To Our Employees, Customers and Shareholders,
Our purpose at Cardinal Health is very clear: to deliver solutions that help our customers fulfill their mission to provide better patient care. That simple statement places Cardinal Health in the enviable and responsible role of being a vital part of the health care “chain of care” around the world. We see health care as an industry that provides an exceptional growth opportunity for those who are innovative enough to pursue it. And we see it as an industry where our employees and customers can contribute profound value to improving people’s lives.
Fiscal 2005 was a challenging year for Cardinal Health. While there were significant accomplishments that better position us for the future, our financial performance was disappointing. We could have done better. First, highlights for the year included:
– The demand for Cardinal Health’s market-leading products and services was strong and unabated during the year. Revenue growth of 15 percent tells us that customers need and want our offerings.
– Our pharmaceutical distribution business led an industry-wide change in how drug distributors are fairly compensated for their services. We reached new “fee-for-service” terms with more than 100 of the most important pharmaceutical companies in the world.
– The integration of the strategically important, $2 billion Alaris Medical Systems, Inc. acquisition has been very successful. Alaris® products lead the market for intravenous medication systems, and have become central to our clinical services and patient safety strategy.
– We continued to introduce new products and innovations to the health-care market. The Pyxis MedStation® 3000 represents the next generation of the flagship medication management system pioneered by Pyxis. The Alaris business continues to produce a steady stream of new products and information services in the clinical arena. Proprietary offerings like CardinalAssist® and LogisticSourceSM services help hospitals reduce costs and manage inventory more effectively. And continued advances in our medical products manufacturing business produce important infection prevention products for health-care providers.
– We made significant progress on our compliance commitments. We responded aggressively to the matters surrounding the regulatory investigations and have implemented important improvements in our controls, compliance and governance practices.
– We introduced One Cardinal Health, a program designed to make our company more efficient and drive even greater innovation in our customer offerings. One of its most important outcomes has been our Integrated Provider Solutions strategy, which brings together our sales efforts for health-care providers under one structure to deliver integrated and innovative solutions with resources from across Cardinal Health.
Our purpose at Cardinal Health is very clear: to deliver solutions that help our customers fulfill their mission to provide better patient care. That simple statement places Cardinal Health in the enviable and responsible role of being a vital part of the health care “chain of care” around the world. We see health care as an industry that provides an exceptional growth opportunity for those who are innovative enough to pursue it. And we see it as an industry where our employees and customers can contribute profound value to improving people’s lives.
Fiscal 2005 was a challenging year for Cardinal Health. While there were significant accomplishments that better position us for the future, our financial performance was disappointing. We could have done better. First, highlights for the year included:
– The demand for Cardinal Health’s market-leading products and services was strong and unabated during the year. Revenue growth of 15 percent tells us that customers need and want our offerings.
– Our pharmaceutical distribution business led an industry-wide change in how drug distributors are fairly compensated for their services. We reached new “fee-for-service” terms with more than 100 of the most important pharmaceutical companies in the world.
– The integration of the strategically important, $2 billion Alaris Medical Systems, Inc. acquisition has been very successful. Alaris® products lead the market for intravenous medication systems, and have become central to our clinical services and patient safety strategy.
– We continued to introduce new products and innovations to the health-care market. The Pyxis MedStation® 3000 represents the next generation of the flagship medication management system pioneered by Pyxis. The Alaris business continues to produce a steady stream of new products and information services in the clinical arena. Proprietary offerings like CardinalAssist® and LogisticSourceSM services help hospitals reduce costs and manage inventory more effectively. And continued advances in our medical products manufacturing business produce important infection prevention products for health-care providers.
– We made significant progress on our compliance commitments. We responded aggressively to the matters surrounding the regulatory investigations and have implemented important improvements in our controls, compliance and governance practices.
– We introduced One Cardinal Health, a program designed to make our company more efficient and drive even greater innovation in our customer offerings. One of its most important outcomes has been our Integrated Provider Solutions strategy, which brings together our sales efforts for health-care providers under one structure to deliver integrated and innovative solutions with resources from across Cardinal Health.
Despite these successes, our performance was hurt by
operational issues in our sterile manufacturing and Pyxis
businesses. In sterile manufacturing, these challenges
created production delays that seriously dampened earnings.
And Pyxis’ delays in both installations and new product
introductions hurt revenue and earnings performance.
Additionally, while the transition to a new compensation
model in drug distribution was successful, it was costly
and volatile, as we anticipated in last year’s letter.
Financial and Business Highlights
For the year, revenues totaled $74.9 billion, with operating earnings of $1.8 billion. Diluted earnings per share from continuing operations, excluding special items, were $2.85*, and would have been $0.31 higher with non-recurring charges excluded. Fiscal 2005 marked the first earnings decline in Cardinal Health’s 35-year history. This is not something we expect to repeat in the future.
A compelling positive for the year was the cash flow generated from operations, at nearly $2.9 billion. This cash flow affords enormous strategic flexibility, but also benefited our shareholders with more than $552 million returned to them during the year in the form of cash dividends and share repurchases. The company’s balance sheet has never been stronger, ending the year with more than $1.4 billion in cash and a remarkably low 11 percent net debt to total capital ratio. So, we find ourselves financially strong, with the ability to invest for the future.
With the introduction of One Cardinal Health, we are becoming a more integrated company, both externally and internally. And we expect to realize benefits in both these areas. Externally, we have demonstrated the value of delivering integrated offerings for customers. New corporate agreements with health-care providers— contracts involving at least three Cardinal Health businesses—grew to more than $7 billion annually. These accounts grow faster, are more profitable and renew at higher levels than our stand-alone businesses.
The internal benefits of One Cardinal Health are equally compelling. In 2005, we achieved significant, ongoing cost savings through facility and product line rationalizations and discontinued operations. We expect over the next three years that program efficiencies and cost savings will yield additional, substantial benefits from further facility consolidations, global procurement and sourcing efforts, implementation of lean manufacturing and quality improvement programs, and the adoption of shared staff services.
Within our four reporting segments, we experienced a mix of consistent, steady performance with some notable operational challenges.
The Pharmaceutical Distribution and Provider Services segment reported strong revenue growth of 16 percent, to $61 billion, and operating earnings of $1 billion, down two percent from the prior year due to the volatility in branded vendor margins as we managed through the fee-for-service transition. Our negotiations with manufacturers demonstrate that Cardinal Health remains a highly efficient, critical link in the “chain of care.” Going forward, we expect continued strong revenue growth, more predictable profit margins and a return to strong operating earnings growth.
Our Medical Products and Services business posted yet another year of solid revenue performance, with sales rising seven percent to $9.8 billion. Earnings declined three percent to $672 million as this business worked to overcome competitive pricing pressures and significant increases in raw material and fuel costs. The introduction of disciplined expense controls, new international product sourcing strategies and new product introductions, as well as facility rationalizations as part of One Cardinal Health, are all expected to contribute to a return to earnings growth in fiscal 2006. In fact, we expect continued solid revenue growth, with earnings growing faster than revenue in this business.
Within Pharmaceutical Technologies and Services, revenue increased six percent to nearly $3 billion, while earnings declined by 28 percent to
$337 million. On the positive side, our Oral Technologies, Packaging Services and Nuclear Pharmacy Services businesses posted strong performances. The disappointment during the year was our sterile manufacturing business. This is a high margin business, with great demand, but one which failed to execute during the year due to operational issues that hampered production. A new leadership team has been established in this segment, and they are focused on resolving our sterile issues. Importantly, this business possesses highly regarded, market-leading, proprietary technologies in specialty pharmaceutical dosage forms. Looking ahead, continued demand should yield solid revenue growth, and we expect to grow earnings much faster than revenues as we address the issues in sterile and drive productivity.
Our Clinical Technologies and Services segment was created during 2005 to bring together all of our market-leading technologies and services in the clinical and medication safety areas. For the year, revenue was up 41 percent to $2.2 billion with operating earnings of $273 million. The Alaris acquisition has proven to be an accelerator of our clinical services strategy, with both revenue and earnings in this business meeting our expectations. Pyxis, however, experienced a very disappointing year with both revenue and earnings down sharply. A new leadership team in this segment, with a clear track record of turnaround experience, has established plans and actions for improvement. That team successfully launched the new Pyxis MedStation 3000 product line, introduced lean manufacturing and operational improvements, rationalized product lines and put particular focus on improving quality and customer service efforts. As demand for patient- and medication-safety products continues to increase, we expect this to be our fastest growing business over the next three years.
We can’t close out a review of 2005 without commenting on the status of actions we undertook to improve controls at the time we filed last year’s annual report. Demonstrable progress has been made in every area. Notably, three of the most senior finance roles in the company have been filled with proven outside talent: our Chief Financial Officer, Treasurer, and Chief Accounting Officer and Controller. And we recruited the company’s first ever Chief Ethics and Compliance Officer. In addition, we have met with our top 300 executives and engaged them in a dialogue on our core values. Lastly, we have made important accounting and control changes in many areas. Along with outstanding efforts to meet SOX 404 requirements, we concluded the year with no material weaknesses in our internal controls over financial reporting. And, our Audit Committee’s investigation of accounting and compliance issues is substantially completed.
Our Performance Commitment
We have very clear goals and objectives for our performance over the next three years. Our financial commitments are:
– Grow revenues by eight to 10 percent annually
– Grow diluted earnings per share ** by an average of 12 to 15 percent
– Achieve a return on equity* of 15 to 20 percent
– Return up to 50 percent of operating cash flow to shareholders via share repurchase and dividends
Health care continues to be among the most dynamic, growing and socially relevant industries in the world. Demand for health-care services continues to increase, and Cardinal Health’s combination of breadth, depth and information within the “chain of care” puts us in a unique position to offer solutions to our customers. The key to our success will be to integrate our capabilities for the benefit of our customers. That integration has started in a major way inside our company, under the banner of One Cardinal Health. The vision is clear and straightforward: to deliver integrated health-care solutions that help our customers provide better patient care. We have the financial resources to invest in the future, and a leadership team united around clear strategic and performance goals.
All companies face challenges over time. It’s how an organization responds to those challenges that ultimately determines its true character. We’re proud to represent Cardinal Health to our shareholders, to our customers and to our employees as a company emerging from 2005 as a stronger and more customer-focused leader in health care.
A Note about Hurricane Katrina
Just before going to press for this year‘s annual report, Hurricane Katrina devastated parts of Louisiana, Mississippi and the Gulf Coast of the United States, leaving immense damage, significant flooding and a number of casualties in its wake. Cardinal Health‘s important role in the chain of health care has been poignantly demonstrated in the aftermath of this tragedy, as was the case with the devastating tsunami in Asia earlier this year. Throughout our company, employees at every level redoubled their efforts on behalf of our customers and in support of each other. Hospitals, military and governmental agencies have turned to us for assistance with medical supplies and pharmaceuticals, and we ‘re both humbled and proud of the way in which our employees have responded. We encourage you to join Cardinal Health in supporting the American Red Cross in its relief efforts. To our employees, thank you for the assistance you have provided our customers and colleagues. Our thoughts and sympathies remain with all those affected and still in need.
Sincerely,
Financial and Business Highlights
For the year, revenues totaled $74.9 billion, with operating earnings of $1.8 billion. Diluted earnings per share from continuing operations, excluding special items, were $2.85*, and would have been $0.31 higher with non-recurring charges excluded. Fiscal 2005 marked the first earnings decline in Cardinal Health’s 35-year history. This is not something we expect to repeat in the future.
A compelling positive for the year was the cash flow generated from operations, at nearly $2.9 billion. This cash flow affords enormous strategic flexibility, but also benefited our shareholders with more than $552 million returned to them during the year in the form of cash dividends and share repurchases. The company’s balance sheet has never been stronger, ending the year with more than $1.4 billion in cash and a remarkably low 11 percent net debt to total capital ratio. So, we find ourselves financially strong, with the ability to invest for the future.
With the introduction of One Cardinal Health, we are becoming a more integrated company, both externally and internally. And we expect to realize benefits in both these areas. Externally, we have demonstrated the value of delivering integrated offerings for customers. New corporate agreements with health-care providers— contracts involving at least three Cardinal Health businesses—grew to more than $7 billion annually. These accounts grow faster, are more profitable and renew at higher levels than our stand-alone businesses.
The internal benefits of One Cardinal Health are equally compelling. In 2005, we achieved significant, ongoing cost savings through facility and product line rationalizations and discontinued operations. We expect over the next three years that program efficiencies and cost savings will yield additional, substantial benefits from further facility consolidations, global procurement and sourcing efforts, implementation of lean manufacturing and quality improvement programs, and the adoption of shared staff services.
Within our four reporting segments, we experienced a mix of consistent, steady performance with some notable operational challenges.
The Pharmaceutical Distribution and Provider Services segment reported strong revenue growth of 16 percent, to $61 billion, and operating earnings of $1 billion, down two percent from the prior year due to the volatility in branded vendor margins as we managed through the fee-for-service transition. Our negotiations with manufacturers demonstrate that Cardinal Health remains a highly efficient, critical link in the “chain of care.” Going forward, we expect continued strong revenue growth, more predictable profit margins and a return to strong operating earnings growth.
Our Medical Products and Services business posted yet another year of solid revenue performance, with sales rising seven percent to $9.8 billion. Earnings declined three percent to $672 million as this business worked to overcome competitive pricing pressures and significant increases in raw material and fuel costs. The introduction of disciplined expense controls, new international product sourcing strategies and new product introductions, as well as facility rationalizations as part of One Cardinal Health, are all expected to contribute to a return to earnings growth in fiscal 2006. In fact, we expect continued solid revenue growth, with earnings growing faster than revenue in this business.
Within Pharmaceutical Technologies and Services, revenue increased six percent to nearly $3 billion, while earnings declined by 28 percent to
$337 million. On the positive side, our Oral Technologies, Packaging Services and Nuclear Pharmacy Services businesses posted strong performances. The disappointment during the year was our sterile manufacturing business. This is a high margin business, with great demand, but one which failed to execute during the year due to operational issues that hampered production. A new leadership team has been established in this segment, and they are focused on resolving our sterile issues. Importantly, this business possesses highly regarded, market-leading, proprietary technologies in specialty pharmaceutical dosage forms. Looking ahead, continued demand should yield solid revenue growth, and we expect to grow earnings much faster than revenues as we address the issues in sterile and drive productivity.
Our Clinical Technologies and Services segment was created during 2005 to bring together all of our market-leading technologies and services in the clinical and medication safety areas. For the year, revenue was up 41 percent to $2.2 billion with operating earnings of $273 million. The Alaris acquisition has proven to be an accelerator of our clinical services strategy, with both revenue and earnings in this business meeting our expectations. Pyxis, however, experienced a very disappointing year with both revenue and earnings down sharply. A new leadership team in this segment, with a clear track record of turnaround experience, has established plans and actions for improvement. That team successfully launched the new Pyxis MedStation 3000 product line, introduced lean manufacturing and operational improvements, rationalized product lines and put particular focus on improving quality and customer service efforts. As demand for patient- and medication-safety products continues to increase, we expect this to be our fastest growing business over the next three years.
We can’t close out a review of 2005 without commenting on the status of actions we undertook to improve controls at the time we filed last year’s annual report. Demonstrable progress has been made in every area. Notably, three of the most senior finance roles in the company have been filled with proven outside talent: our Chief Financial Officer, Treasurer, and Chief Accounting Officer and Controller. And we recruited the company’s first ever Chief Ethics and Compliance Officer. In addition, we have met with our top 300 executives and engaged them in a dialogue on our core values. Lastly, we have made important accounting and control changes in many areas. Along with outstanding efforts to meet SOX 404 requirements, we concluded the year with no material weaknesses in our internal controls over financial reporting. And, our Audit Committee’s investigation of accounting and compliance issues is substantially completed.
Our Performance Commitment
We have very clear goals and objectives for our performance over the next three years. Our financial commitments are:
– Grow revenues by eight to 10 percent annually
– Grow diluted earnings per share ** by an average of 12 to 15 percent
– Achieve a return on equity* of 15 to 20 percent
– Return up to 50 percent of operating cash flow to shareholders via share repurchase and dividends
Health care continues to be among the most dynamic, growing and socially relevant industries in the world. Demand for health-care services continues to increase, and Cardinal Health’s combination of breadth, depth and information within the “chain of care” puts us in a unique position to offer solutions to our customers. The key to our success will be to integrate our capabilities for the benefit of our customers. That integration has started in a major way inside our company, under the banner of One Cardinal Health. The vision is clear and straightforward: to deliver integrated health-care solutions that help our customers provide better patient care. We have the financial resources to invest in the future, and a leadership team united around clear strategic and performance goals.
All companies face challenges over time. It’s how an organization responds to those challenges that ultimately determines its true character. We’re proud to represent Cardinal Health to our shareholders, to our customers and to our employees as a company emerging from 2005 as a stronger and more customer-focused leader in health care.
A Note about Hurricane Katrina
Just before going to press for this year‘s annual report, Hurricane Katrina devastated parts of Louisiana, Mississippi and the Gulf Coast of the United States, leaving immense damage, significant flooding and a number of casualties in its wake. Cardinal Health‘s important role in the chain of health care has been poignantly demonstrated in the aftermath of this tragedy, as was the case with the devastating tsunami in Asia earlier this year. Throughout our company, employees at every level redoubled their efforts on behalf of our customers and in support of each other. Hospitals, military and governmental agencies have turned to us for assistance with medical supplies and pharmaceuticals, and we ‘re both humbled and proud of the way in which our employees have responded. We encourage you to join Cardinal Health in supporting the American Red Cross in its relief efforts. To our employees, thank you for the assistance you have provided our customers and colleagues. Our thoughts and sympathies remain with all those affected and still in need.
Sincerely,
Robert D. Walter
Chairman and
Chief Executive Officer
Chairman and
Chief Executive Officer
George L. Fotiades
President and
Chief Operating Officer
President and
Chief Operating Officer
* Diluted earnings per share from continuing operations and return
on equity exclude special items. Reference page 25 for definitions of
these non-GAAP measures and/or for a reconciliation of such measures
to their comparable GAAP equivalent.
** Excluding special items and non-recurring charges. Reference page 25 for a definition of this non-GAAP measure.
** Excluding special items and non-recurring charges. Reference page 25 for a definition of this non-GAAP measure.