Cencora, Inc. annual report, FY2014

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Business context and reporting period

This is AmerisourceBergen Corporation’s Form 10-K for the fiscal year ended September 30, 2014, with unaudited fourth-quarter results included. The filing is for AmerisourceBergen, not a filing under the name Cencora. The company distributes pharmaceuticals and provides specialty distribution, logistics, and manufacturer services.

Financial performance and liquidity

  • Revenue: $119.57 billion, up 35.9% from fiscal 2013. Pharmaceutical Distribution revenue rose 36.4%, largely reflecting the Walgreens distribution ramp; Other revenue increased 17.3%.
  • Gross profit and margins: Gross profit was $2.98 billion, up 18.9%; consolidated gross margin was approximately 2.49%, down from approximately 2.85%. Pharmaceutical Distribution gross margin fell to 2.36% from 2.64%, reflecting lower-margin Walgreens and other large-customer volume and competitive pressure.
  • Operating and net income: Operating income declined 13.3% to $778.9 million; operating margin was approximately 0.65%. Continuing-operations income fell 42.4% to $284.0 million and diluted EPS from continuing operations fell to $1.21 from $2.10. Net income was $276.5 million versus $433.7 million.
  • Cash flow: Operating cash flow was $1.46 billion, up from $788.1 million. Cash flow benefited from higher accounts payable, accrued expenses, and taxes, partly offset by increases in receivables and inventory. Capital expenditures were $264.5 million; cash and cash equivalents ended the year at $1.81 billion.
  • Debt and liquidity: Debt was $2.00 billion, all fixed-rate notes, compared with $1.40 billion a year earlier. The company reported no variable-rate debt outstanding at year-end and $2.43 billion of additional availability across its revolving, receivables-securitization, and revolving-note facilities. Current assets of $16.80 billion were below current liabilities of $17.25 billion; the current ratio was approximately 0.97. Working-capital measures increased: days sales outstanding 19.8, inventory on hand 28.1, and days payable outstanding 45.3.
  • Fourth quarter: Revenue was $31.59 billion; gross profit was $872.5 million; operating income was $207.3 million; continuing-operations income was $67.8 million; diluted EPS from continuing operations was $0.29.

Material changes versus the prior comparable period

  • Walgreens sales increased by $25.0 billion in fiscal 2014 as the ten-year distribution agreement was phased in. Walgreens represented 28% of annual revenue; Express Scripts represented 18%.
  • Revenue growth substantially exceeded gross-profit growth, and lower distribution margins tempered the benefit of higher volume. Pharmaceutical Distribution operating income nonetheless rose 21.0% to $1.41 billion before specified items.
  • Reported operating income included $422.7 million of warrant expense versus $90.1 million in 2013, and LIFO expense of $348.1 million versus $277.0 million. The company also recorded a $33.0 million loss on early retirement of debt.
  • The effective tax rate increased to 57.8% from 40.2%, largely because much of the increase in warrant fair value was not tax deductible. The warrants were valued at $1.14 billion at year-end and are remeasured quarterly.
  • Operating cash flow improved, while inventory and receivables rose with the increased business volume. The company issued $1.1 billion of notes and repaid $500 million of 5.875% notes early; reported long-term debt increased by approximately $599 million.
  • Share repurchases totaled $753.9 million, capped-call purchases were $211.4 million, and dividends paid were $214.5 million. Stockholders’ equity declined to $1.96 billion from $2.32 billion.

Outlook, risks, contingencies, and unusual items

  • Guidance: Management expected fiscal 2015 revenue growth of 7%–8%, supported in part by a full year of generic distribution to Walgreens. Planned fiscal 2015 capital expenditures were approximately $300 million. Management expected about $400 million of regular-program repurchases and approximately $400 million of special repurchases, subject to market conditions.
  • Customer and partnership exposure: Walgreens and Express Scripts together accounted for 46% of fiscal 2014 revenue. The Express Scripts contract was scheduled to expire in September 2015, subject to an automatic one-year renewal at the customer’s election. The Walgreens relationship, including its expected purchasing and efficiency benefits, carries execution and concentration risks.
  • Warrants and dilution: Walgreens and Alliance Boots hold warrants that may be exercised in 2016 and 2017. Exercise could dilute shareholders; capped calls and repurchases were intended to offset only part of the potential dilution. Future warrant expense and the effective tax rate may fluctuate materially with the company’s share price and valuation assumptions.
  • Legal and regulatory matters: The filing describes sealed qui tam matters, subpoenas concerning oncology distribution and controlled-substance monitoring, and a West Virginia action alleging deficiencies in controls over controlled substances. Outcomes were not predictable. The company also cited potential cost and operating effects from drug-supply tracking rules, healthcare reimbursement changes, fraud-and-abuse enforcement, and privacy requirements.
  • Other items: Fiscal 2014 included $24.4 million of antitrust settlement gains, recorded as a reduction to cost of goods sold; future gains were uncertain. The company invested $117.8 million in a Brazilian wholesaler and specialty joint venture. It also approved termination of its salaried defined-benefit pension plan, with a future settlement expense expected but not quantified clearly in this filing.
  • Controls and audit: Management and the independent auditor reported effective internal control over financial reporting; the auditor issued an unqualified opinion on the financial statements.

Most important facts for investors to verify

  1. Whether Walgreens volume and partnership benefits translate into improved margins, cash generation, and durable economics.
  2. Renewal terms and timing for the Express Scripts contract, and any changes to other major customer or GPO relationships.
  3. The impact of warrant remeasurement, potential exercise and dilution, and how effectively capped calls and repurchases mitigate it.
  4. Developments in the sealed qui tam matters, controlled-substance investigations and subpoenas, and the West Virginia litigation.
  5. Whether working-capital needs, particularly receivables and inventory, remain financeable as sales grow; verify actual facility availability and debt covenant compliance.
  6. Fiscal 2015 performance against the stated revenue-growth and capital-spending outlook, and the effects of LIFO costs, generic price deflation, and reimbursement changes.