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CFN > SEC Filings for CFN > Form 10-K on 11-Aug-2014All Recent SEC Filings

Show all filings for CAREFUSION CORP

Form 10-K for CAREFUSION CORP


11-Aug-2014

Annual Report


ITEM 7. 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") presented below refer to and should be read in conjunction with the audited consolidated financial statements and related notes included in this Annual Report on Form 10-K.
Unless the context otherwise requires, references to "CareFusion Corporation", "CareFusion", "we", "us", "our" and "our company" refer to CareFusion Corporation and its consolidated subsidiaries. References in this Annual Report on Form 10-K to "Cardinal Health" refers to Cardinal Health, Inc. and its consolidated subsidiaries.
Overview
We are a global medical technology company with proven and industry-leading products and services designed to measurably improve the safety, quality, efficiency and cost of healthcare. We offer a comprehensive portfolio of products in the areas of medication management, infection prevention, operating room and procedural effectiveness, and respiratory care. Our offerings include established brands used in hospitals throughout the United States and approximately 130 countries worldwide. Our strategy is to enhance growth by focusing on healthcare safety and productivity, driving innovation and clinical differentiation, accelerating our global growth and pursuing strategic opportunities.
Our primary customers in the United States include hospitals, ambulatory surgical centers, clinics, long-term care facilities and physician offices. For the fiscal years ended June 30, 2014 and 2013, we generated revenue of $3.84 billion and $3.55 billion, respectively. We generated income from continuing operations of $417 million in fiscal year 2014 and $389 million in fiscal year 2013. Approximately 23% of our fiscal year 2014 revenue was from customers outside of the United States.
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.
Factors Affecting Our Results of Operations The Overall Global Economic Environment, Industry Growth and Trends Healthcare-related industries are generally less susceptible than some other industries to fluctuations in the overall economic environment. However, some of our businesses rely on capital spending from our customers (primarily hospitals), which can be influenced by a variety of economic factors, including interest rates, access to financing and endowment fluctuations. Significant changes in these economic factors can affect the sales of our capital equipment products, such as infusion pumps, dispensing equipment and ventilators. Additionally, sales volumes for some of our businesses are dependent on hospital admissions. Changes in admissions due to difficult economic times can affect our results for surgical and single-use products, such as infusion and respiratory disposable sets, surgical instruments and skin antiseptic products. Healthcare providers globally are focused on reducing the rising costs to deliver care. As a result, hospitals have prioritized and, in some cases, constrained their capital equipment purchases. Despite seeing some improvement during fiscal year 2013 and a stable environment in fiscal year 2014, we continue to anticipate it will take time before significant market improvements are realized. Even in this environment, we believe our Medical Systems business is well positioned, and will strengthen with improvements in hospital capital equipment spending.
Procedural volumes in acute care facilities represent one indicator for the demand of the disposable products sold within our Procedural Solutions operating segment and have remained relatively stable since fiscal year 2012. In addition to procedural volumes, demand for many of our Procedural Solutions products is created when physicians convert their existing practices away from legacy methods and adopt our clinically differentiated products. As a result, our clinically differentiated product revenue has consistently outperformed trends in acute care facility procedural volumes.


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Healthcare Reform
We are also affected by uncertainties in the healthcare industry related to healthcare reform. In March 2010, comprehensive healthcare reform was enacted in the United States through the passage of the Patient Protection and Affordable Health Care and the Health Care and Education Reconciliation Acts. Among other initiatives, the legislation implemented a 2.3% annual excise tax on the sales of certain medical devices in the United States, effective January 2013. As this excise tax is recorded as a selling, general and administrative expense, it has, and will continue to have, an adverse effect on our operating expenses and results of operations. In fiscal year 2014, we paid approximately $23 million related to the medical device tax. We currently expect the impact of the tax to be approximately $25 million in fiscal year 2015 and annually thereafter. In addition, as the United States federal government implements additional provisions of healthcare reform, we anticipate that Congress, regulatory agencies 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. The uncertainties regarding the implementation and impact of the enacted healthcare reform measures, as well as other potential reform initiatives in the future, may have an adverse effect on our customers' purchasing decisions regarding our products and services.
Innovation and New Products
Our business strategy relies significantly on innovation to develop and introduce new products and to differentiate our products from our competitors. Our investment in research and development during fiscal year 2014 was $190 million, or 5% of revenues. Looking forward, we remain committed to producing a pipeline of innovative products to continue to support our growth strategies. Our internal and external investments will be focused on initiatives that we believe will offer the greatest opportunity for growth and profitability. With a significant investment in research and development, a strong focus on innovation and a well-managed innovation process, we believe we can continue to innovate and grow. If, however, our future innovations are not successful in meeting customers' needs or prove to be too costly versus their perceived benefit, our growth may slow.
International and Foreign Exchange
We sell our products in approximately 130 countries and manufacture our products in 9 countries in North America, Europe, and Latin America. Due to the global nature of our business, our revenue and expenses are influenced by foreign exchange movements. In fiscal year 2014, approximately 18% of our sales were in currencies other than the United States dollar. Increases or decreases in the value of the United States dollar compared to other currencies will affect our reported results as we translate those currencies into United States dollars. The percentage of fiscal year 2014 sales by major currencies was as follows:

United States Dollar  82 %
Euro                   8 %
British Pound          4 %
All Other              6 %
                     100 %

Acquisitions and Divestitures
Acquisitions have historically played a role in our growth, and we have made several significant acquisitions in the last five years. Our business was formed principally through a series of acquisitions by Cardinal Health of established healthcare companies, including the acquisition in 2007 of VIASYS Healthcare Inc., a developer of respiratory care systems, and the acquisition in 2008 of the assets of Enturia, Inc., a manufacturer of skin-antiseptic products. Since our spinoff from Cardinal Health, we have taken steps to expand and refine our product offerings, including through the acquisitions and divestitures described below.


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Acquisitions:
Date                Business
May 2010            Medegen, a manufacturer of clinically differentiated IV
                    needleless access valves and administration sets, including
                    our MaxGuard and MaxPlus products
April 2011          Vestara, a developer of technology solutions that enable the
                    safe, efficient disposal and tracking of environmentally
                    sensitive pharmaceutical waste
August 2011         Rowa, a German based company specializing in robotic
                    medication storage and retrieval systems for retail and
                    hospital pharmacies
April 2012          PHACTS, a technology and consulting company that helps
                    hospital pharmacies better manage inventory, reduce
                    pharmaceutical costs, and streamline operations
June 2012           UK Medical Holdings, a leading distributor of specialized
                    medical products to the National Health Service and private
                    healthcare sector in the United Kingdom
November 2012       Intermed, a leading respiratory technologies company based in
                    Brazil
October 2013        Sendal, an infusion specialty disposable manufacturer in
                    Spain that primarily serves the Western European market
December 2013       Vital Signs, a leading manufacturer of single-use consumables
                    for respiratory care and anesthesiology, which also markets
                    products for temperature management and patient monitoring
                    consumables

In addition to the acquisitions listed above, we have acquired non-controlling equity interests in privately held companies, including our March 2014 investment in Caesarea Medical Electronics Ltd. ("CME"). CME is a global infusion pump manufacturer headquartered in Israel that designs, manufactures and markets a range of infusion and syringe pumps, as well as related accessories and disposable administration sets for both homecare and hospital settings.

Divestitures:
Date                Business
October 2009        Audiology, a manufacturer and marketer of hearing diagnostic
                    equipment
May 2010            Research Services, a clinical trial service provider to
                    pharmaceutical firms
March 2011          OnSite Services, a surgical instrument management and repair
                    service provider
April 2011          International Surgical Products, a distributor of medical
                    supplies and surgical products outside the United States
July 2012           Nicolet, a manufacturer of neurodiagnostic monitoring
                    equipment

Acquired In-Process Research and Development During fiscal year 2010 we acquired and capitalized $45 million of in-process research and development ("IPR&D") related to our acquisition of Medegen. The value of this IPR&D was calculated based on a discounted cash flow method, which involved a number of significant assumptions, including timing of product deployment, revenues, margin, and associated discount rates. Effective July 1, 2009, IPR&D associated with business combinations is initially recorded in the balance sheet at fair value and tested for impairment annually until it is put into service. Prior to July 1, 2009, all acquired IPR&D was expensed immediately. See note 11 to the audited consolidated financial statements. During the quarter ended March 31, 2014, we reclassified IPR&D associated with the Medegen acquisition to developed technology due to commercialization. The developed technology will be amortized over 15 years. Product Quality and Recalls
Product quality, particularly in life saving and sustaining technologies, plays a critical role in our success. A quality or safety issue may result in public warning letters, product recalls or seizures, monetary sanctions, consent decrees, injunctions to halt manufacture 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. In addition, recalls may negatively affect sales due to customer concerns about product quality. For the fiscal years ended June 30, 2014 and 2013, net charges related to product recalls were not material. For the fiscal year ended June 30, 2012, net charges related to product recalls were $23 million.
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,


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we and the FDA amended the consent decree ("amended 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 customers, and had an independent expert inspect the Alaris SE pump facilities and provide a certification to the FDA as to compliance. As 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 could proceed to the audit inspection phase of the amended consent decree, which included the requirement to retain an independent expert to conduct periodic audits of our infusion pump facilities over a four-year period. While we are no longer subject to these periodic audits, the FDA maintains the ability to conduct inspections of our infusion pump facilities. In addition, 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 June 30, 2014, we do not believe that a loss is probable in connection with the amended consent decree, and accordingly, we have no reserves associated with compliance with the amended consent decree.
In response to infusion product recalls and the amended consent decree, we have made substantial investments in quality systems and quality personnel headcount over the past several years. While we believe that we have made significant improvements to our product quality and overall quality systems, further quality concerns, whether real or perceived, could adversely affect our results. Conversely, improving quality can be a competitive advantage and improve our results.
Infusion Business and Market Developments Our consolidated results have also been affected by developments within our infusion business and the infusion market in the United States. Because of safety concerns, the FDA has increased its scrutiny of infusion pumps. During fiscal year 2011, three of our competitors recalled their infusion pumps to correct safety concerns. In addition, a fourth was ordered by the FDA to recall and destroy as many as 200,000 of its infusion pumps and to provide refunds to its customers or replace pumps at no cost. As a result, there was increased demand for infusion pumps in the United States in fiscal year 2011 and 2012, as healthcare providers sought to replace or upgrade their existing equipment. We experienced increased demand for our infusion pumps as a result, which contributed to higher infusion revenues for fiscal year 2011 and 2012. In order to successfully compete in this business environment, we temporarily discounted the pricing on our infusion pumps, in some cases up to 30% or more. In late fiscal year 2013, a competitor that recalled infusion pumps during fiscal year 2011, recalled additional infusion pumps to correct safety concerns, and it announced that it would stop selling several of its infusion pumps in the United States and seek to retire its older pump technologies from the market. As a result, we again experienced increased demand for our infusion pumps in the United States in fiscal year 2014.
Income Taxes
Prior to the spinoff, our operations were included in Cardinal Health's United States federal and state tax returns or non-United States jurisdictions tax returns. In connection with the spinoff, we and Cardinal Health entered into a tax matters agreement that governs the parties' respective rights, responsibilities and obligations with respect to taxes. The tax matters agreement generally provides that the control of audit proceedings and payment of any additional liability related to our business is our responsibility.


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Basis of Presentation
The audited consolidated financial statements reflect the consolidated operations of CareFusion Corporation and its subsidiaries. Leading up to our spinoff from Cardinal Health, we organized our business into two reportable segments: Critical Care Technologies and Medical Technologies and Services. During the quarter ended September 30, 2011, we realigned our business into two new global operating and reportable segments, Medical Systems and Procedural Solutions, in order to reduce complexity, provide clearer governance for our investments and make it easier for our customers to do business with us. Additionally, during the quarter ended September 30, 2012, we combined our respiratory diagnostics products with the Respiratory Technologies business line within the Medical Systems segment. Our respiratory diagnostics products had previously been reported within the Procedural Solutions segment as "Other." Financial information for all periods presented have been reclassified to reflect these changes to our operating and reportable segments.
The Medical Systems segment is organized around our medical equipment business lines. Within the Medical Systems segment, we operate our Dispensing Technologies, Infusion Systems and Respiratory Technologies business lines. The Dispensing Technologies business line includes equipment and related services for medication and supply dispensing. The Infusion Systems business line includes infusion pumps and dedicated disposable infusion sets and accessories. The Respiratory Technologies business line includes respiratory ventilation and diagnostics equipment and dedicated consumables used during respiratory diagnostics and therapy. We also include our data mining surveillance service business within the Medical Systems segment, which we report as "Other." The Procedural Solutions segment is organized around our disposable products and reusable surgical instruments business lines. Within the Procedural Solutions segment, we operate our Infection Prevention, Medical Specialties and Specialty Disposables business lines. The Infection Prevention business line includes single-use skin antiseptic and other patient-preparation products and specialty IV infusion valves, administration sets and accessories. The Medical Specialties business line includes interventional specialty products used for biopsy, drainage and other procedures, as well as reusable surgical instruments. The Specialty Disposables business line includes non-dedicated disposable ventilator circuits and oxygen masks used for providing respiratory therapy, as well as single-use consumables for respiratory care and anesthesiology.

CONSOLIDATED RESULTS OF OPERATIONS
Fiscal Year Ended June 30, 2014 Compared to Fiscal Year Ended June 30, 2013 Below is a summary of comparative results of operations and a more detailed discussion of results for the fiscal years ended June 30, 2014 and 2013:

                                                          Fiscal Year Ended June 30,
(in millions)                                       2014              2013            Change
Revenue                                        $      3,842       $     3,550     $        292
Cost of Products Sold                                 1,934             1,700              234
Gross Profit                                          1,908             1,850               58
Selling, General and Administrative Expenses          1,061               980               81
Research and Development Expenses                       190               192               (2 )
Restructuring and Acquisition Integration
Charges                                                  43                18               25
Gain on Sale of Assets                                   (4 )               -               (4 )
Reserve for Expected Government Settlement                -                41              (41 )
Share of Net (Earnings) Loss of Equity
Method Investee                                          (3 )               -               (3 )
Operating Income                                        621               619                2
Interest Expense and Other, Net                          89                76               13
Income Before Income Taxes                              532               543              (11 )
Provision for Income Taxes                              115               154              (39 )
Income from Continuing Operations                       417               389               28
Loss from Discontinued Operations, Net of
Tax                                                       -                (4 )              4
Net Income                                     $        417       $       385     $         32


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Revenue
The following table presents the revenue information for select business lines
within each of our reportable segments for the fiscal years ended June 30, 2014
and 2013:
                                    Fiscal Year Ended June 30,
(in millions)                       2014            2013      Change
Medical Systems
Dispensing Technologies      $      954           $   993    $  (39 )
Infusion Systems                  1,037               916       121
Respiratory Technologies            377               393       (16 )
Other                                26                27        (1 )
Total Medical Systems        $    2,394           $ 2,329    $   65
Procedural Solutions
Infection Prevention         $      656           $   594    $   62
Medical Specialties                 364               344        20
Specialty Disposables               428               283       145
Total Procedural Solutions   $    1,448           $ 1,221    $  227
Total CareFusion             $    3,842           $ 3,550    $  292

Revenue in our Medical Systems segment increased 3% to $2,394 million compared to the prior fiscal year. The increase was primarily a result of increased revenues in the Infusion Systems ($121 million) business line, partially offset by a decrease in Dispensing Technologies ($39 million) business line. Revenue in the Dispensing Technologies business line decreased $39 million to $954 million, primarily due to a decrease in the volume of equipment installations as we began to launch a new product release. Revenue in the Infusion Systems business line increased $121 million to $1,037 million, primarily due to the impact of an increase in the volume of pump installations, competitive displacements and higher dedicated disposables from a larger installed base. Revenue in the Respiratory Technologies business line decreased $16 million to $377 million, primarily due to the fulfillment of significant government orders in the prior year.
Revenue in our Procedural Solutions segment increased 19% to $1,448 million compared to the prior fiscal year. The increase in Procedural Solutions revenue was due to growth in the Specialty Disposables ($145 million), Infection Prevention ($62 million), and Medical Specialties ($20 million) business lines. Revenue in the Specialty Disposables business line increased by $145 million to $428 million, primarily as a result of revenues associated with Vital Signs, which we acquired in December 2013, and increased distribution activities for bronchial hygiene products. Revenue in the Infection Prevention business line increased by $62 million to $656 million, primarily as a result of revenues associated with Sendal, which we acquired in October 2013, and increased sales of our clinically differentiated skin preparation products. Revenue in the Medical Specialties business line increased by $20 million to $364 million, primarily as a result of continued strength in pleural drainage and biopsy categories.
Gross Profit and Gross Margins
Gross profit increased 3% to $1,908 million compared to the prior fiscal year. As a percentage of revenue, gross margin was 49.7% and 52.1% for fiscal year 2014 and 2013, respectively.
The decrease in gross margin during the fiscal year was primarily due to product mix associated with lower dispensing equipment installation volumes, higher infusion capital placements and increased sales in lower margin product lines associated with our acquisition of Sendal and Vital Signs. In addition, the decrease in gross margins were further impacted by a key supplier winding down its business and the costs associated with transitioning to a new supplier. Selling, General and Administrative and Research and Development Expenses SG&A expenses increased 8% to $1,061 million compared to the prior fiscal year. The increase was primarily due to acquisition and operating costs associated with Sendal and Vital Signs, the impact of the medical device excise tax and costs associated with selling activities.


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R&D expenses decreased 1% to $190 million compared to the prior fiscal year. During the fiscal year, we continued to invest in next generation platforms for . . .

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