------- -----------
Assets:
Pharmaceutical Distribution and Provider Services $ 9,302.9 8,512.2
Medical Products and Services 4,067.7 3,829.6
Pharmaceutical Technologies and Services 4,340.1 4,389.3
Clinical Technologies and Services 3,691.2 3,647.7
Corporate (6) 387.1 990.3
--------- ---------
Total assets $21,789.0 $21,369.1
========= =========
(1) Effective the first quarter of fiscal 2005, the Pharmaceutical
Technologies and Services segment changed its basis for measuring
the impact of translating foreign subsidiaries' operating results
into U.S. dollars. Historically since 2000, this segment's revenues
and operating earnings were not impacted by foreign exchange
fluctuations as the Company applied constant exchange rates to
translate its foreign operating results into U.S. dollars and
recorded the actual impact of foreign exchange rate changes within
the Corporate segment. The positive impact of foreign exchange rate
allocations on the Pharmaceutical Technologies and Services
segment's revenue for the three and six months ended December 31,
2003 was $2.7 million and $16.5 million, respectively. The positive
impact on operating earnings for the three and six months ended
December 31, 2003 was $3.2 million and $8.2 million, respectively.
(2) Effective the first quarter of fiscal 2005, the Pyxis products
business did not receive an allocation adjustment from Corporate for
the estimated interest income related to the sale of certain lease
portfolios. In prior year, the Pyxis products business sold portions
of its leased asset portfolio, and the proceeds were transferred to
Corporate for general corporate purposes. In fiscal 2004, the Pyxis
products business received an allocation from Corporate related to
the estimated interest income that would have been earned had the
associated lease portfolios not been sold. The positive impact of
estimated interest income related to the sale of portions of the
lease portfolios on both the Pyxis products business' revenue and
operating
Page 20
earnings for the three and six months ended December 31, 2003 was
$4.4 million and $9.3 million, respectively.
(3) As discussed above, the Clinical Technologies and Services segment
was formed during the first quarter of fiscal 2005 and includes
ALARIS, which was acquired in a transaction completed in early July
2004, the Company's businesses formerly within the Automation and
Information Services segment and the Company's Clinical Services and
Consulting business, which was formerly reported under the
Pharmaceutical Distribution and Provider Services segment. The
prior period financial results have been adjusted to reflect these
changes.
(4) Corporate revenue primarily consists of the elimination of
intersegment revenues.
(5) Corporate operating earnings include special items of $103.1 million
and ($3.5) million, respectively, in the three-month periods ended
December 31, 2004 and 2003, and $135.0 million and $9.7 million,
respectively, for the six-month periods ended December 31, 2004 and
2003. See Note 5 for further discussion of the Company's special
items. In addition, corporate operating earnings include $83.0
million and $86.8 million, respectively, of operating asset
impairments and gains and losses from the sale of operating and
corporate assets during the three and six months ended December 31,
2004. In the comparable periods of 2003, corporate operating
earnings include gains of approximately $8.1 million and $6.4
million, respectively. See Note 11 for further discussion of the
Company's impairment charges. Corporate operating earnings also
include unallocated corporate administrative expenses and investment
spending.
(6) The Corporate assets primarily include cash and cash equivalents,
Corporate net property and equipment and unallocated deferred taxes.
8. COMMITMENTS AND CONTINGENT LIABILITIES
Latex Litigation
On September 30, 1996, Baxter International Inc. ("Baxter") and its
subsidiaries transferred to Allegiance Corporation and its subsidiaries
("Allegiance"), Baxter's U.S. health care distribution business, surgical and
respiratory therapy business and health care cost-management business, as well
as certain foreign operations (the "Allegiance Business") in connection with a
spin-off of the Allegiance Business by Baxter. In connection with this spin-off,
Allegiance Corporation, which merged with a subsidiary of the Company on
February 3, 1999, agreed to indemnify Baxter, and to defend and indemnify Baxter
Healthcare Corporation, as contemplated by the agreements between Baxter and
Allegiance Corporation, 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.
Since the inception of this litigation, Baxter/Allegiance have been sued
by 872 plaintiffs in 834 lawsuits (excluding derivative claims filed by family
members). During fiscal 2002, Allegiance began settling some of these lawsuits
with greater frequency. As of December 31, 2004, Allegiance had resolved nearly
all of these cases and had only 15 cases remaining. About 20% of the lawsuits
that have been resolved were concluded without any liability to
Baxter/Allegiance. Of all the cases Allegiance has agreed to settle with the
plaintiffs, the settlement amounts have averaged approximately $42,000 per case,
for an aggregate amount of approximately $28 million. Allegiance believes it is
probable that it will incur additional legal fees related to the resolution of
the remaining cases.
During the first quarter of fiscal 2005, the Company reassessed its
ability to estimate the potential cost to settle these lawsuits. Following this
reassessment, the Company concluded that it was in a position to reasonably
estimate the total remaining costs for this litigation. As such, during the
first quarter of fiscal 2005, the Company recognized a charge of $16.4 million
as its reasonable estimate of future costs to be incurred in defending or
settling outstanding claims as well as pursuing insurance recoveries. This
charge is net of expected proceeds under insurance policies in place with
financially viable insurance companies, subject to self-insurance retentions,
exclusions, conditions, coverage gaps, policy limits and insurer solvency. The
Company continues to believe that insurance recovery is probable. While the
Company does not anticipate significant charges in future periods, additional
charges may be required if there is a significant increase in the number of new
lawsuits filed or an adverse outcome from insurance recovery activities.
Currently, the Company considers both of these potential events to be remote.
Page 21
Derivative Actions
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. Doris Staehr v. Robert D.
Walter, et al., No. 02-CVG-11-639. 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 that added three new individual defendants and included new
allegations that, among other things, the Company improperly recognized revenue
in December 2000 and September 2001 related to settlements with certain vitamin
manufacturers. The Company filed a Motion to Dismiss the second amended
complaint, and on November 20, 2003, the Court denied the motion. Discovery is
proceeding in this action. The defendants intend to vigorously defend this
action. The Company currently does not believe that the impact of this lawsuit
will have a material adverse effect on the Company's financial position,
liquidity or results of operations.
Since July 1, 2004, three complaints have been filed by purported
shareholders against the members of the Company's Board of Directors, certain of
its officers and employees and the Company as a nominal defendant in the Court
of Common Pleas, Franklin County, Ohio, as a purported derivative actions
(collectively referred to as the "Cardinal Health Franklin County derivative
actions"). These cases include: Donald Bosley, Derivatively on behalf of
Cardinal Health, Inc. v. David Bing, et al., Sam Wietschner v. Robert D. Walter,
et al. and Green Meadow Partners, LLP, Derivatively on behalf of Cardinal
Health, Inc. v. David Bing, et al. The Cardinal Health Franklin County
derivative actions allege that the individual defendants failed to implement
adequate internal controls for the Company and thereby violated their fiduciary
duty of good faith, GAAP and the Company's Audit Committee charter. The
complaints in the Cardinal Health Franklin County derivative actions seek money
damages and equitable relief against the defendant directors and an award of
attorney's fees. On November 22, 2004, the Cardinal Health Franklin County
derivative actions were consolidated. Furthermore, by agreement of the parties,
the Cardinal Health Franklin County derivative actions have been stayed. None of
the defendants has responded to the complaints yet, nor has the Company.
Shareholder/ERISA Litigation against Cardinal Health
Since July 2, 2004, 10 purported class action complaints have been filed
by purported purchasers of the Company's securities against the Company and
certain of its officers and directors, asserting claims under the federal
securities laws (collectively referred to as the "Cardinal Health federal
securities actions"). To date, all of these actions have been filed in the
United States District Court for the Southern District of Ohio. These cases
include: Gerald Burger v. Cardinal Health, Inc., et al. (04 CV 575), Todd Fener
v. Cardinal Health, Inc., et al. (04 CV 579), E. Miles Senn v. Cardinal Health,
Inc., et al. (04 CV 597), David Kim v. Cardinal Health, Inc. (04 CV 598), Arace
Brothers v. Cardinal Health, Inc., et al. (04 CV 604), John Hessian v. Cardinal
Health, Inc., et al. (04 CV 635), Constance Matthews Living Trust v. Cardinal
Health, Inc., et al. (04 CV 636), Mariss Partners, LLP v. Cardinal Health, Inc.,
et al. (04 CV 849), The State of New Jersey v. Cardinal Health, Inc., et al. (04
CV 831) and First New York Securities, LLC v. Cardinal Health, Inc., et al. (04
CV 911). The Cardinal Health federal securities actions purport to be brought on
behalf of all purchasers of the Company's securities during various periods
beginning as early as October 24, 2000 and ending as late as July 26, 2004 and
allege, among other things, that the defendants violated Section 10(b) of the
Securities Exchange Act of 1934, as amended (the "Exchange Act"), and Rule 10b-5
promulgated thereunder and Section 20(a) of the Exchange Act by issuing a series
of false and/or misleading statements concerning the Company's financial
results, prospects and condition. Certain of the complaints also allege
violations of Section 11 of the Securities Act of 1933, as amended, claiming
material misstatements or omissions in prospectuses issued by the Company in
connection with its acquisition of Bindley Western Industries, Inc. in 2001 and
Syncor in 2003. The alleged misstatements relate to the Company's accounting for
recoveries relating to antitrust litigation against vitamin manufacturers, and
to classification of revenue in the Company's Pharmaceutical Distribution
business as either operating revenue or revenue from bulk deliveries to customer
warehouses, among other matters. The alleged misstatements are claimed to have
caused an artificial inflation in the Company's stock price during the proposed
class period. The complaints seek unspecified money damages and equitable relief
against the defendants and an award of attorney's fees. On December 15, 2004,
the Cardinal Health federal securities actions were consolidated into one action
captioned In re Cardinal Health, Inc. Federal Securities Litigation, and on
January 26, 2005, the Court appointed the Pension Fund Group as lead plaintiff
in this consolidated action. None of the defendants has yet responded to any of
the complaints in the Cardinal Health federal securities actions.
Since July 2, 2004, 14 purported class action complaints have been filed
against the Company and certain officers, directors and employees of the Company
by purported participants in the Cardinal Health Profit Sharing, Retirement and
Savings Plan (collectively referred to as the "Cardinal Health ERISA actions").
To date, all of these actions have been filed in the United States District
Court for the Southern District of Ohio. These cases include: David McKeehan and
James Syracuse v. Cardinal Health, Inc., et al. (04 CV 643), Timothy Ferguson v.
Cardinal
Page 22
Health, Inc., et al. (04 CV 668), James DeCarlo v. Cardinal Health, Inc., et al.
(04 CV 684), Margaret Johnson v. Cardinal Health, Inc., et al. (04 CV 722),
Harry Anderson v. Cardinal Health, Inc., et al. (04 CV 725), Charles Heitholt v.
Cardinal Health, Inc., et al. (04 CV 736), Dan Salinas and Andrew Jones v.
Cardinal Health, Inc., et al. (04 CV 745), Daniel Kelley v. Cardinal Health,
Inc., et al. (04 CV 746), Vincent Palyan v. Cardinal Health, Inc., et al. (04 CV
778), Saul Cohen v. Cardinal Health, Inc., et al. (04 CV 789), Travis Black v.
Cardinal Health, Inc., et al. (04 CV 790), Wendy Erwin v. Cardinal Health, Inc.,
et al. (04 CV 803), Susan Alston v. Cardinal Health, Inc., et al. (04 CV 815),
and Jennifer Brister v. Cardinal Health, Inc., et al. (04 CV 828). The Cardinal
Health ERISA actions purport to be brought on behalf of participants in the
Cardinal Health Profit Sharing, Retirement and Savings Plan and the Syncor
Employees' Savings and Stock Ownership Plan (the "Syncor ESSOP," and together
with the Cardinal Health Profit Sharing, Retirement and Savings Plan, the
"Plans"), and also on behalf of the Plans themselves. The complaints allege that
the defendants breached certain fiduciary duties owed under the Employee
Retirement Income Security Act ("ERISA"), generally asserting that the
defendants failed to make full disclosure of the risks to the Plans'
participants of investing in the Company's stock, to the detriment of the Plans'
participants and beneficiaries, and that Company stock should not have been made
available as an investment alternative for the Plans' participants. The
misstatements alleged in the Cardinal Health ERISA actions significantly overlap
with the misstatements alleged in the Cardinal Health federal securities
actions. The complaints seek unspecified money damages and equitable relief
against the defendants and an award of attorney's fees. On December 15, 2004,
the Cardinal Health ERISA actions were consolidated into one action captioned In
re Cardinal Health, Inc. ERISA Litigation. On January 14, 2005, the court
appointed lead counsel and liaison counsel for the consolidated Cardinal Health
ERISA action. None of the defendants has yet responded to any of the complaints
in the Cardinal Health ERISA actions.
With respect to the proceedings described under the headings "Derivative
Actions" and "Shareholder/ERISA Litigation against Cardinal Health," the Company
currently believes that there will be some insurance coverage available under
the Company's insurance policies in effect at the time the actions were filed.
Such policies are with financially viable insurance companies, and are subject
to self-insurance retentions, exclusions, conditions, coverage gaps, policy
limits and insurer solvency.
Shareholder/ERISA 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 "Syncor federal securities
actions"). All of these actions were filed in the United States District Court
for the Central District of California. These cases include Richard Bowe v.
Syncor Int'l Corp., et al., No. CV 02-8560 LGB (RCx) (C.D. Cal.), Alan Kaplan v.
Syncor Int'l Corp., et al., No. CV 02-8575 CBM (MANx) (C.D. Cal), Franklin
Embon, Jr. v. Syncor Int'l Corp., et al., No. CV 02-8687 DDP (AJWx) (C.D. Cal),
Jonathan Alk v. Syncor Int'l Corp., et al., No. CV 02-8841 GHK (RZx) (C.D. Cal),
Joyce Oldham v. Syncor Int'l Corp., et al., CV 02-8972 FMC (RCx) (C.D. Cal),
West Virginia Laborers Pension Trust Fund v. Syncor Int'l Corp., et al., No. CV
02-9076 NM (RNBx) (C.D. Cal), Brad Lookingbill v. Syncor Int'l Corp., et al., CV
02-9248 RSWL (Ex) (C.D. Cal), Them Luu v. Syncor Int'l Corp., et al., CV 02-9583
RGK (JwJx) (C.D. Cal), David Hall v. Syncor Int'l Corp., et al., CV 02-9621 CAS
(CWx) (C.D. Cal), Phyllis Walzer v. Syncor Int'l Corp., et al., CV 02-9640 RMT
(AJWx) (C.D. Cal), and Larry Hahn v. Syncor Int'l Corp., et al., CV 03-52 LGB
(RCx) (C.D. Cal.). The Syncor 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. The actions
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 Syncor 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. The consolidated complaint seeks unspecified money damages and other
unspecified relief against the 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. Syncor filed a Motion to Dismiss the second amended consolidated
class action complaint on March 4, 2004. On July 6, 2004, the Court granted
Defendants' Motion to Dismiss without prejudice as to defendants Syncor, Monty
Fu, Robert Funari and Haig Bagerdjian. As to the other individual defendants,
the Motion to Dismiss was granted with prejudice. On September 14, 2004, the
lead plaintiff filed a Motion for Clarification of the Court's July 6, 2004
dismissal order. The court clarified its July 6, 2004 dismissal order on
November 29, 2004 and lead plaintiff filed a third amended consolidated
complaint on December 29, 2004. Syncor filed a motion to dismiss the third
amended consolidated complaint on January 31, 2005, which motion is pending.
Page 23
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 Syncor 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 by Syncor
stockholders in the Company's merger with Syncor 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 action moved the
Court to file a second amended complaint. Plaintiffs' request was granted in
February 2004. Monty Fu was the only named defendant in the second amended
complaint. On September 15, 2004, the Court granted Monty Fu's Motion to Dismiss
the second amended complaint. The Court dismissed the second amended complaint
with prejudice.
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. These cases include Joseph Famularo v. Monty Fu, et al., Case
No. BC285478 (Cal. Sup. Ct., Los Angeles Cty.), and Mark Stroup v. Robert G.
Funari, et al., Case No. BC285480 (Cal. Sup. Ct., Los Angeles Cty.). 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. On November
29, 2004, the court dismissed the California actions with prejudice.
A purported class action complaint, captioned Pilkington v. Cardinal
Health, et al., 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 ESSOP). A related purported class action complaint, captioned Donna
Brown, et al. v. Syncor International Corp, et al., was filed on September 11,
2003 against the Company, Syncor and certain individual defendants. Another
related purported 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. Each of these actions was brought in
the United States District Court for the Central District of California. A
consolidated complaint was filed on February 24, 2004 against Syncor and certain
former Syncor officers, directors and/or employees alleging that the defendants
breached certain fiduciary duties owed under ERISA based on the same underlying
allegations of improper and unlawful conduct alleged in the federal securities
litigation. The consolidated complaint seeks unspecified money damages and other
unspecified relief against the defendants. On April 26, 2004, the defendants
filed Motions to Dismiss the consolidated complaint. On August 24, 2004, the
Court granted in part and denied in part Defendants' Motions to Dismiss. The
Court dismissed, without prejudice, all claims against defendants Ed Burgos and
Sheila Coop, all claims alleging co-fiduciary liability against all defendants,
and all claims alleging that the individual defendants had conflicts of interest
precluding them from properly exercising their fiduciary duties under ERISA. A
claim for breach of the duty to prudently manage plan assets was upheld against
Syncor, and a claim for breach of the alleged duty to "monitor" the performance
of Syncor's Plan Administrative Committee was upheld against defendants Monty Fu
and Robert Funari. 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 continues to cooperate in the investigation.
It is impossible to predict the outcome of the proceedings described under
the heading "Shareholder/ERISA Litigation against Syncor" or their impact on 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 believes the
allegations made in the complaints described above are without merit and it
intends to vigorously defend such actions. The Company has been informed that
the individual director and officer defendants deny liability for the claims
asserted in these actions, believe they have meritorious defenses
Page 24
and intend to vigorously defend such actions. The Company currently believes
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. E.I. Du Pont De Nemours and Company
v. Cardinal Health, Inc., BBA Materials Technology and BBA Nonwovens
Simpsonville, Inc., No. 3-03-0848. 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 co-defendants 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.
Other Matters
In addition to the legal proceedings disclosed above, 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
as well as litigation in connection with future and prior acquisitions. The
Company intends to vigorously defend itself against this other litigation and
does not currently believe that the outcome of this other litigation will have a
material adverse effect on the Company's financial position, liquidity or
results of operations.
See also the discussion of the SEC investigation, U.S. Attorney inquiry,
Audit Committee internal review and separate Board committee internal review
in Note 1.
9. GOODWILL AND OTHER INTANGIBLE ASSETS
Changes in the carrying amount of goodwill for the six months ended
December 31, 2004 were as follows:
Pharmaceutical
Distribution Medical Pharmaceutical Clinical
and Provider Products and Technologies Technologies
(in millions) Services Services and Services and Services Total
- ------------- -------------- ------------ -------------- ------------ -----------
Balance at June 30, 2004 (1) $ 211.0 $ 677.2 $ 1,843.6 $ 1,587.5 $ 4,319.3
Goodwill acquired - net of purchase price
adjustments, foreign currency
translation adjustments and other 15.4 10.9 113.4(2) 9.4 149.1
Impairment charges (3) - - (15.4) - (15.4)
Goodwill related to the divestiture/closure of
businesses (4) - - (7.3) - (7.3)
Transfer (5) (60.1) - - 60.1 -
-------- -------- ---------- ---------- ----------
Balance at December 31, 2004 $ 166.3 $ 688.1 $ 1,934.3 $ 1,657.0 $ 4,445.7
======== ======== ========== ========== ==========
(1) The June 30, 2004 balances for the Automation and Information
Services segment and ALARIS were combined under Clinical
Technologies and Services.
(2) The increase within the Pharmaceutical Technologies and Services
segment primarily relates to an acquisition within its Nuclear
Pharmacy Services business resulting in a goodwill allocation of
$62.8 million and foreign currency translation adjustments of $23.5
million related to the Intercare acquisition. The remaining amounts
represent goodwill acquired from other immaterial acquisitions,
purchase price adjustments and other foreign currency translation
adjustments.
Page 25
(3) These impairment charges relate to the Pharmaceutical Development
and Oral Technologies businesses within the Pharmaceutical
Technologies and Services segment. See Note 5 above for additional
information regarding these impairment charges.
(4) This goodwill decrease relates to the sale of the Radiation
Management Services business within the Pharmaceutical Technologies
and Services segment. See Note 12 below for additional information
regarding this sale of business.
(5) During the first quarter of fiscal 2005, the Company transferred its
Clinical Services and Consulting business, previously reported
within the Pharmaceutical Distribution and Provider Services
segment, to its Clinical Technologies and Services segment to better
align business operations. This transfer resulted in approximately
$60.1 million of goodwill being reclassed between the segments.
The allocation of the purchase price related to the ALARIS acquisition and
certain immaterial acquisitions are not yet finalized and are subject to
adjustment as the Company assesses the value of the pre-acquisition
contingencies and certain other matters. The Company expects any future
adjustments to the allocation of the purchase price to be recorded to goodwill.
Intangible assets with definite lives are being amortized using the
straight-line method over periods that range from three to forty years. The
detail of other intangible assets by class as of June 30 and December 31, 2004
was as follows:
Gross Accumulated Net
(in millions) Intangible Amortization Intangible
- -------------------------- ---------- ------------ ----------
June 30, 2004
Trademarks and patents $345.9 $23.4 $322.5
Non-compete agreements 32.0 24.8 7.2
Customer relationships 231.4 6.8 224.6
Other 82.4 17.2 65.2
------ ----- ------
Total $691.7 $72.2 $619.5
------ ----- ------
December 31, 2004
Trademarks and patents $349.6 $30.4 $319.2
Non-compete agreements 31.1 25.2 5.9
Customer relationships 239.9 20.8 219.1
Other 69.5 19.4 50.1
------ ----- ------
Total $690.1 $95.8 $594.3
------ ----- ------
There were no significant acquisitions of other intangible assets for the
periods presented. Amortization expense for the three and six months ended
December 31, 2004 was $12.7 million and $25.0 million, respectively, and $2.4
million and $4.7 million, respectively, during the comparable periods of 2003.
Amortization expense for each of the next five fiscal years is estimated
to be:
(in millions) 2005 2006 2007 2008 2009
- -------------------- ------ ------ ------ ------ ------
Amortization expense $ 48.2 $ 47.5 $ 46.6 $ 43.9 $ 41.6
10. 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, 2004, the maximum amount the Company could be required to reimburse
was $395.4 million. Certain of these leases qualify as capital lease
obligations, and accordingly, the Company recorded approximately $61.9 million
of property and equipment offset by long-term liabilities on its balance sheet
during the second quarter of fiscal 2005. Based upon current market information
obtained from a third party valuation expert, the Company believes that the
payment obligation under certain leases would exceed the proceeds from the sale
of related properties and equipment. Therefore, the Company recorded
approximately $8.3 million of impairment charges during the second quarter of
fiscal 2005. See Note 11 below for additional information regarding impairment
charges. In accordance with FASB Interpretation No. 45, the Company has a
liability of $4.1 million recorded as of December 31, 2004 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 and disposition agreements, customer agreements and
intellectual property licensing agreements. Such indemnification obligations
vary in scope and, when defined, in
Page 26
duration. In many cases, a maximum obligation is not explicitly stated and,
therefore, the overall maximum amount of the liability under such
indemnification obligations cannot be reasonably estimated. Where appropriate,
such indemnification obligations are recorded as a liability. 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 business. 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.
11. IMPAIRMENT CHARGES AND OTHER
The Company classifies asset impairments related to restructurings in
special items, which is included in operating earnings within the consolidated
statements of earnings. Asset impairments not associated with restructurings and
gains and losses on long lived assets were historically classified in "interest
expense and other" within the consolidated statements of earnings. Significant
asset impairments were incurred during the three months ended December 31, 2004
and may continue to be incurred in the future due to the Company's global
restructuring program and ongoing strategic planning efforts. Effective the
second quarter of fiscal 2005, the Company presented non-restructuring operating
asset impairments and gains and losses from the sale of operating and corporate
assets within "impairment charges and other" within the consolidated statements
of earnings. These impairment charges were included within the Corporate
segment's results. Prior period financial results were reclassified to conform
to this change in presentation.
For the three and six months ended December 31, 2004, the Company incurred
charges of $83.0 million and $86.8 million, respectively, as compared to gains
of $8.1 million and $6.4 million, respectively, for the comparable periods of
2003. With respect to the more significant impairments recorded during the three
months ended December 31, 2004, the Company incurred approximately $67.8 million
of asset impairments within its Pharmaceutical Technologies and Services
segment. These asset impairments relate primarily to recognizing reductions in
the value of assets within the Oral Technologies business based on discounted
cash flow analyses performed in accordance with SFAS No. 144, "Accounting for
the Impairment or Disposal of Long-Lived Assets" as a result of strategic
business decisions during the second quarter of fiscal 2005. Also during the
three months ended December 31, 2004, the Company incurred asset impairments of
approximately $8.3 million related to operating lease agreements for certain
real estate and equipment used in the operations of the Company. The Company
also recorded a $5.2 million impairment during the three months ended December
31, 2004 on an aircraft which is currently available for sale within its
Corporate entity. The aircraft met all criteria to be classified as held for
sale during the second quarter of fiscal 2005. The impairment recognized reduces
the carrying value of the aircraft to its fair market value based upon quoted
market prices of similar assets. The Company expects to sell the aircraft by the
end of fiscal 2005. For the comparable period of 2003, the Company recorded a
net gain of approximately $8.9 million related to the sale of a non-strategic
business within the Pharmaceutical Technologies and Services segment. This gain
was offset by other insignificant asset impairments and losses recognized during
the three months ended December 31, 2003.
12. 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 2005. The net
liabilities at December 31, 2004 and net assets at June 30, 2004 for the
discontinued operations are included within the Pharmaceutical Technologies and
Services segment.
Page 27
During the three months ended December 31, 2004, the Company recorded a
gain of approximately $18.7 million related to the sale of the Radiation
Management Services business within the Company's Pharmaceutical Technologies
and Services segment. This business unit was not previously classified as
discontinued operations as it did not qualify in accordance with SFAS No. 144
until the second quarter of fiscal 2005. The assets, liabilities and results of
operations related to this business were not included in the tables below as the
amounts were not significant.
The results of discontinued operations for the three and six months ended
December 31, 2004 and 2003 are summarized as follows:
Three Six
Months Ended Months Ended
December 31, December 31,
------------------- --------------------
(in millions) 2004 2003 2004 2003
------ ------ ------ ------
Revenue $ 0.9 $ 24.7 $ 3.7 $ 50.9
Gain from sale of business unit 18.7 - 18.7 -
Earnings/(loss) before income taxes 16.7 (8.2) 9.4 (11.1)
Income tax benefit/(expense) (6.5) 3.1 (3.7) 4.2
------ ------ ------ ------
Earnings/(loss) from discontinued operations $ 10.2 $ (5.1) $ 5.7 $ (6.9)
====== ====== ====== ======
There was no interest expense allocated to discontinued operations for the
three or six months ended December 31, 2004, as the note assumed in connection
with the Syncor acquisition was paid off in the fourth quarter of fiscal 2004.
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, 2004 and June 30, 2004, the major components of assets and
liabilities of the discontinued operations were as follows:
December 31, June 30,
(in millions) 2004 2004
------------- -----------
Current assets $ 18.2 $ 21.2
Property and equipment, net 10.9 22.0
Other assets 3.0 17.2
---------- ----------
Total assets $ 32.1 $ 60.4
========== ==========
Current liabilities $ 33.0 $ 30.9
Long term debt and other 20.5 24.2
---------- ----------
Total liabilities $ 53.5 $ 55.1
========== ==========
Operating cash flows generated from the discontinued operations were
immaterial to the Company and, therefore, are not disclosed separately. However,
the proceeds received from the sale of the discontinued operations of
approximately $39.5 million were presented separately on the consolidated
statements of cash flows.
13. CHANGE IN ACCOUNTING
Effective as of the first quarter of fiscal 2004, the Company changed its
method of recognizing cash discounts from recognizing cash discounts as a
reduction of cost of products sold primarily upon payment of vendor invoices to
recording cash discounts as a component of inventory cost and recognizing such
discounts as a reduction to cost of products sold upon the sale of inventory.
The Company believes the change in accounting method provides a more objectively
determinable method of recognizing cash discounts and a better matching of
inventory cost to revenues. The Company recorded a $38.5 million (net of tax of
$22.5 million) cumulative effect of change in accounting in the consolidated
statements of earnings. The cumulative effect reduced net diluted earnings per
Common Share by $0.09.
Page 28
14. OFF-BALANCE SHEET TRANSACTIONS
Cardinal Health Funding ("CHF") was organized for the sole purpose of
buying receivables and selling those receivables to multi-seller conduits
administered by third-party banks or other third-party investors. CHF was
designed to be a special purpose, bankruptcy-remote entity. Although
consolidated in accordance with GAAP, CHF is a separate legal entity from the
Company. The sale of receivables by CHF qualifies for sales treatment under SFAS
No. 140 "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities," and, accordingly, is not included in the
Company's consolidated financial statements.
At December 31, 2004, the Company had a committed receivables sales
facility program available through CHF with capacity to sell $800 million in
receivables. During the first quarter of fiscal 2005, the capacity under the
committed receivables sales facility program was increased from $500 million to
$800 million. Recourse is provided under the CHF program by the requirement that
CHF retain a percentage subordinated interest in the sold receivables. The
Company sold $500 million of receivables under this committed receivables sales
facility program during the first quarter of fiscal 2005. The Company sold an
additional $300 million under this program during the second quarter of fiscal
2005. After these sales, the Company had sold in the aggregate $800 million
under the program, all of which remained outstanding at December 31, 2004. The
Company also retained subordinated interests of $393.9 million at December 31,
2004, as required under this program. At June 30, 2004, there were no
outstanding receivables or subordinated interests related to this facility.
For additional information regarding off-balance sheet arrangements, see
Note 16 below and Note 10 of "Notes to Consolidated Financial Statements" in the
2004 Form 10-K.
15. EMPLOYEE RETIREMENT BENEFIT PLANS
Components of the Company's net periodic benefit costs for the three and
six months ended December 31, 2004 and 2003, were as follows:
Three Months Ended Six Months Ended
December 31, December 31,
----------------------------- ----------------------------
(in millions) 2004 2003 2004 2003
----------- ------------ ---------- -----------
Components of net periodic benefit cost:
Service cost $ 0.4 $ 0.4 $ 0.7 $ 0.8
Interest cost 2.6 2.3 5.1 4.6
Expected return on plan assets (1.8) (1.4) (3.5) (2.8)
Net amortization and other (1) 0.6 0.7 1.2 1.4
----------- ------------ ---------- -----------
Net periodic benefit costs $ 1.8 $ 2.0 $ 3.5 $ 4.0
=========== ============ ========== ===========
(1) Amount primarily represents the amortization of actuarial
(gains)/losses, as well as the amortization of the transition
obligation and prior service costs.
The Company sponsors other postretirement benefit plans which are
immaterial for all periods presented.
16. SUBSEQUENT EVENTS
Subsequent to December 31, 2004, the Company repurchased approximately
$133.8 million of receivables under its committed receivables sales facility
program. See Note 14 above for further information regarding this facility.
Page 29
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
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, 2004 and June 30, 2004,
and for the condensed consolidated statements of earnings for the three- and
six-month periods ended December 31, 2004 and 2003.
This discussion and analysis should be read together with management's
discussion and analysis included in the Company's Form 10-K for the fiscal year
ended June 30, 2004 (the "2004 Form 10-K").
In connection with certain conclusions made by the Audit Committee during
September and October 2004 as part of its ongoing internal review, the Company
made certain reclassification and restatement adjustments to its fiscal 2004 and
prior historical financial statements, as more fully described in Note 1 of
"Notes to Condensed Consolidated Financial Statements." Revenue previously
disclosed separately as "Bulk Deliveries to Customer Warehouses and Other" has
been aggregated with "Operating Revenue" resulting in combined "Revenue" being
reported in the financial statements. In addition, the Company changed its
accounting method for recognizing income from cash discounts. The Company also
reduced its fourth quarter fiscal 2004 results of operations for premature
revenue recognition within its former Automation and Information Services
segment after assessing the impact this segment's sales practice had on the
Company's results of operations for the three-year period ended June 30, 2004.
Lastly, the Company restated its financial statements for fiscal 2000, 2001,
2002 and 2003 and the first three quarters of fiscal 2004 as a result of various
misapplications of generally accepted accounting principles ("GAAP") and errors
relating primarily to balance sheet reserve and accrual adjustments recorded in
prior periods. As a result, the Company supplemented its historical disclosures
within "Management's Discussion and Analysis of Financial Condition and Results
of Operations" to reflect these reclassification and restatement adjustments on
previously reported Company and business segment operating earnings performance.
All prior period disclosures presented in "Management's Discussion and Analysis
of Financial Condition and Results of Operations" have been adjusted to reflect
these changes.
Portions of this Quarterly Report on Form 10-Q (including information
incorporated by reference) include "forward-looking statements" within the
meaning of the Private Securities Litigation Reform Act of 1995, as amended. The
words "believe," "expect," "anticipate," "project," and similar expressions,
among others, generally identify "forward-looking statements," which speak only
as of the date the statement was made. Forward-looking statements are subject to
risks, uncertainties and other factors that 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 in the 2004 Form 10-K (including in the section titled "Risk
Factors That May Affect Future Results" within "Item 1: Business") and are
incorporated in this Form 10-Q by reference. Except to the limited extent
required by applicable law, the Company undertakes no obligation to update or
revise any forward-looking statements, whether as a result of new information,
future events, or otherwise.
OVERVIEW
The following summarizes the Company's results of operations for the
three and six months ended December 31, 2004.
Three Months Ended Six Months Ended
December 31, December 31,
(in millions, except per Common Share ----------------------------------- -----------------------------------
amounts) Growth (1) 2004 2003 Growth (1) 2004 2003
- ------------------------------------- ---------- --------- --------- ---------- --------- ---------
Revenue 13% $18,554.6 $16,350.8 15% $36,350.6 $31,739.0
Operating earnings (45%) $ 320.8 $ 584.6 (38%) $ 678.5 $ 1,094.9
Earnings from continuing operations (45%) $ 203.8 $ 373.6 (40%) $ 421.6 $ 697.1
Net earnings (42%) $ 214.0 $ 368.5 (34%) $ 427.3 $ 651.7
Diluted earnings per Common Share (42%) $ 0.49 $ 0.84 (33%) $ 0.98 $ 1.47
(1) Growth is calculated as the change (increase or decrease) for the
three and six months ended December 31, 2004 compared to the three
and six months ended December 31, 2003.
The results of operations during the three and six months ended December
31, 2004, 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 revenue growth in every segment of the Company. The
Company continues to
Page 30
experience strong demand for integrated solutions from health care providers.
These integrated solutions include products and services from multiple lines of
businesses within the Company. These agreements currently represent more than $7
billion of annual sales.
The Company has four reportable segments: Pharmaceutical Distribution and
Provider Services, Medical Products and Services, Pharmaceutical Technologies
and Services and Clinical Technologies and Services. See Note 7 of "Notes to
Condensed Consolidated Financial Statements" for a discussion of changes to
business segments during fiscal 2005.
As previously reported, the Company's Pharmaceutical Distribution business
is in the midst of a business model transition with respect to how it is
compensated for the logistical, capital and administrative services that it
provides to branded pharmaceutical manufacturers. Historically, the compensation
received by the Pharmaceutical Distribution business from branded pharmaceutical
manufacturers was based on each manufacturer's unique sales practices (e.g.,
volume of product available for sale, eligibility to purchase product, cash
discounts for prompt payment, rebates, etc.) and pharmaceutical pricing
practices (e.g., the timing, frequency and magnitude of product price
increases). Specifically, a significant portion of the compensation the
Pharmaceutical Distribution business received from manufacturers was derived
through the Company's ability to purchase pharmaceutical inventory in advance of
pharmaceutical price increases, hold that inventory as manufacturers increased
pharmaceutical prices, and generate a higher operating margin on the subsequent
sale of that inventory. This compensation system was dependent to a large degree
upon the sales practices of each branded pharmaceutical manufacturer, including
established policies concerning the volume of product available for purchase in
advance of a price increase, and on stable and predictable pharmaceutical
pricing practices. Beginning in fiscal 2003, branded pharmaceutical
manufacturers began to seek greater control over the amount of pharmaceutical
product available in the supply chain, and, as a result, began to change their
sales practices by restricting the volume of product available for purchase by
pharmaceutical wholesalers. In addition, manufacturers have increasingly sought
more services from the Company, including the provision of data concerning
product sales and distribution patterns. The Company believes these changes have
been made to provide greater visibility to branded pharmaceutical manufacturers
over product demand and movement in the market and to increase product safety
and integrity by reducing the risks associated with product being available to,
and distributed in, the secondary market. Nevertheless, the impact of these
changes has significantly reduced the compensation received by the Company from
branded pharmaceutical manufacturers. In addition, since the fourth quarter of
fiscal 2004, the frequency and amount of product price increases from branded
pharmaceutical manufacturers have become less predictable. As a result of these
actions by branded pharmaceutical manufacturers, the Company believes it is no
longer being adequately and consistently compensated for the reliable and
consistent logistical, capital and administrative services being provided by the
Company to these manufacturers.
In response to the developments discussed above, the Company is working to
establish a compensation system that is no longer dependent on manufacturers'
sales or pricing practices, but rather is based on the services provided by the
Company to meet the unique distribution requirements of each manufacturer's
products. To that end, the Company is working with individual branded
pharmaceutical manufacturers to define fee-for-service terms that will
adequately compensate the Company, in light of each product's unique
distribution requirements, for the logistical, capital and administrative
services being provided by the Company. To accelerate this process, in August
2004, the Company communicated to its branded pharmaceutical manufacturing
vendors a new policy that sets the next anniversary date of the manufacturers'
existing agreement with the Company, if any, or April 1, 2005 as the deadline by
which manufacturers must have entered into a mutually satisfactory distribution
services agreement with the Company providing for reliable, predictable and
adequate compensation for the Company's services. For any manufacturer with
which the Company is unable to enter into such a mutually satisfactory
agreement, the Company plans to assist such manufacturer in transitioning to
another method of distribution. The Company's goal is to have entered into
agreements by April 1, 2005 that will provide for a majority of the
Pharmaceutical Distribution business' branded vendor margin to be based on
non-contingent distribution fees. The Company continues to make progress on this
transition and currently expects to achieve the April 1 goal. There can be no
assurance that this business model transition will be successful, or if such
transition is successful, of the timing of such a successful transition.
Revenue and operating earnings within the Pyxis products business of the
Clinical Technologies and Services segment declined significantly during the
three and six months ended December 31, 2004. The decline was a result of:
softening demand for its core products; the delayed introduction of Pyxis
MedStation(R) 3000, the next generation of Pyxis' medication management system;
increased competition within the industry; and the impact from the Audit
Committee's internal review, as more fully described in Note 1 of "Notes to
Condensed Consolidated Financial Statements," which review has created execution
issues as the efforts and attention of certain sales and installation teams were
diverted from ordinary business operations. These factors were also observed in
the weakening of the Pyxis products business' committed contract backlog. The
Company believes that the softening demand for the Pyxis products business' core
products and the increased competition within the industry may continue in the
short-term; however, the Company remains confident in the
Page 31
long-term prospects for this business as patient safety concerns combine with
innovative new products to drive future demand.
Global Restructuring Program
As previously announced, the Company has launched a global restructuring
program with a goal of increasing the value the Company provides its customers
through better integration of existing businesses and improved efficiency from a
more disciplined approach to procurement and resource allocation. The Company
expects the program to be completed over a three-year period and to improve
operating earnings in fiscal 2005 and beyond and position the Company for future
growth. The plan is expected to improve operating earnings by $125 million for
fiscal 2005 and reach an annualized amount of $200 million for fiscal 2006.
The Company expects the program to be implemented in two phases. The first
phase of the program will focus on business consolidations and process
improvements, including rationalizing approximately 25 of the Company's
facilities worldwide, reducing the Company's approximately 58,000 global
workforce by approximately 4,200 employees, and rationalizing and discontinuing
overlapping and under-performing product lines. The Company expects the second
phase of the program will focus on longer term integration activities that will
help generate future revenue growth and create greater productivity. The second
phase of the program remains subject to approval by the Company's Board of
Directors, and at this time, the Company is unable to estimate the expected
costs for the second phase. See the Form 8-K filed by the Company on December
14, 2004 for a description of the costs the Company expects to incur in
connection with the first phase of the program.
See Notes 5 and 11 of "Notes to Condensed Consolidated Financial
Statements" for discussion of the restructuring costs incurred by the Company
during the three and six months ended December 31, 2004 related to the first
phase of the global restructuring program.
Government Investigations and Board Committee Internal Reviews
The Company is currently the subject of a formal investigation by the
Securities and Exchange Commission (the "SEC") relating to certain accounting
matters. The Company also learned that the U.S. Attorney for the Southern
District of New York has commenced an inquiry with respect to the Company. Also,
the Company's Audit Committee commenced its own internal review, assisted by
independent counsel. In addition, a Board committee, with the assistance of
independent counsel, is separately conducting an internal review to assign
responsibility for the matters relating to the Company's accounting treatment of
certain recoveries from vitamin manufacturers. For further information regarding
these matters, see Note 1 to "Notes to Condensed Consolidated Financial
Statements."
RESULTS OF OPERATIONS
Revenue Three Months Ended Six Months Ended
December 31, December 31,
------------------------------ -----------------------------
Percent of Company Percent of Company
Revenue Revenue
------------------------------ -----------------------------
Growth (1) 2004 2003 Growth (1) 2004 2003
---------- ---- ---- ---------- ---- ----
Pharmaceutical Distribution and Provider
Services 15% 80% 80% 15% 80% 80%
Medical Products and Services 6% 13% 14% 9% 13% 14%
Pharmaceutical Technologies and Services 7% 4% 4% 8% 4% 4%
Clinical Technologies and Services 38% 3% 2% 46% 3% 2%
Total Company 13% 100% 100% 15% 100% 100%
(1) Growth is calculated as the change (increase or decrease) in the
revenue for the three and six months ended December 31, 2004
compared to the three and six months ended December 31, 2003.
Revenue for the three and six months ended December 31, 2004 increased 13%
and 15%, respectively, compared to the same periods in the prior year. These
increases resulted from: a higher sales volume across each of the Company's
segments; revenue growth from existing customers; the addition of new customers,
some of which resulted from new corporate agreements with health care providers
that integrate the Company's diverse offerings; the addition of new products;
and the year-over-year impact of acquisitions.
The Pharmaceutical Distribution and Provider Services revenue growth of
15% for the three and six months ended December 31, 2004 resulted from strong
sales to customers within this segment's core Pharmaceutical Distribution
business. The most significant growth was in "Bulk Revenue" (defined below),
which increased approximately 30% and 27%, respectively, during the three and
six months ended December 31, 2004. See the Bulk Revenue discussion below for
further details. Also contributing to the revenue growth were sales to health
systems and nursing home customers. In addition, annualized pharmaceutical price
increases of approximately 4.3% and
Page 32
3.6%, respectively, during the three and six months ended December 31, 2004
contributed to the growth in this segment. However, these rates of
pharmaceutical price increases were lower than rates experienced over the past
fiscal year.
As discussed in Note 2 of "Notes to Consolidated Financial Statements" in
the 2004 Form 10-K, during fiscal 2004, the Company decided to aggregate revenue
classes within the 2004 Form 10-K. "Operating Revenue" and "Bulk Deliveries to
Customer Warehouses and Other" were combined for all periods presented so that
total revenue and total cost of products sold are presented as single amounts in
the consolidated statements of earnings. Beginning with the 2004 Form 10-K,
information concerning the portion of the Company's revenue that arises from
Bulk Revenue is discussed in the Company's "Management's Discussion and Analysis
of Financial Condition and Results of Operations." For more information
regarding this reclassification, see Note 2 of "Notes to Consolidated Financial
Statements" in the 2004 Form 10-K.
The Pharmaceutical Distribution and Provider Services segment reports
transactions with the following characteristics as "Bulk Revenue": (a)
deliveries to customer warehouses whereby the Company acts as an intermediary in
the ordering and delivery of pharmaceutical products; (b) delivery of products
to the customer in the same bulk form as the products are received from the
manufacturer; (c) warehouse to customer warehouse or process center deliveries;
or (d) deliveries to customers in large or high volume full case quantities.
Bulk Revenue for the three months ended December 31, 2004 and 2003 was $5.8
billion and $4.5 billion, respectively, and for the six months ended December
31, 2004 and 2003 was $11.3 billion and $8.8 billion, respectively. The increase
in Bulk Revenue primarily relates to additional volume from existing and new
customers as well as market growth within the mail order business. The increase
from existing customers is primarily due to certain customers purchasing from
the Company rather than directly from the manufacturer.
The Medical Products and Services revenue growth of 6% and 9%,
respectively, during the three and six months ended December 31, 2004 resulted
primarily from new contracts signed during fiscal 2004 within the
medical-surgical distribution business, new products, favorable foreign exchange
translation and increased revenue from the specialty distribution business. The
increase in the medical-surgical distribution business was within the hospital
supply and ambulatory care customer segments. The increase within the specialty
distribution business reflects increased revenue from the business' largest
customer and growth of the existing customer base. This segment's revenue growth
was adversely affected by slower growth in the distribution of self-manufactured
products, the loss of certain business from customers within a group purchasing
organization ("GPO") and dampened flu-related sales.
The Pharmaceutical Technologies and Services segment's revenue growth of
7% and 8%, respectively, during the three and six months ended December 31, 2004
primarily resulted from the impact of acquisitions, primarily The Intercare
Group, plc ("Intercare"), strong demand for certain softgel products and the
impact of foreign exchange rates. Excluding the impact of all acquisitions and
divestitures within this segment, revenue growth would have been approximately
1% for the three and six months ended December 31, 2004. The results of
operations from Intercare only include a portion of the month of December in the
fiscal 2004 amounts. In addition, revenue for the three and six months ended
December 31, 2004 increased by approximately 2% and 1%, respectively, as a
result of the impact of foreign exchange rates. This impact takes into
consideration the fiscal 2005 rate fluctuations due to the weakening of the U.S.
dollar and the fiscal 2004 constant rate adjustment (see footnote 1 to the table
in Note 7 of "Notes to Condensed Consolidated Financial Statements" for
additional discussion as it relates to fiscal 2004 constant rate adjustment).
The segment's growth was adversely affected by continued regulatory delays
impacting production at certain Biotechnology and Sterile Life Sciences
facilities and lower demand for medical communication services within the
Healthcare Marketing Services business.
The Clinical Technologies and Services revenue growth of 38% and 46%,
respectively, during the three and six months ended December 31, 2004 resulted
from the impact of the acquisition of ALARIS Medical Systems, Inc. (which has
been given the legal designation of Cardinal Health 303, Inc. and is referred to
in this Form 10-Q as "ALARIS") and strong revenue growth within the Clinical
Services and Consulting business offset by revenue declines within the Pyxis
products business. Excluding the impact of the ALARIS acquisition, revenue
growth/(decline) would have been approximately (4%) and 3%, respectively, during
the three and six months ended December 31, 2004. ALARIS' results of operations
are not included in the prior period amounts. The Pyxis products business
experienced decreased revenue of approximately 28% and 21%, respectively, during
the three and six months ended December 31, 2004 due to: softening demand for
its core products; the delayed introduction of Pyxis MedStation(R) 3000, the
next generation of Pyxis' medication management system; increased competition
within the industry; and the impact from the Audit Committee's internal review,
as more fully described in Note 1 of "Notes to Condensed Consolidated Financial
Statements," which review has created execution issues as the efforts and
attention of certain sales and installation teams were diverted from ordinary
business operations. These factors were also observed in the weakening of the
Pyxis products business' committed contract backlog.
Page 33
In fiscal 2004, the Pyxis products business sold portions of its leased
asset portfolio, at the direction of Corporate. The proceeds were transferred to
Corporate, and the Pyxis products business subsequently received a $4.4 million
and $9.3 million allocation, respectively, from Corporate during the three and
six months ended December 31, 2003 related to the estimated interest income
that would have been earned had the associated lease portfolios not been sold.
Effective the first quarter of fiscal 2005, the Pyxis products business did not
receive this Corporate allocation. See footnote 2 to the table in Note 7 of
"Notes to Condensed Consolidated Financial Statements" for further details.
Operating Earnings Three Months Ended Six Months Ended
December 31, December 31,
------------------------------ ------------------------------
Percent of Company Percent of Company
Operating Earnings Operating Earnings
------------------------------ ------------------------------
Growth (1) 2004 2003 Growth (1) 2004 2003
---------- ---- ---- ---------- ---- ----
Pharmaceutical Distribution and Provider
Services (9%) 39% 38% (19%) 39% 39%
Medical Products and Services 0% 31% 28% (7%) 32% 28%
Pharmaceutical Technologies and Services (22%) 16% 18% (23%) 17% 19%
Clinical Technologies and Services (21%) 14% 16% (25%) 12% 14%
Total Company (2) (45%) 100% 100% (38%) 100% 100%
(1) Growth is calculated as the change (increase or decrease) in the
operating earnings for the three and six months ended December 31,
2004 compared to the three and six months ended December 31, 2003.
(2) The Company's overall operating earnings decrease of 45% and 38%,
respectively, during the three and six months ended December 31,
2004 includes the effect of special items and impairment charges.
Special items and impairment charges are not allocated to the
segments. See Notes 5 and 11 in "Notes to Condensed Consolidated
Financial Statements" for further information regarding the
Company's special items and impairment charges.
Total Company operating earnings for the three months ended December 31,
2004 decreased 45% compared to the same period in the prior year, while
operating earnings for the six months ended December 31, 2004 decreased 38%
compared to the same period in the prior year. These overall decreases resulted
from declining operating earnings in each of the Company's segments. The
Company's gross margins continue to be dampened primarily by: (1) reduced
branded vendor margins within the Pharmaceutical Distribution business driven by
changes in branded pharmaceutical manufacturers' sales and pricing practices
(see the "Overview" section for further discussion) and competitive pricing; (2)
increased mix of lower-margin distribution business, competitive pricing and
increased raw material costs within the Medical Products and Services segment;
(3) continued regulatory delays adversely affecting manufacturing efficiencies
within the Pharmaceutical Technologies and Services segment; and (4) reduced
customer demand, new product launch delays and increased competition within the
Pyxis products business in the Clinical Technologies and Services segment.
Total operating earnings were also adversely affected by the unfavorable
impact related to special items of $103.1 million and $135.0 million,
respectively, during the three and six months ended December 31, 2004. The
increased costs were associated with the Company's global restructuring program,
the SEC investigation and Audit Committee internal review and the integration of
certain acquisitions and were partially offset by settlements received in
antitrust litigation (see Note 5 of "Notes to Condensed Consolidated Financial
Statements" for additional information). In addition, the Company recorded $83.0
million and $86.8 million, respectively, for non-restructuring asset impairments
during the three and six months ended December 31, 2004 (see Note 11 of "Notes
to Condensed Consolidated Financial Statements" for additional information)
compared to gains of $8.1 million and $6.4 million, respectively, in the
comparable periods in the prior year. In addition, Company expenses for the six
months ended December 31, 2004 were impacted by an increase in incentive
compensation expense of approximately $9.0 million from the comparable period of
2003, primarily due to no expense being recorded during the first quarter of
fiscal 2004.
The Pharmaceutical Distribution and Provider Services operating earnings
decrease of 9% and 19%, respectively, during the three and six months ended
December 31, 2004 resulted primarily from reduced vendor margins resulting from
changes in branded pharmaceutical manufacturers' sales and pricing practices, as
discussed above in the "Overview" section. As discussed above, branded
pharmaceutical manufacturers have changed their sales practices by restricting
product available for purchase by pharmaceutical wholesalers. In addition, since
the fourth quarter of fiscal 2004, branded pharmaceutical manufacturers' product
pricing practices have become less predictable, as the frequency of price
increases has slowed and the amounts have decreased versus historical levels.
Page 34
For the six months ended December 31, 2004, annualized pharmaceutical price
increases were approximately 3.6% compared to 5.5% during the six months ended
December 31, 2003. The Company continues to work with individual branded
pharmaceutical manufacturers to develop non-contingent, fair market value
compensation that will adequately compensate the Company based on the services
provided for each product's unique distribution requirements. In addition,
operating earnings benefited during the second quarter of fiscal 2005 by
approximately $7.6 million as a result of improvements in vendor estimation
reserves.
The Medical Products and Services segment's operating earnings were flat
for the three months ended December 31, 2004, and decreased 7% during the six
months ended December 31, 2004 primarily due to an increased mix of lower margin
distributed products, competitive pricing on a large GPO contract, increased raw
material costs and reduced secondary source purchasing opportunities. Operating
earnings for the six months ended December 31, 2004 were also adversely impacted
by a $16.4 million charge for latex litigation as more fully described within
Note 8 of "Notes to Condensed Consolidated Financial Statements."
The Pharmaceutical Technologies and Services segment's operating earnings
decrease of 22% and 23%, respectively, during the three and six months ended
December 31, 2004 resulted from continued manufacturing and regulatory issues
within the Company's Biotechnology and Sterile Life Sciences business which
impacted product volume and plant efficiencies. In addition, the operating
margins in this segment's Nuclear Pharmacy Services business were adversely
affected by increased raw material costs and competitive pricing in selected
markets as new independent pharmacies were opened. The impact of foreign
exchange rates on operating earnings for the three and six months ended December
31, 2004 was less than 1%. This impact takes into consideration the fiscal 2005
rate fluctuations due to the weakening of the U.S. dollar and the fiscal 2004
constant rate adjustment (see footnote 1 to the table in Note 7 of "Notes to
Condensed Consolidated Financial Statements" for additional discussion as it
relates to fiscal 2004 constant rate adjustment).
The Clinical Technologies and Services segment's operating earnings
decrease of 21% and 25%, respectively, during the three and six months ended
December 31, 2004 resulted primarily from decreased operating earnings within
the Pyxis products business that were not offset by the acquisition benefit from
the ALARIS transaction. The Pyxis products business' performance was impacted by
decreased revenues of 28% and 21%, respectively, for the three and six months
ended December 31, 2004 and lower unit margins due to adverse year-over-year
sales mix and more aggressive price discounting in the market place. Operating
earnings were also adversely impacted by increased year-over-year bad debt
expense and inventory reserve adjustments for excess and obsolete inventory. The
Pyxis products business was also adversely impacted by the positive segment
allocation adjustments recorded during the three and six months ended December
31, 2003 of $4.4 million and $9.3 million, respectively, for the estimated
interest income that the business would have earned from assets sold as part of
the leased asset portfolio sales (which proceeds from such sales were returned
to Corporate for general corporate requirements).
Excluding the impact of the ALARIS acquisition, operating earnings would
have decreased 51% and 44%, respectively, for the three and six months ended
December 31, 2004. The results of operations from this acquisition are not
included in the prior period amounts. Operating results from ALARIS, while
incremental to the segment's results year-over-year, were adversely impacted by
the effect of purchase accounting adjustments recorded during the first quarter
of fiscal 2005. These adjustments included an inventory valuation adjustment to
"fair value," with the adjusted, higher cost inventory being sold, adversely
affecting gross margins by approximately $3.4 million and $23.6 million,
respectively, for the three and six months ended December 31, 2004.
Impairment Charges and Other
See Note 11 of "Notes to Condensed Consolidated Financial Statements" for
additional information regarding "impairment charges and other."
Page 35
Special Items
Three Months Ended Six Months Ended
December 31, December 31,
------------------- -------------------
(in millions) 2004 2003 2004 2003
- ----------------------------- ------ ------ ------ ------
Restructuring costs $105.1 $ 12.9 $112.6 $ 20.2
Merger-related costs 10.2 7.8 27.1 16.4
Litigation settlements, net (21.2) (24.2) (21.2) (26.9)
Other special items 9.0 - 16.5 -
------ ------ ------ ------
Total special items $103.1 $ (3.5) $135.0 $ 9.7
====== ====== ====== ======
See Note 5 of "Notes to Condensed Consolidated Financial Statements" for
detail of the Company's special items during the three and six months ended
December 31, 2004 and 2003.
Interest Expense and Other
The decrease in "interest expense and other" of $10.7 million during the
three months ended December 31, 2004 compared to the same period in the prior
fiscal year primarily resulted from the Company recording the minority interest
impact of approximately $15.7 million for certain impairment charges within the
Oral Technologies business within the Pharmaceutical Technologies and Services
segment. These impairment charges were recorded within "impairment charges and
other" on the consolidated statements of earnings. See Note 11 of "Notes to
Condensed Consolidated Financial Statements" for additional information
regarding "impairment charges and other." The minority interest was partially
offset by increased interest expense of approximately $11.8 million during the
three months ended December 31, 2004 due to increased borrowing rates. "Interest
expense and other" was relatively consistent for the six months ended December
31, 2004 due to the minority interest mentioned above which was offset by
increased interest expense of approximately $20.1 million due to the increased
borrowing rates.
Provision for Income Taxes
The Company's provision for income taxes relative to earnings before
income taxes and discontinued operations was 32.9% and 32.5%, respectively, for
the three and six months ended December 31, 2004, as compared to 32.9% and
33.0%, respectively, for the three and six months ended December 31, 2003.
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.
The American Jobs Creation Act of 2004 introduced a special one-time
dividend received deduction of 85% for the repatriation of certain foreign
earnings to U.S. taxpayers. The Company has a significant international presence
and has always reinvested excess foreign earnings in the improvement and
expansion of its foreign operations. Although no decision has been made, the
Company can elect to apply the favorable repatriation provision to distributions
made in fiscal year 2005 or 2006 and is currently evaluating the effect the
American Jobs Creation Act of 2004 might have on its foreign reinvestment plans
as well as on its worldwide tax position.
Earnings/(Loss) from Discontinued Operations
See Note 12 in the "Notes to Condensed Consolidated Financial Statements"
for information on the Company's discontinued operations.
Page 36
LIQUIDITY AND CAPITAL RESOURCES
Sources and Uses of Cash
The following table summarizes the Company's Condensed Consolidated
Statements of Cash Flows for the six months ended December 31, 2004 and
2003.
Six Months Ended
December 31,
------------------------
(in millions) 2004 2003
- --------------------------- -------- ---------
Cash provided by/(used in):
Operating activities $1,519.2 $ 548.4
Investing activities $ (444.1) $ (658.0)
Financing activities $ (897.4) $(1,070.1)
OPERATING ACTIVITIES. Net cash provided by operating activities during the
six months ended December 31, 2004 totaled $1.5 billion, an increase of $970.8
million when compared to the same period a year ago. The increase was primarily
a result of the sale of $800 million of receivables during the six months ended
December 31, 2004 under the Company's committed receivables sales facility
program and the timing of receipt of payments from significant customers within
the Pharmaceutical Distribution segment. These operating cash flow benefits were
adversely affected by a $275.5 million decrease in operating earnings. A
significant portion of this operating earnings decrease was due to non-cash
asset impairments of approximately $155.8 million.
INVESTING ACTIVITIES. Cash used in investing activities primarily
represents the Company's use of cash to complete acquisitions. During the six
months ended December 31, 2004, the majority of the cash used in investing
activities related to costs associated with the acquisition of ALARIS and an
acquisition within the Nuclear Pharmacy Services business. The majority of the
cash used in investing activities during the six months ended December 31, 2003
was related to costs associated with the acquisitions of Intercare and Medicap
Pharmacies, Inc. In addition, during the six months ended December 31, 2004, the
Company received approximately $39.5 million related to the sale of discontinued
operations. See Note 12 of "Notes to Condensed Consolidated Financial
Statements" for information on the Company's discontinued operations.
FINANCING ACTIVITIES. The Company's financing activities utilized cash of
$897.4 million and $1.1 billion, respectively, during the six months ended
December 31, 2004 and 2003. Cash used in financing activities during the six
months ended December 31, 2004 primarily reflects the Company's decision to
retire the Company's commercial paper, portions of its revolving credit
facilities and certain debt assumed in the ALARIS acquisition. These cash
outflows for the six months ended December 31, 2004 were partially offset by net
proceeds of $1.3 billion received from the Company's bank revolving credit
facilities. During the six months ended December 31, 2003, the Company's
financing activities primarily were the $1.0 billion repurchase of its Common
Shares.
International Cash
The Company's cash balance of approximately $1.3 billion as of December
31, 2004 includes $419.5 million of cash held by its subsidiaries outside of the
United States. Although the vast majority of cash held outside the United States
is available for repatriation, doing so could subject it to U.S. federal income
tax.
Share Repurchase Program
In December 2004, the Company announced that its Board of Directors
authorized the purchase of up to $500 million of its common shares as management
deems appropriate. The Company expects to begin repurchasing shares in the
second half of fiscal 2005. During the three months ended December 31, 2004,
outside of its share repurchase program, the Company repurchased 78,199 common
shares for an aggregate purchase price of approximately $4.1 million. See the
table under "Part II, Item 2" for more information regarding these repurchases.
Capital Resources
In addition to cash, the Company's sources of liquidity include a $1.5
billion commercial paper program backed by $1.5 billion of bank revolving credit
facilities. During the first quarter of fiscal 2005, the Company borrowed $500
million in aggregate on its revolving credit facilities. The proceeds of this
borrowing were utilized to repay a portion of the Company's commercial paper and
for general corporate purposes, including the establishment of pharmaceutical
inventory at the Pharmaceutical Distribution business' National Logistics Center
in Groveport, Ohio. During the second quarter of fiscal 2005, the Company
borrowed an additional $750 million in the aggregate on the revolving credit
facilities, with the proceeds utilized primarily for the establishment of the
National Logistics Center.
Page 37
The Company fully repaid the $1.25 billion outstanding balance under the bank
revolving credit facilities during the second quarter of fiscal 2005 due to
stabilization in its short-term liquidity requirements in light of, among other
things, the Company having substantially completed the initial establishment of
inventory for the National Logistics Center.
Also during the second quarter of fiscal 2005, the Company received a
commitment letter for a $500 million borrowing facility to be used for general
corporate purposes. The Company later determined that it was not necessary to
proceed with the $500 million borrowing facility, which would have provided
incremental borrowing capacity.
The Company's sources of liquidity also include a committed receivables
sales facility program with the capacity to sell $800 million in receivables.
See "Off-Balance Sheet Arrangements" below.
The Company's capital resources are more fully described in "Liquidity and
Capital Resources" within "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and Note 6 of "Notes to Consolidated
Financial Statements" in the 2004 Form 10-K. See also Note 6 in "Notes to
Condensed Consolidated Financial Statements."
The Company believes that it has adequate capital resources at its
disposal to fund currently anticipated capital expenditures, business growth and
expansion, contractual obligations and current and projected debt service
requirements, including those related to business combinations.
Debt Covenants
The Company's various borrowing facilities and long-term debt, except for
the preferred debt securities as discussed below, are free of any financial
covenants other than minimum net worth which cannot fall below $4.1 billion at
any time. As of December 31, 2004, the Company was in compliance with this
covenant.
The Company's preferred debt securities contain a minimum adjusted
tangible net worth covenant (adjusted tangible net worth cannot fall below $3.0
billion) and certain financial ratio covenants. As of December 31, 2004, the
Company was in compliance with these covenants. A breach of any of these
covenants would be followed by a cure period during which the Company may
discuss remedies with the security holders, or extinguish the securities without
causing an event of default.
Contractual Obligations
There have been no material changes, outside the ordinary course of
business, in the Company's outstanding contractual obligations from those
disclosed within "Management's Discussion and Analysis of Financial Condition
and Results of Operations" in the 2004 Form 10-K.
OFF-BALANCE SHEET ARRANGEMENTS
During the first quarter of fiscal 2005, the Company sold $500 million of
receivables under its committed receivables sales facility program. During the
second quarter of fiscal 2005, the Company sold an additional $300 million of
receivables under this program. In the aggregate, $800 million in receivables
have been sold under this program to date. Subsequent to December 31, 2004, the
Company repurchased approximately $133.8 million of receivables under this
program. See Note 14 in "Notes to Condensed Consolidated Financial Statements"
of this Form 10-Q and "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and Note 10 of "Notes to Consolidated
Financial Statements" in the 2004 Form 10-K for more information regarding these
and other off-balance sheet arrangements.
OTHER
See Note 2 in the "Notes to Condensed Consolidated Financial Statements"
for a discussion of recent financial accounting standards.
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 2004 Form
10-K.
Page 38
ITEM 4: CONTROLS AND PROCEDURES
The Company carried out an evaluation, as required by Rule 13a-15(b) under
the Securities Exchange Act of 1934, as amended (the "Exchange Act"), under the
supervision and with the participation of the Company's management, including
the Company's principal executive officer and principal 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. This
evaluation, which has taken into account conclusions reached to date in
connection with the internal review conducted by the Audit Committee of the
Company's Board of Directors, has allowed the Company to make conclusions, as
set forth below, regarding the state of its disclosure controls and procedures.
As noted below, material weaknesses have been identified in the Company's
internal controls.
The Company's disclosure controls and procedures are designed to provide
reasonable assurance that information required to be disclosed in its reports
filed under the Exchange Act, such as this Form 10-Q, is recorded, processed,
summarized and reported within the time periods specified in the SEC rules and
forms. The Company's disclosure controls and procedures are also designed to
ensure that such information is accumulated and communicated to management to
allow timely decisions regarding required disclosure. The Company's internal
controls are designed to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of its financial statements in
conformity with GAAP.
As disclosed in Note 1 of "Notes to Condensed Consolidated Financial
Statements" and described in "Management's Discussion and Analysis of Financial
Condition and Results of Operations," the Company has taken certain actions as a
result of the internal review undertaken by the Audit Committee with respect to
certain accounting matters. These actions include: a restatement of the
Company's financial statements for fiscal 2000, 2001, 2002 and 2003 and the
first three quarters of fiscal 2004; a reclassification of certain categories of
revenue; and expanded disclosure with respect to various items in the 2004 Form
10-K.
In connection with the Audit Committee's internal review, since the end of
fiscal 2004, the Company has adopted and is in the process of implementing
various measures in connection with the Company's ongoing efforts to improve its
internal control processes and corporate governance. These measures are more
fully discussed under Item 9a of the 2004 Form 10-K. The Company is in the
process of implementing these control enhancements, which are intended to
improve the Company's control procedures and address the issues resulting in the
material weaknesses identified by the Company's independent auditor.
In connection with the completion of its audit with respect to the
Company's financial statements for fiscal 2004, including additional procedures
resulting from the Audit Committee's internal review, the Company's independent
auditor identified and communicated to the Company's management and the Audit
Committee a "material weakness" (as defined under standards established by the
American Institute of Certified Public Accountants) in the Company's entity
level controls relating to the Company's control environment through June 30,
2004. Further, the Company's independent auditor concluded that a material
weakness existed with respect to the timing of revenue recognition within the
Company's former Automation and Information Services segment. As described in
Note 1 in "Notes to Condensed Consolidated Financial Statements," the Company
became aware that some equipment confirmation forms were being executed prior to
completion of installation of Pyxis equipment. Equipment revenue is recognized
upon completion of equipment confirmation forms. See Note 1 in "Notes to
Condensed Consolidated Financial Statements" for a description of this revenue
recognition policy. The Company did not have controls in place to assure that
installations had in fact occurred before customer acceptance.
The Company's independent auditor also acknowledged that in connection
with the Audit Committee's internal review, since the end of fiscal 2004, the
Company has adopted and is in the process of implementing various measures in
connection with the Company's ongoing efforts to improve its internal control
process and corporate governance and address the Company's independent auditor's
material weakness conclusions.
The Company believes that, once implemented, the enhancements identified
in Item 9a and Note 1 of "Notes to Consolidated Financial Statements" in the
2004 Form 10-K will correct these material weaknesses and the Company will
continue to examine this issue for possible further enhancements to its control
processes. In addition, the Company and the Audit Committee will continue to
implement enhancements in the Company's control processes as necessary in
response to specific accounting and reporting issues arising out of the Audit
Committee's internal review. The Company will continue to develop policies and
procedures and reinforce compliance with existing policies and procedures in the
Company's effort to constantly improve its internal control environment.
Page 39
The Company's management, including the Company's principal executive
officer and principal 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 individual acts, collusion of two or more people, or
management override of the controls. 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.
Based on the evaluation of the effectiveness of the Company's disclosure
controls and procedures as of December 31, 2004, subject to the matters
described in this Item 4, the Company's principal executive officer and
principal financial officer have concluded that, although progress has been made
and further corrective actions have been implemented during the quarter to the
Company's controls, as identified above, the Company will not be in a position
to adequately and thoroughly assess whether the identified weaknesses have been
resolved until the Company conducts its fiscal-year-end processes and reviews.
The Company continues to take corrective actions with respect to the Company's
disclosure controls and procedures. As such, the Company's principal executive
officer and principal financial officer were unable to conclude that the
material weaknesses described above were corrected as of December 31, 2004, and
as such, such officers were unable to conclude that the Company's disclosure
controls and procedures were effective as of December 31, 2004. Therefore, the
Company's principal executive officer and principal financial officer have
concluded that their prior determination as of September 30, 2004 that material
weaknesses exist and that the Company's disclosure controls and procedures were
not effective continues to apply as of December 31, 2004. Other than the
enhancements identified in Item 9a and Note 1 of "Notes to Consolidated
Financial Statements" in the 2004 Form 10-K and discussed above, which
enhancements the Company is in the process of implementing, there were no
changes in the Company's internal controls over financial reporting during the
quarter ended December 31, 2004 that have materially affected, or are reasonably
likely to materially affect, its internal control over financial reporting. The
Company believes, and its principal executive officer and principal financial
officer have concluded, that the implementation in fiscal 2005 of the
improvements and enhancements described above, once implemented, should be
sufficient to provide for adequate and effective disclosure controls and
procedures.
Appearing as exhibits to this Form 10-Q are the certifications of the
Company's principal executive officer and the principal financial officer
required in accordance with Section 302 of the Sarbanes-Oxley Act of 2002. The
disclosures set forth in this Item 4 contain information concerning the
evaluation of the Company's disclosure controls and procedures, and changes in
internal control over financial reporting, referred to in paragraphs 4(b) and
(c) of the certifications. This Item 4 should be read in conjunction with the
certifications for a more complete understanding of the topics presented.
PART II. OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS
The discussion below is limited to certain of the legal proceedings in
which the Company is involved, including material developments to certain of
those proceedings. Additional information regarding the legal proceedings in
which the Company is involved is provided in "Item 3: Legal Proceedings" of the
2004 Form 10-K, and is incorporated in this Form 10-Q by reference. To the
extent any statements therein constitute "forward-looking statements," reference
is made to Exhibit 99.01 of this Form 10-Q and the section entitled "Risk
Factors That May Affect Future Results" within "Item 1: Business" of the 2004
Form 10-K.
The legal proceedings described in Note 8 of "Notes to Condensed
Consolidated Financial Statements" are incorporated in this Item 1 by
reference. Unless otherwise indicated, all proceedings discussed in Note 8
remain pending.
Vitamins Litigation
On May 17, 2000, R.P. Scherer Corporation (which was acquired by the
Company in August 1998, has been given the legal designation of Cardinal Health
409, Inc. and is referred to in this Form 10-Q as "Scherer") filed a
Page 40
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 was pending in the United States District
Court for the District of Columbia (where it was transferred). As of December
31, 2004, Scherer had entered into settlement agreements with all of the
defendants in the lawsuit in consideration of payments of approximately $145.3
million, net of attorney fees, payments due to other interested parties and
expenses withheld prior to the disbursement of the funds to Scherer. As more
fully described in Note 1 of "Notes to Consolidated Financial Statements" of the
2004 Form 10-K, the Company has decided, as a result of discussions with the SEC
staff, to reverse its previous recognition of estimated recoveries from vitamin
manufacturers for amounts overcharged in prior years and to recognize the income
from such recoveries as a special item in the period that cash was received from
the manufacturers.
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 these 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. Total recoveries from
these actions through December 31, 2004 were $76.5 million. The Company is
unable at this time to estimate definitively future recoveries, if any, it will
receive as a result of these class actions.
SEC Investigation and U.S. Attorney Inquiry
On October 7, 2003, the Company received a request from the SEC, in
connection with an informal inquiry, for historical financial and related
information. The SEC's request sought a variety of documentation, including the
Company's accounting records for fiscal 2001 through fiscal 2003, as well as
notes, memoranda, presentations, e-mail and other correspondence, budgets,
forecasts and estimates.
On May 6, 2004, the Company was notified that the pending SEC informal
inquiry had been converted into a formal investigation. On June 21, 2004, as
part of the SEC's formal investigation, the Company received an SEC subpoena
that included a request for the production of documents relating to revenue
classification, and the methods used for such classification, in the Company's
Pharmaceutical Distribution business as either "Operating Revenue" or "Bulk
Deliveries to Customer Warehouses and Other." The Company has learned that the
U.S. Attorney's Office for the Southern District of New York has commenced an
inquiry that the Company understands relates to this same subject. On October
12, 2004, in connection with the SEC's formal investigation, the Company
received a subpoena from the SEC requesting the production of documents relating
to compensation information for specific current and former employees and
officers.
In connection with the SEC's inquiry, the Company's Audit Committee
commenced its own internal review in April 2004, assisted by independent
counsel. This internal review was prompted by documents contained in the
production to the SEC that raised issues as to certain accounting matters,
including but not limited to the establishment and adjustment of certain
reserves and their impact on quarterly earnings. The Audit Committee and its
independent counsel also have reviewed the revenue classification issue that is
the subject of the SEC's June 21, 2004 subpoena and are reviewing other matters
identified in the course of the Audit Committee's internal review. During
September and October 2004, the Audit Committee reached certain conclusions with
respect to findings from its internal review as of the date of the
determination, which are discussed in Note 1 of "Notes to Condensed Consolidated
Financial Statements" in this Form 10-Q and Note 1 of "Notes to Consolidated
Financial Statements" contained in the 2004 Form 10-K, which was filed with the
SEC on October 26, 2004. In connection with the Audit Committee's conclusions,
the Company made certain reclassification and restatement adjustments to its
fiscal 2004 and prior historical financial statements. These adjustments were
reflected in the 2004 Form 10-K. The Audit Committee's internal review with
respect to the financial statement impact of the matters reviewed to date is
substantially complete.
Following the conclusions reached by the Audit Committee in September and
October 2004, the Audit Committee began the task of assigning responsibility for
the financial statement matters described above which were reflected in the 2004
Form 10-K and has determined to take disciplinary actions with respect to the
Company's
Page 41
employees who it determined bore responsibility for these matters, other than
with respect to the accounting treatment of certain recoveries from vitamin
manufacturers for which there is an ongoing separate Board committee internal
review (discussed below). The disciplinary actions ranged from terminations or
resignations of employment to required repayments of some or all of fiscal 2003
bonuses from certain employees to letters of reprimand. These disciplinary
actions affect senior financial and managerial personnel, as well as other
personnel, at the corporate level and in four business segments. None of the
Company's current corporate executive officers (who are identified at
www.cardinal.com) were the subject of disciplinary action by the Audit
Committee. All affected employees have been notified. In connection with the
determinations made by the Audit Committee, Gary S. Jensen, the Company's
controller, has resigned, which resignation will be effective on February 15,
2005. The Audit Committee has completed its determinations of responsibility for
the financial statement matters described above which were reflected in the 2004
Form 10-K, with the exception of conclusions concerning the responsibility for
matters relating to the Company's accounting treatment of certain recoveries
from vitamin manufacturers which are being addressed by a separate committee of
the Board.
As the Company continues to respond to the SEC's investigation, the U.S.
Attorney's inquiry and the Audit Committee's internal review, there can be no
assurance that additional restatements will not be required, that the historical
financial statements included in the 2004 Form 10-K, the Form 10-Q for the
period ended September 30, 2004 or this Form 10-Q will not change or require
amendment, or that additional disciplinary actions would not be required in such
circumstances. In addition, the SEC's investigation, the U.S. Attorney's inquiry
and the Audit Committee may identify new issues, or make additional findings if
it receives additional information, that may impact the Company's financial
statements and the scope of the restatements described in the 2004 Form 10-K,
the Form 10-Q for the period ended September 30, 2004 and this Form 10-Q.
In connection with the SEC's formal investigation, a committee of the
Board of Directors, with the assistance of independent counsel, is separately
conducting an internal review to assign responsibility for matters relating to
the Company's accounting treatment of certain recoveries from vitamin
manufacturers. In the 2004 Form 10-K, as part of the Audit Committee's internal
review, the Company reversed its previous recognition of estimated recoveries
from vitamin manufacturers for amounts overcharged in prior years and recognized
the income from such recoveries as a special item in the period cash was
received from the manufacturers. The SEC staff had previously advised the
Company that, in its view, the Company did not have an appropriate basis for
recognizing the income in advance of receiving the cash. The Company is
responding to the separate committee internal review and providing all
information required.
The conclusions of the Audit Committee's internal review to date with
respect to financial statement matters are set forth in Notes 1 and 2 of "Notes
to the Consolidated Financial Statements" included in the 2004 Form 10-K and
additional information is set forth in Note 1 of "Notes to Condensed
Consolidated Financial Statements" to this Form 10-Q.
The SEC investigation, the U.S. Attorney inquiry, the Audit Committee
internal review and the separate committee internal review remain ongoing. While
the Company is continuing in its efforts to respond to these inquiries and
provide all information required, the Company cannot predict the outcome of the
SEC investigation, the U.S. Attorney inquiry, the Audit Committee internal
review or the separate committee internal review. The outcome of the SEC
investigation, the U.S. Attorney inquiry and any related legal and
administrative proceedings could include the institution of administrative,
civil injunctive or criminal proceedings involving the Company and/or current or
former Company employees, officers and/or directors, as well as the imposition
of fines and other penalties, remedies and sanctions.
FTC Investigation
In December 2004, the Company received a request for documents from the
Federal Trade Commission ("FTC") that asks the Company to voluntarily produce
certain documents to the FTC. The document request, which does not allege any
wrongdoing, is part of an FTC non-public investigation to determine whether the
Company may be engaging in anticompetitive practices with other wholesale drug
distributors in order to limit competition for provider customers seeking
distribution services. The Company is not aware of the scope of the FTC
investigation as it relates to other wholesale drug distributors. The Company is
in the process of responding to the FTC request. Because the investigation is at
an early stage, the Company cannot predict its outcome or its effect, if any, on
the Company's business.
Page 42
Other Matters
In addition to the legal proceedings disclosed above, 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
as well as litigation in connection with future and prior acquisitions. The
Company intends to vigorously defend itself against this other litigation and
does not currently believe that the outcome of this other litigation will have a
material adverse effect on the Company's financial position, liquidity or
results of operations.
The health care industry is highly regulated, and government agencies
continue to increase their scrutiny over certain practices affecting government
programs and otherwise. From time to time, the Company receives subpoenas or
requests for information from various government agencies. The Company generally
responds to such subpoenas and requests in a timely and thorough manner, which
responses sometimes require considerable time and effort and can result in
considerable costs being incurred by the Company. The Company expects to incur
additional costs in the future in connection with existing and future requests.
ITEM 2: UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
The following table provides information about purchases the Company made
of its Common Shares during the quarter ended December 31, 2004:
ISSUER PURCHASES OF EQUITY SECURITIES
Total Number of
Shares Purchased Approximate Dollar
Total Number as Part of Value of Shares that
of Shares Average Price Publicly Announced May Yet Be Purchased
Period Purchased Paid per Share Program Under the Program
- ------------------- ------------ -------------- ------------------ --------------------
October 1-31, 2004 -- -- -- --
November 1-30, 2004 73,164(1) $51.71 -- --
December 1-31, 2004 5,035(2) $58.15 -- --
------ ------ ---- ----
Total 78,199 $52.12 -- --
====== ====== ==== ====
(1) Reflects Common Shares owned and tendered by an employee and a director to
meet the exercise price and, in the case of the employee, the tax withholding
for option exercises.
(2) Reflects Common Shares repurchased by the Company from a subsidiary's
profit-sharing plan that was terminated.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The following matters were submitted to a vote of security holders at the
Company's 2004 Annual Meeting of Shareholders held on December 8, 2004.
VOTES AUTHORITY
CAST FOR WITHHELD
----------- ----------
1. Election of Directors:
George H. Conrades 361,860,982 28,315,330
Robert L. Gerbig 361,618,659 28,557,653
Richard C. Notebaert 332,138,122 58,038,190
BROKER
FOR AGAINST ABSTENTIONS NON-VOTES
----------- ---------- ----------- ----------
2. Amendment of the Company's
Performance-Based Incentive
Compensation Plan and approval
of the material terms of the
plan, as amended 347,403,596 39,761,799 3,010,917 --
3. Proposal from shareholder on
annual election of directors 277,767,855 57,029,921 3,350,834 52,027,702
Page 43
ITEM 5: OTHER INFORMATION
The Company entered into an amendment, effective February 4, 2005, to an
employment agreement with George L. Fotiades, the Company's President and Chief
Operating Officer, as part of an annual review of Mr. Fotiades' compensation by
the Human Resources and Compensation Committee of the Company's Board of
Directors. The amendment reduces Mr. Fotiades' annual bonus target from 160% to
140% of annual base salary payable under the terms of the bonus plan for which
Mr. Fotiades is eligible, increases Mr. Fotiades' annual base salary from
$725,000 to $790,000, and discontinues an automobile allowance received by Mr.
Fotiades of approximately $25,000 per year.
ITEM 6: EXHIBITS
Exhibit
Number Exhibit Description
- ------- --------------------------------------------------------------------------------------------
10.01 Stock Incentive Plan, as amended
10.02 Amended and Restated Directors' Stock Option Plan, as amended
10.03 Form of Nonqualified Stock Option Agreement under the Amended and Restated Equity Incentive
Plan, as amended, for manual signature
10.04 Form of Nonqualified Stock Option Agreement under the Amended and Restated Equity Incentive
Plan, as amended, for electronic signature
10.05 Form of Restricted Share Units Agreement under the Amended and Restated Equity Incentive
Plan, as amended
10.06 Form of Directors' Stock Option Agreement under the Amended and Restated Equity Incentive
Plan, as amended
10.07 Form of Directors' Stock Option Agreement under the Outside Directors Equity Incentive Plan
10.08 Amendment, dated and effective as of February 4, 2005, to Employment Agreement, dated and
effective as of February 1, 2004, between the Registrant and George L. Fotiades
31.01 Certification of Chairman and Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
31.02 Certification of 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 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
99.02 Third Amendment to the Cardinal Health Profit Sharing, Retirement and Savings Plan (As
amended and restated July 1, 2002)
99.03 Cardinal Health 401(k) Savings Plan, as amended and restated effective as of January 1, 2005
99.04 Cardinal Health 401(k) Savings Plan for Employees of Puerto Rico, as amended and restated
effective as of January 1, 2005
Page 44
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 9, 2005
/s/ Robert D. Walter
------------------------------------
Robert D. Walter
Chairman and Chief Executive Officer
/s/ J. Michael Losh
------------------------------------
J. Michael Losh
Chief Financial Officer
Page 45