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ABC > SEC Filings for ABC > Form 10-Q on 7-Aug-2014All Recent SEC Filings

Show all filings for AMERISOURCEBERGEN CORP

Form 10-Q for AMERISOURCEBERGEN CORP


7-Aug-2014

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 related notes included in our Annual Report on Form 10-K for the fiscal year ended September 30, 2013.

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. 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; 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.

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 and the World Courier Group, Inc. ("World Courier") operating segment. 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.


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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.

Results of Operations



Revenue



                                  Three months ended                        Nine months ended
                                       June 30,                                 June 30,
(dollars in thousands)            2014           2013        Change        2014           2013        Change
Pharmaceutical Distribution   $ 29,812,837   $ 21,407,853      39.3%   $ 86,367,923   $ 62,061,060      39.2%
Other                              620,275        549,400      12.9%      1,796,910      1,569,392      14.5%
Intersegment eliminations          (84,958 )      (50,605 )    67.9%       (184,414 )     (140,325 )    31.4%
Revenue                       $ 30,348,154   $ 21,906,648      38.5%   $ 87,980,419   $ 63,490,127      38.6%

Revenue increased by 38.5% and 38.6% from the prior year quarter and nine month period, respectively. This increase was largely due to the revenue growth of Pharmaceutical Distribution and, to a lesser extent, the revenue growth of Other.

We currently expect our revenue in fiscal 2014 to increase approximately 35%. Our expected growth rate is driven primarily by our distribution contract with Walgreen Co. ("Walgreens"), which became effective on September 1, 2013. Fiscal 2014 will include eleven incremental months of brand drug distribution and the phase-in of generic drug distribution to Walgreens. 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 39.3% and 39.2% 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. These revenues primarily consisted of ABSG sales directly to ABDC customer sites or ABSG sales to ABDC's facilities. Total intrasegment revenues were $1.1 billion and $809.2 million in the quarters ended June 30, 2014 and 2013, respectively. Total intrasegment revenues were $3.0 billion and $2.4 billion in the nine months ended June 30, 2014 and 2013, respectively.

ABDC's revenue of $25.9 billion and $75.1 billion in the quarter and nine months ended June 30, 2014 increased 45.5% and 45.7%, respectively, from the prior year periods (before intrasegment eliminations). The increase in ABDC's revenue was primarily due to increased sales to Walgreens of $6.6 billion and $19.7 billion in the quarter and nine months ended June 30, 2014, respectively, and increased sales (including new Hepatitis C drugs) to some of our other larger customers.

ABSG's revenue of $5.0 billion and $14.3 billion in the quarter and nine months ended June 30, 2014 increased 12.8% and 10.3%, respectively, from the prior year periods (before intrasegment eliminations) primarily due to increased sales of certain


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specialty products and growth in its blood products, vaccine, and physician office distribution businesses. The physician office distribution business continues to benefit from sales of an ophthalmology drug.

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. Under federal sequestration legislation, Medicare physician reimbursement rates for Part B drugs were reduced on April 1, 2013. Community oncologists and other specialty physicians that administer drugs under Medicare Part B continue to be impacted by lower reimbursement rates for specialty pharmaceutical drugs. As a result, some physician practices continue to consider consolidation or selling their businesses to hospitals. While we service the needs of many hospitals, the continuing shift in this service channel has reduced community oncology revenue. (Refer to Item 1A. Risk Factors, in our Annual Report on Form 10-K for the fiscal year ended September 30, 2013 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. Since ABSG provides a number of services to or through physicians, any changes affecting this service channel could result in additional revenue reductions.

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, 2014, no significant contracts expired. Over the next twelve months, the only significant contract scheduled to expire is our contract with the Department of Defense ("DOD"), which expires in April 2015. Our revenue, results of operations, and cash flows will be negatively impacted if the DOD contract is not renewed or the terms of the renewed contract are less favorable than the existing contract.

Other

Revenue in Other increased 12.9% and 14.5% from the prior year quarter and nine month period, respectively, primarily due to our TheraCom distribution business within ABCS, which benefited from the launch of two new products in the middle of the prior fiscal year. Increased revenue from World Courier also contributed to the nine month period revenue growth.

Gross Profit



                           Three months ended                    Nine months ended
                                June 30,                             June 30,
(dollars in thousands)      2014        2013       Change       2014          2013       Change
Pharmaceutical
Distribution             $  691,303   $ 551,985      25.2%   $ 1,980,711   $ 1,667,811     18.8%
Other                       131,414     126,558       3.8%       398,362       373,737      6.6%
Gains on antitrust
litigation settlements        2,524       5,984                   24,396        21,748
LIFO expense               (133,237 )  (122,077 )               (293,647 )    (123,029 )
Gross profit             $  692,004   $ 562,450      23.0%   $ 2,109,822   $ 1,940,267      8.7%

Gross profit increased 23.0%, or $129.6 million, and 8.7%, or $169.6 million, from the prior year quarter and nine month period, respectively.

Pharmaceutical Distribution gross profit increased 25.2%, or $139.3 million, and 18.8%, or $312.9 million, from the prior year quarter and nine month period, respectively. These increases were primarily due to the higher brand and generic sales volume to Walgreens, brand and generic price appreciation, and the growth of our non-community oncology specialty distribution businesses. Gross profit in the quarter ended June 30, 2014 also benefited from supplier fee income resulting from our participation in the Walgreens and Alliance Boots procurement joint venture. As a percentage of revenue, Pharmaceutical Distribution gross profit margin of 2.32% and 2.29% in the quarter and nine months ended June 30, 2014 decreased 26 basis points and 40 basis points from


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the prior year quarter and nine month period, respectively. These declines were primarily due to a significant increase in lower margin brand business with Walgreens and some of our other larger customers and competitive pressures on customer margins.

Gross profit in Other increased 3.8%, or $4.9 million, and 6.6%, or $24.6 million, from the prior year quarter and nine month period, respectively. These increases were primarily due to improved gross margin in World Courier and higher revenue in TheraCom's distribution business. As a percentage of revenue, gross profit margin in Other of 21.19% in the quarter ended June 30, 2014 decreased from 23.04% in the prior year quarter. As a percentage of revenue, gross profit margin in Other of 22.17% in the nine months ended June 30, 2014 decreased from 23.81% in the prior year nine month period. These decreases were primarily due to increases in TheraCom's distribution revenue, which has a lower gross profit margin in comparison to other businesses within Other. These decreases were offset, in part, by increases in the gross profit margin of World Courier.

We recognized gains of $2.5 million and $6.0 million from antitrust litigation settlements with pharmaceutical manufacturers during the quarters ended June 30, 2014 and 2013, respectively. We recognized gains of $24.4 million and $21.7 million from antitrust litigation settlements with pharmaceutical manufacturers during the nine months ended June 30, 2014 and 2013, 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. We recorded LIFO expense of $133.2 million and $122.1 million in the quarters ended June 30, 2014 and 2013, respectively. Our LIFO expense was $293.6 million and $123.0 million in the nine months ended June 30, 2014 and 2013, respectively. The annual LIFO provision, which we estimate on a quarterly basis, is affected by expected changes in inventory quantities (such as the inventory build for the Walgreens business), product mix, and manufacturer pricing practices, which may be impacted by market and other external influences. 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)      2014        2013       Change       2014          2013        Change
Distribution, selling
and administrative       $  387,611   $ 331,173      17.0%   $ 1,128,012   $   975,409      15.6%
Depreciation and
amortization                 47,334      41,138      15.1%       135,778       119,690      13.4%
Warrants                    145,040      35,815                  267,000        39,576
Employee severance,
litigation and other          1,142      19,678                    7,411        21,383
Total operating
expenses                 $  581,127   $ 427,804      35.8%   $ 1,538,201   $ 1,156,058      33.1%

Distribution, selling and administrative expenses increased 17.0%, or $56.4 million, from the prior year quarter, and increased 15.6%, or $152.6 million from the prior year nine month period, primarily due to the on-boarding of our distribution agreement with Walgreens. More specifically, expenses relating to payroll, information technology and delivery were higher in the current year quarter and nine month period.

Depreciation expense increased from the prior year periods due to an increase in the amount of capital projects being depreciated. Amortization expense was comparable to the prior year periods.

Warrant expense was $145.0 million and $267.0 million in the quarter and nine month period ended June 30, 2014, respectively, compared to $35.8 million and $39.6 million in the prior year quarter and nine month period, respectively. The Warrants were issued in March 2013 in connection with the agreements and arrangements that define our strategic relationship with Walgreens


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and Alliance Boots. Future Warrant expense could fluctuate significantly. (Refer to "Critical Accounting Policies and Estimates - Warrants" in our Annual Report on Form 10-K for the fiscal year ended September 30, 2013 for a more detailed description of the accounting for the Warrants.)

Employee severance, litigation and other for the quarter ended June 30, 2014 included $1.5 million of employee severance and other costs offset, in part, by the net reversal of $0.4 million of other costs. Employee severance, litigation and other for the nine months ended June 30, 2014 included $5.3 million of deal-related transaction costs and $2.1 million of employee severance and other costs. Employee severance, litigation and other for the quarter ended June 30, 2013 included $18.1 million of deal-related transaction costs (primarily related to professional fees with respect to the Walgreens and Alliance Boots transaction) and $1.6 million of facility closure and other costs. Employee severance, litigation and other for the nine months ended June 30, 2013 included $22.8 million of deal-related transaction costs (primarily related to professional fees with respect to the Walgreens and Alliance Boots transaction), $4.5 million of facility closure and other costs, offset in part by a reversal of $5.9 million of employee severance costs that were initially recorded in connection with fiscal 2012 initiatives.

As a percentage of revenue, operating expenses were 1.91% in the quarter ended June 30, 2014, a decrease of 4 basis points from the prior year quarter. For the nine months ended June 30, 2014, operating expenses, as a percentage of revenue, were 1.75%, down 7 basis points from the prior year nine month period. These decreases were primarily due to economies of scale as a result of the increased revenue provided by the Walgreens distribution agreement offset, in part, by the larger Warrant expense in the current year periods.

Operating Income



                           Three months ended                   Nine months ended
                                June 30,                            June 30,
(dollars in thousands)      2014        2013       Change       2014         2013       Change
Pharmaceutical
Distribution             $  359,795   $ 278,728      29.1%   $ 1,019,506   $ 866,482      17.7%
Other                        33,678      33,600       0.2%       113,261      98,260      15.3%
Total segment
operating income            393,473     312,328      26.0%     1,132,767     964,742      17.4%
Gains on antitrust
litigation settlements        2,524       5,984                   24,396      21,748
LIFO expense               (133,237 )  (122,077 )               (293,647 )  (123,029 )
Acquisition related
intangibles
amortization                 (5,701 )    (6,096 )                (17,484 )   (18,293 )
Warrants                   (145,040 )   (35,815 )               (267,000 )   (39,576 )
Employee severance,
litigation and other         (1,142 )   (19,678 )                 (7,411 )   (21,383 )
Operating income         $  110,877   $ 134,646     -17.7%   $   571,621   $ 784,209     -27.1%

Segment operating income is evaluated before gains on antitrust litigation settlements; LIFO expense; acquisition related intangibles amortization; Warrants; and employee severance, litigation and other.

Pharmaceutical Distribution operating income increased 29.1%, or $81.1 million, and 17.7%, or $153.0 million, from the prior year quarter and nine month period, respectively, due to the increases in gross profit, offset in part by the increases in operating expenses. As a percentage of revenue, Pharmaceutical Distribution operating income margin declined 9 basis points from the prior year quarter and declined 22 basis points from the prior year nine month period due to a significant increase in lower margin brand business with Walgreens and some of our other larger customers.


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Operating income in Other increased 0.2%, or $0.1 million, as an increase in World Courier's gross profit was offset by an increase in ABCS operating expenses. Operating income in Other increased 15.3%, or $15.0 million, from the prior year nine month period primarily due to the increase in gross profit of World Courier.

Interest expense, interest income, and the respective weighted average interest rates in the quarters ended June 30, 2014 and 2013 were as follows (in thousands):

                                   2014                          2013
                                   Weighted Average              Weighted Average
                         Amount     Interest Rate      Amount     Interest Rate
Interest expense        $ 21,125              4.01%   $ 18,547              4.74%
Interest income             (222 )            0.28%       (357 )            0.28%
Interest expense, net   $ 20,903                      $ 18,190

Interest expense increased 13.9%, or $2.6 million, from the prior year quarter due to an increase of $445.0 million in fixed rate average borrowings due to the May 2014 issuance of our $600 million, 1.15% senior notes and our $500 million, 3.40% senior notes, offset in part by the repayment of our $500 million, 5.875% senior notes in June 2014.

Interest expense, interest income, and the respective weighted average interest rates in the nine months ended June 30, 2014 and 2013 were as follows (in thousands):

                                   2014                          2013
                                   Weighted Average              Weighted Average
                         Amount     Interest Rate      Amount     Interest Rate
Interest expense        $ 59,746              4.19%   $ 55,931              4.72%
Interest income             (537 )            0.37%       (706 )            0.29%
Interest expense, net   $ 59,209                      $ 55,225

Interest expense increased 6.8%, or $3.8 million, from the prior year nine month period due to an increase of $148.2 million in fixed rate average borrowings due to the May 2014 issuance of our $600 million, 1.15% senior notes and our $500 million, 3.40% senior notes, offset in part by the repayment of our $500 million, 5.875% senior notes in June 2014. In addition, variable rate average borrowings increased $117.5 million to fund seasonal working capital needs and the on-boarding of the Walgreens business.

During the quarter and nine month period ended June 30, 2014, we recorded a $33.0 million loss resulting from the early retirement of our $500 million, 5.875% senior notes due in September 2015 (See Liquidity and Capital Resources).

A significant portion of Warrant expense is not tax deductible. As a result, income taxes in the quarter ended June 30, 2014 reflect an effective income tax rate of 121.9%, compared to 44.7% in the prior year quarter. Income taxes in the nine months ended June 30, 2014 reflect an effective tax rate of 55.4%, compared to 39.1% in the prior year period. The fluctuations in our effective tax rate were the result of quarterly changes in the valuation of the Warrants for financial reporting purposes. Our future effective tax rate could fluctuate significantly depending upon the quarterly valuation of the Warrants for financial reporting purposes. Excluding the impact of Warrant expense, we expect that our effective tax rate in fiscal 2014 will be approximately 38%.

Loss from continuing operations of $12.8 million and diluted loss per share from continuing operations of $0.06 in the quarter ended June 30, 2014 was primarily due to the increase in Warrant expense, LIFO expense, and the loss on the early retirement of debt. Income from continuing operations of $216.2 million in the nine months ended June 30, 2014 decreased 51.2% from the prior year period. Diluted earnings per share from continuing operations of $0.92 in the nine months ended June 30, 2014 decreased 51.1% from $1.88 in the prior year period. These declines were primarily due to the increases in Warrant and LIFO expenses and the loss on the early retirement of debt.


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Income or loss from discontinued operations, net of income taxes, for all periods presented includes the operating results of AndersonBrecon ("AB") and AmerisourceBergen Canada Corporation ("ABCC"). The income in the quarter ended June 30, 2013 also includes the gain on the divestiture of AB and an adjustment to the initial estimated loss on the sale of ABCC. The loss in the nine months ended June 30, 2013 also includes a goodwill impairment charge and the initial estimated loss on the sale of ABCC.

Liquidity and Capital Resources



The following table illustrates our debt structure at June 30, 2014, including
availability under the multi-currency revolving credit facility, the receivables
securitization facility and the revolving credit note (in thousands):



                                                    Outstanding      Additional
                                                      Balance       Availability
Fixed-Rate Debt:
$600,000, 1.15% senior notes due 2017               $    599,363   $            -
$400,000, 4.875% senior notes due 2019                   398,041                -
$500,000, 3.50% senior notes due 2021                    499,479                -
$500,000, 3.40% senior notes due 2024                    498,599                -
Total fixed-rate debt                                  1,995,482                -

Variable-Rate Debt:
Multi-currency revolving credit facility due 2018              -        1,400,000
Receivables securitization facility due 2016                   -          950,000
Revolving credit note                                          -           75,000
Total variable-rate debt                                       -        2,425,000
Total debt                                          $  1,995,482   $    2,425,000

Along with our cash balances, our aggregate availability under our multi-currency revolving credit facility, our receivables securitization facility and the revolving credit note provides us sufficient sources of capital to fund our working capital requirements. We have increased seasonal needs . . .

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