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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 March 31, 2005 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 April 30, 2005 was as follows:
Common Shares, without par value: 428,258,980
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 Nine Months
Ended March 31, 2005 and 2004 (unaudited).......................................... 3
Condensed Consolidated Balance Sheets at March 31, 2005 and
June 30, 2004 (unaudited).......................................................... 4
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended
March 31, 2005 and 2004 (unaudited)................................................ 5
Notes to Condensed Consolidated Financial Statements............................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.............................................................. 32
Item 3. Quantitative and Qualitative Disclosures about Market Risk......................... 41
Item 4. Controls and Procedures............................................................ 41
Part II. Other Information:
Item 1. Legal Proceedings.................................................................. 43
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds........................ 46
Item 5. Other Information.................................................................. 46
Item 6. Exhibits........................................................................... 47
* 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 NINE MONTHS ENDED
MARCH 31, MARCH 31,
2005 2004 2005 2004
---------- ---------- ---------- ----------
Revenue $ 19,103.0 $ 16,391.8 $ 55,453.6 $ 48,130.8
Cost of products sold 17,756.2 15,108.4 51,813.8 44,613.6
---------- ---------- ---------- ----------
Gross margin 1,346.8 1,283.4 3,639.8 3,517.2
Selling, general and administrative expenses 703.1 608.9 2,095.8 1,744.5
Impairment charges and other 16.2 (0.6) 103.0 (7.0)
Special items - restructuring charges 25.8 4.9 138.4 25.1
- merger charges 10.4 7.2 37.5 23.6
- other 7.1 (3.8) 2.4 (30.7)
---------- ---------- ---------- ----------
Operating earnings 584.2 666.8 1,262.7 1,761.7
Interest expense and other 40.8 28.2 95.1 82.1
---------- ---------- ---------- ----------
Earnings before income taxes, discontinued operations
and cumulative effect of change in accounting 543.4 638.6 1,167.6 1,679.6
Provision for income taxes 175.8 208.5 378.4 552.4
---------- ---------- ---------- ----------
Earnings from continuing operations before
cumulative effect of change in accounting 367.6 430.1 789.2 1,127.2
Earnings/(loss) from discontinued operations
(net of tax $1.2 and $0.6, respectively, for the
three months ended March 31,2005 and 2004
and $(2.5) and $4.8, respectively, for the nine
months ended March 31, 2005 and 2004) (1.9) (0.8) 3.8 (7.7)
Cumulative effect of change in accounting - - - (38.5)
---------- ---------- ---------- ----------
Net earnings $ 365.7 $ 429.3 $ 793.0 $ 1,081.0
========== ========== ========== ==========
Basic earnings per Common Share:
Continuing operations $ 0.85 $ 1.00 $ 1.83 $ 2.59
Discontinued operations - (0.01) 0.01 (0.02)
Cumulative effect of change in accounting - - - (0.09)
---------- ---------- ---------- ----------
Net basic earnings per Common Share $ 0.85 $ 0.99 $ 1.84 $ 2.48
========== ========== ========== ==========
Diluted earnings per Common Share:
Continuing operations $ 0.84 $ 0.99 $ 1.81 $ 2.56
Discontinued operations - (0.01) 0.01 (0.02)
Cumulative effect of change in accounting - - - (0.09)
---------- ---------- ---------- ----------
Net diluted earnings per Common Share $ 0.84 $ 0.98 $ 1.82 $ 2.45
========== ========== ========== ==========
Weighted average number of Common Shares outstanding:
Basic 431.8 433.4 431.7 435.7
Diluted 437.8 439.0 436.7 441.3
Cash dividends declared per Common Share $ 0.03 $ 0.03 $ 0.09 $ 0.09
See notes to condensed consolidated financial statements.
Page 3
CARDINAL HEALTH, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(IN MILLIONS)
MARCH 31, JUNE 30,
2005 2004
--------- ---------
ASSETS
Current assets:
Cash and equivalents $ 1,549.5 $ 1,096.0
Trade receivables, net 3,293.0 3,432.7
Current portion of net investment in sales-type leases 215.3 202.1
Inventories 7,771.3 7,471.3
Prepaid expenses and other 871.9 795.4
Assets held for sale from discontinued operations 28.2 60.4
--------- ---------
Total current assets 13,729.2 13,057.9
--------- ---------
Property and equipment, at cost 4,492.9 4,300.1
Accumulated depreciation and amortization (2,120.9) (1,936.1)
--------- ---------
Property and equipment, net 2,372.0 2,364.0
Other assets:
Net investment in sales-type leases, less current portion 640.9 546.0
Goodwill and other intangibles, net 4,998.2 4,938.8
Other 398.2 462.4
--------- ---------
Total $22,138.5 $21,369.1
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Notes payable and other short-term borrowings $ 81.6 $ 5.6
Current portion of long-term obligations 507.0 855.0
Accounts payable 7,613.1 6,432.4
Other accrued liabilities 1,802.7 2,021.3
Liabilities from discontinued operations 44.6 55.1
--------- ---------
Total current liabilities 10,049.0 9,369.4
--------- ---------
Long-term obligations, less current portion 2,303.1 2,834.7
Deferred income taxes and other liabilities 1,112.2 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 - 475.6
million shares and 473.1 million shares, respectively,
at March 31, 2005 and June 30, 2004 2,726.8 2,653.8
Retained earnings 8,642.4 7,888.0
Common Shares in treasury, at cost, 45.7 million shares
and 42.2 million shares, respectively, at
March 31, 2005 and June 30, 2004 (2,768.7) (2,588.1)
Other comprehensive income 95.1 28.9
Other (21.4) (6.3)
--------- ---------
Total shareholders' equity 8,674.2 7,976.3
--------- ---------
Total $22,138.5 $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)
NINE MONTHS ENDED
MARCH 31,
2005 2004
---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Earnings from continuing operations before cumulative effect of
change in accounting $ 789.2 $ 1,127.2
Adjustments to reconcile earnings from continuing operations before
cumulative effect of change in accounting to net cash from operations:
Depreciation and amortization 300.9 220.4
Asset impairments 172.9 5.5
Provision for bad debts 8.6 1.6
Change in operating assets and liabilities, net of effects
from acquisitions:
Decrease/(increase) in trade receivables 143.3 (613.9)
Increase in inventories (301.2) (943.8)
Increase in net investment in sales-type leases (108.1) (65.4)
Increase in accounts payable 1,175.2 1,611.9
Other accrued liabilities and operating items, net (129.9) (8.1)
---------- ----------
Net cash provided by operating activities 2,050.9 1,335.4
---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of subsidiaries, net of cash acquired (273.2) (561.2)
Proceeds from sale of property, equipment and other assets 18.7 8.3
Additions to property and equipment (288.3) (272.0)
Proceeds from sale of discontinued operations 39.5 5.1
---------- ----------
Net cash used in investing activities (503.3) (819.8)
---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net change in commercial paper and short-term debt (558.1) (0.9)
Reduction of long-term obligations (1,617.0) (442.8)
Proceeds from long-term obligations, net of issuance costs 1,261.2 86.7
Proceeds from issuance of Common Shares 87.2 144.3
Purchase of treasury shares (228.5) (1,460.3)
Dividends on Common Shares (38.9) (39.4)
---------- ----------
Net cash used in financing activities (1,094.1) (1,712.4)
---------- ----------
NET INCREASE/(DECREASE) IN CASH AND EQUIVALENTS 453.5 (1,196.8)
CASH AND EQUIVALENTS AT BEGINNING OF PERIOD 1,096.0 1,724.0
---------- ----------
CASH AND EQUIVALENTS AT END OF PERIOD $ 1,549.5 $ 527.2
========== ==========
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 was notified in
April 2005 that certain current and former employees and directors received
subpoenas from the SEC requesting the production of documents. The subject
matter of these requests is consistent with the subject matter of the subpoenas
the Company had previously received from the SEC. 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 taken 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 affected 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. In connection with the determinations made by the Audit Committee,
Gary S. Jensen, the Company's controller, resigned, which resignation was
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.
Page 6
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 Forms 10-Q for the
periods ended September 30, 2004 and December 31, 2004, or this Form 10-Q will
not change or require amendment, or that additional disciplinary actions will
not be required in such circumstances. In addition, as the SEC's investigation,
the U.S. Attorney's inquiry 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 Forms 10-Q for the periods ended September 30, 2004 and December 31, 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 and this internal review is continuing. 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 Board 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
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 three 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
Third Quarter (0.3)
------
First Nine Months $ 2.5
======
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.
Page 7
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 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
$5.3 million reduction of operating earnings during the fourth quarter of fiscal
2004 to adjust for premature revenue recognition that was determined to have
occurred within that quarter. These revenues and operating earnings were
recognized in the first quarter of fiscal 2005 upon completion of the applicable
installation process.
The Company does not maintain accounting records that allow it to
determine the precise impact of this matter on prior quarters. However, during
the investigation there was sufficient data accumulated independent of the
accounting systems to estimate the impact using a variety of methods. These
estimation methods were utilized solely to test the materiality of prior periods
and are not necessarily indicative of what the actual results would have been.
If the results of the June 30, 2004 interviews were applied to all quarters of
fiscal 2004 (i.e., utilizing the 10.8% exception rate) the net increase in
revenue and operating earnings for the first three quarters of fiscal 2004, and
the related percentage of the former Automation and Information Services
segment's reported amounts, would have been as follows:
Operating
($ 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%
Third Quarter (1.9) (1.1%) (1.2) (1.7%)
----- -----
First Nine Months $ 1.9 0.4% $ 1.2 0.6%
===== =====
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
Page 8
table above, the percentage change in operating earnings for the first, second
and third quarters of fiscal 2004 would be 2.1%, 0.7% and (5.5%), 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 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 and third quarters of fiscal 2005, the
Company's internal audit function 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 by the internal audit function during the second and third
quarters of fiscal 2005 did not indicate any additional occurrences of premature
revenue recognition as described above.
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 three 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 three quarters of fiscal 2004 is reflected in the table below.
Page 9
The following table summarizes the restatement impact on previously
reported net earnings as defined above for the first three quarters of fiscal
2004:
Misapplication Total
(in millions) of GAAP Errors Restatement
- ------------- -------------- ------ -----------
FISCAL 2004
First Quarter $(0.3) $ (4.5) $ (4.8)
Second Quarter (0.4) (4.5) (4.9)
Third Quarter - (5.7) (5.7)
----- ------ ------
First Nine Months $(0.7) $(14.7) $(15.4)
===== ====== ======
The impact of these restatements on both basic and diluted earnings per
Common Share from continuing operations for the three and nine months ended
March 31, 2004 was a decrease of $0.01 and $0.03, 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.
The SEC investigation, the U.S. Attorney inquiry, the Audit Committee
internal review and the separate Board 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 Board 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 certain
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.
Page 10
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 adoption of this
statement is not expected 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 expected to have a material impact
on the Company's financial position or results of operations.
In December 2004, the FASB 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.
In December 2004, the FASB 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 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 Board ("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 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: (a) 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 (b) 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
Page 11
option exercises. However, the amount of operating cash flows recognized in the
nine months ended March 31, 2005 and 2004 for such excess tax deductions were
$11.2 million and $40.8 million, respectively.
In March 2005, the FASB issued FASB Interpretation No. 47, "Accounting for
Conditional Asset Retirement Obligations." This Interpretation clarifies the
term of conditional asset retirement obligations as used in SFAS No. 143,
"Accounting for Asset Retirement Obligations." This Interpretation is effective
no later than the end of fiscal years ending after December 15, 2005. The
adoption of this Interpretation is not expected to have a material impact on
the Company's financial position or results of operations.
ACCOUNTING FOR STOCK-BASED COMPENSATION. At March 31, 2005, 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 amended options 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 Nine Months
Ended Ended
March 31, March 31,
-------------------- -------------------
(in millions) 2005 2004 2005 2004
- ------------- -------- --------- -------- --------
Net earnings, as reported $ 365.7 $ 429.3 $ 793.0 $1,081.0
Stock-based employee compensation expense
included in net earnings, net of related tax effects 1.5 0.6 4.6 1.5
Total stock-based employee compensation expense
determined under fair value method for all awards,
net of related tax effects (1) (38.8) (24.0) (109.4) (77.3)
-------- -------- -------- --------
Pro forma net earnings $ 328.4 $ 405.9 $ 688.2 $1,005.2
======== ======== ======== ========
For the Three Months For the Nine Months
Ended Ended
March 31, March 31,
-------------------- -------------------
2005 2004 2005 2004
-------- --------- -------- --------
Basic earnings per Common Share:
As reported $ 0.85 $ 0.99 $ 1.84 $ 2.48
Pro forma basic earnings per Common Share $ 0.76 $ 0.94 $ 1.59 $ 2.31
Diluted earnings per Common Share:
As reported $ 0.84 $ 0.98 $ 1.82 $ 2.45
Pro forma diluted earnings per Common Share (2) $ 0.76 $ 0.93 $ 1.59 $ 2.29
(1) The total stock-based employee compensation expense was adjusted to
include gross employee stock purchase plan expense of $3.0 million and
$3.1 million, respectively, for the three months ended March 31, 2005 and
2004 and $8.8 million and $10.4 million, respectively, for the nine months
ended March 31, 2005 and 2004.
(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, unvested restricted shares and unvested restricted share units,
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 nine months ended March 31, 2005 and
2004:
For the Three Months Ended For the Nine Months Ended
March 31, March 31,
-------------------------- -------------------------
(in millions) 2005 2004 2005 2004
- ------------- ---- ---- ---- ----
Weighted-average Common Shares - basic 431.8 433.4 431.7 435.7
Effect of dilutive securities:
Employee stock options, unvested
restricted shares and share units 6.0 5.6 5.0 5.6
----- ----- ----- -----
Weighted-average Common Shares - diluted 437.8 439.0 436.7 441.3
===== ===== ===== =====
The potentially dilutive employee stock options that were antidilutive for
the three months ended March 31, 2005 and 2004 were 27.9 million and 19.2
million, respectively, and for the nine months ended March 31, 2005 and 2004
were 28.3 million and 20.2 million, respectively.
In December 2004, the Company's Board of Directors authorized the
repurchase of Common Shares up to an aggregate amount of $500.0 million as
management deems appropriate. Pursuant to this authorization, the Company
repurchased approximately 4.2 million Common Shares having an aggregate cost of
approximately $241.9 million during the three months ended March 31, 2005. The
average price paid per Common Share was $57.29. The repurchased shares are held
in treasury to be used for general corporate purposes.
In February 2004, the Company's Board of Directors authorized the
repurchase of Common Shares up to an aggregate amount of $500.0 million.
Pursuant to this authorization, the Company repurchased approximately 6.9
million Common Shares under an accelerated share repurchase program having an
aggregate cost of approximately $460.3 million during the three months ended
March 31, 2004. The average price paid per Common Share was $66.80. The share
repurchase program was completed on May 11, 2004 at which time the Company
settled the forward contract associated with the transaction for $22.5 million
in cash. The resulting final volume weighted average price per share was $70.07.
The repurchased shares are held in treasury to be used for general corporate
purposes.
4. COMPREHENSIVE INCOME
The following is a summary of the Company's comprehensive income for the
three and nine months ended March 31, 2005 and 2004:
Three Months Ended Nine Months Ended
March 31, March 31,
------------------- ------------------
(in millions) 2005 2004 2005 2004
- ------------- -------- -------- -------- --------
Net earnings $ 365.7 $ 429.3 $ 793.0 $1,081.0
Foreign currency translation adjustment (53.9) 26.1 65.2 76.0
Net unrealized gain/(loss) on derivative
instruments (2.3) 3.1 - 3.3
Unrealized gain/(loss) on investment - (0.1) 1.0 (0.3)
-------- -------- -------- --------
Total comprehensive income $ 309.5 $ 458.4 $ 859.2 $1,160.0
======== ======== ======== ========
Page 13
5. SPECIAL ITEMS
The following is a summary of the special items for the three and nine
months ended March 31, 2005 and 2004.
Three Months Ended Nine Months Ended
March 31, March 31,
------------------ ------------------
(in millions, except for Diluted EPS amounts) 2005 2004 2005 2004
- --------------------------------------------- -------- -------- -------- --------
Restructuring costs $ 25.8 $ 4.9 $ 138.4 $ 25.1
Merger-related costs 10.4 7.2 37.5 23.6
Litigation settlements, net - (3.8) (21.2) (30.7)
Other special items 7.1 - 23.6 -
-------- -------- -------- --------
Total special items $ 43.3 $ 8.3 $ 178.3 $ 18.0
Tax effect of special items (1) (14.8) (3.4) (58.7) (7.7)
-------- -------- -------- --------
Net earnings effect of special items $ 28.5 $ 4.9 $ 119.6 $ 10.3
======== ======== ======== ========
Net decrease on Diluted EPS $ 0.06 $ 0.01 $ 0.27 $ 0.02
======== ======== ======== ========
(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 Nine Months Ended
March 31, March 31,
------------------ -----------------
(in millions) 2005 2004 2005 2004
- ------------- ------- ------- ------- -------
Restructuring costs:
Global restructuring program:
Pharmaceutical Distribution and Provider Services $ 5.2 $ - $ 8.6 $ -
Medical Products and Services 4.4 - 23.8 -
Pharmaceutical Technologies and Services 2.3 - 75.3 -
Clinical Technologies and Services - - 0.7 -
Other 11.2 - 19.7 -
Other restructuring programs:
Medical Products and Services 2.3 1.8 5.0 7.1
Pharmaceutical Technologies and Services - 2.2 4.0 15.5
Other 0.4 0.9 1.3 2.5
------- ------- ------- -------
Total restructuring costs $ 25.8 $ 4.9 $ 138.4 $ 25.1
======= ======= ======= =======
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 tables summarize the significant costs recorded within
special items for the three and nine months ended March 31, 2005 in connection
with Phase I, and the year in which the project activities are expected
to be completed, the expected headcount reductions and the actual headcount
reductions to date.
Page 14
Three Months Ended Nine Months Ended
(in millions) March 31, 2005 March 31, 2005
- ------------- ------------------ -----------------
Global restructuring program costs:
Pharmaceutical Distribution and Provider Services
Employee-related costs (1) $ 1.4 $ 2.6
Facility exit and other costs (2) 3.8 6.0
------ ------
Total Pharmaceutical Distribution and Provider Services 5.2 8.6
Medical Products and Services
Employee-related costs (1) 0.5 17.3
Facility exit and other costs (2) 3.9 6.5
------ ------
Total Medical Products and Services 4.4 23.8
Pharmaceutical Technologies and Services
Employee-related costs (1) 1.8 7.0
Asset impairments (3) - 67.5
Facility exit and other costs (2) 0.5 0.8
------ ------
Total Pharmaceutical Technologies and Services 2.3 75.3
Clinical Technologies and Services
Employee-related costs (1) - 0.7
------ ------
Total Clinical Technologies and Services - 0.7
Other
Facility exit and other costs (2) 11.2 19.7
------ ------
Total Other 11.2 19.7
------ ------
Total global restructuring program costs $ 23.1 $128.1
====== ======
(1) Employee-related costs consist primarily of severance accrued upon either
communication of terms to employees or management's commitment to the
restructuring plan when a defined severance plan exists. Outplacement
services provided to employees who have been involuntarily terminated and
duplicate payroll costs during transition periods are also included within
this classification.
(2) Facility exit and other costs consist of accelerated depreciation,
equipment relocation costs, project consulting fees, and costs associated
with restructuring the Company's delivery of information technology
infrastructure services.
(3) Asset impairments were recorded in connection with the Company's plan to
sell two facilities and transfer business from a third facility, as
described in more detail below.
Headcount Reduction
Expected -----------------------------
Fiscal Year of As of
Completion (1) Expected(2) March 31, 2005
-------------- ----------- --------------
Global restructuring program:
Pharmaceutical Distribution and Provider Services 2006 75 70
Medical Products and Services 2008 2,675 240
Pharmaceutical Technologies and Services 2007 810 330
Clinical Technologies and Services 2005 20 15
Other 2006 - -
----- ---
Total global restructuring program 3,580 655
===== ===
(1) Expected fiscal year in which the last project will be completed.
(2) Represents projects that have been initiated as of March 31, 2005.
Page 15
The Company incurred costs of $5.2 million and $8.6 million, respectively,
related to restructuring projects associated with Phase I initiated within the
Pharmaceutical Distribution and Provider Services segment during the three and
nine months ended March 31, 2005. The projects within this segment include the
closing of two distribution centers and consolidating them into existing
locations, the closing of multiple company-owned pharmacies within Medicine
Shoppe International Inc., and the outsourcing of information technology
functions.
The Company incurred costs of $4.4 million and $23.8 million,
respectively, related to restructuring projects associated with Phase I
initiated within the Medical Products and Services segment during the three and
nine months ended March 31, 2005. The projects within this segment include
centralizing of management functions within the distribution business,
transitioning to a customer needs-based sales representative model in the
ambulatory care business, and improvements within the manufacturing business via
consolidation or outsourcing of production from higher cost facilities to lower
cost facilities.
The Company incurred costs of $2.3 million and $75.3 million,
respectively, related to restructuring projects associated with Phase I
initiated within the Pharmaceutical Technologies and Services segment during the
three and nine months ended March 31, 2005. The projects within this segment
include planned reductions of headcount within existing operations and
consolidation of overlapping operations. The costs for the nine months ended
March 31, 2005 also include $67.5 million of asset impairment charges. Of the
$67.5 million in asset impairments, the Company incurred costs of approximately
$67.2 million during the nine months ended March 31, 2005 related to its plan to
sell two facilities and transfer business from a third facility. The Company
plans to sell a portion of the businesses housed in the two facilities to be
sold and transfer the remaining portion of the businesses to other existing
Company facilities. 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 second quarter of
fiscal 2005, 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 second quarter of fiscal 2005. The Company also
committed to a plan to transfer production from one of its Pharmaceutical
Technologies and Services facilities to another existing Company facility in the
second quarter of fiscal 2005. Production is expected to continue at the
facility through fiscal 2007. The Company recorded an asset impairment of $24.6
million in the second quarter of fiscal 2005 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 nine months ended March 31, 2005. The costs were
incurred in connection with a planned headcount reduction.
During the three and nine months ended March 31, 2005, the Company
incurred costs of $11.2 million and $19.7 million, respectively, related to
restructuring projects associated with Phase I that impacted multiple segments.
These costs related primarily to project consulting fees incurred as a result of
design and implementation of the Company's overall restructuring plan and
restructuring the Company's delivery of information technology infrastructure
services.
OTHER RESTRUCTURING PROGRAMS. Separate from the global restructuring
program discussed above, during the three and nine months ended March 31, 2005,
the Company incurred costs of $2.3 million and $5.0 million, respectively, to
restructure operations (both domestically and internationally) within the
Medical Products and Services segment, as compared to $1.8 million and $7.1
million, respectively, in the same periods of 2004. The Company incurred costs
of $4.0 million during the nine months ended March 31, 2005 as compared to $2.2
million and $15.5 million, respectively, for the three and nine months ended
March 31, 2004 to restructure operations (both domestically and internationally)
within the Pharmaceutical Technologies and Services segment. Included in these
costs for the three and nine months ended March 31, 2004, respectively, were
$1.3 million and $12.2 million in asset impairments 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: (a)
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 severance plan exists; and (b) exit costs,
including asset impairment charges, costs incurred to relocate physical
Page 16
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 2,125 had been terminated as of March 31, 2005.
The restructuring plans within the Pharmaceutical Technologies and Services
segment overall have resulted in the termination of approximately 1,000
employees, all of whom were terminated as of March 31, 2005.
During the three and nine months ended March 31, 2005 the Company incurred
costs of $0.4 million and $1.3 million, respectively, as compared to $0.9
million and $2.5 million, respectively, from the comparable periods of 2004
related to restructuring plans that impacted more than one segment. The costs
incurred in fiscal 2005 relate 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
2004 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 March 31, 2005.
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 nine months ended March 31, 2005 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 nine months ended March 31, 2004 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 Nine Months Ended
March 31, March 31,
------------------ -----------------
(in millions) 2005 2004 2005 2004
- ------------- ------ ------ ------ ------
Merger-related costs:
Employee-related costs $ 4.6 $ 1.4 $ 13.6 $ 8.5
Asset impairments and other exit costs 0.9 0.4 1.5 0.9
Debt issuance cost write-off - - 8.8 -
Integration costs and other 4.9 5.4 13.6 14.2
------ ------ ------ ------
Total merger-related costs $ 10.4 $ 7.2 $ 37.5 $ 23.6
====== ====== ====== ======
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 nine months ended March 31, 2005,
the Company incurred employee-related costs of $4.6 million and $13.6 million,
respectively. The costs incurred in the three and nine months ended March 31,
2005 consisted primarily of severance and retention bonuses accrued over the
service period as a result of the Alaris and Syncor acquisitions. For the three
and nine months ended March 31, 2004, the employee-related costs of $1.4 million
and $8.5 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 nine months
ended March 31, 2005, the Company incurred asset impairments and other exit
costs of $0.9 million and $1.5 million, respectively, as compared to $0.4
million and $0.9 million, respectively, during the comparable periods in 2004.
The asset impairment costs incurred during the three months ended March 31, 2005
related primarily to fixed asset disposals as a result of the Alaris
acquisition. The asset impairment costs for the nine months ended March 31, 2005
related primarily to fixed asset disposals as a result of the Alaris acquisition
and facility closures associated with the Syncor acquisition. The asset
impairment costs incurred during the three and nine months ended March 31, 2004
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 nine months ended March 31, 2004.
DEBT ISSUANCE COST WRITE-OFF. During the nine months ended March 31, 2005,
the Company incurred charges of $8.8 million related to the write-off of debt
issuance costs and other debt tender offer costs related to the Company's
Page 17
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 nine months ended March 31, 2005 of $4.9 million and
$13.6 million, respectively, as compared to $5.4 million and $14.2 million,
respectively, during the comparable periods in 2004. The costs included in this
category generally relate to expenses incurred to integrate the merged or
acquired company's operations and systems into the Company's pre-existing
operations and systems. These costs include, but are not limited to, the
integration of information systems, employee benefits and compensation,
accounting/finance, tax, treasury, internal audit, risk management, compliance,
administrative services, sales and marketing and others. These costs were offset
during the nine months ended March 31, 2004 by income of approximately $3.0
million related to two foreign currency hedges purchased in connection with the
acquisition of The Intercare Group, plc (which has been given the legal
designation of Cardinal Health U.K. 432 Limited and is referred to in this Form
10-Q as "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 nine months ended March 31, 2004, 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 nine months ended March 31, 2005 and 2004.
Three Months Ended Nine Months Ended
March 31, March 31,
------------------- -----------------
(in millions) 2005 2004 2005 2004
- ------------- -------- ----- -------- ------
Litigation settlements, net:
Vitamin litigation $ - (3.8) $ (0.6) (6.5)
Pharmaceutical manufacturer antitrust litigation - - (20.6) (24.2)
-------- ---- ------- -----
Total litigation settlements, net $ - (3.8) $ (21.2) (30.7)
======== ==== ======= =====
VITAMIN LITIGATION. During the nine months ended March 31, 2005 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 three and nine months ended March 31, 2004, the Company
recorded income of $3.8 million and $6.5 million, respectively, resulting from
the recovery of such claims. The total recovery of such claims through March 31,
2005 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.
PHARMACEUTICAL MANUFACTURER ANTITRUST LITIGATION. During the nine months
ended March 31, 2005, the Company recorded income of $20.6 million, as compared
to income of $24.2 million for the comparable period ending March 31, 2004,
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 such claims through
March 31, 2005 was $76.5 million (net of attorney fees, payments due to other
interested parties and expenses withheld).
OTHER SPECIAL ITEMS
During the three and nine months ended March 31, 2005 the Company incurred
costs recorded within other special items totaling $7.1 million and $23.6
million, respectively. These costs primarily relate to legal fees and document
preservation and production costs incurred in connection with the SEC
investigation and the Audit Committee internal review and related matters. For
further information regarding these matters, see Note 1.
Page 18
SPECIAL ITEMS ACCRUAL ROLLFORWARD
The following table summarizes activity related to the liabilities
associated with the Company's special items during the nine months ended March
31, 2005.
Nine Months Ended
(in millions) March 31, 2005
- ------------- -----------------
Balance at June 30, 2004 $ 39.9
Additions (1) 199.5
Payments (175.6)
-------
Balance at March 31, 2005 $ 63.8
=======
(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
nine months ended March 31, 2005.
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 and $11.0 million related to the closing of certain facilities.
As of March 31, 2005, 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 March 31, 2005, the
Company had paid $13.6 million of employee related costs, $3.0 million
associated with the facility closures and $0.8 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 $196.1 million (approximately $128 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 amount of $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. During the second quarter of
fiscal 2005, 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 March 31,
2005 were $46.4 million of standby letters of credit issued on behalf of the
Company.
Page 19
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, 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. In June 2004, the Company acquired
approximately 98.7% of Alaris' outstanding common stock, and in July 2004,
Alaris merged with a subsidiary of the Company to complete the transaction. 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.
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 operates
and franchises 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 hospitals 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 items and 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
impairment charges. The accounting policies of the segments are the same as
those described in the summary of significant accounting policies.
Page 20
The following tables include revenue and operating earnings for the three
and nine months ended March 31, 2005 and 2004 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 Nine Months Ended
March 31, March 31,
-------------------------- -------------------------
(in millions) 2005 2004 2005 2004
- ------------- --------- --------- --------- --------
Revenue:
Pharmaceutical Distribution and Provider Services $15,607.6 $13,176.7 $45,068.0 $38,768.6
Medical Products and Services 2,472.6 2,303.8 7,292.5 6,738.4
Pharmaceutical Technologies and Services (1) 728.5 709.8 2,193.9 2,064.3
Clinical Technologies and Services (2) (3) 522.4 395.1 1,593.3 1,126.3
Corporate (4) (228.1) (193.6) (694.1) (566.8)
--------- --------- --------- ---------
Total revenue $19,103.0 $16,391.8 $55,453.6 $48,130.8
========= ========= ========= =========
For the Three Months Ended For the Nine Months Ended
March 31, March 31,
-------------------------- -------------------------
(in millions) 2005 2004 2005 2004
- ------------- -------- -------- -------- --------
Operating earnings:
Pharmaceutical Distribution and Provider Services $ 344.1 $ 319.8 $ 720.8 $ 784.5
Medical Products and Services 199.5 193.1 507.7 524.0
Pharmaceutical Technologies and Services (1) 82.4 113.9 252.1 333.7
Clinical Technologies and Services (2) (3) 65.3 86.5 187.2 250.0
Corporate (5) (107.1) (46.5) (405.1) (130.5)
-------- -------- -------- --------
Total operating earnings $ 584.2 $ 666.8 $1,262.7 $1,761.7
======== ======== ======== ========
The following table includes total assets at March 31, 2005 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 March 31, At June 30,
(in millions) 2005 2004
- ------------- ------------ -----------
Assets:
Pharmaceutical Distribution and Provider Services $ 9,489.5 $ 8,512.2
Medical Products and Services 4,064.2 3,829.6
Pharmaceutical Technologies and Services 4,353.8 4,389.3
Clinical Technologies and Services 3,670.5 3,647.7
Corporate (6) 560.5 990.3
---------- ----------
Total assets $ 22,138.5 $ 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 impact of foreign exchange rate
allocations on the Pharmaceutical Technologies and Services segment's
revenue for the three and nine months ended March 31, 2004 was a negative
$7.6 million and a positive $8.9 million, respectively. The positive
impact on operating earnings for the three and nine months ended March 31,
2004 was $0.8 million and $9.0 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 fiscal
2004, the Pyxis products business sold portions of its leased asset
portfolio, and the proceeds were transferred to Corporate for general
corporate purposes. The Pyxis products business received an allocation
from Corporate in fiscal 2004 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
Page 21
sale of portions of the lease portfolios on both the Pyxis products
business' revenue and operating earnings for the three and nine months
ended March 31, 2004 was $6.0 million and $15.3 million, respectively.
(3) As discussed above, the Clinical Technologies and Services segment was
formed during the first quarter of fiscal 2005 and includes Alaris, 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 $43.3 million and
$8.3 million, respectively, in the three-month periods ended March 31,
2005 and 2004, and $178.3 million and $18.0 million, respectively, for the
nine-month periods ended March 31, 2005 and 2004. See Note 5 for further
discussion of the Company's special items. In addition, corporate
operating earnings include $16.2 million and $103.0 million, respectively,
of operating asset impairments and gains and losses from the sale of
operating and corporate assets during the three and nine months ended
March 31, 2005. In the comparable periods of 2004, corporate operating
earnings include gains of approximately $0.6 million and $7.0 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 March 31, 2005, Allegiance had resolved nearly all
of these cases and had only 16 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 22
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. On April 14,
2005, the Court stayed the action for a period of six months. 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 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, ten 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. On April 22, 2005, the lead plaintiff filed a
consolidated amended complaint naming the
Page 23
Company, certain current and former officers and employees and the Company's
external auditors as defendants. The complaint seeks unspecified money damages
and other unspecified relief against the defendants.
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 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. On April 29, 2005, the lead plaintiff filed a consolidated
amended ERISA complaint naming the Company, certain current and former
directors, officers and employees, the Company's Employee Benefits Policy
Committee and Putnam Fiduciary Trust Company as defendants. The complaint seeks
unspecified money damages and other unspecified relief against the defendants.
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
Page 24
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 the 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. On April 15, 2005, the Court granted the Motion to Dismiss
with prejudice. The lead plaintiff has 30 days to file an appeal.
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
Page 25
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 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 nine months ended March
31, 2005 were as follows:
Pharmaceutical Medical
Distribution Products Pharmaceutical Clinical
and Provider and Technologies and Technologies
(in millions) Services Services Services (1) and Services (2) Total
- ------------- -------------- -------- ---------------- ---------------- --------
Balance at June 30, 2004 (3) $ 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 12.0 7.6 100.2 (16.6) 103.2
Impairment charges (4) - - (15.4) - (15.4)
Goodwill related to the divestiture/
closure of businesses (5) - - (7.3) - (7.3)
Transfer (6) (60.1) - - 60.1 -
-------- -------- -------- -------- --------
Balance at March 31, 2005 $ 162.9 $ 684.8 $1,921.1 $1,631.0 $4,399.8
======== ======== ======== ======== ========
Page 26
(1) 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 $63.8 million. The
remaining amounts represent goodwill acquired from other immaterial
acquisitions,purchase price adjustments and foreign currency translation
adjustments.
(2) The decrease within the Clinical Technologies and Services segment
primarily relates to the reclassification of goodwill to intangibles
within the Alaris business of $19.3 million.
(3) The June 30, 2004 balances for the Automation and Information Services
segment and Alaris were combined under Clinical Technologies and Services.
(4) 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.
(5) This goodwill decrease relates to the sale of the Radiation Management
Services business within the Pharmaceutical Technologies and Services
segment during the second quarter. See Note 12 below for additional
information regarding this sale of business.
(6) 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 March 31, 2005 was
as follows:
Gross Accumulated Net
(in millions) Intangible Amortization Intangible
- ------------- ---------- ------------ ----------
June 30, 2004
Unamortized intangibles
Trademarks and patents $ 183.9 $ 0.4 $ 183.5
-------- -------- --------
Total unamortized intangibles $ 183.9 $ 0.4 $ 183.5
Amortized intangibles
Trademarks and patents $ 162.0 $ 23.0 $ 139.0
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 unamortized intangibles $ 507.8 $ 71.8 $ 436.0
-------- -------- --------
Total intangibles $ 691.7 $ 72.2 $ 619.5
-------- -------- --------
March 31, 2005
Unamortized intangibles
Trademarks and patents $ 184.6 $ 0.4 $ 184.2
-------- -------- --------
Total unamortized intangibles $ 184.6 $ 0.4 $ 184.2
Amortized intangibles
Trademarks and patents $ 168.8 $ 34.5 $ 134.3
Non-compete agreements 31.4 25.6 5.8
Customer relationships 237.5 27.8 209.7
Other 87.2 22.8 64.4
-------- -------- --------
Total unamortized intangibles $ 524.9 $ 110.7 $ 414.2
-------- -------- --------
Total intangibles $ 709.5 $ 111.1 $ 598.4
-------- -------- --------
There were no significant acquisitions of other intangible assets for the
periods presented. Amortization expense for the three and nine months ended
March 31, 2005 was $13.4 million and $40.2 million, respectively, and $4.3
million and $9.0 million, respectively, during the comparable periods of 2004.
Amortization expense for each of the next five fiscal years is estimated
to be:
----- ----- ----- ----- -----
(in millions) 2005 2006 2007 2008 2009
- ------------- ----- ----- ----- ----- -----
Amortization expense $55.0 $53.0 $51.6 $47.2 $45.0
Page 27
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
March 31, 2005, the maximum amount the Company could be required to reimburse
was $396.0 million. Certain of these leases qualified as capital lease
obligations, and accordingly, the Company recorded approximately $81.1 million
of property and equipment offset by long-term liabilities on its balance sheet
at March 31, 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 $1.6 million and $9.9
million, respectively, of impairment charges during the three and nine months
ended March 31, 2005. See Note 11 below for additional information regarding
impairment charges. In accordance with FASB Interpretation No. 45, the Company
has a liability of $4.0 million recorded as of March 31, 2005 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 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 certain asset impairments related to restructurings
in special items, which is included in operating earnings within the
consolidated statements of earnings. Asset impairments not eligible to be
classified as special items and gains and losses from the sale of assets were
historically classified in "interest expense and other" within the consolidated
statements of earnings. Significant asset impairments were incurred during the
nine months ended March 31, 2005 and should 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 asset impairments and gains and losses not eligible to be classified
as special items within "impairment charges and other" within the consolidated
statements of earnings. These asset 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 nine months ended March 31, 2005, the Company incurred
charges of $16.2 million and $103.0 million, respectively, as compared to gains
of $0.6 million and $7.0 million, respectively, for the comparable periods of
2004. With respect to the more significant asset impairments recorded during the
three months ended March 31, 2005, the Company incurred approximately $7.2
million of asset impairments within its Corporate segment relating to a decision
to write-off internally developed software. The Company also recognized a $5.4
million asset impairment to record machinery and equipment at its net realizable
value as it met the held for sale criteria of SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" ("SFAS No. 144") within the
Pharmaceutical Technology and Services segment. With respect to the more
significant asset impairments recorded during the nine months ended March 31,
2005, the Company incurred approximately $75.0 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
Page 28
analyses performed in accordance with SFAS No. 144 as a result of strategic
business decisions made during the second quarter of fiscal 2005. Also during
the nine months ended March 31, 2005, the Company incurred asset impairments of
approximately $9.9 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 asset impairment during the nine months ended March
31, 2005 on an aircraft within its Corporate entity which met all criteria to be
classified as held for sale during the second quarter of fiscal 2005. The asset
impairment recognized reduced the cost of the aircraft to its fair market value
based upon quoted market prices of similar assets. The Company subsequently sold
the aircraft during the third quarter of fiscal 2005 and no significant gain or
loss was recognized. For the comparable period of 2004, the Company recorded a
net gain of approximately $8.7 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 nine months ended March 31, 2004.
12. DISCONTINUED OPERATIONS
In connection with the acquisition of Syncor, the Company acquired certain
operations of Syncor that were discontinued. Prior to the acquisition, Syncor
announced the discontinuation of certain operations including the medical
imaging business and certain overseas operations. The Company continued with
these plans and 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 sold substantially all of the remaining discontinued operations prior to
the end of the third quarter of fiscal 2005. The net liabilities at March 31,
2005 and net assets at June 30, 2004 for the discontinued operations are
included within the Pharmaceutical Technologies and Services segment.
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 nine months ended
March 31, 2005 and 2004 are summarized as follows:
Three Nine
Months Ended Months Ended
March 31, March 31,
------------------ ------------------
(in millions) 2005 2004 2005 2004
- ------------- ------- ------- ------- -------
Revenue $ 0.7 $ 20.3 $ 4.4 $ 71.2
Gain from sale of business unit - - 18.7 -
Earnings/(loss) before income taxes (3.1) (1.4) 6.3 (12.5)
Income tax benefit/(expense) 1.2 0.6 (2.5) 4.8
------- ------- ------- -------
Earnings/(loss) from discontinued operations $ (1.9) $ (0.8) $ 3.8 $ (7.7)
======= ======= ======= =======
There was no interest expense allocated to discontinued operations for the
three or nine months ended March 31, 2005, as a 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 nine
months ended March 31, 2004 was $0.1 million and $0.2 million, respectively.
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.
Page 29
At March 31, 2005 and June 30, 2004, the major components of assets and
liabilities of the discontinued operations were as follows:
March 31, June 30,
--------- --------
(in millions) 2005 2004
- ------------- --------- --------
Current assets $ 15.4 $ 21.2
Property and equipment, net 9.8 22.0
Other assets 3.0 17.2
------ ------
Total assets $ 28.2 $ 60.4
====== ======
Current liabilities $ 29.0 $ 30.9
Long term debt and other 15.6 24.2
------ ------
Total liabilities $ 44.6 $ 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.
14. OFF-BALANCE SHEET TRANSACTIONS
Cardinal Health Funding, LLC ("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 March 31, 2005, 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 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. In the
third quarter of fiscal 2005, the Company repurchased and subsequently sold
$133.8 million of receivables under this program. After these sales, the Company
had sold in the aggregate $800 million under the program, all of which remained
outstanding at March 31, 2005. The Company also provided a secured interest in
the existing receivables of $375.1 million at March 31, 2005, 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 10 of "Notes to Consolidated Financial Statements" in the 2004 Form 10-K.
Page 30
15. EMPLOYEE RETIREMENT BENEFIT PLANS
Components of the Company's net periodic benefit costs for the three and
nine months ended March 31, 2005 and 2004, were as follows:
Three Months Ended Nine Months Ended
March 31, March 31,
------------------- -----------------
(in millions) 2005 2004 2005 2004
- ------------- ------- -------- ------- -------
Components of net periodic benefit cost:
Service cost $ 0.4 $ 0.4 $ 1.1 $ 1.2
Interest cost 2.6 2.2 7.8 6.6
Expected return on plan assets (1.8) (1.3) (5.3) (4.0)
Net amortization and other (1) 0.6 0.6 1.8 1.8
------- ------- ------- -------
Net periodic benefit costs $ 1.8 $ 1.9 $ 5.4 $ 5.6
======= ======= ======= =======
(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 March 31, 2005, the Company repurchased $250.0 million of
receivables under its committed receivables sales facility program. See Note 14
above for further information regarding this facility.
Also subsequent to March 31, 2005, the Company decided to close the
pharmaceutical manufacturing facility in Humacao, Puerto Rico as part of its
global restructuring program. These operations, which are within the Company's
Pharmaceutical Technologies and Services segment, have underperformed relative
to company expectations, due in part to continued regulatory issues at the
facility. The Company is working with customers in an effort to transition
projects to other Company manufacturing sites. The decision does not affect the
Company's other operations in Puerto Rico or at other locations worldwide. At
this time, the Company is unable to estimate the expected costs related to
exiting these operations.
Also subsequent to March 31, 2005, the Company decided to exit its
pharmaceutical trading operations within its Pharmaceutical Distribution and
Provider Services segment. At this time, the Company estimates the expected
costs related to exiting these operations to range between $2 and $3 million.
Page 31
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 March 31, 2005 and June 30, 2004,
and for the condensed consolidated statements of earnings for the three- and
nine-month periods ended March 31, 2005 and 2004. This discussion and analysis
should be read together with "Management's Discussion and Analysis of Financial
Condition and Results of Operations" 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 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 statements were 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 nine months ended March 31, 2005.
Three Months Ended Nine Months Ended
March 31, March 31,
---------------------------------- ----------------------------------
(in millions, except per Common Share
amounts) Growth (1) 2005 2004 Growth (1) 2005 2004
- ------------------------------------- ---------- --------- --------- ---------- --------- ---------
Revenue 17% $19,103.0 $16,391.8 15% $55,453.6 $48,130.8
Operating earnings (12%) $ 584.2 $ 666.8 (28%) $ 1,262.7 $ 1,761.7
Earnings from continuing operations (15%) $ 367.6 $ 430.1 (30%) $ 789.2 $ 1,127.2
Net earnings (15%) $ 365.7 $ 429.3 (27%) $ 793.0 $ 1,081.0
Diluted earnings per Common Share (14%) $ 0.84 $ 0.98 (26%) $ 1.82 $ 2.45
(1) Growth is calculated as the change (increase or decrease) for the three
and nine months ended March 31, 2005 compared to the three and nine months
ended March 31, 2004.
Page 32
The results of operations during the three and nine months ended March 31,
2005 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 each of the Company's four segments. The Company
continues to experience strong demand from health care providers for the Company
to provide integrated solutions. These integrated solutions include products and
services from multiple lines of businesses within the Company, and currently
represent approximately $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 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 concluded it was 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 has
established a compensation system that is significantly less dependent on
manufacturers' sales or pricing practices, and 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. During the third quarter, the Company
continued to make progress in reaching new distribution services agreements with
branded pharmaceutical manufacturers. To date, agreements have been reached with
pharmaceutical manufacturers to convert more than half of the Company's
projected branded vendor margin for fiscal 2006 to sources which are not
contingent on the manufacturers' selling and pricing practices, as discussed
above.
Revenue and operating earnings within the Pyxis products business of the
Clinical Technologies and Services segment declined significantly during the
three and nine months ended March 31, 2005. The decline was a result of the
following: a lengthened sales and installation cycle; the delayed introduction
of Pyxis MedStation(R) 3000, the next generation of Pyxis' medication management
system; and increased competition within the industry. The Company believes
these adverse conditions will impact the Pyxis products business' in the
short-term; however, the Company remains confident in the long-term prospects
for this business due to the expected efficiencies from the formation of the
Clinical Technologies and Services segment, the greater efficiency to be
realized from new installation processes and continuing customer demand for
products and services focusing on patient safety.
Operating earnings within the Company's Pharmaceutical Technologies and
Services segment declined during the three and nine months ended March 31, 2005.
The decline was a result of the following: continued delays in
Page 33
opening new facilities and from existing facilities operating below planned
capacity within the Biotechnology and Sterile Life Sciences business and lower
demand for medical communication services within the Healthcare Marketing
Services business. These adverse conditions were partially offset by the
strength of certain softgel products, ongoing productivity improvements at the
Biotechnology and Sterile Life Sciences manufacturing facility in Albuquerque,
New Mexico and the release of branded pharmaceuticals using the Company's
Zydis(R) quick dissolve formulation.
Global Restructuring Program
As previously announced, the Company has launched a global restructuring
program with the 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 by $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 nine months ended March 31,
2005 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 and the Company has learned that the U.S. Attorney for the Southern
District of New York has commenced an inquiry with respect to the Company. The
Company's Audit Committee also is conducting its own internal review, assisted
by independent counsel, which internal review is ongoing. 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,
which internal review is also ongoing. For further information regarding these
matters, see Note 1 to "Notes to Condensed Consolidated Financial Statements."
For information on other government investigations, see "Part II, Item 1: Legal
Proceedings."
RESULTS OF OPERATIONS
Revenue
Three Months Ended Nine Months Ended
March 31, March 31,
-------------------------- --------------------------
Percent of Percent of
Company Revenue Company Revenue
-------------------------- --------------------------
Growth (1) 2005 2004 Growth (1) 2005 2004
---------- ---- ---- ---------- ---- ----
Pharmaceutical Distribution and Provider
Services 18% 80% 80% 16% 80% 80%
Medical Products and Services 7% 13% 14% 8% 13% 14%
Pharmaceutical Technologies and Services 3% 4% 4% 6% 4% 4%
Clinical Technologies and Services 32% 3% 2% 41% 3% 2%
Total Company 17% 100% 100% 15% 100% 100%
(1) Growth is calculated as the change (increase or decrease) in the revenue
for the three and nine months ended March 31, 2005 compared to the three
and nine months ended March 31, 2004.
Page 34
Revenue for the three and nine months ended March 31, 2005 increased 17%
and 15%, respectively, compared to the same periods in the prior year. These
increases resulted from the following: 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
18% and 16%, respectively, for the three and nine months ended March 31, 2005
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 41% and 32%,
respectively, during the three and nine months ended March 31, 2005. See the
Bulk Revenue discussion below for further details. In addition, annualized
pharmaceutical price increases of approximately 6.6% and 4.6%, respectively,
during the three and nine months ended March 31, 2005 contributed to the growth
in this segment. However, the rate of price increases was lower than the rate
experienced over the prior 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 March 31, 2005 and 2004 was $6.2 billion
and $4.4 billion, respectively, and for the nine months ended March 31, 2005 and
2004 was $17.5 billion and $13.3 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 7% and 8%,
respectively, during the three and nine months ended March 31, 2005 resulted
primarily from increased volume from existing customers, new contracts signed
during fiscal 2004 within the medical-surgical distribution business, strong
international growth, especially in Canada and Europe, and increased revenue
from the specialty distribution business. The growth in the medical-surgical
distribution business was within the hospital supply and ambulatory care
customer segments and the growth within the specialty distribution business
resulted from increased revenues 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, and
the loss of certain business from customers within a group purchasing
organization ("GPO").
The Pharmaceutical Technologies and Services segment's revenue growth of
3% and 6%, respectively, during the three and nine months ended March 31, 2005
resulted primarily from strong demand for certain softgel products and the
impact of foreign exchange rates. Revenue for the three and nine months ended
March 31, 2005 increased by approximately 2% 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 issues impacting production at
certain Biotechnology and Sterile Life Sciences facilities, primarily the
Humacao, Puerto Rico facility, and lower demand for medical communication
services within the Healthcare Marketing Services business.
The Clinical Technologies and Services revenue growth of 32% and 41%,
respectively, during the three and nine months ended March 31, 2005 resulted
primarily 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
declined
Page 35
approximately 8% and 1%, respectively, during the three and nine months ended
March 31, 2005. Alaris' results of operations are not included in the prior
period amounts. The Pyxis products business experienced decreased revenue of
approximately 29% and 24%, respectively, during the three and nine months ended
March 31, 2005 due to the following: a lengthened sales and installation cycle;
the delayed introduction of Pyxis MedStation(R) 3000, the next generation of
Pyxis' medication management system; and increased competition within the
industry. The Company believes these adverse conditions will impact the Pyxis
products business' in the short-term; however, the Company remains confident in
the long-term prospects for this business due to the expected efficiencies from
the formation of the Clinical Technologies and Services segment, the greater
efficiency to be realized from new installation processes and continuing
customer demand for products and services focusing on patient safety.
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 $6.0 million
and $15.3 million allocation, respectively, from Corporate during the three and
nine months ended March 31, 2004 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 Nine Months Ended
March 31, March 31,
------------------------------ ------------------------------
Percent of Company Percent of Company
Operating Earnings Operating Earnings
------------------------------ ------------------------------
Growth (1) 2005 2004 Growth (1) 2005 2004
---------- ---- ---- ---------- ---- ----
Pharmaceutical Distribution and Provider
Services 8% 50% 45% (8%) 43% 41%
Medical Products and Services 3% 29% 27% (3%) 31% 28%
Pharmaceutical Technologies and Services (28%) 12% 16% (24%) 15% 18%
Clinical Technologies and Services (25%) 9% 12% (25%) 11% 13%
Total Company (2) (12%) 100% 100% (28%) 100% 100%
(1) Growth is calculated as the change (increase or decrease) in the operating
earnings for the three and nine months ended March 31, 2005 compared to
the three and nine months ended March 31, 2004.
(2) The Company's overall operating earnings decrease of 12% and 28%,
respectively, during the three and nine months ended March 31, 2005
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 March 31, 2005
decreased 12% compared to the same period in the prior year. The overall
decrease resulted from continued regulatory issues that are adversely affecting
manufacturing efficiencies within the Pharmaceutical Technologies and Services
segment and a lengthened sales and installation cycle, new product launch delays
and increased competition within the Pyxis products business in the Clinical
Technologies and Services segment as described above in the "Overview" section.
The decrease in total Company operating earnings for the nine months ended
March 31, 2005 of 28% resulted from declining operating earnings in each of the
Company's segments. The Company's gross margins were dampened primarily by the
following: (a) reduced vendor margins within the Pharmaceutical Distribution
business driven primarily by changes in branded pharmaceutical manufacturers'
sales and pricing practices (see the "Overview" section for further discussion)
and competitive pricing; (b) increased mix of lower-margin distribution
business, competitive pricing and increased raw material and fuel costs within
the Medical Products and Services segment; (c) continued regulatory issues
adversely affecting manufacturing efficiencies within the Pharmaceutical
Technologies and Services segment; and (d) a lengthened sales and installation
cycle, new product launch delays and increased competition within the Pyxis
products business in the Clinical Technologies and Services segment.
Total Company operating earnings were also adversely affected by the
unfavorable impact related to special items of $43.3 million and $178.3 million,
respectively, during the three and nine months ended March 31, 2005. The
increased costs were associated with the Company's global restructuring program,
the SEC investigation and
Page 36
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 $16.2 million and $103.0
million, respectively, for asset impairments during the three and nine months
ended March 31, 2005 compared to gains of $0.6 million and $7.0 million,
respectively, in the comparable periods in the prior year (see Note 11 of "Notes
to Condensed Consolidated Financial Statements" for additional information).
The Pharmaceutical Distribution and Provider Services operating earnings
increased 8% during the three months ended March 31, 2005 primarily as a result
of the segments revenue growth of 18% during the same time, improvements within
generic pharmaceutical margins, stabilizing selling margins and continued
expense control. Operating earnings grew at a slower rate than revenue during
the three months ended March 31, 2005 due to the impact of the ongoing business
model transition and the revenue growth within the lower margin bulk revenue
classification. In addition, operating earnings were adversely impacted during
the third quarter of fiscal 2005 by approximately $7.2 million as a result of
inventory rationalization of certain health and beauty care products and a $5.2
million increase in vendor estimation reserves.
The operating earnings decline of 8% during the nine months ended March
31, 2005 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 changed their sales practices by restricting
product available for purchase by pharmaceutical wholesalers. In addition,
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. For the nine months ended March 31, 2005,
annualized pharmaceutical price increases were approximately 4.6% compared to
6.9% during the nine months ended March 31, 2004. The Company is working with
individual branded pharmaceutical manufacturers to define fee-for-service terms
that adequately compensate the Company based on the services being provided to
such manufacturers. During the third quarter, the Company continued to make
progress in reaching new distribution service agreements with branded
pharmaceutical manufacturers. To date, agreements have been reached to convert
more than half of the Company's projected branded vendor margin for fiscal 2006
to non-contingent sources.
The Medical Products and Services segment's operating earnings increased
3% during the three months ended March 31, 2005 primarily as a result of the
segments revenue growth of 7% during the same time period, manufacturing
efficiencies and expense control related to the Company's global restructuring
program. Operating earnings grew at a slower rate than revenue during the three
months ended March 31, 2005 due to the same issues noted in the nine month
analysis that follows, other than the latex litigation charge. Operating
earnings declined 3% during the nine months ended March 31, 2005 primarily due
to pricing pressures related to self-manufactured products, increased raw
material and fuel costs, an increased mix of lower margin distributed products,
and competitive pricing on a large GPO contract. Operating earnings for the nine
months ended March 31, 2005 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 28% and 24%, respectively, during the three and nine months ended
March 31, 2005 primarily relate to the continued delays in opening new
facilities and from existing facilities operating below planned capacity within
the Company's Biotechnology and Sterile Life Sciences business. In addition, the
operating margins in this segment's Healthcare Marketing Services business
continued to be adversely affected by lower demand for medical communication
services. The operating earnings declines were partially offset by the strength
of certain softgel products, ongoing productivity improvements at the
Biotechnology and Sterile Life Sciences manufacturing facility in Albuquerque,
New Mexico and the release of branded pharmaceuticals using the Company's
Zydis(R) quick dissolve formulation. The impact of foreign exchange rates on
operating earnings growth rates above, for the three and nine months ended March
31, 2005 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 the fiscal 2004 constant rate adjustment).
The Clinical Technologies and Services segment's operating earnings
decreases of 25% during the three and nine months ended March 31, 2005 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 29%
and 24%, respectively, for the three and nine months ended March 31, 2005 and
lower unit margins due to adverse year-over-year sales mix and more aggressive
price discounting in the market place. The Pyxis products business was also
adversely impacted by the positive segment allocation adjustments recorded
during the three and nine months ended March 31, 2004 of $6.0 million and $15.3
Page 37
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 57% and 48%, respectively, for the three and nine
months ended March 31, 2005. The results of operations from this acquisition are
not included in the prior period amounts.
Impairment Charges and Other
See Note 11 of "Notes to Condensed Consolidated Financial Statements" for
additional information regarding "impairment charges and other."
Special Items
Three Months Ended Nine Months Ended
March 31, March 31,
------------------ -----------------
(in millions) 2005 2004 2005 2004
- ------------- -------- ------- -------- -------
Restructuring costs $ 25.8 $ 4.9 $ 138.4 $ 25.1
Merger-related costs 10.4 7.2 37.5 23.6
Litigation settlements, net - (3.8) (21.2) (30.7)
Other special items 7.1 - 23.6 -
-------- ------- -------- -------
Total special items $ 43.3 $ 8.3 $ 178.3 $ 18.0
======== ======= ======== =======
See Note 5 of "Notes to Condensed Consolidated Financial Statements" for
detail of the Company's special items during the three and nine months ended
March 31, 2005 and 2004.
Interest Expense and Other
"Interest expense and other" increased $12.6 million and $13.0 million,
respectively, during the three and nine months ended March 31, 2005 compared to
the same periods in the prior fiscal year. The increases resulted primarily from
increased interest expense of $18.1 million and $37.8 million, respectively, due
to increased borrowing rates and levels. The $37.8 million increase in interest
expense during the nine months ended March 31, 2005 was partially offset by 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 during the second quarter of fiscal 2005. See Note 11 of "Notes to
Condensed Consolidated Financial Statements" for additional information
regarding "impairment charges and other."
Provision for Income Taxes
The Company's provision for income taxes relative to earnings before
income taxes and discontinued operations was 32.3% and 32.4%, respectively, for
the three and nine months ended March 31, 2005, as compared to 32.7% and 32.9%,
respectively, for the three and nine months ended March 31, 2004. 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 38
LIQUIDITY AND CAPITAL RESOURCES
Sources and Uses of Cash
The following table summarizes the Company's Condensed Consolidated
Statements of Cash Flows for the nine months ended March 31, 2005 and 2004.
Nine Months Ended
March 31,
---------------------
(in millions) 2005 2004
- ------------- --------- ---------
Cash provided by/(used in):
Operating activities $ 2,050.9 $ 1,335.4
Investing activities $ (503.3) $ (819.8)
Financing activities $(1,094.1) $(1,712.4)
OPERATING ACTIVITIES. Net cash provided by operating activities during the
nine months ended March 31, 2005 totaled $2.1 billion, an increase of $715.5
million when compared to the same period a year ago. The increase was primarily
the result of the sale of $800 million of receivables during the nine months
ended March 31, 2005 under the Company's committed receivables sales facility
program. See Note 14 of "Notes to Condensed Consolidated Financial Statements"
for information regarding this program. Overall, the operating cash flow
benefits were adversely affected by a $338.0 million decrease in earnings from
continuing operations. A significant portion of this earnings from continuing
operations decrease was due to non-cash asset impairments of approximately
$172.9 million.
INVESTING ACTIVITIES. Cash used in investing activities primarily
represents the Company's use of cash to complete acquisitions. During the nine
months ended March 31, 2005, 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 nine months ended March 31, 2004
was related to costs associated with the acquisitions of Intercare and Medicap
Pharmacies, Inc. During the nine months ended March 31, 2005, 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
$1.1 billion and $1.7 billion, respectively, during the nine months ended March
31, 2005 and 2004. Cash used in financing activities during the nine months
ended March 31, 2005 primarily reflects the Company's decisions to retire the
Company's commercial paper and certain debt assumed in the Alaris acquisition
and repurchase its Common Shares. During the third quarter of fiscal 2005, the
Company utilized $228.5 million to repurchase its Common Shares. During the nine
months ended March 31, 2004, the Company repurchased approximately $1.5 billion
of its Common Shares.
International Cash
The Company's cash balance of approximately $1.5 billion as of March 31,
2005 includes $496.8 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 began repurchasing shares in the third quarter of
fiscal 2005 under this program. During the third quarter of fiscal 2005, the
Company purchased approximately $241.9 million of its Common Shares. See Note 3
of "Notes to Condensed Consolidated Financial Statements" and 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
Page 39
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. The Company fully repaid the
$1.25 billion in outstanding aggregate balances under its 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 Notes 6 and 10 of "Notes to
Consolidated Financial Statements" in the 2004 Form 10-K. See also Notes 6 and
14 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 March 31, 2005, 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 March 31, 2005, 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 of 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 third quarter of fiscal 2005, the Company
repurchased and subsequently sold $133.8 million of receivables under this
program. In the aggregate, $800 million in receivables had been sold under this
program as of March 31, 2005. Subsequent to March 31, 2005, the Company
repurchased approximately $250.0 million of receivables under its committed
receivables sales facility program. See Notes 14 and 16 in "Notes to Condensed
Consolidated Financial Statements" of this Form 10-Q 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 "Notes to Condensed Consolidated Financial Statements" for a
discussion of recent financial accounting standards.
Page 40
RECENT DEVELOPMENTS
Following the end of the third quarter, the Company decided to close the
pharmaceutical manufacturing facility in Humacao, Puerto Rico as part of its
global restructuring program. These operations, which are within the Company's
Pharmaceutical Technologies and Services Segment, have underperformed relative
to company expectations, due in part to continued regulatory issues at the
facility. The Company is working with customers in an effort to transition
projects to other Company manufacturing sites. The decision does not affect the
Company's other operations in Puerto Rico or at other locations worldwide. At
this time, the Company is unable to estimate the expected costs related to
exiting these operations.
Also following the end of the third quarter, one of the Company's
subsidiaries received a subpoena from the Attorney General's Office of the State
of New York. The Company believes that the New York Attorney General is
conducting a broad industry inquiry that appears to focus on the secondary
market within the wholesale pharmaceutical industry and that the Company is one
of multiple parties that have received such a subpoena. The Company intends to
be responsive to the New York Attorney General's Office in its investigation.
Because the investigation is at an early stage, the Company cannot predict its
outcome or its effect, if any, on the Company's business.
Also following the end of the third quarter, the Company decided to exit
its pharmaceutical trading operations within its Pharmaceutical Distribution and
Provider Services segment. At this time, the Company estimates the expected
costs related to exiting these operations to range between $2 and $3 million.
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.
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's principal executive
officer and principal financial officer to make conclusions, as set forth below,
regarding the state of the Company's 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
Page 41
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.
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 March 31, 2005, 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 March 31, 2005, and as
such, such officers were unable to conclude that the Company's disclosure
controls and procedures were effective as of March 31, 2005. Therefore, the
Company's principal executive officer and principal financial officer have
concluded that their prior determinations as of September 30, 2004 and December
31, 2004 that material weaknesses exist and that the Company's disclosure
controls and procedures were not effective continues to apply as of March 31,
2005. 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 March 31, 2005 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.
Page 42
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.
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 March 31, 2005 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. The Company was notified in April 2005 that certain current and former
employees and directors received subpoenas from the SEC requesting the
production of documents. The subject matter of these requests is consistent with
the subject matter of the subpoenas the Company had previously received from the
SEC.
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
Page 43
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 taken 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 affected 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. In connection with the determinations made by the Audit Committee,
Gary S. Jensen, the Company's controller, resigned, which resignation was
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 Forms 10-Q for the
periods ended September 30, 2004 and December 31, 2004, or this Form 10-Q will
not change or require amendment, or that additional disciplinary actions will
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 Forms 10-Q for the periods ended September 30, 2004 and
December 31, 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 Board 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 Board 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 Board 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.
Page 44
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.
New York Attorney General Investigation
In April 2005, one of the Company's subsidiaries received a subpoena from
the Attorney General's Office of the State of New York. The Company believes
that the New York Attorney General is conducting a broad industry inquiry that
appears to focus on the secondary market within the wholesale pharmaceutical
industry and that the Company is one of multiple parties that have received such
a subpoena. The Company intends to be responsive to the New York Attorney
General's Office in its investigation. Because the investigation is at an early
stage, the Company cannot predict its outcome or its effect, if any, on the
Company's business.
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.
Page 45
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 March 31, 2005:
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 (1) Under the Program
- ------------------- ------------ -------------- ------------------ --------------------
January 1-31, 2005 207(2) $ 54.32 - $ -
February 1-28, 2005 3,226,250(3) 57.75 3,225,000 313,687,650
March 1-31, 2005 996,000 55.80 996,000 258,085,992
--------- ------- --------- --------------
Total 4,222,457 $ 57.29 4,221,000 $ 258,085,992
========= ======= ========= ==============
(1) The Company repurchased approximately 4.2 million Common Shares pursuant
to a $500 million share repurchase program publicly announced on December
13, 2004 (the "Program"). The average price paid per Common Share under
the Program was $57.29. The Program will expire when the entire $500
million in aggregate amount of Common Shares has been repurchased.
(2) Reflects Common Shares owned and tendered by an employee to meet the
exercise price for an option exercise.
(3) Reflects Common Shares purchased pursuant to the Program and 1,250 Common
Shares owned and tendered by an employee to meet the exercise price for an
option exercise.
ITEM 5: OTHER INFORMATION
On April 13, 2005, the Executive Committee of the Board of Directors of
the Company, acting on behalf of the Board of Directors, appointed Jeffrey W.
Henderson as the Company's Executive Vice President and, effective May 15, 2005,
the Company's Chief Financial Officer. Mr. Henderson joined the Company on April
18, 2005 as Executive Vice President, and will assume the duties of, and will be
designated as, the Chief Financial Officer effective as of May 15, 2005. The
Company's current Chief Financial Officer on an interim basis, J. Michael Losh,
will continue to serve as Chief Financial Officer through May 15th after which
date, Mr. Losh will no longer be an executive officer of the Company but will
continue to serve as a director of the Company. Also effective May 15, 2005, the
Board of Directors will designate Mr. Henderson as principal accounting officer
of the Company, replacing Mr. Losh in that designation. Mr. Henderson's
biographical information and a description of the material terms of Mr.
Henderson's compensatory arrangements with the Company are incorporated by
reference from the Form 8-K report filed by the Company on April 15, 2005.
In addition, effective April 22, 2005, Brendan A. Ford, the Company's
current Executive Vice President - Corporate Development, was appointed as the
Company's Interim General Counsel and Secretary, replacing Paul S. Williams, who
has resigned from the Company to become a managing director of a legal
recruiting firm. Mr. Ford is also continuing in his duties as Executive Vice
President - Corporate Development.
Page 46
ITEM 6: EXHIBITS
Exhibit
Number Exhibit Description
- ------- -------------------
10.01 Form of Nonqualified Stock Option Agreement under the Amended and
Restated Equity Incentive Plan, as amended, for cliff vesting and
manual signature
10.02 Form of Nonqualified Stock Option Agreement under the Amended and
Restated Equity Incentive Plan, as amended, for cliff vesting and
electronic signature
10.03 Form of Nonqualified Stock Option Agreement under the Amended and
Restated Equity Incentive Plan, as amended, for staggered vesting and
manual signature
10.04 Form of Nonqualified Stock Option Agreement under the Amended and
Restated Equity Incentive Plan, as amended, for staggered vesting and
electronic signature
10.05 Form of Restricted Share Units Agreement under the Amended and Restated
Equity Incentive Plan, as amended, for cliff vesting
10.06 Form of Restricted Share Units Agreement under the Amended and Restated
Equity Incentive Plan, as amended, for staggered vesting
10.07 Supplemental Benefit Plan for Key Employees of R.P. Scherer Corporation
31.01 Certification of 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 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(1)
99.02 Employee Stock Purchase Plan, as amended
(1) Included as an exhibit to the Company's Form 10-Q filed February 9,
2005 (File No. 1-11373) and incorporated herein by reference.
Page 47
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: May 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 48