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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

 

þ	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2011

or

 

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number: 001-34273

CareFusion Corporation

(Exact name of Registrant as specified in its charter)

 

Delaware		26-4123274
(State or other jurisdiction of incorporation or organization)		(I.R.S Employer Identification No.)

3750 Torrey View Court

San Diego, CA 92130

Telephone: (858) 617-2000

(Address of principal executive offices, zip code and

Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  þ    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer		¨				Accelerated filer		¨
Non-accelerated filer		þ				Smaller reporting company		¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  þ

The number of outstanding shares as of the registrant’s common stock, as of April 26, 2011 was 223,437,364.

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TABLE OF CONTENTS

 

IMPORTANT INFORMATION REGARDING FORWARD-LOOKING STATEMENTS			3
PART I—FINANCIAL INFORMATION			4
ITEM 1. FINANCIAL STATEMENTS			4
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS			26
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK			35
ITEM 4. CONTROLS AND PROCEDURES			38
PART II—OTHER INFORMATION			39
ITEM 1. LEGAL PROCEEDINGS			39
ITEM 1A. RISK FACTORS			39
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS			53
ITEM 6. EXHIBITS			53

 

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Important Information Regarding Forward-Looking Statements

Portions of this Quarterly Report on Form 10-Q (including information incorporated by reference) include “forward-looking statements” based on our current beliefs, expectations and projections regarding our business strategies, market potential, future financial performance, industry and other matters. This includes, in particular, “Item 2—Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Quarterly Report on Form 10-Q as well as other portions of this Quarterly Report on Form 10-Q. The words “believe,” “expect,” “anticipate,” “project,” “could,” “would,” and similar expressions, among others, generally identify “forward-looking statements,” which speak only as of the date the statements were made. The matters discussed in these forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results to differ materially from those projected, anticipated or implied in the forward-looking statements. The most significant of these risks, uncertainties and other factors are described in this Quarterly Report on Form 10-Q under “Item 1A—Risk Factors”. Except to the limited extent required by applicable law, we undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

 

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PART I – FINANCIAL INFORMATION

 

ITEM 1.

FINANCIAL STATEMENTS

CAREFUSION CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 

		Quarters Ended March 31,								Nine Months Ended March 31,
(in millions, except per share amounts)		2011				2010				2011				2010
Revenue		$	867			$	837			$	2,564			$	2,542
Cost of Products Sold			420				423				1,259				1,263
Gross Margin			447				414				1,305				1,279
Selling, General and Administrative Expenses			263				285				805				834
Research and Development Expenses			39				42				115				115
Restructuring and Acquisition Integration Charges			14				1				53				7
Gain on the Sale of Assets			(15	)			—				(15	)			—
Operating Income			146				86				347				323
Interest Expense and Other, Net			19				27				62				89
Income Before Income Tax			127				59				285				234
Provision for Income Tax			41				72				90				123
Income (Loss) from Continuing Operations			86				(13	)			195				111
Discontinued Operations
Impairment/Loss from the Disposal of Discontinued Businesses, Net of Tax			(40	)			—				(40	)			(8	)
Income (Loss) from the Operations of Discontinued Businesses, Net of Tax			(1	)			4				4				39
Income (Loss) from Discontinued Operations, Net of Tax			(41	)			4				(36	)			31
Net Income (Loss)		$	45			$	(9	)		$	159			$	142
PER SHARE AMOUNTS:
Basic Earnings (Loss) per Common Share:
Continuing Operations		$	0.39			$	(0.06	)		$	0.88			$	0.50
Discontinued Operations		$	(0.18	)		$	0.02			$	(0.16	)		$	0.14
Basic Earnings (Loss) per Common Share		$	0.20			$	(0.04	)		$	0.71			$	0.64
Diluted Earnings (Loss) per Common Share:
Continuing Operations		$	0.38			$	(0.06	)		$	0.87			$	0.50
Discontinued Operations		$	(0.18	)		$	0.02			$	(0.16	)		$	0.14
Diluted Earnings (Loss) per Common Share		$	0.20			$	(0.04	)		$	0.71			$	0.64
Weighted-Average Number of Common Shares Outstanding:
Basic			223.0				221.6				222.6				221.4
Diluted			225.6				221.6				224.6				222.7

See accompanying notes to condensed consolidated financial statements

 

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CAREFUSION CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

(in millions, except per share amounts)		March 31, 2011				June 30, 2010
ASSETS
Current Assets:
Cash and Cash Equivalents		$	1,180			$	985
Trade Receivables, Net			435				393
Current Portion of Net Investment in Sales-Type Leases			403				389
Inventories, Net			369				343
Prepaid Expenses			14				17
Other Current Assets			223				183
Current Assets of Discontinued Operations			226				198
Total Current Assets			2,850				2,508
Property and Equipment, Net			461				441
Net Investment in Sales-Type Leases, Less Current Portion			940				946
Goodwill			2,944				2,954
Intangible Assets, Net			897				945
Other Assets			102				87
Non-Current Assets of Discontinued Operations			—				62
Total Assets		$	8,194			$	7,943
LIABILITIES AND EQUITY
Current Liabilities:
Current Portion of Long-Term Obligations and Other Short-Term Borrowings		$	1			$	4
Accounts Payable			164				163
Deferred Revenue			82				82
Accrued Compensation and Benefits			119				182
Other Accrued Liabilities			245				254
Current Liabilities of Discontinued Operations			74				68
Total Current Liabilities			685				753
Long-Term Obligations, Less Current Portion			1,387				1,386
Deferred Income Taxes			670				671
Other Liabilities			476				427
Non-Current Liabilities of Discontinued Operations			—				2
Total Liabilities			3,218				3,239
Commitments and Contingencies
Stockholders’ Equity:
Preferred Stock (50.0 Authorized Shares; $.01 Par Value) Issued and Outstanding—None			—				—
Common Stock (1,200.0 Authorized Shares; $.01 Par Value) Issued and Outstanding—223.3 at March 31, 2011			2				2
Treasury Stock, at cost, 0.1 common shares at March 31, 2011			(3	)			—
Additional Paid-in Capital			4,715				4,666
Retained Earnings			280				121
Accumulated Other Comprehensive Loss			(18	)			(85	)
Total Stockholders’ Equity			4,976				4,704
Total Liabilities and Stockholders’ Equity		$	8,194			$	7,943

See accompanying notes to condensed consolidated financial statements

 

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CAREFUSION CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

		Nine Months Ended March 31,
(in millions)		2011				2010
Cash and Cash Equivalents at July 1, Attributable to Continuing Operations		$	985			$	609
Cash and Cash Equivalents at July 1, Attributable to Discontinued Operations		$	34			$	174
Cash Flows from Operating Activities:
Net Income			159				142
Income (Loss) from Discontinued Operations			(36	)			31
Income from Continuing Operations			195				111
Adjustments to Reconcile Income from Continuing Operations to Net Cash Provided by Operating Activities:
Depreciation and Amortization			141				128
Gain on Sale of Assets			(15	)			—
Other Non-Cash Items			46				156
Change in Operating Assets and Liabilities:
Trade Receivables			(47	)			(20	)
Inventories			(33	)			19
Net Investment in Sales-Type Leases			(8	)			(5	)
Accounts Payable			2				35
Other Accrued Liabilities and Operating Items, Net			(60	)			111
Net Cash Provided by Operating Activities—Continuing Operations			221				535
Net Cash Used in Operating Activities—Discontinued Operations			(9	)			(13	)
Net Cash Provided by Operating Activities			212				522
Cash Flows from Investing Activities:
Proceeds from Divestitures			32				27
Other Investing Activities			(110	)			(92	)
Net Cash Used in Investing Activities—Continuing Operations			(78	)			(65	)
Net Cash Used in Investing Activities—Discontinued Operations			(1	)			(3	)
Net Cash Used in Investing Activities			(79	)			(68	)
Cash Flows from Financing Activities:
Proceeds from Issuance of Debt			—				1,378
Reduction of Long Term Obligations			—				(6	)
Bridge Facility Fees and Debt Issuance Costs			—				(29	)
Dividend Payment to Cardinal Health			—				(1,374	)
Net Cash Transfer from Cardinal Health			—				46
Net Cash Transfer (to)/from subsidiaries			23				(36	)
Other Financing Activities			(7	)			5
Net Cash (Used in) Provided by Financing Activities—Continuing Operations			16				(16	)
Net Cash Used in Financing Activities—Discontinued Operations			(23	)			(118	)
Net Cash Used in Financing Activities			(7	)			(134	)
Effect of Exchange Rate Changes on Cash—Continuing Operations			36				(6	)
Effect of Exchange Rate Changes on Cash—Discontinued Operations			11				(3	)
Net Effect of Exchange Rate Changes on Cash			47				(9	)
Net Increase in Cash and Cash Equivalents—Continuing Operations			195				448
Net Decrease in Cash and Cash Equivalents—Discontinued Operations			(22	)			(137	)
Net Increase in Cash and Cash Equivalents			173				311
Cash and Cash Equivalents at March 31, Attributable to Continuing Operations		$	1,180			$	1,057
Cash and Cash Equivalents at March 31, Attributable to Discontinued Operations		$	12			$	37

See accompanying notes to condensed consolidated financial statements

 

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CAREFUSION CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 1. BASIS OF PRESENTATION

Basis of Presentation. References in these notes to the condensed consolidated financial statements to “CareFusion Corporation,” “CareFusion,” “we,” “us,” “our,” “the company” and “our company” refer to CareFusion Corporation and its consolidated subsidiaries. References in the notes to the condensed consolidated financial statements to “Cardinal Health” refer to Cardinal Health, Inc., an Ohio corporation, and its consolidated subsidiaries.

The condensed consolidated financial statements included in this Form 10-Q have been prepared in accordance with the U.S. Securities and Exchange Commission (“SEC”) instructions for Quarterly Reports on Form 10-Q. Accordingly, the condensed consolidated financial statements are unaudited and do not contain all the information required by U.S. generally accepted accounting principles (“GAAP”) to be included in a full set of financial statements. The condensed consolidated balance sheet at June 30, 2010 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by GAAP for a complete set of financial statements. The audited financial statements for our fiscal year ended June 30, 2010, filed with the SEC on Form 10-K on August 19, 2010 include a summary of our significant accounting policies and should be read in conjunction with this Form 10-Q. In the opinion of management, all material adjustments necessary to present fairly the results of operations for such periods have been included in this Form 10-Q. All such adjustments are of a normal recurring nature. The results of operations for interim periods are not necessarily indicative of the results of operations for the entire year.

We have evaluated subsequent events for recognition or disclosure through the date these financial statements were issued.

On September 29, 2008, Cardinal Health announced that it intended to separate its clinical and medical products businesses from the remainder of its businesses through a pro-rata distribution of common stock of an entity holding the assets and liabilities associated with the clinical and medical products businesses. CareFusion Corporation was incorporated in Delaware on January 14, 2009 for the purpose of holding such businesses. We completed the spinoff from Cardinal Health on August 31, 2009. In connection with the spinoff, Cardinal Health contributed the majority of the businesses comprising its clinical and medical products segment to us (“the contribution”), and distributed approximately 81% of our outstanding common stock, or approximately 179.8 million shares, to its shareholders (“the distribution”), based on a distribution ratio of 0.5 shares of our common stock for each common share of Cardinal Health held on the record date of August 25, 2009. Cardinal Health retained approximately 19% of our outstanding common stock, or approximately 41.4 million shares, in connection with the spinoff. As of September 15, 2010, Cardinal Health had sold all remaining shares of our common stock retained in connection with the spinoff.

The condensed consolidated financial statements reflect the consolidated operations of CareFusion Corporation and its subsidiaries as a separate, stand-alone entity subsequent to August 31, 2009. Certain lines of business that manufacture and sell surgical and exam gloves, drapes and apparel and fluid management products in the U.S. market that were historically managed by us prior to the spinoff and were part of the clinical and medical products business of Cardinal Health, were retained by Cardinal Health as a result of the spinoff, and are presented in these financial statements as discontinued operations. Our condensed consolidated financial statements do not necessarily reflect what the results of operations, financial position and cash flows would have been had we operated as an independent, publicly-traded company during the periods prior to the spinoff from Cardinal Health. See Note 2 for further information regarding discontinued operations.

Reclassification. We have reclassified certain prior-period amounts to conform to the current-period presentation. Beginning in the quarter ended March 31, 2011, we have reclassified certain amounts in our

 

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CAREFUSION CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

unaudited condensed consolidated statements of cash flows for the effect of exchange rate changes on cash to conform to a refinement in our estimation for determining the impact of fluctuations in foreign currency exchange rates on cash. For the nine months ended March 31, 2010, we have reclassified $12 million from other accrued liabilities and operating items, net included in net cash provided by operating activities to the effect of exchange rate changes on cash.

New Accounting Pronouncements (Adopted during Fiscal Year 2011)

ASU 2009-13. In October 2009, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) 2009-13—Multiple-Deliverable Revenue Arrangements (“ASU 2009-13”). ASU 2009-13 amends Accounting Standards Codification (“ASC”) 605-25—Revenue Recognition—Multiple-Element Arrangements. The update replaces the concept of allocating revenue consideration amongst deliverables in a multiple-element revenue arrangement according to fair value with an allocation based on selling price. ASU 2009-13 also establishes a hierarchy for determining the selling price of revenue deliverables sold in multiple element revenue arrangements. The selling price used for each deliverable will be based on vendor-specific objective evidence (“VSOE”) if available, third-party evidence if VSOE is not available, or management’s estimate of an element’s stand-alone selling price if neither VSOE nor third-party evidence is available. The amendments in this update also require an allocation of selling price amongst deliverables be performed based upon each deliverable’s relative selling price to total revenue consideration, rather than on the residual method previously permitted. We prospectively adopted ASU 2009-13 on July 1, 2010. We have applied ASU 2009-13 to our revenue arrangements containing multiple deliverables that were entered into or significantly modified on or after July 1, 2010. We now allocate revenue consideration, excluding contingent consideration, based on the relative selling prices of the separate units of accounting contained within an arrangement containing multiple deliverables. Selling prices are determined using fair value, when available, or our estimate of selling price when fair value is not available for a given unit of accounting. The adoption did not result in a material change in either the units of accounting or a change in the pattern or timing of revenue recognition. Additionally, the adoption of this standard did not have a material impact on our financial condition, results of operations or cash flows.

ASU 2009-14. In October 2009, the FASB issued ASU 2009-14—Certain Revenue Arrangements That Include Software Elements (“ASU 2009-14”). ASU 2009-14 amends ASC 985-605—Revenue Recognition—Software. ASU 2009-14 changes the accounting model in revenue arrangements for products which include both tangible and software elements. Tangible products containing software components and non-software components that function together to deliver the tangible product’s essential functionality are no longer within the scope of the software revenue guidance in ASC 985-605. We adopted the amendment provisions of ASU 2009-14 on July 1, 2010; the adoption of this standard did not have material impact on our financial condition, results of operations or cash flows.

ASU 2010-20. In July 2010, the FASB issued ASU 2010-20—Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses (“ASU 2010-20”). ASU 2010-20 requires certain disclosures about the credit quality of financing receivables and the related allowance for credit losses. In addition, disclosures are required related to the nature of credit risk inherent in the portfolio of financing receivables, how the credit risk is analyzed and assessed in arriving at the allowance for credit losses, and the changes and reasons for those changes in the allowance for credit losses. ASU 2010-20 is effective for interim and annual periods ending on or after December 15, 2010. We adopted the amendment provisions of ASU 2010-20 for the quarter ended December 31, 2010. As ASU 2010-20 is a disclosure standard, the adoption of this did not have any impact on our financial condition, results of operations or cash flow. See note 6.

 

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CAREFUSION CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 2. DISCONTINUED OPERATIONS AND ASSETS HELD FOR SALE

Spinoff from Cardinal Health

On August 31, 2009, we completed the spinoff from Cardinal Health. In connection with the spinoff, CareFusion paid a cash dividend of $1.374 billion to Cardinal Health, and Cardinal Health contributed the majority of the businesses comprising its clinical and medical products segment to us, and retained certain lines of business that manufacture and sell surgical and exam gloves, drapes and apparel and fluid management products in the United States markets that were historically managed by us and, prior to the spinoff, were part of the clinical and medical products businesses of Cardinal Health. The businesses retained by Cardinal Health are presented within these financial statements as discontinued operations.

Audiology Business

During the quarter ended September 30, 2009, we committed to a plan to dispose of our Audiology business which produces and markets hearing diagnostic equipment, and therefore treated the business as discontinued operations. As a result of being held for sale, the assets of the Audiology business were written down to fair value less costs to sell, resulting in a pre-tax impairment charge of $7 million recorded in the quarter ended September 30, 2009. On October 1, 2009, we completed the sale of the Audiology business, resulting in a total loss from discontinued operations associated with the Audiology business of $7 million, which includes a $3 million loss recorded in the quarter ended December 31, 2009, related to the write-off of non-deductible goodwill associated with the closing. At the closing of the sale, we received approximately $27 million in cash, which is net of purchase price adjustments.

International Surgical Products Business

During the quarter ended March 31, 2011, we entered into a definitive agreement to sell our International Surgical Products (“ISP”) distribution business, which was part of our Medical Technologies and Services segment, resulting in held for sale classification of the underlying assets. Accordingly, the assets of the ISP business were written down to fair value less costs to sell, resulting in a pre-tax impairment charge of $40 million recorded in the quarter ended March 31, 2011. See note 14. On April 1, 2011, we completed the sale of the ISP business, at which time we received approximately $124 million in cash and an additional $26 million in receivables, for total consideration of approximately $150 million, which is net of purchase price adjustments. Under the terms of the agreement, certain post-closing adjustments to the purchase price may occur in future periods.

Summarized selected financial information for the businesses retained by Cardinal Health, the Audiology business and the ISP business for the quarters and nine months ended March 31, 2011 and 2010, is as follows:

 

(in millions)		Quarters Ended March 31,								Nine Months Ended March 31,
		2011				2010				2011				2010
Revenue		$	112			$	115			$	325			$	517
Operating Income (Loss)		$	(35	)		$	7			$	(28	)		$	51
Income (Loss) Before Income Tax		$	(37	)		$	5			$	(32	)		$	67
Provision for Income Tax		$	4			$	1			$	4			$	36
Income (Loss) from Discontinued Operations, Net of Tax		$	(41	)		$	4			$	(36	)		$	31

 

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CAREFUSION CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

The assets and liabilities of discontinued operations are stated separately as of March 31, 2011 and June 30, 2010, in the condensed consolidated balance sheets and are comprised of the following items:

 

(in millions)		March 31, 2011				June 30, 2010
ASSETS
Current Assets:
Cash and Cash Equivalents		$	12			$	34
Trade Receivables, Net			85				79
Inventories, Net			85				79
Prepaid Expenses and Other			19				6
Other Current Assets			25				—
Current Assets of Discontinued Operations			226				198
Property and Equipment, Net			—				8
Goodwill			—				41
Intangible Assets			—				1
Other Assets			—				12
Total Assets of Discontinued Operations		$	226			$	260
LIABILITIES
Current Liabilities:
Accounts Payable		$	36			$	36
Other Accrued Liabilities			35				32
Other Current Liabilities			3				—
Current Liabilities of Discontinued Operations			74				68
Other Liabilities			—				2
Total Liabilities of Discontinued Operations		$	74			$	70

All discontinued operations businesses presented were previously included in the Medical Technologies and Services segment.

OnSite Services Business

During the quarter ended March 31, 2011, we entered into a definitive agreement to sell our OnSite Services instrument management and repair business, which was historically part of our Medical Technologies and Services segment, and met the criteria for classification as assets held for sale. The transaction closed on March 28, 2011, and a pre-tax gain related to the disposition of approximately $15 million was recorded in the quarter ended March 31, 2011. The terms of the agreement may result in certain post-closing adjustments to the purchase price in future periods. The results of this business are reported within earnings from continuing operations in the condensed consolidated statements of operations for periods up to the closing date.

 

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CAREFUSION CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 3. EARNINGS PER SHARE

The following table sets forth the reconciliation of basic and diluted earnings per share for the quarters and nine months ended March 31, 2011 and 2010:

 

(shares in millions)		Quarters Ended March 31,								Nine Months Ended March 31,
		2011				2010				2011				2010
Denominator for Basic Earnings per Share			223.0				221.6				222.6				221.4
Effect of Dilutive Securities:
Stock Options			1.1				—				0.7				0.5
Restricted Stock Awards, Restricted Stock Units and Performance Stock Units			1.5				—				1.3				0.8
Denominator for Diluted Earnings per Share			225.6				221.6				224.6				222.7

As there was a net loss for the three-month period ended March 31, 2010, the “Effect of Dilutive Securities” caption in the previous table does not include 0.7 million employee stock options or 1.3 million restricted stock awards, restricted stock units and performance share units because to do so would have been antidilutive.

The table below provides a summary of the securities that could potentially dilute earnings per share in the future that were not included in the computation of diluted earnings per share because to do so would have been antidilutive for the period presented. Antidilutive securities were as follows for the quarters and nine months ended March 31, 2011 and 2010:

 

(securities in millions)		Quarters Ended March 31,								Nine Months Ended March 31,
		2011				2010				2011				2010
Number of Securities			7.2				6.6				9.7				9.7
Weighted Average Exercise Price		$	32.69			$	34.98			$	30.79			$	30.95

Basic and diluted earnings per share amounts are computed independently in the condensed consolidated statements of operations, therefore, the sum of per share components may not equal the per share amounts presented.

NOTE 4. RESTRUCTURING AND ACQUISITION INTEGRATION CHARGES

Restructuring liabilities and associated charges are measured at fair value as incurred. Acquisition integration charges are expensed as incurred.

The following is a summary of restructuring and acquisition integration charges for the quarters and nine months ended March 31, 2011 and 2010:

 

		Quarters Ended March 31,								Nine Months Ended March 31,
(in millions)		2011				2010				2011				2010
Restructuring Charges		$	13			$	—			$	50			$	5
Acquisition Integration Charges			1				1				3				2
Total Restructuring and Acquisition Integration Charges		$	14			$	1			$	53			$	7

 

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CAREFUSION CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Restructuring Charges

In August 2010, we initiated a global restructuring program (the “2011 Plan”) which was initially expected to result in a reduction of approximately 700 positions. We now expect the 2011 Plan will result in a reduction of approximately 800 positions in fiscal 2011. The total estimated restructuring costs associated with the 2011 Plan are approximately $50 million and will be recorded to the “Restructuring and Acquisition Integration Charges” line within our condensed consolidated statements of operations as they are recognized. We expect the 2011 Plan to be substantially complete by the end of fiscal year 2011.

In addition to the restructuring program discussed above, we periodically incur costs to implement smaller restructuring efforts for specific operations. These restructuring plans focus on various aspects of operations, including closing and consolidating certain manufacturing operations, rationalizing headcount, and aligning operations in the most strategic and cost-efficient structure.

The following table includes information regarding our current restructuring programs:

 

						Nine Months Ended March 31, 2011
(in millions)		Accrued June  30, 20101				Accrued Costs				Cash Payments				Accrued Mar.  31, 20111				Total Costs Expensed to Date				Total Expected Program Costs
2011 Plan2		$	—			$	39			$	(30	)		$	9			$	39			$	50
Total Other Restructuring Plans3			8				11				(16	)			3
Total Restructuring Plans		$	8			$	50			$	(46	)		$	12

 

1	Included within “Other Accrued Liabilities” in the condensed consolidated balance sheets.

2	The costs associated with the 2011 Plan primarily consist of severance and outplacement services and associated payroll costs accrued upon either communication of terms to employees or over the required service period.

3	Total costs expensed to date and total program costs are not provided separately for other restructuring programs based on the short duration and smaller size of these programs.

The following table segregates our restructuring charges into our reportable segments for the quarters and nine months ended March 31, 2011 and 2010:

 

		Quarters Ended March 31,								Nine Months Ended March 31,
(in millions)		2011				2010				2011				2010
Medical Technologies and Services		$	7			$	—			$	16			$	(1	)
Critical Care Technologies			6				—				34				6
Total Restructuring Charges		$	13			$	—			$	50			$	5

Acquisition Integration Charges

Costs of integrating operations of various acquired companies are recorded as acquisition integration charges when incurred. The acquisition integration charges incurred during the quarter and nine months ended March 31, 2011 were primarily a result of the acquisition of Medegen, LLC in May 2010.

 

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(Unaudited)

 

Certain acquisition and restructuring costs are based upon estimates. Actual amounts paid may ultimately differ from these estimates. If additional costs are incurred or recognized amounts exceed costs, such changes in estimates will be recognized when incurred.

NOTE 5. INVENTORIES

Inventories, accounted for at the lower of cost or market on the FIFO method, consisted of the following:

 

(in millions)		March 31, 2011				June 30, 2010
Finished Goods		$	247			$	241
Work-in-Process			32				32
Raw Materials			139				121
			418				394
Reserve for Excess and Obsolete Inventories			(49	)			(51	)
Inventories, Net		$	369			$	343

NOTE 6. FINANCING RECEIVABLES

Our net investment in sales-type leases are considered financing receivables. As our portfolio of financing receivables primarily arise from the leasing of our dispensing equipment, the methodology for determining our allowance for credit losses is based on the collective population and not stratified by class or portfolio segment. Reserves for bad debts on the entire portfolio are based on historical experience loss rates and the potential impact of anticipated changes in business practices, market dynamics, and economic conditions. We also reserve individual balances based on the evaluation of customers’ specific circumstances. We write off amounts that are deemed uncollectible. Financing receivables are generally considered past due 30 days after the billing date. We do not accrue interest on past due financing receivables.

The change in the allowance for credit losses on financing receivables for the three months ended March 31, 2011, consisted of the following:

 

(in millions)
Beginning balance of allowance for credit losses—December 31, 2010		$	8
Charge-offs			—
Recoveries			—
Provisions			—
Ending balance of allowance for credit losses—March 31, 2011		$	8

 

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The following table summarizes the credit losses and recorded investment in sales-type leases as of March 31, 2011:

 

(in millions)
Allowance for credit losses:
Ending Balance at March 31, 2011		$	8
Ending Balance: individually evaluated for impairment		$	1
Ending Balance: collectively evaluated for impairment		$	7
Sales-Type Leases:
Ending Balance at March 31, 2011		$	1,343
Ending Balance: individually evaluated for impairment		$	25
Ending Balance: collectively evaluated for impairment		$	1,318

NOTE 7. PROPERTY AND EQUIPMENT

Property and equipment consisted of the following:

 

(in millions)		March 31, 2011				June 30, 2010
Land, Buildings and Improvements		$	182			$	178
Machinery and Equipment			784				729
Furniture and Fixtures			24				23
			990				930
Accumulated Depreciation			(529	)			(489	)
Property and Equipment, Net		$	461			$	441

Depreciation expense was $27 million and $25 million for the quarters ended March 31, 2011 and 2010, respectively, and $78 million and $71 million for the nine months ended March 31, 2011 and 2010, respectively. We expense repairs and maintenance expenditures as incurred.

NOTE 8. GOODWILL AND OTHER INTANGIBLE ASSETS

Goodwill

The following table summarizes the changes in the carrying amount of goodwill:

 

(in millions)		Total
Balance at June 30, 2010		$	2,954
Goodwill Related to the Divestiture of Businesses and Other Adjustments			(10	)
Balance at March 31, 2011		$	2,944

As of March 31, 2011, goodwill for the Critical Care Technologies segment and the Medical Technologies and Services segment was $2,254 million and $690 million, respectively. As of June 30, 2010, goodwill for the Critical Care Technologies segment and the Medical Technologies and Services segment was $2,254 million and

 

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$700 million, respectively. The goodwill related to the divestiture of businesses and other adjustments is primarily a result of the allocation of goodwill associated with the divesture of the OnSite Services business.

Intangible Assets

Intangible assets with definite lives are amortized over their useful lives which range from three to 20 years. The detail of other intangible assets by class is as follows:

 

(in millions)		Weighted Average  Life (years)				Gross Intangibles				Accumulated Amortization				Net Intangibles
March 31, 2011
Unamortized Intangibles:
In-Process Research and Development			Indefinite			$	45			$	—			$	45
Trademarks			Indefinite				336				—				336
Total Unamortized Intangibles							381				—				381
Amortized Intangibles:
Trademarks and Patents			12				87				40				47
Developed Technology			9				287				117				170
Customer Relationships			14				502				212				290
Other			8				38				29				9
Total Amortized Intangibles			12				914				398				516
Total Intangibles						$	1,295			$	398			$	897
June 30, 2010
Unamortized Intangibles:
In-Process Research and Development			Indefinite			$	45			$	—			$	45
Trademarks			Indefinite				336				—				336
Total Unamortized Intangibles							381				—				381
Amortized Intangibles:
Trademarks and Patents			12				83				35				48
Developed Technology			9				275				91				184
Customer Relationships			14				502				180				322
Other			8				37				27				10
Total Amortized Intangibles			12				897				333				564
Total Intangibles						$	1,278			$	333			$	945

Amortization expense is as follows:

 

		Quarters Ended March 31,								Nine Months Ended March 31,
(in millions)		2011				2010				2011				2010
Amortization Expense		$	21			$	20			$	63			$	57

Amortization expense for each of the next five fiscal years is estimated to be:

 

(in millions)		2011				2012				2013				2014				2015
Amortization Expense		$	83			$	80			$	58			$	55			$	43

 

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NOTE 9. COMPREHENSIVE INCOME AND ACCUMULATED OTHER COMPREHENSIVE LOSS

The computation of comprehensive income (loss) for the quarters and nine months ended March 31, 2011 and 2010 is as follows:

 

		Quarters Ended March 31,								Nine Months Ended March 31,
(in millions)		2011				2010				2011				2010
Net Income (Loss)		$	45			$	(9	)		$	159			$	142
Foreign Currency Translation Adjustments			25				(31	)			71				(29	)
Net Unrealized Gain (Loss) on Derivatives			—				2				(1	)			5
Net Change in Minimum Pension Liability			—				—				1				—
Other			(2	)			1				(4	)			1
Comprehensive Income (Loss), Net of Tax		$	68			$	(37	)		$	226			$	119

The components of accumulated other comprehensive loss, net of tax, consisted of the following:

 

(in millions)		March 31, 2011				June 30, 2010
Foreign Currency Translation Adjustments1		$	(12	)		$	(83	)
Net Unrealized Gain on Derivative Instruments			—				1
Minimum Pension Liability			(4	)			(5	)
Other			(2	)			2
Accumulated Other Comprehensive Loss		$	(18	)		$	(85	)

 

1	Included within the $(12) million and $(83) million of foreign currency translation adjustments as of March 31, 2011 and June 30, 2010 is $2 million and $(21) million associated with discontinued operations, respectively.

NOTE 10. BORROWINGS

Borrowings consisted of the following:

 

(in millions)		March 31, 2011				June 30, 2010
Senior Notes due 2012, 4.125% Less Unamortized Discount of $0.8 million at March 31, 2011, Effective Rate 4.37%		$	249			$	249
Senior Notes due 2014, 5.125% Less Unamortized Discount of $3.2 million at March 31, 2011, Effective Rate 5.36%			447				446
Senior Notes due 2019, 6.375% Less Unamortized Discount of $10.1 million at March 31, 2011, Effective Rate 6.60%			690				689
Other Obligations; Interest Averaging 7.37% at March 31, 2011 and 2.82% at June 30, 2010, due in varying installments through 2014			2				6
Total Borrowings			1,388				1,390
Less: Current Portion			1				4
Long-Term Portion		$	1,387			$	1,386

 

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Senior Unsecured Notes. On July 14, 2009, we offered and sold $1.4 billion aggregate principal amount of senior unsecured notes and received net proceeds of $1.374 billion. As part of the spinoff, the net proceeds were subsequently distributed as a dividend payment to Cardinal Health.

Revolving Credit Facility. We maintain a senior unsecured revolving credit facility with an aggregate available principal amount of $480 million, which matures on August 31, 2012. At March 31, 2011 and June 30, 2010, we had no amount outstanding under our senior unsecured revolving credit facility. Our $240 million senior unsecured revolving credit facility expired on August 30, 2010.

Other Borrowings. We also maintain other uncommitted short-term credit facilities and letter of credit facilities. At March 31, 2011, we had no borrowings drawn and $26 million of standby letters of credit ($7 million attributed to discontinued operations) outstanding on these facilities. At June 30, 2010, we had $2 million of borrowings drawn (entirely attributed to discontinued operations) and $18 million of standby letters of credit ($5 million attributed to discontinued operations) outstanding on these facilities. The remaining $2 million and $4 million balance of other obligations at March 31, 2011 and June 30, 2010, respectively, consisted primarily of additional notes, loans and capital leases (none attributed to discontinued operations). Obligations related to capital leases are secured by the underlying assets.

NOTE 11. INCOME TAX

For the period July 1, 2009 through the spinoff date from Cardinal Health on August 31, 2009, our operations were included in the consolidated income tax returns of Cardinal Health. However, income taxes were calculated and provided for CareFusion on a separate return basis subsequent to the spinoff on August 31, 2009.

The effective tax rate was 32.7% and 31.7%, respectively, for the quarter and nine months ended March 31, 2011, as compared to 122.8% and 52.8%, respectively, for the quarter and nine months ended March 31, 2010.

The difference in the effective rate for the quarter and nine months ended March 31, 2011 and the U.S. federal statutory rate of 35% is primarily attributable to the favorable impact of foreign earnings taxed at less than the U.S. statutory rate, partially offset by unfavorable discrete adjustments for uncertain tax positions.

The difference in the effective tax rate for the quarter and nine months ended March 31, 2010 and the U.S. federal statutory rate of 35% is primarily attributable to the $58 million change in tax estimate in the quarter ended March 31, 2010.

During the quarter ended March 31, 2010, we completed a detailed analysis of our tax reserves prompted by new information related to our potential tax positions, tax liabilities, and tax planning strategies. Upon completion of this analysis, we determined it was appropriate to increase our existing tax reserves by approximately $58 million, which was treated as a change in estimate and recorded as a charge to net income for the quarter ended March 31, 2010.

During the quarter ended September 30, 2008, Cardinal Health received an IRS Revenue Agent’s Report for the fiscal tax years 2003 through 2005 that included Notices of Proposed Adjustment related to transfer pricing arrangements between foreign and domestic subsidiaries and the transfer of intellectual property among our subsidiaries. The amount of additional tax proposed by the IRS in these notices totals $462 million, excluding penalties and interest, which may be significant. In addition, during the quarter ended December 31, 2010, we received an IRS Revenue Agent’s Report for fiscal tax years 2006 and 2007 that included Notices of Proposed

 

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Adjustment related to transfer pricing arrangements between foreign and domestic subsidiaries. We and Cardinal Health disagree with the IRS regarding its application of the United States Treasury regulations to the arrangements under review and the valuations underlying such adjustments and intend to vigorously contest them. The tax matters agreement that we entered into with Cardinal Health in connection with the spinoff generally provides that the control of audit proceedings and payment of any additional liability related to our business is our responsibility. During the quarter ended December 31, 2010, we began substantive discussions with the IRS Appeals office related to our 2003 through 2005 fiscal tax years.

We believe that we have provided adequate contingent tax reserves for these matters. However, if upon the conclusion of these audits, the ultimate determination of taxes owed is for an amount that is materially different than our current reserves, our overall tax expense and effective tax rate may be materially impacted in the period of adjustment. It is reasonably possible that we will reach a settlement with the IRS in relation to the fiscal tax years 2003 through 2005 within the next twelve months.

NOTE 12. COMMITMENTS AND CONTINGENCIES

In addition to commitments and obligations in the ordinary course of business, we are subject to various claims, other pending and potential legal actions for damages, investigations relating to governmental laws and regulations and other matters arising out of the normal conduct of our business. We assess contingencies to determine the degree of probability and range of possible loss for potential accrual in our financial statements. An estimated loss contingency is accrued in our financial statements if it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. Because litigation is inherently unpredictable and unfavorable resolutions could occur, assessing contingencies is highly subjective and requires judgments about future events. We regularly review contingencies to determine the adequacy of our accruals and related disclosures. The amount of ultimate loss may differ from these estimates. It is possible that cash flows or results of operations could be materially affected in any particular period by the unfavorable resolution of one or more of these contingencies.

Administrative Subpoena. In April 2011, we received a federal administrative subpoena from the U.S. Department of Justice (“Department of Justice”) through the U.S. Attorney for the District of Kansas. Based on the request, we believe the Department of Justice is investigating various aspects of our sales and marketing practices related to our ChloraPrep skin preparation product. We are cooperating with the request, which seeks documents and other materials for the period July 2000 through the present. We are unable to determine when this matter will be resolved, whether any additional areas of inquiry will be opened, or any outcome of this matter. We cannot estimate what, if any, impact this matter and any results from this matter could have on our business, financial position, operating results or cash flows.

FDA Consent Decree. We are operating under an amended consent decree with the FDA related to our infusion pump business in the United States. We entered into a consent decree with the FDA in February 2007 related to our Alaris SE pumps, and in February 2009, we and the FDA amended the consent decree to include all infusion pumps manufactured by or for CareFusion 303, Inc., our subsidiary that manufactures and sells infusion pumps in the United States. The amended consent decree does not apply to intravenous administration sets and accessories.

While we remain subject to the amended consent decree, which includes the requirements of the consent decree, we have made substantial progress in our compliance efforts. In accordance with the consent decree, we reconditioned Alaris SE pumps that had been seized by the FDA, remediated Alaris SE pumps in use by

 

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customers, and had an independent expert inspect the Alaris SE pump facilities and provide a certification to the FDA as to compliance. As a result of these efforts, in January 2010, we announced that the FDA had given us permission to resume the manufacturing and marketing of our Alaris SE pumps. In accordance with the amended consent decree, and in addition to the requirements of the original consent decree, we also implemented a corrective action plan to bring the Alaris System and all other infusion pumps in use in the United States market into compliance, had our infusion pump facilities inspected by an independent expert, and had our recall procedures and all ongoing recalls involving our infusion pumps inspected by an independent recall expert. In July 2010, the FDA notified us that we can proceed to the audit inspection phase of the amended consent decree, which includes the requirement to retain an independent expert to conduct periodic audits of our infusion pump facilities. The amended consent decree authorizes the FDA, in the event of any violations in the future, to order us to cease manufacturing and distributing, recall products and take other actions. We may be required to pay damages of $15,000 per day per violation if we fail to comply with any provision of the amended consent decree, up to $15 million per year.

We cannot currently predict the outcome of this matter, whether additional amounts will be incurred to resolve this matter, if any, or the matter’s ultimate impact on our business. We may be obligated to pay more costs in the future because, among other things, the FDA may determine that we are not fully compliant with the amended consent decree and therefore impose penalties under the amended consent decree, and/or we may be subject to future proceedings and litigation relating to the matters addressed in the amended consent decree. As of March 31, 2011, we had no reserves in connection with the amended consent decree to cover any future costs and expenses of compliance with the amended consent decree.

Other Matters. In addition to the matters described above, we also become involved in other litigation and regulatory matters incidental to our business, including, but not limited to, product liability claims, employment matters, commercial disputes, intellectual property matters, inclusion as a potentially responsible party for environmental clean-up costs, and litigation in connection with acquisitions and divestitures. We intend to defend ourselves in any such matters and do not currently believe that the outcome of any such matters will have a material adverse effect on our financial condition, results of operations and cash flows.

We may also determine that products manufactured or marketed by us, or our sales and marketing practices for such products, do not meet our specifications, published standards or regulatory requirements. When a quality or regulatory issue is identified, we investigate the issue and take appropriate corrective action. We may be required to report such issues to regulatory authorities, which could result in fines, sanctions or other penalties. In some cases, we may also withdraw a product from the market, correct a product at the customer location, notify the customer of revised labeling and take other actions. We have recalled, and/or conducted field alerts relating to, certain of our products from time to time. These activities can lead to costs to repair or replace affected products, temporary interruptions in product sales and action by regulators, and can impact reported results of operations. We currently do not believe that these activities (other than those specifically disclosed herein) have had or will have a material adverse effect on our business or results of operations.

NOTE 13. FINANCIAL INSTRUMENTS

We use derivative instruments to partially mitigate our business exposure to foreign currency exchange risk. We may enter into foreign currency forward contracts to offset some of the foreign exchange risk of expected future cash flows on certain forecasted revenue and expenses, and on certain assets and liabilities. The maximum period of time that we hedge exposure is up to twelve months.

 

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The following table summarizes the fair value of our assets and liabilities related to derivative instruments as of March 31, 2011 and June 30, 2010:

 

(in millions)		March 31, 2011				June 30, 2010
Assets1:
Derivatives Designated as Hedging Instruments:
Foreign Currency Forward Contracts		$	1			$	2
Liabilities2:
Derivatives Designated as Hedging Instruments:
Foreign Currency Forward Contracts		$	2			$	1

 

1	All derivative assets are recorded as “Other Current Assets” in the condensed consolidated balance sheets.

2	All derivative liabilities are recorded as “Other Accrued Liabilities” in the condensed consolidated balance sheets.

Cash Flow Hedges. We enter into foreign currency forward contracts to protect the value of anticipated foreign currency revenues and expenses associated with certain forecasted transactions. These derivative instruments are designated and qualify as cash flow hedges. Accordingly, the effective portion of the gain or loss on the derivative instrument is reported as a component of other comprehensive income (“OCI”) and reclassified into earnings in the same line item associated with the forecasted transaction and in the same period during which the hedged transaction affects earnings. The ineffective portion of the gain (loss) on derivative instruments is recognized in earnings immediately. The impact of cash flow hedges is included in the condensed consolidated statements of cash flows in “Other Accrued Liabilities and Operating Items, Net”.

At March 31, 2011 and June 30, 2010, we held forward contracts to hedge probable, but not firmly committed, revenue, inventory purchases and expenses.

The following table shows the notional amount of the outstanding cash flow hedges as of March 31, 2011 and June 30, 2010:

 

		March 31, 2011				June 30, 2010
(in millions)		Notional Amount				Notional Amount
Foreign Currency Forward Contracts		$	60			$	35

As of March 31, 2011, the foreign currency forward contracts are expected to mature through November 2011.

Credit risk of these contracts was not material as of March 31, 2011 and June 30, 2010. The unrealized gain (loss) included in OCI in the condensed consolidated balance sheets at March 31, 2011 and June 30, 2010, as well as the amounts reclassified from OCI to the condensed consolidated statements of operations for the quarters and nine months ended March 31, 2011 and 2010 was not material.

The amount of ineffectiveness associated with these derivative instruments was not material.

Fair Value (Non-Designated) Hedges. We enter into foreign currency forward contracts to manage foreign exchange exposure related to intercompany financing transactions and other balance sheet items subject to revaluation that do not meet the requirements for hedge accounting treatment. Accordingly, these derivative instruments are adjusted to current market value at the end of each period. The gain or loss recorded on these

 

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instruments is substantially offset by the remeasurement adjustment on the foreign currency denominated asset or liability. The settlement of the derivative instrument and the remeasurement adjustment on the foreign currency denominated asset or liability are both recorded in the condensed consolidated statements of operations in “Interest Expense and Other, Net”. The cash flow impact of fair value hedges is included in the condensed consolidated statements of cash flows in “Other Accrued Liabilities and Operating Items, Net”. The maximum period of time that we hedge exposure for foreign currency fair value hedges is 31 days.

The following table summarizes the notional amount of the fair value hedges outstanding as of March 31, 2011 and June 30, 2010:

 

		March 31, 2011				June 30, 2010
(in millions)		Notional Amount				Notional Amount
Foreign Currency Forward Contracts		$	219			$	82

We recognized $9 million of losses and $1 million of gain within “Interest Expense and Other, Net” for foreign currency forward contracts for the quarters ended March 31, 2011 and 2010, respectively. We recognized $7 million and $4 million of losses within “Interest Expense and Other, Net”, for foreign currency forward contracts for the nine months ended March 31, 2011 and 2010, respectively.

The following is a summary of all unsettled derivative instruments and the associated amount we would have paid/ received to terminate these contracts based on quoted market prices for the same or similar instruments as of March 31, 2011 and June 30, 2010:

 

		March 31, 2011								June 30, 2010
(in millions)		Notional Amount				Fair Value Loss				Notional Amount				Fair Value Gain
Foreign Currency Forward Contracts		$	279			$	1			$	117			$	2

NOTE 14. FAIR VALUE MEASUREMENTS

Assets and Liabilities Measured at Fair Value on a Recurring Basis. The following table presents information about our financial assets and financial liabilities that are measured at fair value on a recurring basis, and indicates the fair value hierarchy of the valuation techniques we utilize to determine such fair value at March 31, 2011:

 

(in millions)		Level 1
Financial Assets:
Cash Equivalents		$	1,016
Other Investments			14
Total		$	1,030

The cash equivalents balance is comprised of highly liquid investments purchased with a maturity of three months or less from the original purchase date. The other investments balance includes investments in mutual funds classified as other long-term assets, all related to our deferred compensation plan. Both the cash equivalents and other investments were valued based on quoted market prices for identical instruments. We had no level 2 or level 3 assets or liabilities measured on a recurring basis at March 31, 2011.

 

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Assets Measured at Fair Value on a Nonrecurring Basis. The following table presents our assets measured at fair value on a nonrecurring basis based upon the level within the fair value hierarchy in which the fair value measurements fall:

 

(in millions)		Balance at March 31, 2011				Level 1				Level 2				Level 3				Total Losses Recognized
Assets held for sale		$	226			$	—			$	—			$	226			$	36

During the quarter ended March 31, 2011, assets held for sale from our discontinued ISP business with a carrying amount of $262 million were written-down to their fair value of $226 million with an additional $4 million of associated costs to sell. The resulting total impairment charge of $40 million is included in results of discontinued operations. See note 2. The fair value measurement used to determine this impairment was based on the market approach and reflected anticipated sales proceeds for these assets.

Other Instruments. The estimated fair value of our long-term obligations and other short-term borrowings was $1,532 million and $1,540 million as of March 31, 2011 and June 30, 2010, respectively, as compared to the carrying amounts of $1,388 million and $1,390 million at March 31, 2011 and June 30, 2010, respectively. The fair value of our senior notes at March 31, 2011 and June 30, 2010 was based on quoted market prices. The fair value of the other obligations at March 31, 2011 and June 30, 2010, was based on either the quoted market prices for the same or similar debt or estimated based on discounted cash flows.

NOTE 15. RELATED PARTY TRANSACTIONS

On September 15, 2010, Cardinal Health sold the remaining shares of our common stock that it retained in connection with the spinoff, and as a result, ceased to be a related party (see note 1). The following paragraphs discuss related party transactions with Cardinal Health prior to September 15, 2010 and how they were accounted for in our financial statements.

Related Party Sales. Historically, we sold certain medical products and supplies through the medical distribution business of Cardinal Health. Title for these products transferred to Cardinal Health when we sold the products to their medical distribution channels; however, we recognized product revenue on these sales primarily when title transferred to the end customer, which was typically upon receipt by the end customer. Our product revenue related to these related party sales totaled $180 million for the two months ended August 31, 2009. Included within this amount is $72 million associated with discontinued operations for the two months ended August 31, 2009.

In connection with the spinoff, on August 31, 2009, we entered into several agreements with Cardinal Health. Pursuant to our Transition Services Agreement (“TSA”), we incurred charges of $16 million for the period July 1, 2010 to September 15, 2010 and $22 million and $78 million for the quarter and nine months ended March 31, 2010, respectively. Prior to August 31, 2009, we were allocated general corporate expenses from Cardinal Health, of which $19 million were allocated for the two months ended August 31, 2009.

We also entered into a distribution agreement with Cardinal Health which states that Cardinal Health will continue to distribute certain of our products and supplies through its medical distribution business. In addition, we entered into an accounts receivable factoring agreement for which we sell certain of our accounts receivable associated with this distribution agreement to Cardinal Health. Title to these products and supplies no longer

 

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transfers to Cardinal Health and inventory related to these products is maintained by CareFusion. Service fees related to this agreement were $8 million for the period July 1, 2010 to September 15, 2010 and $11 million and $25 million for the quarter and nine months ended March 31, 2010, respectively.

In addition to the distribution agreement noted above, upon the spinoff, we entered into other agreements with Cardinal Health in which we buy from Cardinal Health and sell to Cardinal Health certain products and services. The product sales and purchases associated with these agreements are utilized for resale by each respective company to their end customers. The service fees and revenues related to these agreements are for a variety of services including the use of the sales force, marketing, sterilization and warehousing services.

Total product revenue related to these agreements was $61 million for the period July 1, 2010 to September 15, 2010 and $84 million and $174 million for the quarter and nine months ended March 31, 2010, respectively. Total product purchases from Cardinal Health were $21 million for the period July 1, 2010 to September 15, 2010 and $24 million and $58 million for the quarter and nine months ended March 31, 2010, respectively. Service fees paid to Cardinal Health were $5 million for the period July 1, 2010 to September 15, 2010 and $9 million and $18 million for the quarter and nine months ended March 31, 2010, respectively. Service fee revenue from Cardinal Health was immaterial for the period July 1, 2010 to September 15, 2010, immaterial for the quarter ended March 31, 2010 and $1 million for the nine months ended March 31, 2010.

For further information regarding these agreements see our Form 10-K, filed with the SEC on August 19, 2010.

NOTE 16. PRODUCT WARRANTIES

We offer warranties on certain products for various periods of time. We accrue for the estimated cost of product warranties at the time revenue is recognized. Our product warranty liability reflects management’s best estimate of the probable liability based on current and historical product sales data and warranty costs incurred.

The table below summarizes the changes in the carrying amount of the liability for product warranties for the nine months ended March 31, 2011:

 

(in millions)
Balance at June 30, 2010		$	24
Warranty Accrual			9
Warranty Claims Paid			(9	)
Adjustments to Preexisting Accruals			(3	)
Balance at March 31, 2011		$	21

As of March 31, 2011 and June 30, 2010, approximately $8 million and $10 million, respectively, of the ending liability balances related to accruals for product recalls.

 

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CAREFUSION CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 17. SEGMENT INFORMATION

The following table presents information about our reporting segments for the quarters ended March 31, 2011 and 2010:

 

(in millions)		Critical Care Technologies				Medical Technologies and Services1				Total
March 31, 2011:
External Revenues		$	661			$	206			$	867
Depreciation and Amortization			37				11				48
Operating Income2			115				16				131
Capital Expenditures			35				6				41
March 31, 2010:
External Revenues		$	629			$	208			$	837
Depreciation and Amortization			31				14				45
Operating Income			77				9				86
Capital Expenditures			22				6				28

The following table presents information about our reporting segments for the nine months ended March 31, 2011 and 2010:

 

(in millions)		Critical Care Technologies				Medical Technologies and Services1				Total
March 31, 2011:
External Revenues		$	1,962			$	602			$	2,564
Depreciation and Amortization			108				33				141
Operating Income2			298				34				332
Capital Expenditures			91				19				110
March 31, 2010:
External Revenues		$	1,928			$	614			$	2,542
Depreciation and Amortization			91				37				128
Operating Income			289				34				323
Capital Expenditures			72				22				94

 

1	Segment results for the Medical Technologies and Services segment have been adjusted for discontinued operations. See note 2.

2	The $15 million gain on the sale of assets associated with the March 31, 2011 divestiture of our OnSite Services business has not been allocated to segment results for the quarter and nine months ended March 31, 2011. See note 2.

 

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CAREFUSION CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

A reconciliation of total segment operating income to consolidated income before income tax is presented below for the quarters and nine months ended March 31, 2011 and 2010:

 

		Quarters Ended March 31,								Nine Months Ended March 31,
(in millions)		2011				2010				2011				2010
Total Segment Operating Income		$	131			$	86			$	332			$	323
Gain on the Sale of Assets			15				—				15				—
Operating Income			146				86				347				323
Interest Expense and Other, Net			19				27				62				89
Income Before Income Tax		$	127			$	59			$	285			$	234

The following table presents revenue and net property and equipment by geographic area:

 

		Revenue																Property and Equipment, Net
		Quarters Ended March 31,								Nine Months Ended March 31,								March  31, 2011				June  30, 2010
(in millions)		2011				2010				2011				2010
United States		$	688			$	640			$	2,065			$	1,968			$	351			$	338
International			179				197				499				574				110				103
Total		$	867			$	837			$	2,564			$	2,542			$	461			$	441

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This management’s discussion and analysis of financial condition and results of operations (“MD&A”), contains forward-looking statements that involve risks and uncertainties. Please see “Important Information Regarding Forward-Looking Statements” for a discussion of the uncertainties, risks and assumptions that may cause our actual results to differ materially from those discussed in the forward-looking statements. This discussion should be read in conjunction with our condensed consolidated financial statements and related notes thereto and the other disclosures contained elsewhere in this Quarterly Report on Form 10-Q, and the audited consolidated financial statements and related notes thereto for the fiscal year ended June 30, 2010, which were included in our Form 10-K, filed with the U.S. Securities and Exchange Commission (“SEC”) on August 19, 2010.

The results of operations for the periods reflected herein are not necessarily indicative of results that may be expected for future periods.

Basis of Presentation

References in this MD&A to “CareFusion Corporation,” “CareFusion,” “we,” “us,” “our,” “the company” and “our company” refer to CareFusion Corporation and its consolidated subsidiaries. References in this MD&A to “Cardinal Health” refer to Cardinal Health, Inc., an Ohio corporation, and its consolidated subsidiaries.

We were incorporated in Delaware on January 14, 2009 for the purpose of holding the clinical and medical products businesses of Cardinal Health in anticipation of spinning off from Cardinal Health. We completed the spinoff from Cardinal Health on August 31, 2009. In connection with the spinoff, Cardinal Health contributed the majority of the businesses comprising its clinical and medical products segment to us (“the contribution”) and distributed approximately 81% of our outstanding common stock, or approximately 179.8 million shares, to its shareholders (“the distribution”). Cardinal Health retained approximately 19% of our outstanding common stock, or approximately 41.4 million shares, in connection with the spinoff. As of September 15, 2010, Cardinal Health had sold all remaining shares of our common stock retained in connection with the spinoff.

The condensed consolidated financial statements presented elsewhere in this Form 10-Q, and discussed below, reflect the consolidated operations of CareFusion Corporation and its subsidiaries as a separate, stand-alone entity subsequent to August 31, 2009. Periods presented prior to our August 31, 2009 spinoff from Cardinal Health have been prepared on a stand-alone basis and are derived from the consolidated financial statements and accounting records of Cardinal Health. Certain lines of business that manufacture and sell surgical and exam gloves, drapes and apparel and fluid management products in the United States markets that were historically managed by us prior to the spinoff and were part of the clinical and medical products business of Cardinal Health, were retained by Cardinal Health as a result of the spinoff and are presented in these financial statements as discontinued operations. Our condensed consolidated financial statements do not necessarily reflect what the results of operations, financial position and cash flows would have been had we operated as an independent, publicly-traded company during the periods prior to the spinoff from Cardinal Health.

The condensed consolidated financial statements included in this Form 10-Q have been prepared in accordance with the SEC instructions to Quarterly Reports on Form 10-Q. Accordingly, the condensed consolidated financial statements presented elsewhere in this Form 10-Q and discussed below are unaudited and do not contain all the information required by U.S. generally accepted accounting principles (“GAAP”) to be included in a full set of financial statements. The audited consolidated financial statements for our fiscal year ended June 30, 2010, filed with the SEC on Form 10-K on August 19, 2010 include a summary of our significant accounting policies and should be read in conjunction with this Form 10-Q. In the opinion of management, all material adjustments necessary to present fairly the results of operations for such periods have been included in this Form 10-Q. All such adjustments are of a normal recurring nature. The results of operations for interim periods are not necessarily indicative of the results of operations for the entire year.

 

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Overview

We are a leading global medical technology company with clinically proven and industry-leading products and services designed to measurably improve the safety and quality of healthcare. We offer comprehensive product lines in the areas of IV infusion, medication and supply dispensing, respiratory care, infection prevention and surgical instruments to customers in the United States and over 130 countries throughout the world. Our strategy is to enhance growth by focusing on healthcare safety and productivity, driving innovation and clinical differentiation, accelerating our global growth and pursing strategic opportunities. In furtherance of our strategy, we may seek to acquire entities that meet our objectives of driving innovation and global growth, as well as assessing our portfolio of businesses with a view of divesting non-core businesses that do not align with our objectives.

Since the beginning of fiscal year 2009, challenges have existed in the capital equipment market from delays in hospital capital spending, as well as prioritization of capital spending. Despite seeing small signs of improvement, we continue to anticipate it will take some time before significant market improvements are realized. We continue to believe that we are well positioned to benefit from increases in hospital capital equipment spending as the market recovers over time.

For the quarter ended March 31, 2011, we generated revenues and income from continuing operations of $867 million and $86 million, respectively, compared to revenues and loss from continuing operations of $837 million and $13 million, respectively, for the quarter ended March 31, 2010. For the nine months ended March 31, 2011, we generated revenues and income from continuing operations of $2,564 million and $195 million, respectively, compared to revenues and income from continuing operations of $2,542 million and $111 million, respectively, for the nine months ended March 31, 2010.

Our year over year results of operations were largely impacted by two significant events that occurred during the fiscal year ended June 30, 2010. These events were the release of the shipping hold for the Alaris System in July 2009, which resulted in higher demand for our infusion products during the nine months ended March 31, 2010, and emergency preparedness efforts, including preparations for an anticipated severe flu season, which drove higher demand for our respiratory products during the quarter and nine months ended March 31, 2010. While strong performance of our infusion business during the quarter and nine months ended March 31, 2011 drove year over year growth, our respiratory business results decreased year over year. Our respiratory business continues to face a challenging capital spending market, and a lighter than expected flu season and lower hospital admissions in the quarter and nine months ended March 31, 2011, has had a negative impact on demand for our respiratory products. We continue to see growth in other areas of our business, including our infection prevention and medical specialties businesses.

During the quarter and nine months ended March 31, 2011, our operations were also impacted by our global restructuring program. This program, announced in August 2010 (“the 2011 Plan”) was designed to reduce our cost structure and streamline operations, and was initially expected to result in a reduction of approximately 700 positions. We now expect the 2011 Plan will result in a reduction of approximately 800 positions in fiscal 2011. This program is expected to provide operating expense savings of approximately $95 million in fiscal year 2011, primarily as a result of reducing headcount and eliminating unfilled positions, increasing to annualized savings of $120 million in fiscal year 2012 and beyond. As a result of this program, during the quarter ended March 31, 2011, we experienced savings of approximately $31 million, of which approximately $19 million was a result of year over year savings in selling, general and administrative expense (“SG&A”) and lower cost of sales expense, and $12 million was a result of not filling open positions. For the nine months ended March 31, 2011, total savings was $76 million, of which $48 million related to year over year savings in SG&A and cost of sales and $28 million was from not filling open positions. Initiation of this program resulted in approximately $9 million and $39 million in restructuring charges during the quarter and nine months ended March 31, 2011, respectively. In total, we expect to incur restructuring charges associated with this program of approximately $50 million during fiscal year 2011.

 

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In fiscal year 2011, we have incurred and expect to continue to incur additional one-time expenditures associated with the separation from Cardinal Health (capital and expense), the total of which is expected to be approximately $80 million, after which all substantive expenditures associated with standing up operations from the spinoff are expected to be complete. We have funded, and expect to continue funding these costs through cash from operations and cash on hand. The capital portion of these expenditures will be amortized over their useful lives and the other expenditures will be expensed as incurred, depending on their nature. During the quarter and nine months ended March 31, 2011, we incurred approximately $22 million and $59 million, respectively, of these one-time expenditures.

Our capital equipment revenues are subject to a certain degree of seasonality that aligns to our customer capital equipment purchasing cycles. As a normal course of business, this seasonality would manifest itself with higher sales in our second and fourth quarters and lower sales in our first and third quarters of our fiscal year.

Consolidated Results of Operations

Quarter Ended March 31, 2011 Compared to the Quarter Ended March 31, 2010

Below is a summary of comparative results of operations and a more detailed discussion of results for the quarters ended March 31, 2011 and 2010:

 

		Quarters Ended March 31,
(in millions)		2011				2010				Change
Revenue		$	867			$	837			$	30
Cost of Products Sold			420				423				(3	)
Gross Margin			447				414				33
Selling, General and Administrative Expenses			263				285				(22	)
Research and Development Expenses			39				42				(3	)
Restructuring and Acquisition Integration Charges			14				1				13
Gain on the Sale of Assets			(15	)			—				(15	)
Operating Income			146				86				60
Interest Expense and Other, Net			19				27				(8	)
Income Before Income Tax			127				59				68
Provision for Income Tax			41				72				(31	)
Income (Loss) from Continuing Operations			86				(13	)			99
Loss from the Disposal of Discontinued Businesses, Net of Tax			(40	)			—				(40	)
Income (Loss) from the Operations of Discontinued Businesses, Net of Tax			(1	)			4				(5	)
Income (Loss) from Discontinued Operations, Net of Tax			(41	)			4				(45	)
Net Income (Loss)		$	45			$	(9	)		$	54

Revenue

Revenue in our Critical Care Technologies segment (“CCT”) increased 5% to $661 million for the quarter ended March 31, 2011 compared to the prior year. Revenue increased largely as a result of increased sales for our infusion and dispensing businesses, which was partially offset by decreased revenue for our respiratory business.

Infusion revenues increased as a result of core business growth in both capital and disposable products and the year over year impact of our acquisition of Medegen in May 2010. Dispensing revenues increased primarily as a result of new business and competitive displacements.

 

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During the quarter ended March 31, 2010, respiratory product revenues were strong due to increased demand resulting from emergency preparedness efforts, including preparations for an anticipated severe flu season. As a result of restrained customer spending, a light flu season, and lower hospital admissions, we experienced lower capital product revenues and decreased utilization of our disposable respiratory products.

Revenue in our Medical Technologies and Services segment (“MT&S”) decreased by 1% to $206 million for the quarter ended March 31, 2011 compared to the prior year. The revenue decrease is primarily attributable to the impact of divesting our Research Services business in May 2010. These decreases were partially offset by growth in our infection prevention and medical specialties businesses.

Gross Margin and Cost of Products Sold

Gross margin increased 8% to $447 million during the quarter ended March 31, 2011 compared to the prior year. As a percentage of revenue, gross margin was 51.6% for the quarter ended March 31, 2011 compared to 49.5% in the prior year.

The overall increase in gross margin was primarily the result of higher sales associated with our infusion and dispensing businesses. Margin as a percentage of revenue increased as a result of favorable changes in product sales mix, with higher sales in our infusion and dispensing businesses, which generally have higher margins; and lower sales in our respiratory products business, which generally has lower margins. Also improving our gross margin percentage were the impacts of our 2011 Plan and favorable manufacturing cost reductions. Manufacturing savings resulted from: (a) cost benefits recognized through strategic sourcing of raw materials; (b) manufacturing efficiencies associated with lean transformation; and (c) reduced overhead spending.

Selling, General and Administrative Expenses and Research and Development

SG&A and Research and Development expenses decreased 8% to $302 million during the quarter ended March 31, 2011 compared to the prior year. This decrease is primarily a result of savings associated with our 2011 Plan and reduced operating expenses associated with the divestiture of our Research Services business in May 2010. These decreases were partially offset by increased expenses associated with our acquisition of Medegen in May 2010 and increasing investment in our selling organization. Included within our SG&A expenses are certain one-time costs associated with our spinoff from Cardinal Health of $10 million and $17 million for the quarters ended March 31, 2011 and 2010, respectively. We expect all substantive expenditures associated with standing up operations from the spinoff to be complete by the end of fiscal year 2011.

Restructuring and Acquisition Integration Charges

Restructuring and acquisition integration charges increased $13 million to $14 million during the quarter ended March 31, 2011 compared to the prior year. We incurred charges of approximately $9 million during the quarter ended March 31, 2011 associated with the 2011 Plan. The total estimated restructuring costs associated with the 2011 Plan are approximately $50 million and we expect the 2011 Plan to be substantially complete by the end of fiscal year 2011. In addition to the 2011 Plan, we periodically incur costs to implement smaller restructuring efforts for specific operations. These restructuring plans focus on various aspects of operations, including closing and consolidating certain manufacturing operations, rationalizing headcount and aligning operations in the most strategic and cost-efficient structure.

Gain on the Sale of Assets

During the quarter ended March 31, 2011, we completed the sale of our Onsite Services business, which was historically part of our MT&S segment. Including estimated working capital adjustments as part of the definitive agreement, the pre-tax gain related to the disposition was approximately $15 million. This transaction is subject to post-closing adjustments, including amounts for the final working capital. See note 2 to the unaudited condensed consolidated financial statements.

 

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Operating Income

Segment profit in our CCT reportable segment increased 49% to $115 million during the quarter ended March 31, 2011 compared to the prior year. The increase in segment profit was primarily driven by higher revenue and gross margins in our infusion and dispensing businesses, the acquisition of Medegen, and reductions in overhead spending. Partially offsetting this increase were lower revenues from our respiratory businesses and the impact of increases in restructuring charges of $6 million.

Segment profit in our MT&S reportable segment increased $7 million to $16 million during the quarter ended March 31, 2011. The increase in segment profit is primarily attributable to the impact of an increase in revenue associated with our infection prevention and medical specialties businesses. Partially offsetting this increase was the impact of increases in restructuring charges of $7 million.

Interest Expense and Other, Net

Interest expense and other, net decreased 30% to $19 million during the quarter ended March 31, 2011 compared to the prior year. This decrease was primarily related to foreign currency gains and lower net interest expense in the quarter ended March 31, 2011.

In general, gains and losses resulting from foreign currency exchange rates are related to the remeasurement of receivables and payables, which are denominated in currencies other than the functional currency of the subsidiary which holds the receivable or payable and are netted with any associated fair value hedging activities entered into to minimize this exposure. See note 13 to the unaudited condensed consolidated financial statements.

Provision for Income Tax

Income tax expense decreased 43% to $41 million for the quarter ended March 31, 2011 compared to the prior year. The effective tax rate for the quarter ended March 31, 2011 was 32.7% compared to 122.8% for the quarter ended March 31, 2010.

The decrease in the effective tax rate was primarily due to a decrease in discrete tax expense recognized in the quarter ended March 31, 2011, partially offset by the favorable impact of a year over year shift in earnings to foreign jurisdictions, which are generally taxed at rates less than our federal statutory rate. This decrease in discrete tax expense was due to the change of tax estimate of $58 million in the quarter ended March 31, 2010. As a result of this change, we increased our existing tax reserves by approximately $58 million, which was treated as a change in estimate and recorded as a charge to net income for the quarter ended March 31, 2010.

We are in substantive discussions with the IRS Appeals office related to our 2003 through 2005 fiscal tax years, which were previously under audit. We believe that we have provided adequate reserves for the matters under appeal with the IRS. However, if upon the conclusion of these audits, the ultimate determination of taxes owed is for an amount that is materially different than our current reserves, our overall tax expense and effective tax rate may be materially impacted in the period of adjustment. It is reasonably possible that we will reach a settlement with the IRS in relation to the fiscal tax years 2003 through 2005 within the next twelve months.

For additional detail regarding the provision for income taxes, see note 11 to the unaudited condensed consolidated financial statements.

Income (Loss) from Discontinued Operations, Net of Tax

Loss from discontinued operations, net of tax, for the quarter ended March 31, 2011 totaled $41 million compared to income from discontinued operations of $4 million for the quarter ended March 31, 2010. The decrease is a result of the impairment charge recorded in the quarter ended March 31, 2011 as a result of writing down the assets of the ISP business to fair value less costs to sell.

 

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See note 2 to the unaudited condensed consolidated financial statements for further information related to these discontinued operations.

Nine Months Ended March 31, 2011 Compared to the Nine Months Ended March 31, 2010

Below is a summary of comparative results of operations and a more detailed discussion of results for the nine months ended March 31, 2011 and 2010:

 

		Nine Months Ended March 31,
(in millions)		2011				2010				Change
Revenue		$	2,564			$	2,542			$	22
Cost of Products Sold			1,259				1,263				(4	)
Gross Margin			1,305				1,279				26
Selling, General and Administrative Expenses			805				834				(29	)
Research and Development Expenses			115				115				—
Restructuring and Acquisition Integration Charges			53				7				46
Gain on the Sale of Assets			(15	)			—				(15	)
Operating Income			347				323				24
Interest Expense and Other, Net			62				89				(27	)
Income Before Income Tax			285				234				51
Provision for Income Tax			90				123				(33	)
Income from Continuing Operations			195				111				84
Impairment/Loss from the Disposal of Discontinued Businesses, Net of Tax			(40	)			(8	)			(32	)
Income (Loss) from the Operations of Discontinued Businesses, Net of Tax			4				39				(35	)
Income (Loss) from Discontinued Operations, Net of Tax			(36	)			31				(67	)
Net Income		$	159			$	142			$	17

Revenue

Revenue in our CCT segment increased $2% to $1,962 million for the nine months ended March 31, 2011 compared to the prior year. Revenue increased largely as a result of increased sales for our infusion and dispensing businesses, which was partially offset by decreased revenue for our respiratory business.

Infusion revenues increased as a result of core business growth in both capital and disposable products and the year over year impact of our acquisition of Medegen in May 2010. These increases were partially offset by a decrease in revenues as a result of the benefit during the nine months ended March 31, 2010 from the release of the shipping hold on the Alaris System in July 2009. Also affecting the year over year revenue change was the downward adjustment to revenue for the quarter ended September 30, 2009 associated with a revised estimate of accrued rebates to distributors.

Dispensing revenues increased primarily as a result of new business and competitive displacements.

During the nine months ended March 31, 2010, respiratory product revenues were strong due to increased demand resulting from emergency preparedness efforts, including preparations for an anticipated severe flu season. As a result of restrained customer spending, a light flu season, and lower hospital admissions, all during the nine months ended March 31, 2011 we experienced lower capital product revenues and decreased utilization of our disposable respiratory products.

 

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Revenue in our MT&S segment decreased by 2% to $602 million for the nine months ended March 31, 2011 compared to the prior year. The revenue decrease is primarily attributable to the impact of divesting our Research Services business in May 2010. These decreases were partially offset by growth in our infection prevention business and, to a lesser extent, growth in our medical specialties business.

Gross Margin and Cost of Products Sold

Gross margin increased 2% to $1,305 million during the nine months ended March 31, 2011 compared to the prior year. As a percentage of revenue, gross margin was 50.9% for the nine months ended March 31, 2011 compared to 50.3% in the prior year.

The increase in gross margin was primarily the result of higher sales associated with our infusion and dispensing businesses. Margin as a percentage of revenue increased as a result of favorable changes in product sales mix, with higher sales in our infusion and dispensing businesses, which generally have higher margins, and lower sales in our respiratory products business, which generally has lower margins. Also improving our gross margin percentage were the impacts of our 2011 Plan and favorable manufacturing cost reductions. Manufacturing savings resulted from: (a) cost benefits recognized through strategic sourcing of raw materials; (b) manufacturing efficiencies associated with lean transformation; and (c) reduced overhead spending.

Selling, General and Administrative Expenses and Research and Development

SG&A and Research and Development expenses decreased 3% to $920 million during the nine months ended March 31, 2011 compared to the prior year. This decrease is primarily a result of savings associated with our 2011 Plan and reduced operating expenses associated with the divestiture of our Research Services business in May 2010. These decreases were partially offset by increased expenses associated with our acquisition of Medegen in May 2010 and increasing investment in our selling organization. Included within our SG&A expenses are certain one-time costs associated with our spinoff from Cardinal Health of $34 million and $45 million for the nine months ended March 31, 2011 and 2010, respectively.

Restructuring and Acquisition Integration Charges

Restructuring and acquisition integration charges increased $46 million to $53 million during the nine months ended March 31, 2011 compared to the prior year, primarily as a result of charges associated with the 2011 Plan.

Gain on the Sale of Assets

During the quarter ended March 31, 2011, we completed the sale of our Onsite Services business, which was historically part of our MT&S segment. Including estimated working capital adjustments as part of the definitive agreement, the pre-tax gain related to the disposition was approximately $15 million. This transaction is subject to post-closing adjustments, including amounts for the final working capital. See note 2 to the unaudited condensed consolidated financial statements.

Operating Income

Segment profit in our CCT reportable segment increased 3% to $298 million during the nine months ended March 31, 2011 compared to the prior year. The increase in segment profit is attributable to higher revenue in our infusion and dispensing businesses and manufacturing and overhead cost savings. Partially offsetting this increase were lower revenues from our respiratory business and the impact of increases in restructuring charges of $28 million.

Segment profit in our MT&S reportable segment was $34 million during the nine months ended March 31, 2011 and 2010. This is primarily attributable to the increase in revenue associated with our infection prevention business offset by increases in restructuring charges of $17 million.

 

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Interest Expense and Other, Net

Interest expense and other, net decreased 30% to $62 million during the nine months ended March 31, 2011 compared to the prior year. The decrease is primarily attributable to a one-time write-off of debt issuance and related costs of $22 million associated with the bridge loan facility, which was terminated on August 31, 2009 and recorded during the quarter ended September 30, 2009 and foreign currency gains and lower net interest expense compared to the prior year.

Provision for Income Tax

Income tax expense decreased 27% to $90 million for the nine months ended March 31, 2011 compared to the prior year. The effective tax rate for the nine months ended March 31, 2011 was 31.7% compared to 52.8 % in the prior year.

The decrease in the effective tax rate was primarily due to a decrease in discrete tax expense recognized for the nine months ended March 31, 2011, partially offset by the favorable impact of a year over year shift in earnings to foreign jurisdictions, which are generally taxed at rates less than our U. S. federal statutory rate. This decrease in discrete tax expense was due to the aforementioned tax change of tax estimate of $58 million in the quarter ended March 31, 2010. As a result of this change, we increased our existing tax reserves by approximately $58 million, which was treated as a change in estimate and recorded as a charge to net income for the quarter ended March 31, 2010.

For additional detail regarding the provision for income taxes, see note 11 to the unaudited condensed consolidated financial statements.

Income (Loss) from Discontinued Operations, Net of Tax

Loss from discontinued operations, net of tax, for the nine months ended March 31, 2011 totaled $36 million compared to income from discontinued operations of $31 million during the nine months ended March 31, 2010.

The decrease is a result of the impairment charge recorded in the quarter ended March 31, 2011 as a result of writing down the assets of the ISP business to fair value less costs to sell. Additionally, included in discontinued operations in the prior year are (a) certain lines of business that manufactured and sold surgical and exam gloves, drapes and apparel and fluid management products in the U.S. markets that were historically managed by us prior to the spinoff and were part of the clinical and medical products business of Cardinal Health, and were retained by Cardinal Health as a result of the spinoff and (b) the company’s former Audiology business, which produced and marketed hearing diagnostic equipment, which was sold on October 1, 2009.

See note 2 to the unaudited condensed consolidated financial statements for further information related to discontinued operations.

Liquidity and Capital Resources

Overview

Historically, we have generated, and expect to continue to generate, positive cash flow from operations. Cash flow from operations primarily represents inflows from net income (adjusted for depreciation and other non-cash items) and outflows from investment in sales-type leases entered into, as we sell and install dispensing equipment, and other increases in working capital needed to grow the business. Cash flows from investing activities represent our investment in intellectual property and capital equipment required to grow our business, as well as acquisitions. In fiscal year 2010, cash flows from financing activities are primarily related to the issuance of debt associated with our spinoff from Cardinal Health. Prior to our spinoff, cash flows from financing activities were primarily related to changes in Cardinal Health’s investment in us. In the past, Cardinal Health would fund our operating and investing activities as needed and transfer our excess cash at its discretion.

 

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Our cash balance at March 31, 2011 was $1,180 million. Of this balance, $1,014 million is held outside of the United States and is denominated in United States dollars as well as other currencies. We believe that our current domestic cash flow from operations and domestic cash balances are sufficient to meet domestic operating needs. However, should our domestic cash needs exceed our current or future domestic cash flows, we could repatriate foreign cash or utilize our senior unsecured revolving credit facility, both of which would result in increased expense.

We believe that our future cash from operations together with our access to funds available under our senior unsecured revolving credit facility and the capital markets will provide adequate resources to fund both short-term and long-term operating requirements, capital expenditures, acquisitions and new business development activities.

During the quarter ended December 31, 2010, we began substantive discussions with the IRS Appeals office related to our 2003 through 2005 fiscal tax years, which were previously under audit. We believe that we have provided adequate reserves for the matters under appeal with the IRS. However, if upon the conclusion of these audits, the ultimate determination of taxes owed is for an amount that is materially different than our current reserves, our overall tax expense and effective tax rate may be materiality impacted in the period of adjustment. Further, even if we are adequately reserved for these matters, final settlement would require us to make a cash payment to the IRS, which could be material. If we determine to repatriate foreign cash or utilize our revolving credit facility to fund the payment to the IRS, it may result in increased costs. See note 11 to the unaudited condensed consolidated financial statements for further information.

Sources and Uses of Cash

The following table summarizes our statements of cash flows from continuing operations:

 

		Nine Months Ended March 31,
(in millions)		2011				2010				Change
Cash Flow Provided by (Used in)
Operating Activities		$	221			$	535			$	(314	)
Investing Activities		$	(78	)		$	(65	)		$	(13	)
Financing Activities		$	16			$	(16	)		$	32

Nine Months Ended March 31, 2011 and 2010

Net operating cash flow from continuing operations decreased $314 million to $221 million for the nine months ended March 31, 2011 compared to the prior year. The decrease is due to the impact of non-cash items ($112 million) as a result of deferred income taxes and debt issuance costs incurred in fiscal 2010; a decrease in cash flow associated with accounts receivable as a result of temporary decreased collections as a result of a new system implementation ($27 million); a decrease in cash flow associated with inventories as a result of increased build ($52 million); a decrease in cash flow associated with accounts payable ($33 million), primarily associated with the year over year timing of payments of accounts payable; and a decrease in cash flow associated with other accrued liabilities and operating items ($171 million), which primarily relates to payments for employee incentive compensation that was accrued at June 30, 2010 and paid during the nine months ended March 31, 2011 and our semi-annual interest payments associated with our senior notes, which are due in August and February each year beginning in February 2010. During the nine months ended March 31, 2010, there were substantially smaller employee incentive compensation payments and we had no interest payments associated with debt allocated to us for periods prior to our August 31, 2009 spinoff date.

Net cash used in continuing operations from investing activities increased $13 million for the nine months ended March 31, 2011 compared to the prior year primarily due to increases in capital spending.

 

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Net cash provided by continuing operations from financing activities increased $32 million for the nine months ended March 31, 2011 compared to the prior year. During the nine months ended March 31, 2010, we received proceeds from the issuance of debt ($1,378 million) and utilized these proceeds to pay a dividend to Cardinal Health ($1,374 million) associated with our spinoff. The remaining year over year change was primarily due to the change in amounts transferred to us from Cardinal Health before our spinoff ($46 million), partially offset by transfers with our ISP business ($59 million), and our payments of debt issuance costs ($29 million) during the nine months ended March 31, 2010.

Capital Resources

Revolving Credit Facility. We maintain a senior unsecured revolving credit facility with an aggregate available principal amount of $480 million, which matures on August 31, 2012. At March 31, 2011 we had no amounts outstanding under our senior unsecured revolving credit facility.

Dividends

We currently intend to retain any earnings to finance research and development, acquisitions and the operation and expansion of our business and do not anticipate paying any cash dividends in the foreseeable future. The declaration and payment of any dividends in the future by us will be subject to the sole discretion of our board of directors and will depend upon many factors, including our financial condition, earnings, capital requirements of our operating subsidiaries, covenants associated with certain of our debt obligations, legal requirements, regulatory constraints and other factors deemed relevant by our board of directors. Moreover, should we pay any dividend in the future, there can be no assurance that we will continue to pay such dividends.

Off-Balance Sheet Arrangements, Contractual Obligations, Contingent Liabilities and Commitments

At March 31, 2011, we did not have any off-balance sheet arrangements. We have had no material changes related to contractual obligations since June 30, 2010. For information on contractual obligations, see the table of Contractual Obligations in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our 2010 Annual Report on Form 10-K, filed with the SEC on August 19, 2010.

 

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

In the normal course of business, our operations are exposed to risks associated with changes in interest rates and foreign exchange rates. We seek to manage these risks using hedging strategies that involve the use of derivative instruments. We do not enter into any derivative agreements for trading or speculative purposes.

While we believe we have designed an effective risk management program, there are inherent limitations in our ability to forecast our exposures, and therefore, we cannot guarantee that our programs will completely mitigate all risks associated with unfavorable movement in either foreign exchange rates or interest rates.

Additionally, the timing of the recognition of gains and losses related to derivative instruments can be different from the recognition of the underlying economic exposure. This may impact our consolidated operating results and financial position.

Interest Rate Risk

Interest income and expense on variable-rate instruments are sensitive to fluctuations in interest rates across the world. Changes in interest rates primarily affect the interest earned on our cash and equivalents and to a significantly lesser extent the interest expense on our debt.

 

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As of March 31, 2011, the majority of our outstanding debt balances is fixed rate debt. While changes in interest rates will have no impact on the interest we pay on this debt, interest on any borrowings under our revolving credit facility will be exposed to interest rate fluctuations as the rate on this facility is variable. At March 31, 2011 we had no amount outstanding under our $480 million revolving credit facility.

The tables below present information about our investment portfolio and debt obligations:

 

		March 31, 2011
		Liabilities Maturing in Fiscal Year																												Fair Market Value3
(in millions)		2011				2012				2013				2014				2015				Thereafter				Total
ASSETS
Cash and Cash Equivalents
Cash		$	164			$	—			$	—			$	—			$	—			$	—			$	164			$	164
Cash Equivalents		$	1,016			$	—			$	—			$	—			$	—			$	—			$	1,016			$	1,016
Weighted Average Interest Rate1			0.18	%			—				—				—				—				—				0.18	%			—
LIABILITIES
Debt Obligations
Fixed Rate Debt2		$	—			$	—			$	250			$	—			$	450			$	700			$	1,400			$	1,530
Weighted Average Coupon Rate			—				—				4.13	%			—				5.13	%			6.38	%			5.57	%			—
Other Obligations		$	—			$	1			$	1			$	—			$	—			$	—			$	2			$	2
Weighted Average Interest Rate			—				7.02	%			6.76	%			—				—				—				7.37	%			—
		June 30, 2010
		Liabilities Maturing in Fiscal Year																												Fair Market Value3
(in millions)		2011				2012				2013				2014				2015				Thereafter				Total
ASSETS
Cash and Cash Equivalents
Cash		$	173			$	—			$	—			$	—			$	—			$	—			$	173			$	173
Cash Equivalents		$	812			$	—			$	—			$	—			$	—			$	—			$	812			$	812
Weighted Average Interest Rate1			0.10	%			—				—				—				—				—				0.10	%			—
LIABILITIES
Debt Obligations
Fixed Rate Debt2		$	—			$	—			$	250			$	—			$	450			$	700			$	1,400			$	1,534
Weighted Average Coupon Rate			—				—				4.13	%			—				5.13	%			6.38	%			5.57	%			—
Other Obligations		$	4			$	1			$	1			$	—			$	—			$	—			$	6			$	6
Weighted Average Interest Rate			2.61	%			2.80	%			4.74	%			—				—				—				2.82	%			—

 

1	Represents weighted average interest rate for cash equivalents only; cash balances generally earn no interest.

2	Fixed rate notes are presented gross of a $14 million and $16 million purchase discount at March 31, 2011 and June 30, 2010, respectively.

3

The estimated fair value of our long-term obligations and other short-term borrowings was $1,532 million and $1,540 million at March 31, 2011 and June 30, 2010, respectively. The fair value of our senior notes at March 31, 2011 and June 30, 2010 was based on quoted market prices. The fair value of the other obligations at March 31, 2011 and June 30, 2010, was based on either the quoted market prices for the same or similar debt and the current interest rates offered for debt or estimated based on discounted cash flows.

Foreign Currency Risk

We are a global company with operations in multiple countries and are a net recipient of currencies other than the United States dollar (USD). Accordingly, a strengthening of the USD will negatively impact revenues and gross margins expressed in consolidated USD terms.

 

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Currently, we have foreign exchange risk associated with currency exposure associated with existing assets and liabilities, committed transactions, forecasted future cash flows and net investments in foreign subsidiaries. We seek to manage our foreign exchange risk by using derivative contracts such as forwards, swaps and options with financial institutions to hedge our risks. In general, we will hedge material foreign exchange exposures up to twelve months in advance; however, we may choose not to hedge some exposures for a variety of reasons including prohibitive economic costs.

The realized and unrealized gains and losses of foreign currency forward contracts and the re-measurement of foreign denominated receivables, payables and loans are recorded in the consolidated statement of income. To the extent that cash flow hedges qualify for hedge accounting, the unrealized gain or loss on the forward will be recorded to OCI. As the forecasted exposures affect earnings, the realized gain or loss on the forward contract will be moved from OCI to the condensed consolidated statements of operations.

The following table provides information about our foreign currency derivative instruments outstanding as of March 31, 2011 and June 30, 2010:

 

		March 31, 2011								June 30, 2010
(in millions)		Notional Amount				Average Contract Rate				Notional Amount				Average Contract Rate
Foreign Currency Forward Contracts:
(Receive USD/pay foreign currency)
Euro		$	141				1.4			$	12				1.4
Australian Dollar			25				1.0				19				0.9
New Zealand Dollar			9				0.8				9				0.7
South African Rand			4				7.2				2				7.7
Norwegian Krone			—				—				2				5.9
Swedish Krona			—				—				2				7.1
Mexico Peso			10				12.1				2				13.0
Canadian Dollar			—				—				5				1.0
Japanese Yen			—				—				1				89.3
Swiss Franc			1				1.0				—				—
British Pound			52				1.6				—				—
Total		$	242							$	54
Estimated Fair Value		$	(1	)						$	1
Foreign Currency Forward Contracts:
(Pay USD/receive foreign currency)
Mexican Peso		$	17				12.1			$	10				13.0
Swiss Franc			7				1.0				5				1.1
British Pound			2				—				19				1.5
Canadian Dollar			—				—				1				1.0
Euro			—				—				8				1.4
Total		$	26							$	43
Estimated Fair Value		$	—							$	—
Foreign Currency Forward Contracts:
(Pay foreign currency/receive euros)
British Pound		$	11				0.9			$	2				0.8
Swiss Franc			—				—				18				1.4
Total		$	11							$	20
Estimated Fair Value		$	—							$	—

 

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ITEM 4.

CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer and our Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this report. Based on that evaluation, our management, including our Chief Executive Officer and our Chief Financial Officer, has concluded that our disclosure controls and procedures were effective as of the end of such period.

Changes in Internal Control Over Financial Reporting

In March 2011, the company began processing selected financial transactions on a newly implemented accounting software system. This change of systems is designed to streamline and integrate the Company’s financial close and reporting processes by reducing the number of platforms used to record and report financial information, improving efficiency by reducing the amount of manual activity, and improving the control environment by reducing variability in the financial policies, processes and systems.

In connection with the evaluation required by Exchange Act Rule 13a-15(f), our management, including our Chief Executive Officer and our Chief Financial Officer, concluded that no other changes in our internal control over financial reporting occurred during the period covered by this report beyond those that are described above, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Inherent Limitations on Effectiveness of Controls

Our management, including our Chief Executive Officer and our Chief Financial Officer, do not expect that our disclosure controls or our internal control over financial reporting will prevent or detect all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of controls effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.

 

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PART II – OTHER INFORMATION

 

ITEM 1.

LEGAL PROCEEDINGS

See note 12 to the unaudited condensed consolidated financial statements.

 

ITEM 1A.

RISK FACTORS

We urge you to carefully consider the following risks and other information in this Quarterly Report on Form 10-Q in evaluating us and our common stock. Any of the following risks, as well as additional risks and uncertainties not currently known to us or that we currently deem immaterial, could materially and adversely affect our results of operations or financial condition. The risk factors generally have been separated into three groups: risks related to our business, risks related to the separation and risks related to our common stock.

Risks Related to Our Business

We may be unable to effectively enhance our existing products or introduce and market new products or may fail to keep pace with advances in technology.

The healthcare industry is characterized by evolving technologies and industry standards, frequent new product introductions, significant competition and dynamic customer requirements that may render existing products obsolete or less competitive. As a result, our position in the industry could erode rapidly due to unforeseen changes in the features and functions of competing products, as well as the pricing models for such products. The success of our business depends on our ability to enhance our existing products and to develop and introduce new products and adapt to these changing technologies and customer requirements. The success of new product development depends on many factors, including our ability to anticipate and satisfy customer needs, obtain regulatory approvals and clearances on a timely basis, develop and manufacture products in a cost-effective and timely manner, maintain advantageous positions with respect to intellectual property and differentiate our products from those of our competitors. To compete successfully in the marketplace, we must make substantial investments in new product development whether internally or externally through licensing, acquisitions or joint development agreements. Our failure to enhance our existing products or introduce new and innovative products in a timely manner would have an adverse effect on our results of operations and financial condition.

Even if we are able to develop, manufacture and obtain regulatory approvals and clearances for our new products, the success of those products would depend upon market acceptance. Levels of market acceptance for our new products could be affected by several factors, including:

 

•

the availability of alternative products from our competitors;

 

•

the price and reliability of our products relative to that of our competitors;

 

•

the timing of our market entry; and

 

•

our ability to market and distribute our products effectively.

We are subject to complex and costly regulation.

Our products are subject to regulation by the FDA and other national, supranational, federal and state governmental authorities. It can be costly and time-consuming to obtain regulatory clearance and/or approval to market a medical device or other product. Clearance and/or approval might not be granted for a new or modified device or other product on a timely basis, if at all. Regulations are subject to change as a result of legislative, administrative or judicial action, which may further increase our costs or reduce sales. In addition, we are subject to regulations covering manufacturing practices, product labeling and advertising, and adverse-event reporting that apply after we have obtained clearance or approval to sell a product. Our failure to maintain clearances or

 

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approvals for existing products, to obtain clearance or approval for new or modified products, or to adhere to regulations for manufacturing, labeling, advertising or adverse event reporting could adversely affect our results of operations and financial condition. Further, if we determine a product manufactured or marketed by us does not meet our specifications, published standards or regulatory requirements, we may seek to correct the product or withdraw the product from the market, which could have an adverse effect on our business. Many of our facilities and procedures and those of our suppliers are subject to ongoing oversight, including periodic inspection by governmental authorities. Compliance with production, safety, quality control and quality assurance regulations can be costly and time-consuming.

In addition, if our sales and marketing activities fail to comply with FDA regulations or guidelines, or other applicable laws, we may be subject to warnings or enforcement actions from the FDA or other enforcement bodies. A number of companies in the healthcare industry have been the subject of enforcement actions related to their sales and marketing practices, including their relationships with doctors and off-label promotion of products. In April 2011, we received a federal administrative subpoena from the Department of Justice. Based on the request, we believe the Department of Justice is investigating various aspects of our sales and marketing practices related to our ChloraPrep skin preparation product. See note 12 to the unaudited condensed consolidated financial statements included in this Form 10-Q for more information. We cannot control the pace or scope of any investigation, and responding to the subpoena request and any investigation will require the allocation of resources, including management time and attention. If we were to become the subject of an enforcement action, including any action resulting from the Department of Justice investigation, it could result in negative publicity, penalties, fines, the exclusion of our products from reimbursement under federally-funded programs and/or prohibitions on our ability to sell our products, which could have an adverse effect on our results of operations and financial condition.

Cost-containment efforts of our customers, purchasing groups, third-party payers and governmental organizations could adversely affect our sales and profitability.

Many existing and potential customers for our products within the United States are members of group purchasing organizations, (“GPOs”), and integrated delivery networks (“IDNs”), in an effort to reduce costs. GPOs and IDNs negotiate pricing arrangements with healthcare product manufacturers and distributors and offer the negotiated prices to affiliated hospitals and other members. Due to the highly competitive nature of the GPO and IDN contracting processes, we may not be able to obtain or maintain contract positions with major GPOs and IDNs across our product portfolio. Furthermore, the increasing leverage of organized buying groups may reduce market prices for our products, thereby reducing our profitability.

While having a contract with a GPO or IDN can facilitate sales to members of that GPO or IDN, it is no assurance that sales volume of those products will be maintained. The members of such groups may choose to purchase from our competitors due to the price or quality offered by such competitors, which could result in a decline in our sales and profitability.

In addition, our capital equipment products typically represent a sizeable initial capital expenditure for healthcare organizations. Changes in the budgets of these organizations, the timing of spending under these budgets and conflicting spending priorities, including changes resulting from adverse economic conditions, can have a significant effect on the demand for our capital equipment products and related services. In addition, the implementation of healthcare reform in the United States, which may reduce or eliminate the amount that healthcare organizations may be reimbursed for our capital equipment products and related services, could further impact demand. Any such decreases in expenditures by these healthcare facilities and decreases in demand for our capital equipment products and related services could have an adverse effect on our results of operations and financial condition.

Distributors of our products may begin to negotiate terms of sale more aggressively in an effort to increase their profitability. Failure to negotiate distribution arrangements having advantageous pricing or other terms of sale

 

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could adversely affect our results of operations and financial condition. In addition, if we fail to implement distribution arrangements successfully, it could cause us to lose market share to our competitors.

Outside the United States, we have experienced downward pricing pressure due to the concentration of purchasing power in centralized governmental healthcare authorities and increased efforts by such authorities to lower healthcare costs. Our failure to offer acceptable prices to these customers could adversely affect our sales and profitability in these markets.

Current economic conditions have and may continue to adversely affect our results of operations and financial condition.

Disruptions in the financial markets and other macro-economic challenges currently affecting the economy and the economic outlook of the United States and other parts of the world have had and we expect will continue to have an adverse impact on our results of operations and financial condition. Recessionary conditions and depressed levels of consumer and commercial spending have caused and may continue to cause our customers to reduce, modify, delay or cancel plans to purchase our products and have caused and may continue to cause vendors to reduce their output or change terms of sales. We have observed certain hospitals delaying as well as prioritizing capital purchasing decisions, which has had and we expect will continue to have an adverse impact on our financial results into the foreseeable future. If our customers’ cash flow or operating and financial performance deteriorate or fail to improve, or if they are unable to make scheduled payments or obtain credit, they may not be able to pay, or may delay payment of, accounts receivable owed to us. Likewise, for similar reasons, vendors may restrict credit or impose different payment terms.

We also extend credit through an equipment leasing program for a substantial portion of sales to our dispensing product customers. This program and any similar programs that we may establish for sales of our other capital equipment, exposes us to certain risks. We are subject to the risk that if these customers fail to pay or delay payment for the products they purchase from us, it could result in longer payment cycles, increased collection costs, defaults exceeding our expectations and an adverse impact on the cost or availability of financing. These risks related to our equipment leasing program may be exacerbated by a variety of factors, including adverse economic conditions, decreases in demand for our capital equipment products and negative trends in the businesses of our leasing customers.

Any inability of current and/or potential customers to pay us for our products or any demands by vendors for different payment terms may adversely affect our results of operations and financial condition.

We may be unable to realize any benefit from our cost reduction and restructuring efforts and our profitability may be hurt or our business otherwise might be adversely affected.

In August 2010, we announced plans for various cost reduction and restructuring activities. These plans are expected to generate operating expense savings of approximately $95 million in fiscal year 2011, increasing to annualized savings of $120 million in fiscal year 2012 and beyond, through direct and indirect overhead expense reductions and other savings. These types of cost reduction and restructuring activities are complex. If we do not successfully manage our current restructuring activities, or any other restructuring activities that we may take in the future, any expected efficiencies and benefits might be delayed or not realized, and our operations and business could be disrupted. In addition, the costs associated with implementing our restructuring plan might exceed expectations, which could result in additional future charges.

We may be unable to protect our intellectual property rights or may infringe on the intellectual property rights of others.

We rely on a combination of patents, trademarks, copyrights, trade secrets and nondisclosure agreements to protect our proprietary intellectual property. Our efforts to protect our intellectual property and proprietary rights

 

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may not be sufficient. We cannot be sure that our pending patent applications will result in the issuance of patents to us, that patents issued to or licensed by us in the past or in the future will not be challenged or circumvented by competitors or that these patents will remain valid or sufficiently broad to preclude our competitors from introducing technologies similar to those covered by our patents and patent applications. In addition, our ability to enforce and protect our intellectual property rights may be limited in certain countries outside the United States, which could make it easier for competitors to capture market position in such countries by utilizing technologies that are similar to those developed or licensed by us.

Competitors also may harm our sales by designing products that mirror the capabilities of our products or technology without infringing our intellectual property rights. If we do not obtain sufficient protection for our intellectual property, or if we are unable to effectively enforce our intellectual property rights, our competitiveness could be impaired, which would limit our growth and future revenue.

We operate in an industry characterized by extensive patent litigation. Patent litigation is costly to defend and can result in significant damage awards, including treble damages under certain circumstances, and injunctions that could prevent the manufacture and sale of affected products or force us to make significant royalty payments in order to continue selling the affected products. At any given time, we are involved as either a plaintiff or a defendant in a number of patent infringement actions, the outcomes of which may not be known for prolonged periods of time. We can expect to face additional claims of patent infringement in the future. A successful claim of patent or other intellectual property infringement against us could adversely affect our results of operations and financial condition.

Defects or failures associated with our products and/or our quality system could lead to the filing of adverse event reports, product recalls or safety alerts and negative publicity and could subject us to regulatory actions.

Manufacturing flaws, component failures, design defects, off-label uses or inadequate disclosure of product-related information could result in an unsafe condition or the injury or death of a patient. These problems could lead to a recall of, or issuance of a safety alert relating to, our products and result in significant costs and negative publicity. Due to the strong name recognition of our brands, an adverse event involving one of our products could result in reduced market acceptance and demand for all products within that brand, and could harm our reputation and our ability to market our products in the future. In some circumstances, adverse events arising from or associated with the design, manufacture or marketing of our products could result in the suspension or delay of regulatory reviews of our applications for new product approvals or clearances. We may also voluntarily undertake a recall of our products or temporarily shut down production lines based on internal safety and quality monitoring and testing data.

Our future operating results will depend on our ability to sustain an effective quality control system and effectively train and manage our employee base with respect to our quality system. Our quality system plays an essential role in determining and meeting customer requirements, preventing defects and improving our products and services. While we have a network of quality systems throughout our business units and facilities, quality and safety issues may occur with respect to any of our products. A quality or safety issue may result in public warning letters, product recalls or seizures, monetary sanctions, consent decrees, injunctions to halt manufacturing and distribution of products, civil or criminal sanctions, refusal of a government to grant clearances or approvals or delays in granting such clearances or approvals, import detentions of products made outside the United States, restrictions on operations or withdrawal or suspension of existing approvals. Any of the foregoing events could disrupt our business and have an adverse effect on our results of operations and financial condition.

We are currently operating under an amended consent decree with the FDA and our failure to comply with the requirements of the amended consent decree may have an adverse effect on our business.

We are operating under an amended consent decree with the FDA related to our infusion pump business in the United States. We entered into a consent decree with the FDA in February 2007 related to our Alaris SE pumps,

 

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and in February 2009, we and the FDA amended the consent decree to include all infusion pumps manufactured by or for our subsidiary that manufactures and sells infusion pumps in the United States. In accordance with the amended consent decree, and in addition to the requirements of the original consent decree, we implemented a corrective action plan to bring the Alaris System and all other infusion pumps in use in the United States market into compliance, had our infusion pump facilities inspected by an independent expert and had our recall procedures and all ongoing recalls involving our infusion pumps inspected by an independent recall expert. In July 2010, the FDA notified us that we can proceed to the audit inspection phase of the amended consent decree, which includes the requirement to retain an independent expert to conduct periodic audits of our infusion pump facilities. The costs associated with these ongoing audits, and any actions that we may need to take resulting from these audits, could be significant.

We have no reserve in connection with the amended consent decree to cover any future costs and expenses of compliance with the amended consent decree. As such, we may be obligated to pay more costs in the future because, among other things, the FDA may determine that we are not fully compliant with the amended consent decree and therefore impose penalties under the amended consent decree, and/or we may be subject to future proceedings and litigation relating to the matters addressed in the amended consent decree. Moreover, the matters addressed in the amended consent decree could lead to negative publicity that could have an adverse impact on our business. The amended consent decree authorizes the FDA, in the event of any violations in the future, to order us to cease manufacturing and distributing, recall products and take other actions. We may also be required to pay monetary damages if we fail to comply with any provision of the amended consent decree. See note 12 to the unaudited condensed consolidated financial statements included in this Form 10-Q for more information. Any of the foregoing matters could disrupt our business and have an adverse effect on our results of operations and financial condition.

We may incur product liability losses and other litigation liability.

We are, and may be in the future, subject to product liability claims and lawsuits, including potential class actions, alleging that our products have resulted or could result in an unsafe condition or injury. Any product liability claim brought against us, with or without merit, could be costly to defend and could result in settlement payments and adjustments not covered by or in excess of insurance. In addition, we may not be able to obtain insurance on terms acceptable to us or at all because insurance varies in cost and can be difficult to obtain. Our failure to successfully defend against product liability claims or maintain adequate insurance coverage could have an adverse effect on our results of operations and financial condition.

We are involved in a number of legal proceedings. Legal proceedings are inherently unpredictable, and the outcome can result in excessive verdicts and/or injunctive relief that may affect how we operate our business, or we may enter into settlements of claims for monetary damages that exceed our insurance coverage, if any. Future court decisions and legislative activity may increase our exposure to litigation and regulatory investigations. In some cases, substantial non-economic remedies or punitive damages may be sought.

We rely on the performance of our information technology systems, the failure of which could have an adverse effect on our business and performance.

Our business requires the continued operation of sophisticated information technology systems and network infrastructure. These systems are vulnerable to interruption by fire, power loss, system malfunction and other events, which are beyond our control. Systems interruptions could reduce our ability to manufacture and provide service for our products, and could have an adverse effect on our operations and financial performance. The level of protection and disaster-recovery capability varies from site to site, and there can be no guarantee that any such plans, to the extent they are in place, will be totally effective.

In addition, we are pursuing initiatives to transform our information technology systems and processes. Many of our business units use disparate systems and processes, including those required to support critical functions

 

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related to our operations, sales, and financial close and reporting. We are implementing new systems to better streamline and integrate critical functions, which we expect to result in improved efficiency and, over time, reduced costs. While we believe these initiatives provide significant opportunity for us, they do expose us to inherent risks. We may suffer data loss or delays or other disruptions to our business, which could have an adverse effect on our results of operations and financial condition. If we fail to successfully implement new information technology systems and processes, we may fail to realize cost savings anticipated to be derived from these initiatives.

An interruption in our ability to manufacture our products, an inability to obtain key components or raw materials or an increase in the cost of key components or raw materials may adversely affect our business.

Many of our key products are manufactured at single locations, with limited alternate facilities. If an event occurs that results in damage to one or more of our facilities, it may not be possible to timely manufacture the relevant products at previous levels or at all. In addition, for reasons of quality assurance or cost effectiveness, we purchase certain components and raw materials from sole suppliers. We may not be able to quickly establish additional or replacement sources for certain components or materials. A reduction or interruption in manufacturing, or an inability to secure alternative sources of raw materials or components that are acceptable to us, could have an adverse effect on our results of operations and financial condition.

Due to the highly competitive nature of the healthcare industry and the cost containment efforts of our customers and third-party payers, we may be unable to pass along cost increases for key components or raw materials through higher prices to our customers. If the cost of key components or raw materials increases and we are unable fully to recover these increased costs through price increases or offset these increases through other cost reductions, we could experience lower margins and profitability.

We may engage in strategic transactions, including acquisitions, investments, or joint development agreements that may have an adverse effect on our business.

We may pursue transactions, including acquisitions of complementary businesses, technology licensing arrangements and joint development agreements to expand our product offerings and geographic presence as part of our business strategy, which could be material to our financial condition and results of operations. We may not complete transactions in a timely manner, on a cost-effective basis, or at all, and we may not realize the expected benefits of any acquisition, license arrangement or joint development agreement. Other companies may compete with us for these strategic opportunities. We also could experience negative effects on our results of operations and financial condition from acquisition-related charges, amortization of intangible assets and asset impairment charges, and other issues that could arise in connection with, or as a result of, the acquisition of an acquired company or business, including issues related to internal control over financial reporting, regulatory or compliance issues and potential adverse short-term effects on results of operations through increased costs or otherwise. These effects, individually or in the aggregate, could cause a deterioration of our credit profile and/or ratings and result in reduced availability of credit to us or in increased borrowing costs and interest expense.

We could experience difficulties, expenditures, or other risks in integrating an acquired company, business, or technology, including, among others:

 

•

diversion of management resources and focus from ongoing business matters;

 

•

retention of key employees following an acquisition;

 

•

demands on our operational resources and financial and internal control systems;

 

•

integration of an acquired company’s corporate and administrative functions and personnel;

 

•

liabilities of the acquired company, including litigation or other claims; and

 

•

consolidation of research and development operations.

 

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In addition, we may face additional risks related to foreign acquisitions, including risks related to cultural and language differences and particular economic, currency, political, and regulatory risks associated with specific countries. If an acquired business fails to operate as anticipated or cannot be successfully integrated with our existing business, our results of operations and financial condition could be adversely affected.

We may engage in the divestiture of some of our non-core businesses or product lines which may have an adverse effect on our business.

Our business strategy involves assessing our portfolio of businesses with a view of divesting non-core businesses and product lines that do not align with our objectives. Any divestitures may result in a dilutive impact to our future earnings, as well as significant write-offs, including those related to goodwill and other intangible assets, which could have a material adverse effect on our results of operations and financial condition. Divestitures could involve additional risks, including difficulties in the separation of operations, services, products and personnel, the diversion of management’s attention from other business concerns, the disruption of our business and the potential loss of key employees. We may not be successful in managing these or any other significant risks that we encounter in divesting a business or product line. See note 2 to the unaudited condensed consolidated financial statements included in this Form 10-Q for a discussion of our divestitures.

We may face significant uncertainty in the industry due to government healthcare reform.

Political, economic and regulatory influences are subjecting the healthcare industry to fundamental changes. In March 2010, comprehensive healthcare reform legislation was signed into law in the United States through the passage of the Patient Protection and Affordable Health Care Act and the Health Care and Education Reconciliation Act. Among other initiatives, the legislation provides for a 2.3% annual excise tax on the sales of certain medical devices in the United States, commencing in January 2013. This enacted excise tax may adversely affect our operating expenses and results of operations. In addition, we anticipate that the current presidential administration, Congress and certain state legislatures will continue to review and assess alternative healthcare delivery systems and payment methods with an objective of ultimately reducing healthcare costs and expanding access. Public debate of these issues will likely continue in the future. We cannot predict with certainty what healthcare initiatives, if any, will be implemented at the state level, or what ultimate effect federal healthcare reform or any future legislation or regulation may have on our customers’ purchasing decisions regarding our products and services. However, the implementation of new legislation and regulation may lower reimbursements for our products, reduce medical procedure volumes and adversely affect our business, possibly materially.

We may need additional financing in the future to meet our capital needs or to make opportunistic acquisitions and such financing may not be available on favorable terms, if at all, and may be dilutive to existing stockholders.

We intend to increase our investment in research and development activities, expand our sales and marketing activities, and may make acquisitions. Our ability to take these and other actions may be limited by our available liquidity, including our ability to access our foreign cash balances in a tax-efficient manner. As a consequence, in the future, we may need to seek additional financing. We may be unable to obtain any desired additional financing on terms favorable to us, if at all. If we lose an investment grade credit rating or adequate funds are not available on acceptable terms, we may be unable to fund our expansion, successfully develop or enhance products or respond to competitive pressures, any of which could negatively affect our business. If we raise additional funds through the issuance of equity securities, our stockholders will experience dilution of their ownership interest. If we raise additional funds by issuing debt, we may be subject to limitations on our operations due to restrictive covenants.

Additionally, our ability to make scheduled payments or refinance our obligations will depend on our operating and financial performance, which in turn is subject to prevailing economic conditions and financial, business and other factors beyond our control. Recent disruptions in the financial markets, including the bankruptcy or

 

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restructuring of a number of financial institutions and reduced lending activity, may adversely affect the availability, terms and cost of credit in the future. We cannot be sure that recent government initiatives in response to the disruptions in the financial markets will stabilize the markets in general or increase liquidity and the availability of credit to us.

We are subject to risks associated with doing business outside of the United States.

Our operations outside of the United States are subject to risks that are inherent in conducting business under non-United States laws, regulations and customs. Sales to customers outside of the United States made up approximately 22% of our revenue in fiscal year 2010, and we expect that non-United States sales will contribute to future growth. The risks associated with our operations outside the United States include:

 

•

changes in non-United States government programs;

 

•

multiple non-United States regulatory requirements that are subject to change and that could restrict our ability to manufacture and sell our products;

 

•

possible failure to comply with anti-bribery laws such as the United States Foreign Corrupt Practices Act and similar anti-bribery laws in other jurisdictions;

 

•

different local product preferences and product requirements;

 

•

possible failure to comply with trade protection and restriction measures and import or export licensing requirements;

 

•

difficulty in establishing, staffing and managing non-United States operations;

 

•

different labor regulations;

 

•

changes in environmental, health and safety laws;

 

•

potentially negative consequences from changes in or interpretations of tax laws;

 

•

political instability and actual or anticipated military or political conflicts;

 

•

economic instability and inflation, recession or interest rate fluctuations;

 

•

uncertainties regarding judicial systems and procedures;

 

•

minimal or diminished protection of intellectual property in some countries; and

 

•

regulatory changes that may place our products at a disadvantage.

These risks, individually or in the aggregate, could have an adverse effect on our results of operations and financial condition. For example, we are subject to compliance with the United States Foreign Corrupt Practices Act and similar anti-bribery laws, which generally prohibit companies and their intermediaries from making improper payments to foreign government officials for the purpose of obtaining or retaining business. While our employees and agents are required to comply with these laws, we cannot be sure that our internal policies and procedures will always protect us from violations of these laws, despite our commitment to legal compliance and corporate ethics. The occurrence or allegation of these types of risks may adversely affect our business, performance, prospects, value, financial condition, and results of operations.

We are also exposed to a variety of market risks, including the effects of changes in foreign currency exchange rates. If the United States dollar strengthens in relation to the currencies of other countries such as the Euro, where we sell our products, our United States dollar reported revenue and income will decrease. Additionally, we incur significant costs in foreign currencies and a fluctuation in those currencies’ value can negatively impact manufacturing and selling costs. Changes in the relative values of currencies occur regularly and, in some instances, could have an adverse effect on our results of operations and financial condition.

 

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We are subject to healthcare fraud and abuse regulations that could result in significant liability, require us to change our business practices and restrict our operations in the future.

We are subject to various United States federal, state and local laws targeting fraud and abuse in the healthcare industry, including anti-kickback and false claims laws. Violations of these laws are punishable by criminal or civil sanctions, including substantial fines, imprisonment and exclusion from participation in healthcare programs such as Medicare and Medicaid. These laws and regulations are wide ranging and subject to changing interpretation and application, which could restrict our sales or marketing practices. Furthermore, since many of our customers rely on reimbursement from Medicare, Medicaid and other governmental programs to cover a substantial portion of their expenditures, our exclusion from such programs as a result of a violation of these laws could have an adverse effect on our results of operations and financial condition.

Tax legislation initiatives or challenges to our tax positions could adversely affect our results of operation and financial condition.

We are a large multinational corporation with operations in the United States and international jurisdictions. As such, we are 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 our tax positions. We cannot be sure that our effective tax rate or tax payments 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. There can be no assurance that our tax positions will not be challenged by relevant tax authorities or that we would be successful in any such challenge.

Our reserves against disputed tax obligations may ultimately prove to be insufficient.

The IRS currently has ongoing audits of fiscal years 2001 through 2007 for Cardinal Health. During the quarter ended September 30, 2008, Cardinal Health received an IRS Revenue Agent’s Report for the fiscal tax years ending June 30, 2003 through 2005 that included Notices of Proposed Adjustment related to transfer pricing arrangements between our foreign and domestic subsidiaries and the transfer of intellectual property among our subsidiaries, which we have appealed. The amount of additional tax proposed by the IRS in these notices totals $462 million, excluding penalties and interest, which may be significant. In addition, during the quarter ended December 31, 2010 we received an IRS Revenue Agent’s Report for fiscal tax years 2006 and 2007 that included Notices of Proposed Adjustments related to transfer pricing arrangements between foreign and domestic subsidiaries. We and Cardinal Health disagree with the IRS regarding its application of the United States Treasury regulations to the arrangements under review and the valuations underlying such adjustments and intend to vigorously contest them. During the quarter ended December 31, 2010, we began substantive discussions with the IRS Appeals office related to our 2003 through 2005 fiscal tax years. The IRS has not yet commenced any IRS audit for our 2008 through 2010 fiscal tax years. The tax matters agreement that we entered into with Cardinal Health in connection with the spinoff generally provides that the control of audit proceedings and payment of any additional liability related to our business is our responsibility. Any such obligation could have an adverse effect on our results of operations and financial condition.

In addition, we regularly review our tax reserves and make adjustments to our reserves when appropriate. Accounting for tax reserves involves complex and subjective estimates by management, which can change over time based on new information or changing events or circumstances, including events or circumstances outside of our control. Although we believe that we have provided appropriate tax reserves for any potential tax exposures, we may not be fully reserved and it is possible that we may be obligated to pay amounts in excess of our reserves, including the full amount that the IRS is seeking in the appeals matters for our 2003 through 2007 fiscal tax years. Any future change in estimate could adversely affect our results of operations and financial condition. See note 12 to the audited consolidated financial statements included in our Form 10-K filed with the SEC on August 19, 2010 for a discussion of the Notices of Proposed Adjustment for our fiscal years ended 2003 through 2005 and the change to our tax reserves, as well as note 11 to the unaudited condensed consolidated financial statements included in this Form 10-Q.

 

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We have a significant amount of indebtedness, which could adversely affect our business and our ability to meet our obligations.

We have outstanding a $480 million senior unsecured revolving credit facility (maturing August 31, 2012). In addition, we have outstanding $1.4 billion of senior unsecured notes that were utilized to finance our separation from Cardinal Health. This significant amount of debt has important risks to us and our investors, including:

 

•

requiring a significant portion of our cash flow from operations to make interest payments on this debt;

 

•

making it more difficult to satisfy debt service and other obligations;

 

•

increasing the risk of a future credit ratings downgrade of our debt, which could increase future debt costs and limit the future availability of debt financing;

 

•

increasing our vulnerability to general adverse economic and industry conditions;

 

•

reducing the cash flow available to fund capital expenditures and other corporate purposes and to grow our business;

 

•

limiting our flexibility in planning for, or reacting to, changes in our business and the industry;

 

•

placing us at a competitive disadvantage to our competitors that may not be as highly leveraged with debt as we are; and

 

•

limiting our ability to borrow additional funds as needed or take advantage of business opportunities as they arise, pay cash dividends or repurchase common stock.

To the extent that we incur additional indebtedness, the risks described above could increase. In addition, our actual cash requirements in the future may be greater than expected. Our cash flow from operations may not be sufficient to repay all of the outstanding debt as it becomes due, and we may not be able to borrow money, sell assets or otherwise raise funds on acceptable terms, or at all, to refinance our debt. In addition, we may draw down our revolving credit facility, which would have the effect of increasing our indebtedness.

As a result of various restrictive covenants in the agreements governing our senior revolving credit facility and our senior unsecured notes, our financial flexibility will be restricted in a number of ways. The agreement governing the senior revolving credit facility subjects us and our subsidiaries to significant financial and other restrictive covenants, including restrictions on our ability to incur additional indebtedness, place liens upon assets, make distributions, pay dividends or make certain other restricted payments and investments, consummate certain asset sales, enter into transactions with affiliates, conduct businesses other than our current or related businesses, merge or consolidate with any other person or sell, assign, transfer, lease, convey or otherwise dispose of all or substantially all of our assets. Our senior revolving credit facility also requires us to meet certain financial ratio tests on an ongoing basis that may require us to take action and reduce debt or act in a manner contrary to our business objectives. Events beyond our control, including changes in general economic and business conditions, may affect our ability to meet those financial ratios and financial condition tests. We cannot be sure that we will be able to meet those tests or that the lenders will waive any failure to meet those tests. A breach of any of these covenants would result in a default under our senior revolving credit facility. If an event of default under our senior revolving credit facility or senior notes occurs, the lenders could elect to declare all amounts outstanding thereunder, together with accrued interest, to be immediately due and payable.

Our success depends on our key personnel, and the loss of key personnel or the transition of key personnel, including our Chief Executive Officer, could disrupt our business.

Our success depends on the continued contributions of our senior management and other key research and development, sales, marketing and operations personnel. In addition, the transition of key personnel exposes us to additional risks. Effective as of December 1, 2010, we announced James Hinrichs as our Chief Financial Officer, and effective as of January 29, 2011, we announced Kieran Gallahue as our new Chairman and Chief

 

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Executive Officer. In addition, on April 5, 2011, we announced that Dwight Winstead, our Chief Operating Officer, would be leaving the company on June 30, 2011. While we will strive to make these transitions as smooth as possible, the transition process related to these individuals, as well as for any other key personnel, may result in disruptions to our operations, which could have an adverse effect on our results of operations and financial condition.

Furthermore, our success depends on our ability to continue to attract, retain and motivate our senior management and other key personnel. Achieving this objective may be difficult due to many factors, including the intense competition for such highly skilled personnel, fluctuations in global economic and industry conditions, changes in our senior management, competitors’ hiring practices, and the effectiveness of our compensation programs. If we are unable to attract, retain and motivate such personnel in sufficient numbers and on a timely basis, we may experience difficulty in implementing our business strategy, which could have an adverse effect on our results of operations and financial condition.

Risks Related to the Separation

We have a limited operating history as a separate publicly-traded company, and our historical financial information is not necessarily representative of the results that we would have achieved as a separate, publicly-traded company and may not be a reliable indicator of our future results.

Our stock began trading publicly on September 1, 2009. Financial information presented for periods prior to September 1, 2009 do not necessarily reflect the financial condition, results of operations or cash flows that we would have achieved as a separate, publicly-traded company during the periods presented or those that we will achieve in the future primarily as a result of the following factors:

 

•

prior to the separation, our business was operated by Cardinal Health as part of its broader corporate organization, rather than as an independent company. Cardinal Health or one of its affiliates performed various corporate functions for us, including, but not limited to, legal, treasury, accounting, auditing, risk management, information technology, human resources, corporate affairs, tax administration, certain governance functions (including compliance with the Sarbanes-Oxley Act of 2002 and internal audit) and external reporting. Our historical financial results reflect allocations of corporate expenses from Cardinal Health for these and similar functions. These allocations are likely to be less than the comparable expenses we believe we would have incurred had we operated as a separate publicly-traded company;

 

•

up until the separation, our business was integrated with the other businesses of Cardinal Health. Historically, we have shared economies of scope and scale in costs, employees, vendor relationships and customer relationships. While we have entered into transition agreements that govern certain commercial and other relationships among us and Cardinal Health, those transitional arrangements may not fully capture the benefits our businesses have enjoyed as a result of being integrated with the other businesses of Cardinal Health. Now that we are a separate, publicly-traded company, the loss of these benefits could have an adverse effect on our results of operations and financial condition; and

 

•

up until the separation, our working capital requirements and capital for our general corporate purposes, including acquisitions, research and development and capital expenditures, had historically been satisfied as part of the corporate-wide cash management policies of Cardinal Health. Given that we no longer receive capital from Cardinal Health under these cash management policies, we may need to obtain additional financing from banks, through public offerings or private placements of debt or equity securities, strategic relationships or other arrangements, which may not be available on acceptable terms, or at all.

Other significant changes may occur in our cost structure, management, financing and business operations as a result of operating as a company separate from Cardinal Health.

 

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If there is a determination that the separation is taxable for United States federal income tax purposes because the facts, assumptions, representations or undertakings underlying the IRS ruling or tax opinions are incorrect or for any other reason, then Cardinal Health and its shareholders that are subject to United States federal income tax could incur significant United States federal income tax liabilities and we could incur significant liabilities.

In connection with the separation, Cardinal Health received a private letter ruling from the IRS substantially to the effect that, among other things, the contribution and the distribution qualified as a transaction that is tax-free for United States federal income tax purposes under Sections 355(a) and 368(a)(1)(D) of the Internal Revenue Code of 1986, as amended, (“the Code”). In addition, Cardinal Health received opinions of Weil, Gotshal & Manges LLP and Wachtell, Lipton, Rosen & Katz, co-counsel to Cardinal Health, to the effect that the contribution and the distribution qualified as a transaction that is described in Sections 355(a) and 368(a)(1)(D) of the Code. The ruling and opinions relied on certain facts, assumptions, representations and undertakings from Cardinal Health and us regarding the past and future conduct of the companies’ respective businesses and other matters. If any of these facts, assumptions, representations or undertakings were incorrect or not otherwise satisfied, Cardinal Health and its shareholders may not be able to rely on the ruling or the opinions of tax counsel and could be subject to significant tax liabilities. Notwithstanding the private letter ruling and opinions of tax counsel, the IRS could determine on audit that the separation is taxable if it determines that any of these facts, assumptions, representations or undertakings are not correct, have been violated or if it disagrees with the conclusions in the opinions that are not covered by the private letter ruling, or for other reasons, including as a result of certain significant changes in the stock ownership of Cardinal Health or us after the separation. If the separation is determined to be taxable for United States federal income tax purposes, Cardinal Health and its shareholders that are subject to United States federal income tax could incur significant United States federal income tax liabilities and we could incur significant liabilities.

We may not be able to engage in certain corporate transactions after the separation.

To preserve the tax-free treatment to Cardinal Health of the contribution and the distribution, under the tax matters agreement that we entered into with Cardinal Health, we are restricted from taking any action that prevents the distribution and related transactions from being tax-free for United States federal income tax purposes. These restrictions may limit our ability to pursue certain strategic transactions or engage in other transactions, including use of our common stock to make acquisitions and equity capital market transactions, which might increase the value of our business.

Certain of our executive officers and directors may have actual or potential conflicts of interest because of their former positions in Cardinal Health.

The ownership by some of our executive officers and some of our directors of common shares, options, or other equity awards of Cardinal Health may create, or may create the appearance of, conflicts of interest. Because of their former positions with Cardinal Health, certain of our executive officers and non-employee directors own common shares of Cardinal Health, options to purchase common shares of Cardinal Health or other equity awards. The individual holdings of common shares, options to purchase common shares of Cardinal Health or other equity awards may be significant for some of these persons compared to these persons’ total assets. Even though our board of directors consists of a majority of directors who are independent, and our executive officers ceased to be employees of Cardinal Health upon the separation, ownership by our directors and officers of common shares or options to purchase common shares of Cardinal Health, or any other equity awards, creates, or may create the appearance of, conflicts of interest when these directors and officers are faced with decisions that could have different implications for Cardinal Health than the decisions have for us.

 

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We may not achieve some or all of the expected benefits of the separation, and the separation may adversely affect our business.

We may not be able to achieve the full strategic and financial benefits expected to result from the separation, or such benefits may be delayed or not occur at all. These benefits include the following:

 

•

improving strategic planning, increasing management focus and streamlining decision-making by providing us the flexibility to implement our unique strategic plans and to respond more effectively to our customer needs and the changing economic environment;

 

•

allowing us to adopt the capital structure, investment policy and dividend policy best suited to our financial profile and business needs, as well as resolving competition for capital among Cardinal Health and its investors; and

 

•

facilitating incentive compensation arrangements for employees more directly tied to the performance of our business, and enhancing employee hiring and retention by, among other things, improving the alignment of management and employee incentives with performance and growth objectives, while at the same time creating an independent equity structure that will facilitate our ability to effect future acquisitions utilizing our common stock.

We may not achieve the anticipated benefits for a variety of reasons. There also can be no assurance that the separation will not adversely affect our business. In addition, we may be more susceptible to market fluctuations and other adverse events than we would have been as a subsidiary of Cardinal Health, and it is possible that investors and securities analysts will not place a greater value on our business as an independent company than on our business as a subsidiary of Cardinal Health.

Cardinal Health may fail to perform under various transaction agreements that were executed as part of the separation or we may fail to have necessary systems and services in place when certain of the transaction agreements expire.

In connection with the separation, we and Cardinal Health entered into various agreements, including a separation agreement, a transition services agreement, a tax matters agreement, an employee matters agreement, intellectual property agreements and commercial agreements. The separation agreement, the tax matters agreement and employee matters agreement determined the allocation of assets and liabilities between the companies following the separation for those respective areas and provide for indemnifications related to liabilities and obligations. The transition services agreement sets forth certain services to be performed by each company for the benefit of the other for a period of time after the separation. We will rely on Cardinal Health to satisfy its performance and payment obligations under these agreements. If Cardinal Health does not satisfy its obligations under these agreements, including its indemnification obligations, we could incur operational difficulties or losses. If we do not have in place our own systems and services, or if we do not have agreements with other providers of these services once certain transaction agreements expire, we may not be able to operate our business effectively and our profitability may decline. We are in the process of creating our own, or engaging third parties to provide, systems and services to replace many of the systems and services Cardinal Health currently provides to us. We may not be successful in implementing these systems and services or in transitioning data from Cardinal Health’s systems to ours.

Risks Related to Our Common Stock

Your percentage of ownership in us may be diluted in the future.

As with any publicly-traded company, your percentage ownership in us may be diluted in the future because of equity issuances for acquisitions, capital market transactions or otherwise, including equity awards that we expect will be granted to our directors, officers and employees.

 

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Our stock price may fluctuate significantly.

The market price of our common stock may fluctuate significantly due to a number of factors, some of which may be beyond our control, including:

 

•

actual or anticipated fluctuations in our operating results;

 

•

changes in earnings estimated by securities analysts or our ability to meet those estimates;

 

•

the operating and stock price performance of comparable companies; and

 

•

domestic and foreign economic conditions.

Certain provisions in our amended and restated certificate of incorporation and amended and restated by-laws, and of Delaware law, may prevent or delay an acquisition of our company, which could decrease the trading price of our common stock.

Our amended and restated certificate of incorporation, our amended and restated by-laws and Delaware law contain provisions that are intended to deter coercive takeover practices and inadequate takeover bids by making such practices or bids unacceptably expensive to the raider and to encourage prospective acquirers to negotiate with our board of directors rather than to attempt a hostile takeover. These provisions include, among others:

 

•

the inability of our stockholders to call a special meeting;

 

•

rules regarding how stockholders may present proposals or nominate directors for election at stockholder meetings;

 

•

the right of our board to issue preferred stock without stockholder approval;

 

•

the division of our board of directors into three classes of directors, with each class serving a staggered three-year term;

 

•

a provision that stockholders may only remove directors with cause;

 

•

the ability of our directors, and not stockholders, to fill vacancies on our board of directors; and

 

•

the requirement that stockholders holding at least 80% of our voting stock are required to amend certain provisions in our amended and restated certificate of incorporation and our amended and restated by-laws relating to the number, term and election of our directors, the filling of board vacancies, stockholder notice procedures and the calling of special meetings of stockholders.

Delaware law also imposes some restrictions on mergers and other business combinations between us and any holder of 15% or more of our outstanding common stock.

We believe these provisions will protect our stockholders from coercive or otherwise unfair takeover tactics by requiring potential acquirers to negotiate with our board of directors and by providing our board of directors with more time to assess any acquisition proposal. These provisions are not intended to make our company immune from takeovers. However, these provisions will apply even if the offer may be considered beneficial by some stockholders and could delay or prevent an acquisition that our board of directors determines is not in the best interests of our company and our stockholders. These provisions may also prevent or discourage attempts to remove and replace incumbent directors.

 

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ITEM 2.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

The following table contains information about our company’s purchases of equity securities during the quarter ended March 31, 2011:

 

Issuer Purchases of Equity Securities
Period		Total Number of Shares Purchased1				Average Price Paid per Share				Total Number of Shares Purchased as Part of Publicly Announced Program				Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Publically Announced Program
January 1 – 31, 2011			—			$	—				—			$	—
February 1 – 28, 2011			—				—				—				—
March 1 – 31, 2011			736				26.81				—				—
Total			736								—			$	—

 

1	Represents restricted stock awards surrendered by employees upon vesting to meet tax withholding obligations.

 

ITEM 6.

EXHIBITS

 

Exhibit Number		Description of Exhibits
12.1		Computation of Ratio of Earnings to Fixed Charges.*
31.1		Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*
31.2		Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*
32.1		Certifications pursuant to 18 U.S.C. Section 1350.*

 

*	Filed herewith.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

				CAREFUSION CORPORATION
Date: May 6, 2011				By:		/s/    James F. Hinrichs
						James F. Hinrichs, Chief Financial Officer (Principal financial officer and duly authorized signatory)

 

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