10-K 1 a14q4_10kx063014xform10-k.htm ANNUAL REPORT 14Q4_10K_06.30.14_Form 10-K
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
þ
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended June 30, 2014
or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to ________
Commission File Number: 1-11373
Cardinal Health, Inc.
(Exact name of registrant as specified in its charter)
Ohio
31-0958666
(State or other jurisdiction of
incorporation or organization)
(IRS Employer
Identification No.)
 
 
7000 Cardinal Place, Dublin, Ohio
43017
(Address of principal executive offices)
(Zip Code)
 
 
(614) 757-5000
(Registrant’s telephone number, including area code)
 
 
Securities registered pursuant to Section 12(b) of the Act:
 
 
Title of class
Name of each exchange on which registered
Common shares (without par value)
New York Stock Exchange
 
 
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  þ    No  ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  þ
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  þ    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  þ    No  ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer  þ
Accelerated filer  o
Non-accelerated filer  o (Do not check if a smaller reporting company)
Smaller reporting company  o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  o    No  þ
The aggregate market value of voting stock held by non-affiliates of the registrant on December 31, 2013, based on the closing price on December 31, 2013, was $22,846,077,361.
The number of the registrant’s common shares, without par value, outstanding as of July 31, 2014, was the following: 336,654,178.
Documents Incorporated by Reference:
Portions of the registrant’s Definitive Proxy Statement to be filed for its 2014 Annual Meeting of Shareholders are incorporated by reference into Part III of this Annual Report on Form 10-K.
 


 
 
Cardinal Health, Inc. and Subsidiaries
Table of Contents

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Important Information Regarding Forward-Looking Statements
This Form 10-K (including information incorporated by reference) includes forward-looking statements, addressing expectations, prospects, estimates and other matters that are dependent upon future events or developments. Many forward-looking statements appear in “Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations,” but there are others throughout this document, which may be identified by words such as “expect,” “anticipate,” “intend,” “plan,” “believe,” “will,” “should,” “could,” “would,” “project,” “continue,” “likely,” and similar expressions, and include statements reflecting future results or guidance, statements of outlook and expense accruals. These matters are subject to risks and uncertainties that could cause actual results to differ materially from those projected, anticipated or implied. The most significant of these risks and uncertainties are described below in “Item 1A: Risk Factors” and in Exhibit 99.1 to this Form 10-K. Forward-looking statements in this document speak only as of the date of this document. Except to the extent required by applicable law, we undertake no obligation to update or revise any forward-looking statement.


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Cardinal Health, Inc. and Subsidiaries
Part I




Item 1: Business
General
Cardinal Health, Inc. is an Ohio corporation formed in 1979. As used in this report, “we,” “our,” “us” and similar pronouns refer to Cardinal Health, Inc. and its subsidiaries, unless the context requires otherwise. We are a healthcare services company providing pharmaceutical and medical products and services that help pharmacies, hospitals 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.
Our fiscal year ends on June 30. References to fiscal 2014, 2013 and 2012 are to the fiscal years ended June 30, 2014, 2013 and 2012, respectively. Except as otherwise specified, information in this Form 10-K is provided as of June 30, 2014.
We report our financial results in two segments: Pharmaceutical and Medical.
Pharmaceutical Segment
In the United States, the Pharmaceutical segment:
distributes branded and generic pharmaceutical, over-the-counter healthcare and consumer products through its Pharmaceutical Distribution division to retailers (including chain and independent drug stores and pharmacy departments of supermarkets and mass merchandisers), hospitals and other healthcare providers. This division:
maintains prime vendor relationships that streamline the purchasing process resulting in greater efficiency and lower costs for our customers;
renders services to pharmaceutical manufacturers including distribution, inventory management, data reporting, new product launch support, and contract pricing and chargeback administration;
provides pharmacy services to hospitals and other healthcare facilities; and
franchises retail pharmacies under the Medicine Shoppe® and Medicap® brands;
operates nuclear pharmacies and cyclotron facilities through its Nuclear Pharmacy Services division that manufacture, prepare and deliver radiopharmaceuticals for use in nuclear imaging and other procedures in hospitals and physician offices; and
distributes specialty pharmaceutical products, provides services to pharmaceutical manufacturers, third-party payors and healthcare providers supporting the development, marketing, distribution and payment for specialty pharmaceutical products, and operates specialty pharmacies through its Specialty Solutions division.
In China, the Pharmaceutical segment distributes branded, generic and specialty pharmaceutical, over-the-counter
 
healthcare and consumer products as well as provides logistics, marketing and other services and operates direct-to-patient specialty pharmacies through Cardinal Health China.
Pharmaceutical Distribution
Our Pharmaceutical Distribution division generates gross margin when the aggregate selling price to our customers exceeds the aggregate cost of products sold. Gross margin includes margin from our generic pharmaceutical programs, margin from branded pharmaceutical distribution agreements and cash discounts. Margin from our generic pharmaceutical programs includes price discounts and rebates and may include price appreciation on some products. Our earnings on generic pharmaceuticals are generally highest during the period immediately following the initial launch of a generic product because generic pharmaceutical selling prices are generally highest during that period and tend to decline over time. Margin from branded pharmaceutical distribution agreements refers primarily to fees we receive for rendering a range of distribution and related services to manufacturers and also includes benefits from pharmaceutical price appreciation.
Joint Venture With CVS Caremark
In July 2014, we established Red Oak Sourcing, LLC (“Red Oak Sourcing”), a U.S.-based generic pharmaceutical sourcing entity with CVS Caremark Corporation (“CVS”) with an initial term of 10 years. Both companies have contributed sourcing and supply chain expertise to the 50/50 joint venture and have committed to source generic pharmaceuticals through arrangements negotiated by it. Red Oak Sourcing will negotiate generic pharmaceutical supply contracts on behalf of both companies, but will not own products or hold inventory on behalf of either company. We are required to pay 39 quarterly payments of $25.6 million to CVS commencing in October 2014 and, only if certain milestones are achieved, to pay additional predetermined amounts to CVS beginning in fiscal 2016. The fixed payments of $25.6 million will be expensed evenly commencing with the ramp-up of the venture, which we expect to begin by the end of the first quarter of fiscal 2015. No physical assets were contributed by either company to Red Oak Sourcing, and minimal funding has been provided to capitalize the entity.
Specialty Pharmaceutical Products and Services
We refer to products and services offered by our Specialty Solutions division as “specialty pharmaceutical products and services.” The Specialty Solutions division distributes oncology, rheumatology, urology and other pharmaceutical products ("specialty pharmaceutical products") and human-derived plasma products to hospitals, physician offices and other healthcare providers; provides consulting, patient support, logistics and other services to pharmaceutical manufacturers, third-party payors and healthcare providers primarily supporting the development, marketing, distribution and payment for specialty pharmaceutical products; and operates specialty


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pharmacies. Our use of the terminology "specialty pharmaceutical products and services" may not be comparable to the use of that terminology by other industry participants.
Pharmaceutical Segment Financial Statements
See Note 15 of the “Notes to Consolidated Financial Statements” for Pharmaceutical segment revenue, profit and assets for fiscal 2014, 2013 and 2012.
Medical Segment
The Medical segment distributes a broad range of medical, surgical and laboratory products to hospitals, ambulatory surgery centers, clinical laboratories, physician offices and other healthcare providers in the United States, Canada and China and to patients in the home in the United States through our Cardinal Health at Home division ("Home division"), which was formerly known as our AssuraMed division. This segment also manufactures, sources and develops its own line of private brand medical and surgical products. Manufactured products include: single-use surgical drapes, gowns and apparel; exam and surgical gloves; and fluid suction and collection systems. The segment began to manufacture extravascular closure devices after the acquisition of Access Closure, Inc. ("AccessClosure") in May 2014. We expect to expand the segment's product offering for orthopedic, cardiovascular and other procedures. This segment also assembles and offers sterile and non-sterile procedure kits. Our manufactured products are sold directly or through third-party distributors in the United States, Canada, Europe and other regions internationally. In addition, the segment provides supply chain services, including spend management, distribution management and inventory management services, to healthcare providers.
Medical Segment Financial Statements
See Note 15 of the “Notes to Consolidated Financial Statements” for Medical segment revenue, profit and assets for fiscal 2014, 2013 and 2012.
 
Acquisitions and Divestitures
In the past five fiscal years, we completed the following four larger acquisitions:
Date
Company
Location
Line
of Business
Acquisition
Price
(in millions)
03/13
AssuraMed, Inc.
Twinsburg, OH
Medical product distribution
$
2,070

 
12/10
Kinray, Inc.
Whitestone, NY
Pharmaceutical product distribution
$
1,336

 
11/10
Cardinal Health China
Shanghai, China
Pharmaceutical and medical product distribution
$
458

(1)
07/10
Healthcare Solutions
Holding, LLC
Ellicott City, MD
Specialty  pharmaceutical services
$
520

(2)
(1)
Includes the assumption of approximately $57 million in debt.
(2)
Includes $506 million in cash paid on the acquisition date and $14 million paid in fiscal 2012 and 2013 in connection with a contingent consideration obligation. The contingent consideration obligation had an acquisition date fair value of $92 million.
In addition, we completed several smaller acquisitions during the last five fiscal years, including AccessClosure, a manufacturer and distributor of extravascular closure devices in the United States, in fiscal 2014 and Futuremed Healthcare Products Corporation, a Canadian medical product distributor, in fiscal 2012.
During the past five fiscal years, we also completed several divestitures, including selling our United Kingdom-based Martindale injectable manufacturing business in fiscal 2010. In addition, effective August 31, 2009, we separated our clinical and medical products businesses (the "CareFusion Spin-Off") through a distribution to our shareholders of 81 percent of the then outstanding common stock of CareFusion Corporation ("CareFusion"). During fiscal 2010 and 2011, we disposed of the remaining shares of CareFusion common stock.
Customers
Our largest customer, CVS, accounted for 28 percent of our fiscal 2014 revenue. In the aggregate, our five largest customers, including CVS, accounted for 42 percent of our fiscal 2014 revenue. Our pharmaceutical distribution contract with Walgreen Co. ("Walgreens"), which was our second largest customer in fiscal 2013 and our third largest in fiscal 2014, expired in August 2013. Walgreens accounted for 4 percent of our fiscal 2014 revenue.
In addition, we have agreements with group purchasing organizations (“GPOs”) that act as agents to negotiate vendor contracts on behalf of their members. Our two largest GPO relationships in terms of member revenue are with Novation, LLC and Premier Purchasing Partners, L.P. Sales to members of these two GPOs, under numerous contracts across all of our


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businesses, collectively accounted for 17 percent of our revenue in fiscal 2014.
Suppliers
We rely on many different suppliers. Products obtained from our five largest suppliers accounted for an aggregate of 24 percent of our revenue during fiscal 2014, but no single supplier’s products accounted for more than 6 percent of revenue. Overall, we believe our relationships with our suppliers are good.
The Pharmaceutical Distribution division is a party to distribution service agreements with pharmaceutical manufacturers. These agreements have terms ranging from one year to five years. Most provide for an automatic renewal feature of one year. Some agreements allow either party and in some instances only the manufacturer to terminate the agreement without cause subject to a defined notice period.
Competition
We operate in a highly competitive environment in the distribution of pharmaceuticals and related healthcare services. We also operate in a highly competitive environment in the development, manufacturing and distribution of medical and surgical products. We compete on many levels, including service offerings, support services, breadth of product lines and price.
In the Pharmaceutical segment, we compete with wholesale distributors with national reach (including McKesson Corporation and AmerisourceBergen Corporation), regional wholesale distributors, self-warehousing chains, specialty distributors, third-party logistics companies, companies that provide services supporting the development, marketing, distribution and payment for specialty pharmaceutical products and nuclear pharmacies, among others. In addition, the Pharmaceutical segment has experienced competition from a number of organizations offering generic pharmaceuticals, including telemarketers. We also compete with manufacturers that sell all or part of their product offerings directly.
In the Medical segment, we compete with many different national medical product distributors, including Owens & Minor, Inc., McKesson Corporation and Medline Industries, Inc. We also compete with regional medical product distributors and companies that distribute medical products to patients in the home as well as third-party logistics companies. In addition, we compete with manufacturers that sell all or part of their product offerings directly. Competitors of the Medical segment’s manufacturing and procedural kit businesses include diversified healthcare companies as well as companies that are more focused on specific product categories.
Employees
At June 30, 2014, we had approximately 23,900 employees in the United States and approximately 10,100 employees outside of the United States. Overall, we consider our employee relations to be good.
 
Intellectual Property
We rely on a combination of trade secret, patent, copyright and trademark laws, nondisclosure and other contractual provisions, and technical measures to protect our products, services and intangible assets. We hold patents relating to some medical and surgical products and to distribution of our nuclear pharmacy products and service offerings. We also operate under licenses for certain proprietary technologies, and in certain instances we license our technologies to third parties.
We believe that we have taken all necessary steps to protect our proprietary rights, but no assurance can be given that we will be able to successfully enforce or protect our rights in the event that they are infringed upon by a third party. While all of these proprietary rights are important to our operations, we do not consider any particular patent, trademark, license, franchise or concession to be material to our overall business.
Regulatory Matters
Our business is highly regulated in the United States at both the federal and state level and in foreign countries. Depending upon their specific business, our subsidiaries may be subject to regulation by government entities including:
the U.S. Food and Drug Administration (the “FDA”);
the U.S. Drug Enforcement Administration (the “DEA”);
the U.S. Nuclear Regulatory Commission (the “NRC”);
the U.S. Department of Health and Human Services;
the U.S. Federal Trade Commission;
U.S. Customs and Border Protection;
state boards of pharmacy;
state controlled substance agencies;
state health departments, insurance departments or other comparable state agencies; and
foreign agencies that are comparable to those listed above.
These regulatory agencies have a variety of civil, administrative and criminal sanctions at their disposal for failure to comply with applicable legal or regulatory requirements. They can suspend our ability to distribute products or can initiate product recalls; they can seize products or impose criminal, civil and administrative sanctions; and they can seek injunctions to halt the manufacture and distribution of products.
Distribution
The FDA, DEA and various state authorities regulate the marketing, purchase, storage and distribution of pharmaceutical and medical products under various state and federal statutes including the Prescription Drug Marketing Act of 1987 and the Federal Controlled Substances Act (the "CSA"), which governs the sale, packaging, storage and distribution of controlled substances. Wholesale distributors of controlled substances must hold valid DEA registrations and state-level licenses, meet various security and operating standards, and comply with the


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CSA. In May 2014, our Lakeland, Florida pharmaceutical distribution center's DEA registration to distribute controlled substances was reinstated in accordance with a settlement agreement that we had entered into with the DEA in May 2012, as further discussed in Note 9 of the "Notes to Consolidated Financial Statements."
Manufacturing and Marketing
Our subsidiaries that manufacture and source medical devices or pharmaceuticals are subject to regulation by the FDA or comparable foreign agencies that administer regulations such as compliance with good manufacturing practices and quality systems.
The FDA and other domestic and foreign governmental agencies administer requirements that cover the design, testing, safety, effectiveness, manufacturing, labeling, promotion and advertising, distribution, importation and post-market surveillance of some of our manufactured products. We need specific approval or clearance from regulatory authorities before we can market and sell many of our products in particular countries. Even after we obtain approval or clearance to market a product, the product and our manufacturing processes are subject to continued regulatory oversight. It can be costly and time-consuming to obtain regulatory approvals or clearances to market a medical device, and such approvals or clearances might not be granted on a timely basis, if at all.
From time to time, we may determine that products we manufacture or market do not meet our specifications, regulatory requirements, or published standards. When we or a regulatory agency identify a quality or regulatory issue, we investigate and take appropriate corrective action, which may include withdrawing the product from the market, correcting the product at the customer location, revising product labeling, and notifying customers.
Nuclear Pharmacies and Related Businesses
Our nuclear pharmacies and cyclotron facilities require licenses or permits and must abide by regulations issued by the NRC, applicable state boards of pharmacy and the radiologic health agency or department of health of each state in which we operate. In addition, our cyclotron facilities must comply with the FDA's good manufacturing practices regulations for positron emission tomography, or PET, drugs.
Prescription Drug Tracing and Supply Chain Integrity
In November 2013, the U.S. Congress enacted the Drug Supply Chain Security Act. This law establishes a phased-in national system for tracing pharmaceutical products through the pharmaceutical distribution supply chain to prevent the introduction of counterfeit, adulterated or mislabeled drugs. The first phase of implementation will begin January 1, 2015, and upon full implementation in 2023, supply chain stakeholders will participate in an electronic, interoperable, prescription drug tracing system.  
 
Government Healthcare Programs
We are subject to U.S. federal healthcare fraud and abuse laws. These laws generally prohibit persons from soliciting, offering, receiving or paying any compensation in order to induce someone to order or purchase items or services that are in any way paid for by Medicare, Medicaid or other federally-funded healthcare programs. They also prohibit submitting or causing to be submitted any fraudulent claim for payment by the federal government. There are often similar state healthcare fraud and abuse laws that apply to Medicaid and other state-funded healthcare programs. Violations of these laws may result in criminal or civil penalties, as well as breach of contract claims and qui tam actions (false claims cases initiated by private parties purporting to act on behalf of federal or state governments).
Our Home division is a Medicare-certified supplier and participates in state Medicaid programs with respect to a small portion of its business. It must meet quality standards and maintain accreditation to receive government reimbursement, and must comply with applicable billing, payment and record-keeping requirements. Failure to comply with quality standards and billing requirements could result in civil or criminal sanctions, including the loss of our ability to participate in Medicare, Medicaid and other federal and state healthcare programs.
In addition, our U.S. federal and state government contracts are subject to specific procurement regulations. Failure to comply with applicable rules or regulations or with contractual or other requirements may result in monetary damages and criminal or civil penalties as well as termination of our government contracts or our suspension or debarment from government contract work.
Health and Personal Information Practices
Some of our businesses collect, handle and maintain patient-identifiable healthcare information. The Health Insurance Portability and Accountability Act of 1996, as augmented by the Health Information Technology for Economic and Clinical Health Act, as well as some state laws, regulate the use and disclosure of patient-identifiable health information, including requiring specified privacy and security measures. Federal and state officials have increasingly focused on how patient-identifiable healthcare information should be handled, secured and disclosed.
Some of our businesses collect, handle and maintain other sensitive personal information that is subject to federal and state laws protecting such information. Security and disclosure of personal information is also highly regulated in many other countries in which we operate.
Environmental, Health and Safety Laws
In the United States and other countries, we are subject to various federal, state and local environmental laws, as well as laws relating to safe working conditions, laboratory and manufacturing practices.


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Laws Relating to Foreign Trade and Operations
U.S. and foreign laws require us to abide by standards relating to the import and export of finished goods, raw materials and supplies and the handling of information. We also must comply with various export control and trade embargo laws, which may require licenses or other authorizations for transactions within some countries or with some counterparties.
Similarly, we are subject to U.S. and foreign laws concerning the conduct of our foreign operations, including the U.S. Foreign Corrupt Practices Act, Chinese anti-corruption laws and other foreign anti-bribery laws. Among other things, these laws generally prohibit companies and their intermediaries from offering, promising or making payments to officials of foreign governments for the purpose of obtaining or retaining business.
Regulation in China
Our China operations are subject to national, regional and local regulations, including licensing and regulatory requirements of the China National Health and Family Planning Commission, the State Administration of Industry and Commerce, the Ministry of Commerce, the Ministry of Finance, the China Food and Drug Administration, the National Development and Reform Commission and the General Administration of Customs.
Other Information
Although our agreements with manufacturers sometimes require us to maintain inventory levels within specified ranges, our distribution businesses are generally not required by our customers to maintain particular inventory levels other than as needed to meet service level requirements. Certain supply contracts with U.S. government entities require us to maintain sufficient inventory to meet emergency demands, but we do not believe those requirements materially affect inventory levels.
Our customer return policies generally require that the product be physically returned, subject to restocking fees. We only allow customers to return products that can be added back to inventory and resold at full value, or that can be returned to vendors for credit.
We offer market payment terms to our customers.
Revenue and Long-Lived Assets by Geographic Area
See Note 15 of the “Notes to Consolidated Financial Statements” for revenue and long-lived assets by geographic area.
Available Information
Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports are available free of charge on our website (www.cardinalhealth.com), under the “Investors—Financial Reporting—SEC Filings” caption, as soon as reasonably practicable after we electronically file them with, or furnish them to, the Securities and Exchange Commission (the “SEC”).
 
You may read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains a website (www.sec.gov) where you can search for annual, quarterly and current reports, proxy and information statements, and other information regarding us and other public companies.
Item 1A: Risk Factors
The risks described below could materially and adversely affect our results of operations, financial condition, liquidity and cash flows. These are not the only risks we face. Our businesses also could be affected by risks that we are not presently aware of or that we currently consider immaterial to our operations.
The U.S. healthcare environment is changing in many ways, some of which may not be favorable to us.
The healthcare industry continues to undergo significant changes designed to increase access to medical care, improve safety, contain costs and increase efficiencies. Medicare and Medicaid reimbursement levels have declined; the use of managed care has increased; distributors, manufacturers, healthcare providers and pharmacy chains have consolidated and have formed strategic alliances; and large purchasing groups are prevalent. The industry also has experienced a shift away from traditional healthcare venues like hospitals and into clinics and physician offices, and, in some cases, patients’ homes. We could be adversely affected directly or indirectly (if our customers are adversely affected) by these and other changes in the delivery or pricing of, or reimbursement for, pharmaceuticals, medical devices or healthcare services.
We could suffer the adverse effects of competitive pressures.
As described in greater detail in "Item 1: Business" above, we operate in markets that are highly competitive. Because of competition, our businesses face continued pricing pressure from our customers and suppliers. If we are unable to offset margin reductions caused by these pricing pressures through steps such as sourcing or cost control measures or additional service offerings, our results of operations and financial condition could be adversely affected.
In addition, in recent years, the healthcare industry has continued to consolidate. Further consolidation among our customers and suppliers could give the resulting enterprises greater bargaining power, which may adversely impact our results of operations.
Our Pharmaceutical segment's margin may be affected by prices established by manufacturers, fewer or less profitable generic pharmaceutical launches and other factors that are beyond our control.
As described in greater detail in "Item 1: Business" above, gross margin in our Pharmaceutical segment is impacted by generic and branded pharmaceutical price appreciation and the number


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and value of generic pharmaceutical launches. In past years, these items have been substantial drivers of Pharmaceutical segment profit.
Prices for generic pharmaceuticals generally decline over time. But at times, some generic products experience price appreciation, which positively impacts our margins. The frequency and magnitude of future generic product price appreciation is uncertain.
Prices for branded pharmaceuticals, on the other hand, generally increase over time. The frequency and magnitude of branded product price appreciation also is uncertain, and branded manufacturers may determine not to increase prices or to implement only modest increases, which can limit our margin.
The number of new generic pharmaceutical launches varies from year to year, and the margin impact of new launches varies from product to product. Fewer generic pharmaceutical launches or launches that are less profitable than those previously experienced will have an adverse effect on our year-over-year margins.
Our business is subject to rigorous regulatory and licensing requirements.
The healthcare industry is highly regulated. As described in greater detail in "Item 1: Business" above, we are subject to regulation in the United States at both the federal and state level and in China and other foreign countries. If we fail to comply with these regulatory requirements, or if allegations are made that we fail to comply, our results of operations and financial condition could be adversely affected.
To lawfully operate our businesses, we are required to obtain and hold permits, licenses and other regulatory approvals from, and to comply with operating and security standards of, numerous governmental bodies. Failure to maintain or renew necessary permits, licenses or approvals, or to comply with required standards, could have an adverse effect on our results of operations and financial condition.
Products that we manufacture, source, distribute or market are required to comply with regulatory requirements. Noncompliance or concerns over noncompliance may result in suspension of our ability to distribute, import or manufacture products, product recalls or seizures, or criminal or civil sanctions. In addition, it can be costly and time-consuming to obtain regulatory approvals to market a medical device, and such approvals might not be granted on a timely basis, if at all.
We are required to comply with laws relating to healthcare fraud and abuse. The requirements of these laws are extremely complex and subject to varying interpretations. It is possible that regulatory authorities could challenge our policies and practices, which may adversely affect our operations, results of operations and financial condition. If we fail to comply with these laws, we could be subject to federal or state government investigations
 
or qui tam actions (false claims cases initiated by private parties purporting to act on behalf of federal or state governments), which could result in civil or criminal sanctions, including the loss of licenses or the ability to participate in Medicare, Medicaid and other federal and state healthcare programs.
Our Home division is a Medicare-certified supplier and participates in state Medicaid programs with respect to a small portion of its business. Its failure to comply with quality standards and billing requirements could result in civil or criminal sanctions, including the loss of our ability to participate in Medicare and other federal and state healthcare programs.
Our government contracts are subject to specific procurement regulations. Failure to comply with applicable rules or regulations or with contractual or other requirements may result in monetary damages and criminal or civil penalties as well as termination of our government contracts or our suspension or debarment from government contract work.
Our global operations are required to comply with the U.S. Foreign Corrupt Practices Act, Chinese anti-corruption laws and similar anti-bribery laws in other jurisdictions and U.S. and foreign export control, trade embargo and customs laws. If we fail to comply with any of these laws, we could suffer civil or criminal sanctions.
Our China operations are subject to national, regional and local regulations. The regulatory environment in China is evolving, and officials in the Chinese government exercise broad discretion in deciding how to interpret and apply regulations. It is possible that the Chinese government's current or future interpretation and application of existing or new regulations will negatively impact our China operations, result in regulatory investigations or lead to fines or penalties.
CVS Caremark is a large customer that generates a significant amount of our revenue.
Our sales and credit concentration is significant. CVS accounted for 28 percent of our fiscal 2014 revenue and 22 percent of our gross trade receivable balance at June 30, 2014. If CVS were to terminate the agreement due to an alleged default by us, default in payment or significantly reduce its purchases of our products and services, our results of operations and financial condition could be adversely affected.
The anticipated benefits of our generic pharmaceutical sourcing joint venture with CVS Caremark may not be realized.
In July 2014, we established the Red Oak Sourcing joint venture with CVS with an initial term of 10 years. Red Oak Sourcing will negotiate generic pharmaceutical supply contracts on behalf of both companies. We are required to pay 39 quarterly payments of $25.6 million to CVS commencing in October 2014 without regard to the level of benefits we receive. If the benefits of the joint venture do not exceed our required payments to CVS, our


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results of operations and financial condition could be adversely affected.
We could be subject to adverse changes in the tax laws or challenges to our tax positions.
We are a large multinational corporation with operations in the United States and many foreign countries. As a result, we are subject to the tax laws of many jurisdictions. From time to time, legislative initiatives are proposed in the United States, such as the repeal of last-in, first-out, or LIFO, treatment of inventory or a change in the current U.S. taxation of income earned by foreign subsidiaries, that could adversely affect our tax positions, effective tax rate, tax payments or financial condition. Tax laws are extremely complex and subject to varying interpretations. Tax authorities have challenged some of our tax positions and it is possible that they will challenge others. These challenges may adversely affect our effective tax rate, tax payments or financial condition.
Our business and operations depend on the proper functioning of information systems and critical facilities.
We rely on our information systems to obtain, rapidly process, analyze and manage data to:
facilitate the purchase and distribution of inventory items from numerous distribution centers;
receive, process and ship orders on a timely basis;
manage the accurate billing and collections for thousands of customers;
process payments to suppliers;
facilitate the manufacturing and assembly of medical products; and
generate financial information.
Our business also depends on the proper functioning of our critical facilities, including our national logistics center. Our results of operations could be adversely affected if our information systems or critical facilities, or our customers' access to them, are interrupted; these systems or facilities are damaged; or these systems or facilities fail, whether due to physical disruptions, such as fire, natural disaster, pandemic or power outage, or due to cyber security incidents or other actions of third parties.
Our business relies on the secure transmission, storage and hosting of sensitive information, including patient-identifiable health information, financial information and other sensitive information relating to our customers, company and workforce. The techniques used by those seeking to obtain unauthorized access to our information systems, or disable them, degrade their service or sabotage them, change frequently. In addition, these techniques may be difficult to detect for a long time and often are not recognized until launched against a target. As a result, we may be unable to anticipate these techniques or to implement adequate preventative measures. Any compromise of our information systems or those of a third-party service
 
provider, including the unauthorized access, use or disclosure of sensitive information, could adversely impact our operations, results of operations or our ability to satisfy legal requirements, including those related to patient-identifiable health information.
Because of the nature of our business, we may become involved in legal proceedings that could adversely impact our cash flows or results of operations.
Due to the nature of our businesses, which includes the manufacture and distribution of healthcare products, we may from time to time become involved in disputes or legal proceedings. For instance, some of the products that we manufacture or distribute may be alleged to cause personal injury or violate the intellectual property rights of another party, subjecting us to product liability or infringement claims.
Our Medical segment's manufacturing businesses operate in an industry characterized by extensive intellectual property litigation. Patent litigation is costly to defend and can result in significant damage awards and injunctions that could prevent the manufacture and sale of affected products or force us to make royalty payments in order to continue selling the affected products.
We also may be named in breach of contract claims or qui tam actions (false claims cases initiated by private parties purporting to act on behalf of federal or state governments). Litigation is inherently unpredictable, and the unfavorable resolution of one or more of these legal proceedings could adversely affect our cash flows or results of operations.
Acquisitions can have unanticipated results.
An important element of our growth strategy has been to acquire other businesses that expand or complement our existing businesses. In fiscal 2014, we spent $519 million to acquire other businesses. Acquisitions involve risks: we may overpay for a business or fail to realize the synergies and other benefits we expect from the acquisition; future developments may impair the value of our purchased goodwill or intangible assets; or we may encounter unforeseen accounting, internal control, regulatory or compliance issues.
We depend on certain suppliers to make their raw materials and products available to us and are subject to fluctuations in costs of raw materials and products.
We depend on the availability of various components, compounds, raw materials (including radioisotopes) and energy supplied by others for our operations. Any of our supplier relationships could be interrupted due to events beyond our control, including natural disasters, or could be terminated. A sustained supply interruption could have an adverse effect on our business.
Our manufacturing businesses use oil-based resins, cotton, latex and other commodities as raw materials in many products. Prices of oil and gas also affect our distribution and transportation costs. Prices of these commodities are volatile


8

 
Cardinal Health, Inc. and Subsidiaries
 
 
 


and can fluctuate significantly, causing our costs to produce and distribute our products to fluctuate. Due to competitive dynamics and contractual limitations, we may be unable to pass along cost increases through higher prices. If we cannot fully offset cost increases through other cost reductions, or recover these costs through price increases or surcharges, our results of operations could be adversely affected.
Our global operations are subject to economic, political and currency risks.
Our global operations are affected by local economic environments, including inflation, recession, currency volatility and competition. Political changes also can disrupt our global operations, as well as our customers and suppliers, in a particular location. We may not be able to hedge or obtain insurance to protect us against these risks, and any hedges or insurance may be expensive and may not successfully mitigate these risks.
Economic conditions may adversely affect demand for our products and services.
Deterioration in general economic conditions in the United States and other countries in which we do business could adversely affect the amount of prescriptions filled and the number of medical procedures undertaken and, therefore, reduce purchases of our products and services by our customers, which could adversely affect our results of operations.
Item 1B: Unresolved Staff Comments
Not applicable.
Item 2: Properties
In the United States, at June 30, 2014, the Pharmaceutical segment operated 21 primary pharmaceutical distribution facilities and one national logistics center; three specialty distribution facilities; and over 140 nuclear pharmacy facilities. The Medical segment operated 60 medical-surgical distribution, assembly, manufacturing and other facilities. Our U.S. operating facilities are located in 45 states and in Puerto Rico.
Outside the United States, at June 30, 2014, our Medical segment operated over 20 facilities in Canada, the Dominican Republic, Malaysia, Malta, Mexico and Thailand that engage in manufacturing, distribution or research. In addition, our Pharmaceutical and Medical segments utilized various distribution and pharmacy facilities in China.
At June 30, 2014, we owned over 70 operating facilities and leased more than 200 operating facilities. Our principal executive offices are headquartered in an owned building located at 7000 Cardinal Place in Dublin, Ohio.
 
We consider our operating properties to be in satisfactory condition and adequate to meet our present needs. However, we regularly evaluate operating properties and may make further additions and improvements or consolidate locations as we seek opportunities to expand or enhance the efficiency of our business.
Item 3: Legal Proceedings
In addition to the proceedings described below, the legal proceedings described in Note 9 of the "Notes to Consolidated Financial Statements" are incorporated in this "Item 3: Legal Proceedings" by reference.
In June 2012, Henry Stanley, Jr., a purported shareholder, filed a derivative action in the U.S. District Court for the Southern District of Ohio against the current and certain former members of our Board of Directors. The complaint alleged that the defendants breached their fiduciary duties in connection with the DEA's past suspensions of our distribution centers’ registrations to distribute controlled substances. In October 2012, the U.S. District Court dismissed the derivative action with prejudice, and in August 2013, the U.S. Court of Appeals affirmed the decision. In September 2013, the same plaintiff made demand on our Board of Directors to take action against current and certain former members of our Board of Directors based on the allegations made in the derivative action. A special committee of independent directors investigated the allegations made in the demand. After receiving and evaluating the special committee's findings and recommendations, our Board of Directors determined in February 2014 that pursuing the claims set forth in the demand was not in the best interest of the company. In May 2014, another purported shareholder made a similar demand on our Board of Directors. Our Board of Directors, through the special committee, is in the process of reviewing the allegations made in this new demand.
Item 4: Mine Safety Disclosures
Not applicable.


9

 
Cardinal Health, Inc. and Subsidiaries
 
 
 


Executive Officers of the Registrant
The following is a list of our executive officers as of July 31, 2014:
Name
Age
Position
George S. Barrett
59
Chairman and Chief Executive Officer
Jeffrey W. Henderson
49
Chief Financial Officer
Michael C. Kaufmann
51
Chief Executive Officer, Pharmaceutical segment
Donald M. Casey Jr.
54
Chief Executive Officer, Medical segment
Craig S. Morford
55
Chief Legal and Compliance Officer
Carole S. Watkins
54
Chief Human Resources Officer
Mark R. Blake
43
Executive Vice President, Strategy and Corporate Development
Stephen T. Falk
49
Executive Vice President, General Counsel and Corporate Secretary
The business experience summaries provided below for our executive officers describe positions held during the last five years (unless otherwise indicated).
Mr. Barrett has served as Chairman and Chief Executive Officer since August 2009. From January 2008 to August 2009, he served as Vice Chairman of Cardinal Health and Chief Executive Officer, Healthcare Supply Chain Services.
Mr. Henderson has served as Chief Financial Officer since May 2005. In June 2014, we announced that Mr. Henderson has decided to retire from the company. To ensure an orderly transition, he will remain with the company until August 2015 and will step down as Chief Financial Officer when we name a successor to that role.
 
Mr. Kaufmann has served as Chief Executive Officer, Pharmaceutical segment, since August 2009. From April 2008 until August 2009, he served as our Group President, Pharmaceutical Supply Chain.
Mr. Casey has served as Chief Executive Officer, Medical segment, since April 2012. Before joining us, he served as Chief Executive Officer of the Gary and Mary West Wireless Health Institute, a non-profit research organization focused on lowering the cost of healthcare through novel technology solutions, from March 2010 to March 2012.  Prior to that, he served as World Wide Franchise Chairman, Comprehensive Care at Johnson & Johnson, a developer and manufacturer of health care products, from 2007 to 2009. 
Mr. Morford has served as Chief Legal and Compliance Officer since May 2009.
Ms. Watkins has served as Chief Human Resources Officer since 2000.
Mr. Blake has served as Executive Vice President, Strategy and Corporate Development since October 2009. From August 2006 until October 2009, he held various business development positions with Medco Health Solutions, Inc., a pharmacy benefits management services company, including Vice President, Business Development and Senior Director, Business Development.
Mr. Falk has served as Executive Vice President, General Counsel and Corporate Secretary since May 2009.


10

 
Cardinal Health, Inc. and Subsidiaries
Part II


a

Item 5: Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our common shares are listed on the New York Stock Exchange under the symbol “CAH.” The following table reflects the range of the reported high and low closing prices of our common shares as reported on the New York Stock Exchange Composite Tape and the per share dividends declared for the fiscal years ended June 30, 2014 and 2013. It also reflects the range of the reported high and low closing prices of our common shares from July 1, 2014 through the period ended on July 31, 2014 and the per share dividends declared from July 1, 2014 through the period ended on August 6, 2014:
 
High
 
Low
 
Dividends
Fiscal 2013
 
 
 
 
 
Quarter Ended:
 
 
 
 
 
September 30, 2012
$
43.50

 
$
37.75

 
$
0.2375

December 31, 2012
42.65

 
39.29

 
0.2750

March 31, 2013
47.09

 
41.62

 
0.2750

June 30, 2013
48.76

 
41.85

 
0.3025

 
 
 
 
 
 
Fiscal 2014
 
 
 
 
 
Quarter Ended:
 
 
 
 
 
September 30, 2013
$
53.57

 
$
47.02

 
$
0.3025

December 31, 2013
67.48

 
52.95

 
0.3025

March 31, 2014
73.54

 
65.26

 
0.3025

June 30, 2014
71.31

 
63.80

 
0.3425

 
 
 
 
 
 
Fiscal 2015
$
72.75

 
$
69.59

 
$
0.3425

At July 31, 2014 there were approximately 10,241 shareholders of record of our common shares.
We anticipate that we will continue to pay quarterly cash dividends in the future. The payment and amount of future dividends remain, however, within the discretion of our Board of Directors and will depend upon our future earnings, financial condition, capital requirements and other factors.
 
Issuer Purchases of Equity Securities
 
 
 
 
 
 
 
 
Period
Total Number
of Shares
Purchased (1)
 
Average Price Paid per Share
 
Total Number of Shares
Purchased
as Part of Publicly Announced Programs (2)
 
Approximate
Dollar Value of
Shares That May
Yet be Purchased
Under the Programs (2)
(in millions)
Apr 2014
252

 
$
69.23

 

 
$
1,011

May 2014
1,661,576

 
67.32

 
1,661,405

 
900

Jun 2014
2,513,482

 
68.64

 
2,513,288

 
727

Total
4,175,310

 
$
68.12

 
4,174,693

 
$
727

(1)
Includes 252, 171 and 194 common shares purchased in April, May and June 2014, respectively, through a rabbi trust as investments of participants in our Deferred Compensation Plan.
(2)
On August 8, 2012, our Board of Directors approved a $750 million share repurchase program, which expires on August 31, 2015. During the three months ended June 30, 2014, we repurchased $11 million of our common shares, the remaining amount under this program. On October 29, 2013, our Board of Directors approved a $1.0 billion share repurchase program, which expires on December 31, 2016. During the three months ended June 30, 2014, we repurchased $273 million of our common shares under this program. On August 6, 2014, our Board of Directors authorized an additional $1.0 billion under this share repurchase program.


11

 
Cardinal Health, Inc. and Subsidiaries
 
 
 


Performance Graph
Five Year Performance Graph
The following line graph compares the cumulative total return of our common shares with the cumulative total return of the Standard & Poor’s Composite—500 Stock Index (the "S&P 500 Index") and the Standard & Poor's Composite—500 Healthcare Index (the "S&P 500 Healthcare Index"). The line graph assumes, in each case, an initial investment of $100 on June 30, 2009, based on the market prices at the end of each fiscal year through and including June 30, 2014, and reinvestment of dividends. The S&P 500 Index and S&P 500 Healthcare Index investments are weighted on the basis of market capitalization at the beginning of each period. We have adjusted the market price of our common shares prior to August 31, 2009 to reflect the CareFusion Spin-Off on August 31, 2009.
 

 
June 30
 
2009
2010
2011
2012
2013
2014
Cardinal Health, Inc.
$
100.00

$
156.67

$
216.08

$
204.09

$
235.31

$
348.54

S&P 500 Index
100.00

114.42

149.51

157.61

190.05

236.75

S&P 500 Healthcare Index
100.00

108.99

140.09

153.76

196.42

255.44




12

 
Cardinal Health, Inc. and Subsidiaries
 
 
 


Item 6: Selected Financial Data
The consolidated financial data below includes all business combinations as of the date of acquisition that occurred during these periods. The following selected consolidated financial data should be read in conjunction with the consolidated financial statements and related notes and “Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
(in millions, except per common share amounts)
2014
 
2013 (1)
 
2012
 
2011
 
2010
Earnings Data:
 
 
 
 
 
 
 
 
 
Revenue
$
91,084

 
$
101,093

 
$
107,552

 
$
102,644

 
$
98,503

 
 
 
 
 
 
 
 
 
 
Earnings from continuing operations
$
1,163

 
$
335

 
$
1,070

 
$
966

 
$
587

Earnings/(loss) from discontinued operations (2)
3

 
(1
)
 
(1
)
 
(7
)
 
55

Net earnings
$
1,166

 
$
334

 
$
1,069

 
$
959

 
$
642

 
 
 
 
 
 
 
 
 
 
Basic earnings/(loss) per common share:
 
 
 
 
 
 
 
 
 
Continuing operations
$
3.41

 
$
0.98

 
$
3.10

 
$
2.77

 
$
1.64

Discontinued operations (2)
0.01

 

 

 
(0.02
)
 
0.15

Net basic earnings per common share
$
3.42

 
$
0.98

 
$
3.10

 
$
2.75

 
$
1.79

 
 
 
 
 
 
 
 
 
 
Diluted earnings/(loss) per common share:
 
 
 
 
 
 
 
 
 
Continuing operations
$
3.37

 
$
0.97

 
$
3.06

 
$
2.74

 
$
1.62

Discontinued operations (2)
0.01

 

 

 
(0.02
)
 
0.15

Net diluted earnings per common share
$
3.38

 
$
0.97

 
$
3.06

 
$
2.72

 
$
1.77

 
 
 
 
 
 
 
 
 
 
Cash dividends declared per common share
$
1.2500

 
$
1.0900

 
$
0.8825

 
$
0.8000

 
$
0.7200

 
 
 
 
 
 
 
 
 
 
Balance Sheet Data:
 
 
 
 
 
 
 
 
 
Total assets
$
26,033

 
$
25,819

 
$
24,260

 
$
22,846

 
$
19,990

Long-term obligations, less current portion
3,171

 
3,686

 
2,418

 
2,175

 
1,896

Shareholders’ equity
6,401

 
5,975

 
6,244

 
5,849

 
5,276

(1)
During the fourth quarter of fiscal 2013, we recognized a non-cash goodwill impairment charge of $829 million ($799 million, net of tax) related to our Nuclear Pharmacy Services division.
(2)
On August 31, 2009, we separated the clinical and medical products businesses from our other businesses through a pro rata distribution to shareholders of 81 percent of the then outstanding common stock of CareFusion and met the criteria for classification of these businesses as discontinued operations.

13

 
Cardinal Health, Inc. and Subsidiaries
Financial Review


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 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 2014, revenue decreased 10 percent to $91.1 billion largely due to the previously disclosed expiration of our pharmaceutical distribution contract with Walgreen Co. ("Walgreens") on August 31, 2013.
Gross margin increased 5 percent to $5.2 billion reflecting the positive impact of acquisitions and strong performance from generic programs, offset in part by the impact of the Walgreens contract expiration.
Operating earnings increased to $1.9 billion and earnings from continuing operations increased to $1.2 billion due primarily to an $829 million ($799 million, net of tax) non-cash goodwill impairment charge related to our Nuclear Pharmacy Services division in fiscal 2013.
Our cash and equivalents balance was $2.9 billion at June 30, 2014 compared to $1.9 billion at June 30, 2013. The increase in cash and equivalents during fiscal 2014 was driven by net cash provided by operating activities of $2.5 billion, which includes the decrease in our net working capital associated with the Walgreens contract expiration. Net cash provided by operating activities was deployed for share repurchases ($673 million), acquisitions ($519 million) and dividends ($415 million). We plan to continue to execute a balanced deployment of available capital to position ourselves for sustainable competitive advantage and to enhance shareholder value.
Walgreens Contract
The Walgreens contract expiration unfavorably impacted period-over-period comparisons of revenue and operating earnings for fiscal 2014, but favorably affected net cash provided by operating activities due to a significant reduction in net working capital. Because revenue from Walgreens was $3.3 billion during the first quarter of fiscal 2014, we expect the
 
contract expiration to have an adverse impact on our period-over-period comparisons of revenue and operating earnings during the first quarter of fiscal 2015.
Joint Venture With CVS Caremark
In July 2014, we established Red Oak Sourcing, LLC (“Red Oak Sourcing”), a U.S.-based generic pharmaceutical sourcing entity with CVS Caremark Corporation (“CVS”) with an initial term of 10 years. Both companies have contributed sourcing and supply chain expertise to the 50/50 joint venture and have committed to source generic pharmaceuticals through arrangements negotiated by it. Red Oak Sourcing will negotiate generic pharmaceutical supply contracts on behalf of both companies, but will not own products or hold inventory on behalf of either company. We are required to pay 39 quarterly payments of $25.6 million to CVS commencing in October 2014 and, only if certain milestones are achieved, to pay additional predetermined amounts to CVS beginning in fiscal 2016. The fixed payments of $25.6 million will be expensed evenly commencing with the ramp-up of the venture, which we expect to begin by the end of the first quarter of fiscal 2015. No physical assets were contributed by either company to Red Oak Sourcing, and minimal funding has been provided to capitalize the entity.
Acquisitions
We have completed several acquisitions since July 1, 2011, the largest of which were AssuraMed, Inc. ("AssuraMed") in fiscal 2013 and Access Closure, Inc. ("AccessClosure") in fiscal 2014.
On May 9, 2014, we completed the acquisition of AccessClosure for $320 million in an all-cash transaction. We funded the acquisition with cash on hand. The acquisition of AccessClosure, a manufacturer and distributor of extravascular closure devices, expands the Medical segment's portfolio of self-manufactured products.
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 Medical segment's ability to serve this patient base. The AssuraMed division is now known as our Cardinal Health at Home division ("Home division"). This acquisition increased revenue and operating earnings during fiscal 2014. The increase in amortization and other acquisition-related costs during fiscal 2014 was primarily due to intangible assets from this acquisition. We expect the amortization of acquisition-related intangible assets to continue to be a significant expense in future periods.
See Note 2 of the "Notes to Consolidated Financial Statements" for additional information on these acquisitions.


14

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


Goodwill
As part of our annual goodwill impairment test during fiscal 2013, 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 did not impact our liquidity, cash flows from operations, or compliance with debt covenants. 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, among other things, we have reorganized our Medical segment, moved production of procedure kits from our facility in Waukegan, Illinois to other facilities, and consolidated office space in Waukegan, Illinois. In addition, we are selling property in Waukegan, Illinois, and we are exiting our gamma sterilization business in El Paso, Texas. We currently estimate the total costs associated with this restructuring plan to be approximately $74 million on a pre-tax basis, of which $18 million and $51 million was recognized in fiscal 2014 and fiscal 2013, respectively.
Trends
Within our Pharmaceutical segment, pharmaceutical price appreciation on some generic products positively impacted our margins during fiscal 2014, but the frequency and magnitude of future generic product price appreciation is uncertain and the impact on earnings may be less in fiscal 2015 than in fiscal 2014.
Results of Operations
Revenue
 
Revenue
 
Change
(in millions)
2014
 
2013
 
2012
 
2014
 
2013
Pharmaceutical
$
80,110

 
$
91,097

 
$
97,925

 
(12
)%
 
(7
)%
Medical
10,962

 
10,060

 
9,642

 
9
 %
 
4
 %
Total segment revenue
91,072

 
101,157

 
107,567

 
(10
)%
 
(6
)%
Corporate
12

 
(64
)
 
(15
)
 
N.M.

 
N.M.

Total revenue
$
91,084

 
$
101,093

 
$
107,552

 
(10
)%
 
(6
)%
Fiscal 2014 Compared to Fiscal 2013
Pharmaceutical Segment
Revenue for fiscal 2014 compared to fiscal 2013 was negatively impacted by the Walgreens contract expiration ($16.9 billion) and by the expiration of our pharmaceutical distribution contract with Express Scripts, Inc. ("Express Scripts") on September 30, 2012 ($2.0 billion). This decrease was partially offset by sales growth from existing pharmaceutical distribution customers ($7.1 billion).
Medical Segment
Revenue for fiscal 2014 compared to fiscal 2013 reflects the benefit of acquisitions ($816 million).
 
Fiscal 2013 Compared to Fiscal 2012
Pharmaceutical Segment
Revenue for fiscal 2013 compared to fiscal 2012 was negatively impacted by the expiration of our pharmaceutical distribution contract with Express Scripts (approximately $6.7 billion). Revenue from existing pharmaceutical distribution customers decreased by approximately $3.6 billion, primarily as a result of brand-to-generic pharmaceutical conversions. 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).
Medical Segment
Revenue for fiscal 2013 compared to fiscal 2012 reflects the benefit of acquisitions ($459 million).
Cost of Products Sold
As a result of the same factors affecting the change in revenue, cost of products sold decreased $10.2 billion (11 percent) and $6.8 billion (7 percent) during fiscal 2014 and fiscal 2013, respectively. See the gross margin discussion below for additional drivers impacting cost of products sold.
Gross Margin
 
Gross Margin
 
Change
(in millions)
2014
 
2013
 
2012
 
2014
 
2013
Gross margin
$
5,161

 
$
4,921

 
$
4,541

 
5
%
 
8
%
Fiscal 2014 Compared to Fiscal 2013
Gross margin increased during fiscal 2014 compared to fiscal 2013 ($240 million), reflecting the positive impact of acquisitions ($221 million).
Gross margin for fiscal 2014 was positively impacted by $32 million due to sales growth, which primarily reflects growth from existing customers, and was largely offset by the impact of the Walgreens contract expiration.
Gross margin rate, apart from the impact of the Walgreens contract expiration, was flat for fiscal 2014. Gross margin rate was positively impacted by strong performance from generic programs, including the impact of generic pharmaceutical price appreciation, and was adversely impacted by customer pricing changes.
Fiscal 2013 Compared to Fiscal 2012
Gross margin increased in fiscal 2013 compared to fiscal 2012 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


15

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


pricing changes was 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.
Distribution, Selling, General and Administrative ("SG&A") Expenses
 
SG&A Expenses
 
Change
(in millions)
2014
 
2013
 
2012
 
2014
 
2013
SG&A expenses
$
3,028

 
$
2,875

 
$
2,677

 
5
%
 
7
%
SG&A expenses increased during fiscal 2014 over fiscal 2013 primarily due to acquisitions ($129 million).
SG&A expenses increased during fiscal 2013 over fiscal 2012 primarily due to acquisitions ($84 million) and investment spending ($17 million).
Segment Profit and Consolidated Operating Earnings
 
Segment Profit and
Operating Earnings
 
Change
(in millions)
2014
 
2013
 
2012
 
2014
 
2013
Pharmaceutical
$
1,745

 
$
1,734

 
$
1,558

 
1
%
 
11
 %
Medical
444

 
372

 
332

 
19
%
 
12
 %
Total segment profit
2,189

 
2,106

 
1,890

 
4
%
 
11
 %
Corporate
(304
)
 
(1,110
)
 
(98
)
 
N.M.

 
N.M.

Total operating earnings
$
1,885

 
$
996

 
$
1,792

 
89
%
 
(44
)%
Segment Profit
We evaluate segment performance based upon segment profit, among other measures. See Note 15 of the "Notes to Consolidated Financial Statements" for additional information on segment profit.
Pharmaceutical Segment Profit
The increase in fiscal 2014 over fiscal 2013 reflected the positive impact of sales growth, which primarily reflects growth from existing customers, and was largely offset by the impact of the Walgreens contract expiration. The impact of gross margin rate, apart from the impact of the Walgreens contract expiration, was flat for fiscal 2014. Gross margin rate was positively impacted by strong performance from generic programs, including the impact of generic pharmaceutical price appreciation, and was adversely impacted by customer pricing changes.
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.
 
Medical Segment Profit
The principal driver for the increase in fiscal 2014 over fiscal 2013 was the positive impact of acquisitions.
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.
Corporate
As discussed further below, the principal driver for the change in Corporate in fiscal 2014 and fiscal 2013 was an $829 million non-cash goodwill impairment charge recognized in fiscal 2013 related to our Nuclear Pharmacy Services division.
Consolidated Operating Earnings
In addition to revenue, gross margin and SG&A expenses discussed above, operating earnings were impacted by the following:
(in millions)
2014
 
2013
 
2012
Restructuring and employee severance
$
31

 
$
71

 
$
21

Amortization and other acquisition-related costs
223

 
158

 
33

Impairments and loss on disposal of assets
15

 
859

 
21

Litigation (recoveries)/charges, net
(21
)
 
(38
)
 
(3
)
Restructuring and Employee Severance
In addition to other restructuring activities during fiscal 2014 and 2013, we recognized restructuring costs of $10 million and $40 million, respectively, related to the restructuring plan in our Medical segment. We also recognized $11 million of employee-related costs related to a restructuring plan within our Nuclear Pharmacy Services division during the fourth quarter of fiscal 2013.
Amortization and Other Acquisition-Related Costs
Amortization of acquisition-related intangible assets was $187 million, $118 million and $78 million for fiscal 2014, 2013 and 2012, respectively. The increase in amortization during 2014 and 2013 was primarily due to intangible assets from the acquisition of AssuraMed. We also recognized transaction costs associated with the purchase of AssuraMed of $20 million during fiscal 2013.
Amortization and other acquisition-related costs for fiscal 2012 included income recognized upon adjustment of the contingent consideration obligation incurred in connection with the Healthcare Solutions Holding, LLC ("P4 Healthcare") acquisition ($71 million). In early fiscal 2013, we terminated and settled the remaining contingent consideration obligation for $4 million.


16

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


Impairments and Loss on Disposal of Assets
During fiscal 2014, we recognized an $8 million loss to write down property in Waukegan, Illinois in connection with our Medical segment restructuring plan.
Also in connection with our Medical segment restructuring plan, during fiscal 2013 we recognized an $11 million loss to write down our gamma sterilization assets in El Paso, Texas.
During fiscal 2013, we recognized an $829 million ($799 million, net of tax) 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". We also recognized an $8 million loss during fiscal 2013 to write down commercial software under development within our Pharmaceutical segment.
During fiscal 2012, we recognized a $16 million loss to write down an indefinite-life intangible asset related to the P4 Healthcare trade name.
Litigation (Recoveries)/Charges, Net
We recognized income resulting from settlements of class action antitrust claims in which we were a class member of $24 million and $38 million during fiscal 2014 and 2013, respectively.
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)
2014
 
2013
 
2012
 
2014
 
2013
Other income, net
$
(46
)
 
$
(15
)
 
$
(1
)
 
N.M.

 
N.M.

Interest expense, net
133

 
123

 
95

 
8
%
 
29
%
Other Income, Net
Other income, net for fiscal 2014 included a $32 million pre-tax gain related to the sale of our minority equity interests in two investments.
Interest Expense, Net
The increase in interest expense, net for fiscal 2014 and 2013 was primarily due to $1.3 billion of notes issued in connection with the AssuraMed acquisition in fiscal 2013.
 
Provision for Income Taxes
Generally, fluctuations in the effective tax rate are due to changes within international and U.S. 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 8 of the "Notes to Consolidated Financial Statements" for a detailed disclosure of the effective tax rate reconciliation):
 
2014
 
2013
 
2012
Provision at Federal statutory rate
35.0
 %
 
35.0
 %
 
35.0
 %
State and local income taxes, net of federal benefit
2.2

 
2.5

 
2.3

Foreign tax rate differential
(1.2
)
 
(4.0
)
 
(2.2
)
Nondeductible/nontaxable items
(0.2
)
 
(0.5
)
 

Nondeductible goodwill impairment

 
33.2

 

Change in measurement of an uncertain tax position and impact of IRS settlements
(0.4
)
 
(5.7
)
 
0.9

Other
(0.1
)
 
1.8

 
1.0

Effective income tax rate
35.3
 %
 
62.3
 %
 
37.0
 %
Fiscal 2014 Compared to Fiscal 2013
The fiscal 2014 effective tax rate was impacted by net favorable discrete items of $37 million, which reduced the rate by 2.1 percentage points. The discrete items include the favorable impact of the settlement of federal and state tax controversies ($80 million) and release of valuation allowances ($12 million) and the unfavorable impact of remeasurement of unrecognized tax benefits ($65 million), primarily as a result of proposed assessments of additional tax.
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).
Ongoing Audits
During fiscal 2014, the U.S. Internal Revenue Service ("IRS") closed audits of fiscal years 2003 through 2005. The IRS is currently conducting audits of fiscal years 2006 through 2010.
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; tax payments; and current and projected debt service requirements, dividends and share repurchases. If we decide to engage in one or more additional


17

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


acquisitions, depending on the size and timing of such transactions, we may need to access capital in addition to cash on hand and our existing committed credit facilities.
Cash and Equivalents
Our cash and equivalents balance was $2.9 billion at June 30, 2014, compared to $1.9 billion at June 30, 2013. At June 30, 2014, our cash and equivalents were held in cash depository accounts with major banks or invested in high quality, short-term liquid investments.
The increase in cash and equivalents during fiscal 2014 was driven by net cash provided by operating activities of $2.5 billion, which was deployed for share repurchases ($673 million), acquisitions ($519 million) and dividends ($415 million). As anticipated, net cash provided by operating activities benefited from a net working capital decrease in excess of $500 million as a result of the Walgreens contract expiration.
During fiscal 2013, we deployed $2.2 billion of cash on acquisitions, $450 million on share repurchases and $353 million on dividends. During fiscal 2013, we received net proceeds from long-term obligations of $981 million.
During fiscal 2012, we deployed $450 million of cash on share repurchases, $300 million on dividends, $260 million on capital expenditures and $174 million on acquisitions. During fiscal 2012, we received net proceeds from long-term obligations of $290 million.
Our working capital can vary significantly depending on factors such as customer payments of accounts receivable, the timing of inventory purchases and payments to vendors in the regular course of business. The decrease in net working capital at June 30, 2014 compared to June 30, 2013 is primarily a result of the Walgreens contract expiration.
The cash and equivalents balance at June 30, 2014 included $420 million of cash held by subsidiaries outside of the United States. Although the vast majority of this cash is available for repatriation, permanently bringing the money into the United States could trigger U.S. federal, state and local income tax obligations. As a U.S. parent company, we may temporarily access cash held by our foreign subsidiaries without becoming subject to U.S. federal income tax through intercompany loans.
Credit Facilities and Commercial Paper
On October 15, 2013, we reduced our committed receivables sales facility program through Cardinal Health Funding, LLC ("CHF") from $950 million to $700 million in light of the Walgreens contract expiration. In addition to our committed receivables sales facility program, our sources of liquidity include a $1.5 billion revolving credit facility and a commercial paper program of up to $1.5 billion, backed by the revolving credit facility.
We had no outstanding balance under the revolving credit facility at June 30, 2014 and 2013, except for standby letters of credit
 
of zero and $43 million at June 30, 2014 and 2013, respectively. We had no outstanding borrowings from the commercial paper program at June 30, 2014 and 2013. We had no outstanding balance under the committed receivables sales facility program at June 30, 2014 and 2013, except for standby letters of credit of $41 million and zero at June 30, 2014 and 2013, respectively. Our revolving credit facility and committed receivables sales facility program require us to maintain a consolidated interest coverage ratio, as of any fiscal quarter end, of at least 4-to-1 and a consolidated leverage ratio of no more than 3.25-to-1. As of June 30, 2014, we were in compliance with these financial covenants.
Available-for-Sale Securities
During fiscal 2014, we purchased $100 million of marketable securities, which are classified as available-for-sale.
Long-Term Obligations and Other Short-Term Borrowings
At June 30, 2014, we had total long-term obligations and other short-term borrowings of $4.0 billion compared to $3.9 billion at June 30, 2013.
Capital Expenditures
Capital expenditures during fiscal 2014, 2013 and 2012 were $249 million, $195 million and $260 million, respectively.
We expect capital expenditures in fiscal 2015 to be between $335 million to $365 million primarily for growth projects in our core businesses as well as information technology projects.
Dividends
During fiscal 2014, we paid quarterly dividends totaling $1.21 per share, an increase of 18 percent from fiscal 2013. On May 7, 2014, our Board of Directors approved a 13 percent increase in our quarterly dividend to $0.3425 per share, or $1.37 per share on an annualized basis, which was paid on July 15, 2014 to shareholders of record on July 1, 2014.
On August 6, 2014, our Board of Directors approved a quarterly dividend of $0.3425 per share, or $1.37 per share on an annualized basis, payable on October 15, 2014 to shareholders of record on October 1, 2014.
Share Repurchases
During fiscal 2014, we repurchased $673 million of our common shares. We funded the repurchases with cash on hand. At June 30, 2014, we had $727 million remaining under our current repurchase authorization which expires December 31, 2016. On August 6, 2014, our Board of Directors authorized an additional $1.0 billion under this share repurchase program.
Interest Rate and Currency Risk Management
We use interest rate swaps, foreign currency contracts and commodity contracts to manage our exposure to cash flow variability. We also use interest rate swaps to protect the value of our debt and foreign currency forward contracts to protect the


18

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


value of our existing foreign currency assets and liabilities. See "Item 7A: Quantitative and Qualitative Disclosures About Market Risk" below as well as Notes 1 and 12 of the “Notes to Consolidated Financial Statements” for information regarding the use of financial instruments and derivatives as well as foreign currency, interest rate and commodity exposures.
Off-Balance Sheet Arrangements
We had no significant off-balance sheet arrangements at June 30, 2014.
Contractual Obligations
At June 30, 2014, our contractual obligations, including estimated payments due by period, are as follows:
(in millions)
2015
 
2016 to
2017
 
2018 to
2019
 
There-after
 
Total
Long-term debt and short-term borrowings (1)
$
800

 
$
787

 
$
560

 
$
1,796

 
$
3,943

Interest on long-term debt
155

 
236

 
151

 
562

 
1,104

Capital lease obligations (2)
1

 
23

 
2

 
3

 
29

Other liabilities (3)
3

 
2

 

 

 
5

Operating leases (4)
97

 
140

 
76

 
74

 
387

Purchase obligations and other payments (5)
275

 
293

 
236

 
513

 
1,317

Total contractual obligations
$
1,331

 
$
1,481

 
$
1,025

 
$
2,948

 
$
6,785

 
(1)
Represents maturities of our long-term debt obligations and other short-term borrowings excluding capital lease obligations described below. See Note 7 of the “Notes to Consolidated Financial Statements” for further information.
(2)
Represents maturities of our capital lease obligations included within long-term debt in our consolidated balance sheets.
(3)
Represents cash outflows by period for certain of our liabilities in which cash outflows could be reasonably estimated. Long-term liabilities, such as unrecognized tax benefits and deferred taxes, have been excluded from the table above because of the inherent uncertainty of the underlying tax positions or because of the inability to reasonably estimate the timing of any cash outflows. See Note 8 of the “Notes to Consolidated Financial Statements” for further discussion of income taxes.
(4)
Represents minimum rental payments and the related estimated future interest payments for operating leases having initial or remaining non-cancelable lease terms as described in Note 9 of the “Notes to Consolidated Financial Statements.”
(5)
A purchase obligation is defined as an agreement to purchase goods or services that is legally enforceable and specifies all significant terms, including fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and approximate timing of the transaction. The purchase obligation amounts disclosed above represent estimates of the minimum for which we are obligated and the time period in which cash outflows will occur. Purchase orders and authorizations to purchase that involve no firm commitment from either party are excluded from the above table. In addition, contracts that can be unilaterally canceled with no termination fee or with proper notice are excluded from our total purchase obligations except for the amount of the termination fee or the minimum amount of goods that must be purchased during the requisite notice period. Purchase obligations and other payments also includes 39 quarterly payments of $25.6 million that we are required to pay CVS commencing in October 2014 in connection with the establishment of Red Oak Sourcing, but does not include contingent payments that may
 
become payable under the joint venture. See Note 1 of the “Notes to Consolidated Financial Statements” for additional information.
Recent Financial Accounting Standards
See Note 1 of the “Notes to Consolidated Financial Statements” for a discussion of recent financial accounting standards.
Critical Accounting Policies and Sensitive Accounting Estimates
Critical accounting policies are those accounting policies that (i) can have a significant impact on our financial condition and results of operations and (ii) require use of complex and subjective estimates based upon past experience and management’s judgment. Other people applying reasonable judgment to the same facts and circumstances could develop different estimates. Because estimates are inherently uncertain, actual results may differ. In this section, we describe the significant policies applied in preparing our consolidated financial statements that management believes are the most dependent on estimates and assumptions. For additional accounting policies, see Note 1 of the “Notes to Consolidated Financial Statements.”
Allowance for Doubtful Accounts
Trade receivables are primarily comprised of amounts owed to us through our distribution businesses and are presented net of an allowance for doubtful accounts of $137 million and $134 million at June 30, 2014 and 2013, respectively. We also provide financing to various customers. Such financing arrangements range from 270 days to 5 years, at interest rates that are generally subject to fluctuation. Interest income on these arrangements is recognized as it is earned. The financings may be collateralized, guaranteed by third parties or unsecured. Finance notes and related accrued interest are reported net of an allowance for doubtful accounts of $18 million and $17 million at June 30, 2014 and 2013, respectively, and are included in other assets (current portion is included in prepaid expenses and other) in the consolidated balance sheets. We must use judgment when deciding whether to extend credit and when estimating the required allowance for doubtful accounts.
The allowance for doubtful accounts includes portfolio and specific reserves. We determine the appropriate allowance by reviewing accounts receivable aging, industry trends, customer financial strength and credit standing, historical write-off trends and payment history. We also regularly evaluate how changes in economic conditions may affect credit risks.
Our methodology for estimating the allowance for doubtful accounts is assessed annually based on historical losses and economic, business and market trends. In addition, the allowance is reviewed quarterly and updated if appropriate. We may adjust the allowance for doubtful accounts if changes in customers’ financial condition or general economic conditions make defaults more frequent or severe.


19

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


The following table gives information regarding the allowance for doubtful accounts over the past three fiscal years:
(in millions, except percentages)
2014
 
2013
 
2012
Allowance for doubtful accounts
$
156

 
$
152

 
$
143

Reduction to allowance for customer deductions and write-offs
51

 
34

 
30

Charged to costs and expenses
51

 
41

 
22

 
 
 
 
 
 
Allowance as a percentage of customer receivables
2.8
%
 
2.3
%
 
2.2
%
Allowance as a percentage of revenue
0.17
%
 
0.15
%
 
0.13
%
A hypothetical 0.1 percent increase or decrease in the reserve as a percentage of trade receivables and finance notes receivables at June 30, 2014, would result in an increase or decrease in bad debt expense of $6 million.
We believe the reserve maintained and expenses recorded in fiscal 2014 are appropriate. At this time, we are not aware of any analytical findings or customer issues that might lead to a significant future increase in the allowance for doubtful accounts as a percentage of revenue.
Inventories
A substantial portion of our inventories (61 percent and 65 percent at June 30, 2014 and 2013, respectively) are valued at the lower of cost, using the last-in, first-out ("LIFO") method, or market. These are primarily merchandise inventories at the core pharmaceutical distribution facilities within our Pharmaceutical segment. The LIFO impact on the consolidated statements of earnings in a given year depends on pharmaceutical price appreciation and the level of inventory. Prices for branded pharmaceuticals generally tend to rise, which results in an increase in cost of products sold, whereas prices for generic pharmaceuticals generally tend to decline, which results in a decrease in cost of products sold.
The LIFO method presumes that the most recent inventory purchases are the first items sold, so LIFO helps us better match current costs and revenue. Using LIFO, if there is a decrease in inventory levels that have experienced pharmaceutical price appreciation, the result generally will be a decrease in future cost of products sold as our older inventory is held at a lower cost. Conversely, if there is a decrease in inventory levels that have experienced a pharmaceutical price decline, the result generally will be an increase in future cost of products sold as our older inventory is held at a higher cost. We believe that the average cost method of inventory valuation reasonably approximates the current cost of replacing inventory within the core pharmaceutical distribution facilities. Accordingly, the LIFO reserve is the difference between (a) inventory at the lower of LIFO cost or market and (b) inventory at replacement cost determined using the average cost method of inventory valuation.
The remaining inventory is stated at the lower of cost, using the first in, first out method, or market. If we had used the average
 
cost method of inventory valuation for all inventory within the Pharmaceutical distribution facilities, the value of our inventories would not have changed in fiscal 2014 or 2013. Primarily because prices for our generic pharmaceutical inventories have declined over time, inventories valued at LIFO were $98 million and $97 million higher than the average cost value at June 30, 2014 and 2013, respectively. We do not record inventories in excess of replacement cost. As such, we did not record any changes in our LIFO reserve in fiscal 2014 and 2013.
Inventories presented in the consolidated balance sheets are net of reserves for excess and obsolete inventory which were $44 million and $40 million at June 30, 2014 and 2013, respectively. We reserve for inventory obsolescence using estimates based on historical experience, sales trends, specific categories of inventory and age of on-hand inventory. If actual conditions are less favorable than our assumptions, additional inventory reserves may be required.
Business Combinations
The assets acquired and liabilities assumed in a business combination, including identifiable intangible assets, are based on their estimated fair values as of the acquisition date. The excess of the purchase price over the estimated fair value of the net tangible and identifiable intangible assets acquired is recorded as goodwill. We base the fair values of identifiable intangible assets on detailed valuations that require management to make significant judgments, estimates and assumptions. Critical estimates and assumptions include: expected future cash flows for customer relationships, trademarks, trade names, developed technology and other identifiable intangible assets; discount rates that reflect the risk factors associated with future cash flows; and estimates of useful lives. When an acquisition involves contingent consideration, we recognize a liability equal to the fair value of the contingent consideration obligation at the acquisition date. The estimate of fair value of a contingent consideration obligation requires subjective assumptions to be made regarding future business results, discount rates and probabilities assigned to various potential business result scenarios. Subsequent revisions to these assumptions could materially change the estimate of the fair value of contingent consideration obligations and therefore could materially affect our financial position or results of operations. See Note 2 of the “Notes to Consolidated Financial Statements” for additional information regarding our acquisitions.
Goodwill and Other Intangible Assets
Purchased goodwill and intangible assets with indefinite lives are not amortized, but instead are tested for impairment annually or when indicators of impairment exist. Intangible assets with finite lives, primarily customer relationships, trademarks and patents, and non-compete agreements, are amortized over their useful lives.


20

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


Goodwill impairment testing involves a comparison of the estimated fair value of reporting units to the respective carrying amount, which may be performed utilizing either a qualitative or quantitative assessment. A reporting unit is defined as an operating segment or one level below an operating segment (also known as a component). If the estimated fair value exceeds the carrying amount, then no impairment exists. If the carrying amount exceeds the estimated fair value, then a second step is performed to determine the amount of impairment, if any. An impairment charge is the amount by which the carrying amount of goodwill exceeds the estimated implied fair value of goodwill. We estimate the implied fair value of goodwill as the excess of the estimated fair value of the reporting unit over the estimated fair value of its net tangible and identifiable intangible assets. This is the same manner we use to recognize goodwill from a business combination. Goodwill impairment testing involves judgment, including the identification of reporting units, the estimation of the fair value of each reporting unit and, if necessary, the estimation of the implied fair value of goodwill.
We have two operating segments, which are the same as our reportable segments: Pharmaceutical and Medical. These operating segments are comprised of divisions (components), for which discrete financial information is available. Components are aggregated into reporting units for purposes of goodwill impairment testing to the extent that they share similar economic characteristics. Our reporting units are: Pharmaceutical operating segment (excluding our Nuclear Pharmacy Services division and Cardinal Health China - Pharmaceutical division); Nuclear Pharmacy Services division; Cardinal Health China - Pharmaceutical division; Medical operating segment (excluding our Home division); and Home division.
Fair value can be determined using market, income or cost-based approaches. Our determination of estimated fair value of the reporting units is based on a combination of the income-based and market-based approaches. Under the income-based approach, we use a discounted cash flow model in which cash flows anticipated over several future periods, plus a terminal value at the end of that time horizon, are discounted to their present value using an appropriate risk-adjusted rate of return. We use our internal forecasts to estimate future cash flows and include an estimate of long-term growth rates based on our most recent views of the long-term outlook for each reporting unit. Actual results may differ materially from those used in our forecasts. We use discount rates that are commensurate with the risks and uncertainty inherent in the respective reporting units and in our internally-developed forecasts. Discount rates used in our reporting unit valuations ranged from 9 to 12 percent. Under the market-based approach, we determine fair value by comparing our reporting units to similar businesses or guideline companies whose securities are actively traded in public markets. To further confirm fair value, we compare the aggregate fair value of our reporting units to our total market capitalization. Estimating the fair value of
 
reporting units requires the use of estimates and significant judgments that are based on a number of factors including actual operating results. The use of alternate estimates and assumptions or changes in the industry or peer groups could materially affect the determination of fair value for each reporting unit and potentially result in goodwill impairment.
We performed annual impairment testing in fiscal 2014, 2013 and 2012 and, with the exception of our Nuclear Pharmacy Services division in fiscal 2013, concluded that there were no impairments of goodwill as the estimated fair value of each reporting unit exceeded its carrying value. For our fiscal 2014, 2013 and 2012 testing, we elected to bypass the optional qualitative assessment. With the exception of our Nuclear Pharmacy Services division in fiscal 2013, if we were to alter our impairment testing by increasing the discount rate in the discounted cash flow analysis by 1 percent, there still would not be any impairment indicated for any of these reporting units for fiscal 2014, 2013 or 2012. As discussed further in Note 5 of the “Notes to Consolidated Financial Statements”, 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, which is included in impairments and loss on disposal of assets in our consolidated statements of earnings.
We review intangible assets with finite lives for impairment whenever events or changes in circumstances indicate that the related carrying amounts may not be recoverable. Determining whether an impairment loss occurred requires a comparison of the carrying amount to the sum of the undiscounted cash flows expected to be generated by the asset.
Vendor Reserves
In the ordinary course of business, our vendors may dispute deductions taken against payments otherwise due to them or assert other billing disputes. These disputed transactions are researched and resolved based upon our policy and findings of the research performed. At any given time, there are outstanding items in various stages of research and resolution. In determining appropriate reserves for areas of exposure with our vendors, we assess historical experience and current outstanding claims. We have established various levels of reserves based on the type of claim and status of review. Though the transaction types are relatively consistent, we periodically refine our methodology by updating the reserve estimate percentages to reflect actual historical experience. Changes to the estimate percentages affect the cost of products sold in the period in which the change was made.
Vendor reserves were $82 million and $66 million at June 30, 2014 and 2013, respectively. Approximately 68 percent of the vendor reserve at the end of fiscal 2014 pertained to the Pharmaceutical segment compared to 60 percent at the end of fiscal 2013. The reserve balance will fluctuate due to variations


21

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


of outstanding claims from period-to-period, timing of settlements, and specific vendor issues, such as bankruptcies.
The ultimate outcome of specific claims may be different than our original estimate and may require adjustment. We believe, however, that reserves recorded for such disputes are adequate based upon current facts and circumstances.
Loss Contingencies
We accrue for contingencies related to disputes, litigation and regulatory matters if it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. Because these matters are inherently unpredictable and unfavorable developments or resolutions can occur, assessing contingencies is highly subjective and requires judgments about future events. We regularly review contingencies to determine whether our accruals and related disclosures are adequate. The amount of ultimate loss may differ from these estimates. See Note 9 of the “Notes to Consolidated Financial Statements” for additional information regarding loss contingencies.
Provision for Income Taxes
Our income tax expense, deferred income tax assets and liabilities, and unrecognized tax benefits reflect management’s assessment of estimated future taxes to be paid on items in the consolidated financial statements.
Deferred income taxes arise from temporary differences between financial reporting and tax reporting bases of assets and liabilities, as well as net operating loss and tax credit carryforwards for tax purposes. The following table presents information about our tax position at June 30:
(in millions)
2014
 
2013
Net deferred income tax assets
$
444

 
$
510

Net deferred income tax liabilities
1,653

 
1,638

Loss and credit carryforwards included in net deferred income tax assets
191

 
158

Net valuation allowance against deferred income tax assets (1)
94

 
88

(1)
This valuation allowance primarily relates to federal, state and international loss carryforwards for which the ultimate realization of future benefits is uncertain.
Expiring loss and credit carryforwards and the required valuation allowances are adjusted annually. After applying the valuation allowances, we do not anticipate any limitations on our use of any of the other net deferred income tax assets described above.
We believe that our estimates for the valuation allowances against deferred tax assets and unrecognized tax benefits are appropriate based on current facts and circumstances. However, others applying reasonable judgment to the same facts and circumstances could develop different estimates. The amount we ultimately pay when matters are resolved may differ from the amounts accrued.
 
Tax benefits from uncertain tax positions are recognized when it is more likely than not that the position will be sustained upon examination of the technical merits of the position, including resolutions of any related appeals or litigation processes. The amount recognized is measured as the largest amount of tax benefit that is greater than 50 percent likely of being realized upon settlement. See Note 8 of the “Notes to Consolidated Financial Statements” for additional information regarding unrecognized tax benefits.
If any of our assumptions or estimates were to change, an increase or decrease in our effective income tax rate by 1 percent would have caused income tax expense to increase or decrease $18 million for fiscal 2014.
Share-Based Compensation
Share-based compensation to employees is recognized in the consolidated statements of earnings based on the grant date fair value of the awards. The fair value of restricted share units and performance share units is determined by the grant date market price of our common shares. The compensation expense associated with nonvested performance share units is dependent on our periodic assessment of the probability of the targets being achieved and our estimate, which may vary over time, of the number of shares that ultimately will be issued. The fair value of stock options is determined using a lattice valuation model. We believe the lattice model provides reasonable estimates because it has the ability to take into account employee exercise patterns based on changes in our stock price and other variables and it provides for a range of input assumptions.
We analyze historical data to estimate option exercise behaviors and employee terminations to be used within the lattice model. The expected life of the options granted is calculated from the option valuation model and represents the length of time in years that the options granted are expected to be outstanding. Expected volatilities are based on implied volatility from traded options on our common shares and historical volatility over a period of time commensurate with the contractual term of the option grant (up to ten years). As required, the forfeiture estimates are adjusted to reflect actual forfeitures when an award vests. The actual forfeitures in future reporting periods could be higher or lower than our current estimates. See Note 16 of the "Notes to Consolidated Financial Statements" for additional information regarding share-based compensation.
Item 7A: Quantitative and Qualitative Disclosures About Market Risk
We are exposed to cash flow and earnings fluctuations as a result of certain market risks. These market risks primarily relate to foreign exchange, interest rate and commodity price-related changes. We maintain a hedging program to manage volatility related to these market exposures which employs operational, economic and derivative financial instruments in order to mitigate risk. See Notes 1 and 12 of the “Notes to Consolidated


22

 
Cardinal Health, Inc. and Subsidiaries
 
 
 


Financial Statements” for further discussion regarding our use of derivative instruments.
Foreign Exchange Rate Sensitivity
By nature of our global operations, we are exposed to cash flow and earnings fluctuations resulting from foreign exchange rate variation. These exposures are transactional and translational in nature. Principal drivers of this foreign exchange exposure include the Canadian dollar, Thai baht, Mexican peso, Chinese renminbi, European euro, Japanese yen, Singapore dollar, and Malaysian ringgit.
Transactional Exposure
Transactional exposure arises from the purchase and sale of goods and services in currencies other than our functional currency or the functional currency of our subsidiaries. As part of our risk management program, at the end of each fiscal year we perform a sensitivity analysis on our forecasted transactional exposure for the upcoming fiscal year. These analyses include the estimated impact of our hedging program, which mitigates transactional exposure. At June 30, 2014 and 2013, we had hedged approximately 48 and 45 percent of transactional exposures, respectively. The following table summarizes the analysis as it relates to transactional exposure and the impact of a hypothetical 10 percent increase or decrease at June 30:
(in millions)
2014
 
2013
Net estimated transactional exposure
$
378

 
$
368

 
 
 
 
Sensitivity gain/loss
$
38

 
$
37

Estimated offsetting impact of hedges
(18
)
 
(17
)
Estimated net gain/loss
$
20

 
$
20

Translational Exposure
We have exposure related to the translation of financial statements of our foreign operations into U.S. dollars, our functional currency. We perform a similar analysis to that described above related to this translational exposure. We do not typically hedge any of our translational exposure and no hedging impact was included in our analysis at June 30, 2014 and 2013. The following table summarizes translational exposure and the impact of a hypothetical 10 percent strengthening or weakening in the U.S. dollar at June 30:
(in millions)
2014
 
2013
Net estimated translational exposure
$
62

 
$
53

Sensitivity gain/loss
6

 
5

Interest Rate Sensitivity
We are exposed to changes in interest rates primarily as a result of our borrowing and investing activities to maintain liquidity and fund operations. The nature and amount of our long-term and short-term debt can be expected to fluctuate as a result of business requirements, market conditions and other factors. Our policy is to manage exposures to interest rates using a mix of fixed and floating rate debt as deemed appropriate by
 
management. We utilize interest rate swap instruments to mitigate our exposure to interest rate movements.
As part of our risk management program, we perform an annual sensitivity analysis on our forecasted exposure to interest rates for the following fiscal year. This analysis assumes a hypothetical 10 percent change in interest rates. At June 30, 2014 and 2013, the potential increase or decrease in annual interest expense under this analysis as a result of this hypothetical change was $4 million and $2 million, respectively.
During fiscal 2014, we purchased marketable securities, which are classified as available-for-sale and are carried at fair value in the consolidated balance sheets. The fair value is subject to change primarily as a result of changes in market interest rates and investment risk related to the issuers' credit worthiness. At June 30, 2014, a hypothetical increase or decrease of 100 basis points in interest rates would cause a potential decrease of up to $1 million in the estimated fair value.
Commodity Price Sensitivity
We are exposed to market price changes for commodities, including oil-based resins, cotton, latex, and diesel fuel. We typically purchase raw materials at market prices and some finished goods at prices based in part on a commodity price index. As part of our risk management program, we perform sensitivity analysis on our forecasted commodity exposure for the following fiscal year. Our forecasted commodity exposure at June 30, 2014 decreased from the prior year primarily as a result of commodity prices and changes in purchasing volumes.
At June 30, 2014 and 2013, we had hedged a portion of these commodity exposures (see Note 12 of the “Notes to Consolidated Financial Statements” for further discussion). The table below summarizes our analysis of these forecasted commodity exposures and a hypothetical 10 percent fluctuation in commodity prices at June 30:
(in millions)
2014
 
2013
Estimated commodity exposure
$
321

 
$
369

 
 
 
 
Sensitivity gain/loss
$
32

 
$
37

Estimated offsetting impact of hedges
(1
)
 
(1
)
Estimated net gain/loss
$
31

 
$
36

We also are exposed to fluctuations in commodities' prices through the purchase of finished goods and various other energy-related commodities, including natural gas and electricity, through our normal course of business where our contracts are not directly tied to a commodity index. We believe our total gross range of exposure to commodities, including the items listed in the table above, is $400 million to $500 million at June 30, 2014.


23

 
Cardinal Health, Inc. and Subsidiaries
 
 
 


Item 8: Financial Statements and Supplementary Data

24

 
Cardinal Health, Inc. and Subsidiaries
 
 
 


Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders of Cardinal Health, Inc.
We have audited the accompanying consolidated balance sheets of Cardinal Health, Inc. and subsidiaries as of June 30, 2014 and 2013, and the related consolidated statements of earnings, comprehensive income, shareholders' equity, and cash flows for each of the three years in the period ended June 30, 2014. Our audits also included the financial statement schedule listed in the Index at Item 15(a)(2). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
 
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Cardinal Health, Inc. and subsidiaries at June 30, 2014 and 2013, and the consolidated results of their operations and their cash flows for each of the three years in the period ended June 30, 2014, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Cardinal Health, Inc. and subsidiaries' internal control over financial reporting as of June 30, 2014, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (1992 framework) and our report dated August 13, 2014 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
 
Columbus, Ohio
August 13, 2014


25

 
Cardinal Health, Inc. and Subsidiaries
 
 
 


Consolidated Statements of Earnings
(in millions, except per common share amounts)
2014
 
2013
 
2012
Revenue
$
91,084

 
$
101,093

 
$
107,552

Cost of products sold
85,923

 
96,172

 
103,011

Gross margin
5,161

 
4,921

 
4,541

 
 
 
 
 
 
Operating expenses:
 
 
 
 
 
Distribution, selling, general and administrative expenses
3,028

 
2,875

 
2,677

Restructuring and employee severance
31

 
71

 
21

Amortization and other acquisition-related costs
223

 
158

 
33

Impairments and loss on disposal of assets
15

 
859

 
21

Litigation (recoveries)/charges, net
(21
)
 
(38
)
 
(3
)
Operating earnings
1,885

 
996

 
1,792

 
 
 
 
 
 
Other income, net
(46
)
 
(15
)
 
(1
)
Interest expense, net
133

 
123

 
95

Earnings before income taxes and discontinued operations
1,798

 
888

 
1,698

 
 
 
 
 
 
Provision for income taxes
635

 
553

 
628

Earnings from continuing operations
1,163

 
335

 
1,070

 
 
 
 
 
 
Earnings/(loss) from discontinued operations, net of tax
3

 
(1
)
 
(1
)
Net earnings
$
1,166

 
$
334

 
$
1,069

 
 
 
 
 
 
Basic earnings per common share:
 
 
 
 
 
Continuing operations
$
3.41

 
$
0.98

 
$
3.10

Discontinued operations
0.01

 

 

Net basic earnings per common share
$
3.42

 
$
0.98

 
$
3.10

 
 
 
 
 
 
Diluted earnings per common share:
 
 
 
 
 
Continuing operations
$
3.37

 
$
0.97

 
$
3.06

Discontinued operations
0.01

 

 

Net diluted earnings per common share
$
3.38

 
$
0.97

 
$
3.06

 
 
 
 
 
 
Weighted-average number of common shares outstanding:
 
 
 
 
 
Basic
341

 
341

 
345

Diluted
345

 
344

 
349

The accompanying notes are an integral part of these consolidated statements.

26

 
Cardinal Health, Inc. and Subsidiaries
 
 
 


Consolidated Statements of Comprehensive Income
(in millions)
2014
 
2013
 
2012
Net earnings
$
1,166

 
$
334

 
$
1,069

 
 
 
 
 
 
Other comprehensive income/(loss):
 
 
 
 
 
Net change in foreign currency translation adjustments
9

 
18

 
(34
)
Net unrealized gain/(loss) on derivative instruments, net of tax
(7
)
 
13

 
(6
)
Total other comprehensive income/(loss), net of tax
2

 
31

 
(40
)
Total comprehensive income
$
1,168

 
$
365

 
$
1,029

The accompanying notes are an integral part of these consolidated statements.

27

 
Cardinal Health, Inc. and Subsidiaries
 
 
 


Consolidated Balance Sheets
 
June 30
(in millions)
2014
 
2013
Assets
 
 
 
Current assets:
 
 
 
Cash and equivalents
$
2,865

 
$
1,901

Trade receivables, net
5,380

 
6,304

Inventories, net
8,266

 
8,373

Prepaid expenses and other
1,428

 
1,192

Total current assets
17,939

 
17,770

 
 
 
 
Property and equipment, net
1,459

 
1,489

Goodwill and other intangibles, net
5,870

 
5,574

Other assets
765

 
986

Total assets
$
26,033

 
$
25,819

 
 
 
 
Liabilities and Shareholders’ Equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
12,149

 
$
12,295

Current portion of long-term obligations and other short-term borrowings
801

 
168

Other accrued liabilities
2,165

 
2,127

Total current liabilities
15,115

 
14,590

 
 
 
 
Long-term obligations, less current portion
3,171

 
3,686

Deferred income taxes and other liabilities
1,346

 
1,568

 
 
 
 
Shareholders’ equity:
 
 
 
Preferred shares, without par value:
 
 
 
Authorized—500 thousand shares, Issued—none

 

Common shares, without par value:
 
 
 
Authorized—755 million shares, Issued—364 million shares at June 30, 2014 and 2013
2,980

 
2,953

Retained earnings
4,774

 
4,038

Common shares in treasury, at cost: 27 million shares and 25 million shares at June 30, 2014 and 2013, respectively
(1,423
)
 
(1,084
)
Accumulated other comprehensive income
70

 
68

Total shareholders’ equity
6,401

 
5,975

Total liabilities and shareholders’ equity
$
26,033

 
$
25,819

The accompanying notes are an integral part of these consolidated statements.

28

 
Cardinal Health, Inc. and Subsidiaries
 
 
 


Consolidated Statements of Shareholders' Equity
 
Common Shares
 
 
 
Treasury Shares
 
Accumulated Other
Comprehensive
Income/(Loss)
 
Total
Shareholders’
Equity
(in millions)
Shares Issued
 
Amount
 
Retained
Earnings
 
Shares
 
Amount
 
 
Balance at June 30, 2011
364

 
$
2,898

 
$
3,331

 
(12
)
 
$
(457
)
 
$
77

 
$
5,849

Net earnings
 
 
 
 
1,069

 
 
 
 
 
 
 
1,069

Other comprehensive loss, net of tax
 
 
 
 
 
 
 
 
 
 
(40
)
 
(40
)
Employee stock plans activity, including tax impact of $4 million

 
32

 
 
 
1

 
91

 
 
 
123

Treasury shares acquired
 
 
 
 
 
 
(10
)
 
(450
)
 
 
 
(450
)
Dividends declared
 
 
 
 
(307
)
 
 
 
 
 
 
 
(307
)
Balance at June 30, 2012
364

 
2,930

 
4,093

 
(21
)
 
(816
)
 
37

 
6,244

Net earnings
 
 
 
 
334

 
 
 
 
 
 
 
334

Other comprehensive income, net of tax
 
 
 
 
 
 
 
 
 
 
31

 
31

Employee stock plans activity, including tax impact of $19 million

 
23

 
 
 
6

 
182

 
 
 
205

Treasury shares acquired
 
 
 
 
 
 
(10
)
 
(450
)
 
 
 
(450
)
Dividends declared
 
 
 
 
(374
)
 
 
 
 
 
 
 
(374
)
Other
 
 
 
 
(15
)
 
 
 
 
 
 
 
(15
)
Balance at June 30, 2013
364

 
2,953

 
4,038

 
(25
)
 
(1,084
)
 
68

 
5,975

Net earnings
 
 
 
 
1,166

 
 
 
 
 
 
 
1,166

Other comprehensive income, net of tax
 
 
 
 
 
 
 
 
 
 
2

 
2

Employee stock plans activity, including tax impact of $39 million

 
27

 
 
 
8

 
334

 
 
 
361

Treasury shares acquired
 
 
 
 
 
 
(10
)
 
(673
)
 
 
 
(673
)
Dividends declared
 
 
 
 
(430
)
 
 
 
 
 
 
 
(430
)
Balance at June 30, 2014
364

 
$
2,980

 
$
4,774

 
(27
)
 
$
(1,423
)
 
$
70

 
$
6,401

The accompanying notes are an integral part of these consolidated statements.

29

 
Cardinal Health, Inc. and Subsidiaries
 
 
 


Consolidated Statements of Cash Flows
(in millions)
2014
 
2013
 
2012
Cash flows from operating activities:
 
 
 
 
 
Net earnings
$
1,166

 
$
334

 
$
1,069

(Earnings)/loss from discontinued operations, net of tax
(3
)
 
1

 
1

Earnings from continuing operations
1,163

 
335

 
1,070

 
 
 
 
 
 
Adjustments to reconcile earnings from continuing operations to net cash provided by operating activities:
 
 
 
 
 
Depreciation and amortization
459

 
397

 
325

Gain on sale of investments
(32
)
 

 

Impairments and loss on disposal of assets
15

 
859

 
21

Share-based compensation
96

 
93

 
85

Provision for deferred income taxes
26

 
21

 
158

Provision for bad debts
42

 
31

 
22

Change in fair value of contingent consideration obligation

 

 
(71
)
Change in operating assets and liabilities, net of effects from acquisitions:
 
 
 
 
 
Decrease/(increase) in trade receivables
925

 
216

 
(129
)
Decrease/(increase) in inventories
142

 
(370
)
 
(495
)
Increase/(decrease) in accounts payable
(196
)
 
426

 
319

Other accrued liabilities and operating items, net
(116
)
 
(281
)
 
(129
)
Net cash provided by operating activities
2,524

 
1,727

 
1,176

 
 
 
 
 
 
Cash flows from investing activities:
 
 
 
 
 
Acquisition of subsidiaries, net of cash acquired
(519
)
 
(2,239
)
 
(174
)
Additions to property and equipment
(249
)
 
(195
)
 
(260
)
Purchase of available-for-sale securities, held-to-maturity securities and other investments
(129
)
 
(12
)
 
(35
)
Proceeds from sale of investments
47

 

 

Proceeds from maturities of held-to-maturity securities

 
71

 
92

Net cash used in investing activities
(850
)
 
(2,375
)
 
(377
)
 
 
 
 
 
 
Cash flows from financing activities:
 
 
 
 
 
Payment of contingent consideration obligation

 
(4
)
 

Net change in short-term borrowings
114

 
(1
)
 
13

Reduction of long-term obligations
(2
)
 
(305
)
 
(251
)
Proceeds from long-term obligations, net of issuance costs

 
1,286

 
496

Net proceeds from issuance of common shares
227

 
121

 
42

Tax proceeds/(disbursements) from share-based compensation
39

 
(19
)
 
(4
)
Dividends on common shares
(415
)
 
(353
)
 
(300
)
Purchase of treasury shares
(673
)
 
(450
)
 
(450
)
Net cash provided by/(used in) financing activities
(710
)
 
275

 
(454
)
 
 
 
 
 
 
Net increase/(decrease) in cash and equivalents
964

 
(373
)
 
345

Cash and equivalents at beginning of period
1,901

 
2,274

 
1,929

Cash and equivalents at end of period
$
2,865

 
$
1,901

 
$
2,274

 
 
 
 
 
 
Supplemental information:
 
 
 
 
 
Cash payments for interest
$
152

 
$
128

 
$
118

Cash payments for income taxes
632

 
899

 
513

The accompanying notes are an integral part of these consolidated statements.

30

 
Cardinal Health, Inc. and Subsidiaries
Notes to Consolidated Financial Statements



1. Basis of Presentation, Summary of Significant Accounting Policies and Other
Cardinal Health, Inc. is a healthcare services company providing pharmaceutical and medical products and services that help pharmacies, hospitals and other healthcare providers focus on patient care while reducing costs, enhancing efficiency and improving quality. Cardinal Health, Inc. also provides medical products to patients in the home. References to “we”, “our” and similar pronouns in these consolidated financial statements are to Cardinal Health, Inc. and its majority-owned or controlled subsidiaries unless the context otherwise requires.
Our fiscal year ends on June 30. References to fiscal 2014, 2013 and 2012 in these consolidated financial statements are to the fiscal years ended June 30, 2014, 2013 and 2012, respectively.
Basis of Presentation
Our consolidated financial statements include the accounts of all majority-owned or controlled subsidiaries, and all significant intercompany transactions and amounts have been eliminated. To conform to the current year presentation, certain prior year amounts have been reclassified. The results of businesses acquired or disposed of are included in the consolidated financial statements from the date of the acquisition or up to the date of disposal, respectively.
Use of Estimates
Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). The preparation of financial statements in accordance with GAAP requires us to make estimates, judgments and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Estimates, judgments and assumptions are used in the accounting and disclosure related to, among other items, allowance for doubtful accounts, inventory valuation, business combinations, goodwill and other intangible asset impairment, vendor reserves, loss contingencies, income taxes and share-based compensation. Actual amounts could ultimately differ from these estimated amounts.
Joint Venture With CVS Caremark
In July 2014, we established Red Oak Sourcing, LLC ("Red Oak Sourcing"), a U.S.-based generic pharmaceutical sourcing entity with CVS Caremark Corporation (“CVS”) with an initial term of 10 years. Both companies have contributed sourcing and supply chain expertise to the 50/50 joint venture and have committed to source generic pharmaceuticals through arrangements negotiated by it. Red Oak Sourcing will negotiate generic pharmaceutical supply contracts on behalf of both companies, but will not own products or hold inventory on behalf of either company. We are required to pay 39 quarterly payments of $25.6 million to CVS commencing in October 2014 and, only if certain milestones are achieved, to pay additional predetermined amounts to CVS beginning in fiscal 2016. The
 
fixed payments of $25.6 million will be e