1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For The Quarter Ended December 31, 1998 Commission File Number 0-12591 CARDINAL HEALTH, INC. (Exact name of registrant as specified in its charter) OHIO 31-0958666 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.) 5555 GLENDON COURT, DUBLIN, OHIO 43016 (Address of principal executive offices and zip code) (614) 717-5000 (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 X No --- --- The number of Registrant's Common Shares outstanding at the close of business on February 4, 1999 was as follows: Common Shares, without par value: 272,056,928 -----------------
2 CARDINAL HEALTH, INC. AND SUBSIDIARIES Index * <TABLE> <CAPTION> Page No. -------- <S> <C> <C> Part I. Financial Information: --------------------- Item 1. Financial Statements: Condensed Consolidated Statements of Earnings for the Three and Six Months Ended December 31, 1998 and 1997 ................................................ 3 Condensed Consolidated Balance Sheets at December 31, 1998 and June 30, 1998 ................................................................... 4 Condensed Consolidated Statements of Cash Flows for the Six Months Ended December 31, 1998 and 1997....................................................... 5 Notes to Condensed Consolidated Financial Statements ............................ 6 Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition.......................................................... 8 Item 3. Quantitative and Qualitative Disclosures about Market Risk....................... 12 Part II. Other Information: ------------------ Item 1. Legal Proceedings................................................................ 13 Item 4. Submission of Matters to a Vote of Security Holders.............................. 13 Item 5. Other Information................................................................ 14 Item 6. Exhibits and Reports on Form 8-K................................................. 14 </TABLE> * Items not listed are inapplicable.
3 PART I. FINANCIAL INFORMATION CARDINAL HEALTH, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) <TABLE> <CAPTION> THREE MONTHS ENDED SIX MONTHS ENDED DECEMBER 31, DECEMBER 31, 1998 1997 1998 1997 ----------- ----------- ----------- ----------- <S> <C> <C> <C> <C> Revenue: Operating revenue $ 4,062,702 $ 3,277,748 $ 7,913,717 $ 6,300,157 Bulk deliveries to customer warehouses 999,813 750,590 1,781,493 1,431,745 ----------- ----------- ----------- ----------- Total revenue 5,062,515 4,028,338 9,695,210 7,731,902 Cost of products sold: Operating cost of products sold 3,701,325 2,978,705 7,231,233 5,723,468 Cost of products sold - bulk deliveries 999,813 750,590 1,781,493 1,431,745 ----------- ----------- ----------- ----------- Total cost of products sold 4,701,138 3,729,295 9,012,726 7,155,213 Gross margin 361,377 299,043 682,484 576,689 Selling, general and administrative expenses 188,093 160,337 366,308 320,660 Merger-related costs (3,095) (3,189) (37,465) (5,372) ----------- ----------- ----------- ----------- Operating earnings 170,189 135,517 278,711 250,657 Other income (expense): Interest expense (9,527) (7,211) (18,240) (14,454) Other, net (2,383) 660 71 3,232 ----------- ----------- ----------- ----------- Earnings before income taxes 158,279 128,966 260,542 239,435 Provision for income taxes 58,572 48,526 103,009 89,673 ----------- ----------- ----------- ----------- Net earnings $ 99,707 $ 80,440 $ 157,533 $ 149,762 =========== =========== =========== =========== Earnings per Common Share: Basic $ 0.50 $ 0.40 $ 0.79 $ 0.75 Diluted $ 0.49 $ 0.40 $ 0.77 $ 0.74 Weighted average number of Common Shares outstanding: Basic 200,836 199,388 200,655 198,996 Diluted 204,209 203,154 204,086 202,673 Cash dividends declared per Common Share $ 0.025 $ 0.0167 $ 0.05 $ 0.0333 </TABLE> See notes to condensed consolidated financial statements.
4 CARDINAL HEALTH, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED) (IN THOUSANDS) <TABLE> <CAPTION> DECEMBER 31, JUNE 30, 1998 1998 ----------- ----------- <S> <C> <C> ASSETS Current assets: Cash and equivalents $ 236,543 $ 338,263 Trade receivables, net 1,105,931 989,583 Current portion of net investment in sales-type leases 103,343 75,450 Merchandise inventories 2,443,375 1,964,382 Prepaid expenses and other 148,272 137,417 ----------- ----------- Total current assets 4,037,464 3,505,095 ----------- ----------- Property and equipment, at cost 1,168,941 1,046,405 Accumulated depreciation and amortization (399,015) (347,468) ----------- ----------- Property and equipment, net 769,926 698,937 Other assets: Net investment in sales-type leases, less current portion 322,232 195,013 Goodwill and other intangibles 277,801 285,571 Other 100,567 98,490 ----------- ----------- Total $ 5,507,990 $ 4,783,106 =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Notes payable, banks $ 106,371 $ 24,653 Current portion of long-term obligations 10,407 7,294 Accounts payable 1,918,800 1,714,108 Other accrued liabilities 239,413 247,661 ----------- ----------- Total current liabilities 2,274,991 1,993,716 ----------- ----------- Long-term obligations, less current portion 642,813 441,170 Deferred income taxes and other liabilities 371,307 324,145 Shareholders' equity: Common Shares, without par value 976,250 944,833 Retained earnings 1,279,838 1,122,230 Common Shares in treasury, at cost (10,629) (9,469) Cumulative foreign currency adjustment (21,050) (28,034) Other (5,530) (5,485) ----------- ----------- Total shareholders' equity 2,218,879 2,024,075 ----------- ----------- Total $ 5,507,990 $ 4,783,106 =========== =========== </TABLE> See notes to condensed consolidated financial statements.
5 CARDINAL HEALTH, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (IN THOUSANDS) <TABLE> <CAPTION> SIX MONTHS ENDED DECEMBER 31, 1998 1997 --------- --------- <S> <C> <C> CASH FLOWS FROM OPERATING ACTIVITIES: Net earnings $ 157,533 $ 149,762 Adjustments to reconcile net earnings to net cash from operating activities: Depreciation and amortization 49,752 45,336 Provision for bad debts 5,119 5,856 Change in operating assets and liabilities: Increase in trade receivables (116,058) (103,736) Increase in merchandise inventories (476,602) (510,438) Increase in net investment in sales-type leases (155,112) (28,451) Increase in accounts payable 200,059 307,922 Other operating items, net 37,123 (26,857) --------- --------- Net cash used in operating activities (298,186) (160,606) --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from sale of property and equipment 2,506 1,365 Additions to property and equipment (110,096) (104,024) Other - 1,715 --------- --------- Net cash used in investing activities (107,590) (100,944) --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Net short-term borrowing activity 80,881 101,278 Reduction of long-term obligations (19,222) (8,327) Proceeds from long-term obligations, net of issuance costs 219,696 26,827 Proceeds from issuance of Common Shares 18,695 14,590 Tax benefit of stock options 11,309 8,922 Dividends on Common Shares and cash paid in lieu of fractional shares (8,609) (5,805) Purchase of treasury shares (1,160) (983) --------- --------- Net cash provided by financing activities 301,590 136,502 EFFECT OF CURRENCY TRANSLATION ON CASH AND EQUIVALENTS 2,462 (578) --------- --------- NET DECREASE IN CASH AND EQUIVALENTS (101,724) (125,626) CASH AND EQUIVALENTS AT BEGINNING OF PERIOD 338,263 270,536 --------- --------- CASH AND EQUIVALENTS AT END OF PERIOD $ 236,539 $ 144,910 ========= ========= </TABLE> See notes to condensed consolidated financial statements.
6 CARDINAL HEALTH, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Note 1. The condensed consolidated financial statements of Cardinal Health, Inc. (the "Company") include the accounts of all majority-owned subsidiaries and all significant intercompany amounts have been eliminated. The condensed consolidated financial statements contained herein have been restated to give retroactive effect to the merger transactions with MediQual Systems, Inc. ("MediQual") on February 18, 1998 and R.P. Scherer Corporation ("Scherer") on August 7, 1998, both of which were accounted for as pooling of interests business combinations (see Note 5). These condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and include all of the information and disclosures required by generally accepted accounting principles for interim reporting. In the opinion of management, all adjustments necessary for a fair presentation have been included. Except as disclosed elsewhere herein, all such adjustments are of a normal and recurring nature. The condensed consolidated financial statements included herein should be read in conjunction with the audited consolidated financial statements and related notes contained in the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1998, and in the Company's Current Report on Form 8-K/A (Amendment No. 1) filed on September 28, 1998. Note 2. Basic earnings per Common Share ("Basic") is computed by dividing net earnings (the numerator) by the weighted average number of Common Shares outstanding during each period (the denominator). Diluted earnings per Common Share is similar to the computation for Basic, except that the denominator is increased by the dilutive effect of stock options outstanding, computed using the treasury stock method. Note 3. On August 12, 1998, the Company declared a three-for-two stock split which was effected as a stock dividend and distributed on October 30, 1998 to shareholders of record at the close of business on October 9, 1998. All share and per share amounts included in the condensed consolidated financial statements have been adjusted to retroactively reflect the stock split. Note 4. As of September 30, 1998, the Company adopted Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"). SFAS 130 requires the presentation of comprehensive income and its components in a full set of general purpose financial statements. The Company's comprehensive income consists of net earnings and foreign currency translation adjustments. For the three months ended December 31, 1998, total comprehensive income was $106.3 million, comprised of $99.7 million of net earnings and $6.6 million of gain on foreign currency translation. Total comprehensive income for the comparable period of fiscal year 1997 was $75.0 million, comprised of $80.4 million of net earnings offset by $5.4 million of loss on foreign currency translation. For the six months ended December 31, 1998, total comprehensive income was $164.5 million, comprised of $157.5 million of net earnings and $7.0 million of gain on foreign currency translation. Total comprehensive income for the first six months of fiscal year 1997 was $143.2 million, comprised of $149.8 million of net earnings offset by $6.6 million of loss on foreign currency translation. Note 5. On August 7, 1998, the Company completed a merger transaction with Scherer (the "Scherer Merger"). The Scherer Merger was accounted for as a pooling of interests. The Company issued approximately 34.2 million Common Shares to Scherer stockholders and Scherer's outstanding stock options were converted into options to purchase approximately 3.5 million Common Shares. The Company's fiscal year end is June 30 and Scherer's fiscal year end was March 31. The condensed consolidated financial statements for the three and six months ended December 31, 1998, combine the Company's and Scherer's results for the same periods. For the three and six months ended December 31, 1997, the condensed consolidated financial statements combine the Company's three and six months ended December 31, 1997 results with Scherer's three and six months ended September 30, 1997 results, respectively. Due to the change in Scherer's fiscal year end from March 31 to conform with the Company's June 30 fiscal year end, Scherer's results of operations for the three months ended June 30, 1998 will not be included in the combined results of operations but will be reflected as an adjustment to combined retained earnings. Scherer's net revenue and net earnings for this period were $161.6 million
7 and $8.6 million, respectively. Scherer's cash flows from operating and financing activities for this period were $12.6 million and $32.6 million, respectively, while cash flows used in investing activities were $12.2 million. Note 6. Costs of effecting mergers and subsequently integrating the operations of the various merged companies are recorded as merger-related costs when incurred. During the three and six months ended December 31, 1998, merger-related costs totaling $3.1 million ($1.9 million, net of tax) and $37.5 million ($29.7 million, net of tax) were recorded, respectively. Of this amount, approximately $22.3 million related to transaction and employee-related costs, and $12.5 million related to business restructuring and asset impairment costs associated with the Company's merger transaction with Scherer, which were recorded during the first quarter of fiscal 1999. In addition, the Company recorded costs of $1.1 million related to severance costs for a restructuring associated with the change in management that resulted from the merger with Owen Healthcare, Inc. and $4.8 million, of which $1.8 million was recorded during the first quarter of fiscal 1999, related to integrating the operations of companies that previously engaged in merger transactions with the Company. Partially offsetting the charge recorded was a $3.2 million credit, of which $2.2 million was recorded during the first quarter of fiscal 1999, to adjust the estimated transaction and termination costs previously recorded in connection with the canceled merger transaction with Bergen Brunswig Corporation ("Bergen") (see Note 7). This adjustment relates primarily to services provided by third parties engaged by the Company in connection with the terminated Bergen transaction. The cost of such services was estimated and recorded in the prior periods when the services were performed. Actual billings were less than the estimate originally recorded, resulting in a reduction of the current period merger-related costs. During the three and six month periods ended December 31, 1997, merger-related costs recorded totaled $3.2 million ($1.9 million, net of tax) and $5.4 million ($3.3 million, net of tax), respectively. These charges related to integrating the operations of companies that previously merged with the Company. The net effect of the various merger-related costs recorded during the three months ended December 31, 1998 and 1997 was to reduce net earnings by $1.9 million to $99.7 million and by $1.9 million to $80.4 million, respectively, and to reduce reported diluted earnings per Common Share by $0.01 per share to $0.49 per share and by $0.01 per share to $0.40 per share, respectively. In addition, the net effect of the various merger-related costs recorded during the six months ended December 31, 1998 and 1997 was to reduce net earnings by $29.7 million to $157.5 million and by $3.3 million to $149.8 million, respectively, and to reduce reported diluted earnings per Common Share by $0.15 per share to $0.77 per share and by $0.02 per share to $0.74 per share, respectively. Note 7. On August 24, 1997, the Company and Bergen announced that they had entered into a definitive merger agreement, as amended, pursuant to which a wholly owned subsidiary of the Company would be merged with and into Bergen (the "Bergen Merger Agreement"). On July 31, 1998, the United States District Court for the District of Columbia granted the Federal Trade Commission's request for a preliminary injunction to halt the proposed merger. On August 7, 1998, the Company and Bergen jointly terminated the Bergen Merger Agreement and, in accordance with the terms of the Bergen Merger Agreement, the Company reimbursed Bergen for $7 million of transaction costs. Additionally, the termination of the Bergen Merger Agreement caused the costs incurred by the Company (that would not have been deductible had the merger been consummated) to become tax deductible for federal income tax purposes, resulting in a tax benefit of $12.2 million. The obligation to reimburse Bergen and the additional tax benefit were recorded in the fourth quarter of the fiscal year ended June 30, 1998. Note 8. On October 9, 1998, the Company announced that it had entered into a definitive merger agreement with Allegiance Corporation ("Allegiance"). This merger transaction was completed on February 3, 1999, and will be accounted for as a pooling of interests for financial reporting purposes. As part of the merger transaction with Allegiance, the Company issued approximately 70.7 million Common Shares to Allegiance stockholders and Allegiance's outstanding stock options were converted into options to purchase approximately 10.3 million Common Shares. The Company has assumed approximately $892.1 million in long-term debt as part of the merger. The Company expects to record a merger-related charge to reflect transaction and other costs incurred as a result of the merger transaction with Allegiance in the quarter ended March 31, 1999.
8 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Management's discussion and analysis presented below has been prepared to give retroactive effect to the pooling of interests business combinations with MediQual Systems, Inc. ("MediQual") on February 18, 1998 and R.P. Scherer Corporation ("Scherer") on August 7, 1998. The discussion and analysis is concerned with material changes in financial condition and results of operations for the Company's condensed consolidated balance sheets as of December 31, 1998 and June 30, 1998, and for the condensed consolidated statements of earnings for the three and six month periods ended December 31, 1998 and 1997. This discussion and analysis should be read together with management's discussion and analysis included in the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1998 and in the Company's Current Report on Form 8-K/A (Amendment No. 1) filed with the Securities and Exchange Commission on September 28, 1998. Portions of management's discussion and analysis presented below include "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. The words "believe", "expect", "anticipate", "project", and similar expressions, among others, identify "forward-looking statements", which speak only as of the date the statement was made. Such forward-looking statements are subject to risks, uncertainties and other factors which could cause actual results to materially differ from those made, projected or implied. The most significant of such risks, uncertainties and other factors are described in this report and in Exhibit 99.01 to this Form 10-Q. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. RESULTS OF OPERATIONS Operating Revenue. Operating revenue for the second quarter and six month period of fiscal 1999 increased 24% and 26%, respectively, as compared to the prior year. Distribution businesses (those whose primary operations involve the wholesale distribution of pharmaceuticals, representing approximately 88% of total operating revenue) grew at a rate of 25% and 28%, respectively, during the three and six month periods ended December 31, 1998, while Service businesses (those that provide services to the healthcare industry, primarily through pharmacy franchising, pharmacy automation equipment, pharmacy management, pharmaceutical packaging, drug delivery systems development and healthcare information systems development) grew at a rate of 20% and 18%, respectively, during the comparable periods of fiscal year 1998, primarily due to the Company's pharmacy automation and pharmaceutical packaging businesses. The majority of the operating revenue increase (approximately 74% and 75% for the three and six month periods ended December 31, 1998, respectively) came from existing customers in the form of increased volume and price increases. The remainder of the growth came from the addition of new customers. Bulk Deliveries to Customer Warehouses. The Company reports as revenue bulk deliveries made to customers' warehouses, whereby the Company acts as an intermediary in the ordering and subsequent delivery of pharmaceutical products. Fluctuations in bulk deliveries result largely from circumstances that are beyond the control of the Company, including consolidation within the chain drugstore industry, decisions by chains to either begin or discontinue warehousing activities, and changes in policies by manufacturers related to selling directly to chain drugstore customers. Due to the lack of margin generated through bulk deliveries, fluctuations in their amount have no significant impact on the Company's operating earnings. Gross Margin. For the three month periods ended December 31, 1998 and 1997, gross margin as a percentage of operating revenue was 8.89% and 9.12%, respectively. For the six month periods ended December 31, 1998 and 1997, gross margin as a percentage of operating revenue was 8.62% and 9.15%, respectively. The decrease in the gross margin percentage is due primarily to a greater mix of lower margin Distribution business in the three and six months ended December 31, 1998, and a general decline in the Distribution businesses gross margin. The Distribution businesses' gross margin as a percentage of operating revenue decreased for the second quarter of the current fiscal year from 5.40% a year ago to 5.29%. In addition, Distribution's gross margin as a percentage of operating revenue was 5.17% and 5.47%, respectively for the six month periods ended December 31, 1998 and 1997. These decreases were primarily due to the impact of lower selling margins, as a result of a highly competitive market and a greater mix of high volume customers, where a lower cost of distribution and better asset
9 management enable the Company to offer lower selling margins to its customers. The Distribution businesses achieved 25% and 28% operating revenue growth during the three and six months ended December 31, 1998, respectively, primarily through the addition or expansion of business with large, high volume customers. The Service businesses' gross margin as a percentage of operating revenue for the second quarter of fiscal 1999 and fiscal 1998 was 32.73% and 31.96%, respectively. For the six month periods ended December 31, 1998 and 1997, Service's gross margin as a percentage of operating revenue was 31.92% and 31.76%, respectively. The slight improvement in gross margin rates experienced by the Service businesses is a function of the mix of the various businesses. Increased operating revenue for the Company's relatively high margin pharmacy automation business was the primary contributor to the gross margin improvement. Selling, General and Administrative Expenses. Selling, general and administrative expenses as a percentage of operating revenue declined to 4.63% in the second quarter of fiscal 1999 compared to 4.89% for the same period of fiscal 1998, and 4.63% for the six month period ended December 31, 1998 compared to 5.09% for the same period in the prior year. The improvements in the second quarter and six month period reflect economies associated with the Company's revenue growth, as well as significant productivity gains resulting from continued cost control efforts and the consolidation and selective automation of operating facilities. The 17% and 14% growth in selling, general and administrative expenses experienced in the three and six months ended December 31, 1998, respectively, was due primarily to increases in personnel costs and depreciation expense, and compares favorably to the 24% and 26% growth in operating revenue for the same respective periods. Merger-Related Costs. Costs of effecting mergers and subsequently integrating the operations of the various merged companies are recorded as merger-related costs when incurred. During the three and six months ended December 31, 1998, merger-related costs totaling $3.1 million ($1.9 million, net of tax) and $37.5 million ($29.7 million, net of tax) were recorded, respectively. Of this amount, approximately $22.3 million related to transaction and employee-related costs, and $12.5 million related to business restructuring and asset impairment costs associated with the Company's merger transaction with Scherer, which were recorded during the first quarter of fiscal 1999. In addition, the Company recorded costs of $1.1 million related to severance costs for a restructuring associated with the change in management that resulted from the merger transaction with Owen Healthcare, Inc. and $4.8 million, of which $1.8 million was recorded during the first quarter of fiscal 1999, related to integrating the operations of companies that previously engaged in merger transactions with the Company. Partially offsetting the charge recorded was a $3.2 million credit, of which $2.2 million was recorded during the first quarter of fiscal 1999, to adjust the estimated transaction and termination costs previously recorded in connection with the canceled merger transaction with Bergen Brunswig Corporation ("Bergen") (see Note 7 of "Notes to Condensed Consolidated Financial Statements"). This adjustment relates primarily to services provided by third parties engaged by the Company in connection with the terminated Bergen transaction. The cost of such services was estimated and recorded in the prior periods when the services were performed. Actual billings were less than the estimate originally recorded, resulting in a reduction of the current period merger-related costs. During the three and six months ended December 31, 1997, the Company recorded costs of $3.2 million ($1.9 million, net of tax) and $5.4 million ($3.3 million, net of tax) respectively, related to integrating the operations of companies that previously merged with Cardinal. The Company estimates that it will incur additional merger-related costs associated with the various mergers it has completed to date (primarily related to the Scherer merger) of approximately $29.2 million ($17.9 million, net of tax) in future periods (primarily fiscal 1999 and 2000) in order to properly integrate operations and implement efficiencies. Such amounts will be charged to expense when incurred. The estimate does not include merger-related costs associated with the Company's merger transaction with Allegiance (see Note 8 of "Notes to Condensed Consolidated Financial Statements" and "Other - Allegiance Merger"). The effect of merger-related costs recorded during the three months ended December 31, 1998 and 1997 was to reduce net earnings by $1.9 million to $99.7 million and by $1.9 million to $80.4 million, respectively, and to reduce reported diluted earnings per Common Share by $0.01 per share to $0.49 per share and by $0.01 per share to $0.40 per share, respectively. In addition, merger-related costs recorded during the six month periods ended December 31, 1998 and 1997 reduced net earnings by $29.7 million to $157.5 million and by $3.3 million to $149.8 million, respectively, and reduced reported diluted earnings per Common Share by $0.15 per share to $0.77 per share and by $0.02 per share to $0.74 per share, respectively. Other Income (Expense). The increase in interest expense of $2.3 million in the second quarter and $3.8 million during the first six months of fiscal 1999 compared to the same respective periods of fiscal 1998 is primarily due to the Company's issuance of $150 million, 6.25% Notes due 2008, in a public offering in July 1998 (see "Liquidity
10 and Capital Resources"). The decrease in other income of $3.0 million in the second quarter and $3.2 million during the first six months of fiscal 1999 compared to the same respective periods of fiscal 1998 is primarily due to the increase in minority interests in the earnings of less than wholly owned subsidiaries. The increase in minority interests was primarily the result of increased profitability at the Company's majority owned German subsidiary. Provision for Income Taxes. The Company's provision for income taxes relative to pre-tax earnings was 37% and 38% for the second quarter of fiscal 1999 and 1998, respectively. The decrease is due primarily to the current year utilization of certain net operating loss carryforwards for which no prior benefit had been recognized. For the six month periods ended December 31, 1998 and 1997, the Company's income tax provision as a percentage of pre-tax earnings was 40% and 38%, respectively. The increase in the effective tax rate for the six months ended December 31, 1998 compared to the same period a year ago is due primarily to nondeductible items associated with the current year's business combinations (see Note 6 of "Notes to Condensed Consolidated Financial Statements"). LIQUIDITY AND CAPITAL RESOURCES Working capital increased to $1,762 million at December 31, 1998 from $1,511 million at June 30, 1998. This increase included additional investments in merchandise inventories and trade receivables of $479.0 million and $116.3 million, respectively. Offsetting the increases in working capital was a decrease in cash and equivalents of $101.7 million and an increase in accounts payable of $204.7 million. The increase in merchandise inventories reflects normal seasonal purchases of pharmaceutical inventories and the higher level of current and anticipated business volume in pharmaceutical distribution activities. The increase in trade receivables is consistent with the Company's operating revenue growth (see "Operating Revenue" above). The change in cash and equivalents and accounts payable is due primarily to the timing of inventory purchases and related payments. On July 13, 1998, the Company issued $150 million of 6.25% Notes due 2008, the proceeds of which are expected to be used for working capital needs due to the growth in the Company's business. The Company currently has the capacity to issue $250 million of additional debt securities pursuant to a shelf registration statement filed with the Securities and Exchange Commission. Property and equipment, at cost, increased by $122.5 million from June 30, 1998. The increase was primarily due to ongoing plant expansion and manufacturing equipment purchases in certain service businesses and additional investments made for management information systems and upgrades to distribution facilities. Shareholders' equity increased to $2.2 billion at December 31, 1998 from $2.0 billion at June 30, 1998, primarily due to net earnings of $157.5 million, the investment of $18.7 million by employees of the Company through various stock incentive plans and the adjustment related to the change in Scherer's fiscal year of $8.6 million during the six month period ended December 31, 1998 (See Note 5 to the "Notes to Condensed Consolidated Financial Statements"). The Company believes that it has adequate capital resources at its disposal to fund currently anticipated capital expenditures, business growth and expansion, and current and projected debt service requirements, including those related to pending business combinations. See "Other" below. OTHER Allegiance Merger. On October 9, 1998, the Company announced that it had entered into a definitive merger agreement with Allegiance Corporation ("Allegiance"). This merger transaction was completed on February 3, 1999, and will be accounted for as a pooling of interests for financial reporting purposes. As part of the merger transaction with Allegiance, the Company issued approximately 70.7 million Common Shares to Allegiance stockholders and Allegiance's outstanding stock options were converted into options to purchase approximately 10.3 million Common Shares. The Company has assumed approximately $892.1 million in long-term debt as part of the merger. The Company expects to record a merger-related charge to reflect transaction and other costs incurred as a result of the merger transaction with Allegiance in the third quarter of fiscal 1999. Additional merger-related costs associated with integrating the separate companies and instituting efficiencies will be charged to expense in subsequent periods when incurred. (See Note 8 of "Notes to the Condensed Consolidated Financial Statements"). Termination Agreement. On August 24, 1997, the Company and Bergen announced that they had entered into a definitive merger agreement, as amended, pursuant to which a wholly owned subsidiary of the Company would be merged with and into Bergen (the "Bergen Merger Agreement"). On July 31, 1998, the United States District Court
11 for the District of Columbia granted the Federal Trade Commission's request for a preliminary injunction to halt the proposed merger. On August 7, 1998, the Company and Bergen jointly terminated the Bergen Merger Agreement and, in accordance with the terms of the Bergen Merger Agreement, the Company reimbursed Bergen for $7 million of transaction costs. Additionally, the termination of the Bergen Merger Agreement caused the costs incurred by the Company (that would not have been deductible had the merger been consummated) to become tax deductible for federal income tax purposes, resulting in a tax benefit of $12.2 million. The obligation to reimburse Bergen and the additional tax benefit were recorded in the fourth quarter of the fiscal year ended June 30, 1998. Year 2000 Project. The Company utilizes computer technologies in each of its businesses to effectively carry out its day-to-day operations. Computer technologies include both information technology in the form of hardware and software, as well as embedded technology in the Company's facilities and equipment. Similar to most companies, the Company must determine whether its systems are capable of recognizing and processing date sensitive information properly as the year 2000 approaches. The Company is utilizing a multi-phased concurrent approach to address this issue. The phases included in the Company's approach are the awareness, assessment, remediation, validation and implementation phases. The Company has completed the awareness phase of its project. The Company has also substantially completed the assessment phase and is well into the remaining phases. The Company is actively correcting and replacing those systems which are not year 2000 ready in order to ensure the Company's ability to continue to meet its internal needs and those of its suppliers and customers. The Company currently intends to substantially complete the remediation, validation and implementation phases of the year 2000 project prior to June 30, 1999. This process includes the testing of critical systems to ensure that year 2000 readiness has been accomplished. The Company currently believes it will be able to modify, replace, or mitigate its affected systems in time to avoid any material detrimental impact on its operations. If the Company determines that it is unable to remediate and properly test affected systems on a timely basis, the Company intends to develop appropriate contingency plans for any such mission-critical systems at the time such determination is made. While the Company is not presently aware of any significant probability that its systems will not be properly remediated on a timely basis, there can be no assurances that all year 2000 remediation processes will be completed and properly tested before the year 2000, or that contingency plans will sufficiently mitigate the risk of a year 2000 readiness problem. The Company estimates that the aggregate costs of its year 2000 project will be approximately $24 million, including costs incurred to date. A significant portion of these costs are not likely to be incremental costs, but rather will represent the redeployment of existing resources. This reallocation of resources is not expected to have a significant impact on the day-to-day operations of the Company. During the three and six month periods ended December 31, 1998, total costs of approximately $1.9 million and $3.2 million, respectively, were incurred by the Company for this project, of which approximately $0.7 million and $1.1 million, respectively, represented incremental costs. Total accumulated costs of approximately $8.9 million have been incurred by the Company through December 31, 1998, of which approximately $2.7 million represented incremental expense. The anticipated impact and costs of the project, as well as the date on which the Company expects to complete the project, are based on management's best estimates using information currently available and numerous assumptions about future events. However, there can be no guarantee that these estimates will be achieved and actual results could differ materially from those plans. Based on its current estimates and information currently available, the Company does not anticipate that the costs associated with this project will have a material adverse effect on the Company's consolidated financial position, results of operations or cash flows in future periods. The Company has initiated formal communications with its significant suppliers, customers, and critical business partners to determine the extent to which the Company may be vulnerable in the event that those parties fail to properly remediate their own year 2000 issues. The Company has taken steps to monitor the progress made by those parties, and intends to test critical system interfaces as the year 2000 approaches. The Company is in the process of developing appropriate contingency plans in the event that a significant exposure is identified relative to the dependencies on third-party systems. Although the Company is not presently aware of any such significant exposure, there can be no guarantee that the systems of third parties on which the Company relies will be converted in a timely manner, or that a failure to properly convert by another company would not have a material adverse effect on the Company. The potential risks associated with the year 2000 issues include, but are not limited, to: temporary disruption of the Company's operations, loss of communication services and loss of other utility services. The Company believes that the most reasonably likely worst-case year 2000 scenario would be a loss of communication services which could result in problems with receiving, processing, tracking and billing customer orders; problems receiving, processing and tracking orders placed with suppliers; and problems with banks and other financial institutions. Currently, as part of the Company's normal business contingency planning, a plan has been developed for business disruptions due to natural disasters and power failures. The Company is in the process of enhancing these contingency plans to include provisions for year 2000 issues, although it will not be possible to develop contingency
12 plans for all potential disruption. Although the Company anticipates that minimal business disruption will occur as a result of the year 2000 issues, based upon currently available information, incomplete or untimely resolution of year 2000 issues by either the Company or significant suppliers, customers and critical business partners could have a material adverse impact on the Company's consolidated financial position, results of operations and/or cash flows in future periods. The above discussion does not include the impact of the Company's merger transaction with Allegiance which was completed on February 3, 1999. The Euro Conversion. On January 1, 1999, certain member countries of the European Union irrevocably fixed the conversion rates between their national currencies and a common currency, the "Euro", which became their legal currency on that date. The participating countries' former national currencies will continue to exist as denominations of the Euro between January 1, 1999 and January 1, 2002. The Company has addressed the business implications of conversion to the Euro, including the need to adapt internal systems to accommodate Euro-denominated transactions, the competitive implications of cross-border price transparency, and other strategic implications. The Company does not expect the conversion to the Euro to have a material impact on its consolidated financial position, results of operations or cash flows in future periods. ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company believes there has been no material change in its exposure to market risk from that discussed in the Company's Form 8-K/A (Amendment No. 1) filed on September 28, 1998.
13 PART II. OTHER INFORMATION ITEM 1: LEGAL PROCEEDINGS The following disclosure should be read together with the disclosure set forth in the Company's Form 10-K for the fiscal year ended June 30, 1998, the Company's Form 10-Q for the quarter ended September 30, 1998, and the Company's Forms 8-K filed with the Securities and Exchange Commission subsequent to the end of the fiscal year ended June 30, 1998, and to the extent any such statements constitute "forward looking statements", reference is made to Exhibit 99.01 of this Form 10-Q. In November 1993, the Company and Whitmire Distribution Corporation ("Whitmire"), one of the Company's wholly-owned subsidiaries, as well as other pharmaceutical wholesalers, were named as defendants in a series of purported class action lawsuits which were later consolidated and transferred by the Judicial Panel for Multi-District Litigation to the United States District Court for the Northern District of Illinois. Subsequent to the consolidation, a new consolidated complaint was filed which included allegations that the wholesaler defendants, including the Company and Whitmire, conspired with manufacturers to inflate prices using a chargeback pricing system. The wholesaler defendants, including the Company and Whitmire, entered into a Judgment Sharing Agreement whereby the total exposure for the Company and its subsidiaries is limited to $1,000,000 or 1% of any judgment against the wholesalers and the manufacturers, whichever is less, and provided for the reimbursement mechanism of legal fees and expenses. The trial of the class action lawsuit began on September 23, 1998. On November 19, 1998, after the close of plaintiffs' case-in-chief, both the wholesaler defendants and the manufacturer defendants moved for a judgment as a matter of law in their favor. On November 30, 1998, the Court granted both of these motions and ordered judgment as a matter of law in favor of both the wholesaler defendants and the manufacturer defendants. On January 25, 1999, the class plaintiffs filed notice of appeal of the District Court's decision by the Court of Appeals for the Seventh Circuit. In addition to the federal court cases described above, the Company and Whitmire have also been named as defendants in a series of related antitrust lawsuits brought by chain drug stores and independent pharmacies who opted out of the federal class action lawsuits, and in a series of state court cases alleging similar claims under various state laws regarding the sale of brand name prescription drugs. The Judgment Sharing Agreement described above also covers these litigation matters. On January 17, 1995, Burlington Drug Company ("Burlington Drug") filed a complaint in the United States District Court for the District of Vermont alleging that certain agreements between VHA, Inc. ("VHA") and the Company violated federal antitrust statutes and that the Company had tortiously interfered with Burlington Drug's contractual relations. The Company filed an answer denying the allegations contained in the complaint. The District Court granted Burlington Drug leave to file an amended and supplemental complaint on July 10, 1997, and the trial was set to begin on February 8, 1999. On January 13, 1999, the District Court dismissed this action based upon a tentative settlement agreement among the parties, allowing Burlington Drug to petition, upon good cause shown within sixty days, to reopen the action if a settlement is not consummated. The Company consummated a merger transaction with Allegiance on February 3, 1999. With respect to the legal proceedings in which Allegiance is involved, reference is made to the Quarterly and Annual Reports on Forms 10-Q and Form 10-K, respectively, filed by Allegiance with the Securities and Exchange Commission. On September 3, 1998, the United States Attorney for the District of Massachusetts filed a civil complaint against the Company in the United States District Court for the District of Massachusetts. The Complaint sought civil penalties for alleged multiple violations of the Controlled Substance Abuse Act. On December 17, 1998, the parties entered into a settlement agreement pursuant to which all claims contained in the complaint were withdrawn, without admission of liability by the Company, in exchange for a payment of $487,500. The Company also becomes involved from time-to-time in other litigation incidental to its business. Although the ultimate resolution of the litigation referenced in this Item 1 cannot be forecast with certainty, the Company does not believe that the outcome of these lawsuits will have a material adverse effect on the Company's financial statements. ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. (a) Registrant's 1998 Annual Meeting of Shareholders was held on November 23, 1998. (b) Proxies were solicited by Registrant's management pursuant to Regulation 14A under the Securities Exchange Act of 1934; there was no solicitation in opposition to management's nominees as listed in the proxy statement; and all director nominees were elected to the class indicated in the proxy statement pursuant to the vote of the Registrant's shareholders.
14 (c) Matters voted upon at the Annual Meeting were as follows: (1) Election of Robert L. Gerbig, George R. Manser, Jerry E. Robertson, and Melburn G. Whitmire. The results of the shareholder vote were as follows: Mr. Gerbig - 115,225,283 for, 0 against, 4,102,439 withheld, and 0 broker non-votes; Mr. Manser - 115,210,909 for, 0 against, 4,116,813 withheld, and 0 broker non-votes; Dr. Robertson - 115,199,117 for, 0 against, 4,133,605 withheld, and 0 broker non-votes; and Mr. Whitmire - 115,229,768 for, 0 against, 4,097,954 withheld, and 0 broker non-votes. (2) Amendment of the Registrant's Articles of Incorporation increasing the number of authorized Company common shares from 300 million to 500 million. The results of the shareholder vote were as follows: 114,841,226 for, 4,186,648 against, 299,848 withheld, and 0 broker non-votes. (3) Amendment and restatement of the Registrant's Code of Regulations primarily to increase the maximum number of members of the Registrant's Board of Directors from 14 to 16. The results of the shareholder vote were as follows: 105,649,422 for, 3,825,832 against, 343,493 withheld, and 9,508,975 broker non-votes. (4) Amendment of the Registrant's Equity Incentive Plan increasing the number of the Registrant's common shares available for grant of awards under such plan. The results of the shareholder vote were as follows: 73,309,518 for, 36,085,384 against, 422,653 withheld, and 9,510,167 broker non-votes. (5) Amendment of the Registrant's Performance-Based Incentive Compensation Plan increasing the maximum award that may be paid to a participant for any performance period. The results of the shareholder vote were as follows: 113,197,420 for, 5,716,171 against, 413,131 withheld, and 1,000 broker non-votes. ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K: (a) Listing of Exhibits: Exhibit Exhibit Description ------- ------------------- Number ------ 3.01 Amended and Restated Articles of Incorporation of the Registrant, as amended (1) 3.02 Restated Code of Regulations of the Registrant, as amended (1) 10.01 Registrant's Equity Incentive Plan, as amended* 10.02 Registrant's Performance-Based Incentive Compensation Plan, as amended* 27.01 Financial Data Schedule - Six months ended December 31, 1998 27.02 Financial Data Schedule - Six months ended December 31, 1997 99.01 Statement Regarding Forward-Looking Information - ------------------ (1) Included as an exhibit to the Registrant's Form 8-K filed November 24, 1998. * Management contract or compensation plan or arrangement (b) Reports on Form 8-K: On October 13, 1998, the Company filed a Current Report on Form 8-K under Item 5 which reported that the Company had signed an Agreement and Plan of Merger, dated as of October 8, 1998, among the Company, Boxes Merger Corp. and Allegiance Corporation.
15 On November 24, 1998, the Company filed a Current Report on Form 8-K under Item 5 which filed the Company's Amended and Restated Articles of Incorporation of the Registrant, as amended, and the Company's Restated Code of Regulations of the Registrant, as amended.
16 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. CARDINAL HEALTH, INC. Date: February 11, 1999 By: /s/ Robert D. Walter --------------------- Robert D. Walter Chairman and Chief Executive Officer By: /s/ Richard J. Miller --------------------- Richard J. Miller Vice President, Controller and Acting Chief Financial Officer