NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1—ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Business
PharMerica Corporation together with its subsidiaries, (the "Corporation"), is a pharmacy services company that services healthcare facilities, provides pharmacy management services to hospitals, provides specialty infusion services to patients outside a hospital setting, and offers the only national oncology pharmacy in the United States. The Corporation is the second largest institutional pharmacy services company in the United States based on revenues and customer licensed beds under contract, operating 99 institutional pharmacies, 20 specialty home infusion pharmacies, and 5 specialty oncology pharmacies in 45 states. The Corporation's customers are institutional healthcare providers, such as skilled nursing facilities, assisted living facilities, hospitals, individuals receiving in-home care and patients with cancer.
On August 1, 2017, the Corporation entered into an Agreement and Plan of Merger (the "Merger Agreement") with Phoenix Parent Holdings Inc., a Delaware corporation ("Parent"), and Phoenix Merger Sub Inc., a Delaware corporation and a wholly owned subsidiary of Parent ("Merger Sub"), pursuant to which Merger Sub will be merged with and into the Corporation, with the Corporation continuing as the surviving corporation (the "Merger"). After the closing of the Merger, the Corporation will be a private company and a wholly-owned subsidiary of Parent. Parent and Merger Sub are affiliates of investment funds affiliated with Kohlberg Kravis Roberts & Co. L.P. and, at the closing of the Merger, affiliates of Walgreens Boots Alliance, Inc. will acquire a minority ownership interest in Parent. Subject to the terms and conditions of the Merger Agreement, at the effective time of the Merger, each share of common stock, $0.01 par value, of the Corporation outstanding immediately prior to the effective time will be converted into the right to receive an amount in cash equal to $29.25 per share, without interest. The Merger is subject to customary closing conditions as set forth in the Merger Agreement. The Merger is expected to be comple
ted by early 2018.
The Corporation cannot predict with certainty when, or if, the Merger will be completed because completion of the Merger is subject to conditions beyond the control of the Corporation. A special meeting of the stockholders of the Corporation was held on November 9, 2017, to vote on the proposal to adopt the Merger Agreement. See Note 11.
Operating Segments
The Corporation consists of three operating segments: institutional pharmacy, specialty infusion services and specialty oncology pharmacy. Management believes the nature of the products and services are similar, the payers for the products and services are common among the segments and all segments operate in the healthcare regulatory environment. In addition, the segments are economically similar. Accordingly, management has aggregated the three operating segments into one reporting segment.
Principles of Consolidation
All intercompany transactions have been eliminated.
The Corporation has an investment in a long-term care pharmacy business that is accounted for by the equity method. This entity is not a variable interest entity and the Corporation's lack of majority voting rights precludes the Corporation from controlling this affiliate. Accordingly, the Corporation does not consolidate this affiliate, but rather applies the equity method of accounting. The Corporation's share of the net income or loss of this unconsolidated affiliate is included in operating income.
Basis of Presentation
The accompanying condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X and do not include all of the information and disclosures required by generally accepted accounting principles in the United States ("U.S. GAAP") for complete financial statements. Accordingly, the accompanying condensed consolidated financial statements should be read in conjunction with the consolidated financial statements of the Corporation and related footnotes for the year ended December 31, 2016, included in the Corporation's Annual Report on Form 10-K. The balance sheet as of December 31, 2016 has been derived from the audited consolidated financial statements.
The results of operations for the interim periods are not necessarily indicative of results of operations for a full year. It is the opinion of management that all necessary adjustments for a fair presentation of the condensed consolidated financial statements for the interim periods have been made and are of a normal recurring nature.
Use of Estimates
The accompanying condensed consolidated financial statements have been prepared in accordance with U.S. GAAP which requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities and disclosure of contingent liabilities as of the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Significant estimates are involved in collectability of accounts receivable, revenue recognition, inventory valuation, supplier rebates and the valuation of long-lived assets and goodwill. Actual amounts may differ from these estimates.
Fair Value of Financial Instruments
Fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based upon assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, the Corporation follows a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows:
Level 1:
|
Observable inputs such as quoted prices in active markets;
|
Level 2:
|
Inputs, other than quoted prices in active markets, that are observable either directly or indirectly; and
|
Level 3:
|
Unobservable inputs for which there is little or no market data, which require the Corporation to develop its own assumptions.
|
PHARMERICA CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
NOTE 1—ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Assets and liabilities measured at fair value are based on one or more of the following three valuation techniques:
|
A.
|
Market approach:
Prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities.
|
|
B.
|
Cost approach:
Amount that would be required to replace the service capacity of an asset (replacement cost).
|
|
C.
|
Income approach:
Techniques to convert future amounts to a single present amount based upon market expectations (including present value techniques, option-pricing and excess earnings models).
|
The financial liabilities recorded at fair value at December 31, 2016 and September 30, 2017 are set forth in the tables below (dollars in millions):
As of December 31, 2016
|
Liability
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Valuation
Technique
|
|
Financial Liability
|
|
|
|
|
|
|
|
|
|
|
Deferred Compensation Plan
|
|
$
|
(8.8
|
)
|
|
$
|
-
|
|
|
$
|
(8.8
|
)
|
|
$
|
-
|
|
|
|
|
A
|
Contingent Considerations
|
|
|
(8.1
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
(8.1
|
)
|
|
|
|
C
|
Mandatorily Redeemable Interest
|
|
|
(4.0
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
(4.0
|
)
|
|
|
|
C
|
As of September 30, 2017
|
Liability
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Valuation
Technique
|
|
Financial Liability
|
|
|
|
|
|
|
|
|
|
|
Deferred Compensation Plan
|
|
$
|
(11.6
|
)
|
|
$
|
-
|
|
|
$
|
(11.6
|
)
|
|
$
|
-
|
|
|
|
|
A
|
Contingent Considerations
|
|
|
(9.0
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
(9.0
|
)
|
|
|
|
C
|
Mandatorily Redeemable Interest
|
|
|
(4.0
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
(4.0
|
)
|
|
|
|
C
|
The deferred compensation plan liability represents an obligation associated with the deferred compensation plan offered to eligible employees and members of the Board of Directors of the Corporation. The fair value of the liability associated with the deferred compensation plan is derived using pricing and other relevant information for investments in phantom shares of certain available investment options, primarily mutual funds. This liability is classified as other long-term liabilities in the accompanying condensed consolidated balance sheets.
The contingent consideration represents future earn-outs associated with certain of the Corporation's acquisitions made in 2015, 2016 and 2017. The fair values of the liabilities associated with the contingent consideration were derived using the income approach with unobservable inputs, which included future gross profit forecasts and present value assumptions, and there was little or no market data. The Corporation assessed the fair values of the liabilities as of the acquisition date and will assess quarterly thereafter until settlement. These liabilities are classified as other current and long-term liabilities in the accompanying condensed consolidated balance sheets.
The mandatorily redeemable interest represents a future obligation associated with the Corporation's acquisition of a specialty pharmacy business, OncoMed Specialty, LLC ("Onco") in which the Corporation made its initial purchase of interests on December 6, 2013 and its purchase of additional interests in December 2016. The mandatorily redeemable interest is classified as a long-term liability and measured at fair value. The fair value was derived using the income approach with unobservable inputs, which included a future gross profit forecast and present value assumptions, and there was little or no market data. The Corporation assessed and adjusted the mandatorily redeemable interest liability to estimated fair value at December 31, 2016. This liability is classified as other long-term liabilities in the accompanying condensed consolidated balance sheets.
For the year ended December 31, 2016 and the nine months ended September 30, 2017, there were no transfers between the valuation hierarchy Levels 1, 2, and 3. The following table summarizes the change in fair value of the Corporation's contingent considerations and mandatorily redeemable interest identified as Level 3 for the year ended December 31, 2016 and the nine months ended September 30, 2017 (in millions):
|
|
Contingent Consideration
|
|
|
Mandatorily Redeemable Interest
|
|
|
|
|
|
|
|
|
Beginning balance, December 31, 2015
|
|
$
|
11.5
|
|
|
$
|
5.8
|
|
Additions from business acquisitions
|
|
|
1.4
|
|
|
|
-
|
|
Contingent consideration payment
|
|
|
(3.9
|
)
|
|
|
-
|
|
Change in fair value
|
|
|
(0.9
|
)
|
|
|
(1.8
|
)
|
Balance at December 31, 2016
|
|
|
8.1
|
|
|
|
4.0
|
|
Additions from business acquisitions
|
|
|
6.0
|
|
|
|
-
|
|
Contingent consideration payment
|
|
|
(3.9
|
)
|
|
|
-
|
|
Change in fair value
|
|
|
(1.2
|
)
|
|
|
-
|
|
Balance, September 30, 2017
|
|
$
|
9.0
|
|
|
$
|
4.0
|
|
The carrying amounts reported in the accompanying condensed consolidated balance sheets for cash and cash equivalents, accounts receivable, inventory and accounts payable approximate fair value because of the short-term maturity of these instruments. The Corporation's debt approximates fair value due to the terms of the interest being set at variable market interest rates (Level 2).
PHARMERICA CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
NOTE 1—ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Accounts Receivable and Allowance for Doubtful Accounts
Accounts receivable primarily consist of amounts due from Prescription Drug Plans ("PDPs") under Medicare Part D, institutional healthcare providers, the respective state Medicaid programs, third party insurance companies, and private payers. The Corporation's ability to collect outstanding receivables is critical to its results of operations and cash flows. To provide for accounts receivable that could become uncollectible in the future, the Corporation establishes an allowance for doubtful accounts to reduce the carrying value of such receivables to the extent it is probable that a portion or all of a particular account will not be collected.
The Corporation has an established process to determine the adequacy of the allowance for doubtful accounts, which relies on analytical tools, specific identification, and benchmarks to arrive at a reasonable allowance. No single statistic or measurement determines the adequacy of the allowance for doubtful accounts. The Corporation monitors and reviews trends by payer classification along with the composition of the Corporation's accounts receivable aging. This review is focused primarily on trends in private and other payers, PDPs, dual eligible co-payments, historic payment patterns of long-term care institutions, and monitoring respective credit risks. In addition, the Corporation analyzes other factors such as revenue days in accounts receivables, denial trends by payer types, payment patterns by payer types, subsequent cash collections, and current events that may impact payment patterns of the Corporation's long-term care institution customers. Accounts receivable are written off after collection efforts have been completed in accordance with the Corporation's policies.
The Corporation's accounts receivable and summarized aging categories are as follows (dollars in millions):
|
|
December 31,
|
|
|
September 30,
|
|
|
|
2016
|
|
|
2017
|
|
Institutional healthcare providers
|
|
$
|
138.2
|
|
|
$
|
144.0
|
|
Medicare Part D
|
|
|
42.5
|
|
|
|
51.0
|
|
Private payer and other
|
|
|
28.1
|
|
|
|
29.3
|
|
Insured
|
|
|
38.7
|
|
|
|
40.0
|
|
Medicaid
|
|
|
15.6
|
|
|
|
16.0
|
|
Medicare
|
|
|
3.4
|
|
|
|
1.9
|
|
Allowance for doubtful accounts
|
|
|
(31.1
|
)
|
|
|
(33.0
|
)
|
|
|
$
|
235.4
|
|
|
$
|
249.2
|
|
|
|
|
|
|
|
|
|
|
0 to 60 days
|
|
|
62.9
|
%
|
|
|
61.9
|
%
|
61 to 120 days
|
|
|
15.7
|
%
|
|
|
15.3
|
%
|
Over 120 days
|
|
|
21.4
|
%
|
|
|
22.8
|
%
|
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
The following is a summary of activity in the Corporation's allowance for doubtful accounts (dollars in millions):
|
Beginning Balance
|
|
Charges Included in Selling, General & Administrative Expenses
|
|
Write-offs
|
|
Ending Balance
|
|
Allowance for doubtful accounts:
|
|
|
|
|
|
|
|
|
Year Ended December 31, 2016
|
|
$
|
49.3
|
|
|
$
|
6.3
|
|
|
$
|
(24.5
|
)
|
|
$
|
31.1
|
|
Nine Months Ended September 30, 2017
|
|
$
|
31.1
|
|
|
$
|
9.6
|
|
|
$
|
(7.7
|
)
|
|
$
|
33.0
|
|
Bad debt expense for the year ended December 31, 2016 was favorably impacted by approximately $5.6 million related to collections of certain previously reserved receivables under note agreements and the settlement of a customer's trade receivable of $3.2 million.
Restructuring and Impairment Charges
Restructuring and impairment charges in the accompanying condensed consolidated financial statements represent amounts expensed for purposes of realigning corporate and pharmacy locations.
Mandatorily Redeemable Interest
On December 6, 2013, the Corporation acquired 37.5% of the membership interests of Onco while also obtaining control of the business. Following the Corporation's exercise of its rights to purchase additional interests of Onco in December 2016, the Corporation owns an aggregate of 81.5% of the membership interests of Onco as of September 30, 2017. The subsidiary is consolidated in the Corporation's condensed consolidated financial statements and the mandatorily redeemable interest is classified as other long-term liabilities in the condensed consolidated balance sheets.
PHARMERICA CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
NOTE 1—ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Recently Issued Accounting Pronouncements
In February 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2016-02, "Leases", which generally requires companies to recognize operating and financing lease liabilities and corresponding right-of-use assets on the balance sheet. This guidance will be adopted in the first quarter of 2019 on a modified retrospective basis. The Corporation is still evaluating the effect that this guidance will have on its condensed consolidated financial statements and related disclosures.
In November 2015, the FASB issued ASU No. 2015-17, "Balance Sheet Classification of Deferred Taxes" related to accounting for income taxes which changes the balance sheet classification of deferred taxes, requiring deferred tax liabilities and assets be classified as noncurrent in a classified statement of financial position. The new guidance is effective for the Corporation beginning with annual and interim periods in 2017, with early adoption permitted. The Corporation adopted this ASU beginning January 1, 2017. The Corporation no longer presents a current deferred tax asset and a noncurrent deferred tax liability. Instead those amounts are combined to a net noncurrent deferred tax asset on its condensed consolidated balance sheets as of December 31, 2016 and September 30, 2017.
In May 2014, the FASB issued ASU No. 2014-09, "Revenue from Contracts with Customers", which amends the existing accounting standards for revenue recognition. In August 2015, the FASB issued ASU No. 2015-14, which delayed the effective date of ASU 2014-09 by one year. In March 2016, the FASB issued Accounting Standards Update No. 2016-08, "Revenue from Contracts with Customers: Principal versus Agent Considerations" which clarifies the implementation guidance on principal versus agent considerations. The guidance includes indicators to assist an entity in determining whether it controls a specified good or service before it is transferred to the customers. The Corporation will adopt the new standard effective January 1, 2018. The new standard also permits two methods of adoption: retrospectively to each prior reporting period presented (full retrospective method), or retrospectively with the cumulative effect of initially applying the guidance recognized at the date of initial application (the modified retrospective method). The Corporation currently anticipates adopting the standard using the modified retrospective method. The Corporation is in the process of completing its analysis on the impact this guidance will have on its condensed consolidated financial statements and related disclosures, however, the Corporation believes it will not have a material impact on its condensed consolidated financial statements.
NOTE 2—ACQUISITIONS
2017 Acquisitions
During the nine months ended September 30, 2017, the Corporation completed acquisitions of two long-term care businesses, two infusion businesses and one specialty and oncology business (collectively the "2017 Acquisitions"), none of which were individually significant to the Corporation. The 2017 Acquisitions had an estimated purchase price of $87.0 million. The Corporation has not yet finalized the purchase price allocation related to these acquisitions. The preliminary amount of goodwill and identifiable intangibles related to these transactions is estimated to be $55.0 million and $32.2 million, respectively. Tax deductible goodwill associated with the acquisitions was $53.8 million as of September 30, 2017. The net assets and operating results of the 2017 Acquisitions have been included in the Corporation's condensed consolidated financial statements from the respective dates of acquisition.
2016 Acquisitions
During the year ended December 31, 2016, the Corporation completed acquisitions of four long-term care businesses and two infusion businesses (collectively the "2016 Acquisitions"), none of which were individually significant to the Corporation. The resulting amount of goodwill and identifiable intangibles related to these transactions in the aggregate were $22.7 million and $32.0 million, respectively. The Corporation believes the resulting amount of goodwill reflects the synergistic benefits of the acquisitions. Tax deductible goodwill associated with the 2016 Acquisitions was $10.7 million as of September 30, 2017. The net assets and operating results of the 2016 Acquisitions have been included in the Corporation's condensed consolidated financial statements from the respective dates of acquisition.
Pro forma financial statements are not presented on the 2017 Acquisitions or 2016 Acquisitions as the results are not material to the Corporation's condensed consolidated financial statements.
PHARMERICA CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
NOTE 3—GOODWILL AND INTANGIBLES
As of December 31, 2016 and September 30, 2017 the carrying amount of goodwill was $392.3 million and $449.3 million, respectively.
The following table presents the components of the Corporation's finite lived intangible assets (dollars in millions):
Finite Lived Intangible Assets
|
|
Balance at
December 31, 2016
|
|
|
Additions
|
|
|
Balance at
September 30, 2017
|
|
Customer relationships
|
|
$
|
245.7
|
|
|
$
|
29.5
|
|
|
$
|
275.2
|
|
Trade name
|
|
|
64.0
|
|
|
|
4.1
|
|
|
|
68.1
|
|
Non-compete agreements
|
|
|
22.2
|
|
|
|
1.2
|
|
|
|
23.4
|
|
Sub Total
|
|
|
331.9
|
|
|
|
34.8
|
|
|
|
366.7
|
|
Accumulated amortization
|
|
|
(144.3
|
)
|
|
|
(29.0
|
)
|
|
|
(173.3
|
)
|
Net intangible assets
|
|
$
|
187.6
|
|
|
$
|
5.8
|
|
|
$
|
193.4
|
|
Amortization expense relating to finite-lived intangible assets was $8.3 million and $10.0 million for the three months ended September 30, 2016 and 2017, respectively, and $24.7 million and $29.0 million for the nine months ended September 30, 2016 and 2017, respectively.
NOTE 4—CREDIT AGREEMENT
On December 9, 2016, the Corporation entered into a First Amendment ("Amendment") to its existing Credit Agreement previously entered into in September 2014 by and among the Corporation, the lenders named therein (the "Lenders"), Bank of America, N.A., as administrative agent, JP Morgan Chase Bank N.A., as syndication agent, and U.S. Bank, National Association, Citibank, N.A., MUFG Union Bank, N.A., BBVA Compass Bank and SunTrust Bank as co-documentation agents (collectively, the "Credit Agreement"). The Credit Agreement originally consisted of a $225.0 million term loan facility and a $310.0 million revolving credit facility. Pursuant to the Amendment, among other things, (a) the revolving commitments to the revolving credit facility were increased to $370.0 million, (b) an additional advance under the term loan was provided in an outstanding principal amount equal to $89.1 million which, when combined with the $210.9 million then outstanding under the term loan as of the date of the Amendment, equals $300.0 million outstanding under the term loan, (c) the amount by which commitments may be increased after the initial closing was increased from $190.0 million to $200.0 million, and (d) The Huntington National Bank was added as a new lender to the Credit Agreement.
As of September 30, 2017, $285.9 million was outstanding under the term loan facility and $174.6 million was outstanding under the revolving credit facility. Indebtedness under the Credit Agreement matures on September 17, 2019, at which time the commitments of the Lenders to make revolving loans also expire.
The table below summarizes the total outstanding debt of the Corporation (dollars in millions):
|
|
|
|
|
|
|
|
|
December 31, 2016
|
|
|
September 30, 2017
|
|
Term Debt - payable to lenders at LIBOR plus applicable margin (3.24% as of September 30, 2017), matures September 17, 2019
|
|
$
|
297.2
|
|
|
$
|
285.9
|
|
Revolving Credit Facility payable to lenders, interest at LIBOR plus applicable margin (3.20% as of September 30, 2017), matures September 17, 2019
|
|
|
176.5
|
|
|
|
174.6
|
|
Deferred financing costs, net
|
|
|
(1.9
|
)
|
|
|
(1.5
|
)
|
Capital lease obligations
|
|
|
1.6
|
|
|
|
1.2
|
|
Total debt
|
|
|
473.4
|
|
|
|
460.2
|
|
Less: Current portion of long-term debt
|
|
|
15.6
|
|
|
|
15.4
|
|
Total long-term debt
|
|
$
|
457.8
|
|
|
$
|
444.8
|
|
The Corporation's indebtedness has the following maturities as of September 30, 2017 (dollars in millions):
Year Ending December 31,
|
|
Term Debt
|
|
|
Revolving
Credit
Facility
|
|
|
Deferred
Financing
Costs
|
|
|
Capital
Lease
Obligations
|
|
|
Total
Maturities
|
|
2017
|
|
$
|
3.7
|
|
|
$
|
-
|
|
|
$
|
(0.2
|
)
|
|
$
|
0.1
|
|
|
$
|
3.6
|
|
2018
|
|
|
15.0
|
|
|
|
-
|
|
|
|
(0.7
|
)
|
|
|
0.5
|
|
|
|
14.8
|
|
2019
|
|
|
267.2
|
|
|
|
174.6
|
|
|
|
(0.6
|
)
|
|
|
0.4
|
|
|
|
441.6
|
|
2020
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
0.2
|
|
|
|
0.2
|
|
|
|
$
|
285.9
|
|
|
$
|
174.6
|
|
|
$
|
(1.5
|
)
|
|
$
|
1.2
|
|
|
$
|
460.2
|
|
The Credit Agreement provides for the issuance of letters of credit which, when issued, reduce availability under the revolving credit facility. The aggregate amount of letters of credit outstanding as of September 30, 2017 was $2.8 million. After giving effect to the letters of credit, total availability under the revolving credit facility was $192.6 million as of September 30, 2017.
PHARMERICA CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
NOTE 5—COMMITMENTS AND CONTINGENCIES
Legal Action and Regulatory
The Corporation maintains liabilities for certain of its outstanding investigations and litigation. In accordance with the provisions of U.S. GAAP for contingencies, the Corporation records a liability when it is probable that such a liability has been incurred and the amount of the loss can be reasonably estimated. To the extent that the resolution of contingencies results in actual losses that differ from the Corporation's recorded liabilities, earnings will be charged or credited accordingly. The Corporation cannot know the ultimate outcome of the pending matters described below, and there can be no assurance that the resolution of these matters will not have a material adverse impact on the Corporation's condensed consolidated results of operations, financial position or cash flows. As a part of its ongoing operations, the Corporation is subject to various inspections, audits, inquiries, investigations and similar actions by third parties, as well as by government/regulatory authorities responsible for enforcing the laws and regulations to which the Corporation is subject. Further, under the federal False Claims Act (the "FCA") , private parties have the right to bring qui tam, or "whistleblower," suits against companies that submit false claims for payments to, or improperly retain overpayments from the government. The inherently unpredictable nature of legal proceedings may be impacted by various factors, including: (i) the damages sought in the proceedings are unsubstantiated or indeterminate; (ii) discovery is not complete; (iii) the proceeding is in its early stages; (iv) the matters present legal uncertainties; (v) significant facts are in dispute; (vi) a large number of parties are participating in the proceedings (including where it is uncertain how liability, if any, will be shared among defendants); or (vii) the proceedings present a wide range of potential outcomes.
The Corporation is the subject of certain investigations and is a defendant in a number of cases, including those discussed below.
On March 4, 2011, a relator, Mark Silver, on behalf of the U.S. Government and various state governments, filed a complaint in the United States District Court for the District of New Jersey against the Corporation. The complaint alleges that, in violation of the Federal Anti-Kickback Statute and of the FCA, the Corporation offered below cost or below fair market value prices on drugs for which nursing homes were at financial risk (e.g., Medicare Part A), in exchange for so-called preferred or exclusive provider status that would allow the Corporation to dispense drugs to patients for which the Corporation could bill federal health care program payers such as Medicare Part D and Medicaid. On February 19, 2013, the U.S. Government declined to intervene in the case. The complaint has been amended several times, most recently on November 12, 2013, and thereafter served upon the Corporation. On December 6, 2013, the Corporation moved to dismiss the amended complaint for failure to state a claim upon which relief may be granted and on September 29, 2014, the court declined to dismiss the case, but limited the relevant time period for which claims could be brought against the Corporation. On March 4, 2016 and April 1, 2016, the Corporation filed motions to dismiss and for summary judgment, respectively, for lack of subject matter jurisdiction under the FCA prior public disclosure bar. On May 9, 2016, the Court granted the joint motion of Silver and the Corporation and dismissed with prejudice all successor liability claims against the Corporation for or regarding the conduct of Chem Rx Corporation. On November 28, 2016, the Court ruled in favor of the Corporation's March and April motions and this case was dismissed. In December of 2016, Silver filed an appeal of the dismissal and summary judgment to the Federal Court of Appeals for the Third Circuit, which will take the case on the merits on November 14, 2017. The Corporation intends to continue to defend the case vigorously.
On November 20, 2013, the complaint filed against the Corporation by a relator, Robert Gadbois, on behalf of the U.S. Government and various state governments, was unsealed by the United States District Court for the District of Rhode Island. The complaint alleges that the Corporation dispensed controlled and non-controlled substances in violation of the CSA and in violation of relevant state laws, and
that as a result,
the dispenses were not eligible for payment and that the claims the Corporation submitted to the Government were false within the meaning of the FCA. The U.S. Government and the various state governments declined to intervene in this case.
On October 3, 2014, the Corporation's motion to dismiss was granted by the court. The relator appealed the court's decision and on December 16, 2015, the First Circuit Court of Appeals granted the relator its appeal and remanded the case to the District Court to allow the relator to file a motion to supplement his complaint and to allow the District Court to rule upon that motion. On December 30, 2015, the Corporation filed with the First Circuit Court of Appeals a petition for a re-hearing en banc, which was denied on January 25, 2016. The Corporation filed a petition for certiorari with the U.S. Supreme Court on April 22, 2016 asking the Supreme Court to review the First Circuit's decision. On June 27, 2016, the Supreme Court denied the petition. Thereafter, on June 28, 2016, the case was returned to the District Court through the issuance by the First Circuit of its Mandate. Subsequently, the relator passed away. The relator filed a motion to substitute the personal representative of the relator's estate as the plaintiff in the case, which was granted on January 23, 2017. The relator also filed a motion for leave to file a third amended complaint. The Corporation filed its opposition to that motion on March 6, 2017 on grounds that amendment of the complaint would be futile because the relator is barred by two provisions of the FCA from proceeding in the action. On March 23, 2017, the relator moved to strike the Corporation's opposition and to defer further briefing of the motion for leave to amend pending discovery. The Corporation filed its opposition on April 10, 2017, and the relator filed his reply thereto on April 20, 2017. By order of the court, a final round of briefing on the relator's motion for leave to file a third amended complaint was concluded on July 10, 2017. Oral argument on the motion was held on August 31, 2017. The Court has not yet issued a ruling on the motion. The Corporation intends to continue to defend the case vigorously.
On September 10, 2014, the Corporation filed a Complaint in Jefferson Circuit Court in Louisville, Kentucky against AmerisourceBergen Drug Corporation ("ABDC") for failure of ABDC to comply with certain pricing and rebate provisions of the Previous Prime Vendor Agreement ("Previous PVA"). The Corporation subsequently filed a First Amended Verified Complaint on September 26, 2014 and later filed Second and Third Amended Verified Complaints asserting additional breaches of the Previous PVA
.
As a result of ABDC's failure to comply with certain pricing and rebate provisions, the Corporation had recorded a receivable of $40.8 million related to these disputes at December 31, 2014. Separately, as of December 31, 2014, the Corporation had recorded $12.2 million for additional rebates owing from ABDC which at that time the Corporation believed were not in dispute and had previously been paid by ABDC in all the prior quarters. These receivables totaled $53.0 million and were included in prepaids and other assets in the consolidated balance sheet as of December 31, 2014. During the period of January 1, 2015 through March 31, 2015, an additional $19.3 million, net of payments received, of certain rebates and guarantees owed by ABDC under the Previous PVA were recognized, which brought the total gross receivable to $72.3 million at December 31, 2015.
PHARMERICA CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
NOTE 5—COMMITMENTS AND CONTINGENCIES (Continued)
On March, 2, 2015, the Corporation notified ABDC of its intent to terminate the Previous PVA effective April 1, 2015. The Corporation also announced that it had entered into the Cardinal Health Prime Vendor Agreement ("Cardinal Health PVA") effective April 1, 2015. On March 3, 2015, the Corporation received a letter from ABDC terminating the Previous PVA effective immediately based upon the Corporation's alleged failure to pay certain disputed miscellaneous charges and the Corporation's signing of the Cardinal Health PVA. The Corporation believes ABDC did not have the right to immediately terminate the contract pursuant to the terms of the Previous PVA. On March 6 and March 13, 2015, the Corporation withheld from ABDC normal recurring payments for drug purchases of approximately $48.9 million. On May 18, 2015, ABDC filed an Amended Counterclaim seeking additional financial damages against the Corporation and asserted claims against two counter-defendants. On November 23, 2015, the Corporation filed its Third Amended Complaint against ABDC for additional financial damages, amounts overcharged by ABDC, and for certain rebates not paid by ABDC under the Previous PVA.
On April 1, 2016, the Jefferson Circuit Court ruled that the Corporation could not set-off payment of the amounts that ABDC owed the Corporation against amounts that ABDC had invoiced the Corporation. Instead the Corporation must first pay ABDC and continue the litigation against ABDC to collect any amounts owed to the Corporation by ABDC upon the conclusion of the entire lawsuit. As a result, the Corporation owes approximately $48.9 million of payments for drug purchases in the first quarter of 2015. The Corporation has continued the litigation in the Jefferson Circuit Court against ABDC. On April 11, 2016, the Corporation filed a Motion to Alter and Amend the April 1, 2016 order of the Jefferson Circuit Court asking the judge to reconsider the final and appealable aspect of the order. On August 8, 2016, the Jefferson County Circuit Court issued an order that granted the Corporation's April 11, 2016 Motion to Alter and Amend the Judgment entered on April 1, 2016. The Court granted the Corporation's motion to remove the final and appealable designation from the April 1, 2016 order; therefore, the Corporation does not presently have to post a bond, pay ABDC post-judgment interest, or appeal the order to the Kentucky Court of Appeals for further relief. The Jefferson Circuit Court's ruling on the right to set-off does not in any way adversely affect the Corporation's claims against ABDC and the Corporation's ability to pursue all of its claims against ABDC in the Jefferson Circuit Court. On August 4, 2017, the parties agreed to stay the litigation.
Amounts owed to and from ABDC were previously offset resulting in a net receivable of $23.4 million from ABDC in the consolidated balance sheet at December 31, 2015 classified as an other long-term asset. As a result of the ruling on the right to set-off during the first quarter of 2016, the Corporation recorded amounts related to this matter on a gross basis resulting in a receivable from ABDC of $72.3 million and the payable to ABDC of $48.9 million. Accordingly, the $72.3 million receivable from ABDC is reflected in other long-term assets and the $48.9 million payable is reflected in other long-term liabilities in the accompanying condensed consolidated balance sheets as of September 30, 2017.
The Corporation has claims for additional damages resulting from ABDC's breaches of the Previous PVA. The Corporation intends to vigorously pursue its claims. At this time, the Corporation is unable to determine the ultimate impact of these litigation proceedings on its consolidated financial condition, results of operations, or liquidity. The litigation with ABDC could continue for an extended period of time. The Corporation cannot provide any assurances about the outcome of the litigation.
In addition, the Corporation is involved in certain legal actions and regulatory investigations arising in the ordinary course of business. At September 30, 2017, the Corporation had accrued approximately $7.8 million related to the pending and settled legal actions and investigations included in other current liabilities in the accompanying condensed consolidated balance sheets.
NOTE 6—MERGER, ACQUISITION, INTEGRATION COSTS AND OTHER CHARGES
Merger, acquisition, integration costs and other charges combined were $5.3 million and $5.6 million for the three months ended September 30, 2016 and 2017, respectively, and $14.1 million and $12.7 million for the nine months ended September 30, 2016 and 2017, respectively. These costs primarily relate to costs incurred prior to an acquisition such as professional advisory fees and the costs associated with integrating completed acquisitions into our business, such as IT transition and facility related costs. Included in these charges are costs associated with the Merger for the nine months ended September 30, 2017 of $3.6 million.
NOTE 7—RESTRUCTURING COSTS AND OTHER CHARGES
The Corporation recorded restructuring costs and other related charges of $0.6 million and $0.1 million for the three months ended September 30, 2016 and 2017, respectively, and $3.1 million and $0.1 million for the nine months ended September 30, 2016 and 2017, respectively. The restructuring charges primarily included severance pay, the buy-out of employment agreements, lease terminations, and other exit-related asset disposals, professional fees and facility exit costs.
The following table presents the components of the Corporation's restructuring liability (dollars in millions):
|
|
Balance at December 31, 2016
|
|
|
Accrual
|
|
|
Utilized Amounts
|
|
|
Balance at September 30, 2017
|
|
Employee Severance and related costs
|
|
$
|
0.2
|
|
|
$
|
-
|
|
|
$
|
(0.1
|
)
|
|
$
|
0.1
|
|
Facility costs
|
|
|
0.4
|
|
|
|
0.1
|
|
|
|
(0.2
|
)
|
|
|
0.3
|
|
|
|
$
|
0.6
|
|
|
$
|
0.1
|
|
|
$
|
(0.3
|
)
|
|
$
|
0.4
|
|
The liability at September 30, 2017 represents amounts not yet paid relating to actions taken in connection with the restructuring plan (primarily lease payments and severance costs).
PHARMERICA CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
NOTE 8—TREASURY STOCK, STOCK-BASED COMPENSATION AND OTHER BENEFITS
Treasury Stock Purchases
In August 2010, the Board of Directors authorized a share repurchase of up to $25.0 million of the Corporation's common stock, of which $10.5 million has been used. On July 2, 2012, the Board of Directors authorized an increase to the remaining portion of the existing share repurchase program that allows the Corporation to again repurchase up to a maximum of $25.0 million of the Corporation's common stock. Approximately $19.7 million remained available under the program as of September 30, 2017. Share repurchases under this authorization may be made in the open market through unsolicited or solicited privately negotiated transactions, or in such other appropriate manner, and may be funded from available cash or the revolving credit facility. The amount and timing of the repurchases, if any, would be determined by the Corporation's management and would depend on a variety of factors including price, corporate and regulatory requirements, capital availability and other market conditions. Common stock acquired through the share repurchase program would be held as treasury shares and may be used for general corporate purposes, including reissuance in connection with acquisitions, employee stock option exercises or other employee stock plans. The share repurchase program does not have an expiration date and may be limited, terminated or extended at any time without prior notice. During the nine months ended September 30, 2017, the Corporation repurchased no shares of common stock under this program.
The Corporation may redeem shares from employees upon the vesting of the Corporation's stock awards for tax withholding purposes and to cover option exercise costs. The Corporation redeemed 94,883 shares from the vesting of certain awards and exercise of certain stock options, for an aggregate price of approximately $2.2 million during the nine months ended September 30, 2017. These shares have also been designated by the Corporation as treasury stock.
Stock Option Activity
Stock options were not granted to officers and employees during the nine months ended September 30, 2017. The following table summarizes option activity for the periods presented:
|
|
Number of
Shares
|
|
|
Weighted-
Average
Exercise Price
Per Share
|
|
Weighted-
Average
Remaining
Term
|
|
Aggregate
Intrinsic Value
(in millions)
|
|
Outstanding shares at December 31, 2016
|
|
|
413,346
|
|
|
$
|
13.99
|
|
0.8 years
|
|
$
|
4.6
|
|
Exercised
|
|
|
(178,079
|
)
|
|
|
18.00
|
|
|
|
|
|
|
Expired
|
|
|
(4,645
|
)
|
|
|
16.39
|
|
|
|
|
|
|
Outstanding shares at September 30, 2017
|
|
|
230,622
|
|
|
$
|
10.85
|
|
0.5 years
|
|
$
|
4.3
|
|
Exercisable at September 30, 2017
|
|
|
230,622
|
|
|
$
|
10.85
|
|
0.5 years
|
|
$
|
4.3
|
|
Nonvested Shares
The following table summarizes nonvested share activity for the periods presented:
|
|
Number of Shares
|
|
|
Weighted- Average Grant Date Fair Value
|
|
Outstanding shares at December 31, 2016
|
|
|
968,834
|
|
|
$
|
22.63
|
|
Granted - Restricted Stock Units
|
|
|
214,895
|
|
|
|
23.90
|
|
Granted - Performance Share Units
|
|
|
185,993
|
|
|
|
23.90
|
|
Forfeited
|
|
|
(104,908
|
)
|
|
|
24.24
|
|
Vested
|
|
|
(255,680
|
)
|
|
|
24.06
|
|
Outstanding shares at September 30, 2017
|
|
|
1,009,134
|
|
|
$
|
22.60
|
|
The weighted average remaining term and intrinsic value of non-vested shares as of September 30, 2017 was 1.6 years and $29.6 million, respectively.
PHARMERICA CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
NOTE 9—INCOME TAXES
The provision for income taxes is based upon the Corporation's estimate of annual taxable income or loss for each respective accounting period. The following table summarizes our provision for income taxes for the periods presented (dollars in millions):
|
Three Months Ended
September 30,
|
|
|
Nine Months Ended
September 30,
|
|
|
2016
|
|
2017
|
|
|
2016
|
|
2017
|
|
Provision for income taxes
|
|
$
|
1.7
|
|
|
$
|
2.9
|
|
|
$
|
4.2
|
|
|
$
|
7.7
|
|
Total provision as a percentage of pre-tax income
|
|
|
19.7
|
%
|
|
|
47.7
|
%
|
|
|
23.4
|
%
|
|
|
40.3
|
%
|
The increase in our provision for income taxes as a percentage of pre-tax income for the nine months ended September 30, 2017 compared to the comparable 2016 period was primarily due to increases in pre-tax income, lower excess tax benefits from employee shared-based compensation, and changes in discrete events. The effective tax rate for the three months and nine months ended September 30, 2017 is higher than the federal statutory rate due to the impact of state and local taxes, decreases in the domestic production activities deduction, and the discrete events previously described.
The Corporation derives a current federal and state income tax benefit from the impact of deductions associated with the amortization of tax deductible goodwill acquired through business combinations. The net tax basis of the Corporation's tax deductible goodwill was approximately $162.7 million and $204.3 million at December 31, 2016 and September 30, 2017, respectively. The future tax benefits of the tax-deductible goodwill are included in the Corporation's deferred tax assets.
The Corporation recognizes an asset or liability for the deferred tax consequences of temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements. These temporary differences will result in taxable or deductible amounts in future years when the reported amounts of the assets are recovered or liabilities are settled. The Corporation also recognizes as deferred tax assets the future tax benefits from net operating loss carryforwards. As of September 30, 2017, the Corporation had $36.2 million ($12.7 million tax benefit) of federal net operating loss carryforwards available. These net operating loss carryforwards resulted from the stock acquisitions the Corporation completed in 2013, 2014, and 2016 as well as net operating carryforwards generated by the Corporation. These net operating loss carryforwards are subject to limitations under Internal Revenue Code Section 382. However, the Corporation expects that it will be able to use the recorded amount which takes into account the limitations of the carryforwards. The Corporation has state net operating loss carryforwards representing a tax benefit of $6.6 million, net of valuation allowances. The net operating losses have carryforward periods ranging from 1 to 20 years depending on the taxing jurisdiction.
A valuation allowance is provided for the Corporation's deferred tax assets if it is more likely than not that some portion or all of the net deferred tax assets will not be realized. The Corporation recognized net deferred tax assets totaling $9.2 million and $1.8 million at December 31, 2016 and September 30, 2017, respectively, net of state valuation allowances of $2.6 million. The Corporation has presented all deferred tax assets and liabilities as noncurrent on the accompanying condensed consolidated balance sheets as of September 30, 2017.
As of December 31, 2016 and September 30, 2017, the Corporation had no reserves recorded for unrecognized tax benefits for U.S. federal and state tax jurisdictions.
The federal statute of limitations remains open for tax years 2014 through 2016.
State tax jurisdictions generally have statutes of limitation ranging from three to five years. The Corporation is generally no longer subject to state and local income tax examinations by tax authorities for years before 2011. The state income tax impact of federal income tax changes remains subject to examination by various states for a period of up to one year after formal notification of IRS settlement to the states.
PHARMERICA CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
NOTE 10—EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings per share (dollars in millions, except per share amounts):
|
|
Three Months Ended
September 30,
|
|
|
Nine Months Ended
September 30,
|
|
|
|
2016
|
|
|
2017
|
|
|
2016
|
|
|
2017
|
|
Numerator:
|
|
|
|
|
|
|
|
|
|
|
|
|
Numerator for basic and diluted earnings per share - net income
|
|
$
|
7.3
|
|
|
$
|
3.2
|
|
|
$
|
13.9
|
|
|
$
|
11.4
|
|
Denominator:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator for basic earnings per share - weighted average shares
|
|
|
30,754,253
|
|
|
|
31,118,756
|
|
|
|
30,670,487
|
|
|
|
31,019,184
|
|
Effect of dilutive securities (stock options, restricted stock units and performance share units)
|
|
|
317,037
|
|
|
|
282,868
|
|
|
|
370,362
|
|
|
|
336,012
|
|
Denominator for earnings per diluted share - adjusted weighted average shares
|
|
|
31,071,290
|
|
|
|
31,401,624
|
|
|
|
31,040,849
|
|
|
|
31,355,196
|
|
Basic earnings per share
|
|
$
|
0.24
|
|
|
$
|
0.10
|
|
|
$
|
0.45
|
|
|
$
|
0.37
|
|
Earnings per diluted share
|
|
$
|
0.23
|
|
|
$
|
0.10
|
|
|
$
|
0.44
|
|
|
$
|
0.36
|
|
Unexercised employee stock options and unvested restricted shares excluded from the effect of dilutive securities above (a)
|
|
|
213
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
(a) These unexercised employee stock options, unvested restricted shares and performance shares that have not yet met performance conditions are not included in the computation of diluted earnings per share because to do so would be anti-dilutive for the periods presented.
Stock options and restricted shares and units granted by the Corporation are treated as potential common shares outstanding in computing earnings per diluted share. Performance share units are treated as potential common shares outstanding in computing earnings per diluted share only when the performance conditions are met.
Common shares repurchased by the Corporation reduce the number of basic shares used in the denominator for basic and diluted earnings per share.
PHARMERICA CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
NOTE 11—SUBSEQUENT EVENT
On November 9, 2017, the Corporation held a special meeting of PharMerica Corporation's stockholders. At the special meeting, holders of the Corporation's common stock, on the record date of September 28, 2017 voted upon and approved the adoption of the Merger Agreement. The Merger is expected to be completed by early 2018. The Corporation cannot predict with certainty when, or if, the Merger will be completed because the completion of the Merger is subject to conditions beyond the control of the Corporation.