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CAH > SEC Filings for CAH > Form 10-Q on 8-May-2013All Recent SEC Filings

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Form 10-Q for CARDINAL HEALTH INC


8-May-2013

Quarterly Report


Item 2: Management's Discussion and Analysis of Financial Condition and Results
of Operations
The discussion and analysis presented below is concerned with material changes in financial condition and results of operations for our condensed consolidated balance sheets at March 31, 2013 and June 30, 2012, and for our condensed consolidated statements of earnings for the three and nine months ended March 31, 2013 and 2012. This discussion and analysis should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in our 2012 Form 10-K.
Portions of this Form 10-Q (including information incorporated by reference) include "forward-looking statements." The words "expect," "anticipate," "intend," "plan," "believe," "will," "should," "could," "would," "project," "continue," "likely," 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 made, projected or implied in the forward-looking statements. The most significant of these risks, uncertainties and other factors are described in Exhibit 99.1 to this Form 10-Q and in "Item 1A: Risk Factors" of our 2012 Form 10-K. Except to the 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. Overview
We are a healthcare services company providing pharmaceutical and medical products and services that help pharmacies, hospitals, surgery centers, physician offices and other healthcare providers focus on patient care while reducing costs, enhancing efficiency and improving quality. We report our financial results in two segments: Pharmaceutical and Medical.
Revenue for the three and nine months ended March 31, 2013 was $24.6 billion and $75.7 billion, a 9 percent and 6 percent decrease, respectively, from the prior-year periods, largely due to the previously disclosed expiration of our pharmaceutical distribution contract with Express Scripts, Inc. and the impact of brand-to-generic pharmaceutical conversions. Gross margin increased 7 percent to $1.3 billion and 8 percent to $3.7 billion for these periods, respectively, reflecting strong performance in our Pharmaceutical segment generic programs. Operating earnings decreased 10 percent to $475 million and increased 4 percent to $1.4 billion for the three and nine months ended March 31, 2013, respectively. The decrease in operating earnings for the three months ended March 31, 2013 was impacted by a $55 million gain realized during the prior-year period upon adjusting the contingent consideration obligation associated with the acquisition of Healthcare Solutions Holding, LLC ("P4 Healthcare"). Contributing to the increase in operating earnings for the nine months ended March 31, 2013 was $37 million of income from settlements of class action antitrust claims.
Earnings from continuing operations were up 4 percent to $346 million and 10 percent to $921 million for the three and nine months ended March 31, 2013, respectively. Earnings from continuing operations for both periods were favorably impacted by $64 million relating to revaluation of the deferred tax liability and related interest on unrepatriated foreign earnings as a result of an agreement with tax authorities.
Our cash and equivalents balance was $2.3 billion at both March 31, 2013

and June 30, 2012. For the nine months ended March 31, 2013, our cash and equivalents balance was impacted by net cash provided by operating activities of $1.4 billion and proceeds from long-term obligations of $1.3 billion, offset by acquisitions of $2.2 billion, cash dividends of $258 million and share repurchases of $200 million. We plan to continue to execute a balanced deployment of available capital to position ourselves for sustainable competitive advantage and to enhance shareholder value. Restructuring
On January 30, 2013, we announced a restructuring plan within our Medical segment. Under this restructuring plan, we expect to, among other things, move production of procedure kits from our facility in Waukegan, Illinois to other facilities and sell property and consolidate office space in Waukegan, Illinois. In addition, we are reorganizing our Medical segment organization and plan to sell our sterilization processes in El Paso, Texas. We estimate the total costs associated with this restructuring plan to be approximately $79 million on a pre-tax basis, of which $40 million was recognized during the three months ended March 31, 2013. Of the approximately $39 million remaining costs to be recognized through the end of fiscal 2014, we estimate that approximately $9 million will be employee-related costs, approximately $16 million will be facility exit and other costs and approximately $14 million will be an expected loss on disposal of assets. These costs are being recorded as restructuring and employee severance and impairments and loss on disposal of assets in the condensed consolidated statements of earnings. We expect to start realizing cost savings and other benefits from the plan in fiscal 2014. Large Customers
On March 19, 2013, we announced that our pharmaceutical distribution contract with Walgreen Co. ("Walgreens"), which is scheduled to expire at the end of August 2013, will not be renewed. Sales to Walgreens generated approximately 21 percent of our consolidated revenue for fiscal 2012. Approximately 60 percent of this revenue from Walgreens was classified as bulk sales, which, as described in our 2012 Form 10-K, generate significantly lower segment profit as a percentage of revenue than non-bulk sales. For fiscal 2012, Walgreens bulk and non-bulk sales generated less segment profit as a percentage of revenue (which includes allocation of variable and non-variable segment expenses) than the segment profit percentages for bulk and non-bulk sales reported in the 2012 Form 10-K. After the expiration of this contract, we anticipate a significant net working capital decrease based on reduced inventory and accounts receivable, partially offset by reduced accounts payable. Based on the expected working capital decrease and other factors, we anticipate that the expiration of the Walgreens contract will result in a net after-tax benefit to cash flow from operating activities in fiscal 2014 in excess of $500 million. We are taking steps to reduce our costs and otherwise mitigate the impact of the expiration of the Walgreens contract in fiscal 2014 and afterward.
On April 25, 2013, we announced the renewal of our pharmaceutical distribution contracts with CVS Caremark Corporation ("CVS"). CVS accounted for approximately 22 percent of our fiscal 2012 revenue.
Acquisitions
On March 18, 2013, we completed the acquisition of AssuraMed, Inc. ("AssuraMed") for $2.07 billion, net of cash acquired, in an all-cash transaction. We funded the acquisition through the issuance of $1.3 billion in fixed rate notes and cash on hand. The acquisition of AssuraMed, a provider of medical supplies to patients in the home, expands our ability


Table of Contents Cardinal Health, Inc. and Subsidiaries Financial Review (continued)

to serve this patient base. We expect the amortization of acquisition-related intangible assets to be a significant expense in future periods. Excluding the impact of amortization of acquisition-related intangible assets, we expect this acquisition to have a positive impact on operating earnings in future periods. See Note 2 of the "Notes to Condensed Consolidated Financial Statements" for additional information on the AssuraMed acquisition.

Results of Operations
Revenue
                         Three Months Ended March 31,
(in millions)               2013               2012         Change
Pharmaceutical        $      22,070       $      24,508      (10 )%
Medical                       2,484               2,414        3  %
Total segment revenue        24,554              26,922       (9 )%
Corporate                        (2 )                (4 )   N.M.
Total revenue         $      24,552       $      26,918       (9 )%


                          Nine Months Ended March 31,
(in millions)               2013               2012         Change
Pharmaceutical        $      68,314       $      73,591       (7 )%
Medical                       7,363               7,210        2  %
Total segment revenue        75,677              80,801       (6 )%
Corporate                        (4 )               (13 )   N.M.
Total revenue         $      75,673       $      80,788       (6 )%

Pharmaceutical Segment
Revenue for the three and nine months ended March 31, 2013 compared to the prior-year periods was negatively impacted by the expiration on September 30, 2012 of our pharmaceutical distribution contract with Express Scripts, Inc. (approximately $2.3 billion and $4.5 billion, respectively), the revenue from which was classified as bulk sales. Revenue from existing pharmaceutical distribution customers decreased by approximately $1.2 billion and $3.6 billion, respectively, primarily as a result of brand-to-generic pharmaceutical conversions. Brand-to-generic pharmaceutical conversions impact our revenue because generic pharmaceuticals generally sell at a lower price than the corresponding brand product and because some of our customers primarily source generic products directly from manufacturers rather than purchasing from us. The decrease was partially offset by increased pharmaceutical distribution revenue from new customers (approximately $1.1 billion and $3.1 billion, respectively) and revenue growth within our specialty solutions division ($260 million and $772 million, respectively).
Non-bulk sales for the nine months ended March 31, 2013 compared to the prior-year period increased by 7 percent driven by growth from new customers. Bulk sales for the nine months ended March 31, 2013 decreased by 26 percent driven primarily by the loss of our contract with Express Scripts, Inc. and brand-to-generic conversions.
Medical Segment
Revenue for the three and nine months ended March 31, 2013 compared to the prior-year periods reflects the benefit of acquisitions ($72 million and $175 million, respectively).
Cost of Products Sold
Consistent with the decrease in revenue, cost of products sold during the three and nine months ended March 31, 2013 decreased $2.5 billion (10

percent) and $5.4 billion (7 percent), respectively, compared to the prior-year periods. See the gross margin discussion below for additional drivers impacting cost of products sold.
Gross Margin
Three Months Ended March 31,

(in millions)              2013                   2012     Change
Gross margin  $         1,291                   $ 1,207      7 %


                     Nine Months Ended March 31,
(in millions)              2013                  2012     Change

Gross margin $ 3,673 $ 3,405 8 %

Pharmaceutical Segment
Gross margin increased $68 million and $200 million during the three and nine months ended March 31, 2013, respectively, compared to the prior-year periods driven by strong performance in our generic pharmaceutical programs (approximately $82 million and $284 million, respectively). Increased margin from branded pharmaceutical agreements (exclusive of the related volume impact) also had a positive impact on gross margin (approximately $33 million and $57 million, respectively). Pharmaceutical distribution customer pricing changes, including rebates (exclusive of the related volume impact), adversely impacted gross margin by an estimated $43 million and $116 million, respectively. The adverse impact of these customer pricing changes for any particular customer is often partially offset by product mix, sourcing programs and other sources of margin.
As described above, brand-to-generic conversions and the expiration of the Express Scripts, Inc. contract resulted in lower revenue; however, these items did not have a significant impact on gross margin. As a result of significant market softness, gross margin from our nuclear pharmacy services division decreased by $13 million and $55 million during the three and nine months ended March 31, 2013, respectively.
Medical Segment
Gross margin increased $15 million and $65 million during the three and nine months ended March 31, 2013, respectively, compared to the prior-year periods. Acquisitions positively impacted gross margin by $17 million and $39 million, respectively. Decreases in the cost of commodities used in our self-manufactured products increased gross margin by $12 million and $28 million, respectively. Favorable product mix positively impacted gross margin by $10 million and $20 million, respectively. These items were partially offset by the adverse impact of customer pricing changes ($14 million and $36 million, respectively), driven in part by customer mix. Gross margin was also moderated by softness in procedural-based utilization.
SG&A Expenses
Three Months Ended March 31,

(in millions)                2013                    2012    Change
SG&A expenses $           712                       $ 683      4 %


                     Nine Months Ended March 31,
(in millions)              2013                  2012     Change

SG&A expenses $ 2,099 $ 1,966 7 %

SG&A expenses increased during the three and nine months ended March 31, 2013 primarily due to acquisitions ($18 million and $41 million, respectively), investment spending and other strategic priorities ($10


Table of Contents Cardinal Health, Inc. and Subsidiaries Financial Review (continued)

million and $22 million, respectively) and business system investments. Segment Profit and Consolidated Operating Earnings

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