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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED JUNE 30, 2003
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 (I.R.S. Employer Identification No.)
incorporation or organization)
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:
COMMON SHARES (WITHOUT PAR VALUE NEW YORK STOCK EXCHANGE
(Title of Class) (Name of each exchange on which
registered)
Securities Registered Pursuant to Section 12(g) of the Act: None.
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark 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. [ x ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Securities Exchange Act of 1934).
Yes [X] No [ ]
The aggregate market value of voting stock held by non-affiliates of
the Registrant on December 31, 2002, based on the closing price on December 31,
2002, was approximately $25,560,031,018.
The number of Registrant's Common Shares outstanding as of September
26, 2003, was as follows: Common Shares, without par value: 432,528,115.
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the Registrant's Definitive Proxy Statement to be filed for
its 2003 Annual Meeting of Shareholders are incorporated by reference into Part
III of this Annual Report on Form 10-K.
TABLE OF CONTENTS
ITEM PAGE
- ---- ----
Important Information Regarding Forward-Looking Statements........................................ 3
PART I
1. Business.......................................................................................... 3
2. Properties........................................................................................ 11
3. Legal Proceedings................................................................................. 11
4. Submission of Matters to a Vote of Security Holders............................................... 15
PART II
5. Market for the Registrant's Common Shares and Related Shareholder Matters......................... 18
6. Selected Financial Data........................................................................... 18
7. Management's Discussion and Analysis of Financial Condition and Results
of Operations..................................................................................... 20
7a. Quantitative and Qualitative Disclosures About Market Risk........................................ 33
8. Financial Statements and Supplementary Data....................................................... 34
9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.............................................................................. 76
9a. Controls and Procedures........................................................................... 76
PART III
10. Directors and Executive Officers of the Registrant................................................ 76
11. Executive Compensation............................................................................ 76
12. Security Ownership of Certain Beneficial Owners and Management and Related
Shareholder Matters............................................................................... 77
13. Certain Relationships and Related Transactions.................................................... 77
PART IV
14. Principal Accounting Fees and Services............................................................ 77
15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.................................. 77
Signatures........................................................................................ 83
2
IMPORTANT INFORMATION REGARDING FORWARD-LOOKING STATEMENTS
Portions of this Annual Report on Form 10-K (including information
incorporated by reference) include "forward-looking statements" within the
meaning of the Private Securities Litigation Reform Act of 1995 as amended. This
includes, in particular, Part II, Item 7 of this Form 10-K. The words "believe,"
"expect," "anticipate," "project" and similar expressions, among others,
identify "forward looking statements," which speak only as of the date the
statement was made. Forward-looking statements are subject to risks,
uncertainties and other factors which could cause actual results to differ
materially from those projected, anticipated or implied. The most significant of
these risks, uncertainties and other factors are described in this Form 10-K
(including in the section titled "Risk Factors That May Affect Future Results"
on page 8) and in Exhibit 99.01 to this Form 10-K. Except to the limited extent
required by applicable law, the Company undertakes no obligation to update or
revise any forward-looking statements, whether as a result of new information,
future events, or otherwise.
PART I
ITEM 1: BUSINESS
GENERAL
Cardinal Health, Inc., an Ohio corporation formed in 1979, is a holding
company encompassing a number of operating subsidiaries that do business as
Cardinal Health. The Company is a leading provider of products and services
supporting the health care industry, and helping health care providers and
manufacturers improve the efficiency and quality of health care. As used in this
report, the terms the "Registrant" and the "Company" refer to Cardinal Health,
Inc. and its subsidiaries, unless the context requires otherwise. Except as
otherwise specified, information in this report is provided as of June 30, 2003
(the end of the Company's fiscal year).
This description of the Company's business should be read in
conjunction with the financial statements and supplementary data included in
this Form 10-K.
BUSINESS SEGMENTS
The Company has four reporting segments. They are: Pharmaceutical
Distribution and Provider Services, Medical Products and Services,
Pharmaceutical Technologies and Services and Automation and Information
Services.
PHARMACEUTICAL DISTRIBUTION AND PROVIDER SERVICES
Through its Pharmaceutical Distribution and Provider Services segment,
the Company distributes a broad line of pharmaceutical and other health care
products and provides pharmacy management and related consulting services to
hospital, retail and alternate-site pharmacies. The Company's Pharmaceutical
Distribution business is one of the country's leading wholesale distributors of
pharmaceutical and related health care products to independent and chain drug
stores, hospitals, alternate care centers and the pharmacy departments of
supermarkets and mass merchandisers located throughout the United States. As a
full-service wholesale distributor, the Company's Pharmaceutical Distribution
business complements its distribution activities by offering a broad range of
value-added support services to assist the Company's customers and suppliers in
maintaining and improving the efficiency and quality of their services. These
support services include: online procurement, fulfillment and information
provided through cardinal.com; computerized order entry and order confirmation
systems; generic sourcing programs; product movement and management reports;
consultation on store operations and merchandising; and customer training. The
Company's proprietary software systems feature customized databases specially
designed to help its distribution customers order more efficiently, contain
costs and monitor their purchases.
Through this segment, the Company also operates several specialty
health care distribution businesses which offer value-added services to the
Company's customers and suppliers while providing the Company with additional
opportunities for growth and profitability. For example, the Company operates a
pharmaceutical repackaging and distribution program for both independent and
chain drug store customers. In addition, the Company serves as a distributor of
oncology products and other specialty pharmaceuticals to hospitals, clinics and
other managed-care facilities on a nationwide basis through the utilization of
telemarketing and direct mail programs.
Also through this segment, the Company provides services that help
enhance performance in hospital pharmacies through integrated pharmacy
management, consulting and temporary staffing and related services. In addition,
the Company operates Medicine Shoppe International, Inc. ("Medicine Shoppe"), a
franchisor of apothecary-style retail pharmacies. Additionally,
3
through this segment, the Company also operates a non-core
wholesale-to-wholesale pharmaceutical trading business that sells excess
inventory.
MEDICAL PRODUCTS AND SERVICES
Through its Medical Products and Services segment, the Company provides
medical products and services and cost-saving services to hospitals and other
health care providers. For example, the Company offers a broad range of medical
and laboratory products, representing approximately 2,000 suppliers in addition
to its own line of surgical and respiratory therapy products to hospitals and
other health care providers. It also manufactures sterile and non-sterile
procedure kits, single-use surgical drapes, gowns and apparel, exam and surgical
gloves, fluid suction and collection systems, respiratory therapy products,
surgical instruments, instrument processing products, special procedure products
and other products. Additionally, the Company also assists its customers in
reducing costs while helping improve the quality of patient care in a variety of
ways, including online procurement, fulfillment and information provided through
cardinal.com, supply-chain management, instrument repair and other professional
consulting services.
PHARMACEUTICAL TECHNOLOGIES AND SERVICES
Through its Pharmaceutical Technologies and Services segment, the
Company provides a broad range of technologies and services to the
pharmaceutical, life sciences and consumer health industry. This segment's Oral
Technologies business provides proprietary drug delivery technologies, including
softgel capsules, controlled release forms and Zydis(R) fast dissolving wafers,
and manufacturing for nearly all traditional oral dosage forms. The
Biotechnology and Sterile Life Sciences business provides advanced aseptic
blow/fill/seal technology, drug lyophilization and manufacturing for nearly all
sterile dose forms, such as vials and prefilled syringes. The Packaging Services
business provides pharmaceutical packaging services, folding cartons, inserts
and labels, with proprietary expertise in child-resistant and unit
dose/compliance package design. The Pharmaceutical Development business provides
drug discovery, development and analytical science expertise and clinical
supplies manufacturing and packaging. The Healthcare Marketing Services business
provides medical education, marketing and contract sales services, along with
product logistics management. Additionally, the Nuclear Pharmacy Services
business operates centralized nuclear pharmacies that prepare and deliver
radiopharmaceuticals for use in nuclear imaging procedures in hospitals and
clinics.
AUTOMATION AND INFORMATION SERVICES
The Company, through its Automation and Information Services segment,
operates businesses focusing on meeting customer needs through unique and
proprietary automation and information products and services. For example, this
segment develops, manufactures, leases, sells and services bedside clinical and
patient entertainment systems as well as point-of-use systems that automate the
distribution and management of medications and supplies in hospitals and other
health care facilities. In addition, this segment markets point-of-use supply
systems in the non-health care market. This segment also provides information
systems that analyze clinical outcomes and clinical pharmaceutical utilization
information.
CARDINAL.COM
This Annual Report on Form 10-K as well as Quarterly Reports on Form
10-Q, Current Reports on Form 8-K and amendments to those reports filed or
furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of
1934, as amended (the "Exchange Act"), are made available on our website
(cardinal.com under the "Investor Relations-- SEC filings" captions) as soon as
reasonably practicable after we electronically file such material with, or
furnish it to, the Securities and Exchange Commission ("SEC"). Required filings
by our officers, directors and third parties with respect to the Company
furnished in electronic form are also made available on our website as are the
Company's proxy statements for its meetings of shareholders. These filings also
may be read and copied at the SEC's Public Reference Room at 450 Fifth Street,
N.W., Washington, D.C. 20549. Information on the operation of the Public
Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. The SEC
also maintains an Internet site (http://www.sec.gov) that contains reports,
proxy and information statements and other information regarding issuers that
file electronically with the SEC.
ACQUISITIONS(1)
Over the last five years, the Company has completed a number of
business combinations including the following. On August 7, 1998, the Company
completed a merger transaction with R.P. Scherer Corporation (which has been
given the legal designation
- ---------
(1) All share references in this paragraph are adjusted to reflect all stock
splits and stock dividends since the time of the applicable acquisitions.
4
of Cardinal Health 409, Inc., and is referred to throughout this Form 10-K as
"Scherer"), a New Jersey-based international developer and manufacturer of drug
delivery systems. The Company issued approximately 51.3 million Common Shares to
Scherer stockholders and Scherer's outstanding stock options were converted into
options to purchase a total of approximately 5.3 million Common Shares. On
February 3, 1999, the Company completed a merger transaction with Allegiance
Corporation ("Allegiance"), a McGaw Park, Illinois-based distributor and
manufacturer of medical, surgical and laboratory products and a provider of
cost-saving services. The Company issued approximately 106.1 million Common
Shares to Allegiance stockholders and Allegiance's outstanding stock options
were converted into options to purchase a total of approximately 15.5 million
Common Shares. On September 10, 1999, the Company completed a merger transaction
with Automatic Liquid Packaging, Inc. (recently given the legal designation of
Cardinal Health 400, Inc. and referred to in this Form 10-K as "ALP"), a
Woodstock, Illinois-based custom manufacturer of sterile liquid pharmaceuticals
and other health care products. The Company issued approximately 8.7 million
Common Shares to ALP stockholders. On August 16, 2000, the Company completed the
acquisition of Bergen Brunswig Medical Corporation ("BBMC"), a distributor of
medical, surgical and laboratory supplies to doctors' offices, long-term care
and nursing centers, hospitals and other providers of care, for approximately
$181 million in cash. On February 14, 2001, the Company completed a merger
transaction with Bindley Western Industries, Inc. (recently given the legal
designation of Cardinal Health 100, Inc. and referred to in this Form 10-K as
"Bindley"), an Indianapolis, Indiana-based wholesale distributor of
pharmaceuticals and provider of nuclear pharmacy services. The Company issued
approximately 23.1 million Common Shares to Bindley stockholders and Bindley's
outstanding stock options were converted into options to purchase a total of
approximately 5.1 million Common Shares. On April 15, 2002, the Company
completed the acquisition of Magellan Laboratories Incorporated (recently given
the legal designation of Cardinal Health 405, Inc., and referred to in this Form
10-K as "Magellan"), a Research Triangle Park, North Carolina-based
pharmaceutical contract development organization that provides a wide range of
analytical and development services to pharmaceutical and biotechnological
industries. The aggregate consideration for the transaction was approximately
$221 million, before consideration of any tax benefits associated with the
transaction. On June 26, 2002, the Company completed the acquisition of Boron,
LePore & Associates, Inc. (recently given the legal designation of Cardinal
Health 401, Inc. and referred to in this Form 10-K as "BLP"), a Wayne, New
Jersey-based full-service provider of strategic medical education solutions to
the health care industry. The Company paid approximately $189 million and
converted BLP's outstanding stock options into options to purchase a total of
approximately 1.0 million Common Shares. On January 1, 2003, the Company
completed a merger transaction with Syncor International Corporation (recently
given the legal designation of Cardinal Health 414, Inc. and referred to in this
Form 10-K as "Syncor"), a Woodland Hills, California-based company which is a
leading provider of nuclear pharmacy services. The Company issued approximately
12.5 million Common Shares to Syncor stockholders and Syncor's outstanding stock
options were converted into options to purchase a total of approximately 3.0
million Common Shares. The Company has also completed a number of smaller
acquisition transactions (asset purchases, stock purchases and mergers) during
the last five years, including acquisitions of Pacific Surgical Innovations,
Inc. ("PSI"); Med Surg Industries, Inc.; Rexam Cartons Inc.; International
Processing Corporation; American Threshold Industries, Inc.; and SP
Pharmaceuticals, L.L.C. ("SP Pharmaceuticals").
The Company regularly evaluates possible candidates for merger or
acquisition and intends to continue to seek opportunities to expand its health
care operations and services across all reporting industry segments. For
additional information concerning the transactions described above, see Notes 1
and 2 of "Notes to Consolidated Financial Statements" and "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
CUSTOMERS AND SUPPLIERS
The Company's largest retail distribution customer in its
Pharmaceutical Distribution and Provider Services segment, CVS Meridian, Inc.
("CVS"), accounted for approximately 13% of the Company's operating revenues (by
dollar volume) for fiscal year 2003. The Company could be adversely affected if
the business of this customer were lost. The two largest retail bulk
distribution customers in the Pharmaceutical Distribution and Provider Services
segment are CVS and Walgreens Co. ("Walgreens"), accounting for approximately
61% and 23%, respectively, of all bulk deliveries in fiscal 2003. Due to the
lack of margin generated through bulk deliveries, fluctuations in their
purchases would have no significant impact on the segment's earnings. Novation,
LLC ("Novation"), a group purchasing organization (a "GPO"), has business
arrangements with the Company that accounted for approximately 11% of the
Company's operating revenues (by dollar volume) in fiscal 2003 through the
Company's Pharmaceutical Distribution and Provider Services, Medical Products
and Services and Automation and Information Services segments. The Company could
be adversely affected if the business arrangement with this GPO were lost,
although the loss of the business arrangement with the GPO would not mean the
loss of sales to all members of the GPO.
The Company obtains its products from many different suppliers, the
largest of which, Pfizer, Inc., accounted for approximately 11% (by dollar
volume) of the Company's total revenue in fiscal 2003. The Company's five
largest suppliers combined accounted for approximately 37% (by dollar volume) of
the Company's total revenue during fiscal 2003 and, overall, the Company's
relationships with its suppliers are good. The Company's arrangements with its
pharmaceutical suppliers typically may
5
be canceled by either the Company or the supplier upon 30 to 90 days prior
notice, although many of these arrangements are not governed by formal
agreements. The loss of certain suppliers could adversely affect the Company's
business if alternative sources of supply were unavailable at reasonable rates.
The Company's Pharmaceutical Distribution business generates operating
margin in many ways from its vendors, including inventory investment buying
opportunities, rebates, vendor program arrangements, agreements and offerings.
The Company has seen changes in supply chain management policies of certain
vendors related to product availability, including the use of inventory
management agreements. Under these types of agreements, the Company is generally
compensated on a negotiated basis to help manufacturers better match their
shipments with market demand. These types of agreements and policies limit the
ability of the Company to invest capital in pharmaceutical inventories in
advance of price increases and also decrease the availability of excess
inventory for sale through the Company's non-core wholesale-to-wholesale
pharmaceutical trading business. In the future, vendors may continue with
similar arrangements that could limit the availability of excess inventory and,
correspondingly, have a negative impact on the Company's investment inventory
margins.
While certain of the Company's operations may show quarterly
fluctuations, the Company does not consider its business to be seasonal in
nature on a consolidated basis.
COMPETITION
The markets in which the Company operates generally are highly
competitive.
In the Pharmaceutical Distribution and Provider Services segment, the
Company's pharmaceutical wholesale distribution business competes directly with
two other national wholesale distributors (McKesson Corporation and
AmerisourceBergen Corporation) and smaller regional wholesale distributors,
direct selling manufacturers, self-warehousing chains and specialty distributors
on the basis of a value proposition that includes breadth of product lines,
marketing programs, support services and pricing. The Company's pharmaceutical
wholesale distribution operations have narrow profit margins and, accordingly,
the Company's earnings depend significantly on its ability to distribute a large
volume and variety of products efficiently and to provide quality support
services. With respect to pharmacy franchising operations, several smaller
franchisors compete with Medicine Shoppe in the franchising of pharmacies, with
competition being based primarily upon benefits offered to both the pharmacist
and the customer, access to third-party programs, the reputation of the
franchise and pricing. Medicine Shoppe also needs to be competitive with a
pharmacist's ongoing options to operate or work for an independent or chain
pharmacy. With respect to services that enhance performance in hospital
pharmacies, the Company competes with both national and regional hospital
pharmacy management firms, and self-managed hospitals and hospital systems on
the basis of services offered, its established base of business, the effective
use of information systems, the development of clinical programs, the quality of
the services it provides to its customers and price.
The Company's Medical Products and Services segment faces competition
from many sources in all of its product and service markets, with competition
focusing primarily on product performance, service levels, support services and
price.
In the Pharmaceutical Technologies and Services segment, the Company
competes on several fronts including competition with other companies providing
outsourcing services to pharmaceutical manufacturers as well as those
manufacturers who choose to handle these services in-house. Specifically, in
this segment, the Company competes as follows: the Oral Technologies business
competes with providers of both new drug delivery technologies and existing
delivery technologies; the Biotechnology and Sterile Life Sciences business
competes with other providers of sterile fill/finish manufacturing and
lyophilization services; the Pharmaceutical Development business competes with
providers of contract discovery, development and analytical laboratory services
and manufacture and packaging of clinical supplies; the Packaging Services
business competes with companies that provide packaging components and packaging
services; and the Healthcare Marketing Services business competes with other
providers of medical education, marketing/product launch services, contract
sales and product logistics services. Through Nuclear Pharmacy Services, the
Company competes with other nuclear pharmacy companies and distributors engaged
in the preparation and delivery of radiopharmaceuticals for use in nuclear
imaging procedures in hospitals and clinics. Such competitors include numerous
operators of radiopharmacies, numerous independent radiopharmacies and
manufacturers and universities that have established their own radiopharmacies.
All of the foregoing groups compete based upon a variety of factors, principally
including quality, responsiveness, proprietary technologies or capabilities,
customer service and price.
In the Automation and Information Services segment, the Company
competes based upon quality, relationships with customers, customer service and
support capabilities, patents and other intellectual property, its ability to
interface with customer information systems and price. Actual and potential
competitors include both existing domestic and foreign companies, as well as
emerging companies that supply products for specialized markets and other
outside service providers.
6
EMPLOYEES
As of September 26, 2003, the Company had more than 50,000 employees in
the U.S. and abroad, of which approximately 1,250 are subject to collective
bargaining agreements. Overall, the Company considers its employee relations to
be good.
INTELLECTUAL PROPERTY
The Company relies on a combination of trade secret, patent, copyright
and trademark laws, nondisclosure and other contractual provisions and technical
measures to protect its products, services and intangible assets. These
proprietary rights are important to the Company's ongoing operations.
The Company has applied in the United States and certain foreign
countries for registration of a number of trademarks and service marks, some of
which have been registered, and also holds common law rights in various
trademarks and service marks. It is possible that in some cases the Company may
be unable to obtain the registrations for trademarks and service marks for which
it has applied.
The Company holds patents relating to certain aspects of its automated
pharmaceutical dispensing systems, automated medication management systems,
medication packaging, medical devices, processes, products, formulations, drug
delivery systems and sterile manufacturing. The Company has a number of pending
patent applications in the United States and certain foreign countries, and
intends to pursue additional patents as appropriate.
The Company does not consider any particular patent, trademark,
license, franchise or concession to be material to its business.
REGULATORY MATTERS
Certain of the Company's subsidiaries may be required to register for
permits and/or licenses with, and comply with operating and security standards
of, the United States Drug Enforcement Administration (the "DEA"), the Food and
Drug Administration (the "FDA"), the United States Nuclear Regulatory Commission
(the "NRC"), the Department of Health and Human Services (the "HHS"), and
various state boards of pharmacy, state health departments and/or comparable
state agencies as well as foreign agencies, and certain accrediting bodies
depending upon the type of operations and location of product distribution and
sale. These subsidiaries include those that distribute prescription
pharmaceuticals (including certain controlled substances) and/or medical
devices; manage or own pharmacy operations; engage in or operate retail
pharmacies or nuclear pharmacies; purchase pharmaceuticals; engage in logistics
and/or manufacture drug delivery systems or surgical and respiratory care
products; package pharmaceutical products and devices; provide analytical
development services; or develop, create, present or distribute accredited and
unaccredited educational or promotional programs or materials. In addition,
certain of the Company's subsidiaries are subject to requirements of the
Controlled Substances Act and the Prescription Drug Marketing Act of 1987 and
similar state laws, which regulate the marketing, purchase, storage and
distribution of prescription drugs and prescription drug samples under
prescribed minimum standards. Laws regulating the manufacture and distribution
of products also exist in most other countries where certain of the Company's
subsidiaries conduct business. In addition, the Medical Products and Services
segment's international manufacturing operations and the Pharmaceutical
Technologies and Services segment's international operations are subject to
local certification requirements, including compliance with good manufacturing
practices established by those applicable foreign jurisdictions. The Automation
and Information Services segment's automated pharmaceutical dispensing systems
are not currently required to be registered or be submitted for pre-market
notifications to the FDA. There can be no assurance, however, that FDA policy in
this regard will not change.
The Company's franchising operations, through Medicine Shoppe, are
subject to Federal Trade Commission regulations, and rules and regulations
adopted by certain states, which require franchisors to make certain disclosures
to prospective franchisees prior to the sale of franchises. In addition, certain
states have adopted laws which regulate the franchisor-franchisee relationship.
The most common provisions of such laws establish restrictions on the ability of
franchisors to terminate or to refuse to renew franchise agreements. From time
to time, similar legislation has been proposed or is pending in additional
states.
The Company's Nuclear Pharmacy Services business operates nuclear
pharmacies, imaging centers and related businesses such as cyclotron facilities
used to produce positron emission tomography ("PET") products used in medical
imaging. This group operates in a regulated industry which requires licenses or
permits from the NRC, the radiologic health agency and/or department of health
of each state in which it operates and the applicable state board of pharmacy.
In addition, the FDA is also involved in the regulation of cyclotron facilities
where PET products are produced.
7
Certain of the Company's businesses are subject to federal and state
health care fraud and abuse, referral and reimbursement laws and regulations
with respect to their operations. Certain of the Company's subsidiaries also
maintain contracts with the federal government and are subject to certain
regulatory requirements relative to government contractors.
Services and products provided by certain of the Company's businesses
include access to health care information gathered and assessed for the benefit
of health care clients. Greater scrutiny on a federal and state level is being
placed on how patient identifiable health care information should be handled and
in identifying the appropriate parties and means to do so. Future changes in
regulations and/or legislation such as the Health Insurance Portability and
Accountability Act of 1996 ("HIPAA") and its accompanying federal regulations,
such as those pertaining to privacy and security, may affect how some of these
information services or products are provided. In addition, certain of the
Company's operations, depending upon their location, may be subject to
additional state or foreign regulations affecting how information services or
products are provided. Failure to comply with HIPAA and other such laws may
subject the Company and/or its subsidiaries to civil and/or criminal penalties,
which could be significant.
The Company is also subject to various federal, state and local laws,
regulations and recommendations, both in the United States and abroad, relating
to safe working conditions, laboratory and manufacturing practices and the use,
transportation and disposal of hazardous or potentially hazardous substances.
The Company's environmental policies mandate compliance with all applicable
regulatory requirements concerning environmental quality and contemplate, among
other things, appropriate capital expenditures for environmental protection for
each of its subsidiaries. In addition, U.S. and international import and export
laws and regulations require that the Company abide by certain standards
relating to the importation and exportation of finished goods, raw materials and
supplies and the handling of information. The Company is also subject to certain
laws and regulations concerning the conduct of its foreign operations, including
anti-bribery laws and laws pertaining to the accuracy of the Company's internal
books and records.
The costs associated with complying with the various applicable federal
regulations, as well as state and foreign regulations, could be significant and
the failure to comply with all such legal requirements could have a significant
impact on the Company's results of operations and financial condition.
INVENTORIES
The Company maintains a high level of inventory in its Pharmaceutical
Distribution business in order to be able to take advantage of price changes and
to be able to satisfy daily delivery requirements, but is not generally required
by its customers to maintain particular inventory levels. Certain supply
contracts with U.S. Government entities require the Company's Pharmaceutical
Distribution and Medical Products Distribution businesses to maintain sufficient
inventory to meet emergency demands. The Company does not believe that the
requirements contained in these U.S. Government supply contracts materially
impact inventory levels. The Company generally permits customers to return
products only where the products can be resold at full value or returned to
vendors for credit. The Company's practice is to offer market payment terms to
its customers. The Company is not aware of any material differences between its
practices and those of other industry participants.
RESEARCH AND DEVELOPMENT
For information on company-sponsored research and development costs in
the last three fiscal years, see Note 1 of "Notes to Consolidated Financial
Statements."
REVENUE AND LONG-LIVED ASSETS BY GEOGRAPHIC AREA
For information on revenue and long-lived assets by geographic area,
see Note 16 of "Notes to Consolidated Financial Statements."
RISK FACTORS THAT MAY AFFECT FUTURE RESULTS
CHANGES IN THE UNITED STATES HEALTH CARE ENVIRONMENT MAY ADVERSELY AFFECT THE
COMPANY'S OPERATING RESULTS. In recent years, the health care industry has
undergone significant changes driven by various efforts to reduce costs. These
efforts include, but are not limited to, potential national health care reform,
trends toward managed care, cuts in Medicare, consolidation of competitors,
suppliers and customers and the development of large, sophisticated purchasing
groups, including the efforts in several states to establish pharmaceutical
purchasing programs on behalf of their residents. This industry is expected to
continue to undergo significant changes for the foreseeable future, which could
have an adverse effect on the Company's business, financial
8
condition or results of operations. Other factors related to the health care
industry that could negatively impact the Company's business, financial
condition, or results of operations include, but are not limited to:
- - changes in governmental support of, and reimbursement for, health care
services;
- - changes in the method by which health care services are delivered;
- - changes in the prices for health care services;
- - other legislation or regulations governing health care services or
mandated benefits; and
- - changes in pharmaceutical and medical-surgical manufacturers' pricing,
selling, inventory, distribution or supply policies or procedures.
Changes in the Company's customer mix could also significantly impact its
business, financial condition, or results of operations. Due to the diverse
range of health care supply management and health care information technology
products and services that the Company offers, such changes may adversely impact
certain of the Company's businesses, while not affecting some of its competitors
who offer a narrower range of products and services.
FAILURE TO COMPLY WITH EXISTING AND FUTURE REGULATORY REQUIREMENTS MAY ADVERSELY
AFFECT THE COMPANY'S RESULTS OF OPERATIONS AND FINANCIAL CONDITION. The health
care industry is highly regulated. The Company is subject to various local,
state, federal, foreign and transnational laws and regulations, which include
the operating and security standards of the DEA, the FDA, various state boards
of pharmacy, state health departments, the NRC, the HHS and other comparable
agencies. Certain of the Company's subsidiaries may be required to register for
permits and/or licenses with, and comply with operating and security standards
of, the DEA, the FDA, the NRC, the HHS and various state boards of pharmacy,
state health departments and/or comparable state agencies as well as foreign
agencies and certain accrediting bodies depending upon the type of operations
and location of product distribution and sale. Although the Company believes
that it is in compliance, in all material respects, with applicable laws and
regulations, there can be no assurance that a regulatory agency or tribunal
would not reach a different conclusion concerning the compliance of the
Company's operations with applicable laws and regulations. In addition, there
can be no assurance that the Company will be able to maintain or renew existing
permits and licenses or obtain without significant delay future permits and
licenses needed for the operation of the Company's businesses. The noncompliance
by the Company with applicable laws and regulations or the failure to maintain,
renew or obtain necessary permits and licenses could have an adverse effect on
the Company's results of operations and financial condition. In addition, if
changes were to occur to the laws and regulations applicable to the Company's
businesses, such changes could adversely affect many of the Company's regulated
operations, which include distributing prescription pharmaceuticals (including
certain controlled substances), operating pharmacy businesses (including nuclear
pharmacies), manufacturing medical/surgical products, manufacturing
pharmaceuticals using proprietary drug delivery systems, packaging
pharmaceuticals and the sales and marketing of pharmaceuticals. Also, the health
care regulatory environment may change in a manner that could restrict the
Company's existing operations, limit the expansion of the Company's businesses,
apply regulations to previously unregulated businesses or otherwise affect the
Company adversely.
RISKS GENERALLY ASSOCIATED WITH THE COMPANY'S ACQUISITION STRATEGY AND INTERNAL
GROWTH MAY ADVERSELY AFFECT THE COMPANY'S OPERATING RESULTS. An important
element of the Company's growth strategy has been, and is expected to continue
to be, the pursuit of acquisitions of other businesses which expand or
complement the Company's existing businesses. Over the past several years, the
Company has expanded beyond its core pharmaceutical distribution business into
areas such as medical/surgical product manufacturing and distribution,
development and manufacturing of drug delivery systems, development and
manufacturing of automation and information products and compounding and
distribution of nuclear pharmaceutical products. Integrating businesses,
however, involves a number of special risks, including the possibility that
management may be distracted from regular business concerns by the need to
integrate operations, unforeseen difficulties in integrating operations and
systems, problems assimilating and retaining the Company's employees or the
employees of the acquired company, accounting issues that could arise in
connection with, or as a result of, the acquisition of the acquired company,
regulatory or compliance issues that could exist at an acquired company,
challenges in retaining the Company's customers or of the acquired company
following the acquisition and potential adverse short term effects on operating
results through increased costs or otherwise. While the Company has not
experienced any material integration problems in recent years, the possibility
of integration issues increases when the Company ventures outside its core
businesses. In addition, the Company may incur debt to finance future
acquisitions and/or may issue securities in connection with future acquisitions
which may dilute the holdings of its current and future shareholders. In
addition to the risks associated with acquisition-related growth, the Company's
business has grown in size and complexity over the past few years as a result of
internal growth. This growth and increase in complexity have placed significant
demands on management, systems, internal controls and financial and physical
resources. To meet such demands, the Company intends to continue to hire new
employees, invest in new technology and make other capital expenditures. If the
Company is unable to successfully and timely complete and integrate strategic
acquisitions or if the Company fails to efficiently manage operations in a way
that accommodates continued internal growth, its business, financial condition
or results of operations could be adversely impacted.
9
PROPRIETARY TECHNOLOGY PROTECTIONS MAY NOT BE ADEQUATE AND PROPRIETARY RIGHTS
MAY INFRINGE ON THE RIGHTS OF THIRD PARTIES. The Company relies on a combination
of trade secret, patent, copyright and trademark laws, nondisclosure and other
contractual provisions and technical measures to protect a number of its
products, services and intangible assets. There can be no assurance that these
protections will provide meaningful protection against competitive products or
services or otherwise be commercially valuable or that the Company will be
successful in obtaining additional intellectual property or enforcing its
intellectual property rights against unauthorized users. There can be no
assurance that the Company's competitors will not independently develop
technologies that are substantially equivalent or superior to the Company's
technology. From time to time, third parties have asserted infringement claims
against the Company and there can be no assurance that third parties will not
assert infringement claims against the Company in the future. While the Company
believes that the products it currently manufactures using its proprietary
technology do not infringe upon proprietary rights of other parties or that
meritorious defenses would exist with respect to any assertions to the contrary,
there can be no assurance that the Company would not be found to infringe on the
proprietary rights of others. Additionally, the Company may find it necessary to
initiate litigation to protect its trade secrets, to enforce its patent,
copyright and trademark rights and to determine the scope and validity of the
proprietary rights of others. This type of litigation can be costly and time
consuming and could generate significant expenses, damage payments or
restrictions or prohibitions on the Company's use of its technology, all of
which could adversely impact the Company's results of operations. In addition,
if the Company were found to be infringing on proprietary rights of others, the
Company may be required to develop non-infringing technology, obtain a license
or cease making, using and/or selling the infringing products.
RISKS GENERALLY ASSOCIATED WITH THE COMPANY'S SOPHISTICATED INFORMATION SYSTEMS
MAY ADVERSELY AFFECT THE COMPANY'S OPERATING RESULTS. The Company relies on
sophisticated information systems in its business to obtain, rapidly process,
analyze and manage data to: facilitate the purchase and distribution of
thousands 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; and process payments to suppliers. The
Company's business and results of operations may be adversely affected if these
systems are interrupted, damaged by unforeseen events or fail for any extended
period of time, including due to the actions of third parties.
THE COMPANY COULD BECOME SUBJECT TO LIABILITY CLAIMS THAT ARE NOT ADEQUATELY
COVERED BY INSURANCE, AND MAY HAVE TO PAY DAMAGES AND OTHER EXPENSES WHICH MAY
HAVE AN ADVERSE IMPACT ON THE COMPANY'S OPERATING RESULTS. The Company's
businesses expose it to risks that are inherent in the distribution and
dispensing of pharmaceuticals and nuclear pharmaceuticals, the provision of
ancillary services (such as pharmacy management and pharmacy staffing services),
the development and manufacture of drug delivery systems and of pharmaceutical
products for the Company's customers, the development, presentation and
distribution of medical education and marketing programs and materials, and the
manufacture and distribution of medical/surgical products and automated drug
dispensing units. A successful product or professional liability claim not fully
covered by the Company's insurance or any applicable contractual indemnity could
have a material adverse effect on the Company's results of operations.
THE LOSS OF THIRD PARTY LICENSES USED BY THE COMPANY'S AUTOMATION AND
INFORMATION SERVICES SEGMENT MAY ADVERSELY AFFECT THE COMPANY'S OPERATING
RESULTS. The Company licenses the rights to use certain technologies from
third-party vendors to incorporate in or complement its Automation and
Information Services segment's products and services. These licenses are
generally nonexclusive, must be renewed periodically by mutual consent and may
be terminated if the Company breaches the terms of the license. As a result, the
Company may have to discontinue, delay or reduce product shipments until it
obtains equivalent technology, which could adversely impact the Company's
business. The Company's competitors may obtain the right to use any of the
technology covered by these licenses and use the technology to compete directly
with the Company. In addition, if the Company's vendors choose to discontinue
support of the licensed technology in the future, the Company may not be able to
modify or adapt certain of its own products.
TAX LEGISLATION INITIATIVES COULD ADVERSELY IMPACT THE COMPANY'S RESULTS OF
OPERATIONS. The Company is a large multinational corporation with operations in
the United States and international jurisdictions. As such, the Company is
subject to the tax laws and regulations of the United States federal, state and
local governments and of many international jurisdictions. From time to time,
various legislative initiatives may be proposed that could adversely affect the
Company's tax positions. There can be no assurance that the Company's effective
tax rate will not be adversely impacted by these initiatives. In addition,
United States federal, state and local, as well as international, tax laws and
regulations are extremely complex and subject to varying interpretations.
Although the Company believes that its historical tax positions are sound and
consistent with applicable laws, regulations and existing precedent, there can
be no assurance that the Company's tax positions will not be challenged by
relevant tax authorities or that the Company would be successful in any such
challenge.
CHANGES IN VENDOR SUPPLY CHAIN MANAGEMENT POLICIES AND THE USE OF INVENTORY
MANAGEMENT AGREEMENTS IN THE PHARMACEUTICAL DISTRIBUTION INDUSTRY COULD
ADVERSELY IMPACT THE COMPANY'S RESULTS OF OPERATIONS. The Company is a purchaser
of a considerable volume of pharmaceutical products. The Company has
historically invested capital in pharmaceutical
10
inventory to take advantage of relevant market dynamics, including anticipated
manufacturer price increases. The Company recently has seen changes in vendor
supply chain management policies related to product availability, including the
use of inventory management agreements. Inventory management agreements
generally provide for the distributor to be compensated on a negotiated basis to
help manufacturers better match their shipments to meet market demand, thereby
resulting in less surplus inventory available to the distributor. Continued
changes in vendor policies related to product availability may limit the
Company's ability to leverage its resources and could adversely impact the
Company's business and results of operations.
ITEM 2: PROPERTIES
In the United States, the Company has 26 principal pharmaceutical
distribution facilities and five specialty distribution facilities utilized by
the Pharmaceutical Distribution and Provider Services segment. In its
Pharmaceutical Technologies and Services segment, the Company has 192 Nuclear
Pharmacy Services laboratory, manufacturing and distribution facilities, nine
Packaging Services packaging and printed components facilities (three of which
are located in Puerto Rico), five Oral Technologies manufacturing and R&D
facilities, five Pharmaceutical Development facilities and five Sterile
Technologies manufacturing facilities (one of which is located in Puerto Rico).
In addition, the Company has one Pyxis assembly operation in its Automation and
Information Services segment. The Company also has 61 medical/surgical
distribution facilities and 16 medical/surgical manufacturing facilities (one of
which is located in Puerto Rico) utilized by the Medical Products and Services
segment. The Company's domestic facilities are located in 45 states and Puerto
Rico.
Internationally, the Company owns, leases or operates through its
Pharmaceutical Technologies and Services segment, 10 Oral Technologies
manufacturing, lab and distribution facilities which are located in the United
Kingdom, Spain, France, Germany, Italy, Australia, Japan, Argentina, Brazil and
Canada. Within this segment, the Company also has two Packaging Services
facilities and two Pharmaceutical Development facilities which are located in
the United Kingdom and Germany. The Company owns, leases or operates through its
Medical Products and Services segment 11 medical/surgical distribution
facilities located in Canada, and 21 medical/surgical manufacturing facilities
located in the Netherlands, Malaysia, Thailand, Malta, Mexico, the Dominican
Republic, Germany and France. The Company's international facilities are located
in a total of 20 countries.
The Company owns 97 of the domestic and international facilities, and
the balance are leased. The Company's principal executive offices are
headquartered in a leased four-story building located at 7000 Cardinal Place in
Dublin, Ohio.
The Company considers its operating properties to be in satisfactory
condition and adequate to meet its present needs. However, the Company regularly
evaluates its operating properties and may make further additions, improvements
and consolidations as it continues to seek opportunities to expand its role as a
provider of products and services to the health care industry.
For certain financial information regarding the Company's facilities,
see Notes 8 and 9 of "Notes to Consolidated Financial Statements."
ITEM 3: LEGAL PROCEEDINGS
In addition to the legal proceedings disclosed below, the Company also
becomes involved from time-to-time in other litigation incidental to its
business, including, without limitation, inclusion of certain of its
subsidiaries as a potentially responsible party for environmental clean-up costs
as well as in connection with future and prior acquisitions. Although the
ultimate resolution of the litigation referenced herein cannot be forecast with
certainty, the Company intends to vigorously defend itself and does not
currently believe that the outcome of any pending litigation will have a
material adverse effect on the Company's consolidated financial statements.
Latex Litigation
On September 30, 1996, Baxter International Inc. ("Baxter") and its
subsidiaries transferred to Allegiance and its subsidiaries Baxter's U.S. health
care distribution business, surgical and respiratory therapy business and health
care cost-saving business as well as certain foreign operations (the "Allegiance
Business") in connection with a spin-off of the Allegiance Business by Baxter
(the "Baxter-Allegiance Spin-Off"). In connection with this spin-off,
Allegiance, which merged with a subsidiary of the Company on February 3, 1999,
agreed to indemnify Baxter, and to defend and indemnify Baxter Healthcare
Corporation ("BHC"), as contemplated by the agreements between Baxter and
Allegiance, for all expenses and potential liabilities associated with claims
arising from the Allegiance Business, including certain claims of alleged
personal injuries as a result of exposure to natural rubber latex gloves. The
Company is not a party to any of the lawsuits and has not agreed to pay any
settlements to the plaintiffs.
11
As of June 30, 2003, there were 233 lawsuits pending against BHC and/or
Allegiance involving allegations of sensitization to natural rubber latex
products and some of these cases were proceeding to trial. The total dollar
amount of potential damages cannot be reasonably quantified. Some plaintiffs
plead damages in extreme excess of what they reasonably can expect to recover,
some plead a modest amount and some do not include a request for any specific
dollar amount. Not including cases that ask for no specific damages, the damage
requests per action have ranged from $10,000 to $240 million. All of these cases
name multiple defendants, in addition to Baxter/Allegiance. The average number
of defendants per case exceeds twenty-five. Based on the significant differences
in the range of damages sought and based on the multiple number of defendants in
these lawsuits, Allegiance cannot reasonably quantify the total amount of
possible/probable damages. Therefore, Allegiance and the Company do not believe
that these numbers should be considered as an indication of either reasonably
possible or probable liability.
Since the inception of this litigation, Baxter/Allegiance have been
named as a defendant in 833 cases. During the fiscal year ended June 30, 2002,
Allegiance began settling some of these lawsuits with greater frequency. As of
June 30, 2003, Allegiance had resolved more than seventy percent of these cases.
About twenty percent of the lawsuits that have been resolved were concluded
without any liability to Baxter/Allegiance. No individual claim has been settled
for a material amount, nor have all the settled claims, in the aggregate,
comprised a material amount. Due to the number of claims filed and the ongoing
defense costs that will be incurred, Allegiance believes it is probable that it
will incur substantial legal fees related to the resolution of the cases still
pending. Although the Company continues to believe that it cannot reasonably
estimate the potential cost to settle these lawsuits, the Company believes that
the impact of such lawsuits upon Allegiance will be immaterial to the Company's
financial position, liquidity or results of operations, and could be in the
range of $0 to $20 million, net of insurance proceeds (with the range reflecting
the Company's reasonable estimation of potential insurance coverage, and defense
and indemnity costs). The Company believes a substantial portion of any
liability will be covered by insurance policies Allegiance has with financially
viable insurance companies, subject to self-insurance retentions, exclusions,
conditions, coverage gaps, policy limits and insurer solvency. The Company and
Allegiance continue to believe that insurance recovery is probable.
Vitamins Litigation
On May 17, 2000, Scherer, which was acquired by the Company in August
1998, filed a civil antitrust lawsuit in the United States District Court for
the District of Illinois against certain of its raw material suppliers and other
alleged co-conspirators alleging that the defendants unlawfully conspired to fix
vitamin prices and allocate vitamin production volume and vitamin customers in
violation of U.S. antitrust laws. The complaint seeks monetary damages and
injunctive relief. After the lawsuit was filed, it was consolidated for
pre-trial purposes with other similar cases. The case is pending in the United
States District Court for the District of Columbia (where it was transferred).
As of June 30, 2003, Scherer has entered into settlement agreements with the
majority of the defendants in consideration of payments of approximately $138.2
million, net of attorney fees, payments due to other interested parties and
expenses withheld prior to the disbursement of the funds to Scherer. While the
Company still has pending claims with smaller vitamin manufacturers and cannot
predict the outcome of the claims against those defendants, the total amount of
any future recovery will not likely represent a material amount.
Environmental Claims
Pennsauken Environmental Claim
In 1985, PCI Services, Inc. ("PCI"), purchased Burgess & Why Folding
Carton Company ("Burgess"), located in Pennsauken, New Jersey. The Company
acquired PCI in 1996. In 1991, the Pennsauken Solid Waste Management Authority
sued various waste transporters and other parties, in New Jersey State court,
alleging contamination of the Pennsauken landfill. One of the waste haulers sued
by the Pennsauken Solid Waste Management Authority was Quick Way, Inc. ("Quick
Way"), a waste hauling company used by Burgess from 1970 to 1982. Quick Way, in
turn, joined several companies that it serviced, including Burgess. There are
approximately 600 parties in the litigation. The Company reasonably believes
that PCI's liability, if any, will be less than $100,000, and the impact of this
claim upon PCI, if any, will be immaterial to the Company's financial position,
liquidity and results of operations.
Environmental Claims Relating to Allegiance
On September 30, 1996, Baxter and its subsidiaries transferred to
Allegiance and its subsidiaries the Allegiance Business in connection with the
Baxter-Allegiance Spin-Off. As a result of the Baxter-Allegiance Spin-Off,
Allegiance agreed to defend and indemnify Baxter from the following
environmental claims.
12
San Gabriel Environmental Claim
Allegiance, through Baxter and its predecessors-in-interest, owned a
facility located in Irwindale, California (the "Irwindale Property"), from
approximately 1961 to approximately 1999, where, among other things, plastics
were manufactured, a chemical laboratory was operated, and certain research and
development activity was carried out. San Gabriel is a Superfund site in the Los
Angeles area that concerns ground water contamination of a local drinking water
aquifer. The U.S. Environmental Protection Agency (the "U.S. EPA") is the lead
government agency in charge of the San Gabriel Valley Groundwater Basin
Superfund Sites, Areas 1-4, Baldwin Park Operable Unit (the "BPOU"). According
to the U.S. EPA, the groundwater within the BPOU is contaminated. The Irwindale
Property is located approximately one-mile away from the BPOU plume. The U.S.
EPA named Allegiance as a potentially responsible party ("PRP") for the
groundwater contamination in the BPOU, along with a number of other PRPs. In
June 2000, the U.S. EPA issued a unilateral administrative order ("UAO") against
a number of companies, including Allegiance. The UAO requires, among other
things, the design and implementation of the interim groundwater remedy selected
by U.S. EPA. This interim remedy generally requires pumping contaminated
groundwater from the aquifer and treating it in accordance with federal and
state government standards in order to remove or reduce contaminants of concern
and to stop the further migration of contaminants. Allegiance has maintained
that the Irwindale Property did not contribute to the alleged ground water
contamination. The levels of contaminants detected on the Irwindale Property are
below any state or federal standard requiring remediation or monitoring. The
U.S. EPA is engaged in settlement discussions with Allegiance, and has not sued
Allegiance in connection with the UAO or the BPOU. Previously, the U.S. EPA made
a cash buy-out demand to Allegiance of $550,000. Allegiance responded with
questions as to the calculations and data utilized by the U.S. EPA to reach the
$550,000 amount. By using the U.S. EPA's own equation and Allegiance's
reasonable understanding of the facts, Allegiance reasonably believes that its
potential liability would be less than the cash buy out demand amount.
Allegiance has recorded environmental accruals, based upon the information
available, that it reasonably believes are adequate to satisfy known costs. The
Company reasonably believes that the impact of this claim upon Allegiance will
be immaterial to the Company's financial position, liquidity and results of
operations.
A-1 Plainwell and A-1 Sunrise Environmental Claims
The Michigan Department of Environmental Quality brought suit against
Baxter as a PRP along with a number of other PRPs, in 1994, in the Circuit Court
of the State of Michigan for Ingham County, alleging contamination of the
A-1 disposal site in Plainwell, Michigan ("A-1 Plainwell"). Among the
contaminants at the site were solvent wastes generated by Burdick & Jackson of
Muskegon, Michigan. Baxter became a PRP through its acquisition of Burdick &
Jackson ("Burdick") in 1986. Allegiance agreed to defend and indemnify Baxter,
in this claim, as part of the Baxter-Allegiance Spin-Off. The principal relief
sought was for the PRPs to clean up the site to applicable standards and to
reimburse the government for its oversight and other costs at the site. In a
related action, Allegiance, through its association with Baxter, and Burdick,
was named a PRP to reimburse the State of Michigan for reimbursement costs
associated with the construction of a landfill cap and continued operation,
maintenance and monitoring of the A-1 Sunrise site in Michigan ("A-1 Sunrise").
Allegiance has paid approximately $95,000 for past remediation costs at the A-1
Plainwell site and approximately $230,000 at the A-1 Sunrise site. Remediation
of the A-1 Plainwell site is substantially complete, subject to minimal
operation, maintenance and monitoring of the site. Allegiance's share of future
remediation at the A-1 Sunrise site is approximately 1.8%. Allegiance has
recorded environmental accruals, based upon the information available, that it
reasonably believes are adequate to satisfy known costs. The Company reasonably
believes that the impact of these claims upon Allegiance will be immaterial to
the Company's financial position, liquidity and results of operations.
Thermochem Environmental Claim
As a result of the Burdick acquisition, Baxter was identified, by the
U.S. EPA, as a PRP for clean-up costs related to the Thermochem waste processing
site in Muskegon, Michigan. Allegiance agreed to defend and indemnify Baxter, in
this claim, as part of the Baxter-Allegiance Spin-Off. Based upon the
information available, Allegiance reasonably believes the total clean-up cost of
this site to be between approximately $17 million and $23 million. A well-funded
PRP group, of which Baxter is a member, has spent approximately $10 million in
clean-up costs. Allegiance reasonably believes that current available funding of
the PRP, along with Allegiance's additional recorded environmental accruals, are
adequate to satisfy known costs. The Company reasonably believes that the impact
of this claim upon Allegiance will be immaterial to the Company's financial
position, liquidity and results of operations.
Shareholder Litigation against Cardinal Health
On November 8, 2002, a complaint was filed by a purported shareholder
against the Company and its directors in the Court of Common Pleas, Delaware
County, Ohio, as a purported derivative action. Doris Staehr v. Robert D.
Walter, et al., No. 02-CVG-11-639. On or about March 21, 2003, after the Company
filed a Motion to Dismiss the complaint, an amended complaint was filed
13
alleging breach of fiduciary duties and corporate waste in connection with the
alleged failure by the Board of Directors of the Company to (a) renegotiate or
terminate the Company's proposed acquisition of Syncor and (b) determine the
propriety of indemnifying Monty Fu, the former Chairman of Syncor. The Company
filed a Motion to Dismiss the amended complaint and the plaintiffs subsequently
filed a second amended complaint which added three new individual defendants and
includes new allegations that the Company improperly recognized revenue in
December 2000 and September 2001 related to settlements with certain vitamins
manufacturers. The Company has filed a Motion to Dismiss the second amended
complaint. The Company believes the allegations made in the second amended
complaint are without merit and intends to vigorously defend this action. The
Company currently does not believe that the impact of this lawsuit, if any, will
have a material adverse effect on the Company's financial position, liquidity or
results of operations. The Company currently believes that there will be some
insurance coverage available under the Company's directors' and officers'
liability insurance policies in effect at the time this action was filed.
Shareholder Litigation against Syncor
Eleven purported class action lawsuits have been filed against Syncor
and certain of its officers and directors, asserting claims under the federal
securities laws (collectively referred to as the "federal securities actions").
All of these actions were filed in the United States District Court for the
Central District of California. These cases include Richard Bowe v. Syncor Int'l
Corp., et al., No. CV 02-8560 LGB (RCx) (C.D. Cal.), Alan Kaplan v. Syncor Int'l
Corp., et al., No. CV 02-8575 CBM (MANx) (C.D. Cal), Franklin Embon, Jr. v.
Syncor Int'l Corp., et al., No. CV 02-8687 DDP (AJWx) (C.D. Cal), Jonathan Alk
v. Syncor Int'l Corp., et al., No. CV 02-8841 GHK (RZx) (C.D. Cal), Joyce Oldham
v. Syncor Int'l Corp., et al., CV 02-8972 FMC (RCx) (C.D. Cal), West Virginia
Laborers Pension Trust Fund v. Syncor Int'l Corp., et al., No. CV 02-9076 NM
(RNBx) (C.D. Cal), Brad Lookingbill v. Syncor Int'l Corp., et al., CV 02-9248
RSWL (Ex) (C.D. Cal), Them Luu v. Syncor Int'l Corp., et al., CV 02-9583 RGK
(JwJx) (C.D. Cal), David Hall v. Syncor Int'l Corp., et al., CV 02-9621 CAS
(CWx) (C.D. Cal), Phyllis Walzer v. Syncor Int'l Corp., et al., CV 02-9640 RMT
(AJWx) (C.D. Cal) and Larry Hahn v. Syncor Int'l Corp., et al., CV 03-52 LGB
(RCx) (C.D. Cal.).
The federal securities actions purport to be brought on behalf of all
purchasers of Syncor shares during various periods, beginning as early as March
30, 2000, and ending as late as November 5, 2002 and allege, among other things,
that the defendants violated Section 10(b) of the Exchange Act and Rule 10b-5
promulgated thereunder and Section 20(a) of the Exchange Act, by issuing a
series of press releases and public filings disclosing significant sales growth
in Syncor's international business, but omitting mention of certain allegedly
improper payments to Syncor's foreign customers, thereby artificially inflating
the price of Syncor shares. A lead plaintiff has been appointed by the court in
the federal securities actions and a consolidated amended complaint was filed
May 19, 2003, naming Syncor and 12 individuals, all former Syncor officers,
directors and employees. Syncor filed a Motion to Dismiss the consolidated
amended complaint on August 1, 2003.
On November 14, 2002, two additional actions were filed by individual
stockholders of Syncor in the Court of Chancery of the State of Delaware (the
"Delaware actions") against seven of Syncor's nine directors (the "director
defendants"). The complaints in each of the Delaware actions were identical and
alleged that the director defendants breached certain fiduciary duties to Syncor
by failing to maintain adequate controls, practices and procedures to ensure
that Syncor's employees and representatives did not engage in improper and
unlawful conduct. Both complaints asserted a single derivative claim, for and on
behalf of Syncor, seeking to recover all of the costs and expenses that Syncor
incurred as a result of the allegedly improper payments (including the costs of
the federal securities actions described above), and a single purported class
action claim seeking to recover damages on behalf of all holders of Syncor
shares in the amount of any losses sustained if consideration received in the
merger by Syncor stockholders was reduced. On November 22, 2002, the plaintiff
in one of the two Delaware actions filed an amended complaint adding as
defendants the Company, its subsidiary Mudhen Merger Corporation and the
remaining two Syncor directors, who are hereafter included in the term "director
defendants." These cases include Alan Kaplan v. Monty Fu, et al., Case No.
20026-NC (Del. Ch.), and Richard Harman v. Monty Fu, et al., Case No. 20027-NC
(Del. Ch). These cases have been consolidated under the caption "In re: Syncor
International Corp. Shareholders Litigation" (the "consolidated Delaware
action"). On August 14, 2003, the Company filed a Motion to Dismiss the
operative complaint in the consolidated Delaware action.
On November 18, 2002, two additional actions were filed by individual
stockholders of Syncor in the Superior Court of California for the County of Los
Angeles (the "California actions") against the director defendants. The
complaints in the California actions allege that the director defendants
breached certain fiduciary duties to Syncor by failing to maintain adequate
controls, practices and procedures to ensure that Syncor's employees and
representatives did not engage in improper and unlawful conduct. Both complaints
asserted a single derivative claim, for and on behalf of Syncor, seeking to
recover costs and expenses that Syncor incurred as a result of the allegedly
improper payments. These cases include Joseph Famularo v. Monty Fu, et al, Case
No. BC285478 (Cal. Sup. Ct., Los Angeles Cty.), and Mark Stroup v. Robert G.
Funari, et al., Case No. BC285480 (Cal. Sup. Ct., Los Angeles Cty.). An amended
complaint was filed on December 6, 2002 in the Famularo action, purporting to
allege direct claims on behalf of a class of shareholders. The defendants'
motion for a stay of the California actions pending the resolution of the
Delaware actions (discussed above) was granted on April 30, 2003.
14
A proposed class action complaint, captioned Pilkington v. Cardinal
Health, et al, was filed on April 8, 2003, against the Company, Syncor and
certain officers and employees of the Company by a purported participant in the
Syncor Employees' Savings and Stock Ownership Plan (the "Syncor ESSOP"). A
related proposed class action complaint, captioned Donna Brown, et al. v. Syncor
International Corp, et al, was filed on September 11, 2003, against the Company,
Syncor and certain individual defendants. The related suits allege that the
defendants breached certain fiduciary duties owed under the Employee Retirement
Income Security Act ("ERISA"). It is expected that these related suits will be
consolidated. In addition, the United States Department of Labor is conducting
an investigation of the Syncor ESSOP with respect to its compliance with ERISA
requirements. The Company has responded to a subpoena received from the
Department of Labor and intends to fully cooperate in its investigation.
Each of the actions described under the heading "Shareholder Litigation
against Syncor" is in its early stages and it is impossible to predict the
outcome of these proceedings or their impact on Syncor or the Company. However,
the Company currently does not believe that the impact of these actions will
have a material adverse effect on the Company's financial position, liquidity or
results of operations. The Company and Syncor believe the allegations made in
the complaints described above are without merit and intend to vigorously defend
such actions and have been informed that the individual director and officer
defendants deny liability for the claims asserted in these actions, believe they
have meritorious defenses and intend to vigorously defend such actions. The
Company and Syncor currently believe that a portion of any liability will be
covered by insurance policies that the Company and Syncor have with financially
viable insurance companies, subject to self-insurance retentions, exclusions,
conditions, coverage gaps, policy limits and insurer solvency.
DuPont Litigation
On September 11, 2003, E.I. Du Pont De Nemours and Company ("DuPont")
filed a lawsuit against the Company and others in the United States District
Court for the Middle District of Tennessee. E.I. Du Pont De Nemours and Company
v. Cardinal Health, Inc., BBA Materials Technology and BBA Nonwovens
Simpsonville, Inc., No. 3-03-0848. The complaint alleges various causes of
action against the Company relating to the production and sale of surgical
drapes and gowns by the Company's Medical Products and Services segment.
DuPont's claims generally fall into the categories of breach of contract, false
advertising and patent infringement. The complaint does not request a specific
amount of damages. The Company believes that the claims made in the complaint
are without merit and it intends to vigorously defend this action. The Company
believes that it is owed a defense and indemnity from its codefendants with
respect to DuPont's claim for patent infringement. The Company currently does
not believe that the impact of this lawsuit, if any, will have a material
adverse effect on the Company's financial position, liquidity or results of
operation.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None during the fiscal quarter ended June 30, 2003.
15
EXECUTIVE OFFICERS OF THE COMPANY
The following is a list of the executive officers of the Company
(information provided as of September 26, 2003):
NAME AGE POSITION
- ---------------------------- --- -------------------------------------------------
Robert D. Walter 58 Chairman and Chief Executive Officer
George L. Fotiades 50 President and Chief Executive Officer -
Life Sciences Products and Services
James F. Millar 55 President and Chief Executive Officer -
Healthcare Products and Services
Ronald K. Labrum 47 Executive Vice President; Group President -
Medical Products and Services
Mark W. Parrish 48 Executive Vice President; Group President -
Pharmaceutical Distribution
Stephen S. Thomas 48 Executive Vice President; Group President -
Automation and Information Services
Jody R. Davids 47 Executive Vice President and Chief
Information Officer
Gary D. Dolch 56 Executive Vice President - Quality and
Regulatory Affairs
Brendan A. Ford 45 Executive Vice President - Corporate
Development
Richard J. Miller 46 Executive Vice President and Chief Financial
Officer
Anthony J. Rucci 53 Executive Vice President and Chief Administrative
Officer
Carole S. Watkins 43 Executive Vice President - Human Resources
Paul S. Williams 43 Executive Vice President, Chief Legal Officer and
Secretary
Unless indicated to the contrary, the business experience summaries
provided below for the Company's executive officers describe positions held by
the named individuals during the last five years but exclude other positions
held with subsidiaries of the Company.
ROBERT D. WALTER has been a Director, Chairman of the Board and Chief
Executive Officer of the Company since its formation in 1979. Mr. Walter also
serves as a director of Viacom Inc. and American Express Company.
GEORGE L. FOTIADES President and Chief Executive Officer - Life
Sciences Products and Services since December 2002; Executive Vice President,
President and Chief Operating Officer - Pharmaceutical Technologies and Services
of the Company, November 2000 to December 2002; Executive Vice President and
Group President - R.P. Scherer Corporation, August 1998 to October 2000;
President of R.P. Scherer Corporation, January 1998 to August 1998. Mr. Fotiades
serves as a director of ProLogis.
JAMES F. MILLAR President and Chief Executive Officer - Healthcare
Products and Services since December 2002; Executive Vice President, President
and Chief Operating Officer - Pharmaceutical Distribution and Medical Products,
November 2000 to December 2002; Executive Vice President and Group President -
Pharmaceutical Distribution and Provider Services, February 2000 to November
2000; Executive Vice President and Group President of the Company's distribution
business, June 1996 to February 2000. Mr. Millar serves as a director of Wendy's
International, Inc.
16
RONALD K. LABRUM Executive Vice President and Group President - Medical
Products and Services since November 2000; President, Manufacturing and
Distribution of Allegiance, October 2000 to November 2000; Corporate Vice
President, Regional Companies/Health Systems of Allegiance, January 1997 to
October 2000.
MARK W. PARRISH Executive Vice President and Group President -
Pharmaceutical Distribution since January 2003; President, Medicine Shoppe
International, July 2001 to January 2003; Executive Vice President - Retail
Sales and Marketing, June 1999 to July 2001; Executive Vice President - Sales
and Marketing, June 1997 to June 1999.
STEPHEN S. THOMAS Executive Vice President and Group President -
Automation and Information Services since September 2000; Executive Vice
President and Group President - Pharmacy Automation, Information Systems and
International Operations, July 1999 to September 2000; Executive Vice President
and President of Pyxis, October 1997 to July 1999.
JODY R. DAVIDS Executive Vice President and Chief Information Officer
of the Company since March 2003; Senior Vice President - Information Technology
- - Pharmaceutical Distribution, January 2000 to March 2003; Director of
Technology Services of NIKE, Inc., April 1997 to January 2000.
GARY D. DOLCH Executive Vice President - Quality and Regulatory Affairs
since December 2002; Senior Vice President of Quality and Regulatory Affairs of
the American Red Cross, May 2001 to December 2002; Vice President, Quality
Assurance for BASF's pharmaceutical operations under the Knoll name, April 1995
to May 2001.
BRENDAN A. FORD Executive Vice President - Corporate Development of the
Company since November 1999; Senior Vice President - Corporate Development,
February 1996 to November 1999.
RICHARD J. MILLER Executive Vice President of the Company since
November 1999; Chief Financial Officer since March 1999; Acting Chief Financial
Officer, August 1998 to March 1999; Corporate Vice President, April 1999 to
November 1999; Vice President and Controller, August 1995 to March 1999.
ANTHONY J. RUCCI Executive Vice President and Chief Administrative
Officer of the Company since January 2000; Executive Vice President - Human
Resources, November 1999 to January 2000; Dean of the University of Illinois at
Chicago's College of Business Administration, 1998 to November 1999; Executive
Vice President for Administration of Sears, Roebuck and Co., 1993 to 1998.
CAROLE S. WATKINS Executive Vice President - Human Resources of the
Company since August 2000; Senior Vice President - Human Resources -
Pharmaceutical Distribution and Provider Services, February 2000 to August 2000;
Vice President - Human Resources - Cardinal Distribution, November 1996 to
February 2000.
PAUL S. WILLIAMS Executive Vice President, Chief Legal Officer and
Secretary of the Company since April 2001; Senior Vice President, Deputy General
Counsel and Assistant Secretary, January 2001 to March 2001; Vice President,
Deputy General Counsel and Assistant Secretary, July 1999 to January 2001; Vice
President, Assistant General Counsel and Assistant Secretary, June 1998 to July
1999; Assistant General Counsel, June 1995 to June 1998. Mr. Williams serves as
a director of State Auto Financial Corporation.
17
PART II
ITEM 5: MARKET FOR THE REGISTRANT'S COMMON SHARES AND RELATED SHAREHOLDER
MATTERS
The Common Shares are quoted on the New York Stock Exchange under the
symbol "CAH." The following table reflects the range of the reported high and
low closing sale prices of the 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, 2003 and 2002, and through the period ended on September
26, 2003, the last full trading day prior to the filing of this Form 10-K.
HIGH LOW DIVIDENDS
----------- ---------- ----------
Fiscal 2002:
Quarter Ended
September 30, 2001 $ 75.30 $ 67.28 $ 0.025
December 31, 2001 76.60 61.50 0.025
March 31, 2002 70.89 60.80 0.025
June 30, 2002 73.00 61.41 0.025
Fiscal 2003:
Quarter Ended
September 30, 2002 $ 68.19 $ 49.08 $ 0.025
December 31, 2002 71.16 57.99 0.025
March 31, 2003 63.48 50.31 0.025
June 30, 2003 66.19 52.17 0.030
Through September 26, 2003 $ 67.96 $ 54.75 $ 0.030
As of September 26, 2003, there were approximately 20,200 shareholders
of record of the Common Shares.
The Company anticipates that it will continue to pay quarterly cash
dividends in the future. However, the payment and amount of future dividends
remain within the discretion of the Company's Board of Directors and will depend
upon the Company's future earnings, financial condition, capital requirements
and other factors.
The Company maintains several stock incentive plans (the "Plans") for
the benefit of certain officers, directors and employees. Options granted
generally vest over three years and are exercisable for periods up to ten years
from the date of grant at a price which equals fair market value at the date of
grant. Certain plans are subject to shareholder approval while other plans have
been authorized solely by the Board of Directors. The following table summarizes
information relating to the Plans as of June 30, 2003:
Outstanding
--------------------------------------
Number of Common Weighted
Shares to be Issued Average Common Shares
Upon Exercise of Exercise Price Available for
Outstanding Options per Common Future Issuance
(in millions) Share (in millions)
- --------------------------------------------------------------------------------------
Plans approved by
shareholders 13.6 $49.97 25.1
Plans not approved by
shareholders 18.3 $61.04 18.0
Plans acquired through
acquisition 9.0 $31.91 -
- --------------------------------------------------------------------------------------
Balance at June 30, 2003 40.9 $50.92 43.1
======================================================================================
ITEM 6: SELECTED FINANCIAL DATA
The following selected consolidated financial data of the Company was
prepared giving retroactive effect to the business combinations with Scherer on
August 7, 1998; Allegiance on February 3, 1999; PSI on May 21, 1999; ALP on
September 10,
18
1999, and Bindley on February 14, 2001, all of which were accounted for as
pooling-of-interests transactions. Additional disclosure related to the Bindley
transaction is included in Note 2 of "Notes to Consolidated Financial
Statements." The consolidated financial data include all purchase transactions
as of the date of acquisition that occurred during these periods.
For the fiscal year ended June 30, 1999, the information presented is
derived from the consolidated financial statements which combine the Company's
financial results for the fiscal year ended June 30, 1999 with Bindley's
financial results for the fiscal year ended December 31, 1998. For the fiscal
year ended June 30, 2000, the information presented is derived from the
consolidated financial statements which combine the Company's financial results
for the fiscal year ended June 30, 2000 with Bindley's financial results for the
fiscal year ended December 31, 1999.
The selected consolidated financial data below should be read in
conjunction with the Company's consolidated financial statements and related
notes and "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
CARDINAL HEALTH, INC. AND SUBSIDIARIES
SELECTED CONSOLIDATED FINANCIAL DATA
(IN MILLIONS, EXCEPT PER COMMON SHARE AMOUNTS)
At or For the Fiscal Year Ended
June 30, (1)
------------------------------------------------------------------
2003 2002 2001 2000 1999 (2)
------------------------------------------------------------------
EARNINGS DATA:
Operating revenue $ 50,466.6 $ 44,394.3 $ 38,660.1 $ 30,257.8 $ 25,682.5
Bulk deliveries to customer warehouses
and other 6,270.4 6,741.4 9,287.5 8,092.1 7,050.4
------------------------------------------------------------------
Total revenue $ 56,737.0 $ 51,135.7 $ 47,947.6 $ 38,349.9 $ 32,732.9
Earnings from continuing operations
before cumulative effect of change
in accounting $ 1,411.9 $ 1,126.3 $ 857.4 $ 717.8 $ 499.3
Loss from discontinued operations (3) (6.1) - - - -
Cumulative effect of change
in accounting (4) - (70.1) - - -
------------------------------------------------------------------
Net earnings $ 1,405.8 $ 1,056.2 $ 857.4 $ 717.8 $ 499.3
Basic earnings per Common Share (5)
Continuing operations $ 3.17 $ 2.50 $ 1.93 $ 1.64 $ 1.14
Discontinued operations (3) (0.02) - - - -
Cumulative effect of change
in accounting (4) - (0.16) - - -
------------------------------------------------------------------
Net basic earnings per Common Share $ 3.15 $ 2.34 $ 1.93 $ 1.64 $ 1.14
Diluted earnings per Common Share (5)
Continuing operations $ 3.12 $ 2.45 $ 1.88 $ 1.60 $ 1.12
Discontinued operations (3) (0.02) - - - -
Cumulative effect of change
in accounting (4) - (0.15) - - -
------------------------------------------------------------------
Net diluted earnings per Common Share $ 3.10 $ 2.30 $ 1.88 $ 1.60 $ 1.12
Cash dividends declared
per Common Share (5) (6) $ 0.105 $ 0.100 $ 0.085 $ 0.070 $ 0.067
BALANCE SHEET DATA:
Total assets $ 18,521.4 $ 16,438.0 $ 14,642.4 $ 12,024.1 $ 9,682.7
Long-term obligations,
less current portion $ 2,471.9 $ 2,207.0 $ 1,871.0 $ 1,524.5 $ 1,224.5
Shareholders' equity $ 7,758.1 $ 6,393.0 $ 5,437.1 $ 4,400.4 $ 3,894.6
19
(1) Amounts reflect business combinations and the impact of merger-related
costs and other special items in all periods presented. See Note 2 of
"Notes to Consolidated Financial Statements" for a further discussion
of merger-related costs and other special items affecting fiscal 2003,
2002, and 2001. Fiscal 2000 amounts reflect the impact of
merger-related charges and other special items of $64.7 million ($49.8
million, net of tax). Fiscal 1999 amounts reflect the impact of
merger-related charges and other special items of $165.4 million
($131.6 million, net of tax).
(2) In April 1998, ALP elected S-Corporation status for income tax
purposes. As a result of the merger, ALP terminated its S-Corporation
election. Amounts above do not reflect the impact of pro forma
adjustments related to ALP taxes as if ALP had been subject to federal
income taxes during the periods presented. For the fiscal year ended
June 30, 1999, the pro forma adjustment for ALP taxes would have
reduced net earnings by $9.3 million. The pro forma adjustment would
have decreased diluted earnings per Common Share by $0.02 to $1.10 for
fiscal 1999.
(3) On January 1, 2003, the Company acquired Syncor. Prior to the
acquisition, Syncor had announced the discontinuation of certain
operations including the medical imaging business and certain overseas
operations. The Company is continuing with the discontinuation of these
operations and has included additional international and non-core
domestic businesses to the discontinued operations. For additional
information regarding discontinued operations, see Note 19 of "Notes to
Consolidated Financial Statements."
(4) In the first quarter of fiscal 2002, the method of recognizing revenue
for pharmacy automation equipment was changed from recognizing revenue
when the units are delivered to the customer to recognizing revenue
when the units are installed at the customer site. For more information
regarding the change in accounting see Note 14 of "Notes to
Consolidated Financial Statements."
(5) Basic earnings, diluted earnings and cash dividends per Common Share
have been adjusted to retroactively reflect all stock dividends and
stock splits through June 30, 2003.
(6) Cash dividends per Common Share exclude dividends paid by all entities
with which subsidiaries of the Company have merged.
ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The discussion and analysis presented below has been prepared giving
retroactive effect to the pooling-of-interests business combination with Bindley
on February 14, 2001. The discussion and analysis presented below refers to and
should be read in conjunction with the consolidated financial statements and
related notes appearing elsewhere in this Form 10-K.
GENERAL
The Company has four operating business segments: Pharmaceutical
Distribution and Provider Services, Medical Products and Services,
Pharmaceutical Technologies and Services and Automation and Information
Services. See Part I, Item 1, "Business," and Note 16 in "Notes to Consolidated
Financial Statements" for a description of these segments.
RESULTS OF OPERATIONS
OPERATING REVENUE
Percent of Company
Growth (1) Operating Revenues
Years ended June 30, 2003 2002 2003 2002 2001
- --------------------------------------------------------------------------------------------------------------
Pharmaceutical Distribution and Provider Services 14% 17% 82% 82% 81%
Medical Products and Services 6% 6% 13% 14% 15%
Pharmaceutical Technologies and Services 44% 12% 4% 3% 3%
Automation and Information Services 19% 19% 1% 1% 1%
Total Company 14% 15% 100% 100% 100%
- --------------------------------------------------------------------------------------------------------------
(1) Growth is calculated as the change (increase or decrease) in the
operating revenue for a given year as a percentage of the operating
revenue in the immediately preceding year.
Total operating revenue increased 14% and 15% during fiscal 2003 and
2002, respectively. The increase in fiscal 2003 resulted from a higher sales
volume across each of the Company's segments; strong sales of self-manufactured
products; the addition of new products; the addition of new customers, some of
which was a result of new corporate agreements with health care
20
providers; and pharmaceutical price increases averaging approximately 5%. In
addition, the Syncor acquisition within the Pharmaceutical Technologies and
Services segment accounted for approximately 1% of the overall growth of the
Company during fiscal 2003. The overall growth was partially offset by a decline
within the Company's non-core wholesaler-to-wholesaler pharmaceutical trading
business, as further discussed below. The increase in fiscal 2002 resulted from
a higher sales volume across various customer segments; strong sales of
self-manufactured products; pharmaceutical price increases averaging
approximately 5%; addition of new products; and the addition of new customers,
some of which was a result of new corporate agreements with health care
providers.
The Pharmaceutical Distribution and Provider Services segment's
operating revenue growth in fiscal 2003 resulted from strong sales to customers
within this segment's core pharmaceutical distribution business, some of which
were generated from the addition of new contracts. The most significant growth
was in the alternate site and chain pharmacy businesses, which yielded growth of
approximately 28% and 15%, respectively. The chain pharmacy growth rate would
have been stronger had it not experienced a reduction in business with Kmart due
to Kmart's closure of various stores in connection with Kmart's bankruptcy. The
overall growth rate in this segment was also negatively impacted by the lack of
availability of certain pharmaceutical products from manufacturers, particularly
in the second half of the fiscal year, which impacted non-core
wholesaler-to-wholesaler revenue. This lack of availability was, in part,
brought about by changes in inventory supply chain management policies of
certain vendors, leading to the use of inventory management agreements.
Inventory management agreements generally provide for the Company to be
compensated on a negotiated basis to help manufacturers better match their
shipments to meet market demand, thereby resulting in less surplus inventory for
the Company's trading business. It is not anticipated that fluctuations in
trading activity will have a significant impact on operating revenue growth
rates in future years. The increase in this segment's operating revenue in
fiscal 2002 resulted from strong sales to all customer segments, especially
retail pharmacy and grocery chains and alternate site customers, each of which
yielded 20% growth, as well as strong growth in mail order and government
customers. A portion of the fiscal 2002 growth was attributable to
pharmaceutical price increases and the addition of new contracts.
The Medical Products and Services segment's operating revenue growth in
fiscal 2003 resulted from increased sales of both distributed and
self-manufactured products. The addition of several new contracts with hospitals
and health care networks, as well as increased market share in the growing
surgery center market contributed to increased sales of distributed and
self-manufactured products. Increased demand for certain existing
self-manufactured products, including medical gloves, Medi-vac(R) suction
canisters, Procedure Based Delivery System(R) kits and other minor procedure
trays, accounted for a portion of this segment's revenue growth. The addition of
new, self-manufactured products also contributed to the overall revenue growth
in this segment. Some examples of these new, self-manufactured products include
the Esteem(R) surgeon gloves and the Tiburon(TM) and Astound(TM) fabrics within
the Converters(R) business. The increase in this segment's operating revenue in
fiscal 2002 resulted from strong sales of self-manufactured products,
particularly sales of surgical instruments and custom kits for surgical
procedures, as well as price increases and increases in sales of distributed
products. Several new long-term contracts were signed within the segment's
distribution business in fiscal 2002.
The Pharmaceutical Technologies and Services segment's operating
revenue growth in fiscal 2003 resulted from increased demand within the Oral
Technologies, Biotechnology and Sterile Life Sciences, and Packaging Services
businesses, and from acquisitions, primarily Syncor. Product sales that showed
particular strength within these businesses included Lilly's Zyprexa(R)
Zydis(R), an anti-psychotic; Mylan's Amnesteem(TM), a generic drug for the
treatment of acne; and Sepracor's Xoponex(R), a respiratory drug. The growth
within the Biotechnology and Sterile Life Sciences business was negatively
impacted by the planned shutdown for twelve weeks of a domestic sterile
manufacturing facility to expand capacity. The acquisition of Syncor, effective
January 1, 2003, contributed to the growth in this segment. Excluding Syncor,
this segment experienced revenue growth in the high teens during fiscal 2003.
The increase in this segment's operating revenue in fiscal 2002 resulted from
higher sales volume particularly involving development and analytical services,
pharmaceutical technologies, and its proprietary packaging offerings. Products
that showed particular strength were Abbott's Kaletra(R), an AIDS product;
Lilly's Zyprexa(R) Zydis(R); and Pharmacia's Detrol(R) LA, an incontinence
medication. Accelerating demand for sterile-liquid and controlled-release
technologies, in addition to the acquisition of SP Pharmaceuticals, was a
significant contributor to the growth in fiscal 2002 within the pharmaceutical
technologies business. The completion of the Magellan acquisition during the
fourth quarter of fiscal 2002 contributed to the growth in the analytical
services business. Excluding the revenues of SP Pharmaceuticals and Magellan,
operating revenues grew approximately 6% in fiscal 2002 over fiscal 2001.
Additionally, the segment experienced growth in fiscal 2002 in its
pharmaceutical packaging business, which was attributable to the addition of
several new customers and increased volume from existing customers. Slowing
sales in the protease inhibitor and health and nutritional product lines
partially offset the growth in this segment during fiscal 2002.
The Automation and Information Services segment's operating revenue
growth in fiscal 2003 resulted from strong sales of new and existing patient
safety and supply management product lines, including Pyxis MedStation(R), Pyxis
Anesthesia System(TM), Pyxis Connect(TM) and Pyxis SupplyStation(R). The
increase in this segment's operating revenue in fiscal 2002 primarily resulted
from strong sales in the patient safety and supply management product lines,
such as Pyxis MedStation(R) SN and Pyxis SupplyStation 30.
21
Significant sales of new products including Pyxis Anesthesia System and products
within the Pyxis SupplyStation line also contributed to this segment's growth.
BULK DELIVERIES TO CUSTOMER WAREHOUSES AND OTHER
The Pharmaceutical Distribution and Provider Services segment reports
bulk deliveries made to customers' warehouses as revenue. These sales involve
the Company acting as an intermediary in the ordering and subsequent delivery of
pharmaceutical products. Fluctuations in bulk deliveries result largely from
circumstances that the Company cannot control, including consolidation within
the customers' industries, decisions by customers to either begin or discontinue
warehousing activities and changes in policies by manufacturers related to
selling directly to customers. Due to the lack of margin generated through bulk
deliveries, fluctuations in their amount have no significant impact on the
Company's net earnings.
The Pharmaceutical Technologies and Services segment records
out-of-pocket reimbursements received through its sales and marketing services
business as revenue. These out-of-pocket expenses, which generally include
travel expenses and other incidental costs, are incurred to fulfill the services
required by the contract. Within these contracts, the customer agrees to
reimburse the Company for the expenses. Due to the Company not generating any
margin from these reimbursements, fluctuations in their amount have no impact on
the Company's net earnings.
GROSS MARGIN
(as a percentage of operating revenue)
Years ended June 30, 2003 2002 2001
- -----------------------------------------------------------------------------------------------
Pharmaceutical Distribution and Provider Services 4.6% 5.0% 5.1%
Medical Products and Services 21.9% 21.9% 22.1%
Pharmaceutical Technologies and Services 33.1% 34.1% 33.6%
Automation and Information Services 70.3% 68.5% 68.6%
Total Company 8.9% 9.1% 9.3%
- -----------------------------------------------------------------------------------------------
The overall gross margin as a percentage of operating revenue decreased
in fiscal 2003 and 2002 due to the mix of businesses contributing to the
consolidated gross margin. The decrease in gross margin as a percentage of
operating revenue within the Pharmaceutical Distribution and Provider Services
segment in fiscal 2003 resulted primarily from the following: (1) an increase in
sales to lower-margin customers (which have a lower cost of distribution) that
reduced gross margins; (2) competitive pricing; and (3) a moderation in vendor
margins due to manufacturers attempting to better match their shipments to meet
market demand, resulting in less surplus inventory (see additional discussion of
these factors below). A decrease in gross margin as a percentage of operating
revenue within Pharmaceutical Technologies and Services also contributed to the
overall decrease. The decrease in the overall gross margin as a percentage of
operating revenue in fiscal 2002 resulted from a greater mix of lower margin
pharmaceutical distribution operating revenues as compared to the prior year.
The Pharmaceutical Distribution and Provider Services segment represented 82% of
operating revenues in fiscal 2002, up from 81% in fiscal 2001. The decline in
the gross margins in the Medical Products and Services and Automation and
Information Services segments also contributed to the overall decline in the
Company's gross margin in fiscal 2002.
The gross margin as a percentage of operating revenue in the
Pharmaceutical Distribution and Provider Services segment decreased in fiscal
2003. This decrease in gross margin as a percentage of operating revenue
primarily resulted from an increase in sales to lower-margin customers (which
include chain pharmacy and alternate site) which have a lower cost of
distribution. The table below shows the percentage breakdown of operating
revenue by customer class within Pharmaceutical Distribution, the largest
business within this segment, for fiscal years 2003, 2002 and 2001.
Customer Class 2003 2002 2001
- --------------------------------------------------------------------------
Chain Pharmacy 47% 47% 46%
Alternate Site 22% 20% 19%
Health System 18% 19% 20%
Independent 13% 14% 15%
----------------------------------
Total 100% 100% 100%
==================================
This segment's selling margins were negatively impacted by competitive pricing,
which was another primary cause of the decrease in gross margin as a percentage
of operating revenue. A moderation in vendor margin programs also contributed to
the decline in this segment's gross margin as a percentage of operating revenue.
The Company has seen changes in vendor supply chain
22
management policies related to product availability, including the use of
inventory management agreements. Under these types of agreements, the Company is
generally compensated on a negotiated basis to help manufacturers better match
their shipments with market demand, therefore adversely affecting the Company's
investment margin opportunities. Generally, the Company is compensated under its
inventory management agreements based on the timing of inventory price increases
and the volume of inventory purchases during the agreed upon period. The Company
recognizes the amounts received from such agreements within gross margin based
upon related inventory sales.
The gross margins in the Pharmaceutical Distribution and Provider
Services segment may be affected in future years by changes occurring in the
industry, such as changes in vendor supply chain management policies, including
the use of inventory management agreements. These changes provide fewer
opportunities for the pharmaceutical distribution business within the
Pharmaceutical Distribution and Provider Services segment to make large
purchases of product with related vendor margin incentives. With fewer
opportunities to make attractive inventory investments, the Company expects to
deploy less capital in this segment.
The decline in gross margin as a percentage of operating revenue in the
Pharmaceutical Distribution and Provider Services segment in fiscal 2002
resulted primarily from the highly competitive market within the pharmaceutical
distribution industry and a greater mix of high volume customers where a lower
cost of distribution and better asset management enabled the Company to offer
lower selling margins to its customers (see table above). In addition, this
segment's gross margin in fiscal 2002 was negatively impacted by several
non-recurring items, primarily related to the Bindley integration. In fiscal
2002, the Company incurred a one-time inventory adjustment related to the
process of closing and rationalizing facilities in addition to the integration
of the operations of Bindley into this segment. These decreases in fiscal 2002
were partially offset by higher vendor margins from favorable price increases
and manufacturer marketing programs.
The gross margin as a percentage of operating revenue in the Medical
Products and Services segment remained unchanged in fiscal 2003. This segment's
gross margin was positively impacted by increased sales of existing and new
higher-margin, self-manufactured products, manufacturing efficiencies achieved
during the fiscal year and outsourcing of some product manufacturing to more
cost efficient areas. The impact of new distribution agreements which increased
sales of lower-margin distributed products offset the gains noted above. The
decline in gross margin as a percentage of operating revenue in this segment in
fiscal 2002 resulted primarily from competitive pricing pressures on distributed
products. This decline was partially offset by manufacturing productivity
improvements and a higher sales volume of self-manufactured products which carry
significantly higher gross margins than other portions of this segment's
business.
The gross margin as a percentage of operating revenue in the
Pharmaceutical Technologies and Services segment decreased during fiscal 2003.
This decrease was primarily driven by the addition of Syncor's nuclear pharmacy
services business. Syncor has a slightly lower gross margin ratio than the other
businesses within this segment. Also, the gross margin was negatively impacted
by certain items that occurred in fiscal 2002 that did not recur in fiscal 2003,
including the recording of pricing adjustments related to the minimum recovery
expected to be received for claims against vitamin manufacturers for amounts
overcharged in prior years (also, see Note 2 of "Notes to Consolidated Financial
Statements"). These pricing adjustments were recorded as a reduction of cost of
goods sold, consistent with the classification of the original overcharge, and
were based on the minimum amounts estimated to be recoverable based on the facts
and circumstances available at the time they were recorded. The Company recorded
$12.0 million in the first quarter of fiscal 2002 and $10.0 million in the
second quarter of fiscal 2001 for these pricing adjustments. This segment's
gross margin as a percentage of operating revenue increased during fiscal 2002.
This increase was primarily due to a larger mix of higher margin pharmaceutical
products versus health and nutritional products, as well as cost efficiencies
due to infrastructure investments at manufacturing facilities. This increase was
partially offset by the impact of certain items that occurred in fiscal 2001
which did not recur in fiscal 2002, namely revenues related to the use of
certain of the Company's proprietary technology.
The gross margin as a percentage of operating revenue in the Automation
and Information Services segment increased in fiscal 2003, primarily from the
mix of products sold as well as productivity gains realized from the operational
improvements implemented in the prior fiscal year. This segment's gross margin
as a percentage of operating revenue decreased in fiscal 2002, primarily due to
changes in its product mix.
23
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
(as a percentage of operating revenue)
Years ended June 30, 2003 2002 2001 (1)
- ----------------------------------------------------------------------------------------------
Pharmaceutical Distribution and Provider Services 1.7% 2.1% 2.3%
Medical Products and Services 12.8% 13.3% 14.6%
Pharmaceutical Technologies and Services 15.1% 14.5% 15.4%
Automation and Information Services 30.4% 31.2% 32.9%
Total Company 4.4% 4.7% 5.2%
- ----------------------------------------------------------------------------------------------
(1) In fiscal 2001, selling, general and administrative expenses as a percentage
of operating revenue include goodwill amortization.
Selling, general and administrative expenses as a percentage of
operating revenue declined in fiscal 2003 and fiscal 2002. This decline reflects
ongoing productivity programs and economies of scale associated with the
Company's revenue growth. Significant productivity gains resulting from
continued cost control efforts in all segments and the continuation of
consolidation and selective automation of operating facilities contributed to
the improvement. In addition, the Company is continuing to take advantage of
synergies from recent acquisitions to decrease selling, general and
administrative expenses as a percentage of operating revenue. The improvement in
fiscal 2003 was partially offset by an increase in selling, general and
administrative expenses as a percentage of operating revenue in the
Pharmaceutical Technologies and Services segment, primarily the result of
changes within the business mix in this segment. This business mix change was
largely driven by the acquisition of Syncor, which has a higher expense ratio as
compared to other businesses in this segment. In the first quarter of fiscal
2002, the Company ceased amortizing goodwill due to the adoption of Statement of
Financial Accounting Standards ("SFAS") No. 142 "Goodwill and Other Intangible
Assets" (see Notes 1 and 15 of "Notes to Consolidated Financial Statements" for
further discussion) which also contributed to the improvement. Goodwill
amortization expense in