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CARDINAL HEALTH INC - 10-K - 20041026 - MANAGEMENTS_DISCUSSION
ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The discussion and analysis presented below refers to and should be read
in conjunction with the consolidated financial statements and related notes
appearing elsewhere in this Form 10-K.
In connection with certain conclusions made by the Audit Committee during
September and October 2004 as part of its internal review to date, the Company
made certain reclassification and restatement adjustments to its fiscal 2004 and
prior historical financial statements, as more fully described in Notes 1 and 2
of "Notes to Consolidated Financial Statements." Revenue previously disclosed
separately as "Bulk Deliveries to Customer Warehouses and Others" 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 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
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.
27
OVERVIEW
Cardinal Health is a leading provider of products and services supporting
the health care industry. The Company helps health care providers and
manufacturers improve the efficiency and quality of health care. For further
information regarding the Company's business, please see "Part I, Item 1:
Business" within this Form 10-K.
Results of Operations
The following summarizes the Company's results of operations for the
fiscal years ended June 30, 2004, 2003 and 2002.
(in millions, except per Common Share amounts) Growth (1) Results of Operations
----------------- ------------------------------------
Years ended June 30, 2004 2003 2004 2003 2002
-------------------- ---- -------- ---------- ---------- ----------
Adjusted Restated Restated
Revenue 15% 11% $ 65,053.5 $ 56,731.5 $ 51,144.6
Operating earnings 6% 18% $ 2,337.3 $ 2,196.0 $ 1,857.4
Earnings from continuing operations before
cumulative effect of change in accounting 10% 21% $ 1,524.7 $ 1,381.2 $ 1,140.8
Net earnings 7% 28% $ 1,474.5 $ 1,375.1 $ 1,070.7
Net diluted earnings per Common Share 11% 30% $ 3.35 $ 3.03 $ 2.33
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(1) Growth is calculated as change (increase or decrease) for a given
year as compared to immediately preceding year.
During the fiscal years noted in the table above, the results of
operations reflect the breadth of products and services the Company offers. The
increasing demand for the Company's diverse portfolio of products and services
led to revenue growth in every segment of the Company. The Company continues to
experience strong demand for integrated solutions from health care providers.
These integrated solutions include products and services from multiple lines of
businesses within the Company. These arrangements currently represent nearly $7
billion of annual sales.
As of June 30, 2004, the Company's operations were organized into four
operating business segments: Pharmaceutical Distribution and Provider Services,
Medical Products and Services, Pharmaceutical Technologies and Services and
Automation and Information Services (see Note 18 of "Notes to Consolidated
Financial Statements" for discussion of changes to business segments resulting
from the ALARIS acquisition which will impact fiscal 2005). The results of
operations also reflect the increasing operating earnings contribution each
segment outside of Pharmaceutical Distribution and Provider Services is making.
The three segments outside of Pharmaceutical Distribution and Provider Services
have gradually increased the amount of operating earnings contributed to the
Company and currently represent more than one-half of the Company's operating
earnings. The Company expects this trend to continue.
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 pharmaceutical manufacturers. Historically, the compensation
received by the Pharmaceutical Distribution business from 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 pharmaceutical manufacturer, including
established policies concerning the volume of product available for purchase in
advance of a price increase, and on stable and predictable pharmaceutical
pricing practices. Beginning in fiscal 2003, 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 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
pharmaceutical manufacturers. In addition, since the fourth quarter of fiscal
2004, pharmaceutical manufacturers' product pricing practices have become less
predictable, as the frequency of product price increases generally has slowed
versus historical levels. As a result of these actions by pharmaceutical
manufacturers, the Company is no longer being
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adequately and consistently compensated for the reliable and consistent
logistical, capital and administrative services being provided by the Company to
these manufacturers.
In response to the developments discussed above, the Company is working to
establish a compensation system that is no longer dependent on manufacturers'
sales or pricing practices, but rather is based on the services provided by the
Company to meet the unique distribution requirements of each manufacturer's
products. To that end, the Company is working with individual pharmaceutical
manufacturers to define fee-for-service terms that will adequately compensate
the Company, in light of each product's unique distribution requirements, for
the logistical, capital and administrative services being provided by the
Company. To accelerate this process, in August 2004, the Company communicated to
its pharmaceutical manufacturing vendors a new policy which sets April 1, 2005
or, for manufacturers with an existing agreement with the Company, the next
anniversary date of such agreement, as the deadline by which manufacturers must
have entered into a mutually satisfactory distribution services agreement with
the Company providing for reliable, predictable and adequate compensation for
the Company's services. For any manufacturer with which the Company is unable to
enter into such a mutually satisfactory agreement, the Company plans to assist
such manufacturer in transitioning to another method of distribution. There can
be no assurance that this business model transition will be successful, or of
the timing of such a successful transition.
Revenue and operating earnings growth within the Company's Automation and
Information Services segment during fiscal 2004 were lower than historical
growth rates. These growth rates were adversely affected by softening demand,
attributable to capital spending pressures experienced by hospitals and
increased competition within the industry. The Company believes this trend may
continue in the short-term; however, the Company remains confident in the
long-term prospects for this segment as patient safety concerns combined with
innovative new products continue to lead to future demand.
Government Investigations and Audit Committee Internal Review
The Company is currently the subject of a formal investigation by the SEC
relating to certain accounting matters. The Company also learned that the U.S.
Attorney for the Southern District of New York has commenced an inquiry with
respect to the Company. Also, the Company's Audit Committee commenced its own
internal review, assisted by independent counsel. For further information
regarding these matters, see "Part I, Item 3: Legal Proceedings" and Note 1 of
"Notes to Consolidated Financial Statements" in this Form 10-K.
Product Safety
As a leading provider of products and services supporting the health care
industry, including the distribution of pharmaceuticals and other health care
products, the Company is monitoring issues regarding importation of
pharmaceuticals and other health care products. The Company is sensitive to the
issue of pharmaceutical prices and the pricing disparity between domestic and
international markets. However, the Company believes that for importation into
the United States to be successful additional controls and protections would
need to be implemented to ensure patients and consumers receive safe and
effective pharmaceutical products. The Company will continue to work proactively
with all participants and regulators in the pharmaceutical supply chain to help
ensure any solution is safe and efficient. The Company continues to work with
its suppliers to help minimize the risks associated with counterfeit products in
the supply chain.
Acquisitions
On June 28, 2004, the Company acquired approximately 98.7% of the
outstanding common stock of ALARIS, a leading provider of intravenous medication
safety products and services. On July 7, 2004, ALARIS merged with a subsidiary
of the Company to complete the transaction. The value of the transaction,
including the assumption of ALARIS' debt, totaled nearly $2.1 billion. For
further information regarding the ALARIS acquisition, the valuation of the
acquisition's intangibles, and the impact on segment reporting, see Notes 4, 17
and 18 of "Notes to Consolidated Financial Statements." Prior to the completion
of the ALARIS acquisition, on June 16, 2004, ICU Medical, Inc. filed a patent
infringement lawsuit against ALARIS in the United States District Court for the
Southern District of California. In the lawsuit, ICU claims that the ALARIS
SmartSite(R) family of needle-free valves and systems infringes upon ICU
patents. ICU seeks monetary damages plus permanent injunctive relief preventing
ALARIS from selling SmartSite(R) products. On July 30, 2004, the Court denied
ICU's application for a preliminary injunction finding, among other things, that
ICU had failed to show a substantial likelihood of success on the merits. The
Company intends to vigorously defend this action.
During December 2003, the Company completed its acquisition of Intercare,
a leading European pharmaceutical products and services company. This
acquisition increased the Company's scale of proprietary sterile manufacturing
and broadened its participation in the fast-growing European generic (including
manufacturing capabilities) and injectible product market. The cash
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transaction was valued at approximately $570 million, including the assumption
of approximately $150 million in Intercare debt. See Note 18 of "Notes to
Consolidated Financial Statements" for further information regarding the impact
this acquisition had on the Company's segment reporting.
During fiscal 2004, 2003 and 2002, the Company completed numerous
acquisitions, including, but not limited to, ALARIS, Intercare and Syncor. The
Company's trend with regard to acquisitions has been to expand its role as a
provider of services to the health care industry. This trend has resulted in
expansion into areas which (a) complement the Company's existing operations, and
(b) provide opportunities for the Company to develop synergies with, and thus
strengthen, the acquired business. As the health care industry continues to
change, the Company evaluates possible candidates for merger or acquisition and
intends to continue to seek opportunities to expand its role as a provider of
services to the health care industry through all its reporting segments. There
can be no assurance that the Company will be able to successfully pursue any
such opportunity or consummate any such transaction, if pursued. To the extent
the Company continues to pursue acquisitions, its ability to complete such
transactions may be adversely affected by the government investigations
described under "Part I, Item 3: Legal Proceedings" and Note 1 of "Notes to
Consolidated Financial Statements" in this Form 10-K. If additional transactions
are pursued or consummated, the Company would incur additional merger- and
acquisition-related costs, and may need to enter into funding arrangements for
such mergers or acquisitions. There can be no assurance that the integration
efforts associated with any such transaction would be successful.
RESULTS OF OPERATIONS
The following sections provide additional detail regarding the results of
operations of the Company and, where applicable, the results of operations of
the Company's reportable segments.
Revenue
Revenue for the Company and its reportable segments are as follows:
(in millions) 2004 2003 2002
------------- ------------- --------------
Restated Restated
Pharmaceutical Distribution and Provider
Services ("PDPS")
Direct Sales to Customers $ 36,222.0 $ 31,833.6 $ 29,317.3
Bulk Revenue (1) 18,009.0 15,426.5 13,680.7
------------- ------------- --------------
Total PDPS 54,231.0 47,260.1 42,998.0
Medical Products and Services 7,357.6 6,614.7 6,256.7
Pharmaceutical Technologies and Services 2,804.1 2,250.0 1,417.5
Automation and Information Services 680.8 666.7 560.2
Corporate (2) (20.0) (60.0) (87.8)
------------- ------------- --------------
Total Company Revenue $ 65,053.5 $ 56,731.5 $ 51,144.6
============= ============= ==============
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(1) See discussion below under "Bulk Deliveries to Customer Warehouses
and Other" for the Company's definition of Bulk Revenue.
(2) Corporate revenue primarily consists of foreign currency translation
adjustments and the elimination of intersegment revenue.
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The following table summarizes the revenue growth rates for the Company
and its reportable segments, as well as the percent of Company revenue,
excluding Corporate, each segment represents:
Percent of Company
Growth (1) Revenue
------------------ ---------------------------
Years ended June 30, 2004 2003 2004 2003 2002
-------------------- ---- ---------- ---- -------- --------
Adjusted Adjusted Adjusted
Pharmaceutical Distribution and Provider Services 15% 10% 84% 83% 84%
Medical Products and Services 11% 6% 11% 12% 12%
Pharmaceutical Technologies and Services 25% 59% 4% 4% 3%
Automation and Information Services 2% 19% 1% 1% 1%
Total Company 15% 11% 100% 100% 100%
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(1) Growth is calculated as change (increase or decrease) for a given
year as compared to immediately preceding year.
TOTAL COMPANY. Revenue increased 15% and 11% during fiscal 2004 and 2003,
respectively. The revenue growth in these fiscal years resulted from a higher
sales volume across each of the Company's segments; revenue growth from existing
customers; addition of new customers, some of which resulted from new corporate
arrangements with health care providers that integrate the Company's diverse
offerings; addition of new products; and pharmaceutical price increases
averaging approximately 6% and 5%, respectively, during fiscal 2004 and 2003. In
addition, acquisitions completed by the Company during fiscal 2004 and 2003
accounted for approximately 1% of the overall growth for fiscal 2004 and 2003.
These increases during fiscal 2004 were partially offset by slower sales growth
within the Pharmaceutical Technologies and Services and Automation and
Information services segments.
PHARMACEUTICAL DISTRIBUTION AND PROVIDER SERVICES. This segment's revenue
growth of 15% in fiscal 2004 resulted primarily from strong sales to existing
customers, sales to new customers and pharmaceutical price increases. Sales
growth to existing customers within the retail chain and alternate site
categories in this segment's Pharmaceutical Distribution business showed
particular strength. This segment also benefited from (1) contract wins during
fiscal 2004, (2) pharmaceutical price increases averaging approximately 6%
during fiscal 2004, and (3) an extra business day. These revenue gains were
partially dampened by continued reduction in business with Kmart Holding Corp.
("Kmart") due to Kmart's closure of various stores and certain contract losses
during fiscal 2004 in this segment's Pharmaceutical Distribution business.
This segment's revenue growth of 10% in fiscal 2003 resulted from strong
sales to customers within the segment's core Pharmaceutical Distribution
business, some of which were generated from the addition of new contracts, and
pharmaceutical price increases averaging approximately 5%. The most significant
growth was in the alternate site and chain pharmacy businesses. The chain
pharmacy growth rate would have been stronger had it not experienced a reduction
in business with Kmart due to Kmart's closure of various stores in connection
with its reorganization. This segment's overall revenue growth was partially
dampened by the loss of certain customers.
MEDICAL PRODUCTS AND SERVICES. This segment's revenue growth of 11% in
fiscal 2004 resulted from increased sales momentum from new and existing
contracts within the distribution business as well as increased sales volume
from the segment's international businesses. New contracts drove increased sales
of both distributed and self-manufactured products, with sales from the
distribution business particularly strong during fiscal 2004. The international
businesses also generated strong revenue growth, increasing nearly 19% from the
prior fiscal year. Approximately 14% of the international business revenue
growth, however, related to changes in foreign currency rates. Sales of new
self-manufactured products, particularly enhancements within surgeon glove
products, also contributed to the overall revenue growth. This segment's revenue
growth was above industry averages during fiscal 2004.
This segment's revenue growth of 6% in fiscal 2003 resulted from increased
sales of both distributed and self-manufactured products. The addition of
several new contracts with hospitals and health care networks, as well as
increased market share in the growing surgery center market contributed to
increased sales of distributed and self-manufactured products. Increased demand
for certain existing self-manufactured products, including medical gloves,
Medi-vac(R) suction canisters, Procedure Based Delivery System(R) kits and other
minor procedure trays, accounted for a portion of this segment's revenue growth.
The addition of new, self-manufactured products also contributed to the overall
revenue growth in this segment. Some examples of these new, self-manufactured
products include the Esteem(R) surgeon gloves and the Tiburon(TM) and
Astound(TM) fabrics within the Convertors(R) business.
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PHARMACEUTICAL TECHNOLOGIES AND SERVICES. This segment's revenue growth of
25% in fiscal 2004 resulted from acquisitions and sales momentum within the
Pharmaceutical Development, Nuclear Pharmacy Services and Packaging Services
businesses. Approximately 5% of this segment's revenue growth was due to the
inclusion of Intercare, an acquisition completed during December 2003.
Intercare's results of operations are not included in the prior period amounts.
Intercare's operations have shown considerable sales momentum since the
acquisition was completed, particularly the fourth quarter fiscal 2004. Also,
this segment's revenue growth benefited from the inclusion of Syncor, an
acquisition that was completed on January 1, 2003. Syncor's results of
operations are not included in the amounts for the first half fiscal 2003.
Excluding the impact of acquisitions within this segment, revenue growth would
have been approximately 2% during fiscal 2004. This segment's revenue growth was
partially dampened by a delay in startup of commercial manufacturing of key
sterile products from signed contracts as certain regulatory inspections and
product approvals were delayed in the Biotechnology and Sterile Life Sciences
business. This segment's revenue growth is not impacted by foreign exchange
fluctuations as the Company applies constant exchange rates to translate its
foreign operations' revenue into U.S. dollars. The impact of actual foreign
exchange rate changes for translation purposes is retained within the Corporate
segment (see footnote 6 of the table in Note 18 in "Notes to Consolidated
Financial Statements").
This segment's revenue growth of 59% in fiscal 2003 resulted from
acquisitions and increased demand within the Oral Technologies, Biotechnology
and Sterile Life Sciences, and Packaging Services businesses. The acquisitions
of Syncor, effective January 1, 2003, and Boron, LePore & Associates, Inc.
(which has been given the legal designation of Cardinal Health 401, Inc., and is
referred to in this Form 10-K as "BLP"), effective June 2002, resulted in
significant revenue growth in fiscal 2003. BLP's revenue includes customer
reimbursements of out-of-pocket expenses, which generally comprise travel
expenses and other incidental costs incurred to fulfill the services required by
various contracts and are recorded as gross revenue. Excluding the impact of
acquisitions within this segment, revenue growth would have been approximately
7% during fiscal 2003. Product sales from this segment's businesses that showed
particular strength included Lilly's Zyprexa(R) Zydis(R), an anti-psychotic;
Mylan's Amnesteem(TM), a generic drug for the treatment of acne; and Sepracor's
Xoponex(R), a respiratory drug. The growth within the Biotechnology and Sterile
Life Sciences business was negatively impacted by the planned shutdown for
twelve weeks of a domestic sterile manufacturing facility to expand capacity.
AUTOMATION AND INFORMATION SERVICES. This segment's revenue growth of 2%
in fiscal 2004 is reflective of the premature revenue recognition adjustment
resulting from the Audit Committee's internal review as more fully described
in Note 1 of "Notes to Consolidated Financial Statements." Operationally, this
segment's revenue growth in fiscal 2004 included sales growth within the
medication product lines (such as the Pyxis MedStation(R) system) and addition
of new products. This segment was adversely affected by a softening of demand at
the hospital level. The Company believes this softening is primarily
attributable to capital spending pressures experienced by hospitals and an
increasingly competitive market. These factors were also seen in the weakening
of this segment's committed contract backlog. The Company believes this trend
may continue in the short-term; however, the Company remains confident in the
long-term prospects for this segment as patient safety concerns combine with
innovative new products to drive future demand. In order to aid in the
comparability of this segment's operating results, during fiscal 2004, the
Company recorded a Corporate allocation adjustment to this segment's revenue of
$21 million representing an estimate of interest income this segment would have
earned had the Company not completed sales of its lease receivables. This
allocation was recorded within revenue, consistent with the recording of
interest income received from sales-type leases. The allocation was recorded for
comparative purposes to reflect the segment's growth rate excluding the impact
of the Corporate-initiated lease sales. Excluding the impact of this allocation
entry, this segment's revenue growth would have been negative 1% for fiscal
2004. For more information, see footnote 6 to the table in Note 18 in "Notes to
Consolidated Financial Statements."
This segment's revenue growth of 19% in fiscal 2003 resulted from strong
sales of new and existing patient safety and supply management product lines,
including Pyxis MedStation(R), Pyxis Anesthesia System(TM), Pyxis Connect(TM)
and Pyxis SupplyStation(R) systems. In addition, the segment's revenue
benefited in fiscal 2003 from gains of approximately $10 million, realized upon
sales of its sales-type lease receivables.
Bulk Deliveries to Customer Warehouses and Other
As presented historically, the Pharmaceutical Distribution and Provider
Services segment's revenue was classified into two categories ("Operating
Revenue" and "Bulk Deliveries to Customer Warehouses and Other"). "Bulk
Deliveries to Customer Warehouses and Other" has historically included revenue
arising from sales where the Company ordered pharmaceutical product in bulk on
behalf of a specific warehousing customer and either the manufacturer ships the
product directly to the customer's warehouse or the product is shipped to the
customer's warehouse shortly after it is received by the Company and is not put
into the Company's inventory (in either case, "Bulk Revenue"). For all Bulk
Revenue, the product was shipped to the customer in the same bulk form in which
it was received by the Company from the manufacturers. The Company previously
(since fiscal 2002) followed an internal policy for distinguishing between
Operating Revenue and Bulk Revenue based on how long the product was in the
Company's possession prior to being shipped to customers. If the product was in
the possession of the Company for more than 24 hours prior to being shipped to
customers, then, regardless of other characteristics of the transaction or the
reason for the product being held for more than 24 hours, the sale of that
product was deemed to be Operating Revenue. The Company's internal policy
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also provided that customer orders for bulk shipments filled from inventory
within the Company's warehouse were deemed to be Operating Revenue if the order
for the product had been placed with the manufacturer prior to the Company
receiving the bulk order from one of its customers ("Just-in-Time"). Operating
Revenue for bulk shipments for product that was in the possession of the Company
for more than 24 hours prior to being shipped to customers (other than with
respect to certain bulk shipments intentionally held for more than 24 hours as
described in the text following the table) and Just-in-Time bulk shipments by
quarter for the three year period ended June 30, 2004 was approximately as
follows:
24 Hour Rule Just-in-Time
--------------------------- ----------------------------
(in millions) Fiscal year ended June 30, Fiscal year ended June 30,
--------------------------- ----------------------------
2004 2003 2002 2004 2003 2002
-------- --------- -------- --------- --------- --------
First Quarter $191 $ 208 - $ 13 $ 351 -
Second Quarter 187 200 156 74 265 -
Third Quarter 148 360 155 31 252 157
Fourth Quarter 149 232 155 - 334 325
-------- --------- -------- --------- --------- --------
Total Year $675 $1,000 $466 $118 $1,202 $482
======== ========= ======== ========= ========= ========
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Based on results of the internal review conducted by the Audit Committee, the
Company has concluded that certain bulk shipments ordered by customers were
intentionally held for more than 24 hours so that, pursuant to the internal
policy, such shipments were classified as Operating Revenue in four quarters
within fiscal 2003 and 2002. The Company estimates that approximately $813
million and $414 million being improperly classified as Operating Revenue in
fiscal 2003 and 2002, respectively. The impact of this practice was not
previously quantified and disclosed as part of the Company's reported Operating
Revenue. The improper classification between Bulk Revenue and Operating Revenue
had no impact on the Company's previously reported total revenue or operating or
net earnings for these periods.
The following table shows the estimated amount of Bulk Revenue that was
improperly classified as Operating Revenue in the manner described above, and
shows the estimated impact from adjusting each of Bulk Revenue and Operating
Revenue for the periods in which these improper classifications occurred:
Bulk Revenue Operating Revenue
-------------------------- --------------------------
Fiscal Year Ended June 30, Fiscal Year Ended June 30,
(in millions) 2003 2002 2003 2002
------------- ------- --------- --------- ---------
First Quarter $ - $ - $ - $ -
Second Quarter 673.0 82.0 (673.0) (82.0)
Third Quarter 140.0 - (140.0) -
Fourth Quarter - 332.0 - (332.0)
------- --------- --------- ---------
Total Year $ 813.0 $ 414.0 $ (813.0) $ (414.0)
======= ========= ========= =========
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In response to the internal review conducted by the Company's Audit
Committee (see "Part I, Item 3: Legal Proceedings" and Note 1 of "Notes to
Consolidated Financial Statements") and a review of Company policies, the
Company has changed its definition of Bulk Revenue. Transactions with the
following characteristics will now be defined 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 under this new definition was $18.0 billion in fiscal 2004, $15.4
billion in fiscal 2003 and $13.7 billion in fiscal 2002. The increase in Bulk
Revenue during fiscal 2004 primarily relates to additional volume from existing
customers. The increase in Bulk Revenue during fiscal 2003 primarily relates to
new customers and additional volume from existing customers.
For fiscal 2004, the Company decided to aggregate revenue classes within
this Form 10-K. "Operating Revenue" and "Bulk Deliveries to Customer Warehouses
and Other" have been combined for all periods presented so that revenue and cost
of products sold are presented as single amounts in the consolidated statements
of earnings. These reclassifications have no effect on previously reported total
revenue, related cost of products sold, net earnings or earnings per share.
However, these reclassifications do impact previously reported growth rates
which focused solely on Operating Revenue. Beginning with this Form 10-K,
information concerning the portion of the Company's revenue that arises from
Bulk Revenue will be discussed in the Company's "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
In the past, "Bulk Deliveries to Customer Warehouses and Other" also
included certain revenue relating to the Pharmaceutical Technologies and
Services segment. The Pharmaceutical Technologies and Services segment's revenue
classified as "Bulk Deliveries to Customer Warehouses and Other" represented
reimbursement from customers of certain out-of-pocket expenses incurred by the
Company on behalf of customers and totaled $200.5 million in fiscal 2003. These
customer reimbursements will not be included within the Company's definition of
Bulk Revenue going forward.
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Operating Earnings
Operating earnings for the Company and its reportable segments are as
follows:
(in millions) 2004 2003 2002
------------- ------------ ----------- ------------
Restated Restated
Pharmaceutical Distribution and Provider Services $ 1,173.4 $ 1,188.1 $ 1,081.0
Medical Products and Services 666.0 591.8 545.2
Pharmaceutical Technologies and Services 465.4 368.3 265.0
Automation and Information Services 270.2 266.0 209.2
Corporate (1) (237.7) (218.2) (243.0)
------------ ----------- ------------
Total Company Operating Earnings $ 2,337.3 $ 2,196.0 $ 1,857.4
============ =========== ============
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(1) See Note 18 of "Notes to Consolidated Financial Statements" for a
description of Corporate operating earnings.
The following table summarizes the operating earnings growth rates for the
Company and its reportable segments, as well as the percent of Company operating
earnings, excluding Corporate, each segment represents:
Percent of Company
Growth (1) Operating Earnings
--------------- --------------------------
Years ended June 30, 2004 2003 2004 2003 2002
-------------------- ---- ---- ---- ---- ----
Adjusted Adjusted Adjusted
Pharmaceutical Distribution and Provider Services (1)% 10% 46% 49% 51%
Medical Products and Services 13% 9% 26% 25% 26%
Pharmaceutical Technologies and Services 26% 39% 18% 15% 13%
Automation and Information Services 2% 27% 10% 11% 10%
Total Company (2) 6% 18% 100% 100% 100%
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(1) Growth is calculated as change (increase or decrease) for a given
year as compared to immediately preceding year.
(2) The Company's overall operating earnings growth of 6% and 18%,
respectively, in fiscal 2004 and 2003 includes the effect of special
items. Special items are not allocated to the segments. See Note 4
in "Notes to Consolidated Financial Statements" for further
information regarding the Company's special items.
TOTAL COMPANY. Total operating earnings increased 6% and 18% during fiscal
2004 and 2003, respectively. The following paragraphs provide a description of
the varying dynamics affecting the total Company's operating earnings for fiscal
2004 and 2003.
FISCAL 2004. Operating earnings increased 6% during fiscal 2004 primarily
as a result of the Company's revenue growth of 15% during the same time period,
which yielded a gross margin increase of 6%. Gross margins grew at a slower rate
than revenue primarily as a result of: (1) continued dampening effect of reduced
vendor margins and competitive pricing within the Pharmaceutical Distribution
business driven by changes to its business model (see the "Overview" section for
further discussion); (2) increased mix of lower-margin distribution business
within the Medical Products and Services segment; (3) increased mix of lower
margin business, primarily Nuclear Pharmacy Services, within the Pharmaceutical
Technologies and Services segment; and (4) competitive product and pricing
actions within the Automation and Information Services segment. The overall
increase in gross margin reflects the increased contributions from the Company's
operating segments outside of the Pharmaceutical Distribution and Provider
Services segment, which generate higher gross margins and operating earnings (as
a percentage of revenue). These segments currently account for more than
one-half of the Company's operating earnings. The Company expects this trend to
continue. Acquisitions completed by the Company accounted for approximately 3%
of the operating earnings growth.
The increases in revenue and gross margin were partially offset by a 4%
increase in selling, general and administrative expenses during fiscal 2004, as
well as an increase of $17.5 million in the Company's special items. The overall
increase in operating expenses was primarily a result of the additional expenses
resulting from acquisitions, higher personnel costs associated with overall
business growth and an increase in depreciation and amortization costs.
Additionally, the Company continues to invest in research and development and
strategic initiatives that will benefit future periods. Investments of
approximately $115 million in fiscal 2004 were charged against current operating
earnings as incurred. These increases in selling, general and administrative
34
expenses were offset partially by: (1) reduction versus the prior fiscal year in
incentive compensation expenses of approximately $64 million due to the
performance of the Company's consolidated operations relative to management's
expectations and established financial performance metrics, such reductions
affecting all of the Company's business segments; and (2) adjustments of certain
trade receivable reserves and lower bad debt expenses, combined impact
approximately $10 million, due to changes in customer-specific credit exposures,
as well as improvements in customer credit, billing and collection processes
yielding significant reductions in past due and uncollectible accounts.
FISCAL 2003. The Company attributes the operating earnings increase of 18%
during fiscal 2003 to its revenue growth of 11% during the same time period,
which yielded a gross margin increase of 11%. Selling, general and
administrative expenses grew 8% during this period primarily due to additional
expenses resulting from acquisitions, higher personnel costs associated with the
overall business growth and an increase in depreciation and amortization costs.
However, selling, general and administrative expenses grew at a slower rate than
gross margin which contributed to the overall percentage increase in operating
earnings. In addition, a significant contributor of the overall operating
earnings increase was a decrease of $76.7 million in the Company's special items
due to the recognition of special item income of $101.5 million related to net
litigation settlements received by the Company in fiscal 2003 as compared to
$33.8 million received in fiscal 2002.
PHARMACEUTICAL DISTRIBUTION AND PROVIDER SERVICES. This segment's
operating earnings declined 1% during fiscal 2004 primarily due to reduced
vendor margins caused by the changing business model within the Pharmaceutical
Distribution business (as further described in the "Overview" section) and the
impact of competitive pricing. Other adjustments which negatively impacted this
segment in fiscal 2004 included the following items within the Pharmaceutical
Distribution business: (a) an increase in inventory valuation and vendor dispute
reserves in the fourth quarter, $11.7 million, and (b) an adverse adjustment in
the third quarter, $9.2 million, for vendor margins. In addition, one of several
aspects of the business model transition adversely impacting Pharmaceutical
Distribution's year over year operating earnings is the change in estimation of
vendor margin with generic, health and beauty products and pharmaceutical
manufacturers, approximately $15.3 million. These declines were partially offset
by the following:
- segment revenue growth of 15% coupled with expense control;
- change in accounting for cash discounts resulting in additional
gross margin of $20.0 million in fiscal 2004 (see additional
discussion of the accounting change in Notes 16 and 19 of "Notes to
Consolidated Financial Statements");
- favorable year over year impact, $14.7 million, from changes in
last-in, first-out ("LIFO") reserve;
- favorable year over year impact of lower incentive compensation
expense;
- favorable year over year impact of certain non-recurring expenses
recorded in fiscal 2003 relating to operations from the Bindley
acquisition; and
- favorable year over year impact of $34 million charge recorded in
fiscal 2003 relating to the segment's vendor margins with its
generic suppliers.
This segment's operating earnings increase of 10% during fiscal 2003
resulted primarily from the following:
- segment revenue growth of 10%;
- change in timing of income recognition for pharmaceutical
manufacturers' payments under existing inventory management
agreements from a modified cash basis to an accrual basis resulting
in a favorable gross margin impact of approximately $13 million
recorded in the third quarter;
- expense controls, which resulted in a decrease of 6% in selling,
general and administrative expenses; and
- favorable year over year impact, $12.4 million, relating to changes
in Corporate expenses allocated to this segment.
Also contributing to the improvement in fiscal 2003 year over year
performance were certain non-recurring expenses of approximately $40 million
recorded in fiscal 2002 associated with operations acquired as part of the
Bindley acquisition. These non-recurring expenses in fiscal 2002 were partially
offset by a $23 million benefit recognized in the same period as a result of
changes in the Company's LIFO calculation with respect to generic products in
order to more accurately reflect inflationary indices. The segment's operating
earnings in fiscal 2003 were negatively impacted by the $5.2 million year over
year impact within the Pharmaceutical Distribution business of the business
model transition impacting its vendor margins with generic, health and beauty
products and pharmaceutical vendors.
MEDICAL PRODUCTS AND SERVICES. This segment's operating earnings growth of
13% during fiscal 2004 resulted primarily from this segment's revenue growth of
11% during the same time period, led by sales momentum from distribution
contracts and gains within international markets. This segment also realized
manufacturing productivity improvements resulting in gross margin gains. In
addition, operating earnings benefited from lower incentive compensation expense
versus prior year. This segment's operating earnings growth was partially
dampened by the increased mix of lower margin distributed products, competitive
pricing within the industry and an increase of approximately $9 million in raw
material prices.
This segment's operating earnings growth of 9% during fiscal 2003 resulted
from this segment's revenue growth of 6% during the same time period and the
ability to leverage this revenue growth into additional gross margin gains. This
segment's gross margin was positively impacted by increased sales of existing
and new higher-margin, self-manufactured products, manufacturing efficiencies
achieved during the fiscal year and outsourcing of some product manufacturing to
more cost efficient areas. In
35
addition, operating earnings benefited from various required balance sheet
reserve adjustments, approximately $8.2 million, recorded during the year
relating to historical customer and vendor disputes. The operating earnings
growth rate was negatively affected by: (1) impact of new distribution
agreements which increased sales of lower-margin distributed products in fiscal
2003; (2) increased Corporate expenses, $2.5 million, allocated to this segment;
and (3) a one-time adjustment recorded in fiscal 2002 to transfer the segment's
incentive compensation expenses, approximately $15 million, to the Corporate
segment. This adjustment was recorded in the Corporate segment as the business
segment's stand-alone incentive compensation program in effect at the time would
have resulted in no incentive compensation expense for the year; however, a
corporate management decision was made to include the segment's employees in the
Company's overall incentive compensation program in advance of integrating
various employee benefit programs.
PHARMACEUTICAL TECHNOLOGIES AND SERVICES. This segment's operating
earnings growth of 26% during fiscal 2004 resulted primarily from this segment's
revenue growth of 25% during the same time period, with sales momentum in the
Pharmaceutical Development, Nuclear Pharmacy Services and Packaging Services
businesses showing particular strength. This segment also benefited from
acquisitions completed by the Company, specifically Intercare and Syncor. The
acquisition of Intercare was completed during the second quarter fiscal 2004
and, therefore, its results of operations are not included in the prior period.
Also, Syncor's results of operations are not included in the first half of
fiscal 2003 since the acquisition was completed on January 1, 2003. Excluding
the impact of acquisitions within this segment, operating earnings growth would
have been approximately 8% during fiscal 2004. This segment's gross margin as a
percentage of revenue was negatively impacted by the increase in services
provided by the Nuclear Pharmacy Services business, which has a lower gross
margin ratio as compared to the other businesses within this segment. The
segment's operating earnings also benefited year over year by reduced incentive
compensation expenses. Operating earnings growth was dampened by the delay in
startup of commercial manufacturing of certain sterile products as discussed in
this segment's revenue discussion. In addition, this segment's operating
earnings growth is not impacted by foreign exchange fluctuations as the Company
applies constant exchange rates to translate its foreign operations' operating
earnings into U.S. dollars. The impact of actual foreign exchange rate changes
for translation purposes is retained within the Corporate segment (see footnote
6 to the table in Note 18 in "Notes to Consolidated Financial Statements").
This segment's operating earnings growth of 39% during fiscal 2003
resulted primarily from this segment's revenue growth of 59% during the same
time period, as discussed above in the "Revenue" section. Excluding the impact
of acquisitions within this segment, operating earnings growth would have been
approximately 13% during fiscal 2003. The deleveraging effect between gross
margin and revenue within this segment was primarily driven by the addition of
Syncor's Nuclear Pharmacy Services business and the addition of BLP's customer
reimbursements of out-of-pocket expenses incurred to fulfill services required
by various contracts. Syncor has a lower gross margin ratio than the other
businesses within this segment, and BLP records these customer reimbursements
gross within revenue and cost of products sold, but generates no margin from
them.
AUTOMATION AND INFORMATION SERVICES. This segment's operating earnings
growth of 2% during fiscal 2004 was impacted by the premature revenue
recognition adjustment resulting from the Audit Committee's internal review as
more fully described in Note 1 of "Notes to Consolidated Financial Statements."
This segment's operating earnings growth during fiscal 2004 resulted, in part,
from this segment's revenue growth of 2% during the same time period in
conjunction with operational improvements and favorable product mix. In
addition, this segment benefited from a reduction in receivable reserves and
lower bad debt expenses, combined impact approximately $8.2 million, due to
improvements in customer-specific credit matters, as well as general
improvements in customer credit, billing and collection procedures, resulting in
significant reductions in past due and uncollectible accounts. The segment's
operating earnings also benefited year over year from reduced (a) incentive
compensation expenses, and (b) Corporate expense allocation of $1.5 million. As
mentioned in this segment's revenue discussion, the Company recorded, for
comparative purposes, a Corporate allocation of $21 million to this segment
representing estimated interest income this segment would have earned had the
Company not initiated the sale of its lease receivables. Excluding the impact of
this allocation, this segment's operating earnings growth would have been
negative 6% during fiscal 2004. See this segment's discussion under "Revenue"
for additional information regarding this allocation entry.
This segment's operating earnings growth of 27% during fiscal 2003
resulted primarily from this segment's revenue growth of 19% during the same
time period in conjunction with an improved mix of higher-margin products sold
and productivity gains realized from operational improvements. In addition,
operating earnings during fiscal 2003 included gains of approximately $10
million from sales of sales-type leases.
36
Special Items
The following is a summary of the Company's special items:
Fiscal Year Ended June 30,
(in millions, except per Common Share amounts) 2004 2003 2002
---------------------------------------------- ------ ------- -------
Restated
Merger-related costs $ 44.7 $ 74.4 $ 131.9
Restructuring costs 37.1 67.0 18.5
Litigation settlements, net (62.3) (101.5) (33.8)
Other special items 37.9 - -
------ ------- -------
Total special items $ 57.4 $ 39.9 $ 116.6
====== ======= =======
|
See Note 4 of "Notes to Consolidated Financial Statements" for detail of
the Company's special items during fiscal 2004, 2003 and 2002.
Interest Expense and Other
The decrease in interest expense and other of $16.4 million during fiscal
2004 and $17.2 million during fiscal 2003 resulted from lower interest rates and
borrowing levels due to the Company's strong operating cash flow. The Company
manages its exposure to interest rates using various hedging strategies (see
Notes 3 and 7 in "Notes to Consolidated Financial Statements"). Also included
within interest expense and other are gains and losses recognized from
transactions outside of the Company's ordinary course of business (e.g., sales
of lines of businesses or individual facilities as well as adjustments of equity
investments). The following summarizes the more significant transactions that
occurred during fiscal 2004, 2003 and 2002.
- During fiscal 2004, the Company recorded net gains of approximately $11.9
million and $6.3 million related to the sale of non-strategic businesses
within its Pharmaceutical Technologies and Services and Medical Products
and Services segments. The Company also recorded a $6.8 million gain
related to the sale of land within its Medical Products and Services
segment. In addition, the Company recorded a $4.2 million asset impairment
charge relating to domestic intellectual property rights within its
Automation and Information Services segment.
- During fiscal 2003, the Company recorded a net gain of approximately $17.6
million related to the sale of a non-strategic business within the
Pharmaceutical Distribution and Provider Services segment and a gain of
$8.0 million as a result of a payment the Company received in exchange for
amending a contract within the Automation and Information Services segment
(releasing the Company's exclusivity rights in a designated territory).
Also within fiscal 2003, the Company recorded a loss of $7.9 million
related to the write-off of certain obsolete assets as a result of a
system implementation within the Pharmaceutical Technologies and Services
segment.
- During fiscal 2002, the Company recorded a net gain of approximately $22.4
million related to the sale of a non-strategic business which was
partially offset by losses related to asset abandonments within the
Pharmaceutical Technologies and Services segment, $11.5 million, and
Medical Products and Services segment, $4.6 million.
Provision for Income Taxes
The provisions for income taxes relative to earnings before income taxes,
discontinued operations and cumulative effect of changes in accounting were
31.9% of pretax earnings in fiscal 2004, 33.6% in fiscal 2003 and 33.8% in
fiscal 2002. Fluctuations in the effective tax rate are primarily due to changes
within state and foreign effective tax rates resulting from the Company's
business mix and changes in the tax impact of special items, which may have
unique tax implications depending on the nature of the item and the taxing
jurisdiction. The Company's effective tax rate reflects tax benefits derived
from increasing operations outside the United States, which are generally taxed
at rates lower than the U.S. statutory rate of 35 percent. During fiscal 2004,
the Company's provision for income taxes benefited from increased profits from
production in lower tax international countries (e.g., Thailand and the
Dominican Republic). The Company has subsidiaries operating in Puerto Rico under
a tax incentive agreement expiring in 2019, as well as a tax agreement in place
with Thailand that expires in 2013.
Loss from Discontinued Operations
See Note 21 in "Notes to Consolidated Financial Statements" for
information on the Company's discontinued operations.
CRITICAL ACCOUNTING POLICIES AND SENSITIVE ACCOUNTING ESTIMATES
Critical accounting policies are those accounting policies that can have a
significant impact on the presentation of the Company's financial condition and
results of operations, and require use of complex and subjective estimates based
upon past experience and management's judgment. Because of the uncertainty
inherent in such estimates, actual results may differ from these estimates.
Below are those policies applied in preparing the Company's financial statements
that management believes are the most dependent on the application of estimates
and assumptions. For additional accounting policies, see Note 3 of "Notes to
Consolidated Financial Statements."
37
- ALLOWANCE FOR DOUBTFUL ACCOUNTS. Trade receivables comprise amounts owed
to the Company through its operating activities and are presented net of
an allowance for doubtful accounts. The Company also provides financing to
various customers. Such financing arrangements range from one year to ten
years at interest rates that generally fluctuate with the prime rate.
These financings may be collateralized, guaranteed by third parties or
unsecured. Finance notes and accrued interest receivables are recorded net
of an allowance for doubtful accounts and are included in other assets.
Extending credit terms and calculating the required allowance for doubtful
accounts involve the use of judgment by the Company's management.
In determining the appropriate allowance for doubtful accounts, which
includes general and specific reserves, the Company reviews accounts
receivable agings, industry trends, customer financial strength, credit
standing and payment history to assess the probability of collection. The
Company continuously monitors the collectibility of its receivable
portfolio by analyzing the aging of its accounts receivable, assessing
credit worthiness of its customers and evaluating the impact of changes in
economic conditions that may impact credit risks. If the frequency or
severity of customer defaults increases due to changes in customers'
financial condition or general economic conditions, the Company's
allowance for uncollectible accounts may require adjustment.
The allowance for doubtful accounts as a percentage of customer
receivables was 3.3% and 4.1% at June 30, 2004 and 2003, respectively. The
decrease was a result of adjustments to certain trade receivable reserves
due to changes in customer-specific credit exposures, as well as
improvements in customer credit, billing and collections processes. A
hypothetical 0.1% increase or decrease in the reserve as a percentage of
trade receivables to the fiscal 2004 reserve would result in an increase
or decrease in bad debt expense of approximately $4.2 million. The Company
believes the reserve maintained and expenses recorded in fiscal year 2004
are appropriate and consistent with historical methodologies employed. The
favorable net effect results from improvements in the Company's credit and
collection practices and actual experiences. The total reserve at June 30,
2004 and 2003 exceeds the total Company receivable balance greater than 60
days past due at those same dates. See Schedule II included in this Form
10-K which includes a rollforward of activity for these allowance
reserves.
- INVENTORIES. A majority of inventories (approximately 66% in 2004 and 68%
in 2003) are stated at the lower of cost, using the LIFO method, or
market, and are primarily merchandise inventories. The remaining inventory
is primarily stated at the lower of cost, using the first-in, first-out
("FIFO") method, or market. If the Company had used the FIFO method of
inventory valuation, which approximates current replacement cost,
inventories would have increased $57.8 million and $61.4 million in fiscal
2004 and 2003, respectively.
Below is a reconciliation of FIFO inventory to LIFO inventory:
June 30,
---------------------------
(in millions) 2004 2003
------------- ----------- -------------
Restated
FIFO inventory $ 7,529.1 $ 7,632.3
LIFO reserve valuation (57.8) (61.4)
----------- -------------
Total inventory $ 7,471.3 $ 7,570.9
=========== =============
|
Inventories recorded on the Company's consolidated balance sheets are net
of reserves for excess and obsolete inventory. The Company reserves for
inventory obsolescence using estimates based on historical experiences,
sales trends, specific categories of inventory and age of on-hand
inventory. If actual conditions are less favorable than the Company's
assumptions, additional inventory reserves may be required, however these
would not be expected to have a material adverse impact on the Company's
financial statements.
- GOODWILL. The Company accounts for goodwill in accordance with Statement
of Financial Accounting Standards ("SFAS") No. 142 "Goodwill and Other
Intangible Assets." Under SFAS No. 142, purchased goodwill and intangible
assets with indefinite lives are no longer amortized, but instead tested
for impairment annually or when indicators of impairment exist.
Accordingly, the Company does not amortize goodwill and intangible assets
with indefinite lives. Intangible assets with finite lives, primarily
customer relationships and patents and trademarks, continue to be
amortized over their useful lives.
In conducting the impairment test, the fair value of the Company's
reporting units is compared to its carrying amount including goodwill. If
the fair value exceeds the carrying amount, then no impairment exists. If
the carrying amount exceeds the fair value, further analysis is performed
to assess impairment.
38
The Company's impairment analysis is based on a review of the
price/earnings ratio for companies similar in nature, scope and size. The
use of alternative estimates, peer groups or changes in the industry could
affect the estimated fair value of the assets and potentially result in
impairment. Any identified impairment would result in adjustment to the
Company's results of operations. The Company completed the required
impairment testing in fiscal 2004 and 2003 and did not incur any
impairment charges.
- BUSINESS COMBINATIONS. Assumptions and estimates are used in determining
the fair value of assets acquired and liabilities assumed in a business
combination. A significant portion of the purchase price in many of the
Company's acquisitions is assigned to intangible assets which require
management to use significant judgment in determining fair value. The
Company typically utilizes third-party valuation experts ("Valuation
Experts") for this process. In addition, current and future amortization
expense for such intangibles is impacted by purchase price allocations as
well as the assessment of estimated useful lives of such intangibles,
excluding goodwill. The Company believes the assets recorded and the
useful lives established are appropriate based upon current facts and
circumstances.
In conjunction with the review of a transaction, the Valuation Experts
assess the status of the acquired company's research and development
projects to determine the existence of in-process research and development
("IPR&D"). The Company has not historically recorded significant costs
related to IPR&D. However, in conjunction with the recent acquisition of
ALARIS, the Company was required to estimate the fair value of acquired
IPR&D which required selecting an appropriate discount rate and estimating
future cash flows for each project. Management also assessed the current
status of development, nature and timing of efforts to complete such
development, uncertainties and other factors when estimating the fair
value. Costs were not assigned to IPR&D unless future development was
probable. Once the fair value was determined, an asset was established and
immediately written-off as a special item in the Company's consolidated
statement of earnings. The Company recorded $12.7 million as a special
item in fiscal 2004 representing an estimate of ALARIS' IPR&D (see Note 4
of "Notes to Consolidated Financial Statements").
- SPECIAL ITEMS. The Company's special items consist primarily of costs that
relate to the integration of previously acquired companies or costs of
restructuring operations to improve productivity. Integration costs from
acquisitions accounted for under the pooling of interests method have been
recorded in accordance with Emerging Issues Task Force ("EITF") Issue No.
94-3, "Liability Recognition for Certain Employee Termination Benefits and
Other Costs to Exit an Activity (including Certain Costs incurred in a
Restructuring)," and SEC Staff Accounting Bulletin No. 100, "Restructuring
and Impairment Charges." Certain costs related to these acquisitions, such
as employee and lease terminations and other facility exit costs, were
recognized at the date the integration plan was adopted by management.
Certain other integration costs that did not meet the criteria for accrual
at the commitment date have been expensed as the integration plan has been
implemented.
The costs associated with integrating acquired companies under the
purchase method are recorded in accordance with EITF Issue No. 95-3,
"Recognition of Liabilities in Connection with a Purchase Business
Combination." Certain costs to be incurred by the Company, as the
acquirer, such as employee and lease terminations and other facility exit
costs, are recognized at the date the integration plan is formalized and
adopted by management. Certain other integration costs that do not meet
the criteria for accrual at the commitment date are expensed as the
integration plan is implemented.
At the beginning of the third quarter fiscal 2003, the Company implemented
SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal
Activities," to account for costs incurred in restructuring activities.
Under this standard, a liability for an exit cost is recognized as
incurred. As discussed above, the Company previously accounted for costs
associated with restructuring activities under EITF Issue No. 94-3, which
required the Company to recognize a liability for restructuring costs on
the date of the commitment to an exit plan.
The majority of the special items related to acquisitions and
restructurings can be classified in one of the following categories:
employee-related costs, exit costs (including lease termination costs),
asset impairments and other integration costs. Employee costs include
severance and termination benefits. Lease termination costs include lease
cancellation fees, forfeited deposits and remaining payments due under
existing lease agreements less estimated sublease income. Other facility
exit costs include costs to move equipment or inventory out of a facility
as well as other costs incurred to shut down a facility. Asset impairment
costs include the remaining net book value of assets no longer used as a
result of the integration or restructuring activities. Other integration
costs primarily include charges directly related to the integration plan
such as consulting costs related to information systems and employee
benefit plans as well as relocation and travel costs directly associated
with the integration plan. Actual costs could differ from management's
estimates. If actual results are different from original estimates, the
Company will record additional expense or reverse previously recorded
expenses. These adjustments will be recorded as special items.
39
The Company also records settlements of significant lawsuits that are
infrequent, non-recurring or unusual in nature as special items. See Note
4 of "Notes to Consolidated Financial Statement" for additional
information.
- VENDOR RESERVES. In determining an appropriate vendor reserve, the Company
assesses historical experience and current outstanding claims. The Company
researches and resolves contested transactions based on discussions with
vendors, Company policy and findings of research performed. At any given
time, there are outstanding items in various stages of research and
resolution. The ultimate outcome of certain claims may be different than
the Company's original estimate and may require adjustment. However, the
Company believes reserves recorded for such disputes are adequate based
upon current facts and circumstances.
- INCOME TAX RESERVES. The Company has established an estimated liability
for federal, state and foreign income tax exposures that arise and meet
the criteria for accrual under SFAS No. 5, "Accounting for Contingencies."
This liability addresses a number of issues for which the Company may have
to pay additional taxes (and interest) when all examinations by taxing
authorities are concluded.
The Company has developed a methodology for estimating its tax liability
related to such matters and has consistently followed such methodology
from period to period. The liability amounts for such matters are based on
an evaluation of the underlying facts and circumstances, a thorough
research of the technical merits of the Company's arguments, and an
assessment of the chances of the Company prevailing in its arguments. In
all cases, the Company considers previous IRS findings. The Company
generally consults with external tax advisers in researching its
conclusions. Amounts accrued for a particular period are not adjusted
upward or downward unless a significant change in facts or circumstances
has occurred and been formally documented.
- LOSS CONTINGENCIES. The Company accrues for contingencies related to
litigation in accordance with SFAS No. 5, "Accounting for Contingencies,"
which requires the Company to assess contingencies to determine degree of
probability and range of possible settlement. An estimated loss
contingency is accrued in the Company's consolidated financial statements
if it is probable that a liability has been incurred and the amount of the
settlement can be reasonably estimated. Assessing contingencies is highly
subjective and requires judgments about future events. The Company
regularly reviews contingencies to determine the adequacy of the accruals
and related disclosures. The amount of ultimate settlement may differ from
these estimates.
- SELF INSURANCE ACCRUALS. The Company is self-insured for employee medical
and dental insurance programs. The Company had recorded liabilities
totaling $23.0 million and $12.8 million for estimated costs related to
outstanding claims at June 30, 2004 and 2003, respectively. These costs
include an estimate for expected settlements on pending claims,
administrative fees and an estimate for claims incurred but not reported.
These estimates are based on the Company's assessment of outstanding
claims, historical analysis and current payment trends. The Company
records an estimate for the claims incurred but not reported using an
estimated lag period. This lag period assumption has been consistently
applied for the periods presented. If the lag period was adjusted by a
period equal to a half month, the impact on earnings would be $4.7
million. However, the Company believes the liabilities recorded are
adequate based upon current facts and circumstances.
The Company is also self-insured for various general liability and
workers' compensation claims. The Company had recorded liabilities
totaling $48.0 million and $39.2 million for anticipated costs related to
general liability and workers' compensation at June 30, 2004 and 2003,
respectively. These costs include an estimate for expected settlements on
pending claims, defense costs and an estimate for claims incurred but not
reported. These estimates are based on the Company's assessment of
outstanding claims, historical analysis, actuarial information and current
payment trends. The amount of ultimate liability in respect to these
matters may differ from these estimates.
40
LIQUIDITY AND CAPITAL RESOURCES
Sources and Uses of Cash
The following table summarizes the Company's Consolidated Statements of
Cash Flows for fiscal 2004, 2003 and 2002:
Fiscal Years Ended June 30,
----------------------------------------------
(in millions) 2004 2003 2002
-----------------------------------------------------------------------------------
Restated Restated
Cash provided by/(used in):
Operating activities $2,624.7 $1,398.0 $ 983.9
Investing activities ($2,437.0) ($ 343.7) ($ 650.9)
Financing activities ($ 815.7) ($ 712.3) $ 114.9
|
OPERATING ACTIVITIES. Cash provided by operating activities nearly doubled
during fiscal 2004 as compared to fiscal 2003 primarily due to an increase in
accounts payable and increased earnings from continuing operations. The primary
driver of the increase in accounts payable was due to the timing of payments at
fiscal year-end, as well as inventory buys executed shortly before fiscal
year-end within the Company's Pharmaceutical Distribution business. In addition,
as a result of certain non-recurring end of year arrangements, payments to
vendors in fiscal 2004 were reduced by $258 million due to the acceleration of
payments at June 30, 2003 to selected pharmaceutical vendors. Such arrangements
resulted in changes to the original payment terms with the vendors for which an
economic consideration was exchanged between both parties. The Company's overall
investment in inventories declined during fiscal 2004 as compared to fiscal 2003
due primarily to the changing business model of the Pharmaceutical Distribution
business (see the "Overview" section earlier within "Management's Discussion and
Analysis of Financial Condition and Results of Operations"). This business model
change should continue to have a positive impact on the Company's operating cash
flows in the near-term, reducing the Company's inventory on-hand and moderating
historical seasonal fluctuations in working capital. For further discussion of
changes within the Company's earnings from continuing operations, see the
"Results of Operations" section. Additionally, the Company's operating cash flow
benefited by approximately $99.3 million during fiscal 2004 due to sales of
lease receivables from the Company's Automation and Information Services
segment. See Note 10 in "Notes to Consolidated Financial Statements" for
information regarding sales of lease receivables.
Cash provided by operating activities during fiscal 2003 increased $414.1
million as compared to fiscal 2002 primarily due to (a) increased earnings from
continuing operations, and (b) sales of lease receivables, which benefited the
Company's operating cash flow by $247.6 million in fiscal 2003 as compared to
$97.8 million in fiscal 2002. These positive factors were partially offset by
year over year impact of (i) end of year payments to selected pharmaceutical
vendors, approximately $370 million, for which economic consideration was
exchanged between both parties; and (ii) accelerated end of year customer
receipts, approximately $152 million, for which economic consideration was
exchanged between both parties. The positive factors were also partially offset
by increases in trade receivables and inventories. The increase in trade
receivables was driven by the Company's revenue growth. The increase in
inventories resulted primarily from increased sales across each of the Company's
segments. The rate of increase in inventories was less than in prior years due
to the impact of branded to generic product conversions, vendor inventory
policies and inventory management agreements. Synergies realized from the
Bindley integration also lowered the Company's investment in inventory.
INVESTING ACTIVITIES. Cash used in investing activities during fiscal
2004, 2003 and 2002 primarily represents the Company's use of cash to complete
acquisitions which expand its role as a provider of services to the health care
industry (see "Acquisitions and Divestitures" within "Part I, Item 1: Business"
for further information regarding the Company's acquisitions); and develop and
enhance the Company's infrastructure, including facilities, information systems
and other machinery and equipment. During these fiscal years, the Company has
focused on developing the infrastructure within its Pharmaceutical Technologies
and Services segment. The uses of cash noted above were partially offset by
proceeds received from the sale of property, equipment and other assets, as well
as proceeds from the sale of discontinued operations during fiscal 2004 and
2003.
FINANCING ACTIVITIES. The Company's financing activities utilized cash of
$815.7 million and $712.3 million during fiscal 2004 and 2003, respectively, and
provided cash of $114.9 million during fiscal 2002. Cash used in financing
activities during fiscal 2004 and 2003 primarily reflects the Company's decision
to repurchase its shares as authorized by its Board of Directors (see "Share
Repurchases" below for additional information). These cash outflows for fiscal
2004 and 2003 were partially offset by net proceeds received from the Company's
debt facilities (see "Capital Resources" below for additional information) and
proceeds received from shares issued under various employee stock plans. Cash
provided by financing activities during fiscal 2002 primarily reflects the
issuance of $300 million of Notes, partially offset by repurchase of the
Company's shares.
International Cash
The Company's cash balance of approximately $1.1 billion as of June 30,
2004, includes $299.3 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 United States
federal income tax.
41
Share Repurchases
During fiscal 2004, 2003 and 2002, the Company's Board of Directors
approved, and management completed, several share repurchase programs. These
share repurchase programs, in the aggregate, allowed the Company to repurchase
$3.0 billion of the Company's shares. During fiscal 2004, the Company
repurchased approximately 24.2 million shares having an average price paid per
share of $62.03. During fiscal 2003, the Company repurchased approximately 19.6
million shares having an average price paid per share of $60.77. During fiscal
2002, the Company repurchased approximately 5.1 million shares having an average
price paid per share of $60.24. The repurchased shares were placed into treasury
to be used for general corporate purposes. See "Issuer Purchases of Equity
Securities" within "Part I, Item 5: Market for the Registrant's Common Shares,
Related Shareholder Matters and Issuer Purchases of Equity Securities" for
further information regarding the Company's most recent share repurchase
program.
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, a $150 million extendible commercial note program and a committed
receivables sales facility program with capacity to sell $500 million in
receivables. Subsequent to June 30, 2004, the capacity under the committed
receivables sales facility program was increased to $800 million and the Company
sold in the aggregate $800 million in receivables under the program (for more
information regarding this committed receivables sales facility program, see
Note 10 of "Notes to Consolidated Financial Statements"). Also subsequent to
June 30, 2004, the Company received a commitment letter for a $500 million
committed borrowing facility to be used for general corporate purposes. This
facility is in the process of being negotiated. As of June 30, 2004, $634.2
million of commercial paper was backed by the $1.5 billion of bank revolving
credit facilities, with the remaining facilities unused. The Company also has
lines of credit of approximately $183.7 million, of which $68.4 million was
outstanding as of June 30, 2004.
The Company maintains two $750 million bank revolving credit facilities.
These facilities are available for general corporate purposes; however, they are
primarily used as backstop liquidity for the Company's commercial paper program.
During the third quarter of fiscal 2004, the Company refinanced its maturing
364-day, $750 million revolving credit facility with a new five-year, $750
million revolving credit facility. Management believes that the extension to a
five-year facility enhanced the Company's liquidity profile by reducing
refinancing risk at nominal marginal cost. In connection with adding the new
five-year revolving credit facility, the Company also amended its existing
five-year $750 million revolving credit facility during the third quarter of
fiscal 2004 to administratively conform it to the new five-year revolving credit
facility. Subsequent to June 30, 2004, the Company borrowed $1.25 billion in the
aggregate on its revolving credit facilities. The proceeds from the Company's
revolving credit facilities were utilized to repay a significant portion of the
Company's commercial paper program, none of which remained outstanding as of the
filing date of this Form 10-K, and for general corporate purposes, including the
establishment of pharmaceutical inventory at the Pharmaceutical Distribution
business' National Logistics Center in Groveport, Ohio.
The Company had an asset securitization facility which allowed the Company
to sell receivables generated from its radiopharmaceutical operations to a
wholly-owned subsidiary, which in turn sold the receivables to a multi-seller
conduit administered by a third party bank. This facility allowed for borrowings
up to $65 million. This securitization facility was terminated in fiscal 2004.
During fiscal 2004, the Company retired two series of $100 million Notes
which matured in 2004. During fiscal 2003 and 2002, the Company issued $500
million of 4.00% Notes (due 2015) and $300 million of 4.45% Notes (due 2005),
respectively. The proceeds of the debt issuances were used for repayment of a
portion of the Company's indebtedness and general corporate purposes, including
working capital, capital expenditures, acquisitions and investments. As of June
30, 2004, the Company, pursuant to a shelf registration statement filed with the
SEC, has the capacity available for issuance of up to $500 million of equity and
debt securities.
During fiscal 2001, the Company entered into an agreement to periodically
sell trade receivables to a special purpose accounts receivable and financing
entity (the "Accounts Receivable and Financing Entity"), which is exclusively
engaged in purchasing trade receivables from, and making loans to, the Company.
The Accounts Receivable and Financing Entity, which is consolidated by the
Company, issued $250 million and $400 million in preferred variable debt
securities to parties not affiliated with the Company during fiscal 2004 and
2001, respectively. These preferred debt securities are classified as long-term
debt in the Company's consolidated balance sheet. These preferred debt
securities must be retired or redeemed by the Accounts Receivable and Financing
Entity before the Company, or its creditors, can have access to the Accounts
Receivable and Financing Entity's receivables.
From time to time, the Company considers and engages in acquisition
transactions in order to expand its role as a leading provider of services to
the health care industry. The Company evaluates possible candidates for merger
or acquisition and intends to continue to seek opportunities to expand its role
as a provider of services to the health care industry through all its reporting
segments. If additional transactions are entered into or consummated, the
Company may need to enter into funding arrangements for such mergers or
acquisitions.
The Company currently believes that, based upon existing cash, operating
cash flows, available capital resources (as discussed above) and other available
market transactions, it has adequate capital resources at its disposal to fund
currently anticipated capital
42
expenditures, business growth and expansion, contractual obligations and current
and projected debt service requirements, including those related to business
combinations.
Debt Ratings/Covenants
The Company's senior debt credit ratings from S&P, Moody's and Fitch are
BBB, Baa3 and BBB+, respectively, the commercial paper ratings are A-3, P-3 and
F-2, respectively, and the ratings outlooks are "negative," "on review for
possible further downgrade" and "negative," respectively. Further reductions in
the Company's credit ratings could negatively impact its ability to access
capital as well as its ability to issue additional debt securities at currently
available interest rates.
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 June 30, 2004, the Company was in compliance with this covenant.
The Company's preferred debt securities contain a minimum adjusted
tangible net worth covenant (adjusted tangible net worth cannot fall below $3.0
billion) and certain financial ratio covenants. As of June 30, 2004, the Company
was in compliance with these covenants. A breach of any of these covenants would
be followed by a grace period during which the Company may discuss remedies with
the security holders, or extinguish the securities, without causing an event of
default.
Interest Rate and Currency Risk Management
The Company uses forward currency exchange contracts, currency options and
interest rate swaps to manage its exposure to cash flow variability. The Company
also uses foreign currency forward contracts and interest rate swaps to protect
the value of its existing foreign currency assets and liabilities and the value
of its debt. See Notes 3 and 7 of "Notes to Consolidated Financial Statements"
for information regarding the use of financial instruments and derivatives,
including foreign currency hedging instruments. As a matter of policy, the
Company rarely engages in "speculative" transactions involving derivative
financial instruments. During fiscal 2003, the Company entered into one
speculative interest rate swap transaction resulting in a gain of approximately
$6.7 million. This gain was recorded in interest expense and other per the
consolidated statement of earnings.
Contractual Obligations
As of June 30, 2004, the Company's contractual obligations, including
estimated payments due by period, are as follows:
Payments Due by Period
----------------------
(in millions) 2005 2006-2007 2008-2009 Thereafter Total
------------- -------- --------- --------- ---------- --------
On Balance Sheet:
Long-term debt (1) $ 849.9 $ 808.4 $ 803.3 $1,200.9 $3,662.5
Capital lease obligations (2) 5.1 8.8 5.5 7.8 27.2
Other long-term liabilities (3) 7.3 15.5 11.6 36.6 71.0
Off-Balance Sheet:
Operating leases (4) 109.1 137.7 79.4 109.1 435.3
Purchase obligations (5) (6) 2,412.3 57.5 11.7 10.2 2,491.7
-------- -------- -------- -------- --------
Total financial obligations $3,383.7 $1,027.9 $ 911.5 $1,364.6 $6,687.7
======== ======== ======== ======== ========
|
(1) Represents maturities of the Company's long-term debt obligations, as shown
on the balance sheet. See Note 6 in "Notes to Consolidated Financial Statements"
for further information.
(2) Represents maturities of the Company's capital lease obligations, included
within long-term debt on the Company's balance sheet.
(3) Represents cash outflows by period for certain of the Company's long-term
liabilities in which cash outflows could be reasonably estimated. The primary
items included are estimates of the Company's pension and other post-retirement
benefit obligations as well as accrued marketing fees and other long-term
liabilities. Certain long-term liabilities, such as deferred taxes, have been
excluded from the table above as there are no cash outflows associated with the
liabilities or the timing of the cash outflows cannot reasonably be estimated.
(4) Represents minimum rental payments for operating leases having initial or
remaining non-cancelable lease terms as described in Note 11 of "Notes to
Consolidated Financial Statements." The Company also has required lease payments
based upon LIBOR
43
which are not included in the above amounts due to variability related to such
payments. See description of these leases in Note 10 of "Notes to Consolidated
Financial Statements."
(5) Purchase obligations are defined as an agreement to purchase goods or
services that is enforceable and legally binding and specifying all significant
terms, including: fixed or minimum quantities to be purchased; fixed, minimum or
variable price provisions; and approximate timing of the transaction. The
purchase obligation amounts disclosed above represent estimates of the minimum
for which the Company is obligated and the time period in which cash outflows
will occur. Purchase orders and authorizations to purchase that involve no firm
commitment from either party are excluded from the above table. In addition,
contracts that can be unilaterally cancelled with no termination fee or with
proper notice are excluded from the Company's total purchase obligations except
for the amount of the termination fee or the minimum amount of goods that must
be purchased during the requisite notice period. The significant amount
disclosed within fiscal 2005, as compared to other periods, primarily represents
obligations to purchase inventories within the Pharmaceutical Distribution and
Provider Services segment.
(6) The Company has certain obligations to repurchase franchisee pharmacies from
its Medicine Shoppe and Medicap businesses at the end of the term of the
franchise renewal agreement. These obligations are determined through
third-party appraisals and are for periods beyond fiscal 2009. At this time, the
Company cannot estimate the amount of these obligations and therefore has not
included them in this presentation.
OFF-BALANCE SHEET ARRANGEMENTS
See Note 10 in "Notes to Consolidated Financial Statements" for a
discussion of off-balance sheet arrangements.
OTHER
RECENT FINANCIAL ACCOUNTING STANDARDS. See Note 3 in "Notes to Consolidated
Financial Statements" for a discussion of recent financial accounting standards.
RECENT DEVELOPMENTS. See Notes 1 and 2 in "Notes to Consolidated Financial
Statements" for a discussion of the SEC investigation, U.S. Attorney inquiry and
Audit Committee internal review, and certain reclassification and restatement
adjustments the Company made to its fiscal 2004 and prior historical financial
statements in connection with certain conclusions made by the Audit Committee
during September and October 2004 as part of its internal review to date. See
also Note 22 in "Notes to Consolidated Financial Statements" for discussion of
subsequent events after June 30, 2004.
44
ITEM 7a: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to cash flow and earnings fluctuations as a result
of certain market risks. These market risks primarily relate to foreign
exchange, interest rate, and commodity related changes. The Company maintains a
comprehensive hedging program to manage volatility related to these market
exposures. It employs operational, economic, and derivative financial
instruments in order to mitigate risk. See Notes 3 and 7 of "Notes to
Consolidated Financial Statements" for further discussion regarding the
Company's use of derivative instruments.
FOREIGN EXCHANGE RATE SENSITIVITY. By nature of the Company's global operations,
it is exposed to cash flow and earnings fluctuations resulting from foreign
exchange rate variation. These exposures are transactional and translational in
nature. Since the Company manufactures and sells its products throughout the
world, its foreign currency risk is diversified. Principal drivers of this
diversified foreign exchange exposure include the European euro, Mexican peso,
British pound and the Thai bhat.
Transactional Exposure
The Company's transactional exposure arises from the purchase and sale of
goods and services in currencies other than the functional currency of the
parent or its subsidiaries. As part of its risk management program, at the end
of each fiscal year the Company performs a sensitivity analysis on its
forecasted transactional exposure for the upcoming fiscal year. This analysis
assumes a hypothetical 10% strengthening or weakening of the U.S. dollar.
Included in the analysis is the estimated impact of its hedging program, which
mitigates the Company's transactional exposure. At June 30, 2004 and 2003, the
Company had hedged approximately 52% and 61% of its transactional exposures,
respectively. The following table summarizes the analysis as it relates to the
Company's transactional exposure (in millions):
2004 2003
------ ------
Net estimated transactional exposure $332.8 $221.8
Sensitivity gain/loss (1) 33.3 22.2
Estimated offsetting impact of hedges (17.2) (13.4)
------ ------
Estimated net gain/loss $ 16.1 $ 8.8
====== ======
|
(1) Impact of a hypothetical 10% strengthening or weakening of the U.S dollar.
Translational Exposure
The Company also has exposure related to the translation of financial
statements of its foreign divisions into U.S dollars, functional currency of the
parent. It performs a similar analysis as described above related to this
translational exposure. The Company does not typically hedge any of its
translational exposure and no hedging impact was included in the Company's
analysis at June 30, 2004 and 2003. The following table summarizes the Company's
translational exposure and the impact of a hypothetical 10% strengthening or
weakening in the U.S dollar (in millions):
2004 2003
------ ------
Net estimated translational exposure $208.3 $108.8
Sensitivity gain/loss (1) $ 20.8 $ 10.9
|
(1) Impact of a hypothetical 10% strengthening or weakening of the U.S dollar.
The increase in net estimated translational exposure between fiscal 2004
and 2003 resulted primarily from international acquisitions completed during
fiscal 2004.
45
INTEREST RATE SENSITIVITY. The Company is exposed to changes in interest rates
primarily as a result of its borrowing and investing activities to maintain
liquidity and fund business operations. The nature and amount of the Company's
long-term and short-term debt can be expected to fluctuate as a result of
business requirements, market conditions, and other factors. The Company's
policy is to manage exposures to interest rates using a mix of fixed and
floating rate debt as deemed appropriate by management. The Company utilizes
interest rate swap instruments to mitigate its exposure to interest rate
movements.
As part of its risk management program, the Company annually performs a
sensitivity analysis on its forecasted exposure to interest rates for the
following fiscal year. This analysis assumes a hypothetical 10% change in
interest rates. At June 30, 2004 and 2003, the potential increase or decrease in
interest expense under this analysis as a result of this hypothetical change was
$6.4 million and $3.2 million, respectively.
COMMODITY PRICE SENSITIVITY. The Company purchases certain commodities for use
in its manufacturing processes, which include rubber, heating oil, diesel fuel,
and polystyrene. The Company typically purchases these commodities at market
prices, and as a result, is affected by price fluctuations. As part of its risk
management program, the Company performs sensitivity analysis on its forecasted
commodity exposure for the following fiscal year. At June 30, 2004 and 2003, the
Company had not hedged any of these exposures. The table below summarizes the
Company's analysis of these forecasted commodity exposures and a hypothetical
10% fluctuation in commodity prices as of June 30, 2004 and 2003 (in millions):
2004 2003
----- -----
Estimated commodity exposure $32.4 $33.3
Sensitivity gain/loss (1) $ 3.2 $ 3.3
|
(1) Impact of a hypothetical 10% change in commodity market prices.
The Company also has exposure to certain energy related commodities,
including natural gas and electricity through its normal course of business.
These exposures result primarily from operating the Company's distribution,
manufacturing, and corporate facilities. In certain deregulated markets, the
Company from time to time enters into long-term purchase contracts to supply
these items at a specific price.
ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Report of Independent Registered Public Accounting Firm
Consolidated Financial Statements and Schedule:
Consolidated Statements of Earnings for the Fiscal Years Ended June 30, 2004, 2003 and 2002
Consolidated Balance Sheets at June 30, 2004 and 2003
Consolidated Statements of Shareholders' Equity for the Fiscal Years Ended June 30, 2004, 2003 and 2002
Consolidated Statements of Cash Flows for the Fiscal Years Ended June 30, 2004, 2003 and 2002
Notes to Consolidated Financial Statements
Schedule II
|
46
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and the
Board of Directors of Cardinal Health, Inc.:
We have audited the accompanying consolidated balance sheets of Cardinal
Health, Inc. and subsidiaries (the "Company") as of June 30, 2004 and 2003, and
the related consolidated statements of earnings, shareholders' equity, and cash
flows for each of the three years in the period ended June 30, 2004. Our audits
also included the financial statement schedule listed in the Index at Item
15(a)(2). These consolidated financial statements and schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements and the schedule based on our
audits.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
the Company as of June 30, 2004 and 2003, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
June 30, 2004, in conformity with the U.S. generally accepted accounting
principles. Also, in our opinion, the related financial statement schedule, when
considered in relation to the basic consolidated financial statements taken as a
whole, present fairly in all material respects the information set forth
therein.
We also audited the adjustments described in Note 1 to the consolidated
financial statements that were applied to restate opening retained earnings as
of July 1, 2002. In our opinion, such adjustments are appropriate and have been
properly applied.
As discussed in Note 16 to the consolidated financial statements, the
Company changed its method of recognizing cash discounts effective at the
beginning of fiscal year 2004 and, in the first quarter of fiscal 2002, the
Company changed its method of recognizing revenue for pharmacy automation
equipment.
/s/ Ernst & Young LLP
ERNST & YOUNG LLP
Columbus, Ohio
October 25, 2004
|
47
CARDINAL HEALTH, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
(IN MILLIONS, EXCEPT PER COMMON SHARE AMOUNTS)
FISCAL YEAR ENDED JUNE 30,
----------------------------------------
2004 2003 2002
----------------------------------------
RESTATED RESTATED
Revenue $ 65,053.5 $ 56,731.5 $ 51,144.6
Cost of products sold 60,312.3 52,249.3 47,099.6
---------- ---------- ----------
Gross margin 4,741.2 4,482.2 4,045.0
Selling, general and administrative expenses 2,346.5 2,246.3 2,071.0
Special items - merger charges 44.7 74.4 131.9
- foundation contribution 31.7 - -
- other (19.0) (34.5) (15.3)
---------- ---------- ----------
Operating earnings 2,337.3 2,196.0 1,857.4
Interest expense and other 98.9 115.3 132.5
---------- ---------- ----------
Earnings before income taxes, discontinued
operations, and cumulative effect of changes
in accounting 2,238.4 2,080.7 1,724.9
Provision for income taxes 713.7 699.5 584.1
---------- ---------- ----------
Earnings from continuing operations before
cumulative effect of changes in accounting 1,524.7 1,381.2 1,140.8
Loss from discontinued operations
(net of tax of $7.4 and $2.5 for the year-to-date
periods ending June 30, 2004 and 2003,
respectively) (11.7) (6.1) -
Cumulative effect of changes in accounting (38.5) - (70.1)
---------- ---------- ----------
Net earnings $ 1,474.5 $ 1,375.1 $ 1,070.7
========== ========== ==========
Basic earnings per Common Share:
Continuing operations $ 3.51 $ 3.10 $ 2.53
Discontinued operations (0.03) (0.02) -
Cumulative effect of changes in accounting (0.09) - (0.16)
---------- ---------- ----------
Net basic earnings per Common Share $ 3.39 $ 3.08 $ 2.37
========== ========== ==========
Diluted earnings per Common Share:
Continuing operations $ 3.47 $ 3.05 $ 2.48
Discontinued operations (0.03) (0.02) -
Cumulative effect of changes in accounting (0.09) - (0.15)
---------- ---------- ----------
Net diluted earnings per Common Share $ 3.35 $ 3.03 $ 2.33
========== ========== ==========
Weighted average number of shares outstanding:
Basic 434.4 446.0 450.1
Diluted 440.0 453.3 459.6
|
The accompanying notes are an integral part of these consolidated statements.
48
CARDINAL HEALTH, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN MILLIONS)
JUNE 30, JUNE 30,
2004 2003
--------- ---------
RESTATED
ASSETS
Current assets:
Cash and equivalents $ 1,096.0 $ 1,724.0
Trade receivables, net 3,432.7 2,784.4
Current portion of net investment in sales-type leases 202.1 171.8
Inventories 7,471.3 7,570.9
Prepaid expenses and other 795.4 776.0
Assets held for sale from discontinued operations 60.4 170.1
--------- ---------
Total current assets 13,057.9 13,197.2
--------- ---------
Property and equipment, at cost:
Land, buildings and improvements 1,412.6 1,218.8
Machinery and equipment 2,734.3 2,401.4
Furniture and fixtures 153.2 135.1
--------- ---------
Total 4,300.1 3,755.3
Accumulated depreciation and amortization (1,936.1) (1,665.8)
--------- ---------
Property and equipment, net 2,364.0 2,089.5
Other assets:
Net investment in sales-type leases, less current portion 546.0 557.3
Goodwill and other intangibles, net 4,938.8 2,332.3
Other 462.4 288.8
--------- ---------
Total $21,369.1 $18,465.1
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Notes payable and other short term borrowings $ 5.6 $ -
Current portion of long-term obligations 855.0 228.7
Accounts payable 6,432.4 5,288.8
Other accrued liabilities 2,021.3 1,728.4
Liabilities from discontinued operations 55.1 64.3
--------- ---------
Total current liabilities 9,369.4 7,310.2
--------- ---------
Long-term obligations, less current portion 2,834.7 2,471.9
Deferred income taxes and other liabilities 1,188.7 1,008.5
Shareholders' equity:
Preferred Stock, without par value
Authorized - 0.5 million shares, Issued - none - -
Common Shares, without par value
Authorized - 755.0 million shares, Issued - 473.1 million shares
and 467.2 million shares at June 30, 2004 and 2003, respectively 2,653.8 2,403.7
Retained earnings 7,888.0 6,465.2
Common Shares in treasury, at cost, 42.2 million shares and 18.8
million shares at June 30, 2004 and 2003, respectively (2,588.1) (1,135.8)
Other comprehensive income / (loss) 28.9 (50.7)
Other (6.3) (7.9)
--------- ---------
Total shareholders' equity 7,976.3 7,674.5
--------- ---------
Total $21,369.1 $18,465.1
========= =========
|
The accompanying notes are an integral part of these consolidated statements.
49
CARDINAL HEALTH, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(IN MILLIONS)
COMMON SHARES
----------------- TREASURY SHARES OTHER TOTAL
SHARES RETAINED ------------------ COMPREHENSIVE SHAREHOLDERS'
ISSUED AMOUNT EARNINGS SHARES AMOUNT INCOME/(LOSS) OTHER EQUITY
------ ---------- ---------- ------- --------- ------------- ------- -------------
BALANCE, JUNE 30, 2001 456.2 $ 1,893.1 $ 4,146.0 (7.5) $ (457.2) $ (140.3) $ (4.5) $ 5,437.1
Adjustment for restated beginning balance (33.6) (33.6)
Comprehensive income:
Net earnings 1,070.7 1,070.7
Foreign currency translation adjustments 24.0 24.0
Unrealized loss on derivatives (10.4) (10.4)
Unrealized gain on investments 2.6 2.6
Reclassification adjustment for investment
losses included in net earnings 3.2 3.2
Net change in minimum pension liability (22.1) (22.1)
------------
Total comprehensive income 1,068.0
Employee stock plans activity,
including tax benefits of $73.6 million 4.5 191.6 0.5 28.1 (6.0) 213.7
Treasury shares acquired (5.1) (308.3) (308.3)
Dividends declared (45.0) (45.0)
Stock issued for acquisitions and other 0.3 20.5 (1.1) (0.1) 0.4 19.8
------ ---------- ---------- ------ --------- ----------- ------- ------------
BALANCE, JUNE 30, 2002 (Restated) 461.0 $ 2,105.2 $ 5,137.0 (12.2) $ (737.0) $ (143.0) $ (10.5) $ 6,351.7
Comprehensive income:
Net earnings 1,375.1 1,375.1
Foreign currency translation adjustments 99.7 99.7
Unrealized gain on derivatives 2.0 2.0
Net change in minimum pension liability (9.4) (9.4)
------------
Total comprehensive income 1,467.4
Employee stock plans activity,
including tax benefits of $65.5 million 6.2 227.8 0.5 35.6 2.5 265.9
Treasury shares acquired (19.6) (1,191.7) (1,191.7)
Dividends declared (47.0) (47.0)
Stock issued for acquisitions and other 70.7 0.1 12.5 757.3 0.1 828.2
------ ---------- ---------- ------ --------- ----------- ------- ------------
BALANCE, JUNE 30, 2003 (Restated) 467.2 $ 2,403.7 $ 6,465.2 (18.8) $(1,135.8) $ (50.7) $ (7.9) $ 7,674.5
Comprehensive income:
Net earnings 1,474.5 1,474.5
Foreign currency translation adjustments 68.3 68.3
Unrealized gain on derivatives 11.7 11.7
Unrealized loss on investments (1.3) (1.3)
Net change in minimum pension liability 0.9 0.9
------------
Total comprehensive income 1,554.1
Employee stock plans activity,
including tax benefits of $66.4 million 5.9 237.2 0.8 47.7 1.6 286.5
Treasury shares acquired (24.2) (1,500.0) (1,500.0)
Dividends declared (51.8) (51.8)
Stock issued for acquisitions and other 12.9 0.1 13.0
------ ---------- ---------- ------ --------- ----------- ------- ------------
BALANCE, JUNE 30, 2004 473.1 $ 2,653.8 $ 7,888.0 (42.2) $(2,588.1) $ 28.9 $ (6.3) $ 7,976.3
====== ========== ========== ====== ========= =========== ======= ============
|
The accompanying notes are an integral part of these consolidated statements.
50
CARDINAL HEALTH, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN MILLIONS)
FISCAL YEAR ENDED JUNE 30,
--------------------------------
2004 2003 2002
-------- -------- --------
RESTATED RESTATED
CASH FLOWS FROM OPERATING ACTIVITIES:
Earnings from continuing operations before cumulative effect
of changes in accounting $1,524.7 $1,381.2 $1,140.8
Adjustments to reconcile earnings from continuing operations before
cumulative effect of changes in accounting to net cash from
operations:
Depreciation and amortization 299.2 265.8 243.5
Provision for deferred income taxes 105.1 215.2 239.7
Provision for bad debts 1.5 22.2 42.6
Change in operating assets and liabilities,
net of effects from acquisitions:
Decrease/(increase) in trade receivables (457.1) (413.7) 142.7
Decrease/(increase) in inventories 245.5 (217.9) (1,065.9)
Decrease/(increase) in net investment in sales-type leases (7.2) 107.8 71.2
Increase/(decrease) in accounts payable 1,014.6 (278.5) 178.6
Other accrued liabilities and operating items, net (101.6) 315.9 (9.3)
-------- -------- --------
Net cash provided by operating activities 2,624.7 1,398.0 983.9
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of subsidiaries, net of cash acquired (2,089.7) (26.8) (383.8)
Proceeds from sale of property and equipment 19.5 57.7 18.3
Additions to property and equipment (410.2) (423.2) (285.4)
Proceeds from sale of discontinued operations 43.4 48.6 -
-------- -------- --------
Net cash used in investing activities (2,437.0) (343.7) (650.9)
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net change in commercial paper and short-term debt 646.2 8.5 (9.7)
Reduction of long-term obligations (464.3) (191.0) (19.6)
Proceeds from long-term obligations, net of issuance costs 338.0 509.4 362.3
Proceeds from issuance of Common Shares 216.7 197.3 140.0
Dividends on Common Shares (52.3) (44.8) (45.0)
Purchase of treasury shares (1,500.0) (1,191.7) (308.3)
Other - - (4.8)
-------- -------- --------
Net cash provided by/(used in) financing activities (815.7) (712.3) 114.9
-------- -------- --------
NET INCREASE/(DECREASE) IN CASH AND EQUIVALENTS (628.0) 342.0 447.9
CASH AND EQUIVALENTS AT BEGINNING OF YEAR 1,724.0 1,382.0 934.1
-------- -------- --------
CASH AND EQUIVALENTS AT END OF YEAR $1,096.0 $1,724.0 $1,382.0
======== ======== ========
|
The accompanying notes are an integral part of these consolidated statements.
51
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ACCOUNTING INVESTIGATIONS AND RESTATEMENT
As previously reported, in October 2003, the Securities and Exchange
Commission (the "SEC") initiated an informal inquiry regarding Cardinal Health,
Inc. (the "Company"). The SEC's request sought historical financial and related
information including but not limited to the accounting treatment of certain
recoveries from vitamin manufacturers. The SEC's request sought a variety of
documentation, including the Company's accounting records for fiscal 2001
through fiscal 2003, as well as notes, memoranda, presentations, e-mail and
other correspondence, budgets, forecasts and estimates. In connection with the
SEC's informal inquiry, the Audit Committee of the Board of Directors of the
Company commenced its own internal review in April 2004, assisted by independent
counsel. On May 6, 2004, the Company was notified that the SEC had converted the
informal inquiry into a formal investigation. On June 21, 2004, as part of the
SEC's formal investigation, the Company received an additional SEC subpoena that
included a request for the production of documents relating to revenue
classification, and the methods used for such classification, in the Company's
Pharmaceutical Distribution business as either "Operating Revenue" or "Bulk
Deliveries to Customer Warehouses and Other." In addition, the Company learned
that the U.S. Attorney for the Southern District of New York had also commenced
an inquiry with respect to the Company that the Company understands relates to
the revenue classification issue. On October 12, 2004, in connection with the
SEC's formal investigation, the Company received a subpoena from the SEC
requesting the production of documents relating to compensation information for
specific current and former employees and officers. The Company continues to
respond to the SEC's investigation and the Audit Committee's internal review and
provide all information required.
During September and October 2004, the Audit Committee reached certain
conclusions with respect to findings to date from its internal review. 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 Automation and Information Services segment; and (4) certain balance
sheet reserve and accrual adjustments that have been identified in the internal
review. 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 has 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. As the Company
continues to respond to the SEC's investigation and the Audit Committee's
internal review, there can be no assurance that additional restatements will not
be required or that the historical financial statements included in this Form
10-K will not change or require amendment. In addition, 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 this Form 10-K.
The conclusions of the Audit Committee's internal review to date are as
follows:
REVENUE IMPACT: 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
As presented historically since 1998, the Pharmaceutical Distribution and
Provider Services segment's revenue was classified into two categories
("Operating Revenue" and "Bulk Deliveries to Customer Warehouses and Other").
"Bulk Deliveries to Customer Warehouses and Other" has historically included
revenue arising from sales where the Company ordered pharmaceutical product in
bulk on behalf of a specific warehousing customer and either the manufacturer
ships the product directly to the customer's warehouse or the product is shipped
to the customer's warehouse by the Company shortly after it is received by the
Company and is not put into the Company's inventory (in either case, "Bulk
Revenue"). For all Bulk Revenue, the product was shipped to the customer in the
same bulk form in which it was received by the Company from the manufacturers.
The Company previously since November 2001 followed an internal policy for
distinguishing between Operating Revenue and Bulk Revenue based on how long the
product was in the Company's possession prior to being shipped to customers. If
the product was in the possession of the Company for more than 24 hours prior to
being shipped to customers, then, regardless of other characteristics of the
transaction or the reason for the product being held more than 24 hours, the
sale of that product was deemed to be Operating Revenue. The Company's internal
policy also provided that customer orders for bulk shipments filled from
inventory within the Company's warehouse were deemed to be Operating Revenue if
the order for the product had been placed with the manufacturer prior to the
Company receiving the bulk order from its customer. Based on results of the
internal review conducted by the Audit Committee, the Company concluded that
certain bulk shipments ordered by customers were intentionally held beyond 24
hours so that, pursuant to the internal policy, such shipments were classified
as Operating Revenue in four quarters within fiscal 2003 and 2002. The impact of
this practice was not previously quantified and disclosed as part of the
Company's reported Operating Revenue. The improper classification between Bulk
Revenue and Operating Revenue had no impact on the Company's previously reported
total revenue or operating or net earnings for these periods. See Note 2 for
further discussion of these matters.
52
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 were
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 as a result of this practice for fiscal 2004, 2003 and 2002 is
as follows:
Fiscal Fiscal Fiscal
(in millions) 2004 2003 2002
------ ------ ------
First Quarter $ (0.2) $ - $ (3.3)
Second Quarter 3.0 2.0 -
Third Quarter (0.3) 5.5 -
Fourth Quarter (1.2) 1.3 -
------ ----- -------
Total $ 1.3 $ 8.8 $ (3.3)
====== ===== =======
|
During the fourth quarter 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
will be 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 16 for further discussion of this change in
accounting.
REVENUE AND EARNINGS IMPACT: Timing of Revenue Recognition Within the
Company's Automation and Information Services Segment
Within its Automation and Information Services segment, 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. 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, there was a material weakness in internal controls
because the Company did not have internal controls in place to assure that
equipment installations were in fact completed before the equipment
confirmations were executed. The Company concluded the impact of such actions
was as follows:
- 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.
53
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- Net impact of this premature revenue recognition was assessed as of
June 30, 2004 based upon interviews of customers as of June 30, 2004
representing a substantial percentage of the segment's end of quarter
reported revenues resulting in approximately 10.8% of revenue in the
last 10 days of the quarter 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 fiscal 2004 to adjust for premature revenue recognition
that was determined to have occurred within that quarter. These
revenues and operating earnings will be recognized in the first quarter
fiscal 2005.
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 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 prior years (i.e., utilizing the 10.8%
exception rate) as was utilized in the fourth quarter fiscal 2004
adjustment, the net increase (decrease) on revenue and operating
earnings for fiscal 2002 and each previously reported quarter of fiscal
2003 and 2004, and the related percentage of the Automation and
Information Services segment's reported amounts, would have been as
follows:
Operating
Revenue % Change Earnings % Change
------- -------- --------- --------
FISCAL 2002 $ (8.3) (1.5%) $ (5.3) (2.5%)
FISCAL 2003
First Quarter $ 2.6 1.9% $ 1.7 3.6%
Second Quarter 0.2 0.1% 0.1 0.1%
Third Quarter (0.3) (0.2%) (0.2) (0.3%)
Fourth Quarter (3.8) (1.9%) (2.4) (2.8%)
------- ---------
Total Year $ (1.3) (0.2%) $ (0.8) (0.3%)
======= =========
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%)
------- ---------
Year-To-Date $ 1.9 0.4% $ 1.2 0.6%
======= =========
|
Using different estimation methods than the methodology used to derive
the table above, the percentage change in operating earnings for the
periods noted above would range from less than 1% to a high of 6.6%.
There were two quarters in which the estimated impact was over 5%
(first quarter fiscal 2003 negative impact of 6.6% and third quarter of
fiscal 2004 negative impact of 5.5%). The Company believes the impact
of the adjustments resulting from the estimation methods are 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 Automation and Information Services segment.
The Company has recently reiterated the revenue recognition policy for
equipment systems installed at a customer's site for its Automation and
Information Services segment, and instructed all employees to strictly
adhere to this policy.
The Company is in the process of implementing the following corrective
actions in response to these initial conclusions:
- Adoption of new customer contracts and equipment confirmation forms
that clarify when the installation is complete and the confirmation is
to be executed.
- Revision of policies and procedures for equipment installation and
revenue recognition processes.
- Enhanced level of internal training for those Company employees
involved in equipment installation and revenue recognition processes.
- Reemphasizing availability of the Company's ethics and compliance
hotline for reporting questions about appropriateness of the Company's
business and accounting practices, including channels of communication
to the Company's Audit Committee.
- Enhanced random audits of the Company's equipment confirmation process.
Such random audits will be performed by the Company's internal audit
department and such procedures will be reviewed and periodically tested
by its independent auditors.
- Within the next year, it is expected that system enhancements will be
implemented that will allow for the automated audit of installation of
equipment at the customer's location.
54
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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) amount of reserve, (b) timing of reserve recognition, or
(c) timing of reserve adjustments could not be substantiated or was in error. As
a result, the financial statements for certain prior fiscal quarters and years
have been restated by the Company.
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.
2. Errors made in previous periods which 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.
3. As a result of discussions with the SEC staff, the Company decided to
reverse its previous recognition of estimated recoveries from vitamin
manufacturers for amounts overcharged in prior years and to recognize the
income from such recoveries as a special item in the period cash was
received from the manufacturers. The Company recognized $10.0 million of
operating earnings ($6.5 million net of taxes) in the second quarter of
fiscal 2001 and $12.0 million of operating earnings ($7.9 million net of
taxes) in the first quarter of fiscal 2002 based on its estimate of amounts
that would subsequently be received. The actual cash payments received from
manufacturers did not exceed the amounts previously recorded until the
fourth quarter of fiscal 2002. 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 following table summarizes the restatement impact on previously
reported net earnings as defined above for fiscal 2004, 2003 and 2002:
Misapplication Vitamin Total
(in millions) of GAAP Errors Litigation 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)
------ ------ ------ -------
Total Year-to-Date $ (0.7) $(14.7) $ - $ (15.4)
====== ====== ====== =======
Fiscal 2003:
First Quarter $ (3.1) $ (3.8) $ - $ (6.9)
Second Quarter (1.1) 3.7 - 2.6
Third Quarter (9.1) (5.4) - (14.5)
Fourth Quarter (2.3) (9.6) - (11.9)
------ ------ ------ -------
Total Year $(15.6) $(15.1) $ - $ (30.7)
====== ====== ====== =======
Fiscal 2002:
First Quarter $ 2.8 $ (5.9) $ (7.9) $ (11.0)
Second Quarter (0.6) (2.1) - (2.7)
Third Quarter 2.1 4.4 - 6.5
Fourth Quarter 0.8 7.5 13.4 21.7
------ ------ ------ -------
Total Year $ 5.1 $ 3.9 $ 5.5 $ 14.5
====== ====== ====== =======
|
55
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes the restatement impact on previously
reported earnings per Common Share amounts for fiscal 2003 and 2002:
Fiscal 2003 Fiscal 2002
------------------------- ------------------------
As As As As
Reported Restated Reported Restated
-------- -------- -------- --------
Earnings from continuing
operations per Common Share:
Basic $ 3.17 $ 3.10 $ 2.50 $ 2.53
Diluted $ 3.12 $ 3.05 $ 2.45 $ 2.48
|
The Company reduced its June 30, 2001 retained earnings balance of
$4,146.0 million by $33.6 million due to the restatement adjustments. This
restatement amount consists of a $3.6 million decrease for misapplication of
GAAP, a $23.5 million decrease for errors and a $6.5 million decrease for
vitamin litigation.
See Note 19 for the restatement impact on previously reported quarterly
earnings per Common Share amounts for fiscal 2004 and 2003.
The SEC investigation, the U.S. Attorney inquiry and the Audit Committee
internal review remain ongoing. While the Company is continuing in its efforts
to respond to the SEC's investigation and the Audit Committee's internal review
and provide all information required, the Company cannot predict the outcome of
the SEC investigation or the U.S. Attorney inquiry. 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 as well as the imposition of fines and
other penalties, remedies and sanctions.
2. RECLASSIFICATIONS
As presented historically since 1998, the Pharmaceutical Distribution and
Provider Services segment's revenue was classified into two categories
("Operating Revenue" and "Bulk Deliveries to Customer Warehouses and Other").
"Bulk Deliveries to Customer Warehouses and Other" has historically included
revenue arising from sales where the Company ordered pharmaceutical product in
bulk on behalf of a specific warehousing customer and either the manufacturer
ships the product directly to the customer's warehouse or the product is shipped
to the customer's warehouse by the Company shortly after it is received by the
Company and is not put into the Company's inventory (in either case, "Bulk
Revenue"). For all Bulk Revenue, the product was shipped to the customer in the
same bulk form in which it was received by the Company from the manufacturers.
The Company since November 2001 previously followed an internal policy for
distinguishing between Operating Revenue and Bulk Revenue based on how long the
product was in the Company's possession prior to being shipped to customers. If
the product was in the possession of the Company for more than 24 hours prior to
being shipped to
56
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
customers, then, regardless of other characteristics of the transaction or the
reason for the product being held more than 24 hours, the sale of that product
was deemed to be Operating Revenue. The Company's internal policy also provided
that customer orders for bulk shipments filled from inventory within the
Company's warehouse were deemed to be Operating Revenue if the order for the
product had been placed with the manufacturer prior to the Company receiving the
bulk order from its customer. Based on results of the internal review conducted
by the Audit Committee, the Company concluded that certain bulk shipments
ordered by customers were intentionally held beyond 24 hours so that, pursuant
to the internal policy, such shipments were classified as Operating Revenue in
four quarters within fiscal 2003 and 2002. The impact of this practice was not
previously quantified and disclosed as part of the Company's reported Operating
Revenue. The improper classification between Bulk Revenue and Operating Revenue
had no impact on the Company's previously reported total revenue or operating or
net earnings for these periods.
The following table shows the amount of Bulk Revenue that was estimated to
be improperly classified as Operating Revenue in the manner described above and
the impact from adjusting each of Bulk Revenue and Operating Revenue for the
periods in which these improper classifications occurred:
Bulk Revenue Operating Revenue
------------ -----------------
Fiscal Year Ended June 30, Fiscal Year Ended June 30,
---------------------------- -----------------------------
(in millions) 2003 2002 2003 2002
------------- ------- ------- -------- --------
First Quarter $ - $ - $ - $ -
Second Quarter 673.0 82.0 (673.0) (82.0)
Third Quarter 140.0 - (140.0) -
Fourth Quarter - 332.0 - (332.0)
------- ------- -------- --------
Total Year $ 813.0 $ 414.0 $ (813.0) $ (414.0)
======= ======= ======== ========
|
During fiscal 2004, the Company decided to aggregate revenue classes
within this Form 10-K. "Operating Revenue" and "Bulk Deliveries to Customer
Warehouses and Other" have been 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. These reclassifications have no effect on
previously reported total revenue, related cost of products sold, operating
earnings, net earnings or earnings per share. Beginning with this Form 10-K,
information concerning the portion of the Company's revenue that arises from
Bulk Revenue will be discussed in the Company's "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
Certain other insignificant reclassifications have been made to conform
prior period amounts to the current presentation.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Company is a leading provider of products and services supporting the
health care industry, and helping health care providers and manufacturers
improve the efficiency and quality of health care. As of June 30, 2004, the
Company conducted its business within the following four business segments:
Pharmaceutical Distribution and Provider Services; Medical Products and
Services; Pharmaceutical Technologies and Services; and Automation and
Information Services. See Note 18 for information related to the Company's
business segments.
BASIS OF PRESENTATION. The consolidated financial statements of the Company
include the accounts of all majority-owned subsidiaries. In addition, all
significant intercompany accounts and transactions have been eliminated upon
consolidation.
During fiscal 2004, 2003 and 2002, the Company completed several
acquisitions, which were accounted for under the purchase method of accounting.
The consolidated financial statements include the results of operations from
each of these business combinations as of the date of acquisition. Additional
disclosure related to the Company's acquisitions is provided in Note 4.
The preparation of financial statements in conformity with GAAP in the
United States requires management to make estimates and assumptions that affect
amounts reported in the financial statements and accompanying notes. Such
estimates include, but are not limited to, inventory valuation, allowance for
doubtful accounts, goodwill and intangible asset impairment, vendor reserves and
restructuring charge reserves. Actual amounts may differ from these estimated
amounts.
CASH EQUIVALENTS. The Company considers all liquid investments purchased with a
maturity of three months or less to be cash equivalents. The carrying value of
these cash equivalents approximates fair value. Cash payments for interest were
$112.7 million, $115.3 million and $116.5 million and cash payments for income
taxes were $566.3 million, $256.8 million and $246.0 million for fiscal 2004,
2003 and 2002, respectively. See Note 4 for additional information regarding
non-cash investing activities.
57
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
RECEIVABLES. Trade receivables are primarily comprised of amounts owed to the
Company through its pharmaceutical and other health care service activities and
are presented net of an allowance for doubtful accounts of $119.1 million and
$121.3 million at June 30, 2004 and 2003, respectively. An account is considered
past due on the first day after its due date. In accordance with contract terms,
the Company generally has the ability to charge a customer service fees or
higher prices if an account is considered past due. The Company continuously
monitors past due accounts and establishes appropriate reserves to cover
potential losses. The Company will write off any amounts deemed uncollectible
against an established bad debt reserve.
The Company provides financing to various customers. Such financing
arrangements range from one year to ten years, at interest rates that generally
fluctuate with the prime rate. Interest income on these accounts is recognized
by the Company as it is earned. The financings may be collateralized, guaranteed
by third parties or unsecured. Finance notes and accrued interest receivables
were $35.4 million and $30.8 million at June 30, 2004 and 2003, respectively
(current portions were $17.2 million and $14.9 million, respectively), and are
included in other assets. These amounts are reported net of an allowance for
doubtful accounts of $4.1 million and $4.5 million at June 30, 2004 and 2003,
respectively.
The Company has formed special purpose entities with the sole purpose of
buying receivables or sales type leases from various legal entities of the
Company and selling those receivables or sales type leases to certain
multi-seller conduits administered by banks or other third-party investors. See
Note 10 for additional disclosure regarding off-balance sheet financing.
During fiscal 2001, the Company entered into an agreement to periodically
sell trade receivables to a special purpose accounts receivable and financing
entity (the "Accounts Receivable and Financing Entity") which is exclusively
engaged in purchasing trade receivables from, and making loans to, the Company.
The Accounts Receivable and Financing Entity, which is consolidated by the
Company, issued $250 million and $400 million in preferred variable debt
securities to parties not affiliated with the Company during fiscal 2004 and
2001, respectively. These preferred debt securities must be retired or redeemed
by the Accounts Receivable and Financing Entity before the Company, or its
creditors, can have access to the Accounts Receivable and Financing Entity's
receivables. See Note 6 for additional information.
INVENTORIES. A majority of inventories (approximately 66% in 2004 and 68% in
2003) are stated at the lower of cost, using the LIFO method, or market and are
primarily merchandise inventories. The remaining inventory is primarily stated
at the lower of cost, using the first-in, first-out ("FIFO") method, or market.
If the Company had used the FIFO method of inventory valuation, which
approximates current replacement cost, inventories would have been higher than
the LIFO method reported at June 30, 2004 and 2003 by $57.8 million and $61.4
million, respectively.
GOODWILL AND OTHER INTANGIBLES. The Company accounts for purchased goodwill and
other intangible assets in accordance with Statement of Financial Accounting
Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets." Under SFAS
No. 142, purchased goodwill and intangible assets with indefinite lives are no
longer amortized, but instead are tested for impairment at least annually.
Intangible assets with finite lives, primarily customer relationships and
patents and trademarks, continue to be amortized over their useful lives. The
Company performed its annual impairment test in fiscal 2004 which did not result
in the recognition of any impairment charges. See Note 17 for additional
disclosure regarding goodwill and other intangible assets.
PROPERTY AND EQUIPMENT. Property and equipment are stated at cost. Depreciation
expense for financial reporting purposes is primarily computed using the
straight-line method over the estimated useful lives of the assets, including
capital lease assets which are depreciated over the terms of their respective
leases. The Company uses the following range of useful lives for its property
and equipment categories: buildings and improvements - 1 to 50 years; machinery
and equipment - 3 to 20 years; furniture and fixtures - 7 years. Depreciation
expense was $278.0 million, $249.0 million and $231.2 million for fiscal 2004,
2003 and 2002, respectively. The Company expenses repairs and maintenance
expenditures as incurred. The Company capitalizes interest on long-term fixed
asset projects using a rate of 5.0%, which approximates the Company's weighted
average interest rate on long-term debt. The amount of capitalized interest was
immaterial for all fiscal years presented.
OTHER ACCRUED LIABILITIES. Other accrued liabilities represent various
obligations of the Company including certain accrued operating expenses and
taxes payable. For the fiscal years ended June 30, 2004 and 2003, the largest
component of other accrued liabilities was deferred tax liabilities of
approximately $530.2 million and $566.1 million, respectively. Other significant
components of other accrued liabilities were current taxes payable and employee
compensation and related benefit accruals. For fiscal 2004 and 2003, current
taxes payable were $286.4 million and $224.7 million, respectively, while
employee compensation and related benefit accruals were $310.8 million and
$373.6 million, respectively.
58
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
REVENUE RECOGNITION
Pharmaceutical Distribution and Provider Services
This segment records distribution revenue when title transfers to its
customers and the business has no further obligation to provide services related
to such merchandise. This revenue is recorded net of sales returns and
allowances (see "Sales Returns and Allowances" below for further information).
This segment also records Bulk Revenue, defined as transactions having any
one or more of the following characteristics: (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 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. See Notes 1 and 2 for a
further discussion of Bulk Revenue.
This segment also owns certain consignment inventory and recognizes
revenue when that inventory is sold to a third party by the segment's customer.
This segment earns franchise and origination fees from its
apothecary-style pharmacy franchisees. Franchise fees represent monthly fees
based upon franchisees' sales and are recognized as revenue when they are
earned. Origination fees from signing new franchise agreements are recognized as
revenue when the new franchise store is opened.
Pharmacy management and other service revenue is recognized as the
services are rendered according to the contracts established. A fee is charged
under such contracts through a capitated fee, a dispensing fee, a monthly
management fee or an actual costs-incurred arrangement. Under certain contracts,
fees for services are guaranteed by the Company not to exceed stipulated amounts
or have other risk-sharing provisions. Revenue is adjusted to reflect the
estimated effects of such contractual guarantees and risk-sharing provisions.
Medical Products and Services
This segment records distribution and self-manufactured medical product
revenue when title transfers to its customers and the business has no further
obligation to provide services related to such merchandise. This revenue is
recorded net of sales returns and allowances (see "Sales Returns and Allowances"
below for further information).
Pharmaceutical Technologies and Services
Manufacturing and packaging revenue is recognized either upon shipment or
delivery of the product, in accordance with the terms of the contract which
specify when transfer of title occurs. Radiopharmaceutical revenue is recognized
upon delivery of the product to the customer. Other revenue from services
provided, such as development or sales and marketing services, is recognized
upon the completion of such services.
Drug delivery system revenue is recognized upon shipment of products to
the customer. Non-product revenue includes annual exclusivity fees, option fees
to extend exclusivity agreements and milestone payments for attaining certain
regulatory approvals. This segment receives exclusivity payments from certain
manufacturers in return for its commitment not to enter into agreements to
manufacture competing products. The revenue related to these agreements is
recognized over the term of the exclusivity or the term of the option agreement
unless a particular milestone is designated, in which case revenue is recognized
when all obligations of performance have been completed.
Analytical science revenue from fixed contracts is recorded as projects
are completed and billed. Projects are primarily for a short-term duration.
Certain contracts contain provisions for price redetermination for cost
overruns. Such amounts are included in service revenue when realization is
assured and the amounts are reasonably determined.
Automation and Information Services
Revenue is recognized from sales-type leases of point-of-use systems once
the Company's installation obligations are complete and the equipment is
functioning according to material specifications of the user's manual and the
customer has accepted the equipment, as evidenced by signing an equipment
confirmation document. At this point, the lease becomes noncancellable (see Note
16 for additional information). Interest income on sales-type leases is
recognized in revenue using the interest method. Sales of point-of-use systems
are recognized upon installation at the customer site. Revenue for systems
installed under operating lease arrangements is recognized over the lease term
as such amounts become receivable according to the provisions of the lease.
59
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
ALARIS Medical Systems, Inc. ("ALARIS")
The Company's recently acquired subsidiary, ALARIS, recognizes revenue,
net of an allowance for estimated returns and credits, upon delivery and/or
installation (depending on the product) and once transfer of title and risk of
loss have occurred. ALARIS frequently enters into revenue arrangements with
multiple deliverables, which, depending on the nature of the contract terms, are
subject to the provisions of SEC Staff Accounting Bulletin ("SAB") No. 104,
"Revenue Recognition," Emerging Issues Task Force ("EITF") Issue No. 00-21,
"Revenue Arrangements with Multiple Deliverables" or Statement of Position 97-2,
"Software Revenue Recognition."
SALES RETURNS AND ALLOWANCES. Pharmaceutical distribution revenue is recorded
net of sales returns and allowances. The Pharmaceutical Distribution business
recognizes sales returns as a reduction of revenue and cost of sales for the
sales price and cost, respectively, when products are returned. The
Pharmaceutical Distribution business' customer return policy requires that the
product be physically returned, subject to restocking fees, and only allows
customers to return products which can be added back to inventory and resold at
full value, or which can be returned to vendors for credit. Product returns are
generally consistent throughout the year, and typically are not specific to any
particular product or customer. Amounts recorded in revenue and cost of sales
under this accounting policy closely approximate what would have been recorded
under SFAS No. 48, "Revenue Recognition When Right of Return Exists." Applying
the provisions of SFAS No. 48 would not materially change the Company's
financial position and results of operations. Sales returns and allowances for
the Pharmaceutical Distribution business were approximately $1.3 billion, $1.2
billion, and $1.0 billion in fiscal 2004, 2003 and 2002, respectively.
Distributed and self-manufactured medical product revenue is recorded
net of sales returns and allowances. The Medical Products and Services segment
has established a reserve against returned goods in accordance with SFAS No. 48.
This reserve amount was immaterial for all periods presented. This segment's
customer return policy requires that the product be physically returned, subject
to restocking fees, and only allows customers to return products which can be
added back to inventory and resold at full value, or which can be returned to
vendors for credit. Product returns are generally consistent throughout the
year, and typically are not specific to any particular product or customer.
Sales returns and allowances for the Medical Products and Services segment were
approximately $56.9 million, $55.6 million and $53.1 million in fiscal 2004,
2003 and 2002, respectively.
CASH DISCOUNTS. Cash discounts are recorded as a component of inventory cost and
recognized as a reduction of cost of products sold when related inventory is
sold. See Note 16 for further information regarding cash discounts and the
change in accounting method adopted in 2004.
ACCOUNTING FOR VENDOR RESERVES. In the ordinary course of business, vendors may
challenge deductions or billings taken against payments otherwise due them from
the Company. These contested transactions are researched and resolved based upon
Company policy and findings of the research performed. At any given time, there
are outstanding items in various stages of research and resolution. In
determining an appropriate vendor reserve, the Company assesses historical
information and current outstanding claims. The ultimate outcome of certain
claims may be different than the Company's original estimate and may require
adjustment.
SHIPPING AND HANDLING. Shipping and handling costs are included in selling,
general and administrative expenses in the consolidated statements of earnings.
Shipping and handling costs include all delivery expenses as well as all costs
to prepare the product for shipment to the end customer. Shipping and handling
costs totaled $250.3 million, $213.8 million and $211.9 million for fiscal 2004,
2003 and 2002, respectively. Shipping and handling revenue received was
immaterial for all periods presented.
TRANSLATION OF FOREIGN CURRENCIES. Financial statements of the Company's
subsidiaries outside the U.S. generally are measured using the local currency as
the functional currency. Adjustments to translate the assets and liabilities of
these foreign subsidiaries into U.S. dollars are accumulated in a separate
component of shareholders' equity. Foreign currency transaction gains and losses
are included in the consolidated statements of earnings and were immaterial for
the fiscal years ended June 30, 2004, 2003 and 2002.
INTEREST RATE AND CURRENCY RISK MANAGEMENT. The Company accounts for derivative
instruments in accordance with SFAS No. 133, as amended, "Accounting for
Derivatives and Hedging Activity." Under this standard, all derivative
instruments are recorded at fair value on the balance sheet and all changes in
fair value are recorded to net earnings or shareholders' equity through other
comprehensive income.
The Company uses forward currency exchange contracts, currency options and
interest rate swaps to manage its exposures to the variability of cash flows
primarily related to the foreign exchange rate changes of future foreign
currency transaction costs and to the interest rate changes on borrowing costs.
These contracts are designated as cash flow hedges.
60
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company also uses interest rate swaps to hedge changes in the value of
fixed rate debt due to variations in interest rates. Both the derivative
instruments and underlying debt are adjusted to market value through "interest
expense and other" at the end of each period. The Company uses foreign currency
forward contracts to protect the value of existing foreign currency assets and
liabilities. The remeasurement adjustments for any foreign currency denominated
assets or liabilities are included in "interest expense and other." The
remeasurement adjustment is offset by the foreign currency forward contract
settlements which are also classified in "interest expense and other." Both
interest rate swaps and foreign currency forward contracts are designated as
fair value hedges.
The Company generally does not use derivative instruments for trading or
speculative purposes. During fiscal 2003, the Company entered into one
speculative interest rate swap transaction resulting in a gain of approximately
$6.7 million.
The Company's derivative contracts are adjusted to current market values
each period and qualify for hedge accounting under SFAS No.133. Periodic gains
and losses of contracts designated as cash flow hedges are deferred in other
comprehensive income until the underlying transactions are recognized. Upon
recognition, such gains and losses are recorded in net earnings as an adjustment
to the carrying amounts of underlying transactions in the period in which these
transactions are recognized. For those contracts designated as fair value
hedges, resulting gains or losses are recognized in net earnings offsetting the
exposures of underlying transactions. Carrying values of all contracts are
included in other assets or liabilities.
The Company's policy requires contracts used as hedges must be effective
at reducing the risk associated with the exposure being hedged and must be
designated as a hedge at the inception of the contract. Hedging effectiveness is
assessed periodically. Any contract not designated as a hedge, or so designated
but ineffective, is adjusted to market value and recognized in net earnings
immediately. If a fair value or cash flow hedge ceases to qualify for hedge
accounting or is terminated, the contract would continue to be carried on the
balance sheet at fair value until settled and future adjustments to the
contract's fair value would be recognized in earnings immediately. If a
forecasted transaction were no longer probable to occur, amounts previously
deferred in other comprehensive income would be recognized immediately in
earnings. Additional disclosure related to the Company's hedging contracts is
provided in Note 7.
RESEARCH AND DEVELOPMENT COSTS. Costs incurred in connection with development of
new products and manufacturing methods are charged to expense as incurred.
Research and development expenses were $56.5 million, $56.9 million and $65.1
million in fiscal 2004, 2003 and 2002, respectively.
INCOME TAXES. In accordance with provisions of SFAS No. 109, "Accounting for
Income Taxes," the Company accounts for income taxes using the asset and
liability method. The asset and liability method requires recognition of
deferred tax assets and liabilities for expected future tax consequences of
temporary differences that currently exist between tax bases and financial
reporting bases of the Company's assets and liabilities. No provision is made
for U.S. income taxes on undistributed earnings of foreign subsidiaries because
those earnings are considered permanently reinvested in the operations of those
subsidiaries.
EARNINGS PER COMMON SHARE. Basic earnings per Common Share ("Basic") is computed
by dividing net earnings (the numerator) by the weighted average number of
Common Shares outstanding during each period (the denominator). Diluted earnings
per Common Share is similar to the computation for Basic, except that the
denominator is increased by the dilutive effect of stock options, computed using
the treasury stock method.
DIVIDENDS. Excluding dividends paid by all entities with which the Company has
merged, the Company paid cash dividends per Common Share of $0.12, $0.10 and
$0.10 for the fiscal years ended June 30, 2004, 2003 and 2002, respectively.
RECENT FINANCIAL ACCOUNTING STANDARDS. In December 2003, the Financial
Accounting Standards Board ("FASB") issued a revision to SFAS No. 132,
"Employers Disclosures about Pensions and Other Postretirement Benefits." The
revision relates to employers' disclosures about pension plans and other
postretirement benefit plans. The revision does not alter the measurement or
recognition provisions of the original SFAS No. 132. The revision requires
additional disclosures regarding assets, obligations, cash flows and net
periodic benefit costs of
61
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
pension plans and other defined benefit postretirement plans. Excluding certain
disclosure requirements, the revised SFAS No. 132 is effective for financial
statements with fiscal years ended after December 15, 2003 (see Note 9 for the
Company's disclosures).
In December 2003, the FASB issued a revision to Interpretation No. 46,
"Consolidation of Variable Interest Entities." This revised Interpretation
defines when a business enterprise must consolidate a variable interest entity.
The revised Interpretation provisions are effective for variable interest
entities commonly referred to as special-purpose entities for periods ending
after December 15, 2003. The revised Interpretation provisions apply to all
other types of variable interest entities for financial statement periods ending
after March 15, 2004. As of June 30, 2004, the Company did not hold a
significant variable interest in a variable interest entity in which the Company
is not the primary beneficiary. See Note 6 for discussion of the Company's
accounts receivable and financing entity which is included in the consolidated
financial statements as the Company is the primary beneficiary of the variable
interest entity. Adoption of the subsequent provisions of the Interpretation did
not have a material impact on the Company's financial position or results of
operations.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133
on Derivative Instruments and Hedging Activities." SFAS No. 149 amends and
clarifies the financial accounting and reporting requirements as originally
established in SFAS No. 133 for derivative instruments and hedging activities.
SFAS No. 149 provides greater clarification of the characteristics of a
derivative instrument so that contracts with similar characteristics will be
accounted for consistently. SFAS No. 149 is effective for contracts entered into
or modified after June 30, 2003, as well as for hedging relationships designated
after June 30, 2003, excluding certain implementation issues that have been
effective prior to this date under SFAS No. 133. The adoption of SFAS No. 149
did not have a material effect on the Company's financial position or results of
operations.
62
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
ACCOUNTING FOR STOCK-BASED COMPENSATION. In December 2002, the FASB issued SFAS
No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure,"
which amends SFAS No. 123. This statement provides alternative methods of
transition for a voluntary change to the fair value-based method of accounting
for stock-based employee compensation and amends the disclosure requirements of
SFAS No. 123. The transition guidance and annual disclosure provisions (shown
below) are effective for fiscal years ending after December 15, 2002. The
adoption of this statement did not have a material effect on the Company's
financial position or results of operations.
At June 30, 2004, the Company maintained several stock incentive plans for
the benefit of certain employees, which are more fully described in Note 14. The
Company accounts for these plans in accordance with Accounting Principles
Bulletin ("APB") 25, and related interpretations. Except for costs related to
restricted shares and restricted share units, no compensation expense has been
recognized in net earnings, as all options granted had an exercise price equal
to the market value of the underlying stock on the date of grant. The following
tables illustrate the effect on net earnings and earnings per share if the
Company adopted the fair value recognition provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation."
Fiscal Year Ended June 30,
--------------------------------------------------------
2004 2003 2002
--------------------------------------------------------
(in millions, except per Common Share amounts) Restated Restated
Net Earnings, as reported $ 1,474.5 $ 1,375.1 $ 1,070.7
Restricted share amortization included in net
earnings, net of related tax effects 2.0 1.8 2.7
Total stock-based employee compensation expense
determined under fair value method for all awards,
net of related tax effects (1) (104.3) (91.6) (79.1)
--------- --------- ---------
Pro Forma net earnings $ 1,372.2 $ 1,285.3 $ 994.3
========= ========= =========
|
Fiscal Year Ended June 30,
--------------------------------------------------------
2004 2003 2002
--------------------------------------------------------
Restated Restated
Basic earnings per Common Share:
As reported $ 3.39 $ 3.08 $ 2.37
Pro Forma basic earnings per Common Share $ 3.16 $ 2.88 $ 2.21
Diluted earnings per Common Share
As reported $ 3.35 $ 3.03 $ 2.33
Pro Forma diluted earnings per Common Share (2) $ 3.14 $ 2.85 $ 2.17
|
(1) The total stock-based employee compensation expense was adjusted to
include employee stock purchase plan expense of $8.4 million, $6.8
million and $6.9 million for the fiscal years ended June 30, 2004,
2003 and 2002, respectively.
(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 123.
The information in the table above has been revised with respect to an
option award previously granted to the Company's Chairman and Chief Executive
Officer in November 1999. For more information, see Note 14.
63
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. BUSINESS COMBINATIONS, SPECIAL ITEMS & MERGER-RELATED COSTS
POLICY
The Company's special items primarily consist of costs relating to the
integration of previously acquired companies or costs of restructuring
operations to improve productivity. Integration costs from acquisitions
accounted for under the pooling of interests method have been recorded in
accordance with EITF Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs incurred in a Restructuring)," and SAB No. 100, "Restructuring and
Impairment Charges." Certain costs related to these acquisitions, such as
employee and lease terminations and other facility exit costs, were recognized
at the date the integration plan was adopted by management. Certain other
integration costs not meeting the criteria for accrual at the commitment date
have been expensed as the integration plan has been implemented.
Costs associated with integrating acquired companies under the purchase
method are recorded in accordance with EITF Issue No. 95-3, "Recognition of
Liabilities in Connection with a Purchase Business Combination." Certain costs
to be incurred by the Company, as the acquirer, such as employee and lease
terminations and other facility exit costs, are recognized at the date the
integration plan is formalized and adopted by management. Certain other
integration costs not meeting the criteria for accrual at the commitment date
are expensed as the integration plan is implemented.
At the beginning of the third quarter of fiscal 2003, the Company
implemented SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal
Activities," to account for costs incurred in restructuring activities. Under
this standard, a liability for an exit cost is recognized as incurred. As
discussed above, the Company previously accounted for costs associated with
restructuring activities under EITF Issue No. 94-3, which required the Company
to recognize a liability for restructuring costs on the date of the commitment
to an exit plan.
The Company records settlements of significant lawsuits that are
infrequent, non-recurring or unusual in nature as special items. Also, the
Company records, from time to time, material charges that are one-time, unusual
or infrequent in nature as special items.
BUSINESS COMBINATIONS
FISCAL 2004. On June 28, 2004, the Company acquired approximately 98.7% of the
outstanding common stock of ALARIS, a San Diego, California-based company which
is a leading provider of intravenous medication safety products and services. On
July 7, 2004, ALARIS merged with a subsidiary of the Company to complete the
transaction. The acquisition extends the Company's portfolio of market leading
products and services to health care providers, and increases its presence in
strategic markets outside the United States. With complementary operations,
product lines, distribution networks and geographic presence, the acquisition
will enable the Company to broaden integrated product and service offerings,
better serve customers globally and deliver a comprehensive suite of medication
safety solutions.
This acquisition was accounted for under the purchase method of
accounting. The cash transaction was valued at approximately $2.1 billion,
including the assumption of approximately $358 million of debt. Under the
agreement, the Company agreed to make a cash tender offer to acquire all of the
outstanding shares of ALARIS common stock at a price of $22.35 per share. ALARIS
employees with outstanding stock options either elected to receive a cash
payment or convert their options into an option to purchase the Company's Common
Shares. In July 2004, certain ALARIS employees elected to convert their options
for the right to purchase a total of approximately 0.6 million Common Shares of
the Company.
The preliminary allocation of the ALARIS purchase price resulted in an
allocation to goodwill of approximately $1.5 billion and an allocation to
identifiable intangible assets of $413.2 million. The Company valued intangible
assets related to trademarks, trade names, patents and customer relationships.
The detail by category is as follows:
Amount Average
Category (in millions) Life (Years)
-------- ------------- ------------
Trademarks and trade names $ 153.8 Indefinite
Patents 108.2 10
Customer relationships 151.2 8
-------
Total intangible assets acquired $ 413.2
=======
|
Given the size and timing of the acquisition, the allocation of the
purchase price is not yet finalized and is subject to adjustment. The Company
worked with a third-party valuation expert to determine the fair value of
in-process research and development ("IPR&D") and the fair value of identifiable
intangible assets. As required by SFAS 141 "Business Combinations,"
64
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
amounts assigned to tangible and intangible assets to be used in research and
development projects that have no alternate future use were charged to expense
at the acquisition date. The Company recorded a charge of $12.7 million, within
special items in the Company's consolidated statement of earnings, for an
estimate of acquired IPR&D.
Supplemental pro forma results of operations are not disclosed as the
impact to the Company from the ALARIS acquisition was not material. The
consolidated financial statements include the results of operations as of June
28, 2004.
Prior to the completion of the ALARIS acquisition, on June 16, 2004, ICU
Medical, Inc. filed a patent infringement lawsuit against ALARIS in the United
States District Court for the Southern District of California. In the lawsuit,
ICU claims that the ALARIS SmartSite(R) family of needle-free valves and systems
infringes upon ICU patents. ICU seeks monetary damages plus permanent injunctive
relief preventing ALARIS from selling SmartSite(R) products. On July 30, 2004,
the Court denied ICU's application for a preliminary injunction finding, among
other things, that ICU had failed to show a substantial likelihood of success on
the merits. The Company intends to vigorously defend this action.
During December 2003, the Company completed its acquisition of The
Intercare Group, plc ("Intercare"), a leading European pharmaceutical products
and services company. This acquisition increased the Company's scale of
proprietary sterile manufacturing and broadened its participation in the
fast-growing European generic (including manufacturing capabilities) and
injectible product market. The cash transaction was valued at approximately $570
million, including the assumption of approximately $150 million in Intercare
debt.
In addition, during fiscal 2004, the Company also completed other
acquisitions that individually were not material and were accounted for under
the purchase method of accounting. The aggregate purchase price of these
individually immaterial acquisitions, which was paid in cash, was approximately
$168 million. Assumed liabilities of acquired businesses, including those of
ALARIS and Intercare, were approximately $1.1 billion. The consolidated
financial statements include the results of operations from each of these
business combinations as of the date of acquisition. Had the transactions,
including ALARIS and Intercare, occurred on July 1, 2001, results of operations
would not have differed materially from reported results.
FISCAL 2003. On January 1, 2003, the Company completed the acquisition of Syncor
International Corporation, a Woodland Hills, California-based company (which has
been given the legal designation of Cardinal Health 414, Inc., and is referred
to in these "Notes to Consolidated Financial Statements" as "Syncor"), which is
a leading provider of nuclear pharmacy services. This acquisition was accounted
for under the purchase method of accounting. The Company issued approximately
12.5 million Common Shares, valued at approximately $780 million, to Syncor
stockholders and Syncor's outstanding stock options were converted into options
to purchase approximately 3.0 million Common Shares. The Company also assumed
approximately $120 million in debt. In connection with this acquisition, certain
operations of Syncor have been or will be sold (see Note 21) and other
operations have been integrated with the Company's existing Nuclear Pharmacy
Services business, a component of the Pharmaceutical Technologies and Services
segment.
In addition, during fiscal 2003, the Company also completed other
acquisitions that individually were not material and were accounted for under
the purchase method of accounting. The aggregate purchase price of these
individually immaterial acquisitions, which was paid in cash, was approximately
$14.4 million. Assumed liabilities of the acquired businesses, including those
of Syncor, were approximately $340.1 million. The consolidated financial
statements include the results of operations from each of these business
combinations as of the date of acquisition. Had the transactions, including
Syncor, occurred on July 1, 2001, results of operations would not have differed
materially from reported results.
FISCAL 2002. During fiscal 2002, the Company completed several acquisitions that
individually were not material and were accounted for under the purchase method
of accounting. These business combinations primarily focused on expanding the
service offerings within the Pharmaceutical Technologies and Services segment to
include contract pharmaceutical development and integrated medical education.
The aggregate purchase price, which was paid primarily in cash, was
approximately $418.0 million. The Company issued approximately 0.3 million
Common Shares to stockholders and outstanding stock options were converted into
options to purchase a total of approximately 1.0 million Common Shares. Assumed
liabilities of the acquired businesses were approximately $93.5 million,
including debt of $11.1 million. The consolidated financial statements include
the results of operations from each of these business combinations subsequent to
the date of acquisition. Had these transactions occurred on July 1, 2001,
results of operations would not have differed materially from reported results.
65
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SPECIAL ITEMS & MERGER-RELATED COSTS.
The following is a summary of the Company's special items for fiscal years
ended June 30, 2004, 2003 and 2002.
Fiscal Year Ended June 30,
---------------------------------------
(in millions, except per Common Share amounts) 2004 2003 2002
---------------------------------------------- ---------------------------------------
Restated
Merger-related costs $ 44.7 $ 74.4 $ 131.9
Restructuring costs 37.1 67.0 18.5
Litigation settlements, net (62.3) (101.5) (33.8)
Other special items 37.9 - -
------- -------- -------
Total special items 57.4 39.9 116.6
Tax effect of special items (1) (21.8) (6.7) (42.9)
------- -------- -------
Net earnings effect of special items 35.6 33.2 73.7
======= ======== =======
Net decrease on Diluted EPS $ 0.08 $ 0.07 $ 0.16
======= ======== =======
|
(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 jurisdiction where
the item was incurred.
Merger-Related Costs
Costs of integrating operations of various merged companies are recorded
as merger-related costs when incurred. The merger-related costs incurred during
fiscal 2004 were primarily a result of the Syncor acquisition. Merger-related
costs incurred during fiscal 2003 and 2002 were primarily a result of the
Bindley Western Industries, Inc. (which has been given the legal designation of
Cardinal Health 100, Inc., and is referred to in these "Notes to Consolidated
Financial Statements" as "Bindley") acquisition. During the fiscal years noted
above, the Company also incurred merger-related costs for numerous smaller
acquisitions. The following table and paragraphs provide additional detail
regarding the types of merger-related costs incurred by the Company.
Fiscal Year Ended June 30,
-------------------------------------
(in millions) 2004 2003 2002
------------- -------------------------------------
Merger-related costs:
Employee-related costs $11.9 $18.7 $ 23.7
Pharmaceutical distribution center consolidation 0.1 22.7 52.4
Asset impairments & other exit costs 0.9 5.4 9.0
In-Process research & development 12.7 - -
Integration costs and other 19.1 27.6 46.8
----- ----- ------
Total merger-related costs $44.7 $74.4 $131.9
===== ===== ======
|
EMPLOYEE-RELATED COSTS. During fiscal 2004, 2003 and 2002, the Company
incurred employee-related costs associated with certain merger and acquisition
transactions of $11.9 million, $18.7 million and $23.7 million, respectively.
These costs primarily consist of severance, stay bonuses, non-compete agreements
and other forms of compensatory payouts made to employees as a direct result of
the mergers or acquisitions. In addition to these types of costs, during fiscal
2003, the Company incurred a charge of $8.8 million related to an approved plan
to curtail defined benefit pension plans within the Pharmaceutical Technologies
and Services segment. This curtailment resulted from the plan to conform the
employee benefit plans of R.P. Scherer Corporation (which was acquired in August
1998, has been given the legal designation of Cardinal Health 409, Inc. and is
referred to in these "Notes to Consolidated Financial Statements" as "Scherer")
to the Company's benefit plan structure at the time of the Scherer merger.
PHARMACEUTICAL DISTRIBUTION CENTER CONSOLIDATION. During fiscal 2004, 2003
and 2002, the Company incurred charges of $0.1 million, $22.7 million and $52.4
million, respectively, primarily associated with the Company's plans to close
and consolidate a total of 16 Bindley distribution centers, Bindley's corporate
office and one of the Company's data centers as a result of the Bindley
acquisition. These charges include, but are not limited to, the following: (1)
employee-related costs, primarily from the termination of approximately 1,250
employees due to the closures and consolidations noted above; (2) exit costs to
consolidate and close the various facilities mentioned above, including asset
impairment charges, inventory move costs and contract/lease termination costs;
and (3) duplicate salary costs incurred during the shutdown periods.
66
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
ASSET IMPAIRMENTS & OTHER EXIT COSTS. During fiscal 2004, 2003 and 2002,
the Company incurred asset impairment and other exit costs of $0.9 million, $5.4
million and $9.0 million, respectively. The asset impairment and other exit
costs incurred during fiscal 2004 related primarily to plans to consolidate
operations as a result of the Syncor acquisition. The asset impairment and other
exit costs incurred during fiscal 2003 and 2002 related primarily to plans to
close and consolidate facilities as a result of the Bergen Brunswig Medical
Corporation acquisition as well as asset impairments, lease terminations and
other exit costs incurred internationally as a result of the Scherer
acquisition.
IN-PROCESS RESEARCH & DEVELOPMENT. During the fourth quarter of fiscal
2004, the Company recorded a charge of $12.7 million related to the writeoff of
in-process research and development costs associated with the ALARIS
acquisition.
OTHER INTEGRATION COSTS. During fiscal 2004, 2003 and 2002, the Company
incurred integration costs and other of $19.1 million, $27.6 million and $46.8
million, respectively. The costs included in this category generally relate to
expenses incurred to integrate merged or acquired companies' 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.
Restructuring Costs
The following table segregates the Company's restructuring costs into the
various reporting segments the restructuring projects impacted. See the
paragraphs that follow for additional information regarding the Company's
restructuring plans.
Fiscal Year Ended June 30,
-------------------------------------
(in millions) 2004 2003 2002
------------- ------------------------------------
Restructuring costs:
Pharmaceutical Distribution and Provider Services - $ 1.4 $ 0.3
Medical Products and Services 8.7 23.6 14.9
Pharmaceutical Technologies and Services 23.3 40.7 2.8
Automation and Information Services 4.2 - -
Other 0.9 1.3 0.5
----- ----- ------
Total restructuring costs $37.1 $67.0 $ 18.5
===== ===== ======
|
PHARMACEUTICAL DISTRIBUTION AND PROVIDER SERVICES. During the fiscal years
noted above, the Company has initiated very few restructuring projects that
impacted the Pharmaceutical Distribution and Provider Services segment. Costs
incurred during fiscal 2003 and 2002 primarily comprised employee-related costs
incurred to reduce headcount for certain businesses within the segment and to
realign the management structure of those businesses. These restructuring
projects resulted in approximately 30 employees being terminated, the majority
of which occurred during fiscal 2003. The restructuring projects that impacted
the Pharmaceutical Distribution and Provider Services segment were substantially
completed by the end of fiscal 2003.
MEDICAL PRODUCTS AND SERVICES. During fiscal 2004, 2003 and 2002, the
Company incurred costs of $8.7 million, $23.6 million and $14.9 million,
respectively, to restructure operations both domestically and internationally.
These restructuring plans focused on various aspects of the segment's
operations, specifically to close and consolidate certain manufacturing
operations, rationalize headcount both domestically and internationally, and
align certain distribution and manufacturing operations in the most strategic
and cost efficient structure. In connection with the implementation of these
restructuring plans, the Company incurred costs which included, but are not
limited to, the following: (1) employee-related costs, the majority of which
represents severance accrued upon either communication of terms to employees or
management's commitment to the restructuring plan, depending upon the project;
and (2) exit costs, including asset impairment charges, costs incurred to
relocate physical assets and project management costs. The earliest of these
restructuring plans was initiated during fiscal 2002, with others being
implemented throughout fiscal 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 will result in
termination of approximately 2,200 employees, of which approximately 1,900 had
been terminated as of June 30, 2004.
PHARMACEUTICAL TECHNOLOGIES AND SERVICES. During fiscal 2004, 2003 and
2002, the Company incurred costs of $23.3 million, $40.7 million and $2.8
million, respectively, to restructure operations both domestically and
internationally. These restructuring plans focused on various aspects of the
segment's operations, specifically to close and consolidate certain
manufacturing and other
67
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
business facilities, exit non-strategic businesses, integrate and align
operations in the most strategic and cost efficient manner and rationalize
headcount both domestically and internationally as a result of integration plans
and market changes. In connection with the implementation of these restructuring
plans, the Company incurred costs which included, but are not limited to, the
following: (1) employee-related costs, the majority of which represents
severance accrued upon communication of terms to employees; (2) asset impairment
charges, including the writedown of physical assets as well as goodwill
writeoffs from the exit of non-strategic and non-integrated businesses; and (3)
other exit costs, including lease/contract termination costs, costs to dismantle
and move machinery, equipment and other physical assets and costs to transfer
certain technologies to other existing facilities. The earliest of these
restructuring plans was initiated during fiscal 2001, with others being
implemented throughout fiscal 2003 and 2004. Some of the restructuring plans
were completed during fiscal 2003 and 2004, while other plans will be completed
throughout fiscal 2005. Overall, these restructuring plans will result in the
termination of approximately 1,000 employees, of which approximately 900 had
been terminated as of June 30, 2004.
AUTOMATION AND INFORMATION SERVICES. During fiscal 2004, the Company
incurred restructuring costs of $4.2 million related to plans to exit or dispose
of certain non-strategic businesses as well as close a manufacturing facility
within this segment. In connection with the implementation of these
restructuring plans, the Company incurred employee-related costs, primarily
severance accrued upon communication of terms to employees, asset impairment
charges and facility exit costs. The Company expects these restructuring plans
to be completed during fiscal 2005. Overall, these restructuring plans will
result in the termination of approximately 35 employees, of which approximately
10 had been terminated as of June 30, 2004.
OTHER. During fiscal 2004, 2003 and 2002, the Company incurred costs of
$0.9 million, $1.3 million and $0.5 million related to restructuring plans that
impacted more than just one segment. These costs related primarily to a plan to
restructure the Company's delivery of information technology infrastructure
services. These plans were initiated during fiscal 2003 and are expected to be
completed during fiscal 2005. Overall, these restructuring plans resulted in the
termination of approximately 20 employees, all of which had been terminated as
of June 30, 2004.
Litigation Settlements, Net
The following table summarizes the Company's net litigation settlements
during fiscal 2004, 2003 and 2002.
Fiscal Year Ended June 30,
--------------------------------------
(in millions) 2004 2003 2002
------------- --------------------------------------
Restated
Litigation settlements, net:
Vitamin litigation ($ 6.5) ($102.9) ($35.3)
Pharmaceutical manufacturer antitrust litigation (55.9) - -
Other litigation 0.1 1.4 1.5
------ ------- ------
Total litigation settlements, net ($62.3) ($101.5) ($33.8)
====== ======= ======
|
VITAMIN LITIGATION. During fiscal 2004, 2003 and 2002, the Company
recorded income of $6.5 million, $102.9 million and $35.3 million, respectively,
resulting from the recovery of antitrust claims against certain vitamin
manufacturers for amounts overcharged in prior years. The total recovery of
antitrust claims against certain vitamin manufacturers through June 30, 2004 was
$144.7 million (net of attorney fees, payments due to other interested parties
and expenses withheld). See Note 1 for additional information regarding the
periods in which these recoveries were recorded. The Company has settled all but
one known claim, and the total amount of any future recovery is not likely to be
a material amount.
PHARMACEUTICAL MANUFACTURER ANTITRUST LITIGATION. During fiscal 2004, the
Company recorded income of $55.9 million resulting from settlement of antitrust
claims alleging certain prescription drug manufacturers took improper actions to
delay or prevent generic drug competition.
OTHER LITIGATION. During fiscal 2004, 2003 and 2002, the Company recorded
settlement charges of $0.1 million, $1.4 million and $1.5 million, respectively,
related to certain immaterial litigation matters, all of which have been fully
resolved.
Other Special Items
FISCAL 2004. During fiscal 2004, the Company incurred other special items
totaling $37.9 million. This total comprises two items. First, the Company
executed a special contribution to The Cardinal Health Foundation during the
fourth quarter which totaled approximately $31.7 million. The special
contribution was executed as a direct result of a large pharmaceutical
manufacturer antitrust litigation settlement received during the fourth quarter.
The Cardinal Health Foundation is the
68
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
primary vehicle used by the Company to provide charitable support to the
community and various organizations. Prior contributions to the Cardinal Health
Foundation were immaterial. Second, the Company incurred costs of $6.2 million
during the fourth quarter related to the SEC investigation and the Audit
Committee's internal review. These costs primarily represent legal fees and
document preservation and production costs incurred in responding to requests
related to the SEC's investigation and the Audit Committee's internal review.
Prior costs incurred related to these matters were immaterial. For further
information regarding the SEC's investigation and the Audit Committee's internal
review, see Note 1.
Special Items Accrual Rollforward
The following table summarizes activity related to liabilities associated
with the Company's special items.
Fiscal Year Ended June 30,
---------------------------------------
($ in millions) 2004 2003 2002
---------------------------------------
Balance at beginning of year $ 45.7 $ 64.7 $ 34.7
Additions (1) 119.8 142.8 151.9
Payments (125.6) (161.8) (121.9)
-------- -------- --------
Balance at end of year $ 39.9 $ 45.7 $ 64.7
======== ======== ========
|
(1) Amounts represent items that have been expensed as incurred or
accrued in accordance with GAAP. These amounts do not include gross
litigation settlement income recorded during fiscal 2004, 2003 and
2002 of $62.4 million, $102.9 million and $35.3 million,
respectively, which were recorded as special items.
Purchase Accounting Accruals
In connection with restructuring and integration plans related to
Intercare, 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 closing of certain facilities. During fiscal 2004,
the Company paid $1.5 million of employee-related costs. No payments were made
associated with the facility closures during fiscal 2004.
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 June 30, 2004, the
Company had paid $12.0 million of employee related costs, $1.0 million
associated with the facility closure and $1.5 million of other restructuring
costs.
Other
Certain merger, acquisition and restructuring costs are based upon
estimates. Actual amounts paid may ultimately differ from these estimates. If
additional costs are incurred or recorded amounts exceed costs, such changes in
estimates will be recorded in special items when incurred.
The Company estimates it will incur additional costs in future periods
associated with various mergers, acquisitions and restructuring activities
totaling approximately $70 million (approximately $45 million net of tax). The
Company believes it will incur these costs to properly integrate and rationalize
operations, a portion of which represents facility rationalizations and
implementing efficiencies regarding information systems, customer systems,
marketing programs and administrative functions, among other things. Such
amounts will be expensed as special items when incurred. This estimate does not
include costs associated with the integration of ALARIS or the Company-wide
restructuring project announced in September 2004 as the Company is still in the
process of determining the costs associated with these projects.
69
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5. LEASES
SALES-TYPE LEASES. The Company's sales-type leases are for terms generally
ranging up to five years. Lease receivables are generally collateralized by the
underlying equipment. The components of the Company's net investment in
sales-type leases are as follows (in millions):
June 30, June 30,
2004 2003
-------- ---------
Future minimum lease payments receivable $ 844.0 $ 840.5
Unguaranteed residual values 21.6 18.6
Unearned income (101.8) (112.2)
Allowance for uncollectible minimum lease payments
receivable (15.7) (17.8)
--------- ----------
Net investment in sales-type leases 748.1 729.1
Less: current portion 202.1 171.8
--------- ----------
Net investment in sales-type leases, less current portion $ 546.0 $ 557.3
========= ==========
|
Future minimum lease payments to be received pursuant to sales-type leases
during the next five fiscal years and thereafter are:
(in millions) 2005 2006 2007 2008 2009 Thereafter Total
------------- ------------------------------------------------------------
Minimum lease payments $228.7 $215.7 $182.4 $138.5 $71.8 $ 6.9 $ 844.0
|
During fiscal 2004 and 2003, the Company entered into four separate
agreements (two in fiscal 2004 and two in fiscal 2003) to transfer ownership of
certain lease receivables along with a security interest in the related leased
equipment to the leasing subsidiary of a bank. The net book value of the leases
sold was $314.2 million and $356.0 million for fiscal 2004 and 2003,
respectively (see Note 10 for additional information).
70
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6. NOTES PAYABLE & LONG-TERM OBLIGATIONS
NOTES PAYABLE, BANKS. The Company has entered into an unsecured, uncommitted
line-of-credit arrangement that allows for borrowings up to $7.3 million at June
30, 2004, at an interest rate of 55 basis points over three month Euro Libor. At
June 30, 2004, $5.6 million was outstanding under this arrangement, at an
effective interest rate of 2.13%. Total available but unused lines of credit at
June 30, 2004 were $1.7 million. At June 30, 2003, there were no notes payable
outstanding.
LONG-TERM OBLIGATIONS. Long-term obligations consist of the following (in
millions):
June 30, June 30,
2004 2003
-------- ---------
4.00% Notes due 2015 $ 432.9 $ 475.7
4.45% Notes due 2005 305.5 317.8
6.00% Notes due 2006 151.6 158.0
6.25% Notes due 2008 150.0 150.0
6.50% Notes due 2004 - 100.0
6.75% Notes due 2011 497.0 495.4
6.75% Notes due 2004 - 100.0
7.25% Senior subordinated notes due 2011 195.3 -
7.30% Notes due 2006 130.3 135.2
7.80% Debentures due 2016 75.7 75.7
7.00% Debentures due 2026 192.0 192.0
Bank term loan due 2009 162.6 -
Commercial paper 634.2 -
Preferred debt securities 650.0 400.0
Short-term borrowings, reclassified 15.0 21.0
Other obligations; interest averaging 4.65% in 2004 and
5.29% in 2003, due in varying installments
through 2015 97.6 79.8
--------- ----------
Total 3,689.7 2,700.6
Less: current portion 855.0 228.7
--------- ----------
Long-term obligations, less current portion $ 2,834.7 $ 2,471.9
========= ==========
|
The 4.00%, 4.45%, 6.00%, 6.25% and 6.50% Notes and the 6.75% Notes due
2011 represent unsecured obligations of the Company, and the 6.75% Notes due
2004 represent unsecured obligations of Scherer, which are guaranteed by the
Company. The 7.30% Notes and the 7.80% and 7.00% Debentures represent unsecured
obligations of Allegiance Corporation, which are guaranteed by the Company.
These obligations are not subject to a sinking fund and are not redeemable prior
to maturity, except for the 7.00% Debentures which included put options that
expired on September 15, 2003, without any put options being exercised. Interest
is paid pursuant to the terms of the notes. These notes are structurally
subordinated to the liabilities of the Company's subsidiaries, including trade
payables of $6.4 billion and $650.0 million of preferred debt securities.
As part of the Company's acquisition of ALARIS, the Company assumed $195.3
million of Senior subordinated notes due 2011, which includes a premium of $20.3
million based on the fair value of the debt. The Senior subordinated notes bear
interest at an annual rate of 7.25%, which is payable semi-annually in arrears
on July 1 and January 1 of each year, commencing January 1, 2004, and mature on
July 1, 2011. The Senior subordinated notes are redeemable at the option of the
Company, in whole or in part, at any time on or after July 1, 2007 at an initial
redemption price of 103.625%, plus accrued and unpaid interest, if any, to the
date of redemption, with the redemption price declining annually thereafter. In
addition, subject to certain limitations, the Company may redeem up to 35% of
the Senior subordinated notes on or before July 1, 2006 with the net cash
proceeds of one or more equity offerings, at a price of 107.25%, plus accrued
and unpaid interest, if any, to the date of redemption. In the event of a change
of control, as defined in the indenture governing the Senior subordinated notes,
holders may require the Company to purchase their Senior subordinated notes at
101% of the principal amount thereof, plus accrued and unpaid interest, if any,
to the date of repurchase. The Senior subordinated notes are subject to certain
restrictive and reporting covenants. As of June 30, 2004, the Company was in
compliance with all such covenants. Subsequent to June 30, 2004, the Company
paid off $183.6 million of the Senior subordinated notes and amended the bond
indenture to remove the restrictive covenants. The remaining $11.7 million
71
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
balance is callable at any time on or after July 1, 2007.
Also related to the ALARIS acquisition, the Company acquired a bank credit
facility consisting of a six-year $245 million term loan and a five-year $30
million revolving credit facility. At June 30, 2004, $162.6 million was
outstanding under the term loan. The term loan bears interest at an annual rate
equal to current LIBOR or a fluctuating base rate, plus a margin of 2.25% as of
June 30, 2004. The Company can elect to use either a one-, two-, three-, or
six-month LIBOR rate. ALARIS has made elections resulting in a weighted average
interest rate at June 30, 2004 of 3.36% per annum (1.11% plus the margin of
2.25%). Subsequent to June 30, 2004, the Company paid off the term loan and
terminated the credit facility.
The Company has a commercial paper program, providing for the issuance of
up to $1.5 billion in aggregate maturity value of commercial paper. The Company
had $634.2 million outstanding under this program at June 30, 2004 with a market
interest rate based upon LIBOR. The Company also had an extendible commercial
notes program providing for the issuance of up to $150.0 million of extendible
commercial notes. The Company did not have any borrowings outstanding under this
extendible commercial notes program at June 30, 2004. The Company also maintains
other short-term credit facilities that allow for borrowings up to $176.4
million. At June 30, 2004 and 2003, $62.8 million and $21.0 million,
respectively, were outstanding under these uncommitted facilities. The June 30,
2004 balance includes $15 million in short-term borrowings reclassified. The
effective interest rate as of June 30, 2004 and 2003 was 1.68% and 2.28%,
respectively. The balance also includes $47.8 million which is classified in
other obligations. The remaining $49.8 million balance of other obligations
consists primarily of additional notes, loans and capital leases.
The Company also has two unsecured $750 million bank revolving credit
facilities, which provide for up to an aggregate 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 and remained unused at June 30, 2004, except for
$37.3 million of standby letters of credit issued on behalf of the Company. At
June 30, 2004, $500.0 million of commercial paper and $15.0 million of other
short-term borrowings were reclassified as long-term. At June 30, 2003, $21.0
million of other short-term borrowings were reclassified as long-term. These
reclassifications reflect the Company's intent and ability, through the
existence of the unused revolving credit facilities, to refinance these
borrowings. The remaining $134.2 million of commercial paper outstanding at June
30, 2004 was classified as short-term.
During fiscal 2001, the Company entered into an agreement to periodically
sell trade receivables to a special purpose accounts receivable and financing
entity (the "Accounts Receivable and Financing Entity"), which is exclusively
engaged in purchasing trade receivables from, and making loans to, the Company.
The Accounts Receivable and Financing Entity, which is consolidated by the
Company, issued $250 million and $400 million in preferred variable debt
securities to parties not affiliated with the Company during fiscal 2004 and
2001, respectively. These preferred debt securities are classified as long-term
debt in the Company's consolidated balance sheet. These preferred debt
securities must be retired or redeemed by the Accounts Receivable and Financing
Entity before the Company, or its creditors, can have access to the Accounts
Receivable and Financing Entity's receivables. At June 30, 2004 and 2003, the
Accounts Receivable and Financing Entity owned approximately $506.9 million and
$463.6 million, respectively, of receivables that are included in the Company's
consolidated balance sheet. The effective interest rate as of June 30, 2004 and
2003 was 2.36% and 2.81%, respectively. Other than for loans made to the Company
or for breaches of certain representations, warranties or covenants, the
Accounts Receivable and Financing Entity does not have any recourse against the
general credit of the Company.
At June 30, 2003, the Company had an asset securitization facility
available which allows the Company to sell receivables generated from its
radiopharmaceutical operations to a wholly-owned subsidiary, which in turn sells
the receivables to a multi-seller conduit administered by a third party bank.
This securitization program allowed the Company to borrow up to $65.0 million.
This securitization facility was terminated in fiscal year 2004.
During fiscal 2003, the Company issued $500 million of 4.00% Notes due
2015. The proceeds of the debt issuance were used for general corporate
purposes, including working capital, capital expenditures, acquisitions,
investments and repurchases of our debt and equity securities. After such
issuance, the Company has the capacity to issue approximately $500 million of
additional equity or debt securities pursuant to effective shelf registration
statements filed with the SEC.
72
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Certain long-term obligations are collateralized with property and
equipment of the Company with an aggregate book value of approximately $70
million at June 30, 2004. Maturities of long-term obligations for future fiscal
years are:
(in millions) 2005 2006 2007 2008 2009 Thereafter Total
--------------------------------------------------------------------------------------------------------
Maturities of long-term obligations $855.0 $680.7 $136.5 $4.5 $804.3 $ 1,208.7 $3,689.7
|
7. FINANCIAL INSTRUMENTS
INTEREST RATE RISK MANAGEMENT. The Company is exposed to the impact of interest
rate changes. The Company's objective is to manage the impact of interest rate
changes on earnings and cash flows and on the market value of its borrowings.
The Company maintains fixed rate debt as a percentage of its net debt within a
certain range.
The Company utilizes a mix of debt maturities along with both fixed-rate
and variable-rate debt to manage changes in interest rates. In addition, the
Company enters into interest rate swaps to further manage its exposure to
interest rate variations related to its borrowings and to lower its overall
borrowing costs.
At June 30, 2004, the Company held two pay-fixed interest rate swaps
acquired through the ALARIS acquisition. These pay-fixed interest rate swaps
were utilized by ALARIS to hedge a bank term loan. The swaps were unwound
subsequent to June 30, 2004 upon the Company's election to pay down the bank
term loan (see Note 6). These swaps did not have a material impact upon the
Company's financial statements. At June 30, 2003, the Company held pay-fixed
interest rate swaps to hedge the variability of cash flows related to changes in
interest rates on borrowing costs of variable-rate debt. These contracts were
classified as cash flow hedges and matured through January 2004. The Company
adjusted the pay-fixed interest rate swaps to current market values through
other comprehensive income, as the contracts were effective in offsetting the
interest rate exposure of the forecasted interest rate payments hedged. The
Company did not recognize any material gains/(losses) related to contracts that
were not effective or forecasted transactions that did not occur during fiscal
2003.
The Company also held pay-floating interest rate swaps to hedge the change
in fair value of the fixed-rate debt related to fluctuations in interest rates.
These contracts are classified as fair value hedges and mature through June
2015. The gain/(loss) recorded on the pay-floating interest rate swaps is
directly offset by the change in fair value of the underlying debt. Both the
derivative instrument and the underlying debt are adjusted to market value at
the end of each period with any resulting gain/(loss) recorded in interest
expense and other.
The following table represents the notional amount hedged, fair value of
the interest rate swaps outstanding at June 30, 2004 and 2003 included in other
assets/liabilities and the amount of net gain/(loss) for pay-floating interest
rate swaps recognized through interest expense and other during fiscal 2004 and
2003.
(in millions) 2004 2003 Classification of net gain/loss
--------------------------------- -------- -------- -------------------------------
Pay-fixed interest rate swaps:
Notional amount $ 171.0 $ 125.0
Assets 0.8 -
Liabilities - 3.5
Pay-floating interest rate swaps:
Notional amount $1,327.8 $1,077.8
Assets 10.6 33.2
Liabilities 67.1 24.4
Gain/(loss) 34.8 27.1 Interest expense and other
|
At June 30, 2003, the Company had net deferred losses on pay-fixed
interest rate swaps of $3.5 million, recorded in other comprehensive income.
During fiscal 2004 and 2003, the Company recognized losses of $4.5 million and
$11.9 million, respectively, within interest expense and other related to these
interest rate swaps.
The counterparties to these contracts are major financial institutions and
the Company does not have significant exposure to any one counterparty.
Management believes the risk of loss is remote and in any event would not be
material.
73
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
CURRENCY RISK MANAGEMENT. The Company conducts business in several major
international currencies and is subject to risks associated with changing
foreign exchange rates. The Company's objective is to reduce earnings and cash
flow volatility associated with foreign exchange rate changes to allow
management to focus its attention on its business operations. Accordingly, the
Company enters into various contracts that change in value as foreign exchange
rates change to protect the value of existing foreign currency assets and
liabilities, commitments and anticipated foreign currency revenue and expenses.
The gains and losses on these contracts offset changes in the value of the
underlying transactions as they occur.
At June 30, 2004 and 2003, the Company held forward contracts expiring
through June 2005 to hedge probable, but not firmly committed, revenue and
expenses. These hedging contracts are classified as cash flow hedges and,
accordingly, are adjusted to current market values through other comprehensive
income until the underlying transactions are recognized. Upon recognition, such
gains and losses are recorded in operations as an adjustment to the recorded
amounts of the underlying transactions in the period in which these transactions
are recognized. The principal currencies hedged are the European euro, British
pound, Mexican peso, and the Thai bhat.
At June 30, 2004 and 2003, the Company also held forward contracts
expiring in December 2013 and September 2003, respectively, to hedge the value
of foreign currency assets and liabilities. These forward contracts are
classified as fair value hedges and are adjusted to current market values
through interest expense and other, directly offsetting the adjustment of the
foreign currency asset or liability.
The following table represents the notional amount hedged, the value of
the forward contracts outstanding at June 30, 2004 and 2003 included in other
assets or liabilities and the amount of net gain/(loss) related to fair value
forward contracts recognized through interest expense and other during fiscal
2004 and 2003.
(in millions) 2004 2003 Classification of net gain/loss
--------------------------------- -------- -------- -------------------------------
Forward contracts - cash flow hedge:
Notional amount $ 276.9 $ 240.5
Assets 1.4 4.7
Liabilities 4.9 14.2
Forward contracts - fair value hedge:
Notional amount $ 489.0 $ 114.0
Assets - 0.3
Liabilities 19.5 1.1
Gain/(loss) (12.7) (8.1) Interest expense and other
|
At June 30, 2004 and 2003, the Company had net deferred losses related to
forward contract cash flow hedges of $3.5 million and $9.5 million,
respectively, recorded in other comprehensive income. During fiscal 2004 and
2003, the Company recognized losses of $14.9 million and $12.2 million,
respectively, within net earnings related to these forward contracts.
The income/loss recorded on the forward contract fair value hedge is
offset by the remeasurement adjustment on the foreign currency denominated asset
or liability. The settlement of the derivative instrument and the remeasurement
adjustment on the foreign currency denominated asset or liability are both
recorded in interest expense and other at the end of each period. The Company
did not recognize any material gains/(losses) related to contracts that were not
effective or forecasted transactions that did not occur during fiscal 2004 and
2003.
In connection with the Company's acquisition of ALARIS, the Company
acquired certain options hedging European euro, Australian dollar, Canadian
dollar, and British pound. These options were entered into by ALARIS to reduce
the risk of earnings and cash flow volatility related to certain forecasted
transactions. As of June 30, 2004, exercise of these options would not result in
a material impact to the Company.
The counterparties to these contracts are major financial institutions and
the Company does not have significant exposure to any one counterparty.
Management believes the risk of loss is remote and in any event would not be
material.
74
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FAIR VALUE OF FINANCIAL INSTRUMENTS. The carrying amounts of cash and
equivalents, trade receivables, accounts payable, notes payable-banks, other
short-term borrowings and other accrued liabilities at June 30, 2004 and 2003,
approximate their fair value because of the short-term maturities of these
items.
Cash balances are invested in accordance with the Company's investment
policy. These investments are exposed to market risk from interest rate
fluctuations and credit risk from the underlying issuers, although this is
mitigated through diversification.
The estimated fair value of the Company's long-term obligations was
$3,787.1 million and $2,926.1 million as compared to the carrying amounts of
$3,689.7 million and $2,700.6 million at June 30, 2004 and 2003, respectively.
The fair value of the Company's long-term obligations is estimated based on
either the quoted market prices for the same or similar issues and the current
interest rates offered for debt of the same remaining maturities or estimated
discounted cash flows.
The following is a summary of the fair value gain/(loss) of the Company's
derivative instruments, based upon the estimated amount that the Company would
receive (or pay) to terminate the contracts as of June 30. The fair values are
based on quoted market prices for the same or similar instruments.
(in millions) 2004 2003
---------------------------------- ---------------------- ----------------------
Notional Fair Value Notional Fair Value
Amount Gain/(Loss) Amount Gain/(Loss)
-------- ----------- -------- -----------
Foreign currency forward contracts $ 765.9 $ (23.0) $ 354.5 $ (10.3)
Interest rate swaps $1,498.8 $ (55.7) $1,202.8 $ 5.3
|
8. INCOME TAXES
Earnings before income taxes, discontinued operations and cumulative
effect of changes in accounting are as follows (in millions):
Fiscal Year Ended June 30,
------------------------------
2004 2003 2002
-------- -------- --------
Restated Restated
U.S. Based Operations $1,845.1 $1,733.8 $1,486.8
Non-U.S. Based Operations 393.3 346.9 238.1
-------- -------- --------
$2,238.4 $2,080.7 $1,724.9
======== ======== ========
|
The provision for income taxes from continuing operations before
cumulative effect of changes in accounting consists of the following (in
millions):
Fiscal Year Ended June 30,
--------------------------------
2004 2003 2002
-------- -------- --------
Restated Restated
Current:
Federal $ 547.3 $ 426.5 $ 296.2
State 39.1 29.5 23.8
Foreign 22.2 28.3 24.4
-------- -------- --------
Total 608.6 484.3 344.4
Deferred:
Federal 99.8 191.0 208.5
State 7.1 27.1 29.8
Foreign (1.8) (2.9) 1.4
-------- -------- --------
Total 105.1 215.2 239.7
-------- -------- --------
Total provision $ 713.7 $ 699.5 $ 584.1
======== ======== ========
|
75
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A reconciliation of the provision based on the federal statutory income
tax rate to the Company's effective income tax rate from continuing operations
before cumulative effect of changes in accounting is as follows:
Fiscal Year Ended June 30,
--------------------------
2004 2003 2002
------ ------ ------
Provision at federal
statutory rate 35.0% 35.0% 35.0%
State income taxes, net of
federal benefit 2.0 1.7 2.6
Foreign tax rates (4.0) (3.2) (3.2)
Nondeductible expenses 0.3 0.5 0.2
Other (1.4) (0.4) (0.8)
---- ---- ----
Effective income tax rate 31.9% 33.6% 33.8%
==== ==== ====
|
The Company's effective tax rate reflects tax benefits derived from
significant operations outside the United States, which are generally taxed at
rates lower than the U.S. statutory rate of 35%. During fiscal 2004, the
Company's results of operations benefited from a lower effective tax rate due to
increased profits from production in lower tax international countries such as
the Dominican Republic and Thailand. In addition, the Company has subsidiaries
operating in Puerto Rico under a tax incentive agreement expiring in 2019.
No provision for income taxes has been made on approximately $1.2 billion
of undistributed earnings of foreign subsidiaries because those earnings are
considered permanently reinvested in the operations of those subsidiaries. It is
not practicable to estimate the amount of tax that might be payable on the
eventual remittance of such earnings.
Deferred income taxes arise from temporary differences between financial
reporting and tax reporting bases of assets and liabilities, and operating loss
and tax credit carryforwards for tax purposes. The components of the deferred
income tax assets and liabilities are as follows (in millions):
June 30, June 30,
2004 2003
---------- ----------
Deferred income tax assets:
Receivable basis difference $ 32.5 $ 55.6
Accrued liabilities 146.8 86.3
Net operating loss carryforwards 21.6 35.3
---------- ----------
Total deferred income tax assets 200.9 177.2
Valuation allowance for deferred income tax assets (15.8) (20.7)
---------- ----------
Net deferred income tax assets $ 185.1 $ 156.5
---------- ----------
Deferred income tax liabilities:
Inventory basis differences (498.8) (521.1)
Property-related (339.2) (359.4)
Revenues on lease contracts (231.2) (207.8)
Other (153.3) (112.2)
---------- ----------
Total deferred income tax liabilities (1,222.5) (1,200.5)
---------- ----------
Net deferred income tax liabilities $ (1,037.4) $ (1,044.0)
========== ==========
|
76
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The above amounts are classified in the consolidated balance sheets as
follows (in millions):
June 30, June 30,
2004 2003
--------- ---------
Other current assets and current liabilities $ (175.8) $ (204.3)
Deferred income taxes and other liabilities (861.6) (839.7)
--------- ---------
Net deferred income tax liabilities $(1,037.4) $(1,044.0)
========= =========
|
The Company had state net operating loss carryforwards of $866.6 million
at June 30, 2004. A valuation allowance of $9.9 million at June 30, 2004 has
been provided for the state net operating loss, as utilization of such
carryforwards within the applicable statutory periods is uncertain. The state
net operating loss carryforwards expire through 2024. Expiring state net
operating loss carryforwards and the required valuation allowances have been
adjusted annually. The Company also has federal capital loss carryovers of $15.6
million at June 30, 2004 for which a 100% valuation allowance has been
established since usage of these carryovers is uncertain at this time. After
application of the valuation allowances described above, the Company anticipates
no limitations will apply with respect to utilization of any of the other net
deferred income tax assets described above.
Under a tax-sharing agreement with Baxter International Inc., Allegiance
Corporation will pay for increases and be reimbursed for decreases to the net
deferred tax assets transferred on the date of the Baxter-Allegiance Spin-Off
(as hereinafter defined in Note 11). Such increases or decreases may result from
audit adjustments to Baxter's prior period tax returns.
9. EMPLOYEE RETIREMENT BENEFIT PLANS
The Company sponsors various retirement and pension plans, including
defined benefit, other postretirement benefit and defined contribution plans.
Substantially all of the Company's domestic non-union employees are eligible to
be enrolled in Company-sponsored contributory profit sharing and retirement
savings plans, which include features under Section 401(k) of the Internal
Revenue Code of 1986, as amended (the "Code"), and provide for Company matching
and profit sharing contributions. The Company's contributions to the plans are
determined by the Board of Directors subject to certain minimum requirements as
specified in the plans.
The total expense for employee retirement benefit plans (excluding defined
benefit and other postretirement benefit plans, see below) was $54.5 million,
$64.2 million and $59.0 million for the fiscal years ended June 30, 2004, 2003
and 2002, respectively.
DEFINED BENEFIT AND OTHER POSTRETIREMENT BENEFIT PLANS. The Company has several
defined benefit plans covering substantially all Scherer salaried and hourly
employees. The Company also assumed defined benefit plans through the Intercare
and ALARIS acquisitions. The Company's domestic defined benefit plans provide
defined benefits based on years of service and level of compensation. Foreign
subsidiaries provide for pension benefits in accordance with local customs or
law. The Company funds its pension plans at amounts required by applicable
regulations.
The Company also has a postretirement medical plan and a postretirement
life insurance plan that covers all eligible Scherer participants.
The Company uses a measurement date of March 31 for substantially all its
pension and postretirement benefit plans.
77
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Obligations and Funded Status
The following table provides a reconciliation of the change in projected
benefit obligation (in millions):
Pension Benefits Other Postretirement Benefits
---------------- -----------------------------
2004 2003 2004 2003
------ ------ ------ ------
Projected benefit obligation at
beginning of year $161.0 $128.8 $ 5.6 $ 10.6
Service cost 1.6 4.6 - 0.6
Interest cost 9.2 8.4 0.2 0.7
Plan participant contributions 0.3 1.2 - -
Actuarial (gain)/loss 0.4 14.1 (0.6) 4.7
Benefits paid (5.9) (4.5) (0.1) (0.1)
Special termination benefits - - - 1.2
Translation 15.2 14.6 - -
Curtailments (7.3) (4.8) - (12.1)
Settlements - (1.4) - -
Plan amendments 0.1 - - -
Business combinations 21.0 - - -
------ ------ ------ ------
Projected benefit obligation at end
of year $195.6 $161.0 $ 5.1 $ 5.6
====== ====== ====== ======
|
The following table provides a reconciliation of the change in fair value
of plan assets (in millions):
Pension Benefits Other Postretirement Benefits
---------------- -----------------------------
2004 2003 2004 2003
------ ------ ------ ------
Fair value of plan assets at beginning of
year $ 74.0 $ 68.4 $ - $ -
Actual return on plan assets 8.5 (2.9) - -
Employer contributions 16.4 5.4 - -
Plan participant contributions 0.3 1.2 0.1 0.1
Benefits paid (5.5) (3.9) (0.1) (0.1)
Settlements - (1.4) - -
Translation 5.7 7.2 - -
Business combinations 20.1 - - -
------ ------ ------ ------
Fair value of plan assets at end of year $119.5 $ 74.0 $ - $ -
====== ====== ====== ======
|
78
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table provides a reconciliation of the net amount recognized
in the consolidated balance sheets (in millions):
Pension Benefits Other Postretirement Benefits
---------------- -----------------------------
2004 2003 2004 2003
------ ------ ------ ------
Funded status $(76.1) $(87.0) $ (5.1) $ (5.6)
Unrecognized net actuarial (gain)/loss 48.5 49.8 (2.5) (2.0)
Unrecognized net transition asset (0.2) (0.3) - -
Unrecognized prior service cost 0.1 0.1 - -
Other 1.5 0.5 - 0.1
------ ------ ------ ------
Net amount recognized $(26.2) $(36.9) $ (7.6) $ (7.5)
====== ====== ====== ======
Consolidated Balance Sheets:
Other comprehensive income $ 30.6 $ 31.5 $ - $ -
Prepaid benefit cost 4.0 - - -
Accrued benefit liability (60.8) (68.4) (7.6) (7.5)
------ ------ ------ ------
Net amount recognized $(26.2) $(36.9) $ (7.6) $ (7.5)
====== ====== ====== ======
|
The projected benefit obligation and fair value of plan assets for pension
plans and other postretirement plans with projected benefit obligations in
excess of plan assets are as follows (in millions):
Pension Benefits Other Postretirement Benefits
---------------- -----------------------------
2004 2003 2004 2003
------ ------- ------ ------
Projected benefit obligation $178.5 $161.0 $ 5.1 $ 5.6
Fair value of plan assets $101.8 $ 74.0 $ - $ -
|
The accumulated benefit obligation and fair value of plan assets for
pension plans with accumulated benefit obligations in excess of plan assets are
as follows (in millions):
Pension Benefits
----------------
2004 2003
------ ------
Accumulated benefit obligation $174.6 $151.2
Fair value of plan assets $101.8 $ 74.0
|
79
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Net Periodic Benefit Cost
Components of the Company's net periodic benefit costs are as follows (in
millions):
Pension Benefits Other Postretirement Benefits
-------------------------- -----------------------------
2004 2003 2002 2004 2003 2002
------ ------ ------ ------ ------ ------
Components of net periodic benefit cost:
Service cost $ 1.6 $ 4.6 $ 4.1 $ - $ 0.6 $ 0.6
Interest cost 9.2 8.4 7.2 0.3 0.7 0.7
Expected return on plan assets (5.6) (5.4) (4.8) - - -
Net amortization and other (1) 2.8 1.2 0.7 (0.1) - 0.1
------ ------ ------ ------ ------ ------
Net amount recognized $ 8.0 $ 8.8 $ 7.2 $ 0.2 $ 1.3 $ 1.4
====== ====== ====== ====== ====== ======
|
(1) Amount primarily represents the amortization of unrecognized
actuarial losses, as well as the amortization of the transition
obligation and prior service costs.
Assumptions
The weighted average assumptions used in determining benefit obligations
are as follows:
Pension Benefits Other Postretirement Benefits
---------------- -----------------------------
2004 2003 2004 2003
---- ---- ---- ----
Discount rate 5.60% 6.00% 6.00% 6.25%
Rate of increase in compensation levels 3.50% 3.80% N/A N/A
|
The weighted average assumptions used in determining net periodic pension
cost are as follows:
Pension Benefits Other Postretirement Benefits
---------------------- -----------------------------
2004 2003 2002 2004 2003 2002
---- ---- ---- ---- ---- ----
Discount rate 5.50% 6.00% 6.30% 6.25% 7.25% 7.25%
Rate of increase in compensation levels 3.50% 3.80% 4.00% N/A N/A N/A
Expected long-term rate of return on
plan assets (1) 6.30% 6.90% 7.20% N/A N/A N/A
|
(1) To develop the expected long-term rate of return on assets
assumption, the Company considered the historical returns and the
future expectations for returns for each asset class, as well as the
target asset allocation of the pension portfolio. This rate is gross
of any investment or administrative expenses.
Health Care Cost Trend Rates
The health care cost trend rates assumed for next year for other
postretirement benefits at December 31 are 11.2% and 11.6% for Pre-Medicare and
Post-Medicare, respectively. The health care cost trend rates are assumed to
decline to 5.6% for Pre-Medicare and Post-Medicare by 2014. A one percentage
point change in the assumed health care cost trend rates would not have a
material impact on total service cost, total interest cost or the accumulated
postretirement benefit obligation.
80
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Plan Assets
The Company's weighted average asset allocations at the measurement date
and the target asset allocations by category are as follows:
2004 2003
Actual Actual Target
------ ------ ------
Asset Category
Equity Securities 46% 50% 52%
Debt Securities 29% 30% 28%
Real Estate 0% 0% 6%
Other 25% 20% 14%
------ ------ ------
Total 100% 100% 100%
|
The investment policy reflects the long-term nature of the plans' funding
obligations. The assets are invested to provide the opportunity for both income
and growth of principal. This objective is pursued as a long-term goal designed
to provide required benefits for participants without undue risk. It is expected
that this objective can be achieved through a well-diversified asset portfolio.
All equity investments are made within the guidelines of quality, marketability
and diversification mandated by the Employee Retirement Income Security Act
("ERISA") and other relevant statutes. Investment managers are directed to
maintain equity portfolios at a risk level approximately equivalent to that of
the specific benchmark established for that portfolio. Assets invested in fixed
income securities and pooled fixed income portfolios are managed actively to
pursue opportunities presented by changes in interest rates, credit ratings or
maturity premiums.
Contributions
The total estimated contributions for the 2005 measurement year are $5.4
million.
Estimated Future Benefit Payments
Future benefit payments, which reflect expected future service, as
appropriate, during the next five fiscal years, and in the aggregate for the
five fiscal years thereafter, are (in millions):
Pension Other
Fiscal Year Ended June 30, Benefits Benefits
---------------------------- -------- --------
2005 $ 5.1 $ 0.5
2006 $ 6.3 $ 0.5
2007 $ 5.3 $ 0.5
2008 $ 5.5 $ 0.5
2009 $ 5.8 $ 0.5
2010 - 2014 $ 35.0 $ 2.2
|
10. OFF-BALANCE SHEET ARRANGEMENTS
The Company periodically enters into certain off-balance sheet
arrangements, primarily receivable sales and operating leases, in order to
maximize diversification of funding and return on assets. The receivable sales,
as described below, also provide for the transfer of credit risk to third
parties.
Lease Receivable-Related Arrangements
During fiscal 2004 and 2003, the Company entered into four separate
agreements (two in fiscal 2004 and two in fiscal 2003) to transfer ownership of
certain equipment lease receivables, plus security interests in the related
equipment, to the leasing subsidiary of a bank in the amounts of $164.2 million
and $150.0 million in fiscal 2004 and $156.0 million and $200.0 million in
fiscal 2003. These transactions resulted in immaterial gains or losses
classified by the Company as revenue within its results of operations. In order
to qualify for sale treatment under SFAS No. 140, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities," the Company
formed wholly-owned, special purpose, bankruptcy-remote subsidiaries (the "Pyxis
SPEs") of Pyxis Corporation (which has been given the legal designation of
Cardinal Health 301, Inc. and is referred to in this Form 10-K as "Pyxis"), and
each of the Pyxis SPEs formed wholly-owned, qualified special purpose
subsidiaries (the "QSPEs") to effectuate the removal of the lease receivables
from the Company's consolidated financial statements. In accordance with SFAS
81
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
No. 140, the Company consolidates the Pyxis SPEs and does not consolidate the
QSPEs. Both the Pyxis SPEs and QSPEs are separate legal entities that maintain
separate financial statements from the Company and Pyxis. The assets of the
Pyxis SPEs and QSPEs are available first and foremost to satisfy the claims of
their respective creditors.
The Company formed Pyxis Funding LLC ("Pyxis Funding") for the sole
purpose of acquiring a pool of leases and the related leased equipment from
Pyxis and ultimately selling the lease receivables to a multi-seller conduit
administered by a third-party bank. Pyxis Funding is a wholly-owned, special
purpose, bankruptcy-remote subsidiary of Pyxis. Pyxis Funding II LLC ("Pyxis
Funding II") was formed for the sole purpose of acquiring lease receivables from
Pyxis Funding and issuing notes secured by its assets to a multi-seller conduit
administered by a third-party bank. Pyxis Funding II is a wholly-owned,
qualified special purpose subsidiary of Pyxis Funding. The transaction qualifies
for sale treatment under SFAS No. 140. Accordingly, the related receivables are
not included in the Company's consolidated financial statements. As required by
U.S. GAAP, the Company consolidates Pyxis Funding and does not consolidate Pyxis
Funding II. Both Pyxis Funding and Pyxis Funding II are separate legal entities
that maintain separate financial statements from the Company and Pyxis. The
assets of Pyxis Funding and Pyxis Funding II are available first and foremost to
satisfy the claims of their creditors. The notes held by investors had a
principal balance of $16.0 million on June 30, 2004, and the investors are
provided with credit protection in the form of 20% ($4.0 million)
over-collateralization. As of June 30, 2003, the notes had a principal balance
of $51.5 million, and $12.9 million of credit protection was provided.
Other Receivable-Related Arrangements
Cardinal Health Funding ("CHF") and Medicine Shoppe Capital Corporation
("MSCC") were 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. MSCC and CHF were designed to be special purpose,
bankruptcy-remote entities. Although consolidated in accordance with GAAP, MSCC
and CHF are separate legal entities from the Company, Medicine Shoppe
International, Inc. and the Company's Financial Shared Services business. The
sale of receivables by MSCC and CHF qualify for sales treatment under SFAS No.
140 and accordingly are not included in the Company's consolidated financial
statements.
At June 30, 2004, the Company had a committed receivables sales facility
program available through CHF with capacity to sell $500.0 million in
receivables. Recourse is provided under the CHF program by the requirement that
CHF retain a percentage subordinated interest in the sold receivables. At June
30, 2004, the Company had no outstanding receivables or subordinated interests
related to this facility. During fiscal 2004, the Company terminated and
liquidated MSCC resulting in an immaterial loss.
At June 30, 2003, the Company had $280.0 million in committed receivables
sales facility programs available through CHF and MSCC. There were no
receivables outstanding or subordinated interests related to CHF at June 30,
2003. The total amount of receivables outstanding under the MSCC program was
$5.4 million. Recourse was provided under the MSCC program by the requirement
that MSCC retain a 20% subordinated interest in the sold receivables.
Subordinated interests were $1.3 million at June 30, 2003.
Cash Flows from all Receivable-Related Arrangements
The Company's net cash flow benefit related to receivable transfers for
fiscal 2004, 2003 and 2002 were as follows:
(in millions) 2004 2003 2002
-------------------------------------------------- ------ ------ ------
Proceeds received on transfer of receivables $321.4 $375.8 $295.4
Cash collected in servicing of related receivables 3.9 2.2 1.2
Proceeds received on subordinated interests 8.9 18.3 58.4
------ ------ ------
Cash inflow to the Company 334.2 396.3 355.0
Cash collection remitted to the bank 226.0 131.0 257.2
Cash collection remitted to QSPE 8.9 17.7 -
------ ------ ------
Net benefit to the Company's Cash Flow $ 99.3 $247.6 $ 97.8
====== ====== ======
|
Pyxis, MSCC and CHF are required to repurchase any receivables sold only
if it is determined that the representations and warranties with regard to the
related receivables were not accurate on the date sold.
82
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Operating Leases
The Company has entered into operating lease agreements with several third
party banks for the construction of various new facilities and equipment. The
initial terms of the lease agreements have varied maturity dates ranging from
February 2005 through June 2013, with optional renewal periods, generally five
years. In the event of termination, the Company is required (at its election) to
either purchase the facility or vacate the property and make reimbursement for a
portion of any unrecovered property cost. The maximum portion of unrecovered
property costs that the Company could be required to reimburse does not exceed
the amount expended to acquire and/or construct the facilities. As of June 30,
2004, the amount expended to acquire and/or construct the facilities was $525.6
million. The agreements provide for maximum funding of $575.0 million, which is
currently greater than the estimated cost to complete the construction projects.
The required lease payments equal the interest expense for the period on the
amounts drawn. Lease payments under the agreements are based primarily upon
LIBOR and are subject to interest rate fluctuations. As of June 30, 2004, the
weighted average interest rate on the agreements approximated 1.79%. The
Company's estimated minimum annual lease payments under the agreements at June
30, 2004 were approximately $9.4 million.
11. COMMITMENTS AND CONTINGENT LIABILITIES
The future minimum rental payments for operating leases (excluding those
referenced in Note 10) having initial or remaining non-cancelable lease terms in
excess of one year at June 30, 2004 are:
(in millions) 2005 2006 2007 2008 2009 Thereafter Total
------------------------------------------------------------------------------------------
Minimum rental payments $109.1 $ 79.1 $ 58.6 $ 44.8 $ 34.6 $ 109.1 $435.3
|
Rental expense relating to operating leases (including those referenced in
Note 10) was approximately $120.6 million, $102.8 million and $77.6 million in
fiscal 2004, 2003 and 2002, respectively. Sublease rental income was not
material for any period presented herein.
Latex Litigation
On September 30, 1996, Baxter International Inc. ("Baxter") and its
subsidiaries transferred to Allegiance Corporation and its subsidiaries
("Allegiance"), which were acquired by the Company in February 1999, 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 (the "Baxter-Allegiance Spin-Off"). 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 ("BHC"), 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.
As of June 30, 2004, there were 36 lawsuits pending against BHC and/or
Allegiance involving allegations of sensitization to natural rubber latex
products, and some of these cases were proceeding to trial. The total dollar
amount of potential damages cannot be reasonably quantified. Some plaintiffs
plead damages in extreme excess of what they reasonably can expect to recover,
some plead a modest amount and some do not include a request for any specific
dollar amount. Not including cases that ask for no specific damages, the damage
requests per action have ranged from $10,000 to $240 million. All of these cases
name multiple defendants, in addition to Baxter/Allegiance. The average number
of defendants per case exceeds 25. Based on the significant differences in the
range of damages sought and, based on the multiple number of defendants in these
lawsuits, Allegiance cannot reasonably quantify the total amount of
possible/probable damages. Therefore, Allegiance and the Company do not believe
that these numbers should be considered as an indication of either reasonably
possible or probable liability.
Since the inception of this litigation, Baxter/Allegiance have been named
as a defendant in 834 cases. During the fiscal year ended June 30, 2002,
Allegiance began settling some of these lawsuits with greater frequency. As of
June 30, 2004, Allegiance had resolved more than 90% of these cases. About 20%
of the lawsuits that have been resolved were concluded without any liability to
Baxter/Allegiance. No individual claim has been settled for a material amount
and all the settled claims through June 30, 2004 amounted to, in the aggregate,
approximately $28 million. Due to the number of claims filed and the ongoing
defense costs that will be incurred, Allegiance believes it is probable that it
will incur substantial legal fees related to the resolution of the cases still
pending. Although the Company continues to believe that it cannot reasonably
estimate the potential cost to settle these lawsuits, the Company believes that
the impact of such lawsuits upon Allegiance will be immaterial to the Company's
financial position, liquidity or results of operations, and could be in the
range of $0 to $20 million, net of insurance proceeds (with the range reflecting
the Company's reasonable estimation of potential insurance coverage, and defense
and indemnity costs). The Company believes a substantial
83
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
portion of any liability will be covered by insurance policies Allegiance has
with financially viable insurance companies, subject to self-insurance
retentions, exclusions, conditions, coverage gaps, policy limits and insurer
solvency. The Company and Allegiance continue to believe that insurance recovery
is probable.
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. 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 the Company improperly recognized
revenue in December 2000 and September 2001 related to settlements with certain
vitamin manufacturers. The Company filed a Motion to Dismiss the second amended
complaint and, on November 20, 2003, the Court denied the motion. Discovery is
proceeding in this action. The defendants intend to vigorously defend this
action. The Company currently does not believe that the impact of this lawsuit
will have a material adverse effect on the Company's financial position,
liquidity or results of operations.
On July 9, 2004, a complaint was filed by a purported shareholder against
the members of the Company's Board of Directors, and the Company as a nominal
defendant in the Court of Common Pleas, Franklin County, Ohio, as a purported
derivative action. The complaint alleges 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 complaint seeks money damages and equitable relief against the
defendant directors, and an award of attorney's fees. None of the defendants has
responded to the complaint yet, nor has the Company.
On August 27, 2004, a complaint was filed by a purported shareholder
against members of the Company's Board of Directors, current and former officers
and/or employees of the Company and the Company as a nominal defendant in the
Court of Common Pleas, Franklin County, Ohio, as a purported derivative action.
The complaint alleges that the individual defendants breached various fiduciary
duties owed to the Company. The complaint seeks money damages and equitable
relief against the individual defendants, and an award of attorney's fees. None
of the defendants has responded to the complaint yet, nor has the Company.
On September 22, 2004, a complaint was filed by a purported shareholder
against the members of the Company's Board of Directors, and the Company as a
nominal defendant in the Court of Common Pleas, Franklin County, Ohio, as a
purported derivative action. The complaint alleges 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 complaint seeks money damages and equitable relief
against the defendant directors, and an award of attorney's fees. None of the
defendants has responded to the complaint 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. 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 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. 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. None of the defendants has yet responded to any of the
complaints in the Cardinal Health federal securities actions.
84
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Since July 2, 2004, fourteen 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. The Cardinal Health
ERISA actions purport to be brought on behalf of participants in the Cardinal
Health Profit Sharing, Retirement and Savings Plan (the "Plan"), and also on
behalf of the Plan itself. The complaints allege that the defendants breached
certain fiduciary duties owed under ERISA, generally asserting that the
defendants failed to make full disclosure of the risks to plan participants of
investing in the Company's stock, to the detriment of the plan's participants
and beneficiaries, and that Company stock should not have been made available as
an investment alternative for plan participants. The misstatements alleged in
the Cardinal Health ERISA actions significantly overlap with the misstatements
alleged in the complaints 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. None of the defendants has yet
responded to any of the complaints in the Cardinal Health ERISA actions.
With respect to the proceedings described under the headings "Derivative
Actions" and "Shareholder/ERISA Litigation against Cardinal Health," the
Company currently believes that there will be some insurance coverage available
under the Company's insurance policies in effect at the time the actions were
filed. Such policies are with financially viable insurance companies, and are
subject to self-insurance retentions, exclusions, conditions, coverage gaps,
policy limits and insurer solvency.
Shareholder/ERISA Litigation against Syncor
Eleven purported class action lawsuits have been filed against Syncor and
certain of its officers and directors, asserting claims under the federal
securities laws (collectively referred to as the "Syncor federal securities
actions"). All of these actions were filed in the United States District Court
for the Central District of California. 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. Syncor filed a Motion to Dismiss the consolidated
amended complaint on August 1, 2003 and, on December 12, 2003, the Court granted
the motion to dismiss without prejudice. A second amended consolidated class
action complaint was filed on January 28, 2004, naming Syncor and 14
individuals, all former Syncor officers, directors and/or employees, as
defendants. Syncor filed a Motion to Dismiss the second amended consolidated
class action complaint on March 4, 2004. On July 6, 2004, the court granted
Defendants' Motion to Dismiss without prejudice as to defendants Syncor, Monty
Fu, Robert Funari and Haig Bagerdjian. As to the other individual defendants,
the motion to dismiss was granted with prejudice. On September 14, 2004, lead
plaintiff filed a Motion for Clarification of the Court's July 6, 2004 dismissal
order.
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 in the
merger by Syncor stockholders was reduced. On November 22, 2002, the plaintiff
in one of the two Delaware actions filed an amended complaint adding as
defendants the Company, its subsidiary Mudhen Merger Corporation and the
remaining two Syncor directors, who are hereafter included in the term "director
defendants." These cases have been consolidated into one action (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 is 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.
85
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
On November 18, 2002, two additional actions were filed by individual
stockholders of Syncor in the Superior Court of California for the County of Los
Angeles (the "California actions") against the director defendants. The
complaints in the California actions allege that the director defendants
breached certain fiduciary duties to Syncor by failing to maintain adequate
controls, practices and procedures to ensure that Syncor's employees and
representatives did not engage in improper and unlawful conduct. Both complaints
asserted a single derivative claim, for and on behalf of Syncor, seeking to
recover costs and expenses that Syncor incurred as a result of the allegedly
improper payments. An amended complaint was filed on December 6, 2002 in one of
the cases, purporting to allege direct claims on behalf of a class of
shareholders. The defendants' motion for a stay of the California actions
pending the resolution of the Delaware actions (discussed above) was granted on
April 30, 2003.
A purported class action complaint was filed on April 8, 2003, against the
Company, Syncor and certain officers and employees of the Company by a purported
participant in the Syncor Employees' Savings and Stock Ownership Plan (the
"Syncor ESSOP"). A related purported class action complaint was filed on
September 11, 2003, against the Company, Syncor and certain individual
defendants. Another related purported class action complaint was filed on
January 14, 2004, against the Company, Syncor and certain individual defendants.
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. On April 26, 2004, the defendants filed Motions to
Dismiss the consolidated complaint. On August 24, 2004, the Court granted in
part and denied in part Defendants' Motions to Dismiss. The Court dismissed,
without prejudice, all claims against defendants Ed Burgos and Sheila Coop, all
claims alleging co-fiduciary liability against all defendants, and all claims
alleging that the individual defendants had conflicts of interest precluding
them from properly exercising their fiduciary duties under ERISA. A claim for
breach of the duty to prudently manage plan assets was upheld against Syncor,
and a claim for breach of the alleged duty to "monitor" the performance of
Syncor's Plan Administrative Committee was upheld against defendants Monty Fu
and Robert Funari. In addition, the United States Department of Labor is
conducting an investigation of the Syncor ESSOP with respect to its compliance
with ERISA requirements. The Company has responded to a subpoena received from
the Department of Labor and continues to cooperate in the investigation.
It is impossible to predict the outcome of the proceedings described under
the heading "Shareholder/ERISA Litigation against Syncor" or their impact on the
Company. However, the Company currently does not believe that the impact of
these actions will have a material adverse effect on the Company's financial
position, liquidity or results of operations. The Company believes the
allegations made in the complaints described above are without merit and it
intends to vigorously defend such actions. The Company has been informed that
the individual director and officer defendants deny liability for the claims
asserted in these actions and 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. 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
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. The Company intends to vigorously defend itself against this
other litigation and does not currently believe that the outcome of this other
litigation now pending will have a material adverse effect on the Company's
consolidated financial statements.
See also the discussion of the SEC investigation and U.S. Attorney inquiry
in Note 1.
86
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. SHAREHOLDERS' EQUITY
At June 30, 2004 and 2003, the Company's authorized capital shares
consisted of (a) 750 million common shares, without par value ("Class A common
shares"); (b) 5 million Class B common shares, without par value; and (c) 0.5
million non-voting preferred shares, without par value. The Class A common
shares and Class B common shares are collectively referred to as "Common
Shares." Holders of Class A and Class B common shares are entitled to share
equally in any dividends declared by the Company's Board of Directors and to
participate equally in all distributions of assets upon liquidation. Generally,
the holders of Class A common shares are entitled to one vote per share and the
holders of Class B common shares are entitled to one-fifth of one vote per share
on proposals presented to shareholders for vote. Under certain circumstances,
the holders of Class B common shares are entitled to vote as a separate class.
Only Class A common shares were outstanding as of June 30, 2004 and 2003.
On February 27, 2004, the Company's Board of Directors authorized the
repurchase of Common Shares up to an aggregate amount of $500 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. The initial price paid per share was $66.80. The
approximately 6.9 million shares repurchased under the program were subject to a
future contingent purchase price adjustment which was settled during the fourth
quarter of fiscal 2004. The purchase price adjustment was based upon the volume
weighted average price during the actual repurchase period and was subject to
certain provisions which establish a cap and a floor for the average share price
in the Company's agreement with its broker-dealer who executed the repurchase
transactions.
The accelerated share repurchase program was completed on May 11, 2004.
The final volume weighted average price was $70.07. As a result, the Company
settled the forward contract for $22.5 million in cash, which cost was included
in the amount associated with Common Shares in treasury. The Company used the
remaining $17.2 million of the initial authorization to repurchase additional
shares of approximately 0.2 million having an average price paid per share of
$70.73. The repurchased shares were placed into treasury to be used for general
corporate purposes.
On August 1, 2003, the Company's Board of Directors authorized the
repurchase of Common Shares up to an aggregate amount of $1.0 billion. Pursuant
to this authorization, the Company repurchased approximately 17.0 million Common
Shares having an aggregate cost of approximately $1.0 billion during the three
months ended September 30, 2003. The average price paid per share was $58.65.
This repurchase was completed during the first quarter of fiscal 2004, and the
repurchased shares were placed into treasury to be used for general corporate
purposes.
In January 2003, the Company's Board of Directors authorized the
repurchase of Common Shares up to an aggregate amount of $500 million. Pursuant
to this authorization, the Company repurchased approximately 8.6 million Common
Shares having an aggregate cost of approximately $500 million. This repurchase
was completed in February 2003, and the repurchased shares were placed into
treasury shares to be used for general corporate purposes.
In August 2002, the Company's Board of Directors authorized the repurchase
of Common Shares up to an aggregate amount of $500 million. Pursuant to this
authorization, the Company repurchased approximately 7.8 million Common Shares
having an aggregate cost of approximately $500 million. This repurchase was
completed in January 2003, and the repurchased shares were placed into treasury
shares to be used for general corporate purposes.
13. CONCENTRATIONS OF CREDIT RISK AND MAJOR CUSTOMERS
The Company invests cash in deposits with major banks throughout the world
and in high quality short-term liquid instruments. Such investments are made
only in instruments issued or enhanced by high quality institutions. These
investments mature within three months and the Company has not incurred any
related losses.
The Company's trade receivables, finance notes and accrued interest
receivables, and lease receivables are exposed to a concentration of credit risk
with customers in the retail and health care sectors. Credit risk can be
affected by changes in reimbursement and other economic pressures impacting the
hospital and acute care sectors of the health care industry. However, such
credit risk is limited due to supporting collateral and the diversity of the
customer base, including its wide geographic dispersion. The Company performs
ongoing credit evaluations of its customers' financial conditions and maintains
reserves for credit losses. Such losses historically have been within the
Company's expectations.
87
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes all of the Company's customers which
individually account for at least 10% of the Company's revenue. The customer in
the table below is serviced through the Pharmaceutical Distribution and Provider
Services segment.
Percent of Revenues
------------------------
2004 2003 2002
---- -------- --------
Adjusted Adjusted
CVS 18% 18% 19%
|
At June 30, 2004 and 2003, CVS Corporation ("CVS") accounted for 18% of
the Company's gross trade receivable balance.
Certain of the Company's businesses have entered into agreements with
group purchasing organizations ("GPOs"), which organizations act as purchasing
agents that negotiate vendor contracts on behalf of their members. In fiscal
2004, 2003 and 2002, approximately 17%, 17% and 18%, respectively, of revenue
was derived from GPO members through the contractual arrangements established
with Novation, LLC and Premier Purchasing Partners, L.P.-- the Company's two
largest GPO relationships in terms of revenue. However, the Company's trade
receivable balances are with individual members of the GPO and therefore no
significant concentration of credit risk exists with these types of
arrangements.
14. STOCK OPTIONS AND RESTRICTED SHARES
The Company maintains several stock incentive plans (the "Plans") for the
benefit of certain officers, directors and employees. Options granted generally
vest over three years and are exercisable for periods up to ten years from the
date of grant at a price which equals fair market value at the date of grant.
The information in the following tables in this Note 14 has been revised
to reflect the maximum number of shares that could be granted under the
Company's Amended and Restated Equity Incentive Plan, as amended (the "Equity
Incentive Plan"), with respect to an option award that the Board of Directors
and its Human Resources and Compensation Committee (the "Compensation
Committee") granted to the Company's Chairman and Chief Executive Officer in
November 1999 for 1,425,000 shares (giving effect to stock splits occurring
after the date of grant). The maximum number of shares that could be granted
pursuant to the terms of the Equity Incentive Plan was 562,500 shares. The
Compensation Committee is currently exploring alternatives to substitute the
remaining portion of the stock option granted to this individual in November
1999 in excess of the 562,500 shares with equivalent value.
EQUITY COMPENSATION PLAN INFORMATION
Certain plans are subject to shareholder approval while other plans have
been authorized solely by the Board of Directors (the "Board"). The following is
a description of the Company's plans that have not been approved by
shareholders:
Broadly-based Equity Incentive Plan, as amended
The Company's Broadly-based Equity Incentive Plan, as amended (the
"Broadly-based Equity Incentive Plan"), was adopted by the Board effective
November 15, 1999 and further amended pursuant to resolutions of the Board
adopted on August 8, 2001. The plan provides for grants in the form of
nonqualified stock options, restricted shares and restricted share units to
employees of the Company. The aggregate number of Common Shares authorized for
issuance pursuant to the plan is 36 million with generally no more than 10% of
the authorized amount issuable in the form of restricted shares and restricted
share units having a restriction period of less than three years. The plan is
not intended to qualify under Section 401(a) of the Code and is not subject to
any of the provisions of ERISA.
Outside Directors Equity Incentive Plan
The Company's Outside Directors Equity Incentive Plan was adopted by the
Board effective May 10, 2000. The plan reserves and makes available for
distribution an aggregate of 1.5 million Common Shares for grants in the form of
nonqualified stock options and restricted shares to members of the Board who are
not employees of the Company. The plan is not intended to qualify under Section
401(a) of the Code and is not subject to any of the provisions of ERISA.
Deferred Compensation Plan, as amended
The Company's Deferred Compensation Plan, as amended (the "Deferred
Compensation Plan"), was adopted by the Board effective April 7, 1994 and has
been subsequently amended several times since then, most recently on May 25,
2004. The plan permits certain management
88
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
employees of the Company to defer salary, bonus and long-term incentive plan
payments into one of several investment alternatives, including a stock
equivalent account. In addition, the Company may, in its discretion, make
additional matching or fixed contributions to the deferred balances of
participating management employees. Deferrals into the stock equivalent account
are valued as if each deferral were invested in the Company's Common Shares as
of the deferral date. Deferred balances are paid upon retirement, termination
from employment, death or disability. The maximum aggregate number of Common
Shares that can be credited to stock equivalent accounts pursuant to the plan is
2.25 million. Deferred balances are paid in cash, or in Common Shares in kind,
with any fractional shares paid in cash. The plan contains a dividend
reinvestment feature for the stock equivalent account with dividends generally
being reinvested in investment options other than the stock equivalent account
for reporting persons under Section 16 of the Exchange Act. The plan is not
intended to qualify under Section 401(a) of the Code and is exempt from many of
the provisions of ERISA as a "top hat" plan for a select group of management or
highly compensated employees.
Directors Deferred Compensation Plan, as amended and restated
The Company's Directors Deferred Compensation Plan, as amended and
restated (the "Directors Deferred Compensation Plan"), was adopted by the Board
effective August 11, 1999 and was recently amended and restated on May 1, 2004.
The plan permits directors of the Company to defer board fees into one of
several investment alternatives, including a stock equivalent account. Deferrals
into the stock equivalent account are valued as if each deferral were invested
in the Company's Common Shares as of the deferral date. Deferred balances are
paid upon retirement or other termination from board service, death or
disability. The maximum aggregate number of Common Shares that can be credited
to stock equivalent accounts pursuant to the plan is 90,000. Deferred balances
are paid in cash, or in Common Shares in kind, with any fractional shares paid
in cash. The plan contains a dividend reinvestment feature for the stock
equivalent account with dividends generally being reinvested in investment
options other than the stock equivalent account. The plan is not intended to
qualify under Section 401(a) of the Code and is not subject to any of the
provisions of ERISA.
Global Employee Stock Purchase Plan
The Company's Global Employee Stock Purchase Plan was adopted by the Board
effective August 11, 1999. The plan permits the Company's international
employees to purchase Common Shares through payroll deductions. The total number
of Common Shares made available for purchase under the plan is 4.5 million.
International employees who have been employed by the Company for at least 30
days are eligible to contribute from 1% to 15% of eligible compensation. The
purchase price is determined by the lower of 85% of the closing market price on
the first day of the offering period or 85% of the closing market price on the
last day of the offering period. During any given calendar year, there are two
offering periods: January 1-June 30; and July 1-December 31. The plan is not
intended to qualify under Section 401(a) of the Code and is not subject to any
of the provisions of ERISA.
89
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes information relating to the Company's equity
compensation plans at June 30, 2004:
Outstanding
------------------------------------
Number of Common Weighted
Shares to be Issued Average Common Shares
Upon Exercise of Exercise Price Available for
Outstanding Options per Common Future Issuance
(in millions) Share (in millions)
------------------- -------------- ---------------
Plans approved by
shareholders (1) 11.8 (2) $ 52.31 (2) 22.6 (3)
Plans not approved by
shareholders 25.2 (4) $ 62.01 (4) 14.0 (5)
Plans acquired through
acquisition (6) 5.8 (6) $ 33.63 -
------------------ ------------- --------------
Balance at June 30, 2004 42.8 $ 55.52 36.6
================== ============= ==============
|
(1) Under the Company's Equity Incentive Plan, which was approved by the
Company's shareholders in November 1995, the total number of Common Shares
available for grant of awards under the plan is an amount equal to the sum of
(a) 1.5% of the total outstanding Common Shares as of the last day of the
Company's immediately preceding fiscal year, plus (b) the number of Common
Shares available for grant under the plan as of November 23, 1998, plus (c) any
Common Shares related to awards that expire or are unexercised, forfeited,
terminated, cancelled, settled in such a manner that all or some of the Common
Shares covered by an award are not issued to a participant, or returned to the
Company in payment of the exercise price or tax withholding obligations in
connection with outstanding awards, plus (d) any unused portion of the Common
Shares available under clause (a) above for the previous two fiscal years as a
result of not being used in such previous two fiscal years.
(2) In addition to stock options outstanding under the Company's Equity
Incentive Plan, also includes 430,302 restricted share units outstanding under
the Equity Incentive Plan that are payable solely in Common Shares. Restricted
share units do not have an exercise price, and therefore were not included for
purposes of computing the weighted-average exercise price.
(3) Includes approximately 4.2 million Common Shares available for issuance
under the Company's Employee Stock Purchase Plan.
(4) In addition to stock options outstanding under the Company's Broadly-based
Equity Incentive Plan and Outside Director Equity Incentive Plan, also includes
10,000 restricted share units outstanding under the Company's Broadly-based
Equity Incentive Plan that are payable solely in Common Shares. Also includes
22,564 and 4,076 Common Share units, respectively, outstanding under the
Company's Directors Deferred Compensation Plan and Deferred Compensation Plan
that are payable solely in Common Shares. These awards do not have an exercise
price, and therefore were not included for purposes of computing the
weighted-average exercise price.
(5) Includes approximately 4.3 million Common Shares available for issuance
under the Company's Global Employee Stock Purchase Plan.
(6) Includes options to purchase approximately 3.4 million Common Shares in the
aggregate that were assumed by the Company in connection with acquisitions that
were approved by the Company's shareholders. The remaining options to purchase
approximately 2.4 million Common Shares in the aggregate were assumed by the
Company in connection with acquisitions that were not approved by the Company's
shareholders.
90
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following summarizes all stock option transactions for the Company
under the Plans from July 1, 2001 through June 30, 2004, giving retroactive
effect to conversions of options in connection with merger transactions and
stock splits (in millions, except per Common Share amounts):
Weighted Average
Options Exercise Price
Outstanding per Common Share
----------- ----------------
Balance at June 30, 2001 32.4 $ 34.92
Granted 8.7 68.02
Exercised (4.5) 23.40
Canceled (1.4) 51.75
Other 1.0 47.32
----------- ----------------
Balance at June 30, 2002 36.2 $ 43.95
Granted 9.5 67.49
Exercised (6.2) 27.04
Canceled (2.5) 63.29
Other 3.0 49.23
----------- ----------------
Balance at June 30, 2003 40.0 $ 51.35
Granted 11.8 61.48
Exercised (5.9) 29.78
Canceled (4.2) 65.30
Other 0.6 34.24
----------- ----------------
Balance at June 30, 2004 42.3 $ 55.52
=========== ================
|
Additional information concerning stock options outstanding as of June 30,
2004 is presented below:
Outstanding Exercisable
------------------------------------------------- ------------------------------
Weighted Weighted Weighted
Range of average average average
exercise prices remaining exercise price exercise price
per Common Options contractual life per Common Options per Common
Share (in millions) in years Share (in millions) Share
----------------- ------------- ---------------- -------------- ------------- --------------
$ 0.92 - $ 29.96 4.2 2.9 $ 18.76 4.2 $ 18.76
$29.99 - $ 59.19 8.2 5.3 $ 38.62 7.9 $ 38.12
$59.60 - $ 64.11 11.8 9.3 $ 61.47 0.1 $ 63.00
$64.40 - $ 67.90 11.5 7.7 $ 67.24 4.0 $ 66.08
$67.98 - $132.23 6.6 7.3 $ 69.07 0.8 $ 75.16
---------------- ------------- ---------------- -------------- ------------- --------------
$ 0.92 - $132.23 42.3 7.1 $ 55.52 17.0 $ 41.71
---------------- ------------- ---------------- -------------- ------------- --------------
|
The Company accounts for the Plans in accordance with APB Opinion No. 25,
under which no compensation cost has been recognized. See Note 3 for table
illustrating the effect on net income and earnings per share if the Company
adopted the fair value recognition provisions of SFAS No. 123, "Accounting for
Stock Based Compensation."
The weighted average fair value of options granted during fiscal 2004,
2003 and 2002 are $22.78, $21.96 and $25.95, respectively.
91
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The fair values of the options granted to Company employees and directors
were estimated on the date of grant using the Black-Scholes option-pricing model
with the following assumptions for grants in the respective periods:
As of June 30,
--------------------------------
2004 2003 2002
------- ------- -------
Risk-free interest rate 3.17% 2.32% 3.84%
Expected life 5 years 4 years 5 years
Expected volatility 37% 38% 36%
Dividend yield 0.19% 0.18% 0.15%
|
The market values of restricted shares and restricted share units awarded
by the Company are recorded in the "Other" component of shareholders' equity in
the accompanying consolidated balance sheets. The restricted shares are
amortized to expense over the period in which participants perform services,
generally one to seven years. The restricted share units are generally amortized
over a five-year vesting period. As of June 30, 2004, approximately 0.3 million
shares and share units remained restricted and subject to forfeiture.
The Company has employee stock purchase plans under which the sale of 12.0
million of the Company's Common Shares has been authorized. All employees who
have been employed by the Company for at least 30 days are eligible to
contribute from 1% to 15% of eligible compensation. The purchase price is
determined by the lower of 85% of the closing market price on the first day of
the offering period or 85% of the closing market price on the last day of the
offering period. During any given calendar year, there are two offering periods:
January 1-June 30; and July 1-December 31. At June 30, 2004, subscriptions
of 0.4 million shares were outstanding. Through June 30, 2004, 3.0 million
shares had been issued to employees under the plans.
15. EARNINGS PER SHARE
The following table reconciles the number of Common Shares used to compute
basic and diluted earnings per Common Share for the three years ending June 30,
2004:
(in millions) 2004 2003 2002
------------------------------- ------ ------ ------
Weighted-average shares-basic 434.4 446.0 450.1
Effect of dilutive securities:
Employee stock options 5.6 7.3 9.5
------ ------ ------
Weighted-average shares-diluted 440.0 453.3 459.6
====== ====== ======
|
The potentially dilutive employee stock options that were antidilutive for
fiscal 2004, 2003 and 2002 were 18.4 million, 22.5 million and 0.9 million,
respectively.
92
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
16. CHANGE IN ACCOUNTING
Effective 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 revenue.
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. The impact of this change for the fiscal year ended June 30, 2004 was an
increase in earnings from continuing operations before cumulative effect of
change in accounting by approximately $13.2 million. This resulted in an
increase in diluted earnings per Common Share from continuing operations of
$0.03 for fiscal 2004. The pro forma effect of this accounting change on prior
periods is as follows:
(in millions, except per Common Share amounts) 2003 2002
------------------------------------------------------------------------
Earnings from continuing operations before
cumulative effect of changes in accounting:
As restated $ 1,381.2 $ 1,140.8
Pro forma $ 1,368.4 $ 1,142.9
Net earnings:
As restated $ 1,375.1 $ 1,070.7
Pro forma $ 1,362.3 $ 1,072.8
Basic earnings per Common Share from
continuing operations:
As restated $ 3.10 $ 2.53
Pro forma $ 3.07 $ 2.54
Diluted earnings per Common Share from
continuing operations:
As restated $ 3.05 $ 2.48
Pro forma $ 3.02 $ 2.49
Net basic earnings per Common Share:
As restated $ 3.08 $ 2.37
Pro forma $ 3.05 $ 2.38
Net diluted earnings per Common Share:
As restated $ 3.03 $ 2.33
Pro forma $ 3.01 $ 2.33
|
In fiscal 2002, the method of recognizing revenue for pharmacy automation
equipment was changed from recognizing revenue when the units were delivered to
the customer to recognizing revenue when the units are installed at the customer
site. Management believes that the change in accounting method provides for a
more objectively determinable method of revenue recognition. In addition, the
Company implemented other changes to better service its customers and leverage
operational efficiencies. The Company recorded a cumulative effect of change in
accounting of $70.1 million (net of tax of $44.6 million) in the consolidated
statement of earnings during fiscal 2002. The after tax dilutive impact of the
cumulative effect is $0.15 per diluted share. The effect of the change for the
fiscal year ended June 30, 2002 was to reduce net earnings before the cumulative
effect by approximately $18.6 million. This change reduced diluted earnings per
share by $0.04 for the fiscal year ended June 30, 2002. The pro-forma effect of
this accounting change on prior periods has not been presented as the required
information is not available.
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CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
17. GOODWILL AND OTHER INTANGIBLE ASSETS
The following table summarizes the changes in the carrying amount of
goodwill for the three years ended June 30, 2004, in total and by reporting
segment:
Pharmaceutical
Distribution Medical Pharmaceutical Automation and
and Provider Products Technologies Information
(in millions) Services and Services and Services Services ALARIS Total
-----------------------------------------------------------------------------------------------------------------------------------
Balance at June 30, 2001 $ 86.9 $ 671.7 $ 358.3 $ 41.7 - $1,158.6
-----------------------------------------------------------------------------------------------------------------------------------
Goodwill acquired, net of purchase
price adjustments, foreign currency
translation adjustments and other 3.6 3.7 350.4 9.0 - 366.7
-----------------------------------------------------------------------------------------------------------------------------------
Balance at June 30, 2002 $ 90.5 $ 675.4 $ 708.7 $ 50.7 - $1,525.3
-----------------------------------------------------------------------------------------------------------------------------------
Goodwill acquired, net of purchase
price adjustments, foreign currency
translation adjustments and other 5.6 19.3 723.6 - - 748.5
Goodwill write-off - - (9.1) - - (9.1)
-----------------------------------------------------------------------------------------------------------------------------------
Balance at June 30, 2003 $ 96.1 $ 694.7 $ 1,423.2 $ 50.7 - $2,264.7
-----------------------------------------------------------------------------------------------------------------------------------
Goodwill acquired, net of purchase
price adjustments, foreign currency
translation adjustments and other (1)(2) 83.3 14.1 428.0 - 1,536.8 2,062.2
-----------------------------------------------------------------------------------------------------------------------------------
Goodwill related to the divestiture/
closure of businesses - - (7.6) - - (7.6)
-----------------------------------------------------------------------------------------------------------------------------------
Transfer (3) 31.6 (31.6) - - - -
-----------------------------------------------------------------------------------------------------------------------------------
Balance at June 30, 2004 $ 211.0 $ 677.2 $ 1,843.6 $ 50.7 $1,536.8 $4,319.3
===================================================================================================================================
|
(1) During the fourth quarter fiscal 2004, the Company acquired approximately
98.7% of the outstanding common stock of ALARIS and ALARIS merged with a
subsidiary of the Company to complete the transaction on July 7, 2004. See
Note 4 for additional information regarding this acquisition. As of June
30, 2004, the acquisition of ALARIS resulted in a preliminary goodwill
allocation of $1,536.8 million. During the second quarter fiscal 2004, the
Company completed the acquisition of Intercare. As of June 30, 2004, the
Company finalized the Intercare purchase price allocation, resulting in a
goodwill allocation of $430.9 million. During the six months ended
December 31, 2003, the Company also finalized the Syncor purchase price
allocation resulting in a goodwill reduction of $6.9 million. The
remaining amounts represent goodwill acquired from other immaterial
acquisitions, purchase price adjustments from prior period acquisitions
and foreign currency translation adjustments.
(2) For segment reporting purposes, as of June 30, 2004, a goodwill allocation
of $66.4 million was included within the Pharmaceutical Distribution and
Provider Services segment related to Intercare's specialty pharmaceutical
distribution business. All other goodwill allocations for Intercare are
included within the Pharmaceutical Technologies and Services segment.
(3) During the first quarter fiscal 2004, the Company transferred its
Consulting and Services business, previously reported within the Medical
Products and Services segment, to its Clinical Services and Consulting
business within the Pharmaceutical Distribution and Provider Services
segment to better align business operations. This transfer resulted in
approximately $31.6 million of goodwill being reclassed between the two
segments.
The purchase price allocation for ALARIS and other immaterial acquisitions
are not yet finalized and are subject to adjustment. Due to the short period of
time between the ALARIS acquisition date and fiscal year end, the Company had
not determined ALARIS's reporting segment treatment as of June 30, 2004. See
Note 18 for information regarding the recently announced new segment which will
include ALARIS.
94
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Intangible assets with limited lives are being amortized using the
straight-line method over periods that range from five to forty years. The
detail of other intangible assets by class for the three years ended June 30,
2004 is as follows:
Gross Accumulated Net
(in millions) Intangible Amortization Intangible
--------------------------------------------------------------------
June 30, 2002
Trademarks and patents $ 30.0 $ 20.4 $ 9.6
Non-compete agreements 20.4 19.1 1.3
Other 16.8 8.9 7.9
--------------------------------------------------------------------
Total $ 67.2 $ 48.4 $ 18.8
--------------------------------------------------------------------
June 30, 2003
Trademarks and patents $ 48.1 $ 20.8 $ 27.3
Non-compete agreements 27.3 21.9 5.4
Customer relationships 12.5 1.2 11.3
Other 37.1 13.5 23.6
--------------------------------------------------------------------
Total $ 125.0 $ 57.4 $ 67.6
--------------------------------------------------------------------
June 30, 2004
Trademarks and patents $ 345.9 $ 23.4 $ 322.5
Non-compete agreements 32.0 24.8 7.2
Customer relationships 231.4 6.8 224.6
Other 82.4 17.2 65.2
--------------------------------------------------------------------
Total $ 691.7 $ 72.2 $ 619.5
====================================================================
|
Additions of intangible assets for fiscal 2003 primarily relate to the
Syncor acquisition (see Note 4).
Additions of intangible assets for fiscal 2004 primarily relate to the
ALARIS and Intercare acquisitions (see Note 4).
Amortization expense for the years ended June 30, 2004, 2003 and 2002
was $13.9 million, $6.7 million and $3.0 million, respectively. Amortization
expense is estimated to be (in millions):
-------------------------------------------------------------
2005 2006 2007 2008 2009
-------------------------------------------------------------
Amortization expense $ 47.5 $ 47.2 $ 46.3 $ 43.5 $ 41.6
|
18. SEGMENT INFORMATION
The Company's operations are principally managed on a products and
services basis and are comprised of four reportable business segments:
Pharmaceutical Distribution and Provider Services, Medical Products and
Services, Pharmaceutical Technologies and Services and Automation and
Information Services. During the first quarter fiscal 2004, the Company
transferred its Consulting and Services business, previously included within the
Medical Products and Services segment, to its Clinical Services and Consulting
business within the Pharmaceutical Distribution and Provider Services segment.
Also during the first quarter fiscal 2004, the Company transferred its clinical
information business, previously included within the Automation and Information
Services segment, to its Clinical Services and Consulting business within the
Pharmaceutical Distribution and Provider Services segment. These transfers were
done to better align business operations. Prior period financial results have
not been restated as each of these businesses is not significant within the
respective segments, and, therefore, the transfers did not have a material
impact on each segment's growth rates.
During fiscal 2003, the Company reclassified Central Pharmacy Services,
Inc. and Cord Logistics, Inc. from the Pharmaceutical Distribution and Provider
Services segment to the Pharmaceutical Technologies and Services segment and
therefore restated these segments' financial results. All prior period financial
results presented in this Form 10-K have been restated to reflect this
reclassification. In addition, with the completion of the Syncor acquisition on
January 1, 2003, Syncor was included within the Pharmaceutical Technologies and
Services segment.
In December 2003, the Company acquired Intercare, which operates specialty
pharmaceutical distribution and pharmaceutical manufacturing operations in
Europe (see Notes 4 and 17 for further discussion of the Intercare acquisition).
For the fiscal year ended June 30, 2004, the results of operations of
Intercare's specialty pharmaceutical distribution business, which is similar to
the Company's
95
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
pharmaceutical distribution business, were included within the Pharmaceutical
Distribution and Provider Services segment (see Note 3 in the table below for
further information). All other results of operations for Intercare were
included within the Pharmaceutical Technologies and Services segment. For
segment reporting purposes, Intercare's results of operations will continue to
be reported in this manner. This classification was not reported during the
second quarter fiscal 2004 immediately following the acquisition as the Company
was still assessing the appropriate segment reporting treatment. Intercare's
results of operations for the second quarter of fiscal 2004 were not material to
the Company or the Company's individual segments.
The Company acquired approximately 98.7% of the outstanding common stock
of ALARIS and ALARIS merged with a subsidiary of the Company to complete the
transaction on July 7, 2004. The results of ALARIS' operations for the period
following the completion of the transaction have been included within the
Corporate segment for the year ended June 30, 2004. Due to the short period of
time between the acquisition date and year end, the impact of the results is not
material. See Notes 4 and 17 for additional information regarding the ALARIS
acquisition.
On August 30, 2004, the Company announced the creation of a new segment,
Clinical Technologies and Services, which will replace the Company's Automation
and Information Services segment and will include ALARIS, the Company's existing
businesses formerly within the Automation and Information Services segment and
the Company's existing Clinical Services and Consulting business, which was
formerly reported under the Pharmaceutical Distribution and Provider Services
segment. The Company will begin reporting results for this new segment beginning
with the first quarter fiscal 2005. In addition, effective first quarter fiscal
2005, the Company will transfer its Specialty Pharmaceutical Distribution
business, previously included within the Pharmaceutical Distribution and
Provider Services segment, to the Medical Products and Services segment. All
prior periods will be restated to reflect these transfers beginning in fiscal
2005.
The Pharmaceutical Distribution and Provider Services segment involves the
distribution of a broad line of pharmaceuticals, health care, and other
specialty pharmaceutical products and other items typically sold by hospitals,
retail drug stores and other health care providers. In addition, this segment
provides services to the health care industry through integrated pharmacy
management, temporary pharmacy staffing, as well as franchising of
apothecary-style retail pharmacies.
The Medical Products and Services segment involves the manufacture of
medical, surgical and laboratory products and the distribution of these products
as well as products not manufactured internally to hospitals, physician offices,
surgery centers and other health care providers.
The Pharmaceutical Technologies and Services segment provides services to
the health care industry through the design 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 sterile injectible pharmaceutical products for pharmacies in the
United Kingdom. It also provides comprehensive packaging, radiopharmaceutical
manufacturing, pharmaceutical development and analytical science expertise, as
well as medical education, marketing and contract sales services.
The Automation and Information Services segment provides services, to
hospitals and other health care providers, focusing on meeting customer needs
through unique and proprietary automation and information products and services.
In addition, this segment markets point-of-use supply systems for use in the
life sciences market.
The Company evaluates the performance of the segments based on operating
earnings after the corporate allocation of administrative expenses. Information
about interest income and expense and income taxes is not provided on a segment
level. In addition, special charges are not allocated to the segments. The
accounting policies of the segments are the same as described in the summary of
significant accounting policies.
96
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following tables include revenue and operating earnings for each
business segment and reconciling items necessary to agree to amounts reported in
the consolidated financial statements for the fiscal years ended June 30, 2004,
2003 and 2002:
Revenue (1)
------------------------------------
(in millions) 2004 2003 2002
------------------------------------
Restated Restated
Revenue:
Pharmaceutical Distribution and Provider Services (1) (2) (3) $ 54,231.0 $ 47,260.1 $ 42,998.0
Medical Products and Services 7,357.6 6,614.7 6,256.7
Pharmaceutical Technologies and Services (1) (4) 2,804.1 2,250.0 1,417.5
Automation and Information Services (6) 680.8 666.7 560.2
Corporate (5) (20.0) (60.0) (87.8)
------------------------------------
Total revenue $ 65,053.5 $ 56,731.5 $ 51,144.6
====================================
|
Operating Earnings
------------------------------------
(in millions) 2004 2003 2002
------------------------------------
Restated Restated
Pharmaceutical Distribution and Provider Services (3) $ 1,173.4 $ 1,188.1 $ 1,081.0
Medical Products and Services 666.0 591.8 545.2
Pharmaceutical Technologies and Services (6) 465.4 368.3 265.0
Automation and Information Services (6) 270.2 266.0 209.2
Corporate (6) (237.7) (218.2) (243.0)
------------------------------------
Total operating earnings $ 2,337.3 $ 2,196.0 $ 1,857.4
====================================
|
The following tables include depreciation and amortization expense and
capital expenditures for the fiscal years ended June 30, 2004, 2003 and 2002 for
each segment as well as reconciling items necessary to total the amounts
reported in the consolidated financial statements:
Depreciation and Amortization Expense
------------------------------------
(in millions) 2004 2003 2002
------------------------------------
Pharmaceutical Distribution and Provider Services $ 56.2 $ 62.3 $ 61.2
Medical Products and Services 88.2 87.7 87.7
Pharmaceutical Technologies and Services 106.6 82.7 65.2
Automation and Information Services 16.3 16.9 14.3
Corporate 31.9 16.2 15.1
------------------------------------
Total depreciation and amortization expense $ 299.2 $ 265.8 $ 243.5
====================================
|
Capital Expenditures
------------------------------------
(in millions) 2004 2003 2002
------------------------------------
Pharmaceutical Distribution and Provider Services $ 64.0 $ 67.3 $ 60.4
Medical Products and Services 100.7 85.4 88.0
Pharmaceutical Technologies and Services 192.9 182.9 104.4
Automation and Information Services 25.1 10.9 15.1
Corporate 27.5 76.7 17.5
------------------------------------
Total capital expenditures $ 410.2 $ 423.2 $ 285.4
====================================
|
97
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table includes total assets for the fiscal years ended
June 30, 2004 and 2003 for each segment as well as reconciling items necessary
to total the amounts reported in the consolidated financial statements:
Assets
-----------------------
(in millions) 2004 2003
-----------------------
Restated
Pharmaceutical Distribution and Provider Services $ 9,011.1 $ 8,729.6
Medical Products and Services 3,431.9 3,350.2
Pharmaceutical Technologies and Services 4,389.3 3,094.7
Automation and Information Services 1,192.3 1,203.2
Corporate (7) 3,344.5 2,087.4
-----------------------
Total assets $ 21,369.1 $ 18,465.1
=======================
|
(1) Revenue previously classified as "Bulk Deliveries to Customer Warehouses
and Other" has been reclassified within this Form 10-K, in all periods
presented, as a result of the Company's decision to aggregate revenue
classes. For additional information concerning the reclassification, see
Note 2.
(2) The Pharmaceutical Distribution and Provider Services segment's revenue is
derived from three main product categories. These product categories and
their respective contributions to revenue are as follows:
Product Category 2004 2003 2002
------------------------------------------------------------------------------
Adjusted Adjusted
Pharmaceuticals and Health Care Products 95% 95% 95%
Specialty Pharmaceutical Products 3% 3% 3%
Other Products & Services 2% 2% 2%
-------------------------------
Total 100% 100% 100%
===============================
|
(3) Operating results for Intercare, acquired in December 2003, include a
specialty pharmaceutical distribution business that is similar to the
Company's pharmaceutical distribution business. For segment reporting
purposes, this specialty pharmaceutical distribution business was included
in the Pharmaceutical Distribution and Provider Services segment for the
fiscal year ended June 30, 2004. This classification was not reported
during the second quarter of fiscal 2004 immediately following the
acquisition as the Company was still assessing the appropriate segment
reporting treatment. Intercare's results of operations for the second
quarter of fiscal 2004 were not material to the Company or the Company's
individual segments.
(4) The Pharmaceutical Technologies and Services segment's revenue is
derived from three main product categories. These product categories and
their respective contributions to revenue are as follows:
Product Category 2004 2003 2002
------------------------------------------------------------------------------
Adjusted Adjusted
Manufactured Products and
Radiopharmaceuticals 66% 63% 68%
Packaged Products 14% 18% 27%
Other Products & Services 20% 19% 5%
-------------------------------
Total 100% 100% 100%
===============================
|
(5) Corporate revenue primarily consists of foreign currency translation
adjustments and the elimination of intersegment revenue.
(6) Corporate operating earnings consist of special items of $57.4 million,
$39.9 million and $116.6 million for the fiscal years ended June 30, 2004,
2003 and 2002, respectively (see Note 4 for discussion of special items).
Corporate costs are allocated to the business segments generally based on
certain factors such as revenue, operating earnings and employee base. In
addition, the Company attempts to maintain a relatively consistent year
over year rate of Corporate allocated costs per segment's net revenue.
These Corporate cost allocations may change from period to period
depending upon an individual segment's use of Corporate services. The
Company does not allocate any Corporate costs for human resources, finance
and technology. Corporate operating earnings include unallocated Corporate
administrative expenses, costs not attributable to the operations of the
segments and certain other Corporate directed costs, as follows:
- Investment spending - the Company has encouraged its business units
to identify investment projects which will provide future returns.
98
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
These projects typically require incremental strategic investments
in the form of additional capital or operating expenses. As approval
decisions for such projects are dependent upon Corporate management,
the expenses for such projects are retained at the Corporate
segment. Investment spending for fiscal years, 2004, 2003 and 2002
was $48.3 million, $58.0 million and $30.6 million, respectively.
- Interest income adjustment - At the direction of Corporate
management, the Automation and Information Services segment sold
portions of its leased asset portfolio and transferred the proceeds
to Corporate. As the capital proceeds associated with these sales
have not been redeployed within the business segment, but utilized
for other general corporate purposes, the segment was allocated a
benefit by Corporate for the interest income that would have been
earned associated with these sold leases. In fiscal 2004, the
segment received a $21 million allocation from Corporate.
- Foreign exchange adjustments - The Company assesses the financial
performance of its Pharmaceutical Technologies and Services business
by applying constant foreign exchange rates to translate foreign
business units operating results into U.S. dollars. For fiscal 2004,
2003 and 2002, $11.2 million, $17.5 million and $17.4 million of
expenses were allocated to Corporate representing the difference
between "constant rates" and "actual" exchange rates.
- At the beginning fiscal 2003, the Company began expanding the use of
its shared service center, which previously supported the Medical
Products and Services segment, to benefit and support company-wide
initiatives and other business segments. Accordingly, the cost of
the shared service center, which was previously reported within the
Medical Products and Services segment, has been classified within
Corporate operating earnings for fiscal 2004 and 2003. The cost of
these services was approximately $18.4 million and $19.0 million,
respectively, for fiscal 2004 and fiscal 2003.
(7) Includes ALARIS assets of approximately $2.4 billion of which
approximately $1.5 billion relates to the preliminary goodwill allocation
and $413.2 million relates to intangible assets. The remaining assets
primarily include Corporate cash and cash equivalents, Corporate net
property and equipment and unallocated deferred taxes.
The following table presents revenue and long-lived assets by geographic area
(in millions):
Revenue Long-Lived Assets
------------------------------------ ------------------------------------
For The Fiscal Year Ended June 30, As of June 30,
------------------------------------ ------------------------------------
2004 2003 2002 2004 2003 2002
---------------------------------------------------------------------------
Restated Restated
United States $ 63,627.3 $ 55,673.1 $ 50,193.9 $ 1,932.1 $ 1,693.5 $ 1,416.6
International 1,426.2 1,058.4 950.7 431.9 396.0 477.8
------------------------------------ ------------------------------------
Total $ 65,053.5 $ 56,731.5 $ 51,144.6 $ 2,364.0 $ 2,089.5 $ 1,894.4
==================================== ====================================
|
Long-lived assets include property and equipment, net of accumulated
depreciation.
99
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
19. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The following is selected quarterly financial data (in millions, except
per Common Share amounts) for fiscal 2004 and 2003. The sum of the quarters may
not equal year-to-date due to rounding.
First Quarter Second Quarter
---------------------------------------- ----------------------------------------
Change in Change in
Reported Accounting (2) Restated (2) Reported Accounting (2) Restated (2)
---------------------------------------- ----------------------------------------
FISCAL 2004
Revenue (1) $ 15,388.7 $ 15,388.7 $ 15,388.2 $ 16,350.4 $ 16,350.4 $ 16,350.8
Gross margin 1,083.2 1,080.0 1,072.8 1,170.7 1,167.2 1,161.0
Selling, general and administrative expenses 547.6 547.6 547.6 586.9 586.9 588.0
Earnings from continuing operations before
cumulative effect of change in accounting 330.4 328.2 323.5 380.9 378.5 373.6
Loss from discontinued operations (1.8) (1.8) (1.8) (5.1) (5.1) (5.1)
Cumulative effect of change in accounting - (38.5) (38.5) - - -
---------------------------------------- ----------------------------------------
Net earnings $ 328.6 $ 287.9 $ 283.2 $ 375.8 $ 373.4 $ 368.5
Earnings from continuing operations before
cumulative effect of change in accounting
per Common Share:
Basic $ 0.75 $ 0.75 $ 0.73 $ 0.88 $ 0.87 $ 0.86
Diluted $ 0.74 $ 0.73 $ 0.72 $ 0.87 $ 0.86 $ 0.85
|
Third Quarter Fourth Quarter
---------------------------------------- --------------
Change in
Reported Accounting (2) Restated (2) Reported
---------------------------------------- ----------
FISCAL 2004
Revenue (1) $ 16,392.3 $ 16,392.3 $ 16,391.8 $ 16,922.7
Gross margin 1,280.8 1,291.0 1,283.4 1,224.0
Selling, general and administrative expenses 608.0 608.0 608.9 602.1
Earnings from continuing operations before
cumulative effect of change in accounting 428.9 435.8 430.1 397.4
Loss from discontinued operations (0.8) (0.8) (0.8) (3.9)
Cumulative effect of change in accounting - - - -
---------------------------------------- ----------
Net earnings $ 428.1 $ 435.0 $ 429.3 $ 393.5
Earnings from continuing operations before
cumulative effect of change in accounting
per Common Share:
Basic $ 0.99 $ 1.01 $ 1.00 $ 0.92
Diluted $ 0.98 $ 0.99 $ 0.99 $ 0.91
|
100
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
First Quarter Second Quarter Third Quarter Fourth Quarter
---------------------- ---------------------- ---------------------- ----------------------
Reported Restated Reported Restated Reported Restated Reported Restated
---------------------- ---------------------- ---------------------- ----------------------
FISCAL 2003
Revenue (1) $ 13,086.1 $ 13,085.0 $ 14,091.0 $ 14,096.6 $ 14,371.3 $ 14,366.1 $ 15,188.6 $ 15,183.8
Gross margin 1,006.9 1,005.8 1,079.5 1,085.5 1,194.1 1,175.4 1,229.5 1,215.5
Selling, general and administrative
expenses 520.7 530.0 526.2 528.3 576.1 579.0 605.2 609.0
Earnings from continuing operations 288.3 281.4 367.5 370.1 384.9 370.5 371.2 359.2
Loss from discontinued operations - - - - (1.8) (1.8) (4.3) (4.3)
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Net earnings $ 288.3 $ 281.4 $ 367.5 $ 370.1 $ 383.1 $ 368.7 $ 366.9 $ 354.9
Earnings from continuing operations
per Common Share:
Basic $ 0.65 $ 0.63 $ 0.83 $ 0.84 $ 0.86 $ 0.83 $ 0.83 $ 0.80
Diluted $ 0.64 $ 0.62 $ 0.82 $ 0.82 $ 0.85 $ 0.82 $ 0.82 $ 0.79
|
(1) Revenue previously classified as "Bulk Deliveries to Customer Warehouses
and Other" has been reclassified within this Form 10-K, in all periods
presented, as a result of the Company's decision to aggregate revenue
classes. These reclassifications have no effect on previously reported
total revenue, gross margins, earnings from continuing operations, net
earnings or earnings per Common Share amounts. For additional information
concerning the reclassification, see Note 2.
(2) During fiscal 2004, the Company changed its method of recognizing cash
discounts for payments made to vendors (See Note 16). Fiscal 2004
quarterly financial information has been restated from previously issued
quarterly financial statements to reflect this change in accounting. The
"change in accounting" column reflects the reported numbers restated for
the change in accounting. The "restated" column includes all restatements
including the change in accounting.
As discussed in Note 4, merger-related costs and other special items were
recognized in various quarters in fiscal 2004 and 2003. The following table
summarizes the impact of such costs on net earnings and diluted earnings per
Common Share in the quarters in which they were recorded (in millions, except
per Common Share amounts):
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
Fiscal 2004
Net earnings $ (8.7) $ 3.3 $ (4.9) $ (25.3)
Diluted net earnings per Common Share $ (0.02) $ 0.01 $ (0.01) $ (0.06)
------- ------- ------- -------
Fiscal 2003
Net earnings $ (15.6) $ 22.1 $ (6.4) $ (33.3)
Diluted net earnings per Common Share $ (0.03) $ 0.05 $ (0.01) $ (0.07)
------- ------- ------- -------
|
20. GUARANTEES
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others." This interpretation enhances a
guarantor's disclosure requirements in its interim and annual financial
statements regarding obligations under certain guarantees. The Company adopted
the enhanced disclosure requirements in the second quarter of fiscal 2003. The
initial recognition and measurement provisions of the interpretation are
applicable on a prospective basis to guarantees issued or modified after
December 31, 2002.
The Company has contingent commitments related to certain operating lease
agreements (see Note 10). 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
101
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
property cost. At June 30, 2004, the maximum amount the Company could be
required to reimburse was $396.9 million. Based upon current information, the
Company believes that the proceeds from the sale of properties under these
operating lease agreements would exceed this contingent obligation. In
accordance with FASB Interpretation No. 45, the Company has recorded $4.3
million related to these guarantees.
In the ordinary course of business, the Company, from time to time, agrees
to indemnify certain other parties under agreements with the Company, including
under acquisition agreements, customer agreements, and intellectual property
licensing agreements. Such indemnification obligations vary in scope and, when
defined, in duration. 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.
21. DISCONTINUED OPERATIONS
In connection with the acquisition of Syncor, the Company acquired certain
operations of Syncor that were or will be discontinued. Prior to the
acquisition, Syncor announced the discontinuation of certain operations
including the medical imaging business and certain overseas operations. The
Company is continuing with these plans and has added additional international
and non-core domestic businesses to the discontinued operations of Syncor. In
accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets," the net assets and results of operations of these businesses
are presented as discontinued operations. The Company is currently overseeing
the planned sale of the discontinued operations and is actively marketing these
businesses. The Company expects to sell substantially all of the remaining
discontinued operations by the end of the second quarter of fiscal 2005. The net
assets for the discontinued operations are included within the Pharmaceutical
Technologies and Services segment.
The results of discontinued operations for the fiscal years ended June 30,
2004 and 2003 are summarized as follows:
Fiscal Year
Ended June 30,
(in millions) 2004 2003
-------------------------------------------------
Revenue $ 77.1 $ 92.5
==============
Loss before income taxes $(19.1) $ (8.6)
Income tax benefit 7.4 2.5
--------------
Loss from discontinued operations $(11.7) $ (6.1)
==============
|
Interest expense allocated to discontinued operations was $0.2 million and
$0.5 million for the fiscal years ended June 30, 2004 and 2003, 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.
102
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
At June 30, 2004 and 2003 the major components of assets and liabilities
of the discontinued operations were as follows:
Fiscal Year
Ended June 30,
(in millions) 2004 2003
---------------------------------------------------
Current Assets $ 21.2 $ 49.9
Property and Equipment 22.0 63.2
Other Assets 17.2 57.0
--------- --------
Total Assets $ 60.4 $ 170.1
========= ========
Current Liabilities $ 30.9 $ 35.6
Long Term Debt and Other 24.2 28.7
--------- --------
Total Liabilities $ 55.1 $ 64.3
========= ========
|
Cash flows generated from the discontinued operations are immaterial to
the Company and, therefore, are not disclosed separately.
22. SUBSEQUENT EVENTS
Subsequent to June 30, 2004, the Company borrowed $1.25 billion in the
aggregate on its two $750 million bank revolving credit facilities. The proceeds
of this borrowing were utilized to repay a significant portion of the Company's
commercial paper, none of which remained outstanding as of the filing date of
this Form 10-K, and for general corporate purposes, including the establishment
of pharmaceutical inventory at the Pharmaceutical Distribution business'
National Logistics Center in Groveport, Ohio. See Note 6 for further discussion
regarding the nature and terms of the Company's bank revolving credit
facilities.
Also, subsequent to June 30, 2004, the Company received a commitment
letter for a $500 million committed borrowing facility to be used for general
corporate purposes. This facility is in the process of being negotiated.
Additionally, subsequent to June 30, 2004, the Company sold in the
aggregate $800 million of receivables under its committed receivables sales
facility program. The capacity under the committed receivables sales facility
program was increased from $500 million to $800 million in September 2004. See
Note 10 for further information regarding this facility.
103
ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9a: CONTROLS AND PROCEDURES
The Company carried out an evaluation, as required by Exchange Act Rule
13a-15(b), with the participation of the Company's principal executive officer
and principal financial officer, of the effectiveness of the Company's
disclosure controls and procedures, as of the end of the period covered by this
report. This evaluation, which has taken into account conclusions reached to
date in connection with the internal review conducted by the Audit Committee
of the Company's Board of Directors, has allowed the Company to make
conclusions, as set forth below, regarding the state of its disclosure controls
and procedures. As noted below, material weaknesses have been identified in the
Company's internal controls.
The Company's disclosure controls and procedures are designed to provide
reasonable assurance that information required to be disclosed in its reports
filed under the Exchange Act, such as this Form 10-K, 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 Notes 1 and 2 in "Notes to 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 this 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 include the
following:
- appointment of an interim Chief Financial Officer with substantial
accounting and public company financial expertise, who is familiar
with the design and operation of effective accounting and disclosure
processes;
- creation of an Office of the Chief Compliance Officer and
appointment of such officer to help ensure that the Company is
following best practices with respect to regulatory and compliance
matters;
- appointment of a Chief Accounting Officer, separate from the
Controller, who will be primarily responsible for keeping the
Company apprised of contemporary accounting issues;
- appointment of a new Treasurer;
- enhancement of the internal audit function by increasing the number
of internal audit staff and recruiting seasoned audit professionals;
- adoption of additional governance processes relating to operation of
the Company's Disclosure Committee;
- development of written procedures for, among other items, reviewing
unusual financial statement adjustments and allocating costs to the
Company's segments;
- adoption of process improvements concerning the Company's financial
statement close process;
- adoption of policy, procedure and oversight improvements concerning
the timing of revenue recognition within the Company's Automation
and Information Services segment (as more fully discussed in
"Management's Discussion and Analysis of Financial Condition and
Results of Operations" and Note 1 of "Notes to Consolidated
Financial Statements");
- development of systems enhancements to enable automated audit
verifications of installed automatic dispensing equipment at
customer locations;
- adoption of process improvements for the establishment and
adjustment of reserves;
- adoption of improved accounting and reporting controls for complex
vendor and customer relationships;
- development of additional training programs for the Company's
finance and accounting personnel;
- development of enhanced educational programs for personnel at all
levels in ethics, corporate compliance, disclosure, procedures for
anonymous reporting of concerns and mechanisms for enforcing Company
policies; and
- implementation of an enhanced certification process from the
Company's finance, accounting and operations personnel in connection
with the financial statement close process, which enhancements are,
in part, intended to ensure operating decisions are based on
appropriate business considerations.
The Company is in the process of implementing the control enhancements
discussed above, 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. Specifically, the Company's independent auditor communicated that its
conclusion was based on the following:
- bulk sales revenue recognition policy was inappropriately applied to
certain sales in several quarters during fiscal 2003 and 2002;
- errors or lack of substantiation with respect to the amount of
certain reserves and the timing of the release of certain reserves;
104
- lack of effective communication relating to balance sheet reserves
and bulk sales treatment; and
- restatement of the Company's financial statements for prior fiscal
years and corresponding expanded disclosures with respect to those
years.
In addition, the Company's independent auditor stated that the
circumstances described above raised questions regarding whether the overall
tone set by the Company's management clearly communicated a strong commitment to
sound financial reporting practices.
Further, the independent auditor concluded that a material weakness
existed with respect to the timing of revenue recognition within the Company's
Automation and Information Services segment. As described in Note 1 in "Notes to
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 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 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 independent auditor's material weakness
conclusions.
The Company believes that the implementation of the enhancements
identified above in this Item 9a and in Note 1 of "Notes to Consolidated
Financial Statements" will correct these material weaknesses for future periods,
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 its principal executive officer and
the principal financial officer, does not expect that the Company's disclosure
controls and procedures and its internal control processes will prevent all
error and all fraud. A control system, no matter how well conceived and
operated, can provide only reasonable, not absolute, assurance that the
objectives of the control system are met. Further, the design of a control
system must reflect the fact that there are resource constraints, and the
benefits of controls must be considered relative to their costs. Because of the
inherent limitations in all control systems, no evaluation of controls can
provide absolute assurance that all control issues and instances of fraud, if
any, within the Company have been detected. These inherent limitations include
the realities that judgments in decision-making can be faulty, and that
breakdowns can occur because of simple error or mistake. Additionally, controls
can be circumvented by the individual acts of some persons, by collusion of two
or more people, or by management override of the control. The design of any
system of controls also is 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
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 June 30, 2004, which included an evaluation of the
effectiveness of the Company's disclosure controls and procedures applicable to
the period covered by and existing through the filing of this periodic report,
and subject to the matters described in this Item 9a, the Company's principal
executive officer and principal financial officer have concluded that the
Company's disclosure controls and procedures needed improvement and were not
effective as of June 30, 2004. There were no changes in the Company's internal
controls over financial reporting during the quarter ended June 30, 2004 that
have materially affected, or are reasonably likely to materially affect, its
internal control over financial reporting. The Company believes, and its
principal executive officer and principal financial officer have concluded, that
the implementation in fiscal 2005 of the improvements and enhancements described
above should be sufficient to provide for adequate and effective disclosure
controls and procedures for future periods.
Appearing as exhibits to this Form 10-K 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 9a 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 9a should be read in conjunction with the
certifications for a more complete understanding of the topics presented.
105
PART III
ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The name, age, principal occupation for the last five years and
selected biographical information for each of the directors and executive
officers of the Company are set forth below. With respect to the principal
occupations held by directors during the past five years, unless otherwise
stated, the occupations listed below have been held during the entire past five
years. All information is provided as of October 25, 2004.
DIRECTORS
ROBERT D. WALTER (Age 59) Director, Chairman of the Board and Chief
Executive Officer of the Company since its formation in 1979, and with the
Company's predecessor business since its formation in 1971. Mr. R. Walter also
serves as a director of the American Express Company, a travel, financial and
network services company; and Viacom Inc., a media company. Mr. R. Walter is the
father of Matthew D. Walter, a director of the Company. Mr. R. Walter's term as
a director of the Company expires in 2006.
DAVE BING (Age 60) Director of the Company since 2000; Chairman and
Chief Executive Officer of The Bing Group, L.L.C., an automotive parts
manufacturer. Mr. Bing also serves as a director of DTE Energy Company. Mr.
Bing's term as a director of the Company expires in 2006.
GEORGE H. CONRADES (Age 65) Director of the Company since 1999;
Chairman and Chief Executive Officer of Akamai Technologies, Inc., an e-business
infrastructure provider ("Akamai"), since April 1999; Venture partner in Polaris
Venture Partners, an early stage investment company, since August 1998. Mr.
Conrades also serves as a director of Akamai and Harley-Davidson, Inc., a
motorcycle manufacturer. Mr. Conrades' term as a director of the Company expires
in 2004.
JOHN F. FINN (Age 56) Director of the Company since 1994; Chairman and
Chief Executive Officer of Gardner, Inc., an outdoor power equipment
distributor. Mr. Finn also serves as a director of the One Group Mutual Funds, a
registered investment company. Mr. Finn's term as a director of the Company
expires in 2006.
ROBERT L. GERBIG (Age 59) Director of the Company since its formation
in 1979, and with the Company's predecessor business since 1975; Retired
Chairman and Chief Executive Officer of Gerbig, Snell/Weisheimer & Associates,
Inc., an advertising agency. Mr. Gerbig's term as a director of the Company
expires in 2004.
JOHN F. HAVENS (Age 77) Director of the Company since 1979; Director
Emeritus and retired Chairman of Bank One Corporation, a bank holding company
("Bank One"). Mr. Havens' term as a director of the Company expires in 2006.
J. MICHAEL LOSH (Age 58) Director of the Company since 1996; Chief
Financial Officer of the Company on an interim basis since July 2004; Chairman
of Metaldyne Corporation, an automotive parts manufacturer ("Metaldyne"),
October 2000 to April 2002; Chief Financial Officer of General Motors
Corporation, an automobile manufacturer, 1994 to August 2000. Mr. Losh also
serves as a director of AMB Property Corporation, an industrial real estate
owner and operator; Aon Corporation, an insurance brokerage, consulting and
underwriting company ("Aon"); H.B. Fuller Company, a specialty chemicals and
industrial adhesives manufacturer; Masco Corp., a manufacturer of home
improvement and building products; Metaldyne; and TRW Automotive Holdings Corp.,
a supplier of automotive systems, modules and components. Mr. Losh's term as a
director of the Company expires in 2005.
JOHN B. MCCOY (Age 61) Director of the Company since 1987; Retired
Chairman of Corillian Corporation, an online banking and software services
company, June 2000 to January 2004; Chief Executive Officer of Bank One, 1984 to
December 1999. Mr. McCoy also serves as a director of the Federal Home Loan
Mortgage Corporation, a corporation supporting homeownership and rental housing;
and SBC Communications, Inc., a telecommunications systems company. Mr. McCoy's
term as a director of the Company expires in 2005.
106
RICHARD C. NOTEBAERT (Age 57) Director of the Company since 1999;
Chairman and Chief Executive Officer of Qwest Communications International Inc.,
a telecommunications systems company ("Qwest"), since July 2002; President and
Chief Executive Officer of Tellabs, Inc., a communications equipment and
services provider, September 2000 to July 2002; Chairman and Chief Executive
Officer of Ameritech Corporation, a full-service communications company, April
1994 to December 1999. Mr. Notebaert also serves as a director of Qwest and Aon.
Mr. Notebaert's term as a director of the Company expires in 2004.
MICHAEL D. O'HALLERAN (Age 54) Director of the Company since 1999;
Senior Executive Vice President of Aon since September 2004; President and Chief
Operating Officer of Aon, April 1999 to September 2004. Mr. O'Halleran also
serves as a director of Aon. Mr. O'Halleran's term as a director of the Company
expires in 2005.
DAVID W. RAISBECK (Age 55) Director of the Company since 2002; Vice
Chairman of Cargill, Incorporated, a marketer, processor and distributor of
agricultural, food, financial and industrial products and services ("Cargill"),
since November 1999, and other merchandising and management positions with
Cargill prior to that. Mr. Raisbeck also serves as a director of Eastman
Chemical Company, a plastics, chemicals and fibers manufacturer. Mr. Raisbeck's
term as a director of the Company expires in 2006.
JEAN G. SPAULDING, M.D (Age 57) Director of the Company since 2002;
Consultant, Duke University Health System, a non-profit academic health care
system, since January 2003; Trustee, The Duke Endowment, a charitable trust,
since January 2002; Private medical practice in psychiatry since 1977; Associate
Clinical Professorships at Duke University Medical Center, a non-profit academic
hospital, since 1998; Vice Chancellor for Health Affairs, Duke University Health
System, 1998 to 2002. Dr. Spaulding's term as a director of the Company expires
in 2005.
MATTHEW D. WALTER (Age 35) Director of the Company since 2002; Chief
Executive Officer of BoundTree Medical Products, Inc., a provider of medical
equipment to the emergency medical market, since November 2000; Managing Partner
of Talisman Capital, a private investment company, since June 2000; Vice
President and General Manager of National PharmPak, Inc., a subsidiary of the
Company, July 1996 to September 2000. Mr. M. Walter also serves as a director of
Bancinsurance Corporation, an insurance holding company. Mr. M. Walter is the
son of Robert D. Walter, Chairman and Chief Executive Officer of the Company.
Mr. M. Walter's term as a director of the Company expires in 2005.
EXECUTIVE OFFICERS
Of the above directors, Messrs. R. Walter and Losh also are executive
officers of the Company.
GEORGE L. FOTIADES (Age 51) President and Chief Operating Officer since
February 2004; President and Chief Executive Officer - Life Sciences Products
and Services, December 2002 to February 2004; Executive Vice President and
President and Chief Operating Officer - Pharmaceutical Technologies and
Services, November 2000 to December 2002; Executive Vice President and Group
President of Scherer, a subsidiary of the Company, August 1998 to October 2000.
Mr. Fotiades serves as a director of ProLogis.
RONALD K. LABRUM (Age 48) Chairman and Chief Executive Officer -
Integrated Provider Solutions and Cardinal Health - International since August
2004; President and Chief Executive Officer - Integrated Provider Solutions,
February 2004 to August 2004; Executive Vice President and Group President -
Medical Products and Services, November 2000 to February 2004; President,
Manufacturing and Distribution of Allegiance, a subsidiary of the Company,
October 2000 to November 2000; Corporate Vice President, Regional
Companies/Health Systems of Allegiance, January 1997 to October 2000.
MARK W. PARRISH (Age 49) Chairman and Chief Executive Officer -
Pharmaceutical Distribution and Provider Services since August 2004; Executive
Vice President and Group President - Pharmaceutical Distribution, January 2003
to August 2004; President, Medicine Shoppe, a subsidiary of the Company, July
2001 to January 2003; Executive Vice President - Retail Sales and Marketing,
June 1999 to July 2001.
107
DAVID L. SCHLOTTERBECK (Age 57) Chairman and Chief Executive Officer -
Clinical Technologies and Services since August 2004; President of ALARIS, a
subsidiary of the Company, June 2004 to August 2004; President and Chief
Executive Officer and a director of ALARIS, November 1999 to June 2004;
President and Chief Operating Officer of ALARIS, April 1999 to November 1999.
JODY R. DAVIDS (Age 48) Executive Vice President and Chief Information
Officer since March 2003; Senior Vice President - Information Technology -
Pharmaceutical Distribution, January 2000 to March 2003; Director of Technology
Services of NIKE, Inc., a designer, marketer and distributor of athletic
footwear, apparel, equipment and accessories for sports and fitness activities,
April 1997 to January 2000.
GARY D. DOLCH (Age 57) Executive Vice President - Quality and
Regulatory Affairs since December 2002; Senior Vice President of Quality and
Regulatory Affairs of the American Red Cross, May 2001 to December 2002; Vice
President, Quality Assurance for the pharmaceutical operations of BASF, a
chemical company, under the Knoll name, April 1995 to May 2001.
BRENDAN A. FORD (Age 46) Executive Vice President - Corporate
Development since November 1999; Senior Vice President - Corporate Development,
February 1996 to November 1999.
ANTHONY J. RUCCI (Age 54) Executive Vice President and President of
Strategic Corporate Resources since August 2004; Executive Vice President and
Chief Administrative Officer, January 2000 to August 2004; Executive Vice
President - Human Resources, November 1999 to January 2000; Dean of the
University of Illinois at Chicago's College of Business Administration, 1998 to
November 1999.
CAROLE S. WATKINS (Age 44) Executive Vice President - Human Resources
since August 2000; Senior Vice President - Human Resources - Pharmaceutical
Distribution and Provider Services, February 2000 to August 2000; Vice President
- Human Resources - Cardinal Distribution, November 1996 to February 2000.
PAUL S. WILLIAMS (Age 45) Executive Vice President, Chief Legal Officer
and Secretary since April 2001; Senior Vice President, Deputy General Counsel
and Assistant Secretary, January 2001 to March 2001; Vice President, Deputy
General Counsel and Assistant Secretary, July 1999 to January 2001. Mr. Williams
serves as a director of State Auto Financial Corporation.
APPOINTMENT OF NEW PRINCIPAL FINANCIAL OFFICER AND PRINCIPAL ACCOUNTING OFFICER
Effective as of July 26, 2004, Mr. Losh was appointed the Company's Chief
Financial Officer on an interim basis and its principal financial officer,
replacing Richard J. Miller. Effective as of October 24, 2004, Mr. Losh was
appointed the Company's principal accounting officer, replacing Gary S. Jensen,
who remains the Company's Controller. Mr. Losh's biographical information
appears above. The Company entered into an employment agreement with Mr. Losh
effective July 26, 2004, the material terms of which are described below in
"Item 11: Executive Compensation," under the heading "Employment Agreements and
Other Arrangements." The compensation to be provided to Mr. Losh under the
employment agreement will not be adjusted as a result of Mr. Losh taking on the
additional role of principal accounting officer.
COMPOSITION OF BOARD COMMITTEES
Messrs. Finn (Chairman), Bing, Conrades, Gerbig, O'Halleran and
Raisbeck are the current members of the Audit Committee of the Company's Board
of Directors. Messrs. McCoy (Chairman), Havens and Notebaert and Dr. Spaulding
are the current members of the Board's Human Resources and Compensation
Committee (the "Compensation Committee"). Messrs. Conrades (Chairman), Finn,
Havens and McCoy are the current members of the Board's Nominating and
Governance Committee.
AUDIT COMMITTEE FINANCIAL EXPERTS
The Board of Directors has determined that each of Messrs. Finn and
O'Halleran is an "audit committee financial expert" for purposes of the SEC
rules. In addition, the Board of Directors has determined that each of Messrs.
Finn and O'Halleran is independent, as defined by the New York Stock Exchange.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Based solely upon a review of Forms 3, 4 and 5 and amendments thereto
furnished to the Company during fiscal 2004 and any written representations
regarding the same, except as set forth below, all officers and directors of the
Company, as well as the beneficial holders of more than 10% of the Company's
Common Shares, timely filed all reports required under Section 16(a) of the
Exchange Act during fiscal 2004. Nine of the Company's directors and one
executive officer inadvertently did not report de minimis exempt acquisitions
consisting of dividends that were reinvested in Common Share units in the
Company's
108
non-qualified deferred compensation plans. The aggregate number of Common Share
units acquired by these directors and the executive officer as a result of
dividend reinvestment was 35. The directors have correctly reported the balance
of their holdings in the deferred compensation plans in all filings to date. The
executive officer has correctly reported the balance of his holdings in the
deferred compensation plans in subsequent filings.
POLICIES ON BUSINESS ETHICS
All of the Company's employees, including its principal executive
officer, principal financial officer, principal accounting officer or
controller, or persons performing similar functions, as well as its directors,
are required to comply with the Company's Standards of Business Ethics to ensure
that the Company's business is conducted in a consistently legal and ethical
manner. The full text of the Cardinal Health Ethics Guide, which includes the
Standards of Business Ethics, is posted on the Company's website, at
www.cardinal.com, under the "Investor Relations--Ethics policy" captions. This
information also is available in print (free of charge) to any shareholder who
requests it from the Company's Investor Relations department. The Company will
disclose future amendments to, or waivers from, its Standards of Business Ethics
for its principal executive officer, principal financial officer, principal
accounting officer or controller, or persons performing similar functions on its
website within four business days following the date of the amendment or waiver.
In addition, the Company also will disclose any waiver from its Standards of
Business Ethics for its executive officers and its directors on its website.
109
ITEM 11. EXECUTIVE COMPENSATION
EXECUTIVE COMPENSATION TABLES
The following information is set forth with respect to the Company's
Chief Executive Officer, each of the Company's four other most highly
compensated executive officers, and one additional individual for whom
disclosure would have been provided but for the fact that the individual was not
serving as an executive officer of the Company at June 30, 2004.
SUMMARY COMPENSATION TABLE
LONG-TERM
COMPENSATION
ANNUAL COMPENSATION AWARDS
------------------------------------------------- ---------------------------
OTHER RESTRICTED SECURITIES
ANNUAL STOCK UNDERLYING ALL OTHER
NAME AND FISCAL SALARY BONUS COMPENSATION AWARDS OPTIONS COMPENSATION
PRINCIPAL POSITION YEAR ($) ($) ($)(1) ($)(2) (#) ($)(3)
------------------ ------ ---------- ---------- ------------ ---------- ----------- -------------
Robert D. Walter 2004 $1,037,500 $ 0 $112,363(4) $ 0 507,086 $ 12,349
Chairman and 2003 $1,015,144 $2,112,135 $111,374(4) $ 0 486,009 $ 36,473(5)
Chief Executive Officer 2002 $1,000,000 $2,701,370 $173,545(4) $10,354,500(6) 440,529 $ 208,938
---- ---------- ---------- -------- ----------- ------- ----------
George L. Fotiades 2004 $ 622,692 $ 0 -- $ 0 225,000 $ 11,278
President and 2003 $ 531,633 $ 387,412 -- $ 0 250,000 $ 35,957
Chief Operating Officer 2002 $ 495,692 $ 498,482 -- $ 0 67,915 $1,052,667(7)(8)
---- ---------- ---------- -------- ----------- ------- ----------
Ronald K. Labrum 2004 $ 488,540 $ 0 -- $ 306,900(6) 85,280 $ 7,321
Chairman and Chief Executive 2003 $ 429,423 $ 247,562 -- $ 0 53,019 $ 29,512
Officer - Integrated Provider 2002 $ 418,462 $ 317,886 -- $ 0 44,604 $ 28,444
Solutions and Cardinal ---- ---------- ---------- -------- ----------- ------- ----------
Health - International
Anthony J. Rucci 2004 $ 445,800 $ 0 -- $ 0 57,021 $ 8,864
Executive Vice President and 2003 $ 433,639 $ 279,068 -- $ 0 48,822 $ 34,061
President of Strategic Corporate 2002 $ 416,219 $ 398,263 -- $ 0 48,164 $ 383,729(7)
Resources ---- ---------- ---------- -------- ----------- ------- ----------
Stephen S. Thomas 2004 $ 427,662 $ 0 -- $ 0 0 $ 784,958(9)
Former Executive Vice President 2003 $ 397,331 $ 378,727 -- $ 0 91,237 $ 37,493
and Group President - 2002 $ 380,694 $ 372,003 -- $ 0 38,546 $ 698,229(7)
Automation and Information ---- ---------- ---------- -------- ----------- ------- ----------
Services
Richard J. Miller 2004 $ 407,400 $ 0 -- $ 0 52,134 $ 8,624
Former Executive Vice President 2003 $ 396,309 $ 247,555 -- $ 0 44,686 $ 34,789
and Chief Financial Officer 2002 $ 371,361 $ 343,000 -- $ 0 41,233 $ 309,729(7)
---- ---------- ---------- -------- ----------- ------- ----------
|
(1) "--" indicates that the aggregate amount of perquisites and other
personal benefits, securities or property in the aggregate did not
exceed the lesser of $50,000 or 10% of the total of Salary and Bonus,
and the executive had no other compensation reportable under this
category.
(2) Aggregate restricted share unit holdings and values on June 30, 2004
(based upon the closing price of the Common Shares on the New York
Stock Exchange on that date, the last trading day of fiscal 2004) for
the named executive officers are as follows: Mr. R. Walter - 264,644
shares, $18,538,312; Mr. Fotiades - 26,362 shares, $1,846,658; Mr.
Labrum - 5,000 shares, $350,250; Mr. Rucci - 25,620 shares, $1,794,681;
Mr. Thomas - 31,039 shares, $2,174,282; and Mr. Miller - 8,325 shares,
$583,166. Dividend equivalents are paid in cash on restricted share
units.
(3) Amounts shown represent Company contributions to the executive's
account under the Company's Profit Sharing, Retirement and Savings Plan
and Deferred Compensation Plan for fiscal 2004 as follows: Mr. R.
Walter - $12,349; Mr. Fotiades - $11,278; Mr. Rucci - $8,864; Mr.
Labrum - $7,321; Mr. Thomas - $8,703; and Mr. Miller - $8,624.
110
(4) Includes $112,363, $111,012 and $160,827 as the incremental cost to the
Company, and related gross-up for taxes, relating to personal use by
Mr. R. Walter of a Company airplane for fiscal 2004, 2003 and 2002,
respectively.
(5) Includes $2,364 for premiums paid by the Company on a split-dollar life
insurance arrangement entered into on April 16, 1993 between the
Company, Mr. R. Walter and a trust for Mr. R. Walter's family. This
arrangement terminated by its terms on January 12, 2003, and the
Company recovered the then-current cash surrender value of the
underlying insurance policy.
(6) Includes restricted share units that vest as follows: Mr. R. Walter -
150,000 shares vesting on January 15, 2006; and Mr. Labrum - 5,000
shares vesting on November 17, 2006.
(7) Includes the vesting of cash incentive awards, granted in fiscal 2000,
as follows: Mr. Fotiades - $878,750; Mr. Rucci - $351,500; Mr. Thomas -
$666,000; and Mr. Miller - $277,500. Employment agreements between the
Company and each of these executive officers during fiscal 2000
provided for such cash incentive awards if the executive officer
remained employed by the Company through February 9, 2002. The
agreements with Messrs. Fotiades and Thomas have since been replaced
and superceded. See "Employment Agreements and Other Arrangements"
below. The agreements with Messrs. Rucci and Miller have since expired.
(8) Includes $166,667 paid to Mr. Fotiades as an incentive fee pursuant to
certain provisions contained in an employment agreement entered into
between the Company and Mr. Fotiades at the time the Company acquired
Scherer. The agreement has since been replaced and superceded. See
"Employment Agreements and Other Arrangements" below.
(9) Includes $776,255 in severance payable to Mr. Thomas pursuant to
certain provisions of an employment agreement entered into between the
Company and Mr. Thomas during fiscal 2003. See "Employment Agreements
and Other Arrangements" below.
With respect to the bonus determinations made for executive officers
for fiscal 2004, the Compensation Committee Report that will be included in the
Company's fiscal 2004 proxy statement for its annual meeting of shareholders
states, in part: "Although the Company achieved double-digit earnings per share
growth during fiscal 2004, actual operating earnings were well below the
Company's internal performance goals for the year, particularly during the third
and fourth quarters. Based on this shortfall and other qualitative factors
considered by the Compensation Committee, overall funding of the Company's
Management Incentive Plan incentive award pool for the Company's management
level employees was significantly below targeted amounts. However, in light of
the Company's pay-for-performance philosophy, it was determined that the
Company's executive officers (including Mr. R. Walter) would not share in that
incentive award pool, and therefore would receive no incentive awards for fiscal
2004. The Compensation Committee determination of a zero incentive award payout
for the Company's executive officers was based upon the factors described above
applicable to fiscal 2004, and does not reflect the Company's overall objectives
concerning annual cash incentives for its executive officers."
OPTION GRANTS IN LAST FISCAL YEAR (1)
INDIVIDUAL GRANTS
----------------------------------------------------------------------------
POTENTIAL REALIZABLE
PERCENT OF VALUE AT ASSUMED
NUMBER OF TOTAL ANNUAL RATES OF
SECURITIES OPTIONS STOCK PRICE
UNDERLYING GRANTED TO APPRECIATION FOR
OPTIONS EMPLOYEES EXERCISE OPTION TERM (4)
GRANTED IN FISCAL PRICE EXPIRATION ----------------------------------
NAME (#)(1) YEAR (2) ($/SH)(3) DATE 0% ($) 5% ($) 10% ($)
---- ---------- ---------- ---------- ---------- ------ ----------- -----------
Robert D. Walter 507,086 4.3% $61.38 11/17/2013 $0.00 $19,574,307 $49,605,136
George L. Fotiades 225,000 1.9% $64.11 2/1/2014 $0.00 $ 9,071,648 $22,989,337
Ronald K. Labrum 85,280 0.7% $61.38 11/17/2013 $0.00 $ 3,291,940 $ 8,342,423
Anthony J. Rucci 57,021 0.5% $61.38 11/17/2013 $0.00 $ 2,201,099 $ 5,578,017
Stephen S. Thomas 0 0% -- -- $0.00 -- --
Richard J. Miller 52,134 0.4% $61.38 11/17/2013 $0.00 $ 2,012,453 $ 5,099,952
|
111
(1) All options granted during the fiscal year to the named executive
officers are nonqualified stock options granted under the Company's
Amended and Restated Equity Incentive Plan, as amended (the "Equity
Incentive Plan"), are exercisable in full on and after the third
anniversary from the date of grant, and have a term of 10 years.
(2) Based on total options to purchase 11,842,030 Common Shares granted to
all employees during fiscal 2004 under the Company's Equity Incentive
Plan and Broadly-based Equity Incentive Plan, as amended.
(3) Market price on date of grant.
(4) These amounts are based on hypothetical annual appreciation rates of
0%, 5% and 10% over the full term of the applicable option and are not
intended to forecast the actual future appreciation of the Company's
stock price. No gain to optionees is possible without an actual
increase in the price of the Company's Common Shares, which benefits
all of the Company's shareholders.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
AND FY-END OPTION VALUES
NUMBER OF SECURITIES
UNDERLYING UNEXERCISED VALUE OF UNEXERCISED
OPTIONS AT IN-THE-MONEY OPTIONS AT
SHARES VALUE FY-END (#) FY-END ($)(2)
ACQUIRED ON REALIZED -------------------------- ----------------------------
NAME EXERCISE (#) ($)(1) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- ------------ ---------- ----------- ------------- ----------- -------------
Robert D. Walter -0- $ 0 1,624,517 1,433,624 $52,550,526 $7,000,887
George L. Fotiades -0- $ 0 434,728 542,915 $13,865,595 $2,006,434
Ronald K. Labrum -0- $ 0 249,084 182,903 $11,681,379 $ 940,346
Anthony J. Rucci -0- $ 0 136,043 154,007 $ 3,699,066 $ 693,259
Stephen S. Thomas 45,000 $1,447,545 133,768 129,783 $ 3,512,092 $ 466,324
Richard J. Miller -0- $ 0 179,095 138,053 $ 5,427,275 $ 628,481
|
(1) Value calculated as the amount by which the fair market value of the
Common Shares on the date of exercise exceeds the option exercise price
before payment of any taxes.
(2) Value calculated as the amount by which the market value of the Common
Shares, based upon the closing price per Common Share of $70.05 on June
30, 2004 (the last trading day of fiscal 2004), exceeds the option
exercise price.
EMPLOYMENT AGREEMENTS AND OTHER ARRANGEMENTS
During fiscal 2004, the Company amended and restated employment
agreements with Mr. R. Walter (the "Walter Agreement"), Mr. Fotiades (the
"Fotiades Agreement") and Mr. Labrum (the "Labrum Agreement"). Mr. Thomas'
employment, which has been terminated, was governed by an employment agreement
dated February 5, 2003 (the "Thomas Agreement"). In addition, in July 2004, the
Company entered into an employment agreement with Mr. Losh, who was appointed
Chief Financial Officer of the Company on an interim basis. Each of Messrs. R.
Walter, Fotiades, Labrum, Thomas and Losh agreed under their respective
agreements to comply with certain non-compete and non-solicitation covenants
during the term of their employment and generally for a period ranging from one
to two years thereafter. In addition, Messrs. R. Walter, Fotiades, Labrum,
Thomas and Losh are obligated to keep the Company's proprietary information and
trade secrets confidential.
The Walter Agreement amends and restates as of February 1, 2004, the
employment agreement dated November 20, 2001 (the "Initial Walter Agreement")
between the Company and Mr. R. Walter. Under the Walter Agreement, the Company
agreed to employ Mr. R. Walter as Chairman and Chief Executive Officer until
February 1, 2007. However, commencing on February 1, 2006, the term shall be
extended each day by one day to create a new one year term until, at any time at
or after such date, either party provides written notice of termination to be
effective one year from the notice date.
The Walter Agreement provides for an annual base salary of not less
than $1,000,000, which will be reviewed simultaneously with the salaries of all
the Company's executive officers, and eligibility for an annual cash bonus
target of at least 250% of annual base salary (although no bonus was awarded to
Mr. R. Walter for fiscal 2004). The Walter Agreement
112
further provides for equity and non-equity awards under the Company's long-term
incentive compensation plans consistent with past practice and competitive pay
practices, including an annual stock option award with a value of no less than
3,000% of annual base salary in terms of dollars at work. The Initial Walter
Agreement provided Mr. R. Walter with 150,000 shares of deferrable restricted
share units effective November 20, 2001. The Walter Agreement, as revised in
fiscal 2004, extends the vesting date of those restricted share units from June
30, 2004 to January 15, 2006 and the vesting date of certain options from
November 19, 2004 to January 15, 2006.
Under the Walter Agreement, if the Company terminates Mr. R. Walter's
employment other than for cause, death or disability, or if Mr. R. Walter
terminates his own employment for good reason, then he is paid: (i) any earned
but unpaid salary; (ii) a prorated portion of his recent average bonus (based on
the average bonus earned in the three previous fiscal years, but not less than
his annual target bonus); and (iii) two times the sum of his annual salary then
in effect and recent average bonus (or three times such sum if a change of
control has occurred within the last three years). If Mr. R. Walter's employment
is terminated by death or disability, then he is paid: (i) any earned but unpaid
salary; and (ii) a prorated portion of his recent average bonus. If Mr. R.
Walter's employment is terminated for any of the reasons above, any stock
options, restricted shares and restricted share units held by Mr. R. Walter vest
immediately and are exercisable until the end of the applicable term of such
award (except that under the Walter Agreement Mr. R. Walter will be treated as a
consulting employee and these awards continue to vest in accordance with their
terms where Mr. R. Walter's employment is terminated by disability or retirement
and the award agreement does not provide for immediate vesting). If the Company
terminates Mr. R. Walter's employment for cause or if Mr. R. Walter terminates
his own employment without good reason, then he is paid any earned but unpaid
salary but no portion of his bonus. If Mr. R. Walter's employment is terminated
for any of the reasons above, to the extent not already provided or paid, he
will also receive any other benefits to which he is entitled pursuant to, and in
accordance with the terms of, existing Company programs and plans. In the event
that any payments made to Mr. R. Walter would be subject to the excise tax
imposed on "parachute payments" by the Internal Revenue Code of 1986, as amended
(the "Code"), under the Walter Agreement, the Company will "gross-up" Mr. R.
Walter's compensation for all such excise taxes and any federal, state and local
taxes applicable to such gross-up payment (including any penalties and
interest).
The Company recently identified an issue with respect to an option
award that the Board of Directors and its Compensation Committee granted to Mr.
R. Walter in November 1999 for 1,425,000 shares (giving effect to stock splits
occurring after the date of grant). This option award was in excess of that
permitted to be granted to a single individual during any fiscal year under the
Company's Equity Incentive Plan. The maximum number of shares that could be
granted pursuant to the terms of the Equity Incentive Plan was 562,500 shares
(although the Company would have been permitted at the time to make a larger
grant outside of such Plan). The information set forth in the "Aggregated Option
Exercises in Last Fiscal Year and FY-End Values" table above under the heading
"Equity Compensation Tables" and the beneficial ownership table and equity
compensation plan information under "Item 12: Security Ownership of Certain
Beneficial Owners and Management" below with respect to Mr. R. Walter has been
revised to reflect the maximum number of shares that could be granted under the
Plan. The Compensation Committee is currently exploring alternatives to
substitute the remaining portion of the stock option granted to him in November
1999 in excess of 562,500 shares with equivalent value.
The Fotiades Agreement replaced the employment agreement previously in
place between the Company and Mr. Fotiades. Under the Fotiades Agreement, the
Company agreed to employ Mr. Fotiades as President and Chief Operating Officer
for three years commencing on February 1, 2004. The Fotiades Agreement provides
for an annual base salary of not less than $725,000 and an annual bonus target
equal to 160% of annual base salary payable under the terms of the bonus plan
for which Mr. Fotiades is eligible (although no bonus was awarded to Mr.
Fotiades for fiscal 2004). The Fotiades Agreement further provides for an
initial stock option grant of 225,000 shares (the "2004 Option"), eligibility
for annual stock option grants beginning in fiscal year 2006 and relocation
benefits.
Under the Fotiades Agreement, if the Company terminates Mr. Fotiades'
employment without cause before February 1, 2009, if Mr. Fotiades' employment is
terminated within one year after a change of control (other than because of
death, incapacity, retirement or for cause) or if he terminates his employment
within one year after a change of control that leads to a qualifying material
diminution of his duties, then he receives: (i) two times the sum of his salary
in effect on the day immediately prior to termination and his annual bonus
target; (ii) any vested benefits required to be paid or provided in law; and
(iii) all benefits provided in the 2004 Option agreement and a November 18, 2002
option agreement. If Mr. Fotiades terminates his employment or if his employment
is terminated by incapacity, death, retirement or for cause, then he receives:
(i) any earned but unpaid salary; (ii) benefits under any long-term disability
insurance coverage (in the event of termination due to incapacity); (iii) any
vested benefits required to be paid or provided in law; and (iv) any benefits
provided for under his then-outstanding equity incentive awards.
The Labrum Agreement replaced the employment agreement previously in
place between the Company and Mr. Labrum. Under the Labrum Agreement, the
Company agreed to employ Mr. Labrum as Executive Vice President and Group
President - Medical Products and Services for three years commencing on
November 5, 2003. The Labrum Agreement
113
provides for an annual base salary of not less than $480,000 and an annual bonus
target equal to 90% of annual base salary payable under the terms of the bonus
plan for which Mr. Labrum is eligible (although no bonus was awarded to Mr.
Labrum for fiscal 2004). The Labrum Agreement further provides for a stock
option grant of 25,000 shares (the "FY2004 Option") and a grant of 5,000
restricted share units effective November 17, 2003.
Under the Labrum Agreement, if the Company terminates Mr. Labrum's
employment without cause, if Mr. Labrum's employment is terminated within one
year after a change of control (other than because of death, incapacity or for
cause) or if he terminates his employment within one year after a change of
control that leads to a material diminution of his duties, then he receives: (i)
the sum of his salary in effect on the day immediately prior to termination and
his annual bonus target; (ii) any vested benefits required to be paid or
provided in law; and (iii) all benefits provided for under the FY2004 Option. If
Mr. Labrum terminates his employment or if his employment is terminated by
incapacity, death or for cause, then he receives: (i) any earned but unpaid
salary; (ii) benefits under any long-term disability insurance coverage (in the
event of termination due to incapacity); (iii) any vested benefits required to
be paid or provided in law; and (iv) any benefits provided for under the FY2004
Option.
Mr. Thomas' employment with the Company terminated on June 14, 2004.
Under the Thomas Agreement, the Company agreed to employ Mr. Thomas as Executive
Vice President and Group President - Automation and Information Services for
three years commencing on February 5, 2003. The Thomas Agreement provided for an
annual base salary of not less than $408,000 and an annual bonus target equal to
90% of annual base salary payable under the terms of the bonus plan for which
Mr. Thomas was eligible (although no bonus was awarded to Mr. Thomas for fiscal
2004). The Thomas Agreement further provided for an initial stock option grant
of 50,000 shares (the "FY2003 Option").
The Thomas Agreement also provided for severance payments and benefits
to Mr. Thomas if the Company terminated Mr. Thomas' employment without cause
prior to the end of his employment period, including (i) payment of the sum of
his salary in effect on the day immediately prior to termination and his annual
bonus target; (ii) any vested benefits required to be paid or provided in law;
and (iii) all benefits provided for under the FY2003 Option. The termination by
the Company of Mr. Thomas' employment was without cause, and pursuant to the
terms of the Thomas Agreement, a severance payment of $776,255 is payable to Mr.
Thomas in twelve equal monthly installments beginning January 2005.
The Company recently entered into an employment agreement with Mr. Losh
(the "Losh Agreement"). Under the Losh Agreement, the Company agreed to employ
Mr. Losh as interim Chief Financial Officer for one year commencing on July 26,
2004. As compensation for the services rendered thereunder, the Losh Agreement
provides for an option grant to purchase 210,000 shares at an exercise price of
$44 per share, the closing price of the Common Shares on July 27, 2004. The
option becomes exercisable in full on July 27, 2007. The Losh Agreement also
provides that Mr. Losh is eligible to receive reimbursement for reasonable
expenses incurred by Mr. Losh during his employment (including travel and living
expenses) in accordance with policies, practices and procedures of the Company
applicable to Mr. Losh. During his employment, Mr. Losh is not eligible to
receive annual option grants during fiscal 2005, unless approved by the
Compensation Committee, or compensation payable solely to nonemployee directors
of the Company.
The Company's Equity Incentive Plan, as well as the Company's Stock
Incentive Plan, as amended (the "Stock Incentive Plan"), which has been replaced
by the Equity Incentive Plan as to ongoing grants, provide for acceleration of
the vesting of stock options, restricted share awards and restricted share unit
awards based upon the occurrence of a change of control of the Company. Messrs.
R. Walter and Miller continue to hold stock options that remain outstanding
under the Stock Incentive Plan.
PENSION PLAN
Mr. Fotiades participates in a defined benefit and supplemental plan
(the "Pension Plan") which was assumed by the Company when it acquired Scherer
in 1998.
Benefits payable under the Pension Plan at retirement are determined
primarily by average final compensation and years of service. The compensation
covered by the Pension Plan for Mr. Fotiades is substantially the same as that
set forth in the Salary and Bonus columns of the Summary Compensation Table
above under the heading "Equity Compensation Tables." The defined benefit plan
was frozen as of December 31, 2002, and the supplemental plan was frozen as of
December 31, 2001. No additional benefits will be earned and no compensation or
credited service will be considered beyond these dates. Mr. Fotiades has 6.5
years of service credited under the defined benefit plan and 5.5 years of
service credited under the supplemental plan.
The annual amount payable to Mr. Fotiades upon retirement is $20,645.
The benefits are payable as a straight-life annuity beginning at age 65. These
benefits are not subject to any deduction for Social Security or any other
offset amounts.
114
COMPENSATION OF DIRECTORS
During fiscal 2004, the Company's directors each were paid a retainer
of $10,000 per quarter. The chairperson of the Audit Committee and each director
serving as the chairperson of another Board committee received an additional
$3,000 and $1,500 per quarter, respectively, for such service during fiscal
2004. Effective as of the beginning of fiscal 2005, the fees for the chairperson
of the Audit Committee were increased to $3,750 per quarter, and the fees for
the chairperson of the Compensation Committee were increased to $2,000 per
quarter. The fees for the chairperson of the Nominating and Governance Committee
remain at $1,500 per quarter. Also effective as of fiscal 2005, the retainer for
each director serving on the Company's Audit Committee was increased to $10,500
per quarter, and the retainer for the Company's non-management presiding
director, currently Mr. McCoy, was increased to $12,500 per quarter. In addition
to regular compensation paid to the chairpersons of each Committee, the members
of the Audit Committee and the presiding director, directors may receive
additional compensation for the performance of duties assigned by the Board or
its committees that are considered beyond the scope of the ordinary
responsibilities of directors or committee members. Directors may elect to defer
payment of their fees into the Company's Directors Deferred Compensation Plan,
one of the investment alternatives for which is a Company Common Shares Fund.
The Company also reimburses directors for out-of-pocket travel expenses incurred
in connection with attendance at Board and committee meetings.
Directors receive an annual option grant to purchase Common Shares with
an aggregate exercise price of $300,000. Each director also receives, upon first
appointment or election to the Board, an option grant to purchase Common Shares
with an aggregate exercise price of $300,000. The exercise price per share of
these options is the fair market value of a Common Share on the date of grant.
The actual value of the options will be the difference between the market value
of the underlying Common Shares on the exercise date and the exercise price. In
determining the value of the director options and, thus, the total compensation
to directors, the Board of Directors made certain assumptions about the future
increase in the market value of the Company's Common Shares over the term of the
options. The options are granted pursuant to the Company's Equity Incentive Plan
and Outside Directors Equity Incentive Plan. All grants to directors generally
vest immediately and are exercisable for 10 years from the date of grant.
Options granted to directors are treated as nonqualified options under the Code.
On November 17, 2003, Messrs. Bing, Conrades, Finn, Gerbig, Havens, Losh, McCoy,
Notebaert, O'Halleran, Raisbeck and M. Walter and Dr. Spaulding each were
granted options to purchase 5,084 Common Shares (having an aggregate exercise
price of $300,000) in accordance with the provisions of the Equity Incentive
Plan and the Outside Directors Equity Incentive Plan. Mr. R. Walter does not
receive any of the compensation described in this paragraph or the preceding
paragraph. Since his appointment on July 26, 2004 as Chief Financial Officer on
an interim basis, Mr. Losh has not received, and does not currently receive, any
of the compensation described in this paragraph or the preceding paragraph.
115
ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information regarding the
beneficial ownership of the Company's Common Shares as of October 25, 2004, by:
(a) the Company's directors; (b) each other person who is known by the Company
to own beneficially more than 5% of the outstanding Common Shares; (c) the
Company's Chief Executive Officer and the other executive officers named in the
Summary Compensation Table under the heading "Equity Compensation Tables" in
"Item 11: Executive Compensation" above; and (d) the Company's executive
officers and directors as a group. Except as otherwise described in the notes
below, the following beneficial owners have sole voting and investment power
with respect to all Common Shares set forth opposite their names:
NUMBER OF
COMMON SHARES
NAME OF BENEFICIAL OWNER BENEFICIALLY OWNED PERCENT OF CLASS
------------------------ ------------------ ----------------
FMR Corp.(1) 50,197,132 11.6%
Wellington Management Company, LLP(2) 25,256,727 5.8%
Robert D. Walter(3)(4)(5)(6) 6,091,835 1.4%
Matthew D. Walter(7)(8) 1,385,009 *
George L. Fotiades(4)(5)(6) 545,368 *
Ronald K. Labrum (4)(5)(6) 313,849 *
Richard J. Miller (4)(5)(6)(9) 240,174 *
Anthony J. Rucci(4)(5)(6) 232,022 *
John B. McCoy(7)(10)(11) 124,375 *
Robert L. Gerbig(7) 89,530 *
John F. Havens(7)(11)(12) 69,264 *
John F. Finn(7)(11)(13) 60,358 *
Richard C. Notebaert(7)(11) 36,917 *
J. Michael Losh(7)(11)(14) 34,492 *
Stephen S. Thomas(4)(5)(6)(15) 31,748 *
Michael D. O'Halleran(7) 26,095 *
Dave Bing(7)(11) 25,143 *
George H. Conrades(7)(11) 22,494 *
David W. Raisbeck(7)(11) 16,895 *
Jean G. Spaulding(7)(11) 13,609 *
All Executive Officers and Directors as a
Group (23 Persons)(16) 9,916,196 2.3%
|
* Indicates beneficial ownership of less than 1% of the outstanding
Common Shares.
(1) Based on information obtained from a Schedule 13G/A jointly filed with
the SEC on February 17, 2004 by FMR Corp. ("FMR"), Edward C. Johnson,
III and Abigail P. Johnson. The address of FMR is 82 Devonshire Street,
Boston, Massachusetts 02109. FMR reported that it has sole voting power
with respect to 781,067 Common Shares and sole dispositive power with
respect to all Common Shares held. The number of shares held by FMR may
have changed since the filing of the Schedule 13G/A.
(2) Based on information obtained from a Schedule 13G filed with the SEC on
February 12, 2004 by Wellington Management Company, LLP ("Wellington").
The address of Wellington is 75 State Street, Boston, Massachusetts
02109. Wellington reported that it has shared voting power with respect
to 10,663,495 Common Shares, and shared dispositive power with respect
to all Common Shares held. The number of shares held by Wellington may
have changed since the filing of the Schedule 13G.
(3) Includes a total of 2,283,564 Common Shares held in Mr. R. Walter's
four grantor retained annuity trusts and 500,000 Common Shares
beneficially owned by Mr. R. Walter through a limited liability company
in which Mr. R. Walter holds the controlling interest and is the sole
manager.
(4) Common Shares and the percent of class listed as being beneficially
owned by the Company's named executive officers include outstanding
options to purchase Common Shares which are exercisable within 60 days
of October 25, 2004, as follows: Mr. R. Walter - 1,624,517 shares; Mr.
Fotiades - 502,643 shares; Mr. Labrum - 293,688 shares; Mr. Rucci -
184,207 shares (such options being held in a trust of which Mr. Rucci
is trustee and the sole beneficiary during his life); Mr. Thomas - 0
shares; and Mr. Miller - 220,328 shares.
116
(5) Common Shares and the percent of class listed as being beneficially
owned by the Company's named executive officers include restricted
share units as of October 25, 2004, as follows: Mr. R. Walter - 264,644
shares; Mr. Fotiades - 26,362 shares; Mr. Labrum - 12,000 shares; Mr.
Rucci - 35,620 shares; Mr. Thomas - 31,039 shares; and Mr. Miller -
8,325 shares. Such restricted share units are not deemed to be
"beneficially owned" under the SEC rules, but are included in the table
above for the convenience of the reader.
(6) Common Shares and the percent of class listed as being beneficially
owned by the Company's named executive officers include Common Shares
in the Company's Employee Stock Purchase Plan as of October 25, 2004,
as follows: Mr. R. Walter - 2,386 shares; Mr. Fotiades - 0 shares; Mr.
Labrum - 2,376 shares; Mr. Rucci - 0 shares; Mr. Thomas - 709 shares;
and Mr. Miller - 1,946 shares.
(7) Common Shares and the percent of class listed as being beneficially
owned by the listed Company directors (except for Mr. R. Walter)
include outstanding options to purchase Common Shares which are
exercisable within 60 days of October 25, 2004, as follows: Mr. Bing -
22,217 shares; Mr. Conrades - 20,284 shares; Mr. Finn - 26,408 shares;
Mr. Gerbig - 26,408 shares; Mr. Havens - 33,226 shares; Mr. Losh -
26,488 shares; Mr. McCoy - 29,540 shares; Mr. Notebaert - 20,284
shares; Mr. O'Halleran - 18,595 shares; Mr. Raisbeck - 12,220 shares;
Dr. Spaulding - 12,211 shares; and Mr. M. Walter - 12,211 shares.
(8) Includes 38,872 Common Shares held in trust for the benefit of Mr. M.
Walter; 1,112,663 Common Shares beneficially owned by Mr. M. Walter
through a limited liability company; 100,000 Common Shares held in Mr.
M. Walter's grantor retained annuity trust; 3,150 Common Shares held in
trusts for the benefit of Mr. M. Walter's children; and 705 Common
Shares held by Mr. M. Walter's spouse.
(9) Mr. Miller resigned as Executive Vice President and Chief Financial
Officer of the Company effective July 25, 2004. Includes Common Shares
beneficially owned by Mr. Miller as of July 25, 2004, except as
otherwise indicated in footnotes (4), (5) and (6) above.
(10) Includes 34,137 Common Shares held in trust for the benefit of Mr.
McCoy, 6,436 Common Shares held in trust for the benefit of Mr. McCoy's
son and 50,773 Common Shares held in the aggregate in Mr. McCoy's two
grantor retained annuity trusts.
(11) Includes Common Share units held under the Company's Directors Deferred
Compensation Plan as follows: Mr. Bing - 2,926 share units; Mr.
Conrades - 1,210 share units; Mr. Finn - 3,651 share units; Mr. Havens
- 3,033 share units; Mr. McCoy - 3,489 share units; Mr. Notebaert -
3,033 share units; Mr. Raisbeck - 1,675 share units; Dr. Spaulding -
1,248 share units; and Mr. Losh - 3,129 share units. Such Common Share
units are not deemed to be "beneficially owned" under the SEC rules,
but are included in the table above for the convenience of the reader.
Mr. Losh's participation in this Plan was suspended as of July 26,
2004, the effective date of his appointment, on an interim basis, as
Chief Financial Officer of the Company.
(12) Includes 26,034 Common Shares held in trust for the benefit of Mr.
Havens' spouse and children.
(13) Includes 1,032 Common Shares held by Mr. Finn's spouse.
(14) Includes 1,500 Common Shares held in trust for the benefit of Mr.
Losh's daughters.
(15) Mr. Thomas ceased serving as Executive Vice President and Group
President - Automation and Information Services of the Company
effective May 15, 2004, and ceased his employment with the Company
effective June 14, 2004. Includes Common Shares beneficially owned by
Mr. Thomas as of June 14, 2004, except as otherwise indicated in
footnotes (4), (5) and (6) above.
(16) Common Shares and percent of class listed as being beneficially owned
by all executive officers and directors as a group include (i)
outstanding options to purchase an aggregate of 3,583,767 Common Shares
which are exercisable within 60 days of October 25, 2004, (ii) 380,001
restricted share units held by all executive officers as a group; and
(iii) 23,394 Common Share units held by all directors as a group under
the Company's Directors Deferred Compensation Plan. The restricted
share units and Common Share units are not deemed to be "beneficially
owned" under the SEC rules, but are included in the table above for the
convenience of the reader.
Information with respect to equity compensation plans of the
Company appears in Note 14 of "Notes to Consolidated Financial Statements" and
is incorporated herein by reference.
117
ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
A property which includes parts of the Company's former Columbus food
distribution center was previously leased by the Company from a limited
partnership, the limited partners of which include four adult children of Mr.
Havens, one individually and the other three through separate trusts. The lease
expired in accordance with its terms in February 2004. Prior to expiration of
the lease, the rent payable by the Company to the limited partnership was
$92,000 per annum (approximately $0.72 per sq. ft.), which amount is
substantially below fair market value for the rental property. From July 1, 2003
through February 28, 2004 (the expiration date of the lease), the Company paid
base rent to the partnership in the amount of approximately $61,000. During
fiscal 2004, the Company had subleased the property to a third party for
approximately $223,000, generating a gross profit net of real estate taxes of
approximately $112,000 for the Company. The Company and the partnership have
entered into a joint listing agreement offering both the formerly-leased
property (owned by the partnership) and the adjoining property (owned by the
Company) for sale as a single parcel. The listing agreement calls for allocation
of proceeds of any eventual sale of the joint parcel in proportion to the
relative square footage of the respective parcels (which results in an
allocation of proceeds of approximately 67% for the partnership and 33% for the
Company).
The Company owns a 28.7% equity interest in ArcLight Systems, LLC
("ArcLight"). In April 2002, ArcLight subleased office space from inChord
Communications, Inc. ("inChord") for a term expiring on June 30, 2008. Mr. M.
Walter is a director and minority shareholder of inChord, and his two brothers
own substantially all of the remainder of inChord. In December 2003, in
connection with the sale of certain of ArcLight's assets, the sublease was
assigned by Arclight to an unaffiliated third party. As a result of the
assignment, ArcLight has no further obligations under the sublease. During
fiscal 2004 ArcLight paid base rent to inChord of approximately $81,000 with
respect to periods prior to the assignment.
inChord and its subsidiaries also perform health care marketing and
recruiting services on behalf of the Company and its subsidiaries from time to
time in the ordinary course of business and on arm's-length terms. During fiscal
2004, the Company paid inChord approximately $87,000 for time and services
rendered on the Company's behalf.
In October 2003, the Company and inChord entered into a joint marketing
program ("RxPedite") designed to promote a comprehensive package of product
commercialization services to pharmaceutical manufacturers. This program
provides a mechanism for the parties to share the joint costs of the RxPedite
marketing effort, and is terminable by either party at any time. During fiscal
2004, the Company's share of co-marketing expenses incurred in connection with
the RxPedite program was approximately $201,000.
Mr. M. Walter and his two brothers own a majority of BoundTree Medical
Products, Inc. ("BMP"), a company engaged in the pre-hospital emergency medical
supply business. Mr. M. Walter also is an officer and director of BMP. During
fiscal 2004, BMP and its affiliates purchased approximately $2,751,000 of
product from the Company and its subsidiaries in the ordinary course of business
and on arm's-length terms. This amount represented less than 3% of BMP's
consolidated gross revenues for its last full fiscal year.
Ms. Beth E. Simonetti, Senior Vice President - Shared Services of the
Company, is the sister-in-law of Ms. Carole S. Watkins, Executive Vice President
- Human Resources of the Company. There is no current reporting relationship
between Ms. Simonetti and Ms. Watkins.
Pursuant to the Company's Restated Code of Regulations, as amended, and
certain indemnification agreements, the Company is obligated to advance legal
fees under certain circumstances to current and former employees, including
executive officers and directors, subject to limitations of the Ohio Revised
Code. As part of that obligation, the Company has advanced legal fees relating
to the representation of its directors by counsel in connection with various
derivative actions against the Company and its directors, and relating to the
representation of certain of its officers by counsel in connection with the SEC
investigation and related investigations described under "Item 3: Legal
Proceedings" of this Form 10-K, under the headings "Derivative Actions" and "SEC
Investigation and U.S. Attorney Inquiry," respectively. The Company has advanced
a total of approximately $1.4 million relating to these matters since July 1,
2003.
The description of the Losh Agreement under "Item 11: Executive
Compensation," under the heading "Employment Agreements and Other Arrangements"
is incorporated herein by reference.
118
PART IV
ITEM 14: PRINCIPAL ACCOUNTING FEES AND SERVICES
AUDIT FEES. Audit fees include fees paid by the Company to Ernst &
Young related to the annual audit of the Company's consolidated financial
statements, the review of financial statements included in the Company's
Quarterly Reports on Form 10-Q, statutory audits of various international
subsidiaries, and additional procedures implemented as a result of the Audit
Committee's internal review commenced in April 2004 that is ongoing. Audit fees
also include fees for services performed by Ernst & Young that are closely
related to the audit and in many cases could only be provided by the Company's
independent accountant, such as comfort letters and consents related to SEC
registration statements. The aggregate fees billed to the Company by Ernst &
Young for audit services rendered to the Company and its subsidiaries for fiscal
2003 and 2004 totaled $3,797,895 and $8,015,584, respectively.
AUDIT-RELATED FEES. Audit-related services include due diligence
services related to mergers and acquisitions, audit-related research and
assistance, document production and employee benefit plan audits. The aggregate
fees billed to the Company by Ernst & Young for audit-related services rendered
to the Company and its subsidiaries for fiscal 2003 and 2004 totaled $3,193,960
and $2,927,687, respectively.
TAX FEES. Tax fees include tax compliance and other tax-related
services. The aggregate fees billed to the Company by Ernst & Young for tax
services rendered to the Company and its subsidiaries for fiscal 2003 and 2004
totaled $1,916,880 and $2,053,411, respectively.
ALL OTHER FEES. The aggregate fees billed to the Company by Ernst &
Young for all other services rendered to the Company and its subsidiaries for
such matters as litigation assistance and internal audit services for fiscal
2003 and 2004 totaled $14,500 and $289,986, respectively.
AUDIT COMMITTEE AUDIT AND NON-AUDIT SERVICES PRE-APPROVAL POLICY
Under the Sarbanes-Oxley Act of 2002 (the "Act"), the Audit Committee
is responsible for the appointment, compensation and oversight of the work of
the independent accountants. As part of this responsibility, the Audit Committee
is required to pre-approve the audit and permissible non-audit services
performed by the independent accountants in order to assure that such services
do not impair the accountants' independence from the Company. To implement these
provisions of the Act, the SEC has issued rules specifying the types of services
that the independent accountants may not provide to their audit client, as well
as the audit committee's administration of the engagement of the independent
accountants. Accordingly, the Audit Committee has adopted an Audit and Non-Audit
Services Pre-Approval Policy (the "Policy") which sets forth the procedures and
the conditions under which services proposed to be performed by the independent
accountants must be pre-approved.
Pursuant to the Policy, certain proposed services may be pre-approved
on a periodic basis so long as the services do not exceed certain pre-determined
cost levels. If not pre-approved on a periodic basis, proposed services must
otherwise be separately pre-approved prior to being performed by the independent
accountants. In addition, any proposed services that were pre-approved on a
periodic basis but later exceed the pre-determined cost level would require
separate pre-approval of the incremental amounts by the Audit Committee.
The Audit Committee has delegated pre-approval authority to the
Chairman of the Audit Committee for proposed services to be performed by the
independent accountants for up to $500,000. Pursuant to such Policy, in the
event the Chairman pre-approves services, the Chairman is required to report
decisions to the full Audit Committee at its next regularly-scheduled meeting.
Proposed services equal to or exceeding $500,000 require full Audit Committee
approval.
119
ITEM 15: EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) The following financial statements are included in Item 8 of this report:
PAGE
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Independent Auditors' Reports.............................................................................. 47
Financial Statements:
Consolidated Statements of Earnings for the Fiscal Years Ended June 30, 2004, 2003 and 2002................ 48
Consolidated Balance Sheets at June 30, 2004 and 2003...................................................... 49
Consolidated Statements of Shareholders' Equity for the Fiscal Years Ended June 30, 2004, 2003 and 2002.... 50
Consolidated Statements of Cash Flows for the Fiscal Years Ended June 30, 2004, 2003 and 2002.............. 51
Notes to Consolidated Financial Statements................................................................. 52
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(a)(2) The following Supplemental Schedule is included in this report:
PAGE
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Schedule II - Valuation and Qualifying Accounts............................................................ 128
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All other schedules not listed above have been omitted as not applicable
or because the required information is included in the Consolidated Financial
Statements or in notes thereto.
(a)(3) Exhibits required by Item 601 of Regulation S-K:
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
------- -------------------
3.01 Amended and Restated Articles of Incorporation, as amended
3.02 Restated Code of Regulations, as amended (14)
4.01 Specimen Certificate for the Registrant's Common Shares (17)
4.02 Indenture, dated as of May 1, 1993, between the Registrant and Bank One, Indianapolis,
NA, Trustee, relating to the Registrant's 6 1/2% Notes Due 2004 and 6% Notes Due 2006 (1)
4.03 Indenture, dated as of April 18, 1997, between the Registrant and Bank One, Columbus, NA,
Trustee, relating to the Registrant's 6 1/4% Notes Due 2008, 6 3/4% Notes Due 2011, 4.45%
Notes Due 2005 and 4.00% Notes Due 2015 (2)
4.04 Indenture, dated as of October 1, 1996, between Allegiance Corporation and PNC Bank, Kentucky,
Inc. ("PNC"), Trustee; and First Supplemental Indenture, dated as of February 3, 1999, by and
among Allegiance Corporation, the Registrant and Chase Manhattan Trust Company, National
Association (as successor in interest to PNC), Trustee (3)
4.05 Indenture, dated as of January 1, 1994, between R.P. Scherer International Corporation and
Comerica Bank, Trustee; First Supplemental Indenture, dated as of February 28, 1995, by and
among R.P. Scherer International Corporation, R.P. Scherer Corporation and Comerica Bank,
Trustee; and Second Supplemental Indenture, dated as of August 7, 1998, by and among
R.P. Scherer Corporation, the Registrant and NBD Bank (4)
4.06 Form of Warrant Certificate to Purchase the Registrant's Common Shares (5)
4.07 Form of Debt Securities (16)
10.01 Pharmaceutical Services Agreement, dated as of August 1, 1996, between the Registrant and
Kmart Corporation, as amended (Confidential treatment has been requested for confidential
commercial and financial information, pursuant to Rule 24b-2 under the Exchange Act,
with respect to the last amendment filed) (9), (15) and (19)
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120
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
------- -------------------
10.02 Wholesale Supply Agreement, dated January 1, 2004, between the Registrant and CVS Pharmacy,
Inc. (Confidential treatment has been requested for confidential commercial and financial
information, pursuant to Rule 24b-2 under the Exchange Act)
10.03 First Amendment to Wholesale Supply Agreement, dated May 26, 2004, between the Registrant
and CVS Pharmacy, Inc. (Confidential treatment has been requested for confidential
commercial and financial information, pursuant to Rule 24b-2 under the Exchange Act)
10.04 Second Amendment to Wholesale Supply Agreement, dated June 2, 2004, between the Registrant
and CVS Pharmacy, Inc. (Confidential treatment has been requested for confidential
commercial and financial information, pursuant to Rule 24b-2 under the Exchange Act)
10.05 Prime Vendor Agreement, dated as of July 1, 2001, between the Registrant and Express
Scripts, Inc., as amended on January 15, 2003 (Confidential treatment has been requested
for confidential commercial and financial information, pursuant to Rule 24b-2 under the
Exchange Act) (20)
10.06 Second Amendment to Prime Vendor Agreement, dated as of November 19, 2003, between the
Registrant and Express Scripts, Inc. (Confidential treatment has been requested | |
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