Cencora, Inc. quarterly report, Q2 FY2018

Business context and reporting period

This is AmerisourceBergen Corporation’s unaudited Form 10-Q for the quarter and six months ended March 31, 2018 (fiscal Q2 and first half of fiscal 2018). The filing registrant was AmerisourceBergen, not Cencora. Its principal business is pharmaceutical distribution; its other operations include animal health, global logistics and commercialization services.

Financial performance

Amounts below are in U.S. dollars; “quarter” compares the three months ended March 31, 2018 with the prior-year quarter, and “six months” compares the corresponding half-year periods.

Pharmaceutical Distribution Services gross profit rose 9.9% for the quarter and 7.6% for six months; its gross margin was 2.41% and 2.22%, respectively, each down 1 basis point year over year. Other-segment gross profit rose, but its gross margin declined to 20.48% for the quarter and 20.61% for six months. Prior-year gross profit benefited from LIFO credits ($86.5 million in the quarter and $58.2 million in the six-month period); current-year results included $22.5 million of PharMEDium remediation costs.

At March 31, 2018, cash and equivalents were $2.09 billion, total debt was $4.53 billion, and long-term debt was $4.28 billion. Debt increased from $3.44 billion at September 30, 2017, reflecting new notes, acquisitions and consolidated Brazilian subsidiary debt. The company reported $2.44 billion of additional availability under specified credit facilities and was compliant with its stated debt covenants. Current assets were $26.40 billion and current liabilities $28.09 billion, including substantial trade payables. The quarterly dividend was raised 4% to $0.38 per share.

Material changes versus prior periods

• Revenue growth reflected growth among large customers, oncology sales, and the January 2018 H.D. Smith acquisition and consolidation of Profarma and a Brazilian specialty joint venture.
• Operating expenses increased: distribution, selling and administrative expense rose 18.3% in the quarter and 12.8% for six months. Management cited acquisitions, additional distribution centers and duplicate information-technology implementation costs.
• Quarterly operating income and attributable earnings declined despite higher revenue. Management cited PharMEDium remediation, higher acquired-intangible amortization, severance and litigation costs, and higher non-operating losses; the prior-year quarter benefited from a LIFO credit.
• Six-month attributable earnings increased primarily because of tax reform. The period included a $423.7 million income tax benefit and a negative 58.8% effective tax rate, versus a 31.1% rate in the prior-year period. The filing records $587.6 million of discrete tax benefits related to the Tax Cuts and Jobs Act, partly offset by a $310.0 million transition-tax expense.
• Operating cash flow shifted to an outflow, mainly due to seasonal and business-growth-related increases in inventory ($805.2 million) and receivables ($590.4 million). Days inventory on hand increased to 33.1 from 30.3 in the quarter.

Outlook, risks and unusual items

• Management expected fiscal 2018 revenue growth of 8%–11% and approximately $325 million of capital expenditures. It expected cash flows and borrowing capacity to fund ongoing requirements; future dividends remained subject to board discretion.
• PharMEDium voluntarily suspended production at its largest Memphis compounding facility in December 2017 following FDA inspections, pending remediation. The company was communicating with the FDA and aimed to resume production after remediation; timing and financial effects were uncertain.
• Opioid-related lawsuits and government investigations remained unresolved, and the company said it could not assess likely outcomes or exposure. It also faced investigations and subpoenas concerning controlled-substance distribution and other pharmaceutical activities. The filing cautioned that some outcomes could materially affect results or cash flows.
• AmerisourceBergen had accrued $625 million for an agreement in principle with the U.S. Attorney’s Office for the Eastern District of New York concerning alleged civil claims. Payment and final resolution remained subject to definitive terms, resolution of related issues and court approval.
• The company recorded a $42.3 million pretax loss on remeasurement of previously held Brazilian investments, a $30 million impairment of a note receivable, and a $23.8 million loss on early retirement of debt in the six-month period. The H.D. Smith purchase-price allocation and tax-reform accounting were still provisional.
• Management identified risks including pricing and reimbursement pressure, customer and supplier concentration or contract changes, regulation and litigation, acquisition integration, information-system disruption, interest-rate exposure and working-capital volatility.

Important facts for investors to verify

• Whether PharMEDium remediation was completed, FDA requirements were satisfied and Memphis production resumed, and the resulting effect on sales and margins.
• Developments, final terms and payment timing for the $625 million EDNY agreement in principle, plus potential exposure from opioid litigation and other investigations.
• Whether H.D. Smith and the Brazilian consolidations delivered expected growth and integration benefits, and whether final purchase-price allocations changed goodwill or amortization.
• How seasonal inventory and receivables levels convert to operating cash flow, and whether working-capital requirements or customer payment terms materially change.
• Final tax-reform measurements and the cash-payment schedule for the estimated $310 million transition tax; the filing states it is payable in installments beginning January 2019.