1
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For The Quarter Ended December 31, 1999 Commission File Number 0-12591
CARDINAL HEALTH, INC.
(Exact name of registrant as specified in its charter)
OHIO 31-0958666
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
7000 CARDINAL PLACE, DUBLIN, OHIO 43017
(Address of principal executive offices and zip code)
(614) 757-5000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
--- ---
The number of Registrant's Common Shares outstanding at the close of
business on February 1, 2000 was as follows:
Common Shares, without par value: 281,295,303
-----------
2
CARDINAL HEALTH, INC. AND SUBSIDIARIES
Index *
Page No.
--------
Part I. Financial Information:
---------------------
Item 1. Financial Statements:
Condensed Consolidated Statements of Earnings for the Three and Six Months
Ended December 31, 1999 and 1998 (unaudited)....................................... 3
Condensed Consolidated Balance Sheets at December 31, 1999 and
June 30, 1999 (unaudited).......................................................... 4
Condensed Consolidated Statements of Cash Flows for the Six Months Ended
December 31, 1999 and 1998 (unaudited)............................................. 5
Notes to Condensed Consolidated Financial Statements............................... 6
Item 2. Management's Discussion and Analysis of Results of Operations
and Financial Condition............................................................ 10
Item 3. Quantitative and Qualitative Disclosures about Market Risk......................... 14
Part II. Other Information:
-----------------
Item 1. Legal Proceedings.................................................................. 15
Item 4. Submission of Matters to a Vote of Security Holders................................ 16
Item 6. Exhibits and Reports on Form 8-K................................................... 16
* Items not listed are inapplicable.
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PART I. FINANCIAL INFORMATION
CARDINAL HEALTH, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
(UNAUDITED)
(IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
THREE MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31,
1999 1998 1999 1998
-------- -------- --------- ---------
Revenue:
Operating revenue $6,254.3 $5,289.5 $12,083.6 $10,306.9
Bulk deliveries to customer warehouses 1,145.2 999.8 2,099.6 1,781.5
-------- -------- --------- ---------
Total revenue 7,399.5 6,289.3 14,183.2 12,088.4
Cost of products sold:
Operating cost of products sold 5,532.7 4,634.9 10,707.2 9,060.9
Cost of products sold - bulk deliveries 1,144.9 999.8 2,099.3 1,781.5
-------- -------- --------- ---------
Total cost of products sold 6,677.6 5,634.7 12,806.5 10,842.4
Gross margin 721.9 654.6 1,376.7 1,246.0
Selling, general and administrative expenses 415.3 401.4 806.6 775.3
Merger-related costs 5.5 3.1 42.3 37.5
-------- -------- --------- ---------
Operating earnings 301.1 250.1 527.8 433.2
Interest expense and other (26.8) (28.9) (51.7) (53.2)
-------- -------- --------- ---------
Earnings before income taxes 274.3 221.2 476.1 380.0
Provision for income taxes 100.8 79.7 180.6 143.8
-------- -------- --------- ---------
Net earnings $ 173.5 $ 141.5 $ 295.5 $ 236.2
======== ======== ========= =========
Earnings per Common Share:
Basic $ 0.62 $ 0.51 $ 1.05 $ 0.85
Diluted $ 0.61 $ 0.50 $ 1.03 $ 0.83
Weighted average number of Common Shares outstanding:
Basic 280.4 277.0 280.2 276.9
Diluted 285.1 284.5 285.8 284.2
Cash dividends declared per Common Share $ 0.025 $ 0.025 $ 0.050 $ 0.050
- --------------------------------------------------------------------------------------------------------------------
Net earnings $ 173.5 $ 141.5 $ 295.5 $ 236.2
Pro forma adjustment for income taxes (Note 4) -- 2.8 -- 4.3
-------- -------- --------- ---------
Pro forma net earnings $ 173.5 $ 138.7 $ 295.5 $ 231.9
======== ======== ========= =========
Pro forma earnings per Common Share:
Basic $ 0.62 $ 0.50 $ 1.05 $ 0.84
Diluted $ 0.61 $ 0.49 $ 1.03 $ 0.82
See notes to condensed consolidated financial statements.
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CARDINAL HEALTH, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(IN MILLIONS)
DECEMBER 31, JUNE 30,
1999 1999
------------ ---------
ASSETS
Current assets:
Cash and equivalents $ 290.5 $ 185.4
Trade receivables, net 1,887.8 1,602.1
Current portion of net investment in sales-type leases 166.2 152.5
Inventories 4,041.2 2,940.0
Prepaid expenses and other 540.5 320.6
--------- ---------
Total current assets 6,926.2 5,200.6
--------- ---------
Property and equipment, at cost 2,904.5 2,798.9
Accumulated depreciation and amortization (1,300.1) (1,237.4)
--------- ---------
Property and equipment, net 1,604.4 1,561.5
Other assets:
Net investment in sales-type leases, less current portion 506.4 454.3
Goodwill and other intangibles 969.4 942.1
Other 273.6 246.0
--------- ---------
Total $10,280.0 $ 8,404.5
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Notes payable, banks $ 153.8 $ 28.6
Current portion of long-term obligations 9.8 11.6
Accounts payable 3,027.3 2,363.9
Other accrued liabilities 961.6 561.2
--------- ---------
Total current liabilities 4,152.5 2,965.3
--------- ---------
Long-term obligations, less current portion 1,657.9 1,223.9
Deferred income taxes and other liabilities 608.2 645.7
Shareholders' equity:
Common Shares, without par value 1,125.1 1,091.7
Retained earnings 2,802.7 2,544.0
Common Shares in treasury, at cost (17.5) (17.2)
Cumulative foreign currency adjustment (43.3) (44.0)
Other (5.6) (4.9)
--------- ---------
Total shareholders' equity 3,861.4 3,569.6
--------- ---------
Total $10,280.0 $ 8,404.5
========= =========
See notes to condensed consolidated financial statements.
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CARDINAL HEALTH, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN MILLIONS)
SIX MONTHS ENDED
DECEMBER 31,
1999 1998
--------- -------
Net earnings $ 295.5 $ 236.2
Adjustments to reconcile net earnings to net cash from operating activities:
Depreciation and amortization 125.3 114.4
Provision for bad debts 14.0 5.1
Change in operating assets and liabilities, net of effects from acquisitions:
Increase in trade receivables (301.4) (139.5)
Increase in inventories (1,102.3) (452.2)
Increase in net investment in sales-type leases (65.8) (151.7)
Increase in accounts payable 675.5 237.7
Other operating items, net 76.5 67.3
--------- -------
Net cash used in operating activities (282.7) (82.7)
--------- -------
Acquisition of subsidiary, net of cash acquired (62.6) (69.6)
Proceeds from sale of property and equipment 14.5 2.6
Additions to property and equipment (149.3) (174.5)
Other 48.3 (0.9)
--------- -------
Net cash used in investing activities (149.1) (242.4)
--------- -------
Net change in commercial paper and short-term debt 693.8 142.7
Reduction of long-term obligations (140.8) (19.2)
Proceeds from long-term obligations, net of issuance costs -- 161.1
Proceeds from issuance of Common Shares 20.6 34.7
Dividends on Common Shares and cash paid
in lieu of fractional shares (14.1) (20.1)
Other (22.6) (45.5)
--------- -------
Net cash provided by financing activities 536.9 253.7
NET INCREASE (DECREASE) IN CASH AND EQUIVALENTS 105.1 (71.4)
CASH AND EQUIVALENTS AT BEGINNING OF PERIOD 185.4 389.1
--------- -------
CASH AND EQUIVALENTS AT END OF PERIOD $ 290.5 $ 317.7
========= =======
See notes to condensed consolidated financial statements.
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CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Note 1. The condensed consolidated financial statements of Cardinal Health,
Inc. (the "Company") include the accounts of all majority-owned
subsidiaries and all significant intercompany amounts have been
eliminated. The condensed consolidated financial statements contained
herein have been restated to give retroactive effect to the merger
transactions with Pacific Surgical, Inc. ("PSI") on May 21, 1999 and
Automatic Liquid Packaging, Inc. ("ALP") on September 10, 1999, both of
which were accounted for as pooling of interests business combinations
(see Note 4).
These condensed consolidated financial statements have been prepared in
accordance with the instructions to Form 10-Q and include all of the
information and disclosures required by generally accepted accounting
principles for interim reporting. In the opinion of management, all
adjustments necessary for a fair presentation have been included.
Except as disclosed elsewhere herein, all such adjustments are of a
normal and recurring nature.
The condensed consolidated financial statements included herein should
be read in conjunction with the audited consolidated financial
statements and related notes contained in the Company's Annual Report
on Form 10-K for the fiscal year ended June 30, 1999 (the "1999 Form
10-K"). Without limiting the generality of the foregoing, Note 1 of the
"Notes to Consolidated Financial Statements" from the 1999 Form 10-K is
specifically incorporated herein by reference.
Note 2. Basic earnings per Common Share ("Basic") is computed by dividing net
earnings (the numerator) by the weighted average number of Common
Shares outstanding during each period (the denominator). Diluted
earnings per Common Share is similar to the computation for Basic,
except that the denominator is increased by the dilutive effect of
stock options outstanding, computed using the treasury stock method.
Note 3. The Company's comprehensive income consists of net earnings and foreign
currency translation adjustments as follows:
For the For the
three months ended six months ended
December 31, December 31,
-------------------- ------------------
(in millions) 1999 1998 1999 1998
------ ------ ------ ------
Net earnings $173.5 $141.5 $295.5 $236.2
Foreign currency
translation gain/(loss) (1.2) 4.1 0.7 3.3
------ ------ ------ ------
Total comprehensive income $172.3 $145.6 $296.2 $239.5
====== ====== ====== ======
Note 4. On September 10, 1999, the Company completed a merger transaction with
ALP (the "ALP Merger") which was accounted for as a pooling of
interests. In the ALP Merger, the Company issued approximately 5.8
million Common Shares to ALP stockholders.
On May 21, 1999, the Company completed a merger transaction with PSI
(the "PSI Merger") which was accounted for as a pooling of interests.
In the PSI Merger, the Company issued approximately 0.2 million Common
Shares to PSI stockholders.
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The table below presents a reconciliation of total revenue and net
earnings available for Common Shares as reported in the accompanying
condensed consolidated financial statements with those previously
reported by the Company. The term "Cardinal Health" as used in the
table below refers to Cardinal Health, Inc. and subsidiaries prior to
the ALP and PSI mergers.
Cardinal
(in millions) Health ALP PSI Combined
-------- --- --- --------
Three months ended December 31, 1998
Total revenue $ 6,269.2 $17.5 $2.6 $ 6,289.3
Net earnings $ 134.1 $ 7.0 $0.4 $ 141.5
Six months ended December 31, 1998
Total revenue $12,050.1 $34.2 $4.1 $12,088.4
Net earnings $ 224.9 $11.0 $0.3 $ 236.2
Adjustments affecting net earnings and shareholders' equity as a result
of ALP and PSI adopting the Company's accounting practices were not
material for any periods presented herein. In addition, there were no
material intercompany transactions.
Since April 1998, ALP had been organized as an S-Corporation for tax
purposes. Accordingly, ALP was not subject to federal income tax from
April 1998 up to the date that the ALP merger transaction was
consummated. For the quarter and six months ended December 31, 1998,
net earnings would have been reduced by $2.8 million and $4.3 million,
respectively, if ALP had been subject to federal income taxes. Pro
forma combined net earnings for the three and six months ended December
31, 1999 are $138.7 million and $231.9 million, respectively, taking
into consideration ALP income taxes.
Note 5. Costs of effecting mergers and subsequently integrating the operations
of the various merged companies are recorded as merger-related costs
when incurred. During the three and six months ended December 31, 1999,
merger-related costs totaling $5.5 million ($3.4 million, net of tax)
and $42.3 million ($33.1 million, net of tax) were recorded,
respectively. During the six months ended December 31, 1999,
approximately $31.6 million related to transaction and employee-related
costs associated with the ALP merger transaction and $5.2 million
related to exit and employee costs associated with the Company's merger
transaction with Allegiance Corporation ("Allegiance"), of which $31.6
million and $4.3 million, respectively were recorded during the first
quarter of fiscal year 2000. In addition, $7.0 million was recorded
associated with the business restructuring as a result of the Company's
merger transaction with R.P. Scherer Corporation ("Scherer"), of which
$6.9 million was recorded during the first quarter of fiscal 2000. As
part of the business restructuring, the Company is currently closing
certain facilities. In connection with such closings, the Company has
incurred employee-related costs, asset impairment charges and exit
costs related to the termination of contracts and lease agreements.
During the first six months of fiscal 2000, the Company recorded costs
of $8.8 million related to integrating the operations of companies that
previously engaged in merger transactions with the Company. Of these
integration costs, $4.3 million were recorded during the quarter ended
September 30, 1999. Partially offsetting the total charges recorded was
a $10.3 million credit recorded in the first quarter of fiscal 2000 to
adjust the estimated transaction and employee-related costs previously
recorded in connection with the Allegiance merger transaction. Actual
billings and employee-related costs were less than the amounts
originally anticipated, resulting in a reduction of the merger-related
costs.
During the three and six-month periods ended December 31, 1998,
merger-related costs totaled $3.1 million ($1.9 million, net of tax)
and $37.5 million ($29.7 million, net of tax), respectively. Of the
amount recorded, $22.3 million related to transaction and
employee-related costs and $12.5 million related to business
restructuring and asset impairment costs associated with the Company's
merger transaction with Scherer. In addition, the Company recorded
costs of $1.1 million related to severance costs for a restructuring
associated with the change in management that resulted from the merger
with Owen Healthcare, Inc. and $4.8 million related to integrating the
operations of companies that previously engaged in merger transactions
with the Company, of which $1.8 million was recorded during the first
quarter of fiscal 1999. Partially offsetting the charge recorded was a
$3.2 million credit, of which $2.2 million was recorded during the
first quarter of fiscal 1999, to adjust the estimated transaction and
termination costs previously recorded in connection with the canceled
merger transaction with Bergen Brunswig Corporation. The actual
billings for services provided by third parties engaged by the Company
were less than the estimate, resulting in a reduction of the
merger-related costs.
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The net of tax effect of the various merger-related costs recorded and
pro forma adjustments related to ALP taxes (see Note 4) during the
three months ended December 31, 1999 and 1998 was to reduce net
earnings by $3.4 million to $173.5 million and to increase net earnings
by $0.9 million to $141.5 million, respectively, and to reduce reported
diluted earnings per Common Share by $0.01 per share to $0.61 per share
and to increase reported diluted earnings per Common Share by $0.01 per
share to $0.50 per share, respectively. The net of tax effect of the
various merger-related costs recorded and pro forma adjustments related
to ALP taxes during the six months ended December 31, 1999 and 1998 was
to reduce net earnings by $33.1 million to $295.5 million and by $25.4
million to $236.2 million, respectively, and to reduce reported diluted
earnings per Common Share by $0.12 per share to $1.03 per share and by
$0.09 per share to $0.83 per share, respectively.
Note 6. The Company is organized based on the products and services it offers.
Under this organizational structure, the Company operates in three
business segments: Pharmaceutical Distribution, Pharmaceutical Services
and Medical-Surgical Products. The Company has not made any significant
changes in the segments reported or the basis of measurement of segment
profit or loss from the information provided in the Company's 1999 Form
10-K.
The Pharmaceutical Distribution segment involves the distribution of a
broad line of pharmaceuticals, health and beauty care products,
therapeutic plasma and other specialty pharmaceutical products and
additional items typically sold by hospitals, retail drug stores and
other health-care providers.
The Pharmaceutical Services segment provides services to the
health-care industry through the design of unique drug delivery
systems, contract manufacturing, comprehensive packaging services,
integrated pharmacy management, reimbursement services, clinical
information system services and pharmacy automation equipment.
The Medical-Surgical Products segment involves the manufacture of
medical, surgical and laboratory products and the distribution of these
products to hospitals, physician offices, surgery centers and other
health-care providers.
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 following table includes revenue and operating earnings for the
three months ended December 31, 1999 and 1998 for each segment and
reconciling items necessary to equal amounts reported in the
consolidated financial statements:
For the three months ended For the six months ended
(in millions) December 31, December 31,
-------------------------- ------------------------
Net Revenue: 1999 1998 1999 1998
-------- -------- --------- ---------
Operating revenue:
Pharmaceutical Distribution $4,509.9 $3,622.0 $ 8,693.1 $ 7,067.7
Pharmaceutical Services 552.6 536.7 1,062.8 1,026.9
Medical-Surgical Products 1,279.2 1,209.3 2,492.0 2,358.9
Inter-segment (1) (87.4) (78.5) (164.3) (146.6)
-------- -------- --------- ---------
Total operating revenue 6,254.3 5,289.5 12,083.6 10,306.9
Bulk Deliveries to Customer
Warehouses:
Pharmaceutical Distribution 1,145.2 999.8 2,099.6 1,781.5
-------- -------- --------- ---------
Total Net Revenue $7,399.5 $6,289.3 $14,183.2 $12,088.4
========================================================================================
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For the For the
three months ended six months ended
December 31, December 31,
-------------------- -------------------
Operating Earnings: 1999 1998 1999 1998
------ ------ ------ ------
Pharmaceutical Distribution $118.1 $ 93.8 $224.7 $175.7
Pharmaceutical Services 107.1 91.9 186.6 160.7
Medical-Surgical Products 88.9 73.5 175.5 144.6
Corporate (2) (13.0) (9.1) (59.0) (47.8)
------ ------ ------ ------
Total Operating Earnings $301.1 $250.1 $527.8 $433.2
===============================================================================
(1) Inter-segment revenue consists primarily of the elimination of
inter-segment activity - primarily sales from Pharmaceutical
Distribution to Pharmaceutical Services. Sales from one segment to
another are priced at the equivalent external customer selling prices.
(2) Corporate operating earnings primarily consist of merger-related costs
of $5.5 million and $3.1 million for the three months ended December
31, 1999 and 1998 and $42.3 million and $37.5 million for the six
months ended December 31, 1999 and 1998, respectively, and unallocated
corporate depreciation and amortization and administrative expenses.
Note 7. On September 30, 1996, Baxter International Inc. ("Baxter") and its
subsidiaries transferred to Allegiance and its subsidiaries their U.S.
Healthcare distribution business, surgical and respiratory therapy
business and healthcare cost-saving business, as well as certain
foreign operations (the "Allegiance Business") in connection with a
spin-off of the Allegiance Business by Baxter. In connection with this
spin-off, Allegiance, which merged with the Company on February 3,
1999, assumed the defense of litigation involving claims related to the
Allegiance Business from Baxter, including certain claims of alleged
personal injuries as a result of exposure to natural rubber latex
gloves. Since none of the cases involving natural rubber latex gloves
has proceeded to a hearing on the merits, the Company is unable to
evaluate the extent of any potential liability, and unable to estimate
any potential loss. Because of the increase in claims filed and the
ongoing defense costs that will be incurred, the Company believes it is
probable that it will continue to incur significant expenses related to
the defense of cases involving natural rubber latex gloves. The Company
believes a substantial portion of any potential liability and defense
costs, excluding defense costs already reserved, relating to natural
latex gloves cases and claims will be covered by insurance, subject to
self-insurance retentions, exclusions, conditions, coverage gaps,
policy limits and insurer solvency.
Although the ultimate resolution of litigation cannot be forecast with
certainty, the Company does not believe that the outcome of any pending
litigation would have a material adverse effect on the Company's
consolidated financial statements.
Note 8. As of July 1, 1999, the Company adopted the Statement of Position 98-1
("SOP 98-1"), "Accounting for the Costs of Computer Software Developed
or Obtained for Internal Use." SOP 98-1 provides guidance on accounting
for costs of computer software developed or obtained for internal use.
The adoption of this statement did not have a material impact on the
Company's financial statements.
On November 24, 1999, the Securities and Exchange Commission ("SEC")
issued Staff Accounting Bulletin No. 100 ("SAB 100"), "Restructuring
and Impairment Charges." SAB 100 provides the SEC staff's views
regarding the accounting for and disclosure of certain expenses
commonly reported in connection with exit activities and business
combinations. The Company believes that its current accounting
procedures related to these expenses comply with SAB 100.
On December 3, 1999, the SEC issued Staff Accounting Bulletin No. 101
("SAB 101"), "Revenue Recognition in Financial Statements." While not
intended to change current literature related to revenue recognition,
SAB 101 provides additional guidance on revenue recognition policies
and procedures. The Company does not anticipate that the issuance of
SAB 101 will have a material impact on the consolidated financial
statements.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Management's discussion and analysis presented below has been prepared to
give retroactive effect to the pooling of interests business combinations with
Pacific Surgical, Inc. ("PSI") on May 21, 1999 and Automatic Liquid Packaging,
Inc. ("ALP") on September 10, 1999. The discussion and analysis is concerned
with material changes in financial condition and results of operations for the
Company's condensed consolidated balance sheets as of December 31, 1999 and June
30, 1999, and for the condensed consolidated statements of earnings for the
three and six month periods ended December 31, 1999 and 1998.
This discussion and analysis should be read together with management's
discussion and analysis included in the Company's Annual Report on Form 10-K for
the fiscal year ended June 30, 1999.
Portions of management's discussion and analysis presented below include
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. The words "believe", "expect", "anticipate",
"project", and similar expressions, among others, identify "forward-looking
statements", which speak only as of the date the statement was made. Such
forward-looking statements are subject to risks, uncertainties and other
factors, which could cause actual results to materially differ from those made,
projected or implied. The most significant of such risks, uncertainties and
other factors are described in Exhibit 99.01 to this Form 10-Q and are
incorporated herein by reference. The Company disclaims any obligation to update
any forward-looking statement.
GENERAL
The Company operates within three operating business segments:
Pharmaceutical Distribution, Pharmaceutical Services and Medical-Surgical
Products. See Note 6 of "Notes to Condensed Consolidated Financial Statements"
for a description of these segments.
RESULTS OF OPERATIONS
Operating Revenue
Three months ended Six months ended
December 31, 1999 December 31, 1999
-------------------------------------------------------------------
Percent of Total Percent of Total
Growth (1) Operating Revenues Growth (2) Operating Revenues
- ------------------------------------------------------------------------------------------------------------
Pharmaceutical Distribution 25% 71% 23% 71%
Pharmaceutical Services 3% 9% 3% 9%
Medical-Surgical Products 6% 20% 6% 20%
Total Company 18% 100% 17% 100%
- ------------------------------------------------------------------------------------------------------------
(1) The growth rate applies to the three-month period ended
December 31, 1999 as compared to the corresponding period of
the prior year.
(2) The growth rate applies to the six-month period ended December
31, 1999 as compared to the corresponding period of the prior
year.
Operating revenue for the three and six months ended December 31, 1999
increased 18% and 17% as compared to the same period in the prior year. The
majority of the operating revenue increase (approximately 85% and 81%,
respectively for the three and six-month periods ended December 31, 1999) came
from existing customers in the form of increased volume and price increases. The
remainder of the growth came from the addition of new customers.
The Pharmaceutical Distribution segment's operating revenue growth over the
three and six months ended December 31, 1999 was primarily related to strong
sales to all customer segments, especially to retail pharmacy chains and through
the Company's specialty distribution businesses. All operating revenue growth
was internal.
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The operating revenue growth for the Pharmaceutical Services segment was
primarily a result of growth in the Company's pharmaceutical drug delivery
systems, comprehensive packaging services and contract manufacturing businesses.
The recent pharmaceutical introductions in the form of the Company's proprietary
drug delivery formulations and sales of health and nutritional products in Asia
contributed to this revenue growth. In addition, the comprehensive packaging
services and the contract manufacturing businesses have contributed to the
revenue growth through the receipt of contracts on new products and organic
growth of existing products under contract. Offsetting this growth was the
impact of the pharmacy management business continuing to exit unprofitable
accounts and temporarily flat sales in the pharmacy automation business due to
customers delaying purchases to focus internally on their Y2K readiness.
The Medical-Surgical Products segment's operating revenue growth was due to
an increase in sales for all product lines. In particular, sales of distributed
products increased during the quarter and six-month periods. In addition,
international and service revenues for the Medical-Surgical Products segment
increased over the comparable quarter of fiscal 1999. Several multiple year
contracts have contributed to this growth.
Bulk Deliveries to Customer Warehouses. The Company reports as revenue bulk
deliveries made to customers' warehouses, whereby the Company acts as an
intermediary in the ordering and subsequent delivery of pharmaceutical products.
Fluctuations in bulk deliveries result largely from circumstances that are
beyond the control of the Company, including consolidation within customers'
industries, decisions by customers to either begin or discontinue warehousing
activities, and changes in policies by manufacturers related to selling directly
to customers. Due to the lack of margin generated through bulk deliveries,
fluctuations in their amount have no significant impact on the Company's
operating earnings.
Gross Margin
Three Months Ended Six Months Ended
December 31, December 31,
- -------------------------------------------------------------------------------------------------------
(As a percentage of operating revenue) 1999 1998 1999 1998
- -------------------------------------------------------------------------------------------------------
Pharmaceutical Distribution 5.02% 5.29% 5.03% 5.17%
Pharmaceutical Services 36.28% 33.27% 34.46% 32.43%
Medical-Surgical Products 22.97% 23.53% 22.99% 23.20%
Total Company 11.54% 12.37% 11.39% 12.09%
- -------------------------------------------------------------------------------------------------------
The decrease in gross margin from the three and six months ended December
31, 1998 to the comparable periods of fiscal 2000 was due primarily to a greater
mix of lower margin pharmaceutical distribution during the first half of fiscal
2000 compared to the same period a year ago. The Pharmaceutical Distribution
segment's mix increased to 71% of total operating revenues for the three and six
months ended December 31, 1999 from 67% and 68% for the comparable periods of
the prior year, respectively.
The Pharmaceutical Distribution segment's gross margin as a percentage of
operating revenue decreased primarily as a result of lower selling margins due
to a greater mix of sales to retail pharmacy chains which have a relatively
lower margin in connection with a lower cost of service (see discussion in
selling, general and administrative expenses). This decrease was partially
offset by higher vendor margins from favorable price increases and manufacturer
marketing programs.
The increase in the Pharmaceutical Services segment's gross margin was due
primarily to the drug delivery development business' improvement as a result of
a shift in mix to higher margin pharmaceutical products from lower margin health
and nutrition products. In addition, the pharmacy management contract
rationalization program has resulted in improved gross margins. Gross margin was
also favorably impacted by an improvement in manufacturing processes as a result
of improved productivity, ongoing plant modernization and rationalization
programs.
The decrease in the Medical-Surgical Products segment's gross margin was
primarily due to a shift in mix between distributed and self-manufactured
products, as well as competitive pressures in the latex glove business.
Competition in the cyclical exam gloves market has become focused on price
resulting in temporarily decreased margins for manufacturers.
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Selling, General and Administrative Expenses
Three Months Ended Six Months Ended
December 31, December 31,
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(As a percentage of operating revenue) 1999 1998 1999 1998
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Pharmaceutical Distribution 2.40% 2.70% 2.43% 2.69%
Pharmaceutical Services 16.90% 16.14% 16.90% 16.78%
Medical-Surgical Products 16.02% 17.46% 15.95% 17.07%
Total Company 6.64% 7.59% 6.67% 7.52%
- -------------------------------------------------------------------------------------------------------
The improvement in selling, general and administrative expenses as a
percentage of operating revenue for the three and six months ended December 31,
1999 reflects economies of scale associated with the Company's revenue growth,
as well as significant productivity gains resulting from continued cost control
efforts and the consolidation and selective automation of operating facilities.
In addition, the Company is continuing to take advantage of synergies from
recent acquisitions to decrease selling, general and administrative expenses as
a percentage of operating revenues. The 3% and 4% growth in selling, general and
administrative expenses experienced in the three and six months ended December
31, 1999, respectively, compared to the same period a year ago, was due
primarily to increases in personnel costs and depreciation expense, and compares
favorably to the 18% and 17% growth in operating revenue for the same respective
periods.
Merger-Related Costs. Costs of effecting mergers and subsequently integrating
the operations of the various merged companies are recorded as merger-related
costs when incurred. During the three and six months ended December 31, 1999,
merger-related costs totaling $5.5 million ($3.4 million, net of tax) and $42.3
million ($33.1 million, net of tax) were recorded, respectively. During the six
months ended December 31, 1999, approximately $31.6 million related to
transaction and employee-related costs associated with the ALP merger
transaction and $5.2 million related to exit and employee costs associated with
the Company's merger transaction with Allegiance Corporation ("Allegiance"), of
which $31.6 million and $4.3 million, respectively were recorded during the
first quarter of fiscal year 2000. In addition, $7.0 million was recorded
associated with the business restructuring as a result of the Company's merger
transaction with R.P. Scherer Corporation ("Scherer"), of which $6.9 million was
recorded during the first quarter of fiscal 2000. As part of the business
restructuring, the Company is currently closing certain facilities. In
connection with such closings, the Company has incurred employee-related costs,
asset impairment charges and exit costs related to the termination of contracts
and lease agreements. During the first six months of fiscal 2000, the Company
recorded costs of $8.8 million related to integrating the operations of
companies that previously engaged in merger transactions with the Company. Of
these integration costs, $4.3 million were recorded during the quarter ended
September 30, 1999. Partially offsetting the total charges recorded was a $10.3
million credit recorded in the first quarter of fiscal 2000 to adjust the
estimated transaction and employee-related costs previously recorded in
connection with the Allegiance merger transaction. Actual billings and
employee-related costs were less than the amounts originally anticipated,
resulting in a reduction of the merger-related costs.
During the three and six-month periods ended December 31, 1998,
merger-related costs totaled $3.1 million ($1.9 million, net of tax) and $37.5
million ($29.7 million, net of tax), respectively. Of the amount recorded, $22.3
million related to transaction and employee-related costs and $12.5 million
related to business restructuring and asset impairment costs associated with the
Company's merger transaction with Scherer. In addition, the Company recorded
costs of $1.1 million related to severance costs for a restructuring associated
with the change in management that resulted from the merger with Owen
Healthcare, Inc. and $4.8 million related to integrating the operations of
companies that previously engaged in merger transactions with the Company, of
which $1.8 million was recorded during the first quarter of fiscal 1999.
Partially offsetting the charge recorded was a $3.2 million credit, of which
$2.2 million was recorded during the first quarter of fiscal 1999, to adjust the
estimated transaction and termination costs previously recorded in connection
with the canceled merger transaction with Bergen Brunswig Corporation. The
actual billings for services provided by third parties engaged by the Company
were less than the estimate, resulting in a reduction of the merger-related
costs.
Since April 1998, ALP had been organized as an S-Corporation for tax
purposes. Accordingly, ALP was not subject to federal income tax from April 1998
up to the date that the ALP merger transaction was consummated. For the quarter
and six months ended December 31, 1998, net earnings would have been reduced by
$2.8 million and $4.3 million, respectively, if ALP had been subject to federal
income taxes.
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The net of tax effect of the various merger-related costs recorded and pro
forma adjustments related to ALP taxes during the three months ended December
31, 1999 and 1998 was to reduce net earnings by $3.4 million to $173.5 million
and to increase net earnings by $0.9 million to $141.5 million, respectively,
and to reduce reported diluted earnings per Common Share by $0.01 per share to
$0.61 per share and to increase reported diluted earnings per Common Share by
$0.01 per share to $0.50 per share, respectively. The net of tax effect of the
various merger-related costs recorded and pro forma adjustments related to ALP
taxes during the six months ended December 31, 1999 and 1998 was to reduce net
earnings by $33.1 million to $295.5 million and by $25.4 million to $236.2
million, respectively, and to reduce reported diluted earnings per Common Share
by $0.12 per share to $1.03 per share and by $0.09 per share to $0.83 per share,
respectively.
The Company estimates that it will incur additional merger-related costs
associated with the various mergers it has completed to date (primarily related
to the Scherer, Allegiance and ALP mergers) of approximately $91.8 million
($58.4 million, net of tax) in future periods (primarily fiscal 2000 and 2001)
related to the exit of contractual arrangements, employee-related costs, and
costs to properly integrate operations and implement efficiencies. Such amounts
will be charged to expense when incurred.
Provision for Income Taxes. The Company's provision for income taxes
relative to pre-tax earnings was 37% and 36% for the second quarter of fiscal
2000 and 1999, respectively. The increase in the effective tax rate for the
second quarter over the corresponding period of prior year is due primarily to
nondeductible items associated with the current year's business combinations and
the change in ALP tax status (see Note 5 to the "Notes to Condensed Consolidated
Financial Statements"). For the six-month periods ended December 31, 1999 and
1998, the Company's income tax provision as a percentage of pre-tax earnings was
38% for both periods.
LIQUIDITY AND CAPITAL RESOURCES
Working capital increased to $2.8 billion at December 31, 1999 from $2.2
billion at June 30, 1999. This increase from June 30, 1999 included additional
investments in inventories and trade receivables of $1.1 billion and $285.7
million, respectively. Offsetting the increases in working capital was an
increase in accounts payable of $663.4 million. The Company's inventory levels
have risen due to the higher volume of current and anticipated business in
pharmaceutical distribution activities. In addition, the Company invested in
supplemental inventory to cover possible year 2000 issues. A portion of the
inventory increase can also be attributed to the Company investing in
inventories in conjunction with various vendor-margin programs. The increase in
trade receivables is consistent with the Company's operating revenue growth (see
"Operating Revenue" above) and the change in accounts payable is due primarily
to the timing of inventory purchases and related payments.
The Company has a commercial paper program, providing for the issuance of
up to $750 million in aggregate maturity value of commercial paper. At December
31, 1999, commercial paper with an effective interest rate of 5.78% and an
aggregate maturity value of $629.9 million was outstanding. At June 30, 1999,
the outstanding commercial paper balance was $49.2 million with an effective
interest rate of 4.82%.
Property and equipment, at cost, increased by $105.6 million from June 30,
1999. The increase was primarily due to ongoing plant expansion and
manufacturing equipment purchases in certain service businesses, as well as
additional investments made for management information systems and upgrades to
distribution facilities.
Shareholders' equity increased to $3.9 billion at December 31, 1999 from
$3.6 billion at June 30, 1999, primarily due to net earnings of $295.5 million
and the investment of $20.6 million by employees of the Company through various
stock incentive plans which are offset by dividends of $14.1 million and a $22.3
million payment related to the repurchase of ALP common shares.
The Company believes that it has adequate capital resources at its disposal
to fund currently anticipated capital expenditures, business growth and
expansion, and current and projected debt service requirements. See "Other"
below.
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OTHER
Year 2000 Project. The Company utilizes computer technologies in each of
its businesses to effectively carry out its day-to-day operations. Computer
technologies include both information technology in the form of hardware and
software, as well as embedded technology in the Company's facilities and
equipment. Similar to most companies, the Company had to determine whether its
systems were capable of recognizing and processing date sensitive information
properly in the year 2000. The Company's year 2000 plan was described in the
Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1999.
The Company believes it has been able to modify, replace, or mitigate its
affected systems in time to avoid any material detrimental impact on its
operations. In addition, the Company has taken steps to monitor the progress
made by significant suppliers, customers and critical business partners, and has
tested critical interfaces for the year 2000 readiness. While the Company is not
presently aware of any significant probability that its systems have not been
properly remediated, there can be no assurances that contingency plans will
sufficiently mitigate the risk of an unanticipated year 2000 readiness problem
Since the initiation of the year 2000 project, the Company estimates that
it has incurred costs of approximately $26.4 million of which approximately $7.6
million represented incremental costs.
To date, the Company has not experienced any significant year 2000 related
system failures nor, to its knowledge, have any of its significant suppliers and
customers.
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company believes there has been no material change in its exposure to
market risk from that discussed in the Company's Form 10-K for the fiscal year
ended June 30, 1999.
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15
PART II. OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS
The following disclosure should be read together with the disclosure set
forth in the Company's Form 10-K for the fiscal year ended June 30, 1999, and to
the extent any such statements constitute "forward looking statements" reference
is made to Exhibit 99.01 of this Form 10-Q.
In November 1993, the Company and Whitmire Distribution Corporation
("Whitmire"), one of the Company's wholly-owned subsidiaries, as well as other
pharmaceutical wholesalers, were named as defendants in a series of purported
class action lawsuits which were later consolidated and transferred by the
Judicial Panel for Multi-District Litigation to the United States District Court
for the Northern District of Illinois. Subsequent to the consolidation, a new
consolidated complaint was filed which included allegations that the wholesaler
defendants, including the Company and Whitmire, conspired with manufacturers to
inflate prices using a chargeback pricing system. The wholesaler defendants,
including the Company and Whitmire, entered into a Judgment Sharing Agreement
whereby the total exposure for the Company and its subsidiaries is limited to
$1,000,000 or 1% of any judgment against the wholesalers and the manufacturers,
whichever is less, and provided for a reimbursement mechanism for legal fees and
expenses. The trial of the class action lawsuit began on September 23, 1998. On
November 19, 1998, after the close of plaintiffs' case-in-chief, both the
wholesaler defendants and the manufacturer defendants moved for judgment as a
matter of law in their favor. On November 30, 1998, the Court granted both of
these motions and ordered judgment as a matter of law in favor of both the
wholesaler defendants and the manufacturer defendants. On January 25, 1999, the
class plaintiffs filed a notice of appeal of the District Court's decision with
the Court of Appeals for the Seventh Circuit. On July 13, 1999, the Court of
Appeals for the Seventh Circuit issued its decision, which, in part, affirmed
the dismissal of the wholesaler defendants, including the Company and Whitmire.
On July 27, 1999, the class plaintiffs filed a Petition for Rehearing with the
Court of Appeals for the Seventh Circuit, which was denied. On November 5, 1999,
the class plaintiffs filed a petition for writ of certiorari with the United
States Supreme Court. In addition to the federal court cases described above,
the Company and Whitmire have also been named as defendants in a series of
related antitrust lawsuits brought by chain drug stores and independent
pharmacies who opted out of the federal class action lawsuits, and in a series
of state court cases alleging similar claims under various state laws regarding
the sale of brand name prescription drugs. The Judgment Sharing Agreement
mentioned above also covers these litigation matters.
On September 30, 1996, Baxter International, Inc. ("Baxter") and its
subsidiaries transferred to Allegiance and its subsidiaries their U.S.
health-care distribution business, surgical and respiratory therapy business and
health-care cost-saving business, as well as certain foreign operations (the
"Allegiance Business") in connection with a spin-off of the Allegiance Business
by Baxter. In connection with this spin-off, Allegiance, which merged with the
Company on February 3, 1999, assumed the defense of litigation involving claims
related to the Allegiance Business from Baxter Healthcare Corporation ("BHC"),
including certain claims of alleged personal injuries as a result of exposure to
natural rubber latex gloves described below. Allegiance will be defending and
indemnifying BHC, as contemplated by the agreements between Baxter and
Allegiance, for all expenses and potential liabilities associated with claims
pertaining to the litigation assumed by Allegiance. As of December 31, 1999,
there were approximately 486 lawsuits involving BHC and/or Allegiance containing
allegations of sensitization to natural rubber latex products. Since none of
these cases has proceeded to a hearing on the merits, the Company is unable to
evaluate the extent of any potential liability, and unable to estimate any
potential loss. Because of the increase in claims filed and the ongoing defense
costs that will be incurred, the Company believes it is probable that it will
continue to incur significant expenses related to the defense of cases involving
natural rubber latex gloves. The Company believes a substantial portion of any
potential liability and defense costs, excluding defense costs already reserved,
relating to natural latex gloves cases and claims will be covered by insurance,
subject to self-insurance retentions, exclusions, conditions, coverage gaps,
policy limits and insurer solvency.
The Company also becomes involved from time-to-time in other litigation
(including environmental matters) incidental to its business. Although the
ultimate resolution of the litigation referenced in this Item 1 cannot be
forecast with certainty, the Company does not believe that the outcome of these
lawsuits would have a material adverse effect on the Company's consolidated
financial statements.
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ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
(a) Registrant's 1999 Annual Meeting of Shareholders was held on November
3, 1999.
(b) Proxies were solicited by Registrant's management pursuant to
Regulation 14A under the Securities Exchange Act of 1934; there was no
solicitation in opposition to management's nominees as listed in the
proxy statement; and all director nominees were elected to the class
indicated in the proxy statement pursuant to the vote of the
Registrant's shareholders.
(c) Matters voted upon at the Annual Meeting were as follows:
(i) Election of Regina E. Herzlinger, John C. Kane, J. Michael
Losh, John B. McCoy, and Michael D. O'Halleran. The results of
the shareholder vote were as follows: Mrs. Herzlinger -
242,017,803 for, 0 against, 2,295,079 withheld, and 0 broker
non-votes; Mr. Kane - 241,998,472 for, 0 against, 2,314,410
withheld, and 0 broker non-votes; Mr. Losh - 242,075,613 for,
0 against, 2,237,269 withheld, and 0 broker non-votes; Mr.
McCoy - 242,016,568 for, 0 against, 2,296,314 withheld, and 0
broker non-votes; Mr. O'Halleran - 242,030,618 for, 0 against,
2,282,264 withheld, and 0 broker non-votes.
(ii) Adoption of the Cardinal Health, Inc. Employee Stock Purchase
Plan pursuant to Section 423(b) of the Internal Revenue Code.
The results of the shareholder vote were as follows:
241,021,665 for, 2,874,793 against, 416,424 withheld, and 0
broker non-votes.
(iii) Re-approval of the Performance Goals under the Cardinal
Health, Inc. Equity Incentive Plan relating to Section 162(m)
of the Internal Revenue Code. The results of the shareholder
vote were as follows: 238,733,365 for, 4,833,411 against,
746,106 withheld, and 0 broker non-votes.
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K:
(a) Listing of Exhibits:
Exhibit
Number Exhibit Description
------ -------------------
10.01 Employment Agreement between Stephen S. Thomas and the
Registrant*
27.01 Financial Data Schedule - Six months ended December 31, 1999
27.02 Financial Data Schedule - Six months ended December 31, 1998
99.01 Statement Regarding Forward-Looking Information
- --------------
* Management contract or compensation plan or arrangement
(b) Reports on Form 8-K:
None.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CARDINAL HEALTH, INC.
Date: February 11, 2000 By: /s/ Robert D. Walter
------------------------------------
Robert D. Walter
Chairman and Chief Executive Officer
By: /s/ Richard J. Miller
------------------------------------
Richard J. Miller
Executive Vice President and Chief
Financial Officer
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