Cencora, Inc. - Quarter Report: 2015 June (Form 10-Q)

Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

FOR THE QUARTERLY PERIOD ENDED June 30, 2015

 

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 1-16671

 

AMERISOURCEBERGEN CORPORATION

(Exact name of registrant as specified in its charter)

 

 

(610) 727-7000

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  x  No  o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes  x  No  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company (as defined in Rule 12b-2 of the Exchange Act).

 

Large accelerated filer  x Accelerated filer  o Non-accelerated filer  o 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  x

 

The number of shares of common stock of AmerisourceBergen Corporation outstanding as of July 31, 2015 was 216,202,116.

 

 

Table of Contents

 

AMERISOURCEBERGEN CORPORATION

 

TABLE OF CONTENTS

 

	Page No.
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets, June 30, 2015 and September 30, 2014	2
Consolidated Statements of Operations for the three and nine months ended June 30, 2015 and 2014	3
Consolidated Statements of Comprehensive Income for the three and nine months ended June 30, 2015 and 2014	4
Consolidated Statements of Cash Flows for the nine months ended June 30, 2015 and 2014	5
Notes to Consolidated Financial Statements	6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	17
Item 3. Quantitative and Qualitative Disclosures About Market Risk	31
Item 4. Controls and Procedures	31
Part II. OTHER INFORMATION
Item 1. Legal Proceedings	32
Item 1A. Risk Factors	32
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	32
Item 3. Defaults Upon Senior Securities	32
Item 4. Mine Safety Disclosures	32
Item 5. Other Information	32
Item 6. Exhibits	33
SIGNATURES	34

 

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PART I. FINANCIAL INFORMATION

 

ITEM I. Financial Statements (Unaudited)

 

AMERISOURCEBERGEN CORPORATION AND SUBSIDIARIES

 

CONSOLIDATED BALANCE SHEETS

 

		June 30,			September 30,
(in thousands, except share and per share data)		2015			2014
		(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents		$	2,555,183		$	1,808,513
Accounts receivable, less allowances for returns and doubtful accounts: $911,727 at June 30, 2015 and $998,383 at September 30, 2014		7,596,558			6,312,883
Merchandise inventories		9,639,961			8,593,852
Prepaid expenses and other		110,332			84,957
Total current assets		19,902,034			16,800,205
Property and equipment, at cost:
Land		39,514			37,538
Buildings and improvements		405,861			359,037
Machinery, equipment and other		1,409,023			1,295,854
Total property and equipment		1,854,398			1,692,429
Less accumulated depreciation		(895,711		)	(792,847		)
Property and equipment, net		958,687			899,582
Goodwill and other intangible assets		6,115,499			3,481,744
Other assets		357,284			350,652
TOTAL ASSETS		$	27,333,504		$	21,532,183
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	19,348,994		$	15,592,834
Accrued expenses and other		633,050			561,863
Short-term debt		7,370			—
Deferred income taxes		1,127,877			1,095,463
Total current liabilities		21,117,291			17,250,160
Long-term debt		3,742,781			1,995,632
Other liabilities		897,808			329,492
Stockholders’ equity:
Common stock, $0.01 par value - authorized: 600,000,000 shares; issued and outstanding: 274,673,530 shares and 216,517,538 shares at June 30, 2015, respectively, and 271,126,753 shares and 221,908,650 shares at September 30, 2014, respectively		2,747			2,711
Additional paid-in capital		3,902,810			2,749,185
Retained earnings		879,201			1,570,429
Accumulated other comprehensive loss		(69,006		)	(52,046		)
Treasury stock, at cost: 58,155,992 shares at June 30, 2015 and 49,218,103 shares at September 30, 2014		(3,140,128		)	(2,313,380		)
Total stockholders’ equity		1,575,624			1,956,899
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY		$	27,333,504		$	21,532,183

 

See notes to consolidated financial statements.

 

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AMERISOURCEBERGEN CORPORATION AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 

		Three months ended						Nine months ended
		June 30,						June 30,
(in thousands, except per share data)		2015			2014			2015			2014
Revenue		$	34,233,556		$	30,348,154		$	100,491,425		$	87,980,419
Cost of goods sold		33,342,092			29,656,150			97,935,686			85,870,597
Gross profit		891,464			692,004			2,555,739			2,109,822
Operating expenses:
Distribution, selling, and administrative		502,744			387,611			1,361,678			1,128,012
Depreciation		48,283			40,880			137,755			116,167
Amortization		20,147			6,454			36,177			19,611
Warrants		(14,900		)	145,040			1,109,211			267,000
Employee severance, litigation and other		2,625			1,142			30,999			7,411
Operating income (loss)		332,565			110,877			(120,081		)	571,621
Other (income) loss		(1,534		)	(1,312		)	11,185			(5,692		)
Interest expense, net		29,793			20,903			70,081			59,209
Loss on early retirement of debt		—			32,954			—			32,954
Income (loss) from continuing operations before income taxes		304,306			58,332			(201,347		)	485,150
Income taxes		90,143			71,112			297,827			268,922
Income (loss) from continuing operations		214,163			(12,780		)	(499,174		)	216,228
Loss from discontinued operations, net of income taxes		—			—			—			(7,546		)
Net income (loss)		$	214,163		$	(12,780	)	$	(499,174	)	$	208,682
Earnings per share:
Basic earnings per share:
Continuing operations		$	0.98		$	(0.06	)	$	(2.27	)	$	0.95
Discontinued operations		—			—			—			(0.03		)
Rounding		—			—			—			(0.01		)
Total		$	0.98		$	(0.06	)	$	(2.27	)	$	0.91
Diluted earnings per share:
Continuing operations		$	0.89		$	(0.06	)	$	(2.27	)	$	0.92
Discontinued operations		—			—			—			(0.03		)
Total		$	0.89		$	(0.06	)	$	(2.27	)	$	0.89
Weighted average common shares outstanding:
Basic		219,359			225,727			219,689			228,477
Diluted		240,236			225,727			219,689			235,532
Cash dividends declared per share of common stock		$	0.290		$	0.235		$	0.870		$	0.705

 

See notes to consolidated financial statements.

 

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AMERISOURCEBERGEN CORPORATION AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

 

		Three months ended						Nine months ended
		June 30,						June 30,
(in thousands)		2015			2014			2015			2014
Net income (loss)		$	214,163		$	(12,780	)	$	(499,174	)	$	208,682
Other comprehensive income (loss):
Net change in foreign currency translation adjustments		6,712			5,223			(20,126		)	(3,392		)
Other		(133		)	(87		)	3,166			(503		)
Total other comprehensive income (loss)		6,579			5,136			(16,960		)	(3,895		)
Total comprehensive income (loss)		$	220,742		$	(7,644	)	$	(516,134	)	$	204,787

 

See notes to consolidated financial statements.

 

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AMERISOURCEBERGEN CORPORATION AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

		Nine months ended June 30,
(in thousands)		2015			2014
OPERATING ACTIVITIES
Net (loss) income		$	(499,174	)	$	208,682
Loss from discontinued operations		—			7,546
(Loss) income from continuing operations		(499,174		)	216,228
Adjustments to reconcile (loss) income from continuing operations to net cash provided by operating activities:
Depreciation, including amounts charged to cost of goods sold		137,870			118,004
Amortization, including amounts charged to interest expense		39,943			23,214
(Benefit) provision for doubtful accounts		(3,482		)	16,626
Benefit for deferred income taxes		(15,799		)	(27,661		)
Warrant expense		1,109,211			267,000
Share-based compensation		46,496			32,165
Loss on sale of business		9,128			—
Loss on early retirement of debt		—			32,954
Other		(9,322		)	(5,856		)
Changes in operating assets and liabilities, excluding the effects of acquisitions and divestitures:
Accounts receivable		(868,708		)	(535,806		)
Merchandise inventories		(700,331		)	(1,002,589		)
Prepaid expenses and other assets		(16,008		)	29,528
Accounts payable, accrued expenses, and income taxes		3,530,780			1,475,627
Other liabilities		(339		)	607
Net cash provided by operating activities - continuing operations		2,760,265			640,041
Net cash used in operating activities - discontinued operations		—			(7,546		)
NET CASH PROVIDED BY OPERATING ACTIVITIES		2,760,265			632,495
INVESTING ACTIVITIES
Capital expenditures		(157,089		)	(198,670		)
Cost of acquired companies, net of cash acquired		(2,606,524		)	(9,103		)
Cost of equity investments		—			(117,794		)
Proceeds from sale of business		17,184			—
Other		1,790			6,366
NET CASH USED IN INVESTING ACTIVITIES		(2,744,639		)	(319,201		)
FINANCING ACTIVITIES
Long-term debt borrowings		1,996,390			1,097,927
Long-term debt repayments		(250,000		)	(531,525		)
Borrowings under revolving and securitization credit facilities		75,542			17,584,500
Repayments under revolving and securitization credit facilities		(68,641		)	(17,584,500		)
Purchases of common stock		(800,299		)	(570,593		)
Exercises of stock options, including excess tax benefits of $82,345 and $39,843 in fiscal 2015 and 2014, respectively		178,146			109,694
Cash dividends on common stock		(192,054		)	(161,558		)
Purchases of call options		(180,000		)	(211,397		)
Debt issuance costs and other		(28,040		)	(14,984		)
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES		731,044			(282,436		)
INCREASE IN CASH AND CASH EQUIVALENTS		746,670			30,858
Cash and cash equivalents at beginning of period		1,808,513			1,231,006
CASH AND CASH EQUIVALENTS AT END OF PERIOD		$	2,555,183		$	1,261,864

 

See notes to consolidated financial statements.

 

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AMERISOURCEBERGEN CORPORATION AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

Note 1.  Summary of Significant Accounting Policies

 

Basis of Presentation

 

The accompanying financial statements present the consolidated financial position, results of operations and cash flows of AmerisourceBergen Corporation and its wholly owned subsidiaries (the “Company”) as of the dates and for the periods indicated.  All intercompany accounts and transactions have been eliminated in consolidation.

 

The accompanying unaudited consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles (“GAAP”) for interim financial information, the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.  In the opinion of management, all adjustments (consisting only of normal recurring accruals, except as otherwise disclosed herein) considered necessary to present fairly the financial position as of June 30, 2015 and the results of operations and cash flows for the interim periods ended June 30, 2015 and 2014 have been included.  Certain information and footnote disclosures normally included in financial statements presented in accordance with U.S. GAAP, but which are not required for interim reporting purposes, have been omitted.  The accompanying unaudited consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2014.

 

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect amounts reported in the financial statements and accompanying notes.  Actual amounts could differ from these estimated amounts.

 

In May 2014, the Financial Accounting Standards Board issued Accounting Standards Update No. 2014-09, “Revenue from Contracts with Customers (Topic 606)” (“ASU 2014-09”).  ASU 2014-09 supersedes the revenue recognition requirements in Accounting Standards Codification 605 — Revenue Recognition and most industry-specific guidance throughout the Codification.  ASU 2014-09 outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers.  The standard’s core principle is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.  ASU 2014-09 was originally scheduled to be effective for annual reporting periods beginning after December 15, 2016, including interim periods within those reporting periods.  In July 2015, the Financial Accounting Standards Board deferred the effective date of ASU 2014-09 by one year.  Entities are permitted to adopt the standard as early as the original public entity effective date, and either full or modified retrospective application is required.  The Company has not yet selected a transition method and is currently evaluating the impact of adopting this new accounting guidance.

 

In April 2015, the Financial Accounting Standards Board issued Accounting Standards Update No. 2015-03, Interest - Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs (“ASU 2015-03”).  ASU 2015-03 is the result of the Financial Accounting Standards Board’s simplification initiative intended to improve U.S. GAAP by reducing costs and complexity while maintaining or enhancing the usefulness of related financial statement information.  ASU 2015-03 specifies that debt issuance costs related to a note shall be reported in the balance sheet as a direct reduction from the face amount of the note.  ASU 2015-03 is effective for annual reporting periods beginning after December 15, 2015, and interim periods within those fiscal years.  ASU 2015-03 will require the Company to reclassify its capitalized debt issuance costs currently recorded as assets on the consolidated condensed balance sheets.  ASU 2015-03 will have no effect on the Company’s results of operations or liquidity.

 

As of June 30, 2015, there were no other recently issued accounting standards that will have a material impact on the Company’s financial position or results of operations upon their adoption.

 

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AMERISOURCEBERGEN CORPORATION AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

Note 2.  Acquisition

 

On February 24, 2015, the Company acquired MWI Veterinary Supply, Inc. (“MWI”) for a purchase price of $2.6 billion.  MWI is a leading animal health distribution company in the United States and in the United Kingdom.  MWI’s annual revenues are estimated to be approximately $3.0 billion.  For reportable segment presentation, MWI’s operating results are included within Other.

 

The purchase price has been preliminarily allocated to the underlying assets acquired and liabilities assumed based upon their estimated fair values at the date of the acquisition.  The preliminary allocation is pending the finalization of the appraisals of intangible assets and the corresponding deferred taxes, as well as the finalization of the working capital account balances.  There can be no assurance that the estimated amounts recorded represent the final purchase price allocation.  The purchase price currently exceeds the estimated fair value of the net tangible and intangible assets acquired by $1.2 billion, which was allocated to goodwill.  The estimated fair value of accounts receivable, inventory, and accounts payable acquired was $346.9 million, $440.0 million and $327.1 million, respectively.  The estimated fair value of the intangible assets acquired of $1.5 billion consists of customer relationships of $1.1 billion, a trade name of $344.0 million, and software technology of $11.0 million.  The Company established an estimated deferred tax liability of $570.2 million primarily in connection with the intangible assets acquired.  The Company is amortizing the estimated fair values of the acquired customer relationships and software technology over the remaining useful lives of 20 years and 8 years, respectively.  The trade name has been determined to have an indefinite life.  Goodwill and intangibles resulting from the acquisition are not expected to be deductible for income tax purposes.

 

Note 3.  Income Taxes

 

The Company files income tax returns in U.S. federal and state jurisdictions as well as various foreign jurisdictions.  As of June 30, 2015, the Company had unrecognized tax benefits, defined as the aggregate tax effect of differences between tax return positions and the benefits recognized in the Company’s financial statements, of $55.5 million ($39.1 million, net of federal benefit).  If recognized, these tax benefits would reduce income tax expense and the effective tax rate.  Included in this amount is $8.7 million of interest and penalties, which the Company records in income tax expense.  During the nine months ended June 30, 2015, unrecognized tax benefits increased by $4.9 million.  During the next 12 months, it is reasonably possible that state tax audit resolutions and the expiration of statutes of limitations could result in a reduction of unrecognized tax benefits by approximately $6.7 million.

 

In March 2013, the Company issued Warrants (as defined in Note 6) in connection with various agreements and arrangements with Walgreens Boots Alliance, Inc. (“WBA”), as successor in interest to Walgreen Co. (“Walgreens”) and Alliance Boots GmbH (“Alliance Boots”).  As of the date of issuance, the Warrants were valued at $242.4 million, which approximates the amount that will be deductible for income tax purposes.  The fair value of the Warrants as of June 30, 2015 was $2,421.5 million.  The excess of the fair value of the Warrants over the initial value is not tax deductible.  As a result, in periods where the fair value of the Warrants exceeds the initial value, the Company’s effective income tax rate will be higher than its normal historical rate.

 

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AMERISOURCEBERGEN CORPORATION AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

Note 4.  Goodwill and Other Intangible Assets

 

Following is a summary of the changes in the carrying value of goodwill, by reportable segment, for the nine months ended June 30, 2015 (in thousands):

 

		Pharmaceutical Distribution			Other			Total
Goodwill at September 30, 2014		$	2,400,926		$	547,576		$	2,948,502
Goodwill recognized in connection with acquisitions		17,048			1,157,442			1,174,490
Goodwill disposed in connection with divestiture		(3,605		)	—			(3,605		)
Foreign currency translation		—			(2,582		)	(2,582		)
Goodwill at June 30, 2015		$	2,414,369		$	1,702,436		$	4,116,805

 

Following is a summary of other intangible assets (in thousands):

 

		June 30, 2015									September 30, 2014
		Gross Carrying Amount			Accumulated Amortization			Net Carrying Amount			Gross Carrying Amount			Accumulated Amortization			Net Carrying Amount
Indefinite-lived intangibles - trade names		$	685,085		$	—		$	685,085		$	343,707		$	—		$	343,707
Finite-lived intangibles:
Customer relationships		1,409,631			(128,333		)	1,281,298			268,208			(98,412		)	169,796
Other		78,181			(45,870		)	32,311			71,114			(51,375		)	19,739
Total other intangible assets		$	2,172,897		$	(174,203	)	$	1,998,694		$	683,029		$	(149,787	)	$	533,242

 

Amortization expense for finite-lived intangible assets was $36.2 million and $19.6 million in the nine months ended June 30, 2015 and 2014, respectively.  Amortization expense for finite-lived intangible assets is estimated to be $56.4 million in fiscal 2015, $80.5 million in fiscal 2016, $77.4 million in fiscal 2017, $75.1 million in fiscal 2018, $74.4 million in fiscal 2019, and $986.1 million thereafter.

 

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AMERISOURCEBERGEN CORPORATION AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

Note 5.  Debt

 

Debt consisted of the following (in thousands):

 

		June 30,			September 30,
		2015			2014
Multi-currency revolving credit facility due 2019		$	—		$	—
Receivables securitization facility due 2017		—			—
Revolving credit note		—			—
Overdraft facility		7,370			—
Term loan		750,000			—
$600,000, 1.15% senior notes due 2017		599,604			599,379
$400,000, 4.875% senior notes due 2019		398,371			398,122
$500,000, 3.50% senior notes due 2021		499,550			499,497
$500,000, 3.40% senior notes due 2024		498,741			498,634
$500,000, 3.25% senior notes due 2025		497,437			—
$500,000, 4.25% senior notes due 2045		499,078			—
Total debt		$	3,750,151		$	1,995,632
Less current portion		7,370			—
Total, net of current portion		$	3,742,781		$	1,995,632

 

The Company has a $1.4 billion multi-currency senior unsecured revolving credit facility, which expires in August 2019 (the “Multi-Currency Revolving Credit Facility”), with a syndicate of lenders.  Interest on borrowings under the Multi-Currency Revolving Credit Facility accrues at specified rates based on the Company’s debt rating and ranges from 69 basis points to 110 basis points over LIBOR/EURIBOR/Bankers Acceptance Stamping Fee, as applicable (90 basis points over LIBOR/EURIBOR/Bankers Acceptance Stamping Fee at June 30, 2015).  Additionally, interest on borrowings denominated in Canadian dollars may accrue at the greater of the Canadian prime rate or the CDOR rate.  The Company pays facility fees to maintain the availability under the Multi-Currency Revolving Credit Facility at specified rates based on its debt rating, ranging from 6 basis points to 15 basis points, annually, of the total commitment (10 basis points at June 30, 2015).  The Company may choose to repay or reduce its commitments under the Multi-Currency Revolving Credit Facility at any time.  The Multi-Currency Revolving Credit Facility contains covenants, including compliance with a financial leverage ratio test, as well as others that impose limitations on, among other things, indebtedness of excluded subsidiaries and asset sales, with which the Company was compliant as of June 30, 2015.

 

The Company has a commercial paper program whereby it may from time to time issue short-term promissory notes in an aggregate amount of up to $1.4 billion at any one time.  Amounts available under the program may be borrowed, repaid, and re-borrowed from time to time.  The maturities on the notes will vary, but may not exceed 365 days from the date of issuance.  The notes will bear interest rates, if interest bearing, or will be sold at a discount from their face amounts.  The commercial paper program does not increase the Company’s borrowing capacity as it is fully backed by the Company’s Multi-Currency Revolving Credit Facility.  There were no borrowings outstanding under the commercial paper program at June 30, 2015.

 

The Company has a $950 million receivables securitization facility (“Receivables Securitization Facility”), which was scheduled to expire in June 2016.  In December 2014, the Company entered into an amendment to the Receivables Securitization Facility to extend the maturity date to December 2017.  The Company has available to it an accordion feature whereby the commitment on the Receivables Securitization Facility may be increased by up to $250 million, subject to lender approval, for seasonal needs during the December and March quarters.  Interest rates are based on prevailing market rates for short-term commercial paper or LIBOR plus a program fee of 75 basis points.  The Company pays a customary unused fee at prevailing market rates, annually, to maintain the availability under the Receivables Securitization Facility.  The Receivables Securitization Facility contains similar covenants to the Multi-Currency Revolving Credit Facility, with which the Company was compliant as of June 30, 2015.

 

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AMERISOURCEBERGEN CORPORATION AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

The Company has an uncommitted, unsecured line of credit available to it pursuant to a revolving credit note (“Revolving Credit Note”).  The Revolving Credit Note provides the Company with the ability to request short-term unsecured revolving credit loans from time to time in a principal amount not to exceed $75 million.  The Revolving Credit Note may be decreased or terminated by the bank or the Company at any time without prior notice.  MWI also has an uncommitted U.K. overdraft facility (“Overdraft Facility”), which allows it to borrow up to £20 million to fund short term normal trading cycle fluctuations.  The Overdraft Facility expires in November 2016.

 

In February 2015, the Company entered into a $1.0 billion term loan credit agreement (“Term Loan”), which matures in 2020.  The Term Loan is subject to quarterly principal payments equal to (1) 1.25% of the aggregate principal amount of the Term Loan beginning with the first quarterly principal payment in June 2015 to and including March 2018, and (2) thereafter, 2.50% of the aggregate principal amount of the Term Loan, with the remaining balance of the Term Loan due upon maturity.  In June 2015, the Company elected to make an early principal payment of $250 million on the Term Loan, $12.5 million of which was scheduled to be paid in June 2015.  The payment was applied in direct order to scheduled principal payments, and as a result, the Company’s next required quarterly principal payment is due in June 2019.  The Term Loan will bear interest at a rate equal either to a base rate plus a margin or a LIBOR rate plus a margin.  The margin will be based on the public debt ratings of the Company and ranges from 75 basis points to 125 basis points over a LIBOR rate (100 basis points at June 30, 2015) and 0 to 25 basis points over a base rate.  The Term Loan contains similar covenants to the Multi-Currency Revolving Credit Facility, with which the Company was compliant as of June 30, 2015.

 

In February 2015, the Company issued $500 million of 3.25% senior notes due March 1, 2025 (the “2025 Notes”) and $500 million of 4.25% senior notes due March 1, 2045 (the “2045 Notes”).  The 2025 Notes were sold at 99.47% of the principal amount and have an effective yield of 3.31%.  The 2045 Notes were sold at 99.81% of the principal amount and have an effective yield of 4.26%.  The interest on the 2025 and 2045 Notes is payable semi-annually in arrears, commencing on September 1, 2015.  The 2025 and 2045 Notes rank pari passu to the Multi-Currency Revolving Credit Facility, the Revolving Credit Note, the Overdraft Facility, the $600 million 1.15% senior notes due in 2017, the $400 million 4.875% senior notes due in 2019, the $500 million 3.50% senior notes due in 2021, and the $500 million 3.40% senior notes due in 2024.

 

The Company used the proceeds from Term Loan, the 2025 Notes and the 2045 Notes to finance a portion of the $2.6 billion purchase price of MWI.

 

Note 6.  Stockholders’ Equity and Earnings per Share

 

In November 2014, the Company’s board of directors increased the quarterly cash dividend by 23% from $0.235 per share to $0.29 per share.

 

In August 2013, the Company’s board of directors authorized a program allowing the Company to purchase up to $750 million of its outstanding shares of common stock, subject to market conditions.  During the nine months ended June 30, 2015, the Company purchased 2.9 million shares of its common stock for a total of $260.2 million under this program, which included $33.6 million of purchases that cash settled in July 2015 and excluded $18.0 million of fiscal 2014 purchases that cash settled in October 2014.  The Company had $315.1 million of availability remaining under this share repurchase program as of June 30, 2015.

 

In March 2013, the Company and WBA entered into various agreements and arrangements pursuant to which WBA was granted the right to purchase a minority equity position in the Company, beginning with the right, but not the obligation, to purchase up to 19,859,795 shares of the Company’s common stock (approximately 7% of the Company’s common stock, on a fully diluted basis as of the date of issuance, assuming the exercise in full of the Warrants, as defined below) in open market transactions.  In connection with these arrangements, Walgreens Pharmacy Strategies, LLC, a wholly owned subsidiary of WBA, was issued (a) a warrant to purchase up to 11,348,456 shares of the Company’s common stock at an exercise price of $51.50 per share exercisable during a six month period beginning in March 2016, and (b) a warrant to purchase up to 11,348,456 shares of the Company’s

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

common stock at an exercise price of $52.50 per share exercisable during a six-month period beginning in March 2017 and Alliance Boots Luxembourg S.à.r.l., also a wholly owned subsidiary of WBA, was issued (a) a warrant to purchase up to 11,348,456 shares of the Company’s common stock at an exercise price of $51.50 per share exercisable during a six-month period beginning in March 2016 and (b) a warrant to purchase up to 11,348,456 shares of the Company’s common stock at an exercise price of $52.50 per share exercisable during a six-month period beginning in March 2017 (collectively, the “Warrants”).

 

The Company valued these Warrants as of March 18, 2013 (date of issuance) and revised the valuation each subsequent quarter.  As of June 30, 2015 the Warrants with an exercise price of $51.50 were valued at $54.14 per share and the Warrants with an exercise price of $52.50 were valued at $52.55 per share.  In total, the Warrants were valued at $2,421.5 million as of June 30, 2015.  Refer to “Critical Accounting Policies and Estimates — Warrants” in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2014 for a more detailed description of the accounting for the Warrants.

 

The Company has taken steps to mitigate the potentially dilutive effect that the exercise of the Warrants could have by hedging a portion of its future obligation to deliver common stock with a financial institution and repurchasing additional shares of its common stock for the Company’s own account over time.  In June 2013, the Company commenced its hedging strategy by entering into a contract with a financial institution pursuant to which it has executed a series of issuer capped call option transactions (“Capped Calls”).  The Capped Calls give the Company the right to buy shares of its common stock subject to the Warrants at specified prices at maturity, should the Warrants be exercised in 2016 and 2017 and were initially intended to cover approximately 60% of the shares subject to the Warrants at the time the Company entered into the transactions.  If the Warrants are exercised, the Company will use a majority of the proceeds to repurchase its shares under the Capped Calls.  The Capped Calls are subject to a “cap” price.  If the Company’s share price exceeds the “cap” price in the Capped Calls at the time the Warrants are exercised, the number of shares that will be delivered to the Company under the Capped Calls will be reduced, and accordingly, will cover less than 60% of the shares of common stock subject to the Warrants.  This hedge transaction was completed in January 2014, and included the purchase of Capped Calls on a total of 27.2 million shares of the Company’s common stock for a total premium of $368.7 million.

 

Based upon the Company’s recent share price, the number of shares of common stock the Company expects to receive under the Capped Calls at maturity has been reduced.  Therefore, the Company amended certain of the Capped Calls to increase their “cap” price to continue to address the potentially dilutive effect of the Warrants.  The Company paid a premium of $100.0 million in January 2015 to increase the cap price on certain of the Capped Calls subject to the warrants that become exercisable in 2016.  The Capped Calls permit the Company to acquire shares of its common stock at strike prices of $51.50 and $52.50 and have expiration dates ranging from February 2016 through October 2017.  The Capped Calls permit net share settlement, which is limited by caps on the market price of the Company’s common stock.  The Company has accounted for the Capped Calls as equity contracts and therefore, the above premiums were recorded as a reduction to paid-in capital.

 

In May 2014, the Company’s board of directors authorized a special program allowing the Company to purchase up to $650 million of its outstanding shares of common stock, subject to market conditions, to further mitigate the potentially dilutive effect of the Warrants and supplements the Company’s previously executed warrant hedging strategy.  During the nine months ended June 30, 2015, the Company purchased 4.3 million shares (1.6 million shares under the Call Options, as defined below) of its common stock for a total of $398.0 million under this program, which excluded $18.0 million of fiscal 2014 purchases that cash settled in October 2014, to complete its authorization under this program.

 

In March 2015, the Company supplemented its hedging strategy by entering into a contract with a financial institution pursuant to which it has executed a series of issuer call options (“Call Options”).  The Call Options give the Company the right to buy shares of its common stock subject to the Warrants at specified prices between April 2015 and October 2015.  In total, the Company purchased Call Options on six million shares of its common stock for a total premium of $80.0 million.  The Company has accounted for the Call Options as equity contracts and therefore, the above premiums were recorded as a reduction to paid-in capital.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

In April 2015, the Company’s board of directors authorized a new special share repurchase program allowing it to repurchase up to $1.0 billion in shares of its common stock, subject to market conditions, to further mitigate the potentially dilutive effect of the Warrants as part of its warrant hedging strategy.  During the nine months ended June 30, 2015, the Company purchased 1.6 million shares (1.4 million under the Call Options) of its common stock for a total of $153.9 million under this program, which included $14.3 million of purchases that cash settled in July 2015.  The Company has $846.1 million of availability remaining under this special share repurchase program as of June 30, 2015.  Availability under the new special share repurchase program is reduced by share repurchases, if any, of its common stock on the open market under the special program, as well as share repurchases due to the Company’s exercise of Call Options and/or Capped Calls.

 

Based on the closing stock price of the Company’s common stock on June 30, 2015, the Capped Calls associated with the warrants exercisable in 2016 would have covered approximately 49% of the shares subject to the warrants and the Capped Calls associated with the warrants exercisable in 2017 would have covered approximately 45% of the shares subject to the warrants.  Adding the shares repurchased through June 30, 2015 under the special share repurchase programs, the Company would have covered approximately 90% of the warrants exercisable in 2016.

 

Basic earnings per share is computed on the basis of the weighted average number of shares of common stock outstanding during the periods presented.  Diluted earnings per share is computed on the basis of the weighted average number of shares of common stock outstanding during the periods presented plus the dilutive effect of stock options, restricted stock, restricted stock units, and the Warrants.

 

		Three months ended				Nine months ended
		June 30,				June 30,
(in thousands)		2015		2014		2015		2014
Weighted average common shares outstanding - basic		219,359		225,727		219,689		228,477
Dilutive effect of stock options, restricted stock, and restricted stock units		4,878		—		—		4,834
Dilutive effect of Warrants		15,999		—		—		2,221
Weighted average common shares outstanding - diluted		240,236		225,727		219,689		235,532

 

There were no potentially dilutive stock options, restricted stock, restricted stock units, or Warrants that were anti-dilutive for the three months ended June 30, 2015.  The potentially dilutive stock options, restricted stock, restricted stock units, and Warrants that were antidilutive for the nine months ended June 30, 2015 were 17.6 million.  The potentially dilutive stock options, restricted stock, restricted stock units, and Warrants that were antidilutive were 9.9 million and 2.0 million for the three and nine months ended June 30, 2014, respectively.

 

Note 7. Legal Matters and Contingencies

 

In the ordinary course of its business, the Company becomes involved in lawsuits, administrative proceedings, government subpoenas, and government investigations, including antitrust, commercial, environmental, product liability, intellectual property, regulatory, employment discrimination, and other matters. Significant damages or penalties may be sought from the Company in some matters, and some matters may require years for the Company to resolve. The Company establishes reserves based on its periodic assessment of estimates of probable losses. There can be no assurance that an adverse resolution of one or more matters during any subsequent reporting period will not have a material adverse effect on the Company’s results of operations for that period or on the Company’s financial condition.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

Qui Tam Matters

 

The qui tam provisions of the federal civil False Claims Act and various state and local civil False Claims Acts permit a private person, known as a “relator” or whistleblower, to file civil actions under these statutes on behalf of the federal, state and local governments. Such cases may involve allegations around the marketing, sale and/or purchase of pharmaceutical products. Qui tam complaints are initially filed by the relator under seal (or on a confidential basis) and the filing of the complaint imposes obligations on government authorities to investigate the allegations in the complaint and to determine whether or not to intervene in the action. Qui tam complaints remain sealed until the court in which the case was filed orders otherwise.

 

The Company has learned that there are filings in one or more federal district courts, including a qui tam complaint filed by one of its former employees, that are under seal and may involve allegations against the Company (and/or subsidiaries or businesses of the Company, including its group purchasing organization for oncologists and its oncology distribution business) relating to its distribution of certain pharmaceutical products to providers. The Company and AmerisourceBergen Specialty Group (“ABSG”) have also received subpoenas from the United States Attorney’s Office for the Eastern District of New York (“USAO”) requesting production of documents and information relating to ABSG’s oncology distribution center and former pharmacy in Dothan, Alabama, its group purchasing organization for oncologists, and intercompany transfers of certain oncology products, which the Company believes could be related to one or more of the qui tam actions that remain under seal. The Company is in the process of responding to the subpoenas.  The Company cannot predict the outcome of any pending action in which any AmerisourceBergen entity is or may become a defendant.

 

Subpoenas and Investigations

 

In fiscal 2012, the Company’s subsidiary, AmerisourceBergen Drug Corporation (“ABDC”), received a subpoena from the United States Attorney’s Office in New Jersey (the “USAO”) in connection with a grand jury proceeding requesting documents concerning ABDC’s program for controlling and monitoring diversion of controlled substances into channels other than for legitimate medical, scientific, and industrial purposes. ABDC also received a subpoena from the Drug Enforcement Administration (“DEA”) in connection with the matter.  In addition to requesting information on ABDC’s diversion control program generally, the subpoenas also request additional information related to electronically stored information and documents concerning specific customers’ purchases of controlled substances. Since fiscal 2012, ABDC has received a number of subpoenas from both the USAO and the DEA requesting additional information, including for grand jury testimony and related documents concerning DEA audits. In fiscal 2013 and in 2014, the Company or ABDC has also received similar subpoenas from the United States Attorney’s Office in the District of Kansas and the United States Attorney’s Office in the Northern District of Ohio in connection with grand jury proceedings requesting documents concerning ABDC’s program for controlling and monitoring diversion of controlled substances into channels other than for legitimate medical, scientific and industrial purposes.  As in the New Jersey matter described above, in addition to requesting information on ABDC’s diversion control program generally, the subpoenas also request documents concerning specific customers’ purchases of controlled substances.  The Company is in the process of responding to the subpoenas and requests for information.  The Company cannot predict the outcome of these matters.

 

State Proceedings

 

On June 26, 2012, the Attorney General of the State of West Virginia (“West Virginia”) filed a complaint in the Circuit Court of Boone County, West Virginia, against a number of pharmaceutical wholesale distributors, including the Company’s subsidiary, ABDC, alleging, among other things, that the distributors failed to provide effective controls and procedures to guard against diversion of controlled substances for illegitimate purposes in West Virginia. The complaint also alleges that the distributors acted negligently by distributing controlled substances to pharmacies that serve individuals who abuse prescription pain medication and were unjustly enriched by such conduct, violated consumer credit and protection laws, created a public nuisance, and violated state antitrust laws in connection with the distribution of controlled substances. West Virginia is seeking injunctive relief to enjoin alleged violations of state regulations requiring suspicious order monitoring and reporting and to require defendants to fund a medical monitoring treatment program. The complaint also seeks a jury trial to determine any losses and damages sustained by West Virginia as a result of the defendants’ alleged conduct. On January 2, 2014, West Virginia filed an Amended Complaint, which removed the

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

claims for unjust enrichment, medical monitoring and antitrust violations and named two additional plaintiffs, the West Virginia Department of Military Affairs and Public Safety and the West Virginia Department of Health and Human Resources (together with West Virginia, “Plaintiffs”).  On January 13, 2015, Plaintiffs filed a Second Amended Complaint under seal, which reasserted an unjust enrichment claim.  Plaintiffs also filed an accompanying motion to modify the protective order so that the Second Amended Complaint may be unsealed and served on all defendants.  On April 6, 2015, ABDC filed a renewed motion to dismiss and to strike the Second Amended Complaint.  A hearing on this motion was held on June 1, 2015.  Pursuant to the Court’s order at that hearing, ABDC filed a proposed order relating to its renewed motion to dismiss on July 7, 2015 and is awaiting the Court’s ruling.  The Company cannot predict the outcome of this matter.

 

On March 10, 2015, the County of Fulton, Georgia (“County”), through its County Attorney R. David Ware, filed a complaint in the Superior Court for Fulton County, Georgia, against a number of pharmaceutical wholesalers, including the Company’s subsidiary ABDC.  The complaint alleges that ABDC and other defendants failed to maintain effective controls against the diversion of controlled substances, failed to maintain records, and failed to report suspicious orders in violation of the Georgia Controlled Substances Act and the Georgia Pharmacy Practice Act.  The complaint also alleges that the defendants acted negligently in the marketing, promotion, and distribution of controlled substances by failing to guard against misconduct by physicians, pharmacists, and other parties who diverted controlled substances for illegitimate users.  The complaint further asserts that defendants were unjustly enriched by such conduct and created a public nuisance.  The County seeks injunctive relief and a trial by jury to determine damages.  The defendants filed a Notice of Removal on April 14, 2015 and filed a motion to dismiss on April 21, 2015. On May 15, 2015, the County filed a Voluntary Dismissal Without Prejudice and the Court dismissed the case without prejudice on May 18, 2015.

 

Note 8.  Litigation Settlements

 

Antitrust Settlements

 

Numerous class action lawsuits have been filed against certain brand pharmaceutical manufacturers alleging that the manufacturer, by itself or in concert with others, took improper actions to delay or prevent generic drugs from entering the market.  The Company has not been named a plaintiff in any of these class actions, but has been a member of the direct purchasers’ class (i.e., those purchasers who purchase directly from these pharmaceutical manufacturers).  None of the class actions have gone to trial, but some have settled in the past with the Company receiving proceeds from the settlement funds.  During the three and nine months ended June 30, 2015, the Company recognized gains of $43.6 million and $65.1 million, respectively, relating to the above-mentioned class action lawsuits.  During the three and nine months ended June 30, 2014, the Company recognized gains of $2.5 million and $24.4 million, respectively, relating to the above-mentioned class action lawsuits.  These gains, which are net of attorney fees and estimated payments due to other parties, were recorded as reductions to cost of goods sold in the Company’s consolidated statements of operations.

 

Note 9.  Fair Value of Financial Instruments

 

The recorded amounts of the Company’s cash and cash equivalents, accounts receivable, and accounts payable at June 30, 2015 and September 30, 2014 approximate fair value based upon the relatively short-term nature of these financial instruments.  Within cash and cash equivalents, the Company had $600.0 million and $400.0 million of investments in money market accounts as of June 30, 2015 and September 30, 2014, respectively.  The fair values of the money market accounts were based on unadjusted quoted prices in active markets for identical assets, otherwise known as Level 1 inputs.  The recorded amount of long-term debt and the corresponding fair value as of June 30, 2015 were $3,742.8 million and $3,734.3 million, respectively.  The recorded amount of long-term debt and the corresponding fair value as of September 30, 2014 were $1,995.6 million and $2,056.6 million, respectively.  The fair values of debt were determined based on quoted market prices, otherwise known as Level 2 inputs.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

Note 10.  Business Segment Information

 

The Company is organized based upon the products and services it provides to its customers.  The Company’s operations are comprised of the Pharmaceutical Distribution reportable segment and Other.  The Pharmaceutical Distribution reportable segment consists of the AmerisourceBergen Drug Corporation (“ABDC”) and AmerisourceBergen Specialty Group (“ABSG”) operating segments.  Other consists of the AmerisourceBergen Consulting Services (“ABCS”), World Courier Group, Inc. (“World Courier”), and MWI Veterinary Supply, Inc. (“MWI”) operating segments.

 

The following tables illustrate reportable segment information for the three and nine months ended June 30, 2015 and 2014 (in thousands):

 

		Revenue
		Three months ended						Nine months ended
		June 30,						June 30,
		2015			2014			2015			2014
Pharmaceutical Distribution		$	32,758,828		$	29,812,837		$	97,504,075		$	86,367,923
Other		1,532,907			620,275			3,214,977			1,796,910
Intersegment eliminations		(58,179		)	(84,958		)	(227,627		)	(184,414		)
Revenue		$	34,233,556		$	30,348,154		$	100,491,425		$	87,980,419

 

Intersegment eliminations primarily represent the elimination of certain ABCS sales to the Pharmaceutical Distribution reportable segment.

 

		Segment Operating Income
		Three months ended						Nine months ended
		June 30,						June 30,
		2015			2014			2015			2014
Pharmaceutical Distribution		$	377,771		$	359,795		$	1,256,747		$	1,019,506
Other		77,372			33,678			186,688			113,261
Total segment operating income		$	455,143		$	393,473		$	1,443,435		$	1,132,767

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

The following table reconciles total segment operating income to income (loss) from continuing operations before income taxes (in thousands):

 

		Income (Loss) From Continuing
		Operations Before Income Taxes
		Three months ended						Nine months ended
		June 30,						June 30,
		2015			2014			2015			2014
Total segment operating income		$	455,143		$	393,473		$	1,443,435		$	1,132,767
Gains on antitrust litigation settlements		43,567			2,524			65,050			24,396
LIFO expense		(158,710		)	(133,237		)	(453,878		)	(293,647		)
Acquisition related intangibles amortization		(19,710		)	(5,701		)	(34,478		)	(17,484		)
Warrant expense		14,900			(145,040		)	(1,109,211		)	(267,000		)
Employee severance, litigation and other		(2,625		)	(1,142		)	(30,999		)	(7,411		)
Operating income (loss)		332,565			110,877			(120,081		)	571,621
Other (income) loss		(1,534		)	(1,312		)	11,185			(5,692		)
Interest expense, net		29,793			20,903			70,081			59,209
Loss on early retirement of debt		—			32,954			—			32,954
Income (loss) from continuing operations before income taxes		$	304,306		$	58,332		$	(201,347	)	$	485,150

 

Segment operating income is evaluated by the chief operating decision maker of the Company before gains on antitrust litigation settlements; LIFO expense; acquisition related intangibles amortization; Warrant expense; employee severance, litigation and other; other (income) loss; interest expense, net; and loss on early retirement of debt.  All corporate office expenses are allocated to each operating segment.

 

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ITEM 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Overview

 

The following discussion should be read in conjunction with the Consolidated Financial Statements and notes thereto contained herein and in conjunction with the financial statements and related notes included in our Annual Report on Form 10-K for the fiscal year ended September 30, 2014.

 

We are one of the largest global pharmaceutical sourcing and distribution services companies, helping both healthcare providers and pharmaceutical and biotech manufacturers improve patient access to products and enhance patient care.  We deliver innovative programs and services designed to increase the effectiveness and efficiency of the pharmaceutical supply chain in both human and animal health.  We are organized based upon the products and services we provide to our customers.  Our operations are comprised of the Pharmaceutical Distribution reportable segment and Other.

 

Pharmaceutical Distribution Segment

 

The Pharmaceutical Distribution reportable segment is comprised of two operating segments, which include the operations of AmerisourceBergen Drug Corporation (“ABDC”) and AmerisourceBergen Specialty Group (“ABSG”).  Servicing healthcare providers in the pharmaceutical supply channel, the Pharmaceutical Distribution segment’s operations provide drug distribution and related services designed to reduce healthcare costs and improve patient outcomes.

 

ABDC distributes a comprehensive offering of brand-name and generic pharmaceuticals (including specialty pharmaceutical products), over-the-counter healthcare products, home healthcare supplies and equipment, and related services to a wide variety of healthcare providers, including acute care hospitals and health systems, independent and chain retail pharmacies, mail order pharmacies, medical clinics, long-term care and other alternate site pharmacies, and other customers.  ABDC also provides pharmacy management, staffing and other consulting services, and supply management software to a variety of retail and institutional healthcare providers.  Additionally, ABDC delivers packaging solutions to institutional and retail healthcare providers.

 

ABSG, through a number of operating businesses, provides pharmaceutical distribution and other services to physicians who specialize in a variety of disease states, especially oncology, and to other healthcare providers, including hospitals and dialysis clinics.  ABSG also distributes plasma and other blood products, injectible pharmaceuticals, vaccines, and other specialty products.  Additionally, ABSG provides third party logistics and outcomes research, and other services for biotechnology and other pharmaceutical manufacturers.

 

Our use of the terms “specialty” and “specialty pharmaceutical products” refers to drugs used to treat complex diseases, such as cancer, diabetes and multiple sclerosis.  Specialty pharmaceutical products are part of complex treatment regimens for serious conditions and diseases that generally require ongoing clinical monitoring.  We believe the terms “specialty” and “specialty pharmaceutical products” are used consistently by industry participants and our competitors.  However, we cannot be certain that other distributors of specialty products define these and other similar terms in exactly the same manner as we do.

 

Both ABDC and ABSG distribute specialty drugs to their customers, with the principal difference between these two operating segments being that ABSG operates distribution facilities that focus primarily on complex disease treatment regimens.  Therefore, a product distributed from one of ABSG’s distribution facilities results in revenue reported under ABSG, and a product distributed from one of ABDC’s distribution centers results in revenue reported under ABDC.  Essentially all of ABSG sales consist of specialty pharmaceutical products.  ABDC sales of specialty pharmaceutical products have historically been a relatively small component of its overall revenue.

 

Other

 

Other consists of the AmerisourceBergen Consulting Services (“ABCS”) operating segment, the World Courier Group, Inc. (“World Courier”) operating segment, and the MWI Veterinary Supply, Inc. (“MWI”) operating segment.  The results of operations of these operating segments are not significant enough to require separate reportable segment disclosure, and therefore, have been included in “Other” for the purpose of our reportable segment presentation.

 

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ABCS, through a number of operating businesses, provides commercialization support services including reimbursement support programs, outcomes research, contract field staffing, patient assistance and co-pay assistance programs, adherence programs, risk mitigation services, and other market access programs to pharmaceutical and biotechnology manufacturers.  World Courier, which operates in over 50 countries, is a leading global specialty transportation and logistics provider for the biopharmaceutical industry.  MWI is a leading animal health distribution company in the United States and in the United Kingdom.  MWI sells pharmaceuticals, vaccines, parasiticides, diagnostics, micro feed ingredients, and various other products to customers in both the companion animal and production animal markets.

 

Executive Summary

 

This executive summary provides highlights from the results of operations that follows:

 

·                  Revenue increased 12.8% and 14.2% from the prior year quarter and nine month period, respectively, as a result of the gradual phase in of generic drug distribution from ABDC to Walgreens Boots Alliance, Inc. (“WBA”) in fiscal 2014, increased sales of brand and generic products, and the strong growth of ABSG and ABCS.  Additionally, the acquisition of MWI contributed to our revenue growth in the current year quarter and nine month period;

 

·                  Pharmaceutical Distribution gross profit increased 7.9% and 18.5% from the prior year quarter and nine month period, respectively, as the result of our strong revenue growth in brand and generic pharmaceuticals in ABDC and ABSG and the incremental income from ABDC’s participation in the WBA procurement joint venture.  Gross profit growth in the current year quarter was adversely impacted by the renewal of our contract with the Department of Defense (“DOD”) at less favorable terms and lower generic price appreciation;

 

·                  Total gross profit was impacted by LIFO expense, which was $158.7 million and $453.9 million in the current year quarter and nine month period, respectively, in comparison to $133.2 million and $293.6 million in the prior year quarter and nine month period, respectively.  The increase in LIFO expense was primarily due to higher brand inflation and lower generic drug deflation resulting from the generics pricing environment;

 

·                  Distribution, selling, and administrative expenses increased 29.7% and 20.7% in the quarter and nine month period, respectively, to support our revenue growth.  Additionally, these expenses were greater in the current year quarter and nine month period due to the addition of MWI;

 

·                  Total operating expenses were impacted by Warrants.  Warrant income was $14.9 million in the current year quarter compared to Warrant expense of $145.0 million in the prior year quarter.  Warrant expense decreased significantly from the prior year quarter primarily due to the decline in our stock price during the quarter ended June 30, 2015.  Warrant expense was $1,109.2 million in the current year nine month period compared to Warrant expense of $267.0 million in the prior year nine month period.  Warrant expense increased significantly from the prior year nine month period primarily due to the increase in our stock price since June 30, 2014;

 

·                  Total segment operating income increased by 15.7% and 27.4% compared to the prior year quarter and nine month period, respectively, primarily due to the increase in Pharmaceutical Distribution’s gross profit and the addition of MWI; and

 

·                  Net income and diluted earnings per share in the quarter were impacted by the significant LIFO expense.  Net loss and diluted loss per share in the nine month period were impacted by the significant LIFO and Warrant expense.

 

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Results of Operations

 

Revenue

 

		Three months ended								Nine months ended
		June 30,								June 30,
(dollars in thousands)		2015			2014			Change		2015			2014			Change
Pharmaceutical Distribution		$	32,758,828		$	29,812,837		9.9%		$	97,504,075		$	86,367,923		12.9%
Other		1,532,907			620,275			147.1%		3,214,977			1,796,910			78.9%
Intersegment eliminations		(58,179		)	(84,958		)	(31.5)%		(227,627		)	(184,414		)	23.4%
Revenue		$	34,233,556		$	30,348,154		12.8%		$	100,491,425		$	87,980,419		14.2%

 

Revenue increased by 12.8% and 14.2% from the prior year quarter and nine month period, respectively.  The increases in revenue were primarily due to increased sales to WBA of $1.8 billion and $6.0 billion from the prior year quarter and nine month period, respectively.  Fiscal 2014 revenue included the gradual phase in of the WBA generics business beginning in January 2014.  Excluding WBA, our revenue increased by 7% from the prior year quarter and nine month period.  See discussions below under “Pharmaceutical Distribution” and “Other” for additional commentary regarding our revenue growth.

 

We currently expect our revenue in fiscal 2015 to increase in the range of 12% to 13%.  Our expected growth rate is driven in part by a full year of generic drug distribution to WBA, which was phased in during fiscal 2014.  Our future revenue growth will continue to be affected by various factors such as industry growth trends, including the introduction of new innovative brand therapies, the likely increase in the number of generic drugs that will be available over the next few years as a result of the expiration of certain drug patents held by brand-name pharmaceutical manufacturers, general economic conditions in the United States, competition within the industry, customer consolidation, changes in pharmaceutical manufacturer pricing and distribution policies and practices, increased downward pressure on government and other third party reimbursement rates to our customers, and changes in Federal government rules and regulations.

 

Pharmaceutical Distribution Segment

 

The Pharmaceutical Distribution segment grew its revenue by 9.9% and 12.9% from the prior year quarter and nine month period, respectively.  Intrasegment revenues between ABDC and ABSG have been eliminated in the presentation of total Pharmaceutical Distribution revenue.  Intrasegment revenues primarily consisted of ABSG sales directly to ABDC customer sites or ABSG sales to ABDC’s facilities.  Intrasegment revenues were $1.6 billion and $1.1 billion in the quarters ended June 30, 2015 and 2014, respectively, and $4.7 billion and $3.0 billion in the nine months ended June 30, 2015 and 2014, respectively.

 

ABDC’s revenue of $28.2 billion and $84.4 billion in the quarter and nine months ended June 30, 2015 increased 9.0% and 12.5%, respectively, from the prior year periods (before intrasegment eliminations).  The increase in ABDC’s revenue was primarily due to increased sales to WBA of $1.8 billion and $6.0 billion in the quarter and nine months ended June 30, 2015 (as noted above); increased sales of products that treat Hepatitis C; and overall market growth.

 

ABSG’s revenue of $6.1 billion and $17.8 billion in the quarter and nine months ended June 30, 2015 increased 22.4% and 24.4%, respectively, from the prior year periods (before intrasegment eliminations).  The increase in ABSG’s revenue was due to the continued growth in our blood products, vaccine and physician office distribution businesses, the impact of manufacturer shifts of certain infused oncology products from full line distribution to specialty distribution, and growth in oncology product sales (including an increase in sales to community oncologists).  Excluding the impact of the manufacturer shifts of certain infused oncology products from full line distribution to specialty distribution, ABSG revenue grew by 13.1% and 15.1% in the quarter and nine months ended June 30, 2015, respectively.

 

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A portion of ABSG’s revenue is generated from the distribution of pharmaceuticals to physicians who specialize in a variety of disease states, especially oncology.  Community oncologists and other specialty physicians that administer drugs under Medicare Part B have been impacted by lower reimbursement rates for specialty pharmaceutical drugs.  ABSG’s business may be adversely impacted in the future by changes in medical guidelines and the Medicare reimbursement rates for certain pharmaceuticals, especially oncology drugs administered by physicians.  Since ABSG provides a number of services to or through physicians, any changes affecting this service channel could result in revenue reductions.  (Refer to Item 1A. Risk Factors, in our Annual Report on Form 10-K for the fiscal year ended September 30, 2014 for a more detailed description of this business risk.)

 

A number of our contracts with customers or group purchasing organizations (“GPOs”) are typically subject to expiration each year.  We may lose a significant customer or GPO relationship if any existing contract with such customer or GPO expires without being extended, renewed, or replaced.  During the nine months ended June 30, 2015, no significant contracts expired.  Over the next twelve months, the only significant contract scheduled to expire is our contract with Kaiser Permanente (“Kaiser”), which expires in June 2016.  Our revenue, results of operations, and cash flows will be negatively impacted if the Kaiser contract is not renewed or the terms of the renewed contract are less favorable than the existing contract.

 

Other

 

Revenue in Other increased 147.1% and 78.9% from the prior year quarter and nine month period, respectively, primarily due to the $810.0 million and $1.1 billion revenue contribution from MWI for the quarter and nine month period, respectively, and increases in ABCS revenue.

 

Gross Profit

 

		Three months ended								Nine months ended
		June 30,								June 30,
(dollars in thousands)		2015			2014			Change		2015			2014			Change
Pharmaceutical Distribution		$	745,866		$	691,303		7.9%		$	2,347,070		$	1,980,711		18.5%
Other		260,741			131,414			98.4%		597,497			398,362			50.0%
Gains on antitrust litigation settlements		43,567			2,524					65,050			24,396
LIFO expense		(158,710		)	(133,237		)			(453,878		)	(293,647		)
Gross profit		$	891,464		$	692,004		28.8%		$	2,555,739		$	2,109,822		21.1%

 

Gross profit increased 28.8%, or $199.5 million, and 21.1%, or $445.9 million, from the prior year quarter and nine month period, respectively.  These increases were due to the increase in Pharmaceutical Distribution gross profit, the increase in the gross profit of Other, and larger gains on antitrust litigation settlements and were offset in part by the $25.5 million and $160.2 million increase in LIFO expense from the prior year quarter and nine month period, respectively.  The increase in LIFO expense was primarily due to higher brand inflation and lower generic drug deflation resulting from the generics pricing environment.

 

Pharmaceutical Distribution gross profit increased 7.9%, or $54.6 million, and 18.5%, or $366.4 million, from the prior year quarter and nine month period, respectively.  These increases were due to higher brand and generic sales volume largely attributable to WBA (as noted above).  Gross profit also increased due to the growth of our specialty distribution businesses and an increase in income resulting from our participation in the WBA procurement joint venture.  Gross profit growth in the current year quarter was adversely impacted by the renewal of our contract with the DOD at less favorable terms and lower generic price appreciation.  As a percentage of revenue, Pharmaceutical Distribution gross profit margin of 2.28% and 2.41% in the quarter and nine months ended June 30, 2015 decreased 4 basis points and increased 12 basis points from the prior year quarter and nine month period, respectively.  The decrease in the quarter ended June 30, 2015 was primarily due to the DOD contract renewal and a decrease in generic price appreciation, and the increase in the nine month period ended June 30, 2015 was primarily due to the increase in ABDC and ABSG sales volume and incremental income from our participation in the WBA procurement joint venture.

 

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Gross profit in Other increased 98.4%, or $129.3 million, and 50.0%, or $199.1 million, from the prior year quarter and nine month period, respectively.  These increases were primarily due to the contribution of our MWI acquisition, and, to a lesser extent, the increase in ABCS and World Courier’s revenue.  As a percentage of revenue, gross profit margin in Other of 17.01% in the quarter ended June 30, 2015 decreased from 21.19% in the prior year quarter.  As a percentage of revenue, gross profit margin in Other of 18.58% in the nine months ended June 30, 2015 decreased from 22.17% in the prior year nine month period.  These decreases were primarily due to the contribution from our MWI acquisition and the increase in ABCS distribution revenue, both of which have a lower gross profit margin in comparison to other businesses within Other.

 

We recognized gains of $43.6 million and $2.5 million from antitrust litigation settlements with pharmaceutical manufacturers during the quarters ended June 30, 2015 and 2014, respectively.  We recognized gains of $65.1 million and $24.4 million from antitrust litigation settlements with pharmaceutical manufacturers during the nine months ended June 30, 2015 and 2014, respectively.  The gains were recorded as reductions to cost of goods sold.

 

Our cost of goods sold for interim periods includes a last-in, first-out (“LIFO”) provision that is based on our estimated annual LIFO provision.  The annual LIFO provision, which we estimate on a quarterly basis, is affected by expected changes in inventory quantities, product mix, and manufacturer pricing practices, which may be impacted by market and other external influences, many of which are difficult to predict.  Changes to any of the above factors can have a material impact to our annual LIFO provision.

 

Operating Expenses

 

		Three months ended								Nine months ended
		June 30,								June 30,
(dollars in thousands)		2015			2014			Change		2015			2014			Change
Distribution, selling and administrative		$	502,744		$	387,611		29.7%		$	1,361,678		$	1,128,012		20.7%
Depreciation and amortization		68,430			47,334			44.6%		173,932			135,778			28.1%
Warrants		(14,900		)	145,040					1,109,211			267,000
Employee severance, litigation and other		2,625			1,142					30,999			7,411
Total operating expenses		$	558,899		$	581,127				$	2,675,820		$	1,538,201

 

Distribution, selling and administrative expenses increased 29.7%, or $115.1 million, from the prior year quarter, and increased 20.7%, or $233.7 million from the prior year nine month period, primarily due to the recent acquisition of MWI.  In addition, operating expenses during the current year periods were higher to support the increase in our revenue, including the WBA volume, which was not fully phased in during the prior year periods.  More specifically, expenses related to payroll (including incentive compensation), delivery and information technology were higher in the current year periods.  As a percentage of revenue, distribution, selling and administrative expenses were 1.47% and 1.36% in the current year quarter and nine month period ended June 30, 2015, respectively, and represents an increase of 19 basis points and 8 basis points, respectively, in comparison to the prior year periods.  These increases were primarily due to our acquisition of MWI, which has higher operating expenses as a percentage of revenue in comparison to Pharmaceutical Distribution.

 

Depreciation expense increased from the prior year periods due to an increase in the amount of capital projects being depreciated.  Amortization expense increased from prior year periods primarily due to the amortization of newly acquired intangible assets resulting from the MWI acquisition.

 

Warrant expense decreased significantly from the prior year quarter primarily due to the decline in our stock price during the quarter ended June 30, 2015.  Warrant expense increased significantly from the prior year nine month period primarily due to the increase in our stock price since June 30, 2014.  The Warrants were issued in March 2013 in connection with the agreements and

 

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