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CAH > SEC Filings for CAH > Form 10-K on 20-Aug-2013All Recent SEC Filings

Show all filings for CARDINAL HEALTH INC

Form 10-K for CARDINAL HEALTH INC


20-Aug-2013

Annual Report


Item 7: Management's Discussion and Analysis of Financial Condition and Results
of Operations
The discussion and analysis presented below refers to, and should be read in conjunction with, the consolidated financial statements and related notes included in this Form 10-K. Unless otherwise indicated, throughout this Management's Discussion and Analysis of Financial Condition and Results of Operations, we are referring to our continuing operations. Overview
We are a healthcare services company providing pharmaceutical and medical products and services that help pharmacies, hospitals, ambulatory surgery centers, clinical laboratories, physician offices and other healthcare providers focus on patient care while reducing costs, enhancing efficiency and improving quality. We also provide medical products to patients in the home. We report our financial results in two segments: Pharmaceutical and Medical. During fiscal 2013, revenue decreased 6 percent to $101.1 billion, largely due to the previously disclosed expiration of our pharmaceutical distribution contract with Express Scripts and the impact of brand-to-generic pharmaceutical conversions.
Gross margin increased 8 percent to $4.9 billion, reflecting strong performance in our Pharmaceutical segment generic programs. Operating earnings decreased 44 percent to $1.0 billion and earnings from continuing operations decreased 69 percent to $335 million due to an $829 million ($799 million, net of tax) non-cash goodwill impairment charge related to our Nuclear Pharmacy Services division.
Our cash and equivalents balance was $1.9 billion at June 30, 2013, compared to $2.3 billion at June 30, 2012. The decrease in cash and equivalents during fiscal 2013 was driven by acquisitions of $2.2 billion, share repurchases of $450 million and dividends of $353 million, offset by strong net cash provided by operating activities of $1.7 billion and net proceeds from long-term obligations of $981 million. We plan to execute a balanced deployment of available capital to position ourselves for sustainable competitive advantage and to enhance shareholder value.
Large Customers
On April 25, 2013, we announced the renewal of our pharmaceutical distribution contracts with CVS. CVS accounted for approximately 23 percent of our fiscal 2013 revenue.
Our pharmaceutical distribution contract with Walgreens will expire at the end of August 2013. Because sales to Walgreens generated approximately 20 percent of our consolidated revenue for fiscal 2013, we expect the expiration of this contract to have an adverse impact on our results of operations. 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. Largely as a result of the contract expiration, we do not currently expect diluted earnings per share from continuing operations to grow in fiscal 2014 compared to fiscal 2013, excluding the effects in both periods of restructuring and employee severance costs; acquisition-related costs and credits; impairments and gains and losses on disposal of assets (including the $829 million Nuclear Pharmacy Services division goodwill impairment charge in fiscal 2013); net litigation recoveries and charges; and charges and tax benefits associated with each of these items. After the expiration of this contract, we also 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. Goodwill
In conjunction with the preparation of our consolidated financial statements for the fiscal year ended June 30, 2013, we recently completed our annual goodwill impairment test, which we perform annually in the fourth quarter. As part of this annual test, we concluded that the entire goodwill amount of our Nuclear Pharmacy Services division was impaired, resulting in a non-cash impairment charge of $829 million ($799 million, net of tax). This impairment charge does not impact our liquidity, cash flows from operations, or compliance with debt covenants.
The majority of the goodwill of our Nuclear Pharmacy Services division was acquired through our acquisition of Syncor International Corporation in fiscal 2003 ($681 million of goodwill). Excluding the impact of the impairment charge, we have a total of approximately $1.0 billion of invested capital in our Nuclear Pharmacy Services division (inclusive of the Syncor acquisition), accumulated over the past 12 years.
As previously disclosed in our Quarterly Reports on Form 10-Q for the quarters ended December 31, 2012, and March 31, 2013, our Nuclear Pharmacy Services division has experienced significant softness in the low-energy diagnostics market. During the second half of fiscal 2013, we experienced sustained volume declines and price erosion for the core, low-energy products provided by this division. In addition, we experienced reduced sales for some existing high-energy diagnostic products, slower-than-expected adoption of new high-energy diagnostic products, and recent reimbursement developments that may adversely impact the future growth of these products. Using this information, we adjusted our outlook and long-term business plans for this division during our annual budgeting process, which we recently concluded. This update resulted in significant reductions in the anticipated future cash flows and estimated fair value for this reporting unit. See Note 5 of the "Notes to Consolidated Financial Statements" for additional information. Restructuring
On January 30, 2013, we announced a restructuring plan within our Medical segment. Under this restructuring plan, we are moving production of procedure kits from our facility in Waukegan, Illinois to other facilities and selling property and consolidating office space in Waukegan, Illinois. In addition, we reorganized our Medical segment 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 $51 million was recognized during fiscal 2013. Of the estimated $28 million remaining costs to be recognized through the end of fiscal 2014, we estimate that approximately $3 million will be employee-related costs; $11 million will be facility exit and other costs; and $14 million will be an expected loss on disposal of the property in Waukegan, Illinois described above. We have evaluated this property and have determined that at June 30, 2013 it does not meet the criteria for classification as held for sale. The costs recognized during 2013 are classified as restructuring and employee severance and impairments and loss on disposal of assets in the consolidated statements of earnings. We


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

expect to start realizing cost savings and other benefits from the plan in fiscal 2014.
Acquisitions
On March 18, 2013, we completed the acquisition of 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 homecare providers and patients in the home, expands our ability 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, this acquisition had a positive impact on operating earnings in fiscal 2013 and we expect it to have a positive impact on operating earnings in future periods. See Note 2 of the "Notes to Consolidated Financial Statements" for additional information on the AssuraMed acquisition. Other Trends
Within our Pharmaceutical segment, we expect continued strength in our generic pharmaceutical programs as well as continued price appreciation from branded pharmaceutical products in fiscal 2014.
Within our Medical segment, variability in the cost of commodities such as oil-based resins, cotton, latex, diesel fuel and other commodities can have a significant impact on cost of products sold. Although commodity prices fluctuate, we do not expect changes in commodity prices to have a significant impact on our year-over-year results of operations in fiscal 2014. We also expect a continuation of relatively flat procedural-based utilization in fiscal 2014.
Results of Operations

Revenue
                                      Revenue                        Change
(in millions)            2013          2012          2011        2013      2012
Pharmaceutical        $  91,097     $  97,925     $  93,744       (7 )%      4 %
Medical                  10,060         9,642         8,922        4  %      8 %
Total segment revenue   101,157       107,567       102,666       (6 )%      5 %
Corporate                   (64 )         (15 )         (22 )   N.M.      N.M.
Total revenue         $ 101,093     $ 107,552     $ 102,644       (6 )%      5 %

Fiscal 2013 Compared to Fiscal 2012
Pharmaceutical Segment
Revenue for fiscal 2013 compared to the prior year was negatively impacted by the expiration on September 30, 2012 of our pharmaceutical distribution contract with Express Scripts (approximately $6.7 billion), the revenue from which was classified as bulk sales. Revenue from existing pharmaceutical distribution customers decreased by approximately $3.6 billion, 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 from us. The decrease was partially offset by increased pharmaceutical distribution revenue from new customers (approximately $3.8 billion) and revenue growth within our Specialty Solutions division ($961 million).

Revenue from bulk sales was $29.8 billion and $40.2 billion for fiscal 2013 and 2012, respectively. Bulk sales for fiscal 2013 decreased by 26 percent driven primarily by the expiration of our contract with Express Scripts and brand-to-generic conversions. Revenue from non-bulk sales was $61.3 billion and $57.7 billion for fiscal 2013 and 2012, respectively. Non-bulk sales for fiscal 2013 increased by 6 percent driven by growth from new customers. See "Item 1:
Business" for more information about bulk and non-bulk sales. In light of the reduction in bulk sales after the expiration of our pharmaceutical distribution contract with Walgreens, we do not expect the distinction between revenue and profit from bulk sales to be meaningful in the future. As such, in the future, we do not expect to present separate information on bulk and non-bulk sales to investors.
Medical Segment
Revenue for fiscal 2013 compared to the prior year reflects the benefit of acquisitions ($459 million).
Fiscal 2012 Compared to Fiscal 2011
Pharmaceutical Segment
Revenue was positively impacted during fiscal 2012 compared to the prior year by acquisitions ($2.3 billion) and increased sales to existing customers ($2.0 billion).
Medical Segment
Revenue was positively impacted during fiscal 2012 compared to the prior year by increased volume from existing customers ($335 million), including the positive impact from sales of self-manufactured and private brand products and the transition during the fourth quarter of fiscal 2011 of our relationship with CareFusion from a fee-for-service arrangement to a traditional distribution model ($131 million).
Cost of Products Sold
Consistent with the change in revenue, cost of products sold decreased $6.8 billion (7 percent) during fiscal 2013, and increased by $4.5 billion (5 percent) during fiscal 2012. See the gross margin discussion below for additional drivers impacting cost of products sold.

Gross Margin
                       Gross Margin               Change
(in millions)   2013       2012       2011     2013    2012
Gross margin  $ 4,921    $ 4,541    $ 4,162      8 %    9 %

Fiscal 2013 Compared to Fiscal 2012
Gross margin increased in fiscal 2013 compared to the prior year driven by strong performance in our generic pharmaceutical programs ($350 million) and acquisitions ($131 million). Increased margin from branded pharmaceutical distribution agreements (exclusive of the related volume impact) also had a positive impact on gross margin ($81 million). Pricing changes, including rebates (exclusive of the related volume impact), adversely impacted gross margin ($211 million), driven in part by customer and product mix. The adverse impact of these pricing changes is offset by sourcing programs and other sources of margin. As a result of significant market softness, gross margin from our Nuclear Pharmacy Services division decreased by $71 million in fiscal 2013. The cost of oil-based resins, cotton, latex and other commodities used in our Medical segment self-manufactured products had a slightly favorable impact on gross margin. As described above, while the expiration of the


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

Express Scripts contract resulted in lower revenue, it had a slightly unfavorable impact on gross margin.
Fiscal 2012 Compared to Fiscal 2011
Gross margin increased in fiscal 2012 compared to the prior year primarily due to strong performance in our generic pharmaceutical programs ($344 million), including the impact of new product launches and price appreciation on a few specific products, and acquisitions ($137 million). Favorable Medical segment product sales mix and increased sales volume resulted in a $100 million favorable impact to gross margin. Pricing changes, including rebates (exclusive of the related volume impact), adversely impacted gross margin ($205 million). The adverse impact of these pricing changes was offset by sourcing programs and other sources of margin. Increased cost of oil-based resins, cotton, latex and other commodities used in our Medical segment self-manufactured products decreased gross margin by $66 million.
Distribution, Selling, General and Administrative ("SG&A") Expenses SG&A Expenses Change (in millions) 2013 2012 2011 2013 2012 SG&A expenses $ 2,875 $ 2,677 $ 2,528 7 % 6 %

SG&A expenses increased during 2013 over fiscal 2012 primarily due to acquisitions ($84 million) and investment spending ($17 million). Increased SG&A expenses in fiscal 2012 over fiscal 2011 were primarily due to acquisitions ($65 million) and business system investments, including the Medical segment business transformation project. Segment Profit and Consolidated Operating Earnings

                                Segment Profit and
                                Operating Earnings                Change
(in millions)              2013        2012        2011       2013      2012
Pharmaceutical           $ 1,734     $ 1,558     $ 1,329       11  %     17  %
Medical                      372         332         373       12  %    (11 )%
Total segment profit       2,106       1,890       1,702       11  %     11  %
Corporate                 (1,110 )       (98 )      (188 )   N.M.      N.M.

Total operating earnings $ 996 $ 1,792 $ 1,514 (44 )% 18 %

Segment Profit
We evaluate segment performance based upon segment profit, among other measures. Segment profit is segment revenue, less segment cost of products sold, less segment SG&A expenses. We do not allocate restructuring and employee severance, acquisition-related costs, impairments and loss on disposal of assets, litigation (recoveries)/charges, net, certain investment and other spending to our segments. These costs are retained at Corporate. Investment spending generally includes the first year spend for certain projects that require incremental investments in the form of additional operating expenses. We encourage our segments to identify investment projects that will promote innovation and provide future returns. As approval decisions for such projects are dependent upon executive management, the expenses for such projects are often retained at Corporate. See Note 14 of the "Notes to Consolidated Financial Statements" for additional information on segment profit.

Pharmaceutical Segment Profit
The principal drivers for the increase in fiscal 2013 over fiscal 2012 were strong performance in our generic pharmaceutical programs and increased margin from branded pharmaceutical distribution agreements. These benefits were partially offset by the unfavorable impact of pharmaceutical distribution pricing changes and significant market softness in our Nuclear Pharmacy Services division.
The principal drivers for the increase in fiscal 2012 over fiscal 2011 were strong performance in our generic pharmaceutical programs, including the impact of new product launches, and the positive impact of acquisitions, offset by the unfavorable impact of pharmaceutical distribution pricing changes.
Segment profit from bulk sales decreased $36 million in fiscal 2013 compared to fiscal 2012 and was 7 percent and 10 percent of Pharmaceutical segment profit in fiscal 2013 and 2012, respectively. Segment profit from non-bulk sales increased $212 million in fiscal 2013 over fiscal 2012 and was 93 percent and 90 percent of Pharmaceutical segment profit in fiscal 2013 and 2012, respectively. The generic pharmaceutical programs discussed above primarily impacted segment profit from non-bulk sales.
Medical Segment Profit
The principal drivers for the increase in fiscal 2013 over fiscal 2012 were the positive impact of acquisitions and decreased cost of commodities used in our self-manufactured products, partially offset by the unfavorable impact of pricing changes, driven in part by customer and product mix. Segment profit was also moderated by softness in procedural-based utilization. The 2.3 percent excise tax on certain manufactured or imported medical devices that became effective January 1, 2013 had a slightly unfavorable impact on segment profit. The principal drivers for the decrease in fiscal 2012 over fiscal 2011 were the increased cost of commodities used in our self-manufactured products and an increase in SG&A expenses, including the impact of business system investments. These items were partially offset by the favorable impact of product sales mix and increased net sales volume.
Corporate
As discussed further below, the principal driver for the decrease in Corporate in fiscal 2013 was an $829 million non-cash goodwill impairment charge related to our Nuclear Pharmacy Services division, in addition to other costs not allocated to our segments.
Consolidated Operating Earnings
In addition to revenue, gross margin and SG&A expenses discussed above, operating earnings were impacted by the following:

(in millions)                               2013     2012     2011
Restructuring and employee severance       $ 71     $ 21     $  15
Acquisition-related costs                   158       33        90
Impairments and loss on disposal of assets  859       21         9
Litigation (recoveries)/charges, net        (38 )     (3 )       6


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

Restructuring and Employee Severance
In addition to other restructuring activities during fiscal 2013, we recognized $30 million of employee-related costs and $10 million of facility exit and other costs related to the restructuring within our Medical segment. We also recognized $11 million of employee-related costs as part of a restructuring plan within our Nuclear Pharmacy Services division during the fourth quarter of fiscal 2013.
Acquisition-Related Costs
Acquisition-related costs for fiscal 2013 included transaction costs associated with the purchase of AssuraMed ($20 million). Additionally, amortization of acquisition-related intangible assets was $118 million, $78 million and $67 million for fiscal 2013, 2012 and 2011, respectively. The increase in amortization during fiscal 2013 was primarily due to intangible assets from the acquisition of AssuraMed.
Acquisition-related costs for fiscal 2012 included income recognized upon adjustment of the contingent consideration obligation incurred in connection with the P4 Healthcare acquisition ($71 million). In early fiscal 2013, we terminated and settled the remaining contingent consideration obligation for $4 million.
Impairments and Loss on Disposal of Assets During the fourth quarter of fiscal 2013, we recognized an $829 million ($799 million, net of tax) non-cash goodwill impairment charge related to our Nuclear Pharmacy Services division, as discussed further in the Overview section and in Note 5 of the "Notes to Consolidated Financial Statements." In connection with our Medical segment restructuring plan discussed in Note 3, during fiscal 2013, we recognized an $11 million loss to write down our gamma sterilization assets in El Paso, Texas to the estimated fair value, less costs to sell. Also during fiscal 2013, we recorded an $8 million write-off of commercial software under development within our Pharmaceutical segment in connection with our decision to discontinue this project.
During fiscal 2012, we recorded a charge of $16 million to write off an indefinite-life intangible asset related to the P4 Healthcare trade name. Litigation (Recoveries)/Charges, Net
During fiscal 2013, we recognized $38 million of income resulting from settlements of class action antitrust claims in which we were a class member. Earnings Before Income Taxes and Discontinued Operations In addition to the items discussed above, earnings before income taxes and discontinued operations were impacted by the following:

                              Earnings Before Income Taxes
                              and Discontinued Operations             Change
(in millions)                2013           2012         2011      2013     2012
Other income, net        $     (15 )     $    (1 )     $  (22 )   N.M.     N.M.
Interest expense, net          123            95           93       29 %      2 %
Gain on sale of
investment in CareFusion         -             -          (75 )   N.M.     N.M.

Interest Expense, Net
The increase in interest expense, net for fiscal 2013 over fiscal 2012 was primarily due to $1.3 billion of notes issued in connection with the AssuraMed acquisition.
Gain on Sale of Investment in CareFusion We recognized $75 million of income during fiscal 2011 related to the sale of our investment in CareFusion common stock. Provision for Income Taxes
Generally, fluctuations in the effective tax rate are due to changes within international and United States state effective tax rates resulting from our business mix and discrete items. A reconciliation of the provision based on the federal statutory income tax rate to our effective income tax rate from continuing operations is as follows (see Note 7 of the "Notes to Consolidated Financial Statements" for a detailed disclosure of the effective tax rate reconciliation):

                                                    2013          2012          2011
Provision at Federal statutory rate                  35.0  %       35.0  %       35.0  %
State and local income taxes, net of federal
benefit                                               2.5           2.3           2.6
Foreign tax rate differential                        (4.0 )        (2.2 )        (3.1 )
Nondeductible/nontaxable items                       (0.5 )           -           0.6
Nondeductible goodwill impairment                    33.2             -             -
Change in measurement of an uncertain tax
position and impact of IRS settlements               (5.7 )         0.9           2.4
Other                                                 1.8           1.0          (1.1 )
Effective income tax rate                            62.3  %       37.0  %       36.4  %

Fiscal 2013 Compared to Fiscal 2012
The fiscal 2013 effective tax rate was unfavorably impacted by 33.2 percentage points ($295 million) due to the nondeductibility of substantially all of the goodwill impairment which was partially offset by the favorable impact of the revaluation of our deferred tax liability and related interest on unrepatriated foreign earnings as a result of an agreement with tax authorities ($64 million or 7.2 percentage points).
Fiscal 2012 Compared to Fiscal 2011
The fiscal 2012 effective tax rate was favorably impacted by a settlement of the fiscal 2001 and 2002 IRS audits ($40 million or 2.4 percentage points). The year-over-year comparison of the effective tax rate was unfavorably impacted by the release in fiscal 2011 of a previously established deferred tax valuation allowance.
Ongoing Audits
The IRS is currently conducting audits of fiscal years 2003 through 2010. We have received proposed adjustments from the IRS for fiscal years 2003 through 2007 related to our transfer pricing arrangements between foreign and domestic subsidiaries. The IRS has proposed additional taxes of $399 million, excluding penalties and interest. If this tax ultimately must be paid, CareFusion is liable under the tax matters agreement entered into in connection with the CareFusion Spin-Off for $142 million of the total amount. We disagree with these proposed adjustments, which we are contesting, and have accounted for the unrecognized tax benefits related to them. The IRS had also proposed additional taxes of $450 million, excluding penalties and interest, related to the transfer of intellectual property among subsidiaries of an acquired entity prior to its acquisition by us, for which CareFusion would be liable under the tax matters agreement. During the fourth quarter of fiscal 2013, CareFusion settled


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

this matter with the IRS. We have adjusted the indemnification receivable that we had recorded for this matter. The settlement has no net impact on our provision for income taxes.
Liquidity and Capital Resources
We currently believe that, based upon available capital resources (cash on hand and access to committed credit facilities) and projected operating cash flow, we have adequate capital resources to fund working capital needs; currently anticipated capital expenditures, business growth and expansion; contractual obligations; payments for tax settlements; and current and projected debt service requirements, dividends and share repurchases. During fiscal 2013, we completed the acquisition of AssuraMed, which we funded through the issuance of $1.3 billion in fixed rate notes and cash on hand, in addition to several other small acquisitions, which we funded with cash on hand. If we decide to engage in one or more additional acquisitions, depending on the size and timing of such transactions, we may need to access capital in addition to cash on hand. Cash and Equivalents
Our cash and equivalents balance was $1.9 billion at June 30, 2013, compared to $2.3 billion at June 30, 2012. At June 30, 2013, our cash and equivalents were held in cash depository accounts with major banks or invested in high quality, short-term liquid investments. The decrease in cash and equivalents during fiscal 2013 was driven by acquisitions of $2.2 billion, share repurchases of . . .

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