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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, 2004
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.[ ]
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, 2003, based on the closing price on December 31,
2003, was approximately $26,147,514,930.
The number of Registrant's Common Shares outstanding as of October 25,
2004, was as follows: Common Shares, without par value: 432,043,722.
TABLE OF CONTENTS
ITEM PAGE
---- ----
Important Information Regarding Forward-Looking Statements.............................. 3
PART I
1. Business................................................................................ 3
2. Properties.............................................................................. 18
3. Legal Proceedings....................................................................... 18
4. Submission of Matters to a Vote of Security Holders..................................... 24
PART II
5. Market for the Registrant's Common Shares, Related Shareholder Matters and
Issuer Purchases of Equity Securities................................................... 25
6. Selected Financial Data................................................................. 26
7. Management's Discussion and Analysis of Financial Condition and Results of Operations... 27
7a. Quantitative and Qualitative Disclosures About Market Risk.............................. 45
8. Financial Statements and Supplementary Data............................................. 46
9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.................................................................... 104
9a. Controls and Procedures................................................................. 104
PART III
10. Directors and Executive Officers of the Registrant...................................... 106
11. Executive Compensation.................................................................. 110
12. Security Ownership of Certain Beneficial Owners and Management.......................... 116
13. Certain Relationships and Related Transactions.......................................... 118
PART IV
14. Principal Accounting Fees and Services.................................................. 119
15. Exhibits, Financial Statement Schedules and Reports on Form 8-K......................... 120
Signatures.............................................................................. 126
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, generally 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" within "Item 1: Business") 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, 2004
(the end of the Company's fiscal year).
The description of the Company's business should be read in conjunction
with the financial statements and supplementary data included in this Form 10-K.
Accounting Investigations and Restatement
As previously reported, in October 2003, the Securities and Exchange
Commission (the "SEC") initiated an informal inquiry regarding the Company. The
SEC's request sought historical financial and related information including but
not limited to the accounting treatment of certain recoveries from vitamin
manufacturers. The SEC's request sought a variety of documentation, including
the Company's accounting records for fiscal 2001 through fiscal 2003, as well as
notes, memoranda, presentations, e-mail and other correspondence, budgets,
forecasts and estimates. In connection with the SEC's informal inquiry, the
Audit Committee of the Board of Directors of the Company commenced its own
internal review in April 2004, assisted by independent counsel. On May 6, 2004,
the Company was notified that the SEC had converted the informal inquiry into a
formal investigation. On June 21, 2004, as part of the SEC's formal
investigation, the Company received an additional SEC subpoena that included a
request for the production of documents relating to revenue classification, and
the methods used for such classification, in the Company's Pharmaceutical
Distribution business as either "Operating Revenue" or "Bulk Deliveries to
Customer Warehouses and Other." In addition, the Company learned that the U.S.
Attorney for the Southern District of New York had also commenced an inquiry
with respect to the Company that the Company understands relates to the revenue
classification issue. On October 12, 2004, in connection with the SEC's formal
investigation, the Company received a subpoena from the SEC requesting the
production of documents relating to compensation information for specific
current and former employees and officers. While the Company is continuing in
its efforts to respond to the SEC's investigation and the Audit Committee's
internal review and provide all information required, the Company cannot predict
the outcome of the SEC investigation or the U.S. Attorney inquiry. The outcome
of the SEC investigation, the U.S. Attorney inquiry and any related legal and
administrative proceedings could include the institution of administrative,
civil injunctive or criminal proceedings as well as the imposition of fines and
other penalties, remedies and sanctions.
During September and October 2004, the Audit Committee reached certain
conclusions with respect to findings to date from its internal review. These
conclusions regarding certain items that impact revenue and earnings relate to
four primary areas of focus: (1) classification of sales to customer warehouses
between "Operating Revenue" and "Bulk Deliveries to Customer Warehouses and
Other" within the Company's Pharmaceutical Distribution and Provider Services
segment; (2) disclosure of the Company's practice, in certain reporting periods,
of accelerating its receipt and recognition of cash discounts earned from
suppliers for prompt payment; (3) timing of revenue recognition within the
Company's Automation and Information Services segment; and (4) certain balance
sheet reserve and accrual adjustments that have been identified in the internal
review. The Audit Committee's internal review with respect to the financial
statement impact of the matters reviewed to date is substantially complete. In
connection with these conclusions, the Audit Committee has determined that the
financial statements of the Company with respect to fiscal 2000, 2001, 2002 and
2003 as well as the first three quarters of fiscal 2004 should be restated to
reflect the conclusions from its internal review to date, and as such, the
previously published financial statements of the Company for such periods should
no longer be relied upon. On September 13, 2004, the Company filed a Form 8-K
disclosing the Audit Committee's determination as of such date.
3
In connection with the Audit Committee's conclusions with respect to
findings to date from its internal review, the Company made certain
reclassification and restatement adjustments to its fiscal 2004 and prior
historical financial statements, as more fully described in Notes 1 and 2 of
"Notes to Consolidated Financial Statements." Revenue previously disclosed
separately as "Bulk Deliveries to Customer Warehouses and Others" has been
aggregated with "Operating Revenue" resulting in combined "Revenue" being
reported in the financial statements. In addition, the Company changed its
accounting method for recognizing income from cash discounts. The Company also
reduced its fourth quarter fiscal 2004 results of operations for premature
revenue recognition within its Automation and Information Services segment after
assessing the impact this segment's sales practice had on the Company's results
of operations for the three year period ended June 30, 2004. Lastly, the Company
restated its financial statements for fiscal 2000, 2001, 2002 and 2003 and the
first three quarters of fiscal 2004 as a result of various misapplications of
generally accepted accounting principles ("GAAP") and errors relating primarily
to balance sheet reserve and accrual adjustments recorded in prior periods. As a
result, the Company supplemented its historical disclosures within "Management's
Discussion and Analysis of Financial Condition and Results of Operations" to
reflect these reclassification and restatement adjustments on previously
reported Company and business segment operating earnings performance. All prior
period disclosures presented in "Management's Discussion and Analysis of
Financial Condition and Results of Operations" have been adjusted to reflect
these changes.
As the Company continues to respond to the SEC's investigation and the
Audit Committee's ongoing internal review, there can be no assurance that
additional restatements will not be required or that the historical financial
statements included in this Form 10-K will not change or require amendment. In
addition, the Audit Committee may identify new issues, or make additional
findings if it receives additional information, that may impact the Company's
financial statements and the scope of the restatements described in this Form
10-K.
ALARIS Acquisition
On June 28, 2004, the Company acquired approximately 98.7% of the
outstanding common stock of ALARIS Medical Systems, Inc. ("ALARIS"), a leading
provider of intravenous medication safety products and services. On July 7,
2004, ALARIS merged with a subsidiary of the Company to complete the
transaction. For additional information concerning the Company's acquisition of
ALARIS, see "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and Note 4 of "Notes to Consolidated Financial
Statements." As of June 30, 2004, the Company had not made a determination as to
the segment reporting for ALARIS. Therefore, the results for ALARIS are reported
in the Corporate segment in this Form 10-K. Due to the short period of time
between the completion of the acquisition and end of fiscal 2004, the impact of
ALARIS' results is not material. As discussed below under "Business Segments,"
the Company recently announced the creation of a new segment, Clinical
Technologies and Services, which will replace the Company's Automation and
Information Services segment and will include ALARIS in addition to other of the
Company's existing businesses.
BUSINESS SEGMENTS
As of June 30, 2004, the Company's operations were organized into four
reporting segments. They are: Pharmaceutical Distribution and Provider Services,
Medical Products and Services, Pharmaceutical Technologies and Services and
Automation and Information Services.
On August 30, 2004, the Company announced the creation of a new segment,
Clinical Technologies and Services, which will replace the Company's Automation
and Information Services segment. This new segment will include ALARIS, the
Company's existing businesses formerly within the Automation and Information
Services segment and the Company's Clinical Services and Consulting business,
which was formerly reported under the Pharmaceutical Distribution and Provider
Services segment. The Company will begin reporting results for this new segment
beginning with the first quarter fiscal 2005. In addition, effective first
quarter fiscal 2005, the Company will transfer its Specialty Pharmaceutical
Distribution business, formerly included within the Pharmaceutical Distribution
and Provider Services segment, to the Medical Products and Services segment. All
prior periods will be restated to reflect these transfers in fiscal 2005. See
Note 18 of "Notes to Consolidated Financial Statements" for more information
regarding the Company's reporting segments.
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.
Through the acquisition of The Intercare Group, plc ("Intercare"), this segment
also operates a distribution network within the United Kingdom offering a
specialized range of branded and generic pharmaceutical products. As a
full-service wholesale distributor, the Company's Pharmaceutical Distribution
business complements its distribution activities by offering a broad range of
support services to assist the Company's customers and suppliers in maintaining
and improving the efficiency and quality of
4
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 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
is a franchisor of apothecary-style retail pharmacies through its Medicine
Shoppe International, Inc. ("Medicine Shoppe") and Medicap Pharmacies
Incorporated ("Medicap") franchise systems. Additionally, through this segment,
the Company operates a non-core wholesale-to-wholesale pharmaceutical trading
business that sells excess pharmaceutical inventory.
MEDICAL PRODUCTS AND SERVICES
Through its Medical Products and Services segment, the Company provides
medical products and cost-saving services to hospitals and other health care
providers. 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. The Company 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, special procedure products and other products. 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 and
instrument repair.
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 industries. 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, as well as biologic development.
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, analytical science
and regulatory consulting 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. The Nuclear Pharmacy Services business operates centralized nuclear
pharmacies that prepare and deliver radiopharmaceuticals for use in nuclear
imaging and other procedures in hospitals and clinics. The Company also
manufactures and markets generic injectible pharmaceutical products for sale to
pharmacies in the United Kingdom and provides manufacturing services for oral
potent drugs and sterile dose forms in Europe.
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. This segment
develops, manufactures, leases, sells and services point-of-use systems that
automate the distribution and management of medications and supplies in
hospitals and other health care facilities, as well as bedside clinical
verification and patient entertainment systems.
5
ALARIS
The Company's recently acquired subsidiary, ALARIS, develops and markets
products for the safe delivery of intravenous ("IV") medications. ALARIS is a
global leader in the design, development and marketing of IV medication safety
and infusion therapy delivery systems, software applications, needle-free
disposables and related patient monitoring equipment. ALARIS' "smart" infusion
pumps, with proprietary Guardrails(R) Safety Software, help to reduce the
risks and costs of medication errors, help to safeguard patients and clinicians
and gather and record clinical information for review, analysis and
interpretation. As discussed above, the Company recently announced the creation
of a new segment, Clinical Technologies and Services, which will replace the
Company's Automation and Information Services segment and will include ALARIS in
addition to other of the Company's existing businesses.
For information on comparative segment revenues, profits and related
financial information, see Note 18 of "Notes to Consolidated Financial
Statements."
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 the Company's website
(www.cardinal.com, under the "Investor Relations--SEC filings" captions) after
the Company electronically files such materials with, or furnishes them to, the
SEC. Required filings by the Company's officers, directors and third parties
with respect to Cardinal Health furnished in electronic form are also made
available on the Company's website as are proxy statements for the Company's
shareholder meetings. 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.
Information relating to corporate governance at Cardinal Health, including
the Company's Corporate Governance Guidelines and Standards of Business Ethics
(as contained in the Cardinal Health Ethics Guide) for all of the Company's
employees, including its principal executive officer, principal financial
officer, principal accounting officer or controller, or persons performing
similar functions, and the Company's directors; and information concerning the
Company's directors and Board Committees, including Committee charters, is
available on the Company's website (www.cardinal.com, under the "Investor
Relations" caption). This information also is available in print (free of
charge) to any shareholder who requests it from the Company's Investor Relations
department.
6
ACQUISITIONS AND DIVESTITURES
Since June 30, 1999, the Company has completed a number of business
combinations including the following (in millions):
CONSIDERATION PAID
--------------------------------------
STOCK OPTIONS
DATE COMPANY LOCATION LINE OF BUSINESS SHARES CONVERTED (1) CASH
- ---------- ------------------- -------------- -------------------------------- ------ ------------------ ----------
Custom manufacturer of sterile
9/10/1999 Automatic Liquid Woodstock, liquid pharmaceuticals and
Packaging, Inc. Illinois other health care products 8.7 - -
Distributor of medical,
surgical and laboratory
supplies to doctors' offices,
8/16/2000 Bergen Brunswig Orange, long-term care and nursing
Medical Corporation California centers, hospitals and other - - $ 181
providers of care
Wholesale distributor of
2/14/2001 Bindley Western Indianapolis, pharmaceuticals and provider of
Industries, Inc. Indiana nuclear pharmacy services 23.1 5.1 -
Pharmaceutical contract
development organization
providing analytical and
4/15/2002 Magellan Research development services to
Laboratories, Inc. Triangle Park, pharmaceutical and - - $ 221(2)
North Carolina biotechnological industries
Full-service provider of
strategic medical education
6/26/2002 Boron, LePore & Wayne, New solutions to the health care
Associates, Inc. Jersey industry - 1.0 $ 189
1/1/2003 Syncor International Woodland Hills, Leading provider of nuclear 12.5 3.0 -
Corporation California pharmacy services
Contract services manufacturer
12/16/2003 The Intercare Group, and distributor for
plc United Kingdom pharmaceutical companies - - $ 570(3)
Provider of intravenous
6/28/2004 ALARIS Medical San Diego, medication safety products and
Systems, Inc. California services - 0.6 $ 2,080(4)
(1) As a result of the acquisition, the outstanding stock options of the
acquired company were converted into options to purchase the Company's Common
Shares. This column represents the number of the Company's Common Shares subject
to such converted stock options immediately following conversion giving effect
to interim stock splits.
(2) Purchase price is before consideration of any tax benefits associated with
the transaction.
(3) This includes the assumption of approximately $150 million in debt.
(4) This includes the assumption of approximately $358 million in debt.
The Company has also completed a number of smaller acquisitions (asset
purchases, stock purchases and mergers) and divestitures during the last five
fiscal years, including acquisitions of Med Surg Industries, Inc.; Rexam Cartons
Inc.; International Processing Corporation; American Threshold Industries, Inc.;
SP Pharmaceuticals, L.L.C.; Medicap; and Snowden Pencer Holdings, Inc.; and the
divestiture of certain operations of the medical imaging business of Syncor
International Corporation (which has been given the legal designation of
Cardinal Health 414, Inc., and is referred to in this Form 10-K as "Syncor").
The Company evaluates possible candidates for merger or acquisition and
intends to continue to seek opportunities to expand its operations and services
across all reporting segments from time to time as appropriate. These
acquisitions may involve the use of cash, stock or other securities as well as
the assumption of indebtedness and liabilities. In addition, the Company
evaluates from time to time as appropriate its portfolio of businesses to
identify any non-core businesses for possible divestiture. For additional
information concerning certain of the transactions described above, see Notes 4
and 17 of "Notes to Consolidated Financial Statements" and "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
7
CUSTOMERS AND SUPPLIERS
The Company's largest customer, CVS Corporation ("CVS"), accounted for
approximately 18% of the Company's revenue (by dollar volume) for fiscal 2004
(15% relates to "Bulk Revenue," as discussed in "Management's Discussion and
Analysis of Financial Condition and Results of Operations"). All of the
Company's business with CVS is included in its Pharmaceutical Distribution and
Provider Services segment. The aggregate of the Company's five largest
customers, including CVS, accounted for approximately 34% of the Company's
revenue (by dollar volume) for fiscal 2004. The Company would be adversely
affected if the business of these customers were lost. In addition, certain of
the Company's businesses have entered into agreements with group purchasing
organizations ("GPOs"), which organizations act as purchasing agents that
negotiate vendor contracts on behalf of their members. Approximately 17% of
revenue for fiscal 2004 was derived from GPO members through the contractual
arrangements established with Novation, LLC ("Novation") and Premier Purchasing
Partners, L.P. ("Premier")--the Company's two largest GPO relationships in terms
of member revenue. Generally, compliance by GPO members with GPO vendor
selections is voluntary. As such, the Company believes the loss of any of the
Company's agreements with a GPO would not mean the loss of sales to all members
of the GPO, although the loss of such an agreement could adversely affect the
Company's operating results. See Note 13 in "Notes to Consolidated Financial
Statements" for further information regarding the Company's concentrations of
credit risk and major customers.
The Company obtains its products from many different suppliers, the
largest of which, Pfizer, Inc., accounted for approximately 14% (by dollar
volume) of the Company's revenue in fiscal 2004. The Company's five largest
suppliers combined accounted for approximately 40% (by dollar volume) of the
Company's revenue during fiscal 2004 and, overall, the Company believes its
relationships with its suppliers are good. The Company's arrangements with its
pharmaceutical suppliers typically may 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 and therefore may be subject to earlier
cancellation. The loss of certain suppliers could adversely affect the Company's
business if alternative sources of supply were unavailable at reasonable rates.
As previously reported, the Company's Pharmaceutical Distribution business
is in the midst of a business model transition with respect to how it is
compensated for the logistical, capital and administrative services that it
provides to pharmaceutical manufacturers. Historically, the compensation
received by the Pharmaceutical Distribution business from pharmaceutical
manufacturers was based on each manufacturer's unique sales practices (e.g.,
volume of product available for sale, eligibility to purchase product, cash
discounts for prompt payment, rebates, etc.) and pharmaceutical pricing
practices (e.g., the timing, frequency and magnitude of product price
increases). Specifically, a significant portion of the compensation the
Pharmaceutical Distribution business received from manufacturers was derived
through the Company's ability to purchase pharmaceutical inventory in advance of
pharmaceutical price increases, hold that inventory as manufacturers increased
pharmaceutical prices, and generate a higher operating margin on the subsequent
sale of that inventory. This compensation system was dependent to a large degree
upon the sales practices of each pharmaceutical manufacturer, including
established policies concerning the volume of product available for purchase in
advance of a price increase, and on stable and predictable pharmaceutical
pricing practices. Beginning in fiscal 2003, pharmaceutical manufacturers began
to seek greater control over the amount of pharmaceutical product available in
the supply chain, and, as a result, began to change their sales practices by
restricting the volume of product available for purchase by pharmaceutical
wholesalers. In addition, manufacturers have increasingly sought more services
from the Company, including the provision of data concerning product sales and
distribution patterns. The Company believes these changes have been made to
provide greater visibility to pharmaceutical manufacturers over product demand
and movement in the market and to increase product safety and integrity by
reducing the risks associated with product being available to, and distributed
in, the secondary market. Nevertheless, the impact of these changes has
significantly reduced the compensation received by the Company from
pharmaceutical manufacturers. In addition, since the fourth quarter of fiscal
2004, pharmaceutical manufacturers' product pricing practices have become less
predictable, as the frequency of product price increases generally has slowed
versus historical levels. As a result of these actions by pharmaceutical
manufacturers, the Company is no longer being adequately and consistently
compensated for the reliable and consistent logistical, capital and
administrative services being provided by the Company to these manufacturers.
In response to the developments described above, the Company is working to
establish a compensation system that is no longer dependent on manufacturers'
sales or pricing practices, but rather is based on the services provided by the
Company to meet the unique distribution requirements of each manufacturer's
products. To that end, the Company is working with individual pharmaceutical
manufacturers to define fee-for-service terms that will adequately compensate
the Company, in light of each product's unique distribution requirements, for
the logistical, capital and administrative services being provided by the
Company. To accelerate this process, in August 2004, the Company communicated to
its pharmaceutical manufacturing vendors a new policy which sets April 1, 2005
or, for manufacturers with an existing agreement with the Company, the next
anniversary date of such agreement, as the deadline by which manufacturers must
have entered into a mutually satisfactory distribution services agreement with
the Company providing for reliable, predictable and adequate compensation for
the Company's services. For any manufacturer with which the
8
Company is unable to enter into such a mutually satisfactory agreement, the
Company plans to assist such manufacturer in transitioning to another method of
distribution. There can be no assurance that this business model transition will
be successful, or of the timing of such a successful transition.
The Company's manufacturing businesses within the Medical Products and
Services and Pharmaceutical Technologies and Services segments use a broad range
of raw materials in the products they produce. These raw materials include for
Medical Products and Services, latex, resin and fuel oil and, for Pharmaceutical
Technologies and Services, resin, gelatin and active pharmaceutical ingredients,
among others. In certain circumstances, the Company's operating results may be
adversely affected by increases in raw materials costs because the Company may
not be able to fully recover the increased costs from the customer or offset the
increased cost through productivity improvements. In addition, although most of
these raw materials are generally available, certain raw materials used by the
Company's manufacturing businesses may be available only from a limited number
of suppliers. There also may be cases where a particular raw material may be
available from another supplier or several other suppliers, but the Company is
constrained to use a particular supplier due to customer requirements,
regulatory filings or product approvals. In either case where there are a
limited number of suppliers, the Company may experience shortages in supply, and
as a result, the Company's operating results could be adversely affected.
Certain of the Company's manufacturing vendors have adopted policies
limiting the ability of distributors to purchase inventory on the secondary
market. If this practice becomes more widespread, the Company's ability to
source product on the secondary market, as well as its ability to sell excess
inventories, may be impaired. This could adversely affect the Company's
operating results.
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 a number of 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, to
provide quality support services, to effectively compete on the pricing of
pharmaceutical products, and to maintain satisfactory arrangements with
pharmaceutical manufacturers whereby the Company is compensated for its
logistical, capital and administrative services. With respect to pharmacy
franchising operations, several smaller franchisors compete with Medicine Shoppe
and Medicap 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 and Medicap also need 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 existing operations, 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 competes both
domestically and internationally. Competitive factors within medical-surgical
supply distribution include price, breadth of product offerings, product
availability, order-filling accuracy (both invoicing and product selection) and
service offerings. Within its distribution services, this segment competes
across several customer classes with many different distributors, including
Owens & Minor, Inc., Fisher Scientific International, Inc., and Henry Schein,
Inc., among others. Competitive factors within medical-surgical product
manufacturing include brand recognition and product innovation, performance,
quality and price. This segment competes against many product manufacturers,
some of which are larger and more diversified than Medical Products and
Services. The Company believes that its key competitive strengths within this
segment include its ability to work with customers to help them provide quality
care while enhancing their competitiveness through cost-savings initiatives.
This competitive strength is enhanced through the integration of products and
services within both the Medical Products and Services segment and across other
Company segments.
In the Pharmaceutical Technologies and Services segment, the Company
competes on several fronts both domestically and internationally, including
competition with other companies that provide outsourcing services to
pharmaceutical manufacturers
9
based in North America, Europe and Asia and competition with those manufacturers
that choose to retain these services in-house. Specifically, in this segment,
the Company competes with providers of both new drug delivery technologies and
existing delivery technologies as well as oral solid dose manufacturing; with
other providers of sterile fill/finish manufacturing and lyophilization
services; with providers of contract discovery, development, analytical
laboratory and regulatory consulting services and manufacturing and packaging of
clinical supplies; with companies that provide packaging components and
packaging services; with other providers of medical education, marketing/product
launch services, contract sales and product logistics services; and 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, which include numerous operators of radiopharmacies,
numerous independent radiopharmacies and manufacturers and universities that
have established their own radiopharmacies. The Company competes in this segment
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. Such competitors include McKesson Corporation and Omnicell, Inc.
ALARIS competes based upon quality, technological innovation, the value
proposition of improving patient outcomes while reducing overall costs
associated with medication safety, and price. ALARIS' competitors include both
domestic and foreign companies, including Baxter International, Inc., Abbott
Laboratories, Inc. and B. Braun Medical, Inc.
EMPLOYEES
As of October 25, 2004, the Company had more than 55,000 employees in the
U.S. and abroad, of which approximately 1,080 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,
infusion therapy systems, infusion administration sets, 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 overall 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,
manufacturing and sale. These subsidiaries include those that distribute and/or
manufacture 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 infusion therapy systems or surgical and
respiratory care and intravenous administration set products and devices;
manufacture or package pharmaceutical products and devices; manufacture and
market pharmaceutical products and provide outsourced pharmaceutical
manufacturing services using
10
both proprietary and nonproprietary drug delivery formulations and outsourced
analytical development services; develop, create, present or distribute
accredited and unaccredited educational or promotional programs or materials;
and provide consulting services that assist healthcare institutions and
pharmacies in their operations as well as pharmaceutical manufacturers with
regard to regulatory submissions and filings made to healthcare agencies such as
the FDA.
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. Certain of the Company's
subsidiaries which manufacture medical devices are subject to the Federal Food,
Drug and Cosmetic Act of 1938, as amended by the Medical Device Amendments of
1976, the Safe Medical Device Act of 1990, as amended in 1992, the Medical
Device User Fee and Modernization Act of 2002, and comparable foreign
regulations. In addition, certain of ALARIS' products are indirectly subject to
the Needlestick Safety and Prevention Act.
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, the Pharmaceutical Technologies and Services segment's
international operations (including Intercare) and ALARIS' international
operations are subject to local certification requirements, including compliance
with domestic and/or foreign good manufacturing practices and quality system
regulations established by the FDA and/or those applicable foreign
jurisdictions. Intercare self-manufactures and markets sterile injectible
products in the United Kingdom in accordance with applicable laws, rules and
regulations of the United Kingdom and the European Union. Intercare also
manufactures methadone syrup in the United Kingdom pursuant to the United
Kingdom's regulations covering the manufacture of controlled opioid substances.
The Company's franchising operations, through Medicine Shoppe and Medicap,
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.
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 relating 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
the U.S. Foreign Corrupt Practices Act and anti-bribery laws and laws pertaining
to the accuracy of the Company's internal books and records.
11
There have been increasing efforts by various levels of government
including state pharmacy boards and comparable agencies to regulate the
pharmaceutical distribution system in order to prevent the introduction of
counterfeit, adulterated or mislabeled drugs into the pharmaceutical
distribution system. Certain states, such as Florida, have already adopted laws
and regulations that are intended to protect the integrity of the pharmaceutical
distribution system while other government agencies are currently evaluating
their recommendations. These laws and regulations could increase the overall
regulatory burden and costs associated with the Company's Pharmaceutical
Distribution business, and may adversely affect the Company's operating results.
The Company continues to work with its suppliers to help minimize the risks
associated with counterfeit products in the supply chain.
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 has historically maintained higher levels of inventory in its
Pharmaceutical Distribution business in order to satisfy daily delivery
requirements and take advantage of price changes as compensation for its
services, but is not generally required by its customers to maintain particular
inventory levels other than may be required to meet service level requirements.
However, in connection with the business model transition discussed under
"Customers and Suppliers" above, the Pharmaceutical Distribution business'
inventory levels are significantly lower than historical levels. This trend,
primarily attributable to reduced pharmaceutical investment buying opportunities
and lower inventory levels negotiated with pharmaceutical manufacturers, is
continuing. 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's
customer return policy requires that the product be physically returned, subject
to restocking fees, and only allows customers to return products which can be
added back to inventory and resold at full value, or which can be returned to
vendors for credit. 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 3 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 18 of "Notes to Consolidated Financial Statements."
RISK FACTORS THAT MAY AFFECT FUTURE RESULTS
Although it is not possible to predict all risks that may affect future
results, these risks may include, but are not limited to, the following:
THE COMPANY'S PHARMACEUTICAL DISTRIBUTION BUSINESS IS TRANSITIONING ITS BUSINESS
MODEL, WHICH SUBJECTS THE COMPANY TO RISKS AND UNCERTAINTIES. As discussed more
fully under "Customers and Suppliers" within "Item 1: Business," the Company's
Pharmaceutical Distribution business, which is the Company's largest business,
is in the midst of a business model transition with respect to how it is
compensated for the logistical, capital and administrative services it provides
to pharmaceutical manufacturers. There can be no assurance that the
Pharmaceutical Distribution business will ultimately succeed in transitioning
its business model or, if such transition is successful, of the timing of that
successful transition. If the transition does not succeed, the Company will not
be adequately compensated for services it provides to pharmaceutical
manufacturers, which will have the effect of reducing the Company's
profitability in a potentially significant manner.
THE ONGOING SEC INVESTIGATION AND U.S. ATTORNEY INQUIRY COULD ADVERSELY AFFECT
THE COMPANY'S BUSINESS, FINANCIAL CONDITION OR OPERATING RESULTS. As discussed
below under "Item 3: Legal Proceedings" and Note 1 of "Notes to Consolidated
Financial Statements," the Company is the subject of a formal SEC investigation
and has learned that the U.S. Attorney for the
12
Southern District of New York has commenced an inquiry with respect to the
Company. In April 2004, the Company's Audit Committee commenced its own internal
review, assisted by independent counsel. While the Company is continuing in its
efforts to respond to the SEC's investigation and the Audit Committee's internal
review and provide all information required, the Company cannot predict the
outcome of the SEC investigation or the U.S. Attorney inquiry. There can be no
assurance that the scope of the SEC investigation or the U.S. Attorney inquiry
will not expand or that other regulatory agencies will not become involved. The
outcome of and costs associated with the SEC investigation and the U.S. Attorney
inquiry could adversely affect the Company's business, financial condition or
operating results, and the investigations could divert the efforts and attention
of its management team from the Company's ordinary business operations. The
outcome of the SEC investigation and U.S. Attorney inquiry and any related legal
and administrative proceedings could include the institution of administrative,
civil injunctive or criminal proceedings against the Company and/or current or
former Company officers or employees, the imposition of fines and penalties,
suspensions or debarments from government contracting, and/or other remedies and
sanctions.
ADDITIONAL RESTATEMENTS MAY BE REQUIRED AND THE HISTORICAL FINANCIAL STATEMENTS
INCLUDED IN THIS FORM 10-K MAY CHANGE OR REQUIRE AMENDMENT; THE AUDIT COMMITTEE
MAY IDENTIFY NEW ISSUES, OR MAKE ADDITIONAL FINDINGS IF IT RECEIVES ADDITIONAL
INFORMATION, THAT MAY IMPACT THE COMPANY'S FINANCIAL STATEMENTS AND THE SCOPE
OF THE RESTATEMENTS DESCRIBED IN THIS FORM 10-K. During September and October
2004, the Audit Committee reached certain conclusions with respect to findings
to date from its internal review, which are discussed in Note 1 of "Notes to
Consolidated Financial Statements." In connection with these conclusions, the
Audit Committee has determined that the financial statements of the Company with
respect to fiscal 2000, 2001, 2002 and 2003 as well as the first three quarters
of fiscal 2004 should be restated to reflect the conclusions from its internal
review to date. As the Company continues to respond to the SEC's investigation
and the Audit Committee's internal review, there can be no assurance that
additional restatements will not be required or that the historical financial
statements included in this Form 10-K will not change or require amendment. In
addition, the Audit Committee may identify new issues, or make additional
findings if it receives additional information, that may impact the Company's
financial statements and the scope of the restatements described in this Form
10-K.
THE COMPANY'S INTERNAL CONTROLS MAY NOT BE SUFFICIENT TO ENSURE TIMELY AND
RELIABLE FINANCIAL INFORMATION. As discussed under Item 9a of this Form 10-K, in
connection with the completion of its audit with respect to the Company's
financial statements for fiscal 2004, including additional procedures resulting
from the Audit Committee's internal review, the Company's independent auditor
identified and communicated to the Company's management and the Audit Committee
"material weaknesses" involving internal controls and their operation. In
connection with the Audit Committee's internal review, since the end of fiscal
2004, the Company has adopted and is in the process of implementing various
measures (as identified in Item 9a) in connection with the Company's ongoing
efforts to improve its internal control processes and corporate governance.
There can be no assurance that these improvements will adequately address the
identified control weaknesses or that further improvements will not be required.
The Company's growth continues to place stress on its internal controls,
and there can be no assurance that the Company's current control procedures will
be adequate. Even after corrective actions have been implemented, the
effectiveness of the Company's controls and procedures may be limited by a
variety of risks, including faulty human judgment and simple errors, omissions
and mistakes, collusion of two or more people, inappropriate management override
of procedures, and risk that enhanced controls and procedures may still not be
adequate to assure timely and reliable financial information. If the Company
fails to have effective internal controls and procedures for financial reporting
in place, it could be unable to provide timely and reliable financial
information.
In addition, as a result of the Sarbanes-Oxley Act of 2002, the Company is
subject to new rules requiring its management to report, in its Form 10-K for
the fiscal year ending June 30, 2005, on the effectiveness of internal controls
over financial reporting, and further requiring the Company's independent
auditor to attest to this report. Significant additional resources will be
required to make the requisite evaluation of the effectiveness of the Company's
internal controls. There can be no assurance, however, that the Company will be
able to complete the work necessary for the Company's management to issue its
report in a timely manner or that management or the Company's independent
auditor will conclude that the Company's internal controls are effective.
13
CHANGES IN THE UNITED STATES HEALTH CARE ENVIRONMENT MAY ADVERSELY AFFECT THE
COMPANY'S BUSINESS, FINANCIAL CONDITION OR 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 condition or operating results. Other factors
related to the health care industry that could adversely affect the Company's
business, financial condition or operating results 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.
Certain of the Company's manufacturing vendors have adopted policies
limiting the ability of distributors to purchase inventory on the secondary
market. If this practice becomes more widespread, the Company's ability to
source product on the secondary market, as well as its ability to sell excess
inventories, may be impaired. This could adversely affect the Company's
operating results.
Healthcare and public policy trends indicate that the number of generic
drugs will increase over the next few years as a result of the expiration of
certain drug patents. An increase or a decrease in the availability of these
generic drugs could have a material impact on the Company's net earnings.
There have been increasing efforts by various levels of government
including state pharmacy boards and comparable agencies to regulate the
pharmaceutical distribution system in order to prevent the introduction of
counterfeit, adulterated or mislabeled drugs into the pharmaceutical
distribution system. Certain states, such as Florida, have already adopted laws
and regulations that are intended to protect the integrity of the pharmaceutical
distribution system while other government agencies are currently evaluating
their recommendations. These laws and regulations could increase the overall
regulatory burden and costs associated with the Company's Pharmaceutical
Distribution business, and may adversely affect the Company's operating results.
There have been increasing efforts by various parties to introduce and
pass legislation that would directly permit the importation of pharmaceutical
products into the United States. If such efforts are successful, the price the
Company receives for pharmaceutical products and related services could be
adversely affected, thereby negatively impacting the Company's operating
results.
The Company is subject to extensive and frequently changing local, state
and federal laws and regulations relating to healthcare fraud. The federal
government continues to increase its scrutiny over practices involving
healthcare fraud affecting Medicare, Medicaid and other government healthcare
programs. Furthermore, the Company's relationships with pharmaceutical
manufacturers and healthcare providers subject its business to laws and
regulations on fraud and abuse. Many of the regulations applicable to the
Company, including those relating to marketing incentives offered by
pharmaceutical or medical-surgical suppliers, are vague and could be interpreted
or applied by a prosecutorial, regulatory or judicial authority in a manner that
could require the Company to make changes in its operations. If the Company
fails to comply with applicable laws and regulations, it could suffer civil and
criminal penalties, including the loss of licenses or its ability to participate
in Medicare, Medicaid and other federal and state healthcare programs.
14
THE OUTCOMES OF LAWSUITS BROUGHT AGAINST THE COMPANY MAY ADVERSELY AFFECT THE
COMPANY'S BUSINESS, FINANCIAL CONDITION OR OPERATING RESULTS. As discussed below
under "Item 3: Legal Proceedings," the Company is subject to numerous lawsuits,
including several class action lawsuits against the Company and certain of its
former and present officers and directors. Any settlement of or judgment in one
or more of these matters could adversely affect the Company's business,
financial condition or operating results. There can be no assurance that all or
any portion of the liability arising from these pending lawsuits will be covered
by insurance policies that the Company currently maintains.
THE COMPANY COULD BE ADVERSELY AFFECTED BY THE LOSS OF ONE OR MORE SIGNIFICANT
CUSTOMERS OR GROUP OF CUSTOMERS, OR BY A CHANGE IN CUSTOMER MIX. The Company's
largest customer, CVS, accounted for approximately 18% of the Company's revenue
(by dollar volume) for fiscal 2004. The aggregate of the Company's five largest
customers, including CVS, accounted for approximately 34% of the Company's
revenue (by dollar volume) for fiscal 2004. The Company's business and operating
results could be adversely affected if the business of these customers were
lost. In addition, certain of the Company's businesses have entered into
agreements with GPOs. Approximately 17% of the Company's revenue for fiscal 2004
was derived from GPO members through the contractual arrangements established
with Novation and Premier. Generally, compliance by GPO members with GPO vendor
selections is voluntary. Notwithstanding this fact, the loss of such an
agreement could adversely affect the Company's operating results. See the
"Customers and Suppliers" discussion within "Item 1: Business" and Note 13 of
"Notes to Consolidated Financial Statements" for further information regarding
the Company's significant customers.
Changes in the Company's customer mix could also significantly impact its
business, financial condition or operating results. 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 affect 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 BUSINESS, FINANCIAL CONDITION OR OPERATING RESULTS. 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, the European
Union member states 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, manufacturing 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 Automation and Information Services
segment's automated pharmaceutical dispensing systems are not currently required
to be registered or submitted for pre-market notifications to the FDA. There can
be no assurance, however, that FDA policy in this regard will not change.
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 (including infusion therapy systems and intravenous administration set
products and devices), manufacturing pharmaceuticals using proprietary drug
delivery systems, manufacturing of oral and sterile pharmaceutical products,
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. The United Kingdom's Medicines and Healthcare
products Regulatory Agency has raised certain issues regarding the appropriate
use and commercial marketing of the ALARIS SmartSite(R) Needle-Free
15
Systems. The commercial availability of the product may be adversely affected if
an unfavorable result is reached.
THE COMPANY'S OPERATING RESULTS COULD BE ADVERSELY AFFECTED BY A DELAY IN, OR
FAILURE TO RECEIVE, REGULATORY APPROVAL. The Company's pharmaceutical and
medical device manufacturing businesses are heavily regulated and strict
compliance with federal and foreign laws, rules, regulations and practices must
be followed. By nature, the manufacturing of such products is a highly
controlled process in which great strides are taken to avoid contamination in
the products. Due to the regulatory issues and challenges, there is a risk of
delay in approval of these products, which could adversely affect the Company's
operating results.
CIRCUMSTANCES 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 the pursuit of acquisitions of
other businesses which expand or complement the Company's existing businesses.
Over the past decade, 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,
compounding and distribution of nuclear pharmaceutical products, and developing,
manufacturing and distributing intravenous pumps and administration sets.
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 the customers of the
acquired company following the acquisition and potential adverse short term
effects on operating results through increased costs or otherwise. 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. To the extent the Company continues to
pursue acquisitions, its ability to complete such transactions may be adversely
affected by the government investigations described above under the risk factor
entitled "The ongoing SEC investigation and U.S. Attorney inquiry could
adversely affect the Company's business, financial condition or operating
results."
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
invest in new technology, make other capital expenditures and, where
appropriate, hire and/or train employees with expertise to handle these
particular demands. If the Company is unable to successfully complete and
integrate strategic acquisitions in a timely manner or if the Company fails to
efficiently manage operations in a way that accommodates continued internal
growth, its business, financial condition or operating results could be
adversely affected.
DOWNGRADES OF THE COMPANY'S CREDIT RATINGS COULD ADVERSELY AFFECT THE COMPANY.
The Company's senior debt credit ratings from S&P, Moody's and Fitch are BBB,
Baa3 and BBB+, respectively, the commercial paper ratings are A-3, P-3 and F-2,
respectively, and the ratings outlooks are "negative," "on review for possible
further downgrade" and "negative," respectively. Although a ratings downgrade by
any of the rating agencies will not trigger an acceleration of any of the
Company's indebtedness, these events may adversely affect its ability to access
capital and would result in an increase in the interest rates payable under the
Company's credit facilities and future indebtedness. See also "Liquidity and
Capital Resources" within "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
THE COMPANY COULD BE ADVERSELY AFFECTED IF TRANSITIONS IN SENIOR MANAGEMENT ARE
NOT SUCCESSFUL. The Company's operations depend in a large extent on the efforts
of its senior management, some of whom have recently been elevated to new
positions at either the corporate level or at several of the Company's many
businesses. Other new members of senior management, including the Company's
interim Chief Financial Officer, have recently joined the Company. The Company
seeks to develop and retain an effective management team through the proper
positioning of existing key employees and the addition of new management
personnel where necessary. The Company's operations could be adversely affected
if transitions in senior management are not successful or if the Company is
unable to sustain an effective management team.
INCREASED COSTS FOR RAW MATERIALS OR RAW MATERIAL SHORTAGES MAY ADVERSELY AFFECT
THE COMPANY'S OPERATING RESULTS. As discussed more fully under "Customers and
Suppliers" within "Item 1: Business," the Company's manufacturing businesses
within the Medical Products and Services and Pharmaceutical Technologies and
Services segments use a broad range of raw materials in the products they
produce. In certain circumstances, the Company's operating results may be
adversely affected by increases in raw materials costs because the Company may
not be able to fully recover the increased costs from the customer or offset the
increased cost through productivity improvements. In addition, in the case where
there are a limited number of suppliers for a particular raw material or where
the Company is constrained to use a particular supplier due to customer
requirements, regulatory
16
filings or product approvals, the Company may experience shortages in supply.
This, in turn, could adversely affect the Company's operating results.
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. (See the discussion of
the ICU Medical, Inc. litigation against ALARIS in the "Overview" section within
"Management's Discussion and Analysis of Financial Condition and Results of
Operations.") 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 be subject to litigation or 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, which could adversely affect 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 AFFECT 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 or its customers, the development, presentation and
distribution of medical education and marketing programs and materials, and the
manufacture and distribution of medical/surgical products, automated drug
dispensing units and infusion therapy systems and intravenous administration set
products and devices. 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 operating results.
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 affect 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 AFFECT THE COMPANY'S NET EARNINGS.
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 affected 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,
17
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.
ITEM 2: PROPERTIES
Domestically, the Company has 26 principal pharmaceutical distribution
facilities and four specialty distribution facilities utilized by the
Pharmaceutical Distribution and Provider Services segment. In its Pharmaceutical
Technologies and Services segment, the Company has 196 domestic sites, 173 of
which are Nuclear Pharmacy Services laboratory, manufacturing and distribution
facilities, and the remainder of which are Packaging Services packaging and
printed components facilities, Oral Technologies manufacturing and R&D
facilities, Pharmaceutical Development facilities, Sterile Technologies
manufacturing facilities and a Specialty Pharmaceutical Services facility. The
Company also has three assembly operation facilities in its Automation and
Information Services segment. Finally, the Company has 58 medical-surgical
distribution facilities and 17 medical-surgical manufacturing facilities
utilized by the Medical Products and Services segment. The Company's domestic
facilities are located in 44 states and Puerto Rico.
Internationally, through the Intercare acquisition, the Company owns or
leases 12 facilities through its Pharmaceutical Distribution and Provider
Services segment, all located in the United Kingdom. The Company owns or leases
19 operating facilities through its Pharmaceutical Technologies and Services
segment, located in Argentina, Australia, Belgium, Brazil, France, Germany,
Ireland, Italy, Japan and the United Kingdom. The Company owns or leases 27
facilities through its Medical Products and Services segment, located in
Australia, Canada, Dominican Republic, France, Germany, Japan, Malaysia, Malta,
Mexico, the Netherlands and Thailand. The Company's international facilities are
located in a total of 28 countries.
ALARIS operates three manufacturing and R&D facilities in the United
States, and it also operates four manufacturing facilities in Mexico and the
United Kingdom.
The Company owns 85 of its domestic and international operating
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 10 and 11 of "Notes to Consolidated Financial Statements."
ITEM 3: LEGAL PROCEEDINGS
Latex Litigation
On September 30, 1996, Baxter International Inc. ("Baxter") and its
subsidiaries transferred to Allegiance Corporation and its subsidiaries
("Allegiance"), which were acquired by the Company in February 1999, Baxter's
U.S. health care distribution business, surgical and respiratory therapy
business and health care cost-management business, as well as certain foreign
operations (the "Allegiance Business") in connection with a spin-off of the
Allegiance Business by Baxter (the "Baxter-Allegiance Spin-Off"). In connection
with this spin-off, Allegiance Corporation, which merged with a subsidiary of
the Company on February 3, 1999, agreed to indemnify Baxter, and to defend and
indemnify Baxter Healthcare Corporation ("BHC"), as contemplated by the
agreements between Baxter and Allegiance Corporation, for all expenses and
potential liabilities associated with claims arising from the Allegiance
Business, including certain claims of alleged personal injuries as a result of
exposure to natural rubber latex gloves. The Company is not a party to any of
the lawsuits and has not agreed to pay any settlements to the plaintiffs.
As of June 30, 2004, there were 36 lawsuits pending against BHC and/or
Allegiance involving allegations of sensitization to natural rubber latex
products, and some of these cases were proceeding to trial. The total dollar
amount of potential damages cannot be reasonably quantified. Some plaintiffs
plead damages in extreme excess of what they reasonably can expect to recover,
some plead a modest amount and some do not include a request for any specific
dollar amount. Not including cases that ask for no specific damages, the damage
requests per action have ranged from $10,000 to $240 million. All of these cases
name multiple defendants, in addition to Baxter/Allegiance. The average number
of defendants per case exceeds 25. Based on the significant differences in the
range of damages sought and, based on the multiple number of defendants in these
lawsuits, Allegiance cannot
18
reasonably quantify the total amount of possible/probable damages. Therefore,
Allegiance and the Company do not believe that these numbers should be
considered as an indication of either reasonably possible or probable liability.
Since the inception of this litigation, Baxter/Allegiance have been named
as a defendant in 834 cases. During the fiscal year ended June 30, 2002,
Allegiance began settling some of these lawsuits with greater frequency. As of
June 30, 2004, Allegiance had resolved more than 90% of these cases. About 20%
of the lawsuits that have been resolved were concluded without any liability to
Baxter/Allegiance. No individual claim has been settled for a material amount
and all the settled claims through June 30, 2004 amounted to, in the aggregate,
approximately $28 million. Due to the number of claims filed and the ongoing
defense costs that will be incurred, Allegiance believes it is probable that it
will incur substantial legal fees related to the resolution of the cases still
pending. Although the Company continues to believe that it cannot reasonably
estimate the potential cost to settle these lawsuits, the Company believes that
the impact of such lawsuits upon Allegiance will be immaterial to the Company's
financial position, liquidity or results of operations, and could be in the
range of $0 to $20 million, net of insurance proceeds (with the range reflecting
the Company's reasonable estimation of potential insurance coverage, and defense
and indemnity costs). The Company believes a substantial 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, R.P. Scherer Corporation (which was acquired by the
Company in August 1998, has been given the legal designation of Cardinal Health
409, Inc. and is referred to in this Form 10-K as "Scherer") 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,
2004, Scherer has entered into settlement agreements with the majority of the
defendants in consideration of payments of approximately $144.7 million, net of
attorney fees, payments due to other interested parties and expenses withheld
prior to the disbursement of the funds to Scherer. The Company has settled all
known claims with all but one of the defendants, and the Company believes that
the total amount of any future recovery will not likely represent a material
amount. As more fully described in Note 1 of "Notes to Consolidated Financial
Statements," the Company has decided, as a result of discussions with the SEC
staff, to reverse its previous recognition of estimated recoveries from vitamin
manufacturers for amounts overcharged in prior years and to recognize the income
from such recoveries as a special item in the period cash was received from the
manufacturers.
Antitrust Litigation against Pharmaceutical Manufacturers
During the past five years, numerous class action lawsuits have been filed
against certain prescription drug manufacturers alleging that the prescription
drug manufacturer, by itself or in concert with others, took improper actions to
delay or prevent generic drug competition against the manufacturer's brand name
drug. The Company has not been a name plaintiff in any of these class actions,
but has been a member of the direct purchasers' class (i.e., those purchasers
who purchase directly from these drug manufacturers). None of the class actions
have gone to trial, but some have settled in the past with the Company receiving
proceeds from the settlement fund. Currently, there are several such class
actions pending in which the Company is a class member. During the fourth
quarter of fiscal 2004, the Company received its share of the settlement
proceeds for one of these actions. Such amount, approximately $31.7 million, is
reported as a special item in the Company's fourth quarter results. See Note 4
of "Notes to Consolidated Financial Statements" for a discussion of recoveries
through June 30, 2004, which totaled $55.9 million. The Company is unable at
this time to estimate definitively future recoveries, if any, it will receive as
a result of these class actions.
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
19
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 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.
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 the U.S. EPA. This Interim Groundwater 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 has been engaged in settlement discussions with
Allegiance, and has not sued Allegiance in connection with the UAO or the BPOU.
During the fourth quarter of fiscal 2004, Allegiance accepted the U.S. EPA's
cash buy-out demand of $550,000 in satisfaction of Allegiance's share of costs
for the Interim Groundwater Remedy. Allegiance also agreed to pay the California
Department of Toxic Substances ("DTSC") $16,050 in settlement of DTSC's claims
related to the Interim Groundwater Remedy. Allegiance has recorded environmental
accruals, based upon 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 ("Burdick") of
Muskegon, Michigan. Baxter became a PRP through its acquisition of 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 group, along with Allegiance's additional recorded environmental
accruals, are adequate to satisfy known costs. The
20
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.
Derivative Actions
On November 8, 2002, a complaint was filed by a purported shareholder
against the Company and its directors in the Court of Common Pleas, Delaware
County, Ohio, as a purported derivative action. Doris Staehr v. Robert D.
Walter, et al., No. 02-CVG-11-639. On or about March 21, 2003, after the Company
filed a Motion to Dismiss the complaint, an amended complaint was filed alleging
breach of fiduciary duties and corporate waste in connection with the alleged
failure by the Board of Directors of the Company to (a) renegotiate or terminate
the Company's proposed acquisition of Syncor, and (b) determine the propriety of
indemnifying Monty Fu, the former Chairman of Syncor. The Company filed a Motion
to Dismiss the amended complaint and the plaintiffs subsequently filed a second
amended complaint that added three new individual defendants and included new
allegations that the Company improperly recognized revenue in December 2000 and
September 2001 related to settlements with certain vitamin manufacturers. The
Company filed a Motion to Dismiss the second amended complaint and, on November
20, 2003, the Court denied the motion. Discovery is proceeding in this action.
The defendants intend to vigorously defend this action. The Company currently
does not believe that the impact of this lawsuit will have a material adverse
effect on the Company's financial position, liquidity or results of operations.
On July 9, 2004, a complaint, captioned Donald Bosley, Derivatively on
behalf of Cardinal Health, Inc. v. David Bing, et al., was filed by a purported
shareholder against the members of the Company's Board of Directors, and the
Company as a nominal defendant in the Court of Common Pleas, Franklin County,
Ohio, as a purported derivative action. The complaint alleges that the
individual defendants failed to implement adequate internal controls for the
Company and thereby violated their fiduciary duty of good faith, GAAP and the
Company's Audit Committee charter. The complaint seeks money damages and
equitable relief against the defendant directors, and an award of attorney's
fees. None of the defendants has responded to the complaint yet, nor has the
Company.
On August 27, 2004, a complaint, captioned Sam Wietschner v. Robert D.
Walter, et al., was filed by a purported shareholder against members of the
Company's Board of Directors, current and former officers and/or employees of
the Company and the Company as a nominal defendant in the Court of Common Pleas,
Franklin County, Ohio, as a purported derivative action. The complaint alleges
that the individual defendants breached various fiduciary duties owed to the
Company. The complaint seeks money damages and equitable relief against the
individual defendants, and an award of attorney's fees. None of the defendants
has responded to the complaint yet, nor has the Company.
On September 22, 2004, a complaint, captioned Green Meadow Partners, LLP,
Derivatively on behalf of Cardinal Health, Inc. v. David Bing, et al., was filed
by a purported shareholder against the members of the Company's Board of
Directors, and the Company as a nominal defendant in the Court of Common Pleas,
Franklin County, Ohio, as a purported derivative action. The complaint alleges
that the individual defendants failed to implement adequate internal controls
for the Company and thereby violated their fiduciary duty of good faith, GAAP
and the Company's Audit Committee charter. The complaint seeks money damages and
equitable relief against the defendant directors, and an award of attorney's
fees. None of the defendants has responded to the complaint yet, nor has the
Company.
Shareholder/ERISA Litigation against Cardinal Health
Since July 2, 2004, ten purported class action complaints have been filed
by purported purchasers of the Company's securities against the Company and
certain of its officers and directors, asserting claims under the federal
securities laws (collectively referred to as the "Cardinal Health federal
securities actions"). To date, all of these actions have been filed in the
United States District Court for the Southern District of Ohio. These cases
include: Gerald Burger v. Cardinal Health, Inc., et al. (04 CV 575), Todd Fener
v. Cardinal Health, Inc., et al. (04 CV 579), E. Miles Senn v. Cardinal Health,
Inc., et al. (04 CV 597), David Kim v. Cardinal Health, Inc. (04 CV 598), Arace
Brothers v. Cardinal Health, Inc., et al. (04 CV 604), John Hessian v. Cardinal
Health, Inc., et al. (04 CV 635), Constance Matthews Living Trust v. Cardinal
Health, Inc., et al. (04 CV 636), Mariss Partners, LLP v. Cardinal Health, Inc.,
et al. (04 CV 849), The State of New Jersey v. Cardinal Health, Inc., et al. (04
CV 831) and First New York Securities, LLC v. Cardinal Health, Inc., et al. (04
CV 911). The Cardinal Health federal securities actions purport to be brought on
behalf of all purchasers of the Company's securities during various periods
beginning as early as October 24, 2000 and ending as late as July 26, 2004 and
allege, among other things, that the defendants violated Section 10(b) of the
Exchange Act and Rule 10b-5 promulgated thereunder and Section 20(a) of the
Exchange Act by issuing a series of false and/or misleading statements
concerning the Company's financial results, prospects and condition. The alleged
misstatements relate to the Company's accounting for recoveries relating to
antitrust litigation against vitamin manufacturers, and to classification of
revenue in the Company's Pharmaceutical Distribution business as either
operating revenue or revenue from bulk deliveries to customer
21
warehouses, among other matters. The alleged misstatements are claimed to have
caused an artificial inflation in the Company's stock price during the proposed
class period. The complaints seek unspecified money damages and equitable relief
against the defendants, and an award of attorney's fees. None of the defendants
has yet responded to any of the complaints in the Cardinal Health federal
securities actions.
Since July 2, 2004, fourteen purported class action complaints have been
filed against the Company and certain officers, directors and employees of the
Company by purported participants in the Cardinal Health Profit Sharing,
Retirement and Savings Plan (collectively referred to as the "Cardinal Health
ERISA actions"). To date, all of these actions have been filed in the United
States District Court for the Southern District of Ohio. These cases include:
David McKeehan and James Syracuse v. Cardinal Health, Inc., et al. (04 CV 643),
Timothy Ferguson v. Cardinal Health, Inc., et al. (04 CV 668), James DeCarlo v.
Cardinal Health, Inc., et al. (04 CV 684), Margaret Johnson v. Cardinal Health,
Inc., et al. (04 CV 722), Harry Anderson v. Cardinal Health, Inc., et al. (04 CV
725), Charles Heitholt v. Cardinal Health, Inc., et al. (04 CV 736), Dan Salinas
and Andrew Jones v. Cardinal Health, Inc., et al. (04 CV 745), Daniel Kelley v.
Cardinal Health, Inc., et al. (04 CV 746), Vincent Palyan v. Cardinal Health,
Inc., et al. (04 CV 778), Saul Cohen v. Cardinal Health, Inc., et al. (04 CV
789), Travis Black v. Cardinal Health, Inc., et al. (04 CV 790), Wendy Erwin v.
Cardinal Health, Inc., et al. (04 CV 803), Susan Alston v. Cardinal Health,
Inc., et al. (04 CV 815), and Jennifer Brister v. Cardinal Health, Inc., et al.
(04 CV 828). The Cardinal Health ERISA actions purport to be brought on behalf
of participants in the Cardinal Health Profit Sharing, Retirement and Savings
Plan (the "Plan"), and also on behalf of the Plan itself. The complaints allege
that the defendants breached certain fiduciary duties owed under the Employee
Retirement Income Security Act ("ERISA"), generally asserting that the
defendants failed to make full disclosure of the risks to plan participants of
investing in the Company's stock, to the detriment of the plan's participants
and beneficiaries, and that Company stock should not have been made available as
an investment alternative for plan participants. The misstatements alleged in
the Cardinal Health ERISA actions significantly overlap with the misstatements
alleged in the complaints in the Cardinal Health federal securities actions. The
complaints seek unspecified money damages and equitable relief against the
defendants, and an award of attorney's fees. None of the defendants has yet
responded to any of the complaints in the Cardinal Health ERISA actions.
With respect to the proceedings described under the headings "Derivative
Actions" and "Shareholder/ERISA Litigation against Cardinal Health," the Company
currently believes that there will be some insurance coverage available under
the Company's insurance policies in effect at the time the actions were filed.
Such policies are with financially viable insurance companies, and are subject
to self-insurance retentions, exclusions, conditions, coverage gaps, policy
limits and insurer solvency.
Shareholder/ERISA Litigation against Syncor
Eleven purported class action lawsuits have been filed against Syncor and
certain of its officers and directors, asserting claims under the federal
securities laws (collectively referred to as the "Syncor federal securities
actions"). All of these actions were filed in the United States District Court
for the Central District of California. These cases include Richard Bowe v.
Syncor Int'l Corp., et al., No. CV 02-8560 LGB (RCx) (C.D. Cal.), Alan Kaplan v.
Syncor Int'l Corp., et al., No. CV 02-8575 CBM (MANx) (C.D. Cal), Franklin
Embon, Jr. v. Syncor Int'l Corp., et al., No. CV 02-8687 DDP (AJWx) (C.D. Cal),
Jonathan Alk v. Syncor Int'l Corp., et al., No. CV 02-8841 GHK (RZx) (C.D. Cal),
Joyce Oldham v. Syncor Int'l Corp., et al., CV 02-8972 FMC (RCx) (C.D. Cal),
West Virginia Laborers Pension Trust Fund v. Syncor Int'l Corp., et al., No. CV
02-9076 NM (RNBx) (C.D. Cal), Brad Lookingbill v. Syncor Int'l Corp., et al., CV
02-9248 RSWL (Ex) (C.D. Cal), Them Luu v. Syncor Int'l Corp., et al., CV 02-9583
RGK (JwJx) (C.D. Cal), David Hall v. Syncor Int'l Corp., et al., CV 02-9621 CAS
(CWx) (C.D. Cal), Phyllis Walzer v. Syncor Int'l Corp., et al., CV 02-9640 RMT
(AJWx) (C.D. Cal), and Larry Hahn v. Syncor Int'l Corp., et al., CV 03-52 LGB
(RCx) (C.D. Cal.). The Syncor federal securities actions purport to be brought
on behalf of all purchasers of Syncor shares during various periods, beginning
as early as March 30, 2000, and ending as late as November 5, 2002. The actions
allege, among other things, that the defendants violated Section 10(b) of the
Exchange Act and Rule 10b-5 promulgated thereunder and Section 20(a) of the
Exchange Act, by issuing a series of press releases and public filings
disclosing significant sales growth in Syncor's international business, but
omitting mention of certain allegedly improper payments to Syncor's foreign
customers, thereby artificially inflating the price of Syncor shares. A lead
plaintiff has been appointed by the court in the Syncor federal securities
actions and a consolidated amended complaint was filed May 19, 2003, naming
Syncor and 12 individuals, all former Syncor officers, directors and/or
employees, as defendants. Syncor filed a Motion to Dismiss the consolidated
amended complaint on August 1, 2003 and, on December 12, 2003, the Court granted
the motion to dismiss without prejudice. A second amended consolidated class
action complaint was filed on January 28, 2004, naming Syncor and 14
individuals, all former Syncor officers, directors and/or employees, as
defendants. Syncor filed a Motion to Dismiss the second amended consolidated
class action complaint on March 4, 2004. On July 6, 2004, the court granted
Defendants' Motion to Dismiss without prejudice as to defendants Syncor, Monty
Fu, Robert Funari and Haig Bagerdjian. As to the other individual defendants,
the motion to dismiss was granted with prejudice. On September 14, 2004, lead
plaintiff filed a Motion for Clarification of the Court's July 6, 2004 dismissal
order.
22
On November 14, 2002, two additional actions were filed by individual
stockholders of Syncor in the Court of Chancery of the State of Delaware (the
"Delaware actions") against seven of Syncor's nine directors (the "director
defendants"). The complaints in each of the Delaware actions were identical and
alleged that the director defendants breached certain fiduciary duties to Syncor
by failing to maintain adequate controls, practices and procedures to ensure
that Syncor's employees and representatives did not engage in improper and
unlawful conduct. Both complaints asserted a single derivative claim, for and on
behalf of Syncor, seeking to recover all of the costs and expenses that Syncor
incurred as a result of the allegedly improper payments (including the costs of
the Syncor federal securities actions described above), and a single purported
class action claim seeking to recover damages on behalf of all holders of Syncor
shares in the amount of any losses sustained if consideration received in the
merger by Syncor stockholders was reduced. On November 22, 2002, the plaintiff
in one of the two Delaware actions filed an amended complaint adding as
defendants the Company, its subsidiary Mudhen Merger Corporation and the
remaining two Syncor directors, who are hereafter included in the term "director
defendants." These cases have been consolidated under the caption In re: Syncor
International Corp. Shareholders Litigation (the "consolidated Delaware
action"). On August 14, 2003, the Company filed a Motion to Dismiss the
operative complaint in the consolidated Delaware action. At the end of September
2003, plaintiffs in the consolidated Delaware action moved the court to file a
second amended complaint. Plaintiffs' request was granted in February 2004.
Monty Fu is the only named defendant in the second amended complaint. On
September 15, 2004, the Court granted Monty Fu's Motion to Dismiss the second
amended complaint. The Court dismissed the second amended complaint with
prejudice.
On November 18, 2002, two additional actions were filed by individual
stockholders of Syncor in the Superior Court of California for the County of Los
Angeles (the "California actions") against the director defendants. The
complaints in the California actions allege that the director defendants
breached certain fiduciary duties to Syncor by failing to maintain adequate
controls, practices and procedures to ensure that Syncor's employees and
representatives did not engage in improper and unlawful conduct. Both complaints
asserted a single derivative claim, for and on behalf of Syncor, seeking to
recover costs and expenses that Syncor incurred as a result of the allegedly
improper payments. These cases include Joseph Famularo v. Monty Fu, et al., Case
No. BC285478 (Cal. Sup. Ct., Los Angeles Cty.), and Mark Stroup v. Robert G.
Funari, et al., Case No. BC285480 (Cal. Sup. Ct., Los Angeles Cty.). An amended
complaint was filed on December 6, 2002 in one of the cases, purporting to
allege direct claims on behalf of a class of shareholders. The defendants'
motion for a stay of the California actions pending the resolution of the
Delaware actions (discussed above) was granted on April 30, 2003.
A purported class action complaint, captioned Pilkington v. Cardinal
Health, et al, was filed on April 8, 2003, against the Company, Syncor and
certain officers and employees of the Company by a purported participant in the
Syncor Employees' Savings and Stock Ownership Plan (the "Syncor ESSOP"). A
related purported class action complaint, captioned Donna Brown, et al. v.
Syncor International Corp, et al., was filed on September 11, 2003, against the
Company, Syncor and certain individual defendants. Another related purported
class action complaint, captioned Thompson v. Syncor International Corp., et
al., was filed on January 14, 2004, against the Company, Syncor and certain
individual defendants. A consolidated complaint was filed on February 24, 2004
against Syncor and certain former Syncor officers, directors and/or employees
alleging that the defendants breached certain fiduciary duties owed under ERISA
based on the same underlying allegations of improper and unlawful conduct
alleged in