Cencora, Inc. quarterly report, Q2 FY2015

Business context and reporting period

AmerisourceBergen Corporation (the company now known as Cencora) filed this unaudited Form 10-Q for its fiscal second quarter and six months ended March 31, 2015. It distributes pharmaceuticals and provides related services; its reporting segments are Pharmaceutical Distribution and Other. Amounts below are in U.S. dollars.

Financial results and liquidity

• Pharmaceutical Distribution gross margin was 2.67% for the quarter, up 18 basis points year over year. Total gross margin, calculated from reported figures, was approximately 2.79%, versus 2.56% a year earlier.
• Cash and equivalents were $2.34 billion at March 31, 2015. Total debt was $4.01 billion, including $64.2 million current debt; unused availability under specified credit facilities was $2.44 billion. The company reported compliance with its debt covenants.
• Six-month operating cash flow rose from $112.7 million to $1.64 billion. The increase reflected $2.57 billion of cash from accounts payable, accrued expenses and income taxes, partly offset by higher receivables and inventory. Capital expenditures were $105.2 million.
• Quarterly dividend declared was $0.29 per share, versus $0.235 a year earlier.

Material changes versus prior comparable periods

• Revenue growth reflected increased WBA sales, brand and generic pharmaceutical sales (including Hepatitis C treatments), growth in specialty businesses, and MWI’s contribution. Sales to WBA increased $2.0 billion in the quarter and $4.2 billion for six months; excluding WBA, revenue increased 8%.
• MWI Veterinary Supply was acquired on February 24, 2015 for approximately $2.6 billion. It added $304.3 million of quarterly revenue and was included in Other. The preliminary allocation included $1.2 billion of goodwill.
• Total segment operating income increased 32.7% for the quarter and 33.7% for six months. Reported operating results nevertheless swung to losses, principally because warrant expense rose to $752.7 million for the quarter and $1.12 billion for six months, largely as the company’s share price increased. This expense is valuation-sensitive and substantially nondeductible for tax purposes.
• LIFO expense increased to $151.1 million for the quarter and $295.2 million for six months, versus $102.8 million and $160.4 million, respectively, a year earlier. Higher LIFO expense partly offset gross-profit growth.
• Debt increased from $2.00 billion at September 30, 2014 to $4.01 billion, primarily to finance MWI: the company raised a $1.0 billion term loan and issued $1.0 billion of senior notes due 2025 and 2045.

Outlook, risks and unusual items

• Management expected fiscal 2015 revenue growth of 12%–13% and approximately $250 million in capital expenditures. It expected operating cash flows and borrowing capacity to fund ongoing requirements; future dividends remained at the board’s discretion.
• WBA warrants may dilute shareholders when exercisable in 2016 and 2017. The company used capped calls, call options and share repurchases to mitigate potential dilution; coverage depends on the share price and hedge terms. In April 2015, the board authorized an additional $1 billion special repurchase program.
• Reported earnings are exposed to changes in the warrant valuation and LIFO estimates. Other stated risks include pharmaceutical pricing and reimbursement changes, customer or supplier concentration and contract retention, acquisition integration, interest and foreign-exchange movements, and regulatory or competitive changes.
• Legal matters included sealed qui tam allegations concerning oncology distribution, federal investigations and subpoenas concerning controlled-substance diversion controls, and state proceedings including West Virginia and Fulton County, Georgia. The company said it could not predict outcomes; adverse resolutions could materially affect results or financial condition.
• The quarter included $24.3 million of deal-related transaction costs. Antitrust litigation settlement gains of $21.5 million were recorded as reductions to cost of goods sold. Management stated disclosure controls were effective; it was evaluating MWI’s impact on internal controls.

Most important facts for investors to verify

1. How much of the reported loss reflects noncash warrant remeasurement and elevated LIFO expense, and how these items may vary with share prices and inventory assumptions.
2. MWI’s post-acquisition performance, integration costs, final purchase-price allocation and expected contribution to earnings and cash flow.
3. Whether operating cash flow remains supported by supplier payment timing and working-capital movements, rather than recurring earnings alone.
4. Potential dilution from WBA warrants and the actual effectiveness, cost and funding of the company’s hedging and repurchase programs.
5. Developments in controlled-substance and qui tam proceedings, along with any material effect on liabilities, operations or customer relationships.