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ABC > SEC Filings for ABC > Form 10-Q on 9-May-2013All Recent SEC Filings

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Form 10-Q for AMERISOURCEBERGEN CORP


9-May-2013

Quarterly Report


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 notes thereto included in our Annual Report on Form 10-K for the fiscal year ended September 30, 2012.

We are a pharmaceutical services company serving the United States, Canada and select global markets. We provide drug distribution and related healthcare services and solutions to our pharmacy, physician, and manufacturer customers. 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.

We are committed to a plan to divest AndersonBrecon (a business unit within AmerisourceBergen Consulting Services) and in March 2013, we committed to a plan to divest AmerisourceBergen Canada Corporation (a business unit within AmerisourceBergen Drug Corporation); therefore, their operations are classified as discontinued operations for all periods presented. All historical information provided herein has been retroactively adjusted to conform to our current presentation.

Recent Developments

On March 19, 2013, we, Walgreen Co. ("Walgreens") and Alliance Boots GmbH ("Alliance Boots") announced various agreements and arrangements, including a ten-year pharmaceutical distribution agreement between Walgreens and us pursuant to which Walgreens will source branded and generic pharmaceutical products from us; an agreement which provides us with the ability to access generics and related pharmaceutical products through Walgreens Boots Alliance Development GmbH, a global sourcing joint venture between Walgreens and Alliance Boots; opportunities to accelerate our efforts to grow our specialty and manufacturer services businesses domestically and internationally; and agreements and arrangements pursuant to which Walgreens and Alliance Boots together have the right, but not the obligation, to purchase a minority equity position in us and gain associated representation on our board of directors in certain circumstances. We currently distribute specialty pharmaceutical products for Walgreens. The ten-year distribution agreement will expand our relationship to include the distribution of branded and generic pharmaceutical products for Walgreens. As part of the transition to the new arrangement, Walgreens has asked us to commence distribution of certain pharmaceutical products to selected Walgreens' locations and we expect to increase our distribution of pharmaceutical products for Walgreens over time until the distribution agreement is fully implemented, effective as of September 1, 2013. Over time, beginning in fiscal 2014, we expect our distribution for Walgreens to increasingly include generic pharmaceutical products that Walgreens currently self-distributes.

In connection with these arrangements, we entered into a Framework Agreement with Walgreens and Alliance Boots, dated as of March 18, 2013, pursuant to which
(i) Walgreens and Alliance Boots together were granted the right to purchase a minority equity position in AmerisourceBergen Corporation, beginning with the right, but not the obligation, to purchase up to 19,859,795 shares of our common stock (approximately 7% of our 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, with the right to designate up to two members of our board of directors upon achieving specified ownership levels;
(ii) Walgreens Pharmacy Strategies, LLC, a wholly owned subsidiary of Walgreens, was issued (a) a warrant to purchase up to 11,348,456 shares of our 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 our common stock at an exercise price of $52.50 per share exercisable during a six-month period beginning in March 2017; and (iii) Alliance Boots Luxembourg
S..r.l., a wholly owned subsidiary of Alliance Boots, was issued (a) a warrant to purchase up to 11,348,456 shares of our 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 our 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 Warrants collectively represented approximately 16% of our common stock on a fully diluted basis as of the date of issuance, assuming exercise in full of the Warrants. The number of shares which may be purchased in the open market is subject to increase in certain circumstances if the market price of our common stock is less than the exercise price of the first tranche of Warrants when those Warrants are exercisable in 2016. Future issuances of shares of our common stock upon exercise of the Warrants will dilute the ownership interests of our then existing shareholders. In addition,


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prior to the exercise of the Warrants, any dilutive effect of the Warrants will be reflected in our diluted earnings per share calculation. The parties and affiliated entities also entered into certain related agreements governing relations between and among the parties thereto, including the AmerisourceBergen Shareholders Agreement, dated as of March 18, 2013, among Walgreens, Alliance Boots and us, described in our Current Report on Form 8-K filed on March 20, 2013.

With the assistance of a third-party valuation firm, we valued these Warrants as of March 18, 2013 (date of issuance) and as of March 31, 2013 using a binomial lattice model approach. As of March 31, 2013, the Warrants with an exercise price of $51.50 were valued at $6.20 per share and the Warrants with an exercise price of $52.50 were valued at $7.64 per share. In total, the Warrants were valued at $314.1 million as of March 31, 2013. The valuation of the Warrants considers our common stock price and various assumptions, such as the volatility of our common stock, the expected dividend yield, and the risk-free interest rate.

Our accounting for the Warrants has been determined in accordance with the guidance for equity-based payments to non-employees. The various agreements and arrangements with Walgreens and Alliance Boots established various performance commitments that they must satisfy during the vesting period of the Warrants, and if not fulfilled, we have the right to cancel the Warrants. The fair value of the Warrants was initially measured at the date of issuance, and is expensed over the three and four year vesting periods as an operating expense. The fair value of the Warrants will be re-measured at the end of each reporting period, and an adjustment will be recorded, if necessary, in the statement of operations to record the impact as if the newly measured fair value of the awards had been used in recognizing expense starting when the awards were originally issued and through the remeasurement date. As a result, future Warrant expense could fluctuate significantly.

Please refer to our Current Report on Form 8-K filed on March 20, 2013 for more detailed information regarding these agreements and arrangements. We currently expect earnings accretion from the pharmaceutical distribution agreement and the generics and related pharmaceutical products global sourcing agreement for fiscal year 2014, excluding certain expenses and non-recurring costs related to the transaction. See "Cautionary Note Regarding Forward-Looking Statements" on page 27 and "Risk Factors" in Item 1A of this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K for the year ended September 30, 2012.

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 pharmaceuticals (including specialty pharmaceutical products) and generic pharmaceuticals, 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; scalable automated pharmacy dispensing equipment; medication and supply dispensing cabinets; 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 primarily to physicians who specialize in a variety of disease states, especially oncology, and to other healthcare providers, including dialysis clinics. ABSG also distributes plasma and other blood products, injectible pharmaceuticals and vaccines. 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.


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Other

Other consists of the AmerisourceBergen Consulting Services ("ABCS") operating segment and the World Courier Group, Inc. ("World Courier") operating segment. World Courier was acquired on April 30, 2012. The results of operations of our ABCS and World Courier 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.

ABCS, through a number of operating businesses, provides commercialization support services including reimbursement support programs, outcomes research, contract field staffing, patient assistance and copay 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.

Results of Operations



Revenue



                          Three months ended                      Six months ended
                               March 31,                              March 31,
(dollars in
thousands)                2013           2012       Change       2013           2012       Change
Pharmaceutical
Distribution          $ 20,133,716   $ 19,454,919     3.5%   $ 40,809,925   $ 39,258,232     4.0%
Other                      435,385        296,401    46.9%        863,274        505,726    70.7%
Intersegment
eliminations               (45,433 )      (42,949 )   5.8%        (89,720 )      (74,402 )  20.6%
Revenue               $ 20,523,668   $ 19,708,371     4.1%   $ 41,583,479   $ 39,689,556     4.8%

Revenue increased 4.1% and 4.8% from the prior year quarter and six month period, respectively. These increases were due to both the revenue growth of Pharmaceutical Distribution and the revenue growth of Other.

Our revenue growth will accelerate in the second half of fiscal 2013, and as a result, we currently expect our revenue in fiscal 2013 to increase between 11% and 13%. Our expected growth rate reflects our three-year contract with Express Scripts, Inc. ("Express Scripts"), which became effective on October 1, 2012, to supply primarily brand-name pharmaceuticals. Annual sales to Express Scripts in fiscal 2013 under this contract are currently estimated to be approximately $20 billion. Our expected growth also reflects the estimated sales to Walgreens resulting from our new ten-year pharmaceutical distribution agreement. In addition, our revenue in fiscal 2013 will include a full year's operating results of World Courier. Our future revenue growth will continue to be affected by various factors such as industry growth trends, including 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.


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Pharmaceutical Distribution Segment

The Pharmaceutical Distribution segment grew its revenue by 3.5% and 4.0% from the prior year quarter and six month period, respectively. Intrasegment revenues between ABDC and ABSG have been eliminated in the presentation of total Pharmaceutical Distribution revenue. These revenues primarily consisted of ABSG sales directly to ABDC customer sites or ABSG sales to ABDC's facilities. Total intrasegment revenues were $764.3 million and $660.1 million in the quarters ended March 31, 2013 and 2012, respectively. Total intrasegment revenues were $1.6 billion and $1.3 billion in the six months ended March 31, 2013 and 2012, respectively.

ABDC's revenue of $16.7 billion and $33.8 billion in the quarter and six months ended March 31, 2013 increased 3.9% and 4.2%, respectively, from the prior year periods (before intrasegment eliminations). The increase in ABDC's revenue was primarily due to the contract with Express Scripts, which became effective on October 1, 2012, offset in part by the loss of a food and drug retail group purchasing organization ("GPO") customer and an increase in the use of lower priced generics.

ABSG's revenue of $4.2 billion and $8.6 billion in the quarter and six months ended March 31, 2013 increased 3.9% and 6.7%, respectively, from the prior year periods (before intrasegment eliminations) primarily due to the growth in its third-party logistics business and growth in its blood products, vaccine, and physician office distribution business. The physician office distribution business continues to benefit from sales of an ophthalmology drug. ABSG's revenue growth was partially offset by a decline in sales of certain specialty oncology drugs. The majority 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 are experiencing declining reimbursement rates for specialty pharmaceutical drugs. Specifically, under federal sequestration legislation, Medicare physician reimbursement rates for Part B drugs were reduced on April 1, 2013. In addition, it appears that more physician practices have consolidated or sold their businesses to hospitals. While we service the needs of many hospitals, the recent shift in this service channel has reduced oncology revenue and is expected to further reduce ABSG's revenue in the second half of fiscal 2013. (Refer to Item 1A. Risk Factors, in our Annual Report on Form 10-K for the fiscal year ended September 30, 2012 for a more detailed description of this business risk.) ABSG's business may continue to 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 and anemia drugs. Since ABSG provides a number of services to or through physicians, any further changes affecting this service channel could result in additional revenue reductions.

Other

Other revenue increased $139.0 million and $357.5 million from the prior year quarter and six month period, respectively, primarily due to the incremental revenue contributions from World Courier, which was acquired in April 2012. We expect Other revenue to increase between 30% and 35% in fiscal 2013 primarily due to the inclusion of World Courier's revenue for a full fiscal year.

Gross Profit

Three months ended Six months ended
March 31, March 31,
(dollars in thousands) 2013 2012 Change 2013 2012 Change Gross profit $ 716,989 $ 679,741 5.5% $ 1,377,817 $ 1,253,003 10.0%

Gross profit increased $37.2 million and $124.8 million from the prior year quarter and six month period, respectively. These increases were primarily due to the incremental contributions made by our fiscal 2012 acquisition of World Courier and the growth of our non-oncology specialty distribution businesses. These increases were offset in part by the lower gross profit related to the Express Scripts contract, the loss of a food and drug retail GPO customer, the lower number of generic launches, and the reduced contribution from the sales of certain specialty oncology drugs. We also recognized gains of $3.5 million and $15.8 million from


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antitrust litigation settlements with pharmaceutical manufacturers during the quarter and six month period ended March 31, 2013, respectively. The gains were recorded as a reduction to cost of goods sold. There were no gains from antitrust litigation settlements in the prior year quarter or six month period.

As a percentage of revenue, our gross profit margin of 3.49% in the quarter ended March 31, 2013 increased 4 basis points from the prior year quarter. As a percentage of revenue, our gross profit margin of 3.31% in the six months ended March 31, 2013 increased 15 basis points from the prior year period. The gross profit margin increases were due to the gross profit contributions from our fiscal 2012 acquisition of World Courier and the above-mentioned gains from antitrust litigation settlements, both of which were offset in part by the lower gross profit margin related to the current Express Scripts contract, the loss of a food and drug retail GPO customer, and competitive pressures on customer margins.

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 changes in inventory quantities, product mix, and manufacturer pricing practices, which may be impacted by market and other external influences.

As a result of the March 2013 Walgreens contract announcement, we have initiated procedures to understand and analyze the amount of branded inventory that we will be required to purchase and warehouse prior to September 1, 2013 to properly service this new customer contract. We expect to complete our analysis during the third fiscal quarter ending June 30, 2013. When we update our estimate of our annual LIFO provision as of June 30, 2013, it is likely that our estimate of the annual provision will change materially because the additional branded inventory that we will be required to purchase to service the Walgreens contract will significantly change our branded inventory quantities, and therefore increase our annual inflation index due to our branded versus generic inventory mix. Cumulatively, three quarters of the estimated annual LIFO expense will be recorded in our third fiscal quarter.

Operating Expenses



                         Three months ended                  Six months ended
                             March 31,                           March 31,
(dollars in
thousands)               2013          2012      Change      2013         2012      Change
Distribution,
selling and
administrative        $   323,536   $  262,421    23.3%   $  644,236   $  519,606    24.0%
Depreciation and
amortization               39,868       31,233    27.6%       78,552       60,348    30.2%
Warrants                    3,761            -                 3,761            -
Employee severance,
litigation and
other                        (299 )      9,027                 1,705       12,586
Total operating
expenses              $   366,866   $  302,681    21.2%   $  728,254   $  592,540    22.9%

Distribution, selling and administrative expenses increased $61.1 million, or 23.3% in the quarter ended March 31, 2013 and increased $124.6 million, or 24.0% in the six-month period ended March 31, 2013, primarily due to the incremental operating costs of our fiscal 2012 acquisition of World Courier.

Depreciation expense increased from the prior year periods due to our fiscal 2012 acquisition of World Courier and due to an increase in capital projects. Amortization expense increased from the prior-year periods due to our fiscal 2012 acquisition of World Courier.

Warrant expense was $3.8 million in the quarter and six months ended March 31, 2013. The Warrants were issued in March 2013 in connection with the agreements and arrangements that define our strategic relationship with Walgreens and Alliance Boots. Refer to the Recent Developments on page 16 for a more detailed description of the Warrants. Future Warrant expense could fluctuate significantly.


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Employee severance, litigation and other for the quarter ended March 31, 2013 included the reversal of $5.1 million of employee severance costs, offset by $4.2 million of deal-related transaction costs, and $0.6 million of facility closure and other costs. Employee severance, litigation and other for the six months ended March 31, 2013 included $4.7 million of deal-related transaction costs, $2.9 million of facility closure and other costs, offset by a reversal of $5.9 million of severance costs that were initially recorded in connection with fiscal 2012 initiatives. As a result of the recently announced Walgreens ten-year pharmaceutical distribution agreement, we terminated a significant portion of our previously planned fiscal 2012 initiatives. Employee severance, litigation and other for the prior year quarter included $6.1 million of employee severance costs and $2.9 million of deal-related transaction costs. The six months ended March 31, 2012 included $6.1 million of employee severance costs and $6.5 million of deal-related transaction costs.

As a percentage of revenue, operating expenses were 1.79% in the quarter ended March 31, 2013, an increase of 25 basis points from the prior year quarter. For the six months ended March 31, 2013, operating expenses, as a percentage of revenue, were 1.75%, up 26 basis points from the prior year six-month period. These increases were primarily due to the addition of our fiscal 2012 World Courier acquisition, which has higher operating expenses as a percentage of revenue. For the Pharmaceutical Distribution segment, as a percentage of revenue, operating expenses were down 3 basis points from the prior year quarter and down 4 basis points from the prior year six-month period.

Operating Income



                         Three months ended                  Six months ended
                             March 31,                           March 31,
(dollars in
thousands)               2013          2012      Change      2013         2012      Change
Pharmaceutical
Distribution          $   328,635   $  362,363    -9.3%   $  609,520   $  639,719    -4.7%
Other                      24,950       23,724     5.2%       45,509       33,330    36.5%
Warrants                   (3,761 )          -                (3,761 )          -
Employee severance,
litigation and
other                         299       (9,027 )              (1,705 )    (12,586 )
Operating income      $   350,123   $  377,060    -7.1%   $  649,563   $  660,463    -1.7%

Segment operating income is evaluated before Warrant expense and employee severance, litigation and other.

Pharmaceutical Distribution operating income decreased $33.7 million and $30.2 million from the prior year quarter and six month period, respectively. The 23 basis point decline in operating margin from the prior year quarter and 14 basis point decline from the prior year six-month period are due to decreased contributions from generic launches, a shift in customer mix towards lower margin business in ABDC (most notably the Express Scripts contract), the loss of a food and drug retail GPO customer, and a decline in the operating margin of our oncology business. Other operating income increased $1.2 million from the prior year quarter due to the contribution made by our World Courier acquisition, offset in part by the decrease in operating income from our ABCS businesses. Other operating income increased $12.2 million from the prior year six-month period due to the contribution made by our World Courier acquisition and an increase in operating income from our ABCS businesses.


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Interest expense, interest income, and the respective weighted average interest rates in the quarters ended March 31, 2013 and 2012 were as follows (in thousands):

                                   2013                          2012
                                   Weighted Average              Weighted Average
                         Amount     Interest Rate      Amount     Interest Rate
Interest expense        $ 18,647              4.67%   $ 24,045              4.86%
Interest income             (137 )            0.29%       (670 )            0.25%
Interest expense, net   $ 18,510                      $ 23,375

Interest expense decreased from the prior year quarter due to a decrease of $392.7 million in average borrowings primarily due to the repayment of our $392 million, 5 5/8% senior notes in September 2012.

Interest expense, interest income, and the respective weighted average interest rates in the six months ending March 31, 2013 and 2012 were as follows (in thousands):

                                   2013                          2012
                                   Weighted Average              Weighted Average
                         Amount     Interest Rate      Amount     Interest Rate
. . .
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