UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
þ | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended June 30, 2012
or
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission File Number: 1-11373
CARDINAL HEALTH, INC.
(Exact name of registrant as specified in its charter)
OHIO | 31-0958666 |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
7000 CARDINAL PLACE, DUBLIN, OHIO | 43017 |
(Address of principal executive offices) | (Zip Code) |
(614) 757-5000
Registrant’s telephone number, including area code
Securities registered pursuant to Section 12(b) of the Act:
Title of Class | Name of Each Exchange on Which Registered |
COMMON SHARES (WITHOUT PAR VALUE) | NEW YORK STOCK EXCHANGE |
Securities registered pursuant to Section 12(g) of the Act:
None.
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes þ No ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No þ
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 þ No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer þ | Accelerated filer ¨ |
Non-accelerated filer ¨ (Do not check if a smaller reporting company) | Smaller reporting company ¨ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No þ
The aggregate market value of voting stock held by non-affiliates of the registrant on December 31, 2011, based on the closing price on December 31, 2011, was $14,015,438,147.
The number of registrant’s Common Shares outstanding as of August 15, 2012, was as follows: Common Shares, without par value: 341,083,853.
Documents Incorporated by Reference:
Portions of the registrant’s Definitive Proxy Statement to be filed for its 2012 Annual Meeting of Shareholders are incorporated by reference into Part III of this Annual Report on Form 10-K.
Table of Contents
Item | Page | |
Part I | ||
1 | ||
1A. | ||
1B. | ||
2 | ||
3 | ||
4 | ||
Part II | ||
5 | ||
6 | ||
7 | ||
7A. | ||
8 | ||
9 | ||
9A. | ||
9B. | ||
Part III | ||
10 | ||
11 | ||
12 | ||
13 | ||
14 | ||
Part IV | ||
15 | ||
Important Information Regarding Forward-Looking Statements
This Form 10-K (including information incorporated by reference) includes forward-looking statements, addressing expectations, prospects, estimates and other matters that are dependent upon future events or developments. Many forward-looking statements appear in “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations,” but there are others throughout this document, which may be identified by words such as “expect,” “anticipate,” “intend,” “plan,” “believe,” “will,” “should,” “could,” “would,” “project,” “continue,” “likely,” and similar expressions, and
include statements reflecting future results or guidance, statements of outlook and expense accruals. These matters are subject to risks and uncertainties that could cause actual results to differ materially from those projected, anticipated or implied. The most significant of these risks and uncertainties are described below in “Item 1A—Risk Factors” and in Exhibit 99.1 to this Form 10-K. Forward-looking statements in this document speak only as of the date of this document. Except to the extent required by applicable law, we undertake no obligation to update or revise any forward-looking statement.
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Part I
Item 1: Business
General
Cardinal Health, Inc. is an Ohio corporation formed in 1979. As used in this report, “we,” “our,” “us” and similar pronouns refer to Cardinal Health, Inc. and its subsidiaries, unless the context requires otherwise. We are a healthcare services company providing pharmaceutical and medical products and services that help pharmacies, hospitals, surgery centers, physician offices and other healthcare providers focus on patient care while reducing costs, enhancing efficiency and improving quality.
Our fiscal year ends on June 30. References to fiscal 2012, 2011 and 2010 are to the fiscal years ended June 30, 2012, 2011 and 2010, respectively. Except as otherwise specified, information in this Form 10-K is provided as of June 30, 2012.
Pharmaceutical Segment
In the United States, including Puerto Rico, the Pharmaceutical segment:
• | distributes branded and generic pharmaceutical, over-the-counter healthcare, and consumer products through its pharmaceutical distribution business to retailers (including chain and independent drug stores and pharmacy departments of supermarkets and mass merchandisers), hospitals, and other healthcare providers (including mail order pharmacies). This business: |
• | maintains prime vendor relationships that streamline the purchasing process resulting in greater efficiency and lower costs for our customers; and |
• | renders services to pharmaceutical manufacturers including distribution, inventory management, data reporting, new product launch support, and contract pricing and chargeback administration. |
• | operates nuclear pharmacies and cyclotron facilities that manufacture, prepare and deliver radiopharmaceuticals for use in nuclear imaging and other procedures in hospitals and clinics; |
• | distributes specialty pharmaceutical products and provides services to pharmaceutical manufacturers, third-party payors and healthcare service providers supporting the marketing, distribution, and payment for specialty pharmaceutical products; |
• | franchises retail pharmacies under the Medicine Shoppe® and Medicap® brands; and |
• | provides pharmacy services to hospitals and other healthcare facilities. |
In China, the Pharmaceutical segment distributes branded, generic and specialty pharmaceuticals, over-the-counter and consumer products as well as provides logistics, marketing and other services through Cardinal Health China.
Pharmaceutical Distribution
Our pharmaceutical distribution business generates gross margin primarily when the aggregate selling price to our customers exceeds the aggregate cost of products sold, net of cash discounts, generic manufacturer margin and margin under branded pharmaceutical agreements. Cash discounts are price reductions that manufacturers may offer to us for prompt payment of purchased products. Generic manufacturer margin refers to price discounts, rebates and other consideration that we receive under our agreements with manufacturers of generic pharmaceuticals. Our earnings on generic pharmaceuticals are generally highest during the period immediately following the initial launch of a generic product because generic pharmaceutical selling prices are generally highest during that period and tend to decline over time, although this may vary. Margin under branded pharmaceutical agreements refers primarily to fees we receive for rendering a range of distribution and related services to manufacturers. In addition, margin under branded pharmaceutical agreements may include benefits from pharmaceutical price appreciation, which occurs when a manufacturer increases its published price for a product after we have purchased that product for inventory.
Bulk and Non-Bulk Sales
The Pharmaceutical segment differentiates between bulk and non-bulk sales based on the nature of our customers’ operations. Bulk sales consist of sales to retail chain customers’ centralized warehouse operations and customers’ mail order businesses in the United States. All other sales are classified as non-bulk. Sales to a retail chain pharmacy customer are classified as bulk sales with respect to its warehouse operations and non-bulk sales with respect to its retail stores.
Substantially all bulk sales consist of products shipped in the same form that we receive them from the manufacturer; a small portion of bulk sales are broken down into smaller units prior to shipping. In contrast, non-bulk sales require more complex servicing. For non-bulk sales, we may receive inventory in large or full case quantities and break it down into smaller quantities, warehouse the product for a longer period of time, pick individual products specific to a customer’s order, and deliver that smaller order to a customer location.
Bulk sales generate significantly lower segment profit as a percentage of revenue than non-bulk sales. Customers receive lower pricing on bulk sales of the same products than non-bulk sales, as bulk sales require less services to be provided to these customers, and hence, less costs are incurred by us in providing these products. In addition, bulk sales in aggregate generate higher segment cost of products sold as a percentage of revenue than non-bulk sales, due to the mix of products sold within the bulk category. Segment distribution, selling, general and administrative (“SG&A”) expenses as a percentage of revenue from bulk sales are substantially lower than from non-bulk sales because bulk sales require substantially fewer services to be rendered by us than non-bulk sales.
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The following table shows the revenues, segment expenses, segment profit and segment profit as a percentage of revenue for bulk and non-bulk sales for fiscal 2012, 2011 and 2010.
(in millions) | 2012 | 2011 | 2010 | ||||||||
Non-bulk sales: | |||||||||||
Revenue from non-bulk sales | $ | 57,738 | $ | 51,816 | $ | 45,795 | |||||
Segment expenses allocated to non-bulk sales (1) | 56,334 | 50,622 | 44,899 | ||||||||
Segment profit from non-bulk sales (1) | $ | 1,404 | $ | 1,194 | $ | 896 | |||||
Segment profit from non-bulk sales as a percentage of revenue from non-bulk sales (1) | 2.43 | % | 2.31 | % | 1.96 | % | |||||
Bulk sales: | |||||||||||
Revenue from bulk sales | $ | 40,187 | $ | 41,928 | $ | 43,995 | |||||
Segment expenses allocated to bulk sales (1) | 40,033 | 41,793 | 43,880 | ||||||||
Segment profit from bulk sales (1) | $ | 154 | $ | 135 | $ | 115 | |||||
Segment profit from bulk sales as a percentage of revenue from bulk sales (1) | 0.38 | % | 0.32 | % | 0.26 | % | |||||
(1) | Segment expenses and profit required complex and subjective estimates and allocations based upon assumptions, past experience and judgment that we believe are reasonable. |
Specialty Pharmaceutical Products and Services
We refer to products and services offered by our specialty solutions division as “specialty pharmaceutical products and services.” The specialty solutions division currently (1) distributes oncology, rheumatology and other pharmaceutical products to physician offices; (2) distributes human plasma products and some limited-distribution pharmaceutical products to hospitals and other healthcare providers; and (3) provides various consulting and other services to pharmaceutical manufacturers, third-party payors and healthcare providers primarily supporting the marketing, distribution and payment for these products. Our use of this terminology may not be comparable to the use by other industry participants.
Pharmaceutical Segment Financials
See Note 15 of the “Notes to Consolidated Financial Statements” for Pharmaceutical segment revenue, profit and assets for fiscal 2012, 2011 and 2010.
Medical Segment
The Medical segment distributes a broad range of medical, surgical and laboratory products to hospitals, surgery centers, laboratories, physician offices and other healthcare providers in the United States, Canada and China. This segment also manufactures, sources and develops its own line of private brand medical and surgical products. Manufactured products include: single-use surgical drapes, gowns and apparel; exam and surgical gloves; and fluid suction and collection systems. The segment also offers sterile and non-sterile procedure
kits. Our manufactured products are sold directly or through third-party distributors in the United States, Canada, Europe, South America and the Asia/Pacific region. In addition, the segment provides supply chain services, including spend management, distribution management, and inventory management services, to healthcare providers.
Medical Segment Financials
See Note 15 of the “Notes to Consolidated Financial Statements” for Medical segment revenue, profit and assets for fiscal 2012, 2011 and 2010.
Acquisitions and Divestitures
In the past five fiscal years, we completed the following three significant acquisitions apart from businesses spun-off as part of CareFusion Corporation (“CareFusion”), as presented below.
Date | Company | Location | Line of Business | Acquisition Price (in millions) | |||
July 15, 2010 | Healthcare Solutions Holding, LCC ("P4 Healthcare") | Ellicott City, Maryland | Specialty pharmaceutical services | $ 598 (1) | |||
November 29, 2010 | Cardinal Health China | Shanghai, China | Pharmaceutical and medical products distribution | 458 (2) | |||
December 21, 2010 | Kinray, Inc. (“Kinray”) | Whitestone, New York | Pharmaceutical, generic, health and beauty, and home health care products distribution | 1,336 | |||
(1) | Includes $506 million in cash and $92 million for the acquisition date fair value of contingent consideration to be paid for the acquisition. We made cash payments of $14 million pursuant to the contingent consideration obligation, which included $10 million paid in fiscal 2011 and $4 million paid in July 2012 to settle the obligation. |
(2) | Includes the assumption of approximately $57 million in debt. |
In addition, we completed several smaller acquisitions during the last five fiscal years, including purchasing Borschow Hospital & Medical Supplies, Inc. in fiscal 2009 and Futuremed Healthcare Products Corporation in fiscal 2012.
During the past five fiscal years, we also completed several divestitures, including selling our United Kingdom-based Martindale injectable manufacturing business in fiscal 2010. In addition, effective August 31, 2009, we separated our clinical and medical products businesses through distribution to our shareholders of 81 percent of the then outstanding common stock of CareFusion (the “Spin-Off”). During fiscal 2010, we disposed of 11 million shares of CareFusion common stock, and during fiscal 2011, we disposed of the remaining 30 million shares. Enturia Inc., a significant acquisition that was made in fiscal 2008, was spun-off as part of CareFusion.
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Customers
Our largest customers, CVS Caremark Corporation (“CVS”) and Walgreen Co. (“Walgreens”), accounted for approximately 22 percent and 21 percent, respectively, of our fiscal 2012 revenue. The aggregate of our five largest customers, including CVS and Walgreens, accounted for approximately 59 percent of our fiscal 2012 revenue. Our contracts with CVS and Walgreens are currently scheduled to expire in June 2013 and August 2013, respectively. In August 2012, Walgreens issued a request for proposal for pharmaceutical distribution services for the three-year period beginning after the expiration of our contract with Walgreens. In the ordinary course of our business, we frequently are in a competitive bid, or request for proposal, process for pharmaceutical distribution and other business of a customer or potential customer.
In April 2012, Express Scripts, Inc., one of our pharmaceutical distribution customers, merged with Medco Health Solutions, Inc., which was a pharmaceutical distribution customer of a competitor. In April 2012, the combined company issued a request for proposal for its combined pharmaceutical distribution business. In July, 2012, Express Scripts, Inc. informed us that it had not awarded the combined contract to us. Our current pharmaceutical distribution contract with Express Scripts, Inc. expires on September 30, 2012 and provided approximately $9.0 billion of revenue in fiscal 2012, all of which is classified as bulk sales. Express Scripts, Inc. was our third largest customer in fiscal 2012.
In addition, we have agreements with group purchasing organizations (“GPOs”) that act as agents to negotiate vendor contracts on behalf of their members. Our two largest GPO relationships in terms of member revenue are with Novation, LLC, and Premier Purchasing Partners, L.P. Sales to members of these two GPOs collectively accounted for 13 percent of our revenue in fiscal 2012.
Suppliers
We rely on many different suppliers. Products obtained from our five largest suppliers accounted for an aggregate of approximately 28 percent of our revenue during fiscal 2012, but no single supplier’s products accounted for more than 7 percent of that revenue. Overall, we believe our relationships with our suppliers are good.
The Pharmaceutical distribution business is a party to distribution service agreements with pharmaceutical manufacturers. These agreements generally have terms ranging from one year, with an automatic renewal feature, to five years. Generally, these agreements are terminable before they expire only if the parties mutually agree, if there is an uncured breach of the agreement, or if one party is the subject of a bankruptcy filing or similar insolvency event. Some agreements allow the manufacturer to terminate the agreement without cause within a defined notice period.
Competition
We operate in a highly competitive environment in the distribution of pharmaceuticals and related healthcare services. We also operate in a highly competitive environment in the development, manufacturing and distribution of medical and surgical products. We compete on many levels, including service offerings, support services, breadth of product lines, and price.
In the Pharmaceutical segment, we compete with national, full-line wholesale distributors (including McKesson Corporation and AmerisourceBergen Corporation), regional wholesale distributors (including H.D. Smith and Morris & Dickson Co., L.L.C.), self-warehousing chains, direct selling manufacturers, specialty distributors, third-party logistics companies (including United Parcel Service, Inc.), and nuclear pharmacies, among others. In addition, the Pharmaceutical segment has experienced competition from a number of organizations offering generic pharmaceuticals, including telemarketers.
In the Medical segment, we compete with many different distributors, including Owens & Minor, Inc., Thermo Fisher Scientific Inc., PSS World Medical, Inc., Henry Schein, Inc., and Medline Industries, Inc. In addition, we compete with regional medical products distributors, third-party logistics companies and manufacturers’ direct distribution. Competitors of the Medical segment’s manufacturing and procedural kit businesses include Kimberly-Clark Corporation, Ansell Limited, DeRoyal Industries Inc., Medline Industries, Inc., Professional Hospital Supply and Medical Action Industries.
Employees
As of June 30, 2012, we had approximately 23,300 employees in the United States and approximately 9,200 employees outside of the United States. Overall, we consider our employee relations to be good.
Intellectual Property
We rely on a combination of trade secret, patent, copyright and trademark laws, nondisclosure and other contractual provisions, and technical measures to protect our products, services and intangible assets. We hold patents relating to the distribution of our nuclear pharmacy products and service offerings, and relating to medical and surgical products, such as fluid suction and irrigation devices; surgical waste management systems; surgical and medical examination gloves; surgical drapes, gowns and facial protection products; and patient temperature management products. We also operate under licenses for certain proprietary technologies, and in certain instances we license our technologies to third parties.
We believe that we have taken all necessary steps to protect our proprietary rights, but no assurance can be given that we will be able to successfully enforce or protect our rights in the event that they are subject to third-party infringement claims. While all of these proprietary rights are important to our operations, we do not consider any particular patent, trademark, license, franchise or concession to be material to our overall business.
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Regulatory Matters
Our business is highly regulated in the United States at both the federal and state level and in foreign countries. Depending upon their specific business, our subsidiaries may be subject to regulation by government entities including:
• | the United States Food and Drug Administration (the “FDA”); |
• | the United States Drug Enforcement Administration (the “DEA”); |
• | the United States Nuclear Regulatory Commission (the “NRC”); |
• | the United States Department of Health and Human Services (“HHS”); |
• | United States Customs and Border Protection; |
• | state boards of pharmacy; |
• | state-controlled substance agencies; |
• | state health departments, insurance departments or other comparable state agencies; and |
• | foreign agencies that are comparable to those listed above. |
These regulatory agencies have a variety of civil, administrative and criminal sanctions at their disposal. They can suspend our ability to distribute products or can initiate product recalls; they can seize products or impose criminal, civil and administrative sanctions; and they can seek injunctions to halt the manufacture and distribution of products.
Distribution
The FDA, DEA and various state authorities regulate the marketing, purchase, storage and distribution of pharmaceutical and medical products under various state and federal statutes including the Prescription Drug Marketing Act of 1987 and the Federal Controlled Substances Act (the "CSA"). Wholesale distributors of controlled substances must hold valid DEA registrations and state-level licenses, meet various security and operating standards, and comply with the CSA which governs the sale, packaging, storage and distribution of controlled substances. As further discussed in Note 9 of the "Notes to Consolidated Financial Statements", on May 14, 2012, we entered into a settlement agreement with the DEA pursuant to which our Lakeland, Florida pharmaceutical distribution center's registration to distribute controlled substances will be suspended until May 15, 2014. During this suspension, our Lakeland facility will continue to distribute pharmaceutical products (other than controlled substances) while controlled substances will be shipped to customers from our other distribution centers.
Our Pharmaceutical segment’s China distribution operations are subject to similar national, regional and local regulations, including licensing and regulatory requirements of the China Ministry of Health, Ministry of Commerce, Ministry of Finance, the State Food and Drug Administration and the General Administration of Customs.
Manufacturing and Marketing
Our subsidiaries that manufacture and source medical devices are subject to regulation by the FDA and comparable foreign agencies including regulations regarding compliance with good manufacturing practices and quality systems.
The FDA and other domestic and foreign governmental agencies administer requirements that cover the design, testing, safety, effectiveness, manufacturing, labeling, promotion and advertising, distribution, importation and post-market surveillance of some of our manufactured products. We need specific approval or clearance from regulatory authorities before we can market and sell many of our products in particular countries. Even after we obtain approval or clearance to market a product, the product and our manufacturing processes are subject to continued regulatory review.
To assess and facilitate compliance with federal, state and foreign regulatory requirements, we routinely review our quality and compliance systems to evaluate their effectiveness and to identify areas for improvement or remediation. As part of our quality review, we assess the suppliers of raw materials, components and finished goods that are incorporated into the medical devices we manufacture. In addition, we conduct quality management reviews designed to highlight key issues that may affect the quality of our products and services.
From time to time, we may determine that products we manufacture or market do not meet our specifications, regulatory requirements, or published standards. When we or a regulatory agency identify a quality or regulatory issue, we investigate and take appropriate corrective action, such as withdrawing the product from the market, correcting the product at the customer location, revising product labeling, and notifying customers. For example, in August 2011, the FDA notified us that it was halting entry into the United States of all Presource® procedure kits that we assemble in Mexico and import through El Paso, Texas. The FDA indicated that we had not supplied adequate documentary support for certain components of these procedure kits, but did not indicate any concerns about patient safety. In response to the FDA's concerns we took remedial actions and have resumed importing procedure kits.
Nuclear Pharmacies and Related Businesses
Our nuclear pharmacies and cyclotron facilities require licenses or permits and must abide by regulations from the NRC, applicable state boards of pharmacy, and the radiologic health agency or department of health of each state in which we operate. In addition, our cyclotron facilities must comply with the FDA's good manufacturing practices regulations for positron emission tomography (“PET”) drugs that became effective in December 2011.
Prescription Drug Pedigree Tracking and Supply Chain Integrity
The FDA Amendments Act of 2007 requires the FDA to establish standards to identify and validate technologies for securing the pharmaceutical supply chain against counterfeit drugs. These standards may include track-and-trace or authentication technologies, such as radio frequency identification devices. In March 2010, the FDA issued guidance establishing standardized numerical identifiers for prescription pharmaceutical packages. Some states also have adopted or are considering adopting pedigree tracking laws. For example, effective July 2016, California will require that pharmaceutical wholesalers and repackagers implement electronic track-and-trace capabilities for pharmaceutical products.
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Healthcare Fraud and Abuse Laws
We are subject to healthcare fraud and abuse laws. These laws generally prohibit companies from soliciting, offering, receiving or paying any compensation in order to induce someone to order or purchase items or services that are in any way paid for by Medicare, Medicaid or other United States government-sponsored healthcare programs. They also prohibit submitting or causing to be submitted any fraudulent claim for payment by the federal government. Violations of these laws may result in criminal or civil penalties, as well as claims under the federal False Claims Act and similar state acts under which private persons may file suit on behalf of the federal and state governments.
Health and Personal Information Practices
Services and products provided by some of our businesses, including some provided by our nuclear and pharmacy services and specialty solutions divisions, involve access to patient-identifiable healthcare information. The Health Insurance Portability and Accountability Act of 1996, as augmented by the Health Information Technology for Economic and Clinical Health Act, as well as some state laws, regulate the use and disclosure of patient identifiable health information, including requiring specified privacy and security measures. Federal and state officials have increasingly focused on how patient-identifiable healthcare information should be handled, secured and disclosed.
Some of our businesses collect and maintain other sensitive personal information that is subject to federal and state laws protecting such information. Security and disclosure of personal information is also highly regulated in many other countries in which we operate.
Environmental, Health and Safety Laws
In the United States and other countries, we are subject to various federal, state and local environmental laws, as well as laws relating to safe working conditions, laboratory and manufacturing practices.
Laws Relating to Foreign Trade and Operations
United States and international laws require us to abide by standards relating to the import and export of finished goods, raw materials and supplies and the handling of information. We also must comply with various export control and trade embargo laws, which may require licenses or other authorizations for transactions within some countries or with some counterparties.
Similarly, we are subject to laws concerning the conduct of our foreign operations, including the United States Foreign Corrupt Practices Act and foreign anti-bribery laws. These laws generally prohibit companies and their intermediaries from offering, promising or making payments to officials of foreign governments for the purpose of obtaining or retaining business.
Other Information
Although our agreements with manufacturers sometimes require us to maintain inventory levels within specified ranges, our distribution businesses are generally not required by our customers to maintain particular inventory levels other than as needed to meet service level requirements. Certain supply contracts with United States government entities require us to maintain sufficient inventory to meet emergency demands, but we do not believe those requirements materially affect inventory levels.
Our customer return policies generally require that the product be physically returned, subject to restocking fees. We only allow customers to return products that can be added back to inventory and resold at full value, or that can be returned to vendors for credit.
We offer market payment terms to our customers.
Revenue and Long-Lived Assets by Geographic Area
See Note 15 of the “Notes to Consolidated Financial Statements” for revenue and long-lived assets by geographic area.
Available Information
Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports are available free of charge on our website (www.cardinalhealth.com), under the “Investors—Financial information—SEC filings” caption, as soon as reasonably practicable after we electronically file them with, or furnish them to, the Securities and Exchange Commission (the “SEC”).
You may read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains a website (www.sec.gov) where you can search for annual, quarterly and current reports, proxy and information statements, and other information regarding us and other public companies.
Item 1A: Risk Factors
The risks described below could materially and adversely affect our results of operations, financial condition, liquidity and cash flows. These are not the only risks we face. Our businesses also could be affected by risks that we are not presently aware of or that we currently consider immaterial to our operations.
We could suffer the adverse effects of competitive pressures.
As described in greater detail in "Item 1-Business" above, we operate in markets that are highly competitive. Because of competition, our businesses face continued pricing pressure from our customers and suppliers. If we are unable to offset margin reductions caused by these pricing pressures through steps such as effective sourcing and enhanced cost control measures, our results of operations and financial condition could be adversely affected.
In addition, in recent years, the healthcare industry has continued to consolidate. Further consolidation among our customers and suppliers (including branded pharmaceutical manufacturers) could give the resulting enterprises greater bargaining power, which may adversely impact our results of operations.
We have a few large customers that generate a significant amount of our revenue.
Our sales and credit concentration is significant. CVS and Walgreens accounted for approximately 22 percent and 21 percent, respectively, of our fiscal 2012 revenue. The aggregate of our five largest customers, including CVS and Walgreens, accounted for approximately 59 percent of our fiscal 2012 revenue. In addition, Walgreens and CVS accounted for 25 percent and 19 percent,
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respectively, of our gross trade receivable balance at June 30, 2012. Our contracts with CVS and Walgreens are scheduled to expire in June 2013 and August 2013, respectively. If CVS, Walgreens or one of our other large customers terminates or does not renew its contract, defaults in payment, or significantly reduces its purchases of our products, our results of operations and financial condition could be adversely affected. For example, in July 2012, Express Scripts, Inc. informed us that it had not awarded us the combined pharmaceutical distribution contract following its merger with Medco Health Solutions, Inc. Our contract with Express Scripts, Inc. expires on September 30, 2012 and provided approximately $9.0 billion of revenue in fiscal 2012, all of which was classified as bulk sales. The expiration of that contract will have an adverse effect on our results of operations and operating cash flow.
Our Pharmaceutical segment's margin may be affected by fewer or less profitable generic pharmaceutical launches, prices established by manufacturers and other factors that are beyond our control.
As described in greater detail in "Item 1-Business" above, margin in our Pharmaceutical segment consists, in part, of generic manufacturer margin and margin from branded pharmaceutical price appreciation.
The number of new generic pharmaceutical launches varies from year to year, and the margin impact of new launches varies from product to product. Fewer generic pharmaceutical launches or launches that are less profitable than those previously experienced will have an adverse effect on our year-over-year margins. Additionally, prices for existing generic pharmaceuticals generally decline over time, although this may vary. Price deflation on existing generic pharmaceuticals will have an adverse effect on our margins.
With respect to branded pharmaceutical price appreciation, if branded manufacturers increase prices less frequently or by amounts smaller than have been experienced historically, we will earn less margin on branded pharmaceuticals.
The United States healthcare environment is changing in many ways, some of which may not be favorable to us, including changes resulting from federal healthcare legislation.
The healthcare industry continues to undergo significant changes designed to increase access to medical care, improve safety and contain costs. Medicare and Medicaid reimbursement levels have declined; the use of managed care has increased; distributors, manufacturers, healthcare providers and pharmacy chains have consolidated; and large purchasing groups are prevalent.
In March 2010, the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act (collectively the “Healthcare Reform Acts”) were enacted. Among other things, the Healthcare Reform Acts seek to expand health insurance coverage to over 30 million uninsured Americans. Many of the significant changes in the Healthcare Reform Acts do not take effect until 2014, including a requirement that most Americans carry health insurance. We expect expansion of access to health insurance to increase the demand for our products and services, but other provisions of the Healthcare Reform Acts could affect us adversely.
The Healthcare Reform Acts contain many provisions designed to generate the revenues necessary to fund the coverage expansions, including, as discussed in "Item 7-Management's Discussion and Analysis of Financial Condition and Results of Operations” below, a tax to be paid by medical device manufacturers.
In addition, the Healthcare Reform Acts have provisions designed to reduce costs of Medicare and Medicaid, including changing the federal upper payment limit for Medicaid reimbursement to no less than 175 percent of the average weighted manufacturer's price ("AMP") from 250 percent of the lowest AMP for generic pharmaceuticals. The Centers for Medicare and Medicaid Services is also considering providing states with alternatives to traditional reimbursement metrics.
We could be adversely affected directly or indirectly (if our customers are adversely affected) by these and other changes in the delivery or pricing of, or reimbursement for, pharmaceuticals, medical devices or healthcare services.
Our business is subject to rigorous regulatory and licensing requirements.
The healthcare industry is highly regulated. As described in greater detail in "Item 1-Business" above, we are subject to regulation in the United States at both the federal and state level and in foreign countries. In addition, the United States federal and state governments are devoting greater resources to the enforcement of these laws. If we fail to comply with these regulatory requirements, or if allegations are made that we fail to comply, our results of operations and financial condition could be adversely affected.
To lawfully operate our businesses, we are required to hold permits, licenses and other regulatory approvals from, and to comply with operating and security standards of, governmental bodies. Failure to maintain or renew necessary permits, licenses or approvals, or to comply with required standards, could have an adverse effect on our results of operations and financial condition. For example, see Note 9 of the "Notes to Consolidated Financial Statements" for a discussion of regulatory matters relating to our distribution of controlled substances.
Products that we manufacture, source, distribute or market are required to comply with regulatory requirements. Noncompliance or concerns over noncompliance may result in suspension of our ability to distribute, import or manufacture products, product recalls or seizures, or criminal and civil sanctions.
We are required to comply with laws relating to healthcare fraud and abuse. If we fail to comply with them, we could be subject to federal or state government investigations, or false claims act proceedings initiated by private parties, which could result in civil and criminal sanctions, including the loss of licenses or the ability to participate in Medicare, Medicaid and other federal and state healthcare programs. The requirements of these laws are complicated and subject to interpretation and may be applied by a regulator, prosecutor or judge in a manner that could negatively impact us or require us to change our operations.
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Our global operations are required to comply with the United States Foreign Corrupt Practices Act and similar anti-bribery laws in other jurisdictions and with United States and foreign export control, trade embargo and customs laws. If we fail to comply with them, we could suffer civil and criminal sanctions.
We could be subject to adverse changes in the tax laws or challenges to our tax positions.
We are a large multinational corporation with operations in the United States and many foreign countries. As a result, we are subject to the tax laws of many jurisdictions. From time to time, legislative initiatives are proposed, such as the repeal of last-in, first-out ("LIFO") treatment of inventory or the current U.S. taxation of income earned by foreign subsidiaries, that could adversely affect our tax positions, effective tax rate, tax payments or financial condition. Tax laws are extremely complex and subject to varying interpretations. Tax authorities have challenged some of our tax positions and it is possible that they will challenge others. These challenges may adversely affect our effective tax rate, tax payments or financial condition.
CareFusion may not satisfy its contractual obligations.
In August 2009, we entered into a tax matters agreement pursuant to which CareFusion is obligated to indemnify us for certain tax exposures and transaction taxes prior to the Spin-Off. The indemnification receivable was $265 million at June 30, 2012. The failure of CareFusion to perform its obligations under this agreement could have an adverse effect on our financial condition and results of operations.
The Spin-Off may have unexpected tax consequences.
In connection with the Spin-Off, we received a private letter ruling from the Internal Revenue Service (“IRS”) to the effect that the contribution by us of the assets of the clinical and medical products businesses to CareFusion and the distribution of CareFusion shares to our shareholders would qualify as a tax-free transaction under Sections 355 and 368(a)(1)(D) of the Internal Revenue Code (the “Code”). In addition, we received opinions of tax counsel to the effect that the Spin-Off would qualify as a transaction that is described in Sections 355(a) and 368(a)(1)(D) of the Code. The IRS private letter ruling and the opinions of counsel rely on certain facts, assumptions, representations and undertakings from us and CareFusion regarding the past and future conduct of the companies' respective businesses and other matters. If any of these facts, assumptions, representations or undertakings is incorrect or not otherwise satisfied, we and our shareholders may not be able to rely on the IRS ruling or the opinions of tax counsel. Similarly, the IRS could determine on audit that the Spin-Off is taxable if it determines that any of the facts, assumptions, representations or undertakings are not correct or have been violated or if the IRS disagrees with the conclusions in the opinions of counsel that are not covered by the private letter ruling or for other reasons. If the Spin-Off is determined to be taxable for United States federal income tax purposes, we and our shareholders that are subject to United States federal income tax could incur significant tax liabilities.
Our business and operations depend on the proper functioning of information systems and critical facilities.
We rely on information systems to obtain, rapidly process, analyze and manage data to:
• | facilitate the purchase and distribution of inventory items from numerous distribution centers; |
• | receive, process and ship orders on a timely basis; |
• | manage the accurate billing and collections for thousands of customers; |
• | process payments to suppliers; |
• | facilitate the manufacturing and assembly of medical products; and |
• | generate financial information. |
Our business also depends on the proper functioning of our critical facilities, including our national logistics center. Our results of operations could be adversely affected if these systems or facilities, or our customers' access to them, are interrupted, damaged by unforeseen events, cyber security incidents or other actions of third parties, or fail for any extended period of time. Any data security breach could adversely impact our operations, results of operations or our ability to satisfy legal requirements, including those related to patient-identifiable health information.
As further described below in "Item 9A-Controls and Procedures", the Medical segment has implemented a medical business transformation project, which includes a new information system for certain supply chain and financial processes. If the system fails to operate as intended, it could adversely affect Medical segment profit and the effectiveness of our internal control over financial reporting.
Because of the nature of our business, we may become involved in legal proceedings that could adversely impact our cash flows or results of operations.
Due to the nature of our businesses, which includes the manufacture and distribution of healthcare products, we may from time to time become involved in disputes or legal proceedings. For instance, some of the products we manufacture or distribute may be alleged to cause personal injury or violate the intellectual property rights of another party, subjecting us to product liability or infringement claims. While we generally obtain indemnity rights from the manufacturers of products we distribute and we carry product liability insurance, it is possible that liability from such claims could exceed those protections. Litigation is inherently unpredictable, and the unfavorable resolution of one or more of these legal proceedings could adversely affect our cash flows or results of operations.
Acquisitions are not always as successful as we expect them to be.
An important element of our growth strategy has been to acquire other businesses that expand or complement our existing businesses. Acquisitions involve risks: we may overpay for a business or fail to realize the synergies and other benefits we expect from the acquisition; or we may encounter unforeseen accounting, internal control, regulatory or compliance issues.
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We depend on certain suppliers to make their raw materials and products available to us and are subject to fluctuations in costs of raw materials and products.
We depend on the availability of various components, compounds, raw materials (including radioisotopes) and energy supplied by others for our operations. Any of our supplier relationships could be interrupted due to events beyond our control, including natural disasters, or could be terminated. A sustained supply interruption could have an adverse effect on our business.
Our manufacturing businesses use oil-based resins, cotton, latex, and other commodities as raw materials in many products. Prices of oil and gas also affect our distribution and transportation costs. Prices of these commodities are volatile and have fluctuated significantly in recent years, so costs to produce and distribute our products also have fluctuated. Due to competitive dynamics and contractual limitations, we may be unable to pass along cost increases through higher prices. If we cannot fully offset cost increases through other cost reductions, or recover these costs through price increases or surcharges, our results of operations could be adversely affected.
Our global operations are subject to economic, political and currency risks.
Our global operations are affected by local economic environments, including inflation, recession, currency volatility and competition. Political changes also can disrupt our global operations, as well as our customers and suppliers, in a particular location. We may not be able to hedge or obtain insurance to protect us against these risks, and any hedges or insurance may be expensive and may not successfully mitigate these risks.
Economic conditions may adversely affect demand for our products and services.
Deterioration in general economic conditions in the United States and other countries in which we do business could adversely affect the amount of prescriptions filled and the number of medical procedures undertaken and, therefore, reduce purchases of our products and services by our customers, which could adversely affect our results of operations.
Item 1B: Unresolved Staff Comments
Not applicable.
Item 2: Properties
In the United States, as of June 30, 2012, the Pharmaceutical segment operated 22 primary pharmaceutical distribution facilities and one national logistics center; four specialty distribution facilities; one specialty pharmacy and over 150 nuclear pharmacy laboratories, manufacturing and distribution facilities. The Medical segment operated over 50 medical-surgical distribution, assembly, manufacturing, and research operation facilities. Our United States operating facilities are located in 44 states and in Puerto Rico.
Outside the United States, as of June 30, 2012, our Pharmaceutical segment operated two nuclear pharmacy laboratories in Canada and our Medical segment operated over 20 facilities in Canada, the Dominican Republic, Malaysia, Malta, Mexico, and Thailand that
engage in manufacturing, distribution or research. In addition, our Pharmaceutical and Medical segments utilized various distribution facilities in China.
As of June 30, 2012, we owned over 70 operating facilities and leased more than 200 operating facilities. Our principal executive offices are headquartered in an owned building located at 7000 Cardinal Place in Dublin, Ohio.
We consider our operating properties to be in satisfactory condition and adequate to meet our present needs. However, we regularly evaluate operating properties and may make further additions and improvements or consolidate locations as we seek opportunities to expand our business.
Item 3: Legal Proceedings
In addition to the proceedings described below, the legal proceedings described in Note 9 of the "Notes to Consolidated Financial Statements" are incorporated in this "Item 3—Legal Proceedings" by reference.
In May and June 2012, Herman Kleid and Henry Stanley, Jr., each purported shareholders, filed derivative actions on behalf of Cardinal Health, Inc. in the United States District Court for the Southern District of Ohio against the current and certain former members of our Board of Directors. A similar action was filed by Daniel Himmel in the Common Pleas Court of Delaware County, Ohio and included certain of our officers as defendants (the "Himmel Action"). The complaints allege that the defendants breached their fiduciary duties in connection with the DEA's recent suspension of our Lakeland, Florida distribution center's registration to distribute controlled substances, and the suspension and reinstatement of such registrations at three of our facilities in 2007 and 2008. The Himmel Action also makes claims based on corporate waste and unjust enrichment. The complaints seek, among other things, unspecified money damages against the defendants and an award of attorney's fees. In July and August 2012, the defendants filed motions to dismiss all three complaints.
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Item 4: Mine Safety Disclosures
Not applicable.
Executive Officers of the Registrant
The following is a list of our executive officers as of August 15, 2012:
Name | Age | Position |
George S. Barrett | 57 | Chairman and Chief Executive Officer |
Jeffrey W. Henderson | 47 | Chief Financial Officer |
Michael C. Kaufmann | 49 | Chief Executive Officer, Pharmaceutical segment |
Donald M. Casey, Jr. | 52 | Chief Executive Officer, Medical segment |
Craig S. Morford | 53 | Chief Legal and Compliance Officer |
Carole S. Watkins | 52 | Chief Human Resources Officer |
Mark R. Blake | 41 | Executive Vice President, Strategy and Corporate Development |
Stephen T. Falk | 47 | Executive Vice President, General Counsel and Corporate Secretary |
The business experience summaries provided below for our executive officers describe positions held during the last five years (unless otherwise indicated).
Mr. Barrett has served as Chairman and Chief Executive Officer since August 2009. From January 2008 to August 2009, he served as Vice Chairman of Cardinal Health and Chief Executive Officer, Healthcare Supply Chain Services. From 1999 until 2007, he held a number of executive positions with Teva Pharmaceutical Industries Limited, a generic and branded pharmaceutical manufacturer, including President and Chief Executive Officer of Teva North America, Corporate Executive Vice President—Global Pharmaceutical Markets and a member of the Office of the Chief Executive Officer, and President of Teva Pharmaceuticals USA.
Mr. Henderson has served as Chief Financial Officer since May 2005.
Mr. Kaufmann has served as Chief Executive Officer, Pharmaceutical segment, since August 2009. From April 2008 until August 2009, he served as Group President, Pharmaceutical Supply Chain, and from April 2007 to April 2008, he was Group President, Healthcare Supply Chain Services—Medical.
Mr. Casey has served as Chief Executive Officer, Medical segment, since April 2012. Before joining us, he served as Chief Executive Officer of the Gary and Mary West Wireless Health Institute, a non-profit research organization focused on lowering the cost of healthcare through novel technology solutions, from March 2010 to March 2012. Prior to that, he served as World Wide Franchise Chairman, Comprehensive Care at Johnson & Johnson, a developer and manufacturer of health care products, from 2007 to 2009.
Mr. Morford has served as Chief Legal and Compliance Officer since May 2009. From May 2008 to May 2009, he served as Chief Compliance Officer. Prior to joining us he held a number of positions in the U.S. Department of Justice including Acting Deputy Attorney General of the United States from August 2007 to March 2008.
Ms. Watkins has served as Chief Human Resources Officer since 2000.
Mr. Blake has served as Executive Vice President, Strategy and Corporate Development since October 2009. From August 2006 until October 2009, he held various business development positions with Medco Health Solutions, Inc., a pharmacy benefits management services company, including Vice President, Business Development and Senior Director, Business Development.
Mr. Falk has served as Executive Vice President, General Counsel and Corporate Secretary since May 2009. From April 2007 to May 2009, he served as Executive Vice President and General Counsel of Healthcare Supply Chain Services.
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Part II
Item 5: Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our Common Shares are listed on the New York Stock Exchange under the symbol “CAH.” The following table reflects the range of the reported high and low closing prices of our Common Shares as reported on the New York Stock Exchange Composite Tape and the per share dividends declared for the fiscal years ended June 30, 2012 and 2011, and from July 1, 2012 through the period ended on August 15, 2012.
High | Low | Dividends | |||||||||
Fiscal 2011 | |||||||||||
Quarter Ended: | |||||||||||
September 30, 2010 | $ | 35.88 | $ | 29.96 | $ | 0.195 | |||||
December 31, 2010 | 39.11 | 31.99 | 0.195 | ||||||||
March 31, 2011 | 42.84 | 38.58 | 0.195 | ||||||||
June 30, 2011 | 45.54 | 40.65 | 0.215 | ||||||||
Fiscal 2012 | |||||||||||
Quarter Ended: | |||||||||||
September 30, 2011 | $ | 46.83 | $ | 37.99 | $ | 0.215 | |||||
December 31, 2011 | 45.49 | 39.88 | 0.215 | ||||||||
March 31, 2012 | 43.31 | 40.82 | 0.215 | ||||||||
June 30, 2012 | 43.33 | 40.33 | 0.2375 | ||||||||
Fiscal 2013 | |||||||||||
Through August 15, 2012 | $ | 43.50 | $ | 39.12 | $ | 0.2375 | |||||
As of August 15, 2012 there were approximately 11,470 shareholders of record of our Common Shares.
We anticipate that we will continue to pay quarterly cash dividends in the future. The payment and amount of future dividends remain, however, within the discretion of our Board of Directors and will depend upon our future earnings, financial condition, capital requirements and other factors.
Issuer Purchases of Equity Securities
Period | Total Number of Shares Purchased (1) | Average Price Paid per Share | Total Number of Shares Purchased as Part of Publicly Announced Program (2) | Approximate Dollar Value of Shares That May Yet be Purchased Under the Program (2)(3) (in millions) | |||||||||
April 1 – 30, 2012 | 364 | $ | 41.40 | 0 | $ | 450 | |||||||
May 1 – 31, 2012 | 1,342,833 | 41.56 | 1,342,172 | 394 | |||||||||
June 1 – 30, 2012 | 2,287,651 | 41.19 | 2,286,165 | 300 | |||||||||
Total | 3,630,848 | $ | 41.33 | 3,628,337 | $ | 300 | |||||||
(1) | Includes 218, 332 and 220 Common Shares purchased in April, May and June 2012, respectively, through a rabbi trust as investments of participants in our Deferred Compensation Plan. Also includes 146, 329 and 1,266 restricted shares surrendered in April, May and June 2012, respectively, by employees upon vesting to meet tax withholding. |
(2) | On November 3, 2010, our Board of Directors approved a $750 million share repurchase program, which was to expire on November 30, 2013. During fiscal 2012, we repurchased 10.3 million Common Shares having an aggregate cost of $450 million under the plan. |
(3) | On August 8, 2012, our Board of Directors approved a new $750 million share repurchase program, which expires on August 31, 2015, and canceled the share repurchase program which was to expire on November 30, 2013. |
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Performance Graphs
In the past we have presented line graphs comparing the cumulative total return of our Common Shares with the cumulative total return of the Standard & Poor’s Composite—500 Stock Index (the "S&P 500 Index") and the Value Line Healthcare Sector Index (the "Value Line Healthcare Sector Index"), an independently prepared index that includes more than 100 companies in the healthcare industry. This year we have also included a comparison against the Standard & Poor's Composite—500 Healthcare Index (the "S&P 500 Healthcare Index"), an independently prepared index that includes more than 50 companies in the healthcare industry. Next year we do not intend to include the Value Line Healthcare Index in our comparison of cumulative total return. We are changing to the S&P 500 Healthcare Index because we believe it to be a more commonly used index by large healthcare companies.
Five Year Performance Graph
The following graph assumes, in each case, an initial investment of $100 on June 30, 2007, based on the market prices at the end of each fiscal year through and including June 30, 2012, and reinvestment of dividends. The Value Line Healthcare Sector Index, the S&P 500 Healthcare Index and the S&P 500 Index investments are weighted on the basis of market capitalization at the beginning of each period. We have adjusted the market price of our Common Shares prior to August 31, 2009 to reflect the Spin-Off of CareFusion on August 31, 2009.
June 30, | |||||||||||||||||||||||
2007 | 2008 | 2009 | 2010 | 2011 | 2012 | ||||||||||||||||||
Cardinal Health, Inc. | $ | 100.00 | $ | 73.68 | $ | 44.40 | $ | 69.56 | $ | 95.94 | $ | 90.62 | |||||||||||
S&P 500 Index | 100.00 | 86.88 | 64.11 | 73.36 | 95.88 | 101.10 | |||||||||||||||||
Value Line Healthcare Sector Index | 100.00 | 89.88 | 77.82 | 85.20 | 123.68 | 132.73 | |||||||||||||||||
S&P 500 Healthcare Index | 100.00 | 88.28 | 78.15 | 85.18 | 109.48 | 120.17 | |||||||||||||||||
Post Spin-Off Graph
We have included a second graph below to show our cumulative total return compared with the cumulative total return of the S&P 500 Index, the Value Line Healthcare Sector Index and the S&P 500 Healthcare Index since the Spin-Off of our clinical and medical products business on August 31, 2009. The line graph assumes, in each case, an initial investment of $100 on August 31, 2009 through and including June 30, 2012, and reinvestment of dividends. We have adjusted the market price of our Common Shares on August 31, 2009 to reflect the Spin-Off.
August 31, 2009 | June 30, 2010 | June 30, 2011 | June 30, 2012 | ||||||||||||
Cardinal Health, Inc. | $ | 100.00 | $ | 138.45 | $ | 190.95 | $ | 180.33 | |||||||
S&P 500 Index | 100.00 | 102.68 | 134.20 | 141.48 | |||||||||||
Value Line Healthcare Sector Index | 100.00 | 100.10 | 145.31 | 155.95 | |||||||||||
S&P 500 Healthcare Index | 100.00 | 100.55 | 129.25 | 141.86 | |||||||||||
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Item 6: Selected Financial Data
The consolidated financial data below includes all business combinations as of the date of acquisition that occurred during these periods. The following selected consolidated financial data should be read in conjunction with the consolidated financial statements and related notes and “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
(in millions, except per Common Share amounts) | 2012 | 2011 | 2010 | 2009 | 2008 | ||||||||||||||
Earnings Data: | |||||||||||||||||||
Revenue | $ | 107,552 | $ | 102,644 | $ | 98,503 | $ | 95,992 | $ | 87,408 | |||||||||
Earnings from continuing operations | $ | 1,070 | $ | 966 | $ | 587 | $ | 758 | $ | 847 | |||||||||
Earnings/(loss) from discontinued operations (1) | (1 | ) | (7 | ) | 55 | 394 | 454 | ||||||||||||
Net earnings | $ | 1,069 | $ | 959 | $ | 642 | $ | 1,152 | $ | 1,301 | |||||||||
Basic earnings/(loss) per Common Share: | |||||||||||||||||||
Continuing operations | $ | 3.10 | $ | 2.77 | $ | 1.64 | $ | 2.12 | $ | 2.37 | |||||||||
Discontinued operations (1) | — | (0.02 | ) | 0.15 | 1.10 | 1.26 | |||||||||||||
Net basic earnings per Common Share | $ | 3.10 | $ | 2.75 | $ | 1.79 | $ | 3.22 | $ | 3.63 | |||||||||
Diluted earnings/(loss) per Common Share: | |||||||||||||||||||
Continuing operations | $ | 3.06 | $ | 2.74 | $ | 1.62 | $ | 2.10 | $ | 2.33 | |||||||||
Discontinued operations (1) | — | (0.02 | ) | 0.15 | 1.08 | 1.24 | |||||||||||||
Net diluted earnings per Common Share | $ | 3.06 | $ | 2.72 | $ | 1.77 | $ | 3.18 | $ | 3.57 | |||||||||
Cash dividends declared per Common Share | 0.8825 | 0.800 | 0.720 | 0.595 | 0.500 | ||||||||||||||
Balance Sheet Data: | |||||||||||||||||||
Total assets | $ | 24,260 | $ | 22,846 | $ | 19,990 | $ | 25,119 | $ | 23,448 | |||||||||
Long-term obligations, less current portion | 2,418 | 2,175 | 1,896 | 3,272 | 3,682 | ||||||||||||||
Shareholders’ equity (2) | 6,244 | 5,849 | 5,276 | 8,725 | 7,748 | ||||||||||||||
(1) | On August 31, 2009, we separated the clinical and medical products businesses from our other businesses through a pro rata distribution to shareholders of 81 percent of the then outstanding common stock of CareFusion and met the criteria for classification of these businesses as discontinued operations. During the fourth quarter of fiscal 2009, we committed to plans to sell our United Kingdom-based Martindale injectable manufacturing business within our Pharmaceutical segment, and met the criteria for classification of this business as discontinued operations. For additional information regarding discontinued operations, see Note 5 of the “Notes to Consolidated Financial Statements.” |
(2) | As noted above, on August 31, 2009, we completed the distribution to our shareholders of 81 percent of the then outstanding common stock of CareFusion and retained the remaining 41 million shares of CareFusion common stock. The distribution of CareFusion common stock to our shareholders resulted in the recognition of a $3.7 billion non-cash dividend. |
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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 included in this Form 10-K. Unless otherwise indicated, throughout this Management’s Discussion and Analysis of Financial Condition and Results of Operations, we are referring to our continuing operations.
Overview
We are a healthcare services company providing pharmaceutical and medical products and services that help pharmacies, hospitals, surgery centers, physician offices and other healthcare providers focus on patient care while reducing costs, enhancing efficiency and improving quality. We report our financial results in two segments: Pharmaceutical and Medical.
During fiscal 2012, we achieved revenue of $107.6 billion and increased our operating earnings by 18 percent to $1.8 billion. Our growth in revenue was due to increased volume from existing customers ($2.4 billion) and acquisitions ($2.4 billion). The increase in operating earnings reflects strong performance in our Pharmaceutical segment generic programs, the positive impact of acquisitions, and a $71 million gain realized upon adjusting the contingent consideration obligation associated with the P4 Healthcare acquisition. Earnings from continuing operations were up 11 percent for the twelve months ended June 30, 2012 due to the factors discussed above.
Our cash and equivalents balance was $2.3 billion as of June 30, 2012, compared to $1.9 billion as of June 30, 2011. The increase in cash and equivalents was primarily attributable to net cash provided by operating activities of $1.2 billion, partially offset by share repurchases of $450 million and cash dividends of $300 million. We plan to continue to execute a balanced deployment of available capital to position ourselves for sustainable competitive advantage and to enhance shareholder value.
Trends
Within our Pharmaceutical segment, we expect revenue to decrease in fiscal 2013. The factors contributing to this decrease include reduced revenue as a result of branded-to-generic pharmaceutical conversions and the expiration on September 30, 2012 of our pharmaceutical distribution contract with Express Scripts, Inc. Branded-to-generic pharmaceutical conversions impact our revenues because generic pharmaceuticals generally sell at a lower price than the corresponding branded product and because some of our customers source generic products directly from manufacturers rather than purchasing from us. Our contract with Express Scripts, Inc. was not renewed in connection with the combined pharmaceutical distribution contract that was not awarded to us following that company's merger with Medco Health Solutions, Inc. We recognized approximately $9.0 billion of revenue from sales to Express Scripts, Inc. in fiscal 2012, all of which was classified as bulk sales.
In our Pharmaceutical segment, we also anticipate fewer significant new generic pharmaceutical product launches in fiscal 2013. However, the impact of these launches on our gross margin can vary depending on the timing, size and number of entrants.
Within our Medical segment, variability in the cost of commodities such as oil-based resins, cotton, latex, diesel fuel and other commodities can have a significant impact on the cost of products sold. Although commodity prices fluctuate, we do not expect changes in commodity prices to have a significant impact on our year-over-year results of operations in fiscal 2013.
The Healthcare Reform Acts include a tax to be paid by medical device manufacturers equal to 2.3 percent of the price for which manufacturers sell their products, which is scheduled to begin January 1, 2013. We manufacture and sell devices that, based on the currently proposed rules, will be subject to this tax. There have been proposals to repeal this tax and modify the proposed rules, which if adopted, may reduce the impact of this tax on us.
Acquisitions
We have completed several acquisitions since July 1, 2009, the largest of which were Kinray, P4 Healthcare and Cardinal Health China, each of which was completed in fiscal 2011. In this Management's Discussion and Analysis, we identify the contribution of an acquisition until the one-year anniversary of the acquisition. Using this definition, for fiscal 2012 and 2011, acquisitions contributed revenues of $2.4 billion and $2.9 billion, respectively, and operating earnings of $79 million and $61 million, respectively.
See Note 2 of the “Notes to Consolidated Financial Statements” for more information on acquisitions.
Spin-Off of CareFusion
Effective August 31, 2009, we separated our clinical and medical products business through the distribution to our shareholders of 81 percent of the then outstanding common stock of CareFusion and retained the remaining 41 million shares of CareFusion common stock. During fiscal 2011 and 2010, we disposed of 30 million and 11 million shares of CareFusion common stock, respectively.
We entered into a separation agreement with CareFusion on July 22, 2009 to effect the Spin-Off and provide a framework for our relationship with CareFusion after the Spin-Off. In addition, on August 31, 2009, we entered into a transition services agreement, a tax matters agreement and an accounts receivable factoring agreement with CareFusion, among other agreements.
Under the transition services agreement, during fiscal 2012, 2011 and 2010, we recognized $3 million, $65 million and $99 million, respectively, in transition service fee income.
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Under the tax matters agreement, CareFusion is obligated to indemnify us for certain tax exposures and transaction taxes prior to the Spin-Off. The indemnification receivable was $265 million and $264 million at June 30, 2012 and 2011, respectively, and is included in other long-term assets in the consolidated balance sheets.
Under the accounts receivable factoring agreement, during fiscal 2011 and 2010, we purchased $460 million and $606 million of CareFusion trade receivables, respectively. The accounts receivable factoring arrangement expired on April 1, 2011.
Results of Operations
Revenue
Change | Revenue | ||||||||||||||||
(in millions) | 2012 | 2011 | 2012 | 2011 | 2010 | ||||||||||||
Pharmaceutical | 4 | % | 4 | % | $ | 97,925 | $ | 93,744 | $ | 89,790 | |||||||
Medical | 8 | % | 2 | % | 9,642 | 8,922 | 8,750 | ||||||||||
Total Segment | 5 | % | 4 | % | $ | 107,567 | $ | 102,666 | $ | 98,540 | |||||||
Corporate | N.M. | N.M. | (15 | ) | (22 | ) | (37 | ) | |||||||||
Consolidated | 5 | % | 4 | % | $ | 107,552 | $ | 102,644 | $ | 98,503 | |||||||
Fiscal 2012 Compared to Fiscal 2011
Pharmaceutical Segment
Revenue was positively impacted during fiscal 2012 by acquisitions ($2.3 billion) and increased sales to existing customers ($2.0 billion).
Revenue from bulk sales was $40.2 billion and $41.9 billion for fiscal 2012 and 2011, respectively. During fiscal 2012, revenue from bulk sales decreased 4 percent as a result of the conversion of branded pharmaceuticals to generic pharmaceuticals as well as a shift in sales mix for certain retail chain pharmacy customers to non-bulk from bulk. Revenue from non-bulk sales was $57.7 billion and $51.8 billion for fiscal 2012 and 2011, respectively. Revenue from non-bulk sales increased 11 percent during fiscal 2012, primarily due to acquisitions and the previously mentioned shift in sales. See “Item 1-Business” for more information about bulk and non-bulk sales.
Medical Segment
Revenue was positively impacted during fiscal 2012 by increased volume from existing customers ($335 million), including the positive impact from sales of self-manufactured and private brand products and the transition during the fourth quarter of fiscal 2011 of our relationship with CareFusion from a fee-for-service arrangement to a traditional distribution model ($131 million). This transition had minimal impact on Medical segment profit.
Fiscal 2011 Compared to Fiscal 2010
Pharmaceutical Segment
During fiscal 2011, Pharmaceutical revenue was positively impacted by acquisitions, net of divestitures ($2.7 billion) and increased sales to existing customers ($1.8 billion). Revenue was negatively impacted by losses of customers in excess of gains ($584 million).
Medical Segment
Medical revenue was positively impacted during fiscal 2011 by increased volume from existing customers ($354 million). These revenue gains were partially offset by the impact of lost customers in excess of gains ($165 million) and decreased volume as a result of strong demand for flu-related products in the prior year ($51 million).
Cost of Products Sold
Consistent with the increases in revenue, our cost of products sold increased $4.5 billion, or 5 percent, during fiscal 2012 and increased by $3.8 billion, or 4 percent, during fiscal 2011. See the following gross margin discussion for additional drivers impacting cost of products sold.
Gross Margin
Change | Gross Margin | ||||||||||||||||
(in millions) | 2012 | 2011 | 2012 | 2011 | 2010 | ||||||||||||
Gross margin | 9 | % | 10 | % | $ | 4,541 | $ | 4,162 | $ | 3,781 | |||||||
Fiscal 2012 Compared to Fiscal 2011
Pharmaceutical Segment
Gross margin increased $335 million in fiscal 2012.
Strong performance in our generic pharmaceutical programs, including the impact of new product launches, increased gross margin by $287 million.
Acquisitions positively impacted gross margin by $122 million.
Increased margin under branded and generic manufacturer agreements (exclusive of related volume impact) had a positive impact on gross margin of $49 million, due in part to price appreciation on a few specific generic pharmaceutical products.
Pharmaceutical distribution customer pricing changes, including rebates (exclusive of the related volume impact), adversely impacted gross margin by an estimated $179 million. The adverse impact of these customer pricing changes was partially offset by product mix, sourcing programs and other sources of margin.
Medical Segment
Gross margin increased $47 million in fiscal 2012.
Favorable product sales mix and increased sales volume resulted in a $100 million favorable impact to gross margin.
Increased cost of oil-based resins, cotton, latex, and other commodities used in our self-manufactured products decreased gross margin by $66 million.
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Fiscal 2011 Compared to Fiscal 2010
Pharmaceutical Segment
Gross margin increased $446 million in fiscal 2011.
Strong performance in our generic pharmaceutical programs, including the impact of new product launches, increased gross margin by $239 million.
Acquisitions, net of divestitures, positively impacted gross margin by $198 million.
Increased margin from branded pharmaceutical agreements (exclusive of the related volume impact) had a positive impact on gross margin of $72 million. The increase was primarily due to our performance under distribution service agreements and the transition of certain vendors to distribution service agreements.
Pharmaceutical distribution customer pricing changes including rebates (exclusive of the related volume impact) adversely impacted gross margin by an estimated $99 million. The adverse impact of these customer pricing changes was partially offset by product mix, sourcing programs and other sources of margin.
Medical Segment
Gross margin decreased $59 million in fiscal 2011.
Increased cost of oil-based resins, cotton, latex, diesel fuel and other commodities used in our self-manufactured products decreased gross margin by $59 million.
Increased net sales volume resulted in a $22 million favorable impact to gross margin.
In the first quarter of fiscal 2010, we realized a one-time gain of $14 million as a result of the recognition of previously deferred intercompany revenue for sales to CareFusion.
Somewhat sluggish healthcare utilization disproportionately affected surgical procedures and consequently our higher-margin products.
Distribution, Selling, General and Administrative Expenses
Change | SG&A | ||||||||||||||||
(in millions) | 2012 | 2011 | 2012 | 2011 | 2010 | ||||||||||||
SG&A | 6 | % | 5 | % | $ | 2,677 | $ | 2,528 | $ | 2,397 | |||||||
Increased SG&A in fiscal 2012 was primarily due to acquisitions ($65 million) and business system investments, including the Medical segment business transformation project. The increase in SG&A in fiscal 2011 was primarily due to acquisitions, net of divestitures ($90 million).
SG&A also included costs related to the Spin-Off of $2 million, $10 million and $11 million for fiscal 2012, 2011 and 2010, respectively.
Segment Profit and Consolidated Operating Earnings
Change | Segment Profit and Operating Earnings | ||||||||||||||||
(in millions) | 2012 | 2011 | 2012 | 2011 | 2010 | ||||||||||||
Pharmaceutical | 17 | % | 31 | % | $ | 1,558 | $ | 1,329 | $ | 1,011 | |||||||
Medical | (11 | )% | (13 | )% | 332 | 373 | 429 | ||||||||||
Total segment profit | 11 | % | 18 | % | 1,890 | 1,702 | 1,440 | ||||||||||
Corporate | N.M. | N.M. | (98 | ) | (188 | ) | (133 | ) | |||||||||
Total consolidated operating earnings | 18 | % | 16 | % | $ | 1,792 | $ | 1,514 | $ | 1,307 | |||||||
Segment Profit
We evaluate the performance of the individual segments based upon, among other things, segment profit, which is segment revenue, less segment cost of products sold, less segment SG&A expenses. We do not allocate restructuring and employee severance, acquisition-related costs, impairments and (gain)/loss on sale of assets, litigation (recoveries)/charges, net, certain investment and other spending to our segments. These costs are retained at Corporate. Investment spending generally includes the first year spend for certain projects which require incremental strategic investments in the form of additional operating expenses. We encourage our segments to identify investment projects which will promote innovation and provide future returns. As approval decisions for such projects are dependent upon executive management, the expenses for such projects are often retained at Corporate. In addition, Spin-Off costs included within SG&A are not allocated to our segments. See Note 15 of the "Notes to Consolidated Financial Statements" for additional information on segment profit.
Pharmaceutical Segment Profit
The principal drivers for the increase in fiscal 2012 and 2011 were strong performance in our generic pharmaceutical programs, including the impact of new product launches, the positive impact of acquisitions, and increased margin under branded pharmaceutical agreements, offset by the unfavorable impact of pharmaceutical distribution customer pricing changes. See the discussion of gross margin above for further information on these drivers.
Segment profit from bulk sales increased $19 million in fiscal 2012 over fiscal 2011 and was 10 percent of Pharmaceutical segment profit in both years. Segment profit from non-bulk sales increased $210 million in fiscal 2012 over fiscal 2011 and was 90 percent of Pharmaceutical segment profit in both years. The generic pharmaceutical programs and acquisitions discussed above primarily impacted segment profit from non-bulk sales.
Medical Segment Profit
The principal drivers for the decrease in fiscal 2012 were the increased cost of commodities used in our self-manufactured products and an increase in SG&A expenditures, including the impact of business system investments. These items were partially offset by the favorable impact of product sales mix and increased net sales volume. See the discussion above for further information on these drivers.
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Results for fiscal 2011 were adversely affected by increased cost of commodities used in our self-manufactured products partially offset by increased sales volume. Results also were impacted by the negative year-over-year impact of recognizing in fiscal 2010 a one-time gain related to previously deferred intercompany revenue for sales to CareFusion.
Consolidated Operating Earnings
In addition to revenue, gross margin and SG&A discussed above, operating earnings were impacted by the following:
(in millions) | 2012 | 2011 | 2010 | ||||||||
Restructuring and employee severance | $ | 21 | $ | 15 | $ | 91 | |||||
Acquisition-related costs | 33 | 90 | 19 | ||||||||
Impairments and loss on disposal of assets | 21 | 9 | 29 | ||||||||
Litigation (recoveries)/charges, net | (3 | ) | 6 | (62 | ) | ||||||
Restructuring and Employee Severance
Fiscal 2011 and 2010 restructuring and employee severance charges included $7 million and $65 million, respectively, of costs arising from the Spin-Off.
Acquisition-Related Costs
Acquisition-related costs for fiscal 2012 included income realized upon adjusting the contingent consideration obligation incurred in connection with the P4 Healthcare acquisition. The former owners of P4 Healthcare had the right to receive certain contingent payments based on targeted earnings before interest, taxes, depreciation, and amortization ("EBITDA"). As a result of changes in our estimate of performance in future periods due in large part to the loss of revenue from a significant customer of the P4 Healthcare legacy business in fiscal 2012, we revised the timing and amount of EBITDA estimates and made changes in probability assumptions with respect to the likelihood of achieving the EBITDA targets. These changes, coupled with the progress of discussions with the former owners regarding an early termination and settlement of the contingent consideration obligation, resulted in a $71 million decrease in the fair value of the obligation to $4 million at June 30, 2012. In early July 2012, we reached final settlement and payment of the remaining contingent consideration liability for $4 million. See Note 2 of the "Notes to Consolidated Financial Statements" for additional information on this item.
Amortization of acquisition-related intangible assets was $78 million, $67 million and $10 million for fiscal 2012, 2011 and 2010, respectively.
Impairments and Loss on Disposal of Assets
During fiscal 2012, we recorded a charge of $16 million to write off an indefinite life intangible asset related to the P4 Healthcare trade name. We have rebranded P4 Healthcare under the Cardinal Health Specialty Solutions name.
During fiscal 2010, we recognized an impairment charge of $18 million related to the write-down of SpecialtyScripts, LLC ("Specialty Scripts"), a business within our Pharmaceutical segment. We sold SpecialtyScripts during the third quarter of fiscal 2010.
Litigation (Recoveries)/Charges, Net
During fiscal 2010, we recognized income of $41 million resulting from settlement of a class action antitrust claim in which we were a class member. In addition, we recognized $26 million of income for insurance proceeds released from escrow after litigation, commenced against certain directors and officers in 2004, was resolved.
Earnings Before Income Taxes and Discontinued Operations
In addition to items discussed above, earnings before income taxes and discontinued operations were impacted by the following:
Change | Earnings Before Income Taxes and Discontinued Operations | ||||||||||||||||
(in millions) | 2012 | 2011 | 2012 | 2011 | 2010 | ||||||||||||
Other income, net | N.M. | 61 | % | $ | (1 | ) | $ | (22 | ) | $ | (13 | ) | |||||
Interest expense, net | 2 | % | (18 | )% | 95 | 93 | 113 | ||||||||||
Loss on extinguishment of debt | N.M. | N.M. | — | — | 40 | ||||||||||||
Gain on sale of Investment in CareFusion common stock | N.M. | 67 | % | — | (75 | ) | (45 | ) | |||||||||
Interest Expense, Net
The decrease in interest expense for fiscal 2011 was primarily due to favorable interest rate swaps.
Loss on Extinguishment of Debt
During fiscal 2010, we recognized a $40 million loss from the early retirement of over $1.1 billion of debt securities through a tender offer.
Gain on Sale of Investment in CareFusion Common Stock
We recognized $75 million and $45 million of income during fiscal 2011 and 2010, respectively, related to the sale of our investment in CareFusion common stock.
Provision for Income Taxes
Generally, fluctuations in the effective tax rate are due to changes within international and United States state effective tax rates resulting from our business mix and discrete items. A reconciliation of the provision based on the federal statutory income tax rate to our effective income tax rate from continuing operations is as follows for fiscal 2012, 2011 and 2010 (see Note 8 of “Notes to Consolidated Financial Statements” for a detailed disclosure of the effective tax rate reconciliation):
2012 | 2011 | 2010 | ||||||
Provision at Federal statutory rate | 35.0 | % | 35.0 | % | 35.0 | % | ||
State and local income taxes, net of federal benefit | 2.3 | 2.6 | 4.2 | |||||
Foreign tax rate differential | (2.3 | ) | (2.5 | ) | (3.3 | ) | ||
Nondeductible/nontaxable items | — | 0.6 | 0.2 | |||||
Change in measurement of an uncertain tax position and an IRS settlement | 0.9 | 2.4 | 1.3 | |||||
Valuation allowances | 0.1 | (0.6 | ) | (2.3 | ) | |||
Unremitted foreign earnings | (0.2 | ) | (0.1 | ) | 13.9 | |||
Other | 1.2 | (1.0 | ) | 2.6 | ||||
Effective income tax rate | 37.0 | % | 36.4 | % | 51.6 | % | ||
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Fiscal 2012 Compared to Fiscal 2011
The fiscal 2012 effective tax rate was favorably impacted by a settlement of the fiscal 2001 and 2002 IRS audits ($40 million or 2.4 percentage points). The year-over-year comparison of the effective tax rate was unfavorably impacted by the release in fiscal 2011 of a previously established deferred tax valuation allowance.
Fiscal 2011 Compared to Fiscal 2010
The effective tax rate was favorably impacted by $28 million, or 1.9 percentage points, attributable to recognizing no income tax expense on the sale of CareFusion stock due to the release of a previously established deferred tax valuation allowance. An unfavorable charge of $168 million, or 13.9 percentage points, attributable to earnings no longer indefinitely invested offshore in fiscal 2010 favorably impacted the year-over-year comparison of the effective tax rate.
Ongoing Audits
During fiscal 2012, the IRS closed audits of fiscal 2001 and 2002, and is currently conducting audits of fiscal years 2003 through 2010. We have received proposed adjustments from the IRS for fiscal 2003 through 2007 related to our transfer pricing arrangements between foreign and domestic subsidiaries and the transfer of intellectual property among subsidiaries of an acquired entity prior to its acquisition by us. The IRS has proposed additional taxes of $849 million, excluding penalties and interest. If this tax ultimately must be paid, CareFusion is liable under the tax matters agreement for $592 million of the total amount. We disagree with these proposed adjustments, which we are contesting, and have accounted for the unrecognized tax benefits related to them.
Earnings/(Loss) from Discontinued Operations
CareFusion operating results are included within earnings from discontinued operations for all periods through the date of the Spin-Off, and had a significant impact on earnings from discontinued operations for fiscal 2010. See Note 5 in the “Notes to Consolidated Financial Statements” for additional information on discontinued operations.
Liquidity and Capital Resources
We currently believe that, based upon available capital resources (cash on hand), projected operating cash flow, and access to committed credit facilities, we have adequate capital resources to fund working capital needs; currently anticipated capital expenditures, business growth and expansion; contractual obligations; payments for tax settlements; and current and projected debt service requirements, dividends and share repurchases. During fiscal 2012, we completed several small acquisitions with cash on hand. If we decide to engage in one or more additional acquisitions, depending on the size and timing of such transactions, we may need supplemental funding.
Cash and Equivalents
Our cash and equivalents balance was $2.3 billion at June 30, 2012, compared to $1.9 billion at June 30, 2011. At June 30, 2012, our cash and cash equivalents were held in cash depository accounts with major banks or invested in high quality, short-term liquid investments. The increase in cash and equivalents during fiscal 2012 was primarily attributable to net cash provided by operating activities of $1.2 billion and net proceeds of $290 million from the sale and repayment of notes. During fiscal 2012, we deployed $450 million of cash on share repurchases, $300 million on dividends, $263 million on capital expenditures, and $174 million on acquisitions.
During fiscal 2011, we deployed $2.3 billion of cash on acquisitions, $291 million on capital expenditures, $274 million on dividends and $270 million on share repurchases. During fiscal 2011, we received $706 million in proceeds from the sale of our remaining investment in CareFusion common stock.
During fiscal 2010, we deployed $350 million of cash to repay floating rate notes at maturity, $260 million on capital expenditures, $253 million on dividends and $230 million on share repurchases. During fiscal 2010, we completed a $1.1 billion debt tender using a portion of the $1.4 billion of cash distributed to us from CareFusion in connection with the Spin-Off. We also received $271 million in proceeds from the sale of our investment in CareFusion common stock and $154 million from divestitures.
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We use days sales outstanding (“DSO”), days inventory on hand (“DIOH”) and days payable outstanding (“DPO”) to evaluate our working capital performance. DSO is calculated as trade receivables, net divided by average daily revenue during the last month of the reporting period. DIOH is calculated as inventories divided by average daily cost of products sold and chargeback billings during the last quarter of the reporting period. DPO is calculated as accounts payable divided by average daily cost of products sold and chargeback billings during the last quarter of the reporting period. Chargeback billings are the difference between a product’s wholesale acquisition cost and the contract price established between the vendors and the end customer.
2012 | 2011 | 2010 | |||
Days sales outstanding | 22.3 | 20.3 | 18.6 | ||
Days inventory on hand | 23.9 | 22.5 | 21.5 | ||
Days payable outstanding | 35.6 | 34.8 | 32.1 | ||
Changes in working capital can vary significantly depending on factors such as the timing of inventory purchases, customer payments of accounts receivable, and payments to vendors in the regular course of business.
DSO increased in fiscal 2012 as a result of the Medical segment's business transformation project implementation, which led to an increase in trade receivables at June 30, 2012. DIOH increased in fiscal 2012 as a result of inventory increases related to on-boarding a new pharmaceutical customer and the Medical segment's business transformation project implementation.
The increase in DSO in fiscal 2011 was driven by the impact of acquisitions and the increase in DPO was due to the timing of payments to vendors in the regular course of business.
The cash and equivalents balance at the end of fiscal 2012 included $380 million of cash held by subsidiaries outside of the United States. Although the vast majority of this cash is available for repatriation, permanently bringing the money into the United States could trigger U.S. federal, state and local income tax obligations. As a U.S. parent company, we may temporarily access cash held by our foreign subsidiaries without becoming subject to U.S. federal income tax through intercompany loans.
In fiscal 2013, we expect two matters to adversely affect our operating cash flows by approximately $500 million compared to fiscal 2012. Specifically, we anticipate that we will make cash payments to the IRS as we work to reach resolution on audits of fiscal 2003 through 2005; however, we can provide no assurance regarding the likelihood or timing of reaching resolution. We also expect a negative working capital impact from the expiration of our contract with Express Scripts, Inc.
Ownership of CareFusion Common Stock
During fiscal 2011 and 2010, we disposed of 30 million and 11 million shares of CareFusion common stock for cash proceeds of $706 million and $271 million, respectively. We have no remaining ownership in CareFusion.
Credit Facilities and Commercial Paper
Our sources of liquidity include a $1.5 billion revolving credit facility and a $950 million committed receivables sales facility program. At times, availability under our committed receivables sales facility program may be less than $950 million based on receivables concentration limits and our outstanding eligible receivables balance. Our revolving credit facility expires in May 2016 and our committed receivables sales facility program expires in November 2012. We also have a commercial paper program of up to $1.5 billion, backed by the revolving credit facility.
We had no outstanding borrowings from the commercial paper program and no outstanding balance under the committed receivables sales facility program at June 30, 2012 and 2011. We also had no outstanding balance under the revolving credit facility at June 30, 2012 and 2011, except for $44 million of standby letters of credit in each fiscal year. Our revolving credit and committed receivables sales facility programs require us to maintain a consolidated interest coverage ratio, as of any fiscal quarter end, of at least 4-to-1 and a consolidated leverage ratio of no more than 3.25-to-1. As of June 30, 2012, we were in compliance with these financial covenants.
Held-to-Maturity Investments
We held high quality investment grade held-to-maturity fixed income debt securities with an amortized cost basis of $72 million and $142 million as of June 30, 2012 and 2011, respectively. These investments vary in maturity date, ranging from one to six months, and pay interest semi-annually.
Long-Term Obligations
As of June 30, 2012, we had total long-term obligations of $2.9 billion compared to $2.5 billion at June 30, 2011. In May 2012, we sold $250 million aggregate principal amount of fixed rate notes due 2017 with interest at 1.900% per year (“1.900% Notes”) in a registered offering. The 1.900% Notes mature on June 15, 2017. In May 2012, we also sold $250 million aggregate principal amount of fixed rate notes due 2022 with interest at 3.200% per year (“3.200% Notes”) in a registered offering. The 3.200% Notes mature on June 15, 2022. These notes are unsecured and unsubordinated obligations and rank equally in right of payment with all of our existing and future unsecured and unsubordinated indebtedness. We used the proceeds to repay $206 million of our 5.65% Notes due June 15, 2012. The remaining net proceeds will be used for general corporate purposes, which may include repayment of other indebtedness, including $300 million aggregate principal of our 5.50% Notes due June 15, 2013.
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Capital Expenditures
Capital expenditures during fiscal 2012, 2011 and 2010 were $263 million, $291 million and $260 million, respectively, primarily related to information technology projects.
We expect capital expenditures in fiscal 2013 to be less than in fiscal 2012. We anticipate that we will be able to fund these expenditures through cash provided by operating activities. Fiscal 2013 capital expenditures will be largely focused on information technology projects.
Dividends
During fiscal 2012, we paid quarterly dividends of $0.215 per share, or $0.86 per share on an annualized basis, an increase of 10 percent from fiscal 2011. On May 2, 2012, our Board of Directors approved a 10 percent increase in our quarterly dividend to $0.2375 per share, or $0.95 per share on an annualized basis, payable on July 15, 2012 to shareholders of record on July 1, 2012.
On August 8, 2012, our Board of Directors approved our 112th consecutive regular quarterly dividend, payable to shareholders of record on October 1, 2012.
Share Repurchases
During fiscal 2012 and 2011, we repurchased $450 million and $250 million of our Common Shares, respectively. At June 30, 2012, we had $300 million remaining under our then current repurchase authorization which was to expire November 30, 2013.
On August 8, 2012, our Board of Directors approved a new $750 million share repurchase program, which expires August 31, 2015, and canceled the share repurchase program which was to expire November 30, 2013.
Interest Rate and Currency Risk Management
We use foreign currency forward contracts, interest rate swaps and commodity swaps to manage our exposure to cash flow variability. We also use foreign currency forward contracts to protect the value of our existing foreign currency assets and liabilities and interest rate swaps to protect the value of our debt. See Item 7A below as well as Notes 1 and 11 of “Notes to Consolidated Financial Statements” for information regarding the use of financial instruments and derivatives as well as foreign currency, interest rate and commodity exposures.
Contractual Obligations
As of June 30, 2012, our contractual obligations, including estimated payments due by period, are as follows:
(in millions) | 2013 | 2014 to 2015 | 2016 to 2017 | There-after | Total | ||||||||||||||
Long-term debt and short-term borrowings (1) | $ | 474 | $ | 526 | $ | 792 | $ | 1,078 | $ | 2,870 | |||||||||
Interest on long-term debt | 106 | 184 | 143 | 205 | 638 | ||||||||||||||
Capital lease obligations (2) | 2 | 1 | 21 | — | 24 | ||||||||||||||
Other long-term liabilities (3) | 3 | 2 | — | — | 5 | ||||||||||||||
Operating leases (4) | 83 | 112 | 60 | 45 | 300 | ||||||||||||||
Purchase obligations (5) | 175 | 84 | 6 | 5 | 270 | ||||||||||||||
Total contractual obligations | $ | 843 | $ | 909 | $ | 1,022 | $ | 1,333 | $ | 4,107 | |||||||||
(1) | Represents maturities of our long-term debt obligations and other short-term borrowings excluding capital lease obligations described below. See Note 7 of “Notes to Consolidated Financial Statements” for further information. |
(2) | Represents maturities of our capital lease obligations included within long-term debt on our consolidated balance sheet. |
(3) | Represents cash outflows by period for certain of our long-term liabilities in which cash outflows could be reasonably estimated. Certain long-term liabilities, such as unrecognized tax benefits and deferred taxes, including those related to the audits of fiscal 2003 through 2005, have been excluded from the table above because of the inherent uncertainty of the underlying tax positions or because of the inability to reasonably estimate the timing of any cash outflows. See Note 8 of “Notes to Consolidated Financial Statements” for further discussion of income taxes. |
(4) | Represents minimum rental payments and the related estimated future interest payments for operating leases having initial or remaining non-cancelable lease terms as described in Note 9 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 the following: 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 we are 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 canceled with no termination fee or with proper notice are excluded from our 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. |
Recent Financial Accounting Standards
See Note 1 of “Notes to Consolidated Financial Statements” for a discussion of recent financial accounting standards.
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Critical Accounting Policies and Sensitive Accounting Estimates
Critical accounting policies are those accounting policies that (i) can have a significant impact on our financial condition and results of operations for continuing operations and (ii) require use of complex and subjective estimates based upon past experience and management’s judgment. Other companies applying reasonable judgment to the same facts and circumstances could develop different estimates. Because estimates are inherently uncertain, actual results may differ. In this section, we describe the policies applied in preparing our consolidated financial statements that management believes are the most dependent on estimates and assumptions. For additional accounting policies, see Note 1 of “Notes to Consolidated Financial Statements.”
Allowance for Doubtful Accounts
Trade receivables are primarily comprised of amounts owed to us through our distribution businesses and are presented net of an allowance for doubtful accounts of $126 million and $134 million at June 30, 2012 and 2011, respectively. We also provide financing to various customers. Such financing arrangements range from 90 days to 10 years at interest rates that generally are subject to fluctuation. Interest income on these arrangements is recognized as it is earned. 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 of $16 million and $15 million at June 30, 2012 and 2011, respectively, and are included in other assets (current portion is included in prepaid expenses and other). We must use judgment when deciding whether to extend credit and when estimating the required allowance for doubtful accounts.
The allowance for doubtful accounts includes portfolio and specific reserves. We determine the appropriate allowance by reviewing accounts receivable aging, industry trends, customer financial strength and credit standing, historical write-off trends and payment history. We also regularly evaluate how changes in economic conditions may affect credit risks.
Our methodology for estimating the allowance for doubtful accounts is assessed annually based on historical losses and economic, business and market trends. In addition, the allowance is reviewed quarterly and updated if appropriate. We may adjust the allowance for doubtful accounts if changes in customers’ financial condition or general economic conditions make defaults more frequent or severe.
The following table gives information regarding the allowance for doubtful accounts over the past three fiscal years.
(in millions, except percentages) | 2012 | 2011 | 2010 | ||||||||
Allowance for doubtful accounts | $ | 143 | $ | 150 | $ | 140 | |||||
Allowance as a percentage of customer receivables | 2.2 | % | 2.4 | % | 2.6 | % | |||||
Allowance as a percentage of revenue | 0.13 | % | 0.15 | % | 0.14 | % | |||||
Reduction to allowance for customer deductions and write-offs | 30 | 22 | 9 | ||||||||
Addition to Allowance | 22 | 27 | 27 | ||||||||
A hypothetical 0.1 percent increase or decrease in the reserve as a percentage of trade receivables, sales-type leases and finance notes receivables at June 30, 2012, would result in an increase or decrease in bad debt expense of $6 million.
We believe the reserve maintained and expenses recorded in fiscal 2012 are appropriate. At this time, we are not aware of any analytical findings or customer issues that might lead to a significant future increase in the allowance for doubtful accounts as a percentage of net revenue.
Inventories
A substantial portion of inventories (69 percent and 70 percent at June 30, 2012, and 2011, respectively) are stated at the lower of cost, using the LIFO method, or market. These are primarily merchandise inventories at the core pharmaceutical distribution facilities within our Pharmaceutical segment. The LIFO impact on the consolidated statements of earnings in a given year depends on pharmaceutical price appreciation and the level of inventory. Prices for branded pharmaceuticals tend to rise, which results in an increase in cost of products sold, whereas prices for generic pharmaceuticals tend to decline, which results in a decrease in cost of products sold.
The LIFO method presumes that the most recent inventory purchases are the first items sold, so LIFO helps us better match current costs and revenue. Using LIFO, if branded pharmaceutical inventory levels decline, the result generally will be a decrease in future cost of products sold: prices for branded pharmaceuticals tend to rise over time, so our older inventory is held at a lower cost. Conversely, if generic pharmaceutical inventory levels decline, future cost of products sold generally will increase: prices for generic pharmaceuticals tend to decline over time, so our older inventory is held at a higher cost. We believe that the average cost method of inventory valuation reasonably approximates the current cost of replacing inventory within the core pharmaceutical distribution facilities. Accordingly, the LIFO reserve is the difference between (a) inventory at the lower of LIFO cost or market and (b) inventory at replacement cost determined using the average cost method of inventory valuation.
The remaining inventory is stated at the lower of cost, using the FIFO (“first in, first out”) method, or market. If we had used the average cost method of inventory valuation for all inventory within the Pharmaceutical distribution facilities, the value of our inventories would not have changed in fiscal 2012 or 2011. Primarily because prices for our generic pharmaceutical inventories have continued to decline, inventories at LIFO were $72 million and $8 million higher than the average cost value as of June 30, 2012, and 2011, respectively. We do not record inventories in excess of replacement cost. As such, we did not record any changes in our LIFO reserve in fiscal 2012 and 2011.
Inventories recorded on the consolidated balance sheets are net of reserves for excess and obsolete inventory, which were $37 million and $40 million at June 30, 2012, and 2011, respectively. We determine reserves for inventory obsolescence based on historical experience, sales trends, specific categories of inventory and age of on-hand inventory. If actual conditions are less favorable than our assumptions, additional inventory reserves may be required.
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Business Combinations
The purchase price of an acquired business is allocated to the assets acquired and liabilities assumed based on their estimated fair values as of the date of acquisition, including identifiable intangible assets. The excess of the purchase price over the estimated fair value of the net tangible and identifiable intangible assets acquired is recorded as goodwill. We base the fair values of identifiable intangible assets on detailed valuations that require management to make significant judgments, estimates and assumptions. Critical estimates and assumptions include: expected future cash flows for trade names, customer relationships and other identifiable intangible assets; discount rates that reflect the risk factors associated with future cash flows; and estimates of useful lives. When an acquisition involves contingent consideration, we recognize a liability equal to the fair value of the contingent consideration obligation at the date of acquisition. The estimate of fair value of a contingent consideration obligation requires subjective assumptions to be made regarding future business results, discount rates and probabilities assigned to various potential business result scenarios. Subsequent revisions to these assumptions could materially change the estimate of the fair value of contingent consideration obligations and therefore could materially affect our financial position or results of operations. See Note 2 of the “Notes to Consolidated Financial Statements” for additional information regarding our acquisitions.
Goodwill and Other Intangibles
Purchased goodwill and intangible assets with indefinite lives are not amortized, but instead are tested for impairment annually or when indicators of impairment exist. Intangible assets with finite lives, primarily customer relationships, trademarks and patents, and non-compete agreements, are amortized over their useful lives.
Goodwill impairment testing involves a comparison of the estimated fair value of reporting units to the respective carrying amount. If estimated fair value exceeds the carrying amount, then no impairment exists. If the carrying amount exceeds the estimated fair value, then a second step is performed to determine the amount of impairment, if any, which would be recorded as an expense to our results of operations. Application of goodwill impairment testing involves judgment, including the identification of reporting units and estimating the fair value of each reporting unit. A reporting unit is defined as an operating segment or one level below an operating segment (also known as a component).
We have two operating segments which are the same as our reportable segments: Pharmaceutical and Medical. These operating segments are comprised of divisions (components), for which discrete financial information is available. Components are aggregated into reporting units for purposes of goodwill impairment testing to the extent that they share similar economic characteristics. Our reporting units are: Pharmaceutical operating segment (excluding our nuclear and pharmacy services division and Cardinal Health China - Pharmaceutical division); nuclear and pharmacy services division; Cardinal Health China - Pharmaceutical division; and Medical operating segment.
Fair value can be determined using market, income or cost-based approaches. Our determination of estimated fair value of the reporting units is based on a combination of the income-based and market-
based approaches. Under the market-based approach, we determine fair value by comparing our reporting units to similar businesses or guideline companies whose securities are actively traded in public markets. Under the income-based approach, we use a discounted cash flow model in which cash flows anticipated over several periods, plus a terminal value at the end of that time horizon, are discounted to their present value using an appropriate rate of return. To further confirm the fair value, we compare the aggregate fair value of our reporting units to our market capitalization. The use of alternate estimates and assumptions or changes in the industry or peer groups could materially affect the determination of fair value for each reporting unit and potentially result in goodwill impairment.
We performed annual impairment testing in fiscal 2012, 2011 and 2010 and concluded that there were no impairments of goodwill as the fair value of each reporting unit exceeded its carrying value. For our fiscal 2012 testing, we elected to bypass the optional qualitative assessment, as permitted by the amended accounting guidance adopted during the year. See Note 6 of the “Notes to Consolidated Financial Statements” for additional information regarding goodwill and other intangible assets.
If we alter our impairment testing by increasing the discount rate in the discounted cash flow analysis by 1 percent, there still would not be any impairment indicated for any of our reporting units for fiscal 2012, 2011 or 2010.
Vendor Reserves
In the ordinary course of business, our vendors may dispute deductions taken against payments otherwise due to them or assert other billing disputes. These disputed transactions are researched and resolved based upon our policy and findings of the research performed. At any given time, there are outstanding items in various stages of research and resolution. In determining appropriate reserves for areas of exposure with our vendors, we assess historical experience and current outstanding claims. We have established various levels of reserves based on the type of claim and status of review. Though the transaction types are relatively consistent, we periodically refine our estimate methodology by updating the reserve estimate percentages to reflect actual historical experience. Changes to the estimate percentages affect the cost of products sold in the period in which the change was made.
Vendor reserves were $55 million and $41 million at June 30, 2012 and 2011, respectively. Approximately 72 percent of the vendor reserve at the end of fiscal 2012 pertained to the Pharmaceutical segment compared to 65 percent at the end of fiscal 2011. The reserve balance will fluctuate due to variations of outstanding claims from period to period, timing of settlements, and specific vendor issues, such as bankruptcies.
The ultimate outcome of specific claims may be different than our original estimate and may require adjustment. We believe, however, that reserves recorded for such disputes are adequate based upon current facts and circumstances.
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Provision for Income Taxes
Our income tax expense, deferred tax assets and liabilities, and unrecognized tax benefits reflect management’s assessment of estimated future taxes to be paid on items in the consolidated financial statements.
Deferred income taxes arise from temporary differences between financial reporting and tax reporting bases of assets and liabilities, as well as net operating loss and tax credit carryforwards for tax purposes. The following table presents information about our tax position:
(in millions) | 2012 | 2011 | |||||
Net deferred income tax assets | $ | 480 | $ | 543 | |||
Net deferred income tax liabilities | 1,462 | 1,352 | |||||
Net loss and credit carryforwards included in net deferred income tax assets | 120 | 199 | |||||
Net valuation allowance against deferred tax assets (1) | 86 | 158 | |||||
(1) | This valuation allowance primarily relates to federal, state and international loss carryforwards for which the ultimate realization of future benefits is uncertain. |
Expiring carryforwards and the required valuation allowances are adjusted annually. After applying the valuation allowances, we do not anticipate any limitations on our use of any of the other net deferred income tax assets described above.
We believe that our estimates for the valuation allowances against deferred tax assets and unrecognized tax benefits are appropriate based on current facts and circumstances. However, other companies applying reasonable judgment to the same facts and circumstances could develop different estimates. The amount we ultimately pay when matters are resolved may differ from the amounts accrued.
Tax benefits from uncertain tax positions are recognized when it is more likely than not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, based on the technical merits. The amount recognized is measured as the largest amount of tax benefit that is greater than 50 percent likely of being realized upon settlement. See Note 8 of “Notes to Consolidated Financial Statements” for a detailed disclosure of the unrecognized tax benefits.
If any of our assumptions or estimates were to change, an increase or decrease in our effective tax rate by 1 percent on earnings before income taxes and discontinued operations would have caused income tax expense to increase or decrease by $17 million for fiscal 2012.
Share-Based Compensation
All share-based payments to employees, including grants of options, are recognized in the consolidated statements of earnings based on the grant date fair value of the award. The fair value of stock options is determined using a lattice valuation model. We believe the lattice model provides reasonable estimates because it has the ability to take into account employee exercise patterns based on changes in our stock price and other variables and it provides for a range of input assumptions.
We analyzed historical data to estimate option exercise behaviors and employee terminations to be used within the lattice model. The expected life of the options granted was calculated from the option valuation model and represents the length of time in years that the options granted are expected to be outstanding. Expected volatilities are based on implied volatility from traded options on our Common Shares and historical volatility over a period of time commensurate with the contractual term of the option grant (up to ten years). As required, the forfeiture estimates will be adjusted to reflect actual forfeitures when an award vests. The actual forfeitures in future reporting periods could be higher or lower than our current estimates. See Note 16 of "Notes to Consolidated Financial Statements" for additional information regarding share-based compensation.
23
Item 7A: Quantitative and Qualitative Disclosures about Market Risk
Our businesses are 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 price related changes. We maintain a hedging program to manage volatility related to these market exposures which employs operational, economic and derivative financial instruments in order to mitigate risk. See Notes 1 and 11 of “Notes to Consolidated Financial Statements” for further discussion regarding our use of derivative instruments.
Foreign Exchange Rate Sensitivity
By nature of our global operations, our businesses are exposed to cash flow and earnings fluctuations resulting from foreign exchange rate variation. These exposures are transactional and translational in nature. Principal drivers of this foreign exchange exposure include the Canadian dollar, Chinese renminbi, European euro, Japanese yen, Malaysian ringgit, Mexican peso, and Thai baht.
Transactional Exposure
Our businesses’ transactional exposure arises from the purchase and sale of goods and services in currencies other than our functional currency or the functional currency of our subsidiaries. As part of our risk management program, at the end of each fiscal year we perform a sensitivity analysis on our forecasted transactional exposure for the upcoming fiscal year. The fiscal 2012 and fiscal 2011 analyses utilized a currency portfolio model, encompassing both implied volatility and historical correlation to estimate the net potential gain or loss. These analyses included the estimated impact of our hedging program, which mitigates our transactional exposure. At each of June 30, 2012 and 2011, we had hedged approximately 45 percent of our businesses’ transactional exposures. The following table summarizes the analysis as it relates to our transactional exposure and the impact of a hypothetical 10 percent increase or decrease:
(in millions) | 2012 | 2011 | |||||
Net estimated transactional exposure | $ | 357 | $ | 374 | |||
Sensitivity gain/loss | $ | 36 | $ | 37 | |||
Estimated offsetting impact of hedges | (11 | ) | (14 | ) | |||
Estimated net gain/loss | $ | 25 | $ | 23 | |||
Translational Exposure
We have exposure related to the translation of financial statements of our foreign operations into U.S. dollars, our functional currency. We perform a similar analysis as described above related to this translational exposure. We do not typically hedge any of our translational exposure and no hedging impact was included in our analysis at June 30, 2012 and 2011. The following table summarizes our translational exposure and the impact of a hypothetical 10 percent strengthening or weakening in the U.S. dollar:
(in millions) | 2012 | 2011 | |||||
Net estimated translational exposure | $ | 63 | $ | 54 | |||
Sensitivity gain/loss | $ | 6 | $ | 5 | |||
Interest Rate Sensitivity
We are exposed to changes in interest rates primarily as a result of our borrowing and investing activities to maintain liquidity and fund business operations. The nature and amount of our long-term and short-term debt can be expected to fluctuate as a result of business requirements, market conditions and other factors. Our policy is to manage exposures to interest rates using a mix of fixed and floating rate debt as deemed appropriate by management. We utilize interest rate swap instruments to mitigate our exposure to interest rate movements.
As part of our risk management program, we perform an annual sensitivity analysis on our forecasted exposure to interest rates for the following fiscal year. This analysis assumes a hypothetical 10 percent change in interest rates. At June 30, 2012 and 2011, the potential increase or decrease in net annual interest expense under this analysis as a result of this hypothetical change was $2 million and $1 million, respectively.
Commodity Price Sensitivity
We are exposed to market price changes for commodities, including oil-based resins, cotton, latex, and diesel fuel. We typically purchase raw materials at market prices and some finished goods at prices based in part on a commodity price index. As part of our risk management program, we perform sensitivity analysis on our forecasted commodity exposure for the following fiscal year. Our forecasted commodity exposure as of June 30, 2012 decreased from the prior year primarily as a result of commodity prices and changes in purchasing volumes.
At June 30, 2012 and 2011, we had hedged a portion of these commodity exposures (see Note 11 of “Notes to Consolidated Financial Statements” for further discussion). The table below summarizes our analysis of these forecasted commodity exposures and a hypothetical 10 percent fluctuation in commodity prices as of June 30, 2012 and 2011:
(in millions) | 2012 | 2011 | |||||
Estimated commodity exposure | $ | 403 | $ | 473 | |||
Sensitivity gain/loss | $ | 40 | $ | 47 | |||
Estimated offsetting impact of hedges | (1 | ) | (2 | ) | |||
Estimated net gain/loss | $ | 39 | $ | 45 | |||
We have additional exposure to commodities through the purchase of finished goods and various other energy-related commodities, including natural gas and electricity through our normal course of business where our contracts are not directly tied to a commodity index. We believe our total gross range of exposure to commodities, including the items listed in the table above, is $500 million to $600 million as of June 30, 2012.
24
Item 8: Financial Statements and Supplementary Data
Consolidated Financial Statements and Schedule: | |
25
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders of Cardinal Health, Inc.
We have audited the accompanying consolidated balance sheets of Cardinal Health, Inc. and subsidiaries as of June 30, 2012 and 2011, and the related consolidated statements of earnings, shareholders’ equity, and cash flows for each of the three years in the period ended June 30, 2012. Our audits also included the financial statement schedule listed in the Index at Item 15(a)(2). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and 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 financial statements referred to above present fairly, in all material respects, the consolidated financial position of Cardinal Health, Inc. and subsidiaries at June 30, 2012 and 2011, and the consolidated results of their operations and their cash flows for each of the three years in the period ended June 30, 2012, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Cardinal Health, Inc. and subsidiaries' internal control over financial reporting as of June 30, 2012, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated August 22, 2012 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP |
Ernst & Young LLP |
Columbus, Ohio |
August 22, 2012 |
26
Cardinal Health, Inc. and Subsidiaries
Consolidated Statements of Earnings
(in millions, except per Common Share amounts) | 2012 | 2011 | 2010 | ||||||||
Revenue | $ | 107,552 | $ | 102,644 | $ | 98,503 | |||||
Cost of products sold | 103,011 | 98,482 | 94,722 | ||||||||
Gross margin | 4,541 | 4,162 | 3,781 | ||||||||
Operating expenses: | |||||||||||
Distribution, selling, general and administrative expenses | 2,677 | 2,528 | 2,397 | ||||||||
Restructuring and employee severance | 21 | 15 | 91 | ||||||||
Acquisition-related costs | 33 | 90 | 19 | ||||||||
Impairments and loss on disposal of assets | 21 | 9 | 29 | ||||||||
Litigation (recoveries)/charges, net | (3 | ) | 6 | (62 | ) | ||||||
Operating earnings | 1,792 | 1,514 | 1,307 | ||||||||
Other income, net | (1 | ) | (22 | ) | (13 | ) | |||||
Interest expense, net | 95 | 93 | 113 | ||||||||
Loss on extinguishment of debt | — | — | 40 | ||||||||
Gain on sale of investment in CareFusion | — | (75 | ) | (45 | ) | ||||||
Earnings before income taxes and discontinued operations | 1,698 | 1,518 | 1,212 | ||||||||
Provision for income taxes | 628 | 552 | 625 | ||||||||
Earnings from continuing operations | 1,070 | 966 | 587 | ||||||||
Earnings/(loss) from discontinued operations, net of tax | (1 | ) | (7 | ) | 55 | ||||||
Net earnings | $ | 1,069 | $ | 959 | $ | 642 | |||||
Basic earnings/(loss) per Common Share: | |||||||||||
Continuing operations | $ | 3.10 | $ | 2.77 | $ | 1.64 | |||||
Discontinued operations | — | (0.02 | ) | 0.15 | |||||||
Net basic earnings per Common Share | $ | 3.10 | $ | 2.75 | $ | 1.79 | |||||
Diluted earnings/(loss) per Common Share: | |||||||||||
Continuing operations | $ | 3.06 | $ | 2.74 | $ | 1.62 | |||||
Discontinued operations | — | (0.02 | ) | 0.15 | |||||||
Net diluted earnings per Common Share | $ | 3.06 | $ | 2.72 | $ | 1.77 | |||||
Weighted average number of Common Shares outstanding: | |||||||||||
Basic | 345 | 349 | 359 | ||||||||
Diluted | 349 | 353 | 361 | ||||||||
27
Cardinal Health, Inc. and Subsidiaries
Consolidated Balance Sheets
(in millions) | June 30, 2012 | June 30, 2011 | |||||
Assets | |||||||
Current assets: | |||||||
Cash and equivalents | $ | 2,274 | $ | 1,929 | |||
Trade receivables, net | 6,355 | 6,156 | |||||
Inventories | 7,864 | 7,334 | |||||
Prepaid expenses and other | 1,017 | 897 | |||||
Total current assets | 17,510 | 16,316 | |||||
Property and equipment, net | 1,551 | 1,512 | |||||
Goodwill and other intangibles, net | 4,392 | 4,259 | |||||
Other | 807 | 759 | |||||
Total assets | $ | 24,260 | $ | 22,846 | |||
Liabilities and Shareholders’ Equity | |||||||
Current liabilities: | |||||||
Accounts payable | $ | 11,726 | $ | 11,332 | |||
Current portion of long-term obligations and other short-term borrowings | 476 | 327 | |||||
Other accrued liabilities | 1,972 | 1,711 | |||||
Total current liabilities | 14,174 | 13,370 | |||||
Long-term obligations, less current portion | 2,418 | 2,175 | |||||
Deferred income taxes and other liabilities | 1,424 | 1,452 | |||||
Shareholders’ equity: | |||||||
Preferred Shares, without par value: | |||||||
Authorized—500 thousand shares, Issued—none | — | — | |||||
Common Shares, without par value: | |||||||
Authorized—755 million shares, Issued—364 million shares at June 30, 2012 and 2011 | 2,930 | 2,898 | |||||
Retained earnings | 4,093 | 3,331 | |||||
Common Shares in treasury, at cost: 21 million shares and 12 million shares at June 30, 2012 and 2011, respectively | (816 | ) | (457 | ) | |||
Accumulated other comprehensive income | 37 | 77 | |||||
Total shareholders’ equity | 6,244 | 5,849 | |||||
Total liabilities and shareholders’ equity | $ | 24,260 | $ | 22,846 | |||
28
Cardinal Health, Inc. and Subsidiaries
Consolidated Statements of Shareholders' Equity
Common Shares | Treasury Shares | Accumulated Other Comprehensive Income/(Loss) | Total Shareholders’ Equity | ||||||||||||||||||||||
(in millions) | Shares Issued | Amount | Retained Earnings | Shares | Amount | ||||||||||||||||||||
Balance at June 30, 2009 | 364 | $ | 3,032 | $ | 5,954 | (4 | ) | $ | (343 | ) | $ | 82 | $ | 8,725 | |||||||||||
Comprehensive income: | |||||||||||||||||||||||||
Net earnings | 642 | 642 | |||||||||||||||||||||||
Foreign currency translation adjustments | (97 | ) | (97 | ) | |||||||||||||||||||||
Unrealized gain on derivatives, net of tax | 24 | 24 | |||||||||||||||||||||||
Unrealized gain on investment in CareFusion, net of tax | 61 | 61 | |||||||||||||||||||||||
Total comprehensive income | 630 | ||||||||||||||||||||||||
Employee stock plans activity, including tax impact of $16 million | — | (142 | ) | 4 | 262 | 120 | |||||||||||||||||||
Treasury shares acquired | (7 | ) | (250 | ) | (250 | ) | |||||||||||||||||||
Dividends declared | (260 | ) | (260 | ) | |||||||||||||||||||||
Non-cash dividend issued in connection with Spin-off | (3,689 | ) | (3,689 | ) | |||||||||||||||||||||
Balance at June 30, 2010 | 364 | 2,890 | 2,647 | (7 | ) | (331 | ) | 70 | 5,276 | ||||||||||||||||
Comprehensive income: | |||||||||||||||||||||||||
Net earnings | 959 | 959 | |||||||||||||||||||||||
Foreign currency translation adjustments | 72 | 72 | |||||||||||||||||||||||
Unrealized loss on derivatives, net of tax | (4 | ) | (4 | ) | |||||||||||||||||||||
Reclassification of unrealized gain upon realization from sale of remaining investment in CareFusion, net of tax | (61 | ) | (61 | ) | |||||||||||||||||||||
Total comprehensive income | 966 | ||||||||||||||||||||||||
Employee stock plans activity, including tax impact of $14 million | — | 8 | 3 | 124 | 132 | ||||||||||||||||||||
Treasury shares acquired | (8 | ) | (250 | ) | (250 | ) | |||||||||||||||||||
Dividends declared | (281 | ) | (281 | ) | |||||||||||||||||||||
Other | 6 | 6 | |||||||||||||||||||||||
Balance at June 30, 2011 | 364 | 2,898 | 3,331 | (12 | ) | (457 | ) | 77 | 5,849 | ||||||||||||||||
Comprehensive income: | |||||||||||||||||||||||||
Net earnings | 1,069 | 1,069 | |||||||||||||||||||||||
Foreign currency translation adjustments | (34 | ) | (34 | ) | |||||||||||||||||||||
Unrealized loss on derivatives, net of tax | (6 | ) | (6 | ) | |||||||||||||||||||||
Total comprehensive income | 1,029 | ||||||||||||||||||||||||
Employee stock plans activity, including tax impact of $4 million | — | 32 | 1 | 91 | 123 | ||||||||||||||||||||
Treasury shares acquired | (10 | ) | (450 | ) | (450 | ) | |||||||||||||||||||
Dividends declared | (307 | ) | (307 | ) | |||||||||||||||||||||
Balance at June 30, 2012 | 364 | $ | 2,930 | $ | 4,093 | (21 | ) | $ | (816 | ) | $ | 37 | $ | 6,244 | |||||||||||
29
Cardinal Health, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(in millions) | 2012 | 2011 | 2010 | ||||||||
Cash flows from operating activities: | |||||||||||
Net earnings | $ | 1,069 | $ | 959 | $ | 642 | |||||
(Earnings)/loss from discontinued operations | 1 | 7 | (55 | ) | |||||||
Earnings from continuing operations | 1,070 | 966 | 587 | ||||||||
Adjustments to reconcile earnings from continuing operations to net cash from operations: | |||||||||||
Depreciation and amortization | 325 | 313 | 254 | ||||||||
Loss on extinguishment of debt | — | — | 40 | ||||||||
Gain on sale of investment in CareFusion | — | (75 | ) | (45 | ) | ||||||
Impairments and loss on disposal of assets | 21 | 9 | 29 | ||||||||
Share-based compensation | 85 | 80 | 100 | ||||||||
Provision for deferred income taxes | 158 | 128 | 120 | ||||||||
Provision for bad debts | 22 | 27 | 27 | ||||||||
Change in fair value of contingent consideration obligation | (71 | ) | (7 | ) | — | ||||||
Change in operating assets and liabilities, net of effects from acquisitions: | |||||||||||
Decrease/(increase) in trade receivables | (129 | ) | (457 | ) | 21 | ||||||
Decrease/(increase) in inventories | (495 | ) | (665 | ) | 477 | ||||||
Increase in accounts payable | 319 | 1,356 | 451 | ||||||||
Other accrued liabilities and operating items, net | (129 | ) | (280 | ) | (74 | ) | |||||
Net cash provided by operating activities—continuing operations | 1,176 | 1,395 | 1,987 | ||||||||
Net cash provided by operating activities—discontinued operations | — | — | 147 | ||||||||
Net cash provided by operating activities | 1,176 | 1,395 | 2,134 | ||||||||
Cash flows from investing activities: | |||||||||||
Acquisition of subsidiaries, net of cash acquired | (174 | ) | (2,300 | ) | (32 | ) | |||||
Purchase of held-to-maturity securities and other investments | (35 | ) | (156 | ) | — | ||||||
Additions to property and equipment | (263 | ) | (291 | ) | (260 | ) | |||||
Proceeds from divestitures and sale of property and equipment | 3 | 3 | 158 | ||||||||
Proceeds from sale of CareFusion common stock | — | 706 | 271 | ||||||||
Proceeds from maturities of held-to-maturity securities | 92 | 10 | — | ||||||||
Net cash provided by/(used in) investing activities—continuing operations | (377 | ) | (2,028 | ) | 137 | ||||||
Net cash used in investing activities—discontinued operations | — | — | (10 | ) | |||||||
Net cash provided by/(used in) investing activities | (377 | ) | (2,028 | ) | 127 | ||||||
Cash flows from financing activities: | |||||||||||
Payment of contingent consideration | — | (10 | ) | — | |||||||
Net change in short-term borrowings | 13 | 46 | — | ||||||||
Reduction of long-term obligations | (251 | ) | (229 | ) | (1,486 | ) | |||||
Proceeds from long-term obligations, net of issuance costs | 496 | 495 | — | ||||||||
Payment of premiums for debt extinguishment | — | — | (66 | ) | |||||||
Proceeds from issuance of Common Shares | 42 | 63 | 40 | ||||||||
Tax disbursements from exercises of stock options | (4 | ) | (14 | ) | (16 | ) | |||||
Dividends on Common Shares | (300 | ) | (274 | ) | (253 | ) | |||||
Purchase of treasury shares | (450 | ) | (270 | ) | (230 | ) | |||||
Net cash used in financing activities—continuing operations | (454 | ) | (193 | ||||||||