Change in Effective Control Application Version 09.2016
Applicant Name of Facility:
Name of Licensee: Amerita, Inc. Name(s) of Parent Entity(ies): Pharmacy Corporation of America owned by PharMerica Holdings, Inc. owned by PharMerica Corp. Amerita, Inc. d/b/a Infusion Resource September 9, 2016, Resubmitted on December 23, 2016 and April 21, 2017
Date of Submission
All questions concerning this application should be directed to the Center for Health Systems Policy and Regulation at (401) 222-2788
Table of Contents Page Number/Tab Index
Question Number/Appendix Q1 Q2 Q3 Q4 Q5 Q6 Q7 Q8 Q9 Q10 Q11 Q12 Q13 Q14 Q15 Q16 Q17 Q18 Q19 Q20 A,B,C Q21 Q22 Q23 A,B,C Q24 Q25 Q26 Q27 Q28 Q29 Appendix A Appendix B Appendix D Appendix F Appendix G
1/Tabs 14A, B, C 1 1 1 1-2 2 2 2 2 2 2 2-3 3 3/Tabs 14A, B, C & 24 3/Tab 15 3/Tab 18 3/Tab 18 3/Tab 18 3 3-4/Tab 20 4 4/Tab 22 4 4/Tab 24 4 5/Tab 26 5/Tab 27 5/Tabs 28A & 28B 5 1-5 1-2 1 1 1-2/Tabs G5A & G5B
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1. Please provide an executive summary describing the nature and scope of the proposal. Additionally, please include the following: (1) identification of all parties, (2) description of the applicant and its licensure track record, (3) the type of transaction proposed including description of the transaction and relevant costs, (4) summary of all transfer documents, (5) summary of the organizational structure of the applicant and its affiliates, and (6) whether the facility will be accredited. Amerita, Inc., A DE Corporation and wholly owned subsidiary of Pharmacy Corporation of America, a CA Corporation, is acquiring 100% of the home infusion pharmacy assets of Infusion Resource, LLC, now known as Care Resource, LLC (“Care Resource”), located at 21 Hemingway Dr. STE 200, East Providence, RI 02915. Pharmacy Corporation of America is a wholly owned subsidiary of PharMerica Holdings, Inc. PharMerica Holdings, Inc. is a wholly owned subsidiary of PharMerica Corporation. PharMerica Corporation, a DE Corporation, is a publicly traded corporation registered with the NY Stock Exchange and files a yearly 10K report with the Securities and Trade Commission. PharMerica Corporation is a national provider of long term care pharmacy services delivering more than 30 million prescriptions a year to nursing facility customers nationwide. Amerita, Inc. is a home infusion pharmacy corporation currently licensed and operating in CA, CO, TN, TX and Utah. Amerita, Inc. is accredited by ACHA (all locations). Attached at Tab 14A is a copy of the Asset Purchase Agreement that outlines the purchase of the assets and assumption of liabilities. The costs of the transaction are outlined on page 13, Section 2.4 of the Asset Purchase Agreement and includes assumption of Assumed Liabilities and a payment of $4,950,000 plus or minus an Inventory Adjustment. Also attached at Tab 14B is a Transition Services Agreement, which provides, among other things, that Care Resource, LLC f/k/a Infusion Resource, LLC shall provide nursing services to Amerita until Amerita has received CEC approval. Finally, attached at Tab 14C is a copy of the April 6, 2017 Consent Agreement between Amerita and the Department of Health, which provides, among other things, that the Department shall maintain in full force and effect the home nursing care provider and organized ambulatory care facility licenses previously issued to Care Resource through the completion of the CEC approval process. 2.
Name and address of the applicant:
Name: Amerita, Inc. Address: 1901 Campus Place Louisville, KY 3.
Telephone: 502-627-7100 Zip Code: 40299
Name and address of facility (if different from applicant):
Name: Infusion Resource, LLC Address: 2 Hemingway Dr. East Providence, RI 4.
Telephone: 401-431-0200 Zip Code: 02915-2224
Information of the President or Chief Executive Officer of the applicant:
Name: Richard Iriye Address: 7307 So. Revere PKY, Ste. 200, Centennial, CO E-Mail:
[email protected] 5.
Telephone: 303-407-0655 Zip Code: 80112-3979 Fax: 877-302-5251
Information for the person to contact regarding this proposal:
Name: Patricia K. Rocha
Telephone: 401-274-7200
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Address: One Citizens Plaza 8th Flr, Providence, RI E-Mail:
[email protected] 6.
Zip Code: 02903-1345 Fax: 401-751-0604
A. EXISTING ENTITY:
License category: Home Nursing Care Provider Name of Facility: Care Resource LLC License #: HNC02385 Address: 2 Hemingway Dr. East Providence, RI 02915-2224 Telephone: 401-431-0200 Type of Ownership: ___ Individual ___ Partnership ___ Corporation X Limited Liability Co. Tax Status: X For Profit ___ Non-Profit B. PROPOSED ENTITY: License category: Home Nursing Care Provider Name of Facility: Amerita, Inc. d/b/a Infusion Resource License #: Address: 2 Hemingway Dr. East Providence, RI 02915-2224 Telephone: 401-431-0200 Type of Ownership: ___ Individual ___ Partnership X Corporation __ Limited Liability Co. Tax Status: X For Profit ___ Non-Profit 7.
Does this proposal involve a nursing facility? Yes __ No X •
8.
If response to Question 7 is ‘Yes’, please complete Appendix C. Will the facility be operated under management agreement with an outside party? Yes_ No X
•
If response to Question 8 is "Yes", please provide copies of that agreement.
9. Will the proposal involve the facility/ies providing healthcare services under contract with an outside party? Yes___ No X • 10.
If response to Question 9 is "Yes", please identify and describe those services to be contracted out. Estimate the date (month and year) for the proposed transfer of ownership, if approved:
June 30, 2017 11. Please provide a concise description of the services currently offered by the licensed entity and identify any services that will be added, terminated, expanded, or reduced and state the reasons therefore: Home infusion therapy and nursing support to patients in their homes. terminated, expanded or reduced.
No services will be added,
12. Please identify the long-term plans of the applicant with respect to the health care programs and health care services to be provided at the facility:
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Amerita, Inc. will continue to provide home infusion therapy and nursing support to patients in their homes. 13. Does the entity seeking licensure plan to participate in Medicare or Medicaid (Titles XVIII or XIX of the Social Security Act)? MEDICARE: Yes X No___ •
MEDICAID:
Yes X No___
If response to Question 13 for either Medicare and/or Medicaid is ‘No’, please explain.
14. Please provide all appropriate signed legal transfer documents (i.e. purchase and sale agreement, affiliation agreement); NOTE: these documents must cause both parties to be legally bound. See Tabs 14A, B, C and 24. 15. Please provide organization charts of both agencies (existing entity and the applicant) for prior to transfer and post transfer, identifying all "parent" legal entities with direct or indirect ownership in or control, all "sister" legal entities also owned or controlled by the parent(s), and all "subsidiary" legal entities. See Tab 15. 16. If the proposed owner, operator or director owned, operated or directed a health care facility (both within and outside Rhode Island) within the past three years, please demonstrate the record of that person(s) with respect to access of traditionally underserved populations to its health care facilities. Amerita, Inc. has provided services to traditionally underserved populations through its Financial Hardship Program as defined at Tab 18. 17. Please identify the proposed immediate and long-term plans of the applicant to ensure adequate and appropriate access to the program and health care services to be provided by the health care facility/ies to traditionally underserved populations. Amerita, Inc. will continue to provide access to traditionally underserved populations through its Financial Hardship Program at Tab 18. 18.
Please provide a copy of charity care policies and procedures and charity care application form.
See Tab 18. 19. After the proposed change in effective control, will the facility/ies provide medically necessary services to patients without discrimination, including the patients' ability to pay for services? Yes X No___. •
If response to Question 23 is ‘No’, please explain.
20. Please identify and describe any and all instances and the status or disposition of each of the following within the past 3 years: A. Citations, enforcement actions, violations, charges, investigations, or similar types of actions involving the applicant and/or its affiliates (including but not limited to actions brought forward by any governmental agency, accrediting agency, or similar type of an agency.); Applicant: None Pharmacies: See Tab 20.
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B. Civil proceedings (whether pending or which have resulted in a disposition or settlement) in any court of law, in which the applicant and/or its affiliates and/or any officers, directors, trustees, members, managing or general partners, or other senior management of the applicant and/or its affiliates has been a party to; See PharMerica Corporation’s 10K at Tab 28A, section 3 entitled “Legal Proceedings” at pages 24-26. In addition, lawsuits are filed in the normal course of business, including actions for workers compensation, slip and falls and the like. There are no pending or settled civil proceedings against the Applicant. C. Convictions and/or placement on probation for any criminal offences by any state, local or federal government of any officers, directors, trustees, members, managing or general partners, or other senior management of the applicant and/or its affiliates; None. 21. Please identify any planned actions of the applicant to reduce, limit, or contain health care costs and improve the efficiency with which health care services are delivered to the citizens of this state. There are no planned actions to reduce, limit or contain health care costs other than leveraging efficiency and use of technology. In addition, as a home infusion nursing provider, the Applicant will likely reduce health care costs as such costs are lower in the home care setting versus institutional settings such as a hospital. 22. Please provide a copy of the Quality Assurance Policies (for the services) and a detailed explanation of how quality assurance for patient services will be implemented at the facility/ies by the applicant. See Tab 22. 23. Please provide a detailed description about the amount and source of the equity and debt commitment for this transaction. (NOTE: If debt is contemplated as part of the financing, please complete Appendix E). Additionally, please demonstrate the following: A. The immediate and long-term financial feasibility of the proposed financing plan; As disclosed in Appendix A, the Applicant will use 100% equity for this transaction and there is no financing required. B. The relative availability of funds for capital and operating needs; and The Applicant projects that it will generate sufficient revenues to cover expenses and it has sufficient cash to fund any capital and operating needs. C. The applicant’s financial capability. The Applicant and its parent companies’ financial capabilities are strong as evidenced in the 10K Statement and successful track record of providing high quality care throughout the country. 24. Please provide legally binding evidence of site control (e.g., deed, lease, option, etc.) sufficient to enable the applicant to have use and possession of the subject property, if applicable. See Tab 24.
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25. If the facility is not-for-profit and/or affiliated with a not-for-profit, please provide written approval from the Rhode Island Department of Attorney General of the proposal. N/A 26.
Please provide each of the following documents applicable to the applicant's legal status:
·Certificate and Articles of Incorporation and By-Laws (for corporations) ·Certificate of Partnership and Partnership Agreement (for partnerships) ·Certificate of Organization and Operating Agreement (for limited liability corporations) •
If any of the above documents are proposed to be revised or modified in any way as a result of the implementation of the proposed change in effective control, please provide the present documents and the proposed documents and clearly identify the revisions and modifications.
See Tab 26. 27. If the applicant and/or one of its parent companies (or ultimate parent) is a publicly traded corporation, please provide copies of its most recent SEC 10K filing. See Tab 27. 28. Please provide audited financial statements (which should include an income statement, balance sheet and cash flow statement) for the last three years for the applicant, and/or its ultimate parent, and for the existing facility. See Tab 28A for PharMerica Corporation (2014 & 2015 Form 10-K – begins on page F-1 of Part II and 2015 & 2016 Form 10-Q – begins on page 3 of Part I) and Tab 28B for Infusion Resource, LLC. 29.
All applicants must complete Appendix A, D, F and G.
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APPENDIX A All applicants must complete this Appendix. 1. Please indicate the financing mix for the capital cost of this proposal. NOTE: the Health Services Council’s policy requires a minimum 20 percent equity investment in CEC projects. Source Equity* Debt** Lease TOTAL
*
Amount $4,950,000 $0 $0 $4,950,000
Percent Interest Rate Terms (Yrs.) 100% 0% % 0% % 100%
Equity means non-debt funds contributed towards the capital cost related to a change in owner or change in operator of a healthcare facility which funds are free and clear of any repayment or liens against the assets of the proposed owner and/or licensee and that result in a like reduction in the portion of the capital cost that is required to be financed or mortgaged.
** If debt financing is indicated, please complete Appendix E.
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2. Please identify the total number of FTEs (full time equivalents) and the associated payroll expense (with fringe benefits) for the facility*. Past Three Fiscal Years
PERSONNEL (by major categories) Medical Director Administrator Director of Nursing RNs LPNs Pharmacy Staff
Totals
Budgeted Current Year
FY: 2013 Number Payroll of FTEs W/Fringes
FY: 2014 Number Payroll of FTEs W/Fringes
FY: 2015 Number Payroll of FTEs W/Fringes
FY:2016 Number of FTEs
Payroll W/Fringes
.05 1 .85 5.30 1.00
1,800 47,000 70,500 447,000 69,500
.05 1 .85 5.30 1.25
1,800 49,000 70,500 464,050 92,000
.05 1 .85 4.80 1.25
1,800 49,000 97,750 436,000 87,000
.05 1 .85 5.00 2.00
1,800 50,500 102,000 468.000 172,000
8.25
635,800
8.45
677,350
7.95
671,550
8.90
794,300
*See Amerita, Inc.’s OACF Change in Effective Control Application for OACF numbers.
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Projected First Three Fiscal Years (if approved)
PERSONNEL (by major categories) Medical Director Administrator Director of Nursing RNs LPNs Pharmacy Staff
FY: 2017 Number of FTEs 0.05 1.0 .85 5.0 2.0
Totals
Payroll W/Fringes 1,800 50,500 105,00 470,700 172,000
FY:2018 Number Payroll of FTEs W/Fringes
FY:2019 Number of FTEs
Payroll W/Fringes
.05 1.0 .85 5.0 2.0
.05 1.0 .85 5.0 2.0
1,800 53500 111,000 501,700 182,000
800,000 8.9
1,800 52,00 108,00 486,200 177,000
825,000 8.9
850,000 8.9
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3.
Please complete the following table for the facility. Round all amounts to the nearest dollar*. Past Three Fiscal Years
REVENUES Net Patient Revenue Other: (_______) Total Revenue EXPENSES Payroll w/Fringes Bad Debt Supplies Office Expenses Utilities Insurance Interest Depreciation/Amortization Leasehold Expenses Other: (__Mileage____) Other: (___________) Total Expenses OPERATING PROFIT/LOSS
FY: 2013
FY:2014
FY:2015
Budgeted Current Fiscal Year FY:2016
Projected Three Fiscal Years (if approved)
494,000
428,000
438,000
450,000
495,000
545,000
600,000
494,000
428,000
438,000
450,000
495,000
545,000
600,000
635,650
677,350
672,550
794,300
800,000
825,000
850,000
15,000 1,200
21,000 1,200
22,000 1,200
23,000 1,200
23,000 1,200
24,000 1,200
25,000 1,200
1,000
1,000
1,000
1,000
1,000
1,000
1,000
82,000
69,000
69,000
72,000
72,000
75,000
78,000
744,850
767,500
769,750
893,500
897,200
926,200
955,200
(250,850)
(341,550)
(331,750)
(443,500)
(402,200)
(381,200)
(355,200)
FY:2017
FY:2018
FY:2019
*See Amerita, Inc.’s OACF Change in Effective Control Application for OACF numbers.
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4. Please provide utilization statistics (both as a dollar value and percentage) for the existing facility by completing the table below for the requested years**. Past Three Fiscal Years (Actual)
PAYOR SOURCE: Medicare Medicaid Blue Cross Commercial HMO's Self Pay Other: TOTAL Charity Care*
FY: 2013 $
%
FY:2014 $
%
FY:2015 $
0 0 376,000 94,000
0 0 76.0 19.0
0 0 321,000 86,000
0 0 75.0 20.0
5,000 20,000 495,000
1.0 4.0
4,000 17,000 428,000
4,950
1
4,280
Budgeted Current Year %
FY:2016 $
%
0 0 329,000 88,000
0 0 75.0 20.0
0 0 338,000 90,000
0 0 75.0 20.0
1.0 4.0
4,000 17,000 438,000
1.0 4.0
4,000 18,000 450,000
1.0 4.0
1
4,380
1
4,500
1
Projected First Three Operating Years (if approved) FY:2017 $ PAYOR SOURCE: Medicare Medicaid Blue Cross Commercial HMO's Self Pay Other: TOTAL Charity Care*
%
FY:2018 $
FY:2019 $
%
%
0 0 371,250 99,000
0 0 75 20
0 0 408,750 10,900
0 0 75 20
0 0 450,000 120,000
0 0 75 20
4,950 19,800 495,000
1 4 100
5,450 21,800 545,000
1 4 100
6,000 24,000 600,000
1 4 100
4,950
1
5,450
1
6,000
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*Charity Care does not include bad debt, and is based on costs (not charges). For Home Nursing Care Providers the statewide community standard shall be one percent (1%) of net patient revenue earned on an annual basis. **See Amerita, Inc.’s OACF Change in Effective Control Application for OACF numbers.
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Appendix B Rhode Island Department of Health Center for Health Systems Policy and Regulation Compliance Report Amerita, Inc. has applied for licensure as a healthcare facility in Rhode Island. As part of the regulatory requirements to determine the character, competence and other quality related information of the applicant, the Center for Health Systems Policy and Regulation is requesting the following information regarding the health care facilities operated by or affiliated with the applicant, as listed on the attached sheet. Please answer the following questions. 1. Are the agencies/facilities currently licensed and in substantial compliance with all applicable codes, rules and regulations?
Yes__
No__
If the answer to #1 is “NO”, please identify the facility(ies) and briefly explain the licensure status. 2.
Has there been any enforcement actions against these agencies/facilities in the past three years?
Yes__
No__
If the answer to #2 is “YES”, please identify the facility(ies) and include any information relevant to those enforcement actions (reason for action, stipulation, fine, etc.). In addition, please furnish a brief description of the outcome of the most recent survey, including any deficiencies cited. Additional pages may be attached, if needed.
Reviewer’s Name: __________________________________ Title: ______________________________ Department: _______________________________________________________ State: ______________ Telephone_________________________________________ E-mail _____________________________ Reviewer’s Signature: _______________________________________________ Date: ______________ If you have any questions, please contact Paula Pullano at (401) 222-2788 or e-mail,
[email protected] Please return the completed form within 15 days to the address below: Rhode Island Department of Health Office of Health Systems Development 3 Capitol Hill, Room 410 Providence, Rhode Island 02908 Thank you. Attachment
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Appendix B (CONT.) Applicant, please provide the following information identifying each facility to the appropriate state agency as an attachment to the letter in the table below, use additional pages if necessary. Please make sure to identify yourself in the cover letter by filling in the blank for ‘Name of Applicant’.
State
Facility Name, Address and Contact Information
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License Number
Appendix D Source of Funds All applicants must complete this Appendix. I. Please provide the total expenditures necessary to implement this proposal and allocate this amount to the sources of funds categories listed below: TOTAL PROJECT COST:
$4,950,000.00*
SOURCE OF FUNDS
AMOUNT
a. Funded depreciation b. Other restricted funds (specify) __________ c. Unrestricted funds (specify) __________ d. Owner’s equity e. Sale of stock/other equity f. Unrestricted donations or gifts g. Restricted donations or gifts h. Government grant (specify) __________ i. Other non-debt funds (specify) __________
$ ____________ ____________ ____________ $4,950,000.00 ____________ ____________ ____________ ____________ ____________
j. Sub-Total Equity Funds
$4,950,000.00
k. Subsidized loan (e.g. FHA etc.) __________ l. Tax-exempt bonds (specify) __________ m. Conventional mortgage n. Lease or rental o. Other debt funds
____________ ____________ ____________ ____________ ____________
p. Sub-Total Debt Funds
____________
q. Total Source of Funds
$4,950,000.00
* should equal the response for line “q”
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Appendix F Disclosure of Ownership and Control Interest All applicants must complete this Appendix. I. Please answer the following questions by checking either ‘Yes’ or ‘No’. If any of the questions are answered ‘Yes’, please list the names and addresses of individuals or corporations. A. Will there be any individuals (or organizations) having a direct (or indirect) ownership or control interest of 5 percent or more in the applicant, that have been convicted of a criminal offense related to the involvement of such persons or organizations in any of the programs established by Titles XVIII, XIX of the Social Security Act? Yes___ No X B. Will there be any directors, officers, agents, or managers of the applicant (or facility) who have ever been convicted of a criminal offense related to their involvement in such programs established by Titles XVIII, XIX of the Social Security Act? Yes___ No X C. Are there (or will there be) any individuals employed by the applicant (or facility) in a managerial, accounting, auditing, or similar capacity who were employed by the applicant's fiscal intermediary within the past 12 months (Title XVIII providers only)? Yes___ No X D. Will there be any individuals (or organizations) having direct (or indirect) ownership interests, separately (or in combination), of 5 percent or more in the applicant (or facility)? (Indirect ownership interest is ownership in any entity higher in a pyramid than the applicant) Yes X No___ (Note, if the applicant is a subsidiary of a "parent" corporation, the response is ‘Yes’) Amerita, Inc. is owned by Pharmacy Corporation of America, owned by PharMerica Holdings, Inc., owned by PharMerica Corporation. E. Will there be any individuals (or organizations) having ownership interest (equal to at least 5 percent of the facility's assets) in a mortgage or other obligation secured by the facility? Yes___ No X F. Will there be any individuals (or organizations) that have an ownership or control interest of 5 percent or more in a subcontractor in which the applicant (or facility) has a direct or indirect ownership interest of 5 percent or more. (Also, please identify those subcontractors.) Yes___ No X G. Will there be any individuals (or organizations) having a direct (or indirect) ownership or control interest of 5 percent or more in the applicant (or facility), who have been direct (or indirect) owners or employees of a health care facility against which sanctions (of any kind) were imposed by any governmental agency? Yes___ No X H. Will there be any directors, officers, agents, or managing employees of the applicant (or facility) who have been direct (or indirect) owners or employees of a health care facility against which any sanctions were imposed by any governmental agency? Yes___ No X
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Appendix G Ownership Information All applicants must complete this Appendix 1. List all officers, members of the board of directors, stockholders, and trustees of the applicant and/or ultimate parent entity. For each individual, provide their home and business address, principal occupation, position with respect to the applicant and/or ultimate parent entity, and amount, if any, of the percentage of stock, share of partnership, or other equity interest that they hold. PharMerica Corporation Officers and Board of Directors Name Gregory S. Weishar Thomas A. Caneris Frank E. Collins W. Robert Dahl, Jr. Marjorie W. Dorr Dr. Thomas P. Gerrity Thomas P. MacMahon Geoffrey G. Meyers Dr. Robert A. Oakley Patrick G. Lepore
Business Address 1901 Campus Place Louisville, KY 40299 1901 Campus Place Louisville, KY 40299 1901 Campus Place Louisville, KY 40299 1901 Campus Place Louisville, KY 40299 1901 Campus Place Louisville, KY 40299 1901 Campus Place Louisville, KY 40299 1901 Campus Place Louisville, KY 40299 1901 Campus Place Louisville, KY 40299 1901 Campus Place Louisville, KY 40299 1901 Campus Place Louisville, KY 40299
Position Chief Executive Officer and Director Senior Vice President, Secretary & General Counsel Director Director Director Director Director Chairman of the Board Director Director
Amerita, Inc. Officers and Board of Directors Name Gregory S. Weishar Richard D. Iriye
Thomas A. Caneris
Business Address Position 1901 Campus Place Chief Executive Officer Louisville, KY 40299 7307 South Revere President Parkway, Ste. 200 Centennial, CO 80112 1901 Campus Place Vice President & Secretary Louisville, KY 40299
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2. For each individual listed in response to Question 1 above, list all (if any) other health care facilities or entities within or outside Rhode Island in which he or she is an officer, director, trustee, shareholder, partner, or in which he or she owns any equity or otherwise controlling interest. For each individual, please identify: A) the relationship to the facility and amount of interest held, B) the type of facility license held (e.g. nursing facility, etc.), C) the address of the facility, D) the state license #, E) Medicare provider #, F) any professional accreditation (e.g. JACHO, CHAP, etc.), and G) complete Appendix B ‘Compliance Report’ and submit it to the appropriate state agency. The individuals listed in response to question 1 are officers and directors only. No individual has any equity or controlling interest. 3. If any individual listed in response to Question 1 above, has any business relationship with the applicant, including but not limited to: supply company, mortgage company, or other lending institution, insurance or professional services, please identify each such individual and the nature of each relationship. N/A 4. Have any individuals listed in response to Question 1 above been convicted of any state or federal criminal violation within the past 20 years? Yes___ No X. •
If response to Question 4 is ‘Yes’, please identify each person involved, the date and nature of each offense and the legal outcome of each incident.
5. Please list all licensed healthcare facilities (in Rhode Island or elsewhere) owned, operated or controlled by any of the entities identified in response to Question 15 of the application. For each facility, please identify: A) the entity, applicant or principal involved, B) the type of facility license held (e.g. nursing facility, etc.), C) the address of the facility, D) the state license #, E) Medicare provider #, F) any professional accreditation (e.g. JACHO, CHAP, etc.), and G) complete Appendix B ‘Compliance Report’ and submit it to the appropriate state agency. See Tabs G5A and G5B. 6. Have any of the facilities owned, operated or managed by the applicant and/or any of the entities identified in Question 5 above during the last 5-years had bankruptcies and/or were placed in receiverships? Yes___ No X •
If response to Question 6 is ‘Yes’, please identify the facility and its current status.
3 845840.v1
Execution Version
TRANSITION SERVICES AGREEMENT THIS TRANSITION SERVICES AGREEMENT (this “Agreement”), dated as of September 30, 2016 (the “Closing Date”), is entered into by and between Amerita, Inc., a Delaware corporation (the “Buyer”), and Infusion Resource LLC, a Rhode Island limited liability company (the “Seller”). RECITALS WHEREAS, on August 30, 2016, the Buyer, the Seller, and the Selling Members entered into that certain Asset Purchase Agreement (the “Purchase Agreement”), pursuant to which the Buyer has agreed to purchase from the Seller, and the Seller has agreed to sell to the Buyer, the Purchased Assets, in each case, as of the Closing Date (subject to the conditions set forth in the Purchase Agreement); WHEREAS, the Buyer has applied, or will apply, for the licenses and permits, and participation in the payment programs, listed on Schedule A, which are required for the Buyer to operate the Business and bill applicable third party payors (the “Licenses”); WHEREAS, the Seller holds the Licenses for the operation of the Business and for billing third party payors; WHEREAS, the provision of home infusion nursing services by the Buyer after the Closing requires the Buyer to first apply for and receive a Home Nursing Care Provider License issued by the Rhode Island and Providence Plantations Department of Health – Center for Health Facilities Regulation (the “Nursing License”); WHEREAS, the Buyer has applied for, but has not yet received the Nursing License; WHEREAS, the Buyer wishes for the Seller to provide home nursing services by registered or practical nurses employed by the Seller as identified in the Purchase Agreement (the “Nursing Employees”) on behalf of the Buyer, in connection with the provision of home infusion therapy services provided by the Buyer after the Closing (the “Nursing Services”); and WHEREAS, in connection with the execution of the Purchase Agreement, the Buyer and the Seller desire to enter into this Agreement to, among other things, formalize the Seller’s agreement to cooperate in the transition of the Business, including under its Licenses, for a period of time as is necessary for the Buyer to obtain the Licenses and any other licenses or permits, bill for services provided and do all other things necessary for the Buyer to operate the Business as is now operated by the Seller. NOW, THEREFORE, in consideration of the foregoing and the respective representations, warranties, covenants and agreements set forth in this Agreement and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto hereby agree as follows: ARTICLE I SCOPE OF TRANSITION SERVICES 1.1 Transition Services; Other Services. Upon the terms and subject to the conditions set forth in this Agreement, (a) the Seller shall cooperate with and support the Buyer in its management, operation and supervision of the Business under the Licenses held by the Seller, in accordance with and during the term of this Agreement (the “License Transition Services”), (b) the Seller shall provide the Nursing Services and (c) the Seller shall provide the additional services set forth on Schedule B (the
1057478.8
1
“Services,” and, together with the License Transition Services and the Nursing Services, the “Transition Services”). 1.2 Submission of Claims. Upon the Buyer’s request, and to the extent permitted by applicable Law and any agreements with third party payors to which the Seller is a party, the License Transition Services shall include the submission on behalf of the Buyer of any claims for payment or reimbursement to applicable payors for services; provided, however, that (a) such claims shall be for services provided by the Buyer during the term of this Agreement, (b) such arrangement shall end at such time as the Buyer qualifies to submit claims for payment directly to all applicable payors, and (c) such arrangement shall only apply to a payor that has not consented to the application of the Buyer’s participation agreement to the Business at the time of request. All claims submitted hereunder shall be in full compliance with all applicable Laws, regulations, billing rules, and the requirements, policies and procedures of each payor. Any payments received by the Seller on account of such submitted claims shall be promptly remitted to the Buyer. 1.3 Maintenance and Use of Licenses. During the term of this Agreement, the Seller shall maintain all of the Licenses in good standing, in compliance with all applicable Laws, regulations, rules, and terms relating to the Licenses, and not take any action to terminate or cause the termination of, or interfere with the operation of, or otherwise permit to lapse, any of the Licenses. To the extent permitted by applicable Law, the Seller shall permit the Buyer to operate the Business under the Licenses during the term of this Agreement. The Buyer shall use all Licenses in accordance with applicable Law. 1.4 Nursing Services. The Seller shall provide the Nursing Services (and, unless otherwise requested by the Buyer, continue to offer employment to the Nursing Employees) to the extent requested by the Buyer until such time as the Buyer receives its own Nursing License and a sufficient number of Nursing Employees have accepted offers of employment with the Buyer such that the Buyer can successfully provide Nursing Services without assistance from the Seller (the “Nursing Services Termination Date”). The Buyer shall notify the Seller promptly once the Buyer has determined that a sufficient number of Nursing Employees have accepted offers of employment with the Buyer. The Buyer is entitled to receive all revenue related to or arising from the Nursing Services. In the event that the Seller receives payment in exchange for any Nursing Services, the Seller shall immediately, but in no event less than five (5) days, notify and remit to the Buyer the entire amount of such payment. 1.5 Fees; Payment Terms. During the term of this Agreement (as provided in Section 1.10) the Buyer shall pay to the Seller (i) a monthly fee of $20,000.00 (the “Monthly Fee”) and, subject to Section 1.6 hereof, (ii) (a) a bi-weekly fee equal to the gross salaries for all Nursing Employees (including the employer portion of the payroll tax, the “Salary Fee”) and (b) an amount of other compensation due to all Nursing Employees in substantially the same manner as provided to such Nursing Employees prior to the Closing Date (including without limitation the out-of-pocket costs associated with the health and dental benefits provided by the Seller to the Nursing Employees) (the “Other Compensation Fee”). The Monthly Fee and the Other Compensation Fee will be payable by the Buyer in arrears within 3 Business Days of the last day of the month in which such Transition Services were provided (or within 3 Business Days of the last day of the term of this Agreement, if such date is not the last day of a month). The Salary Fee shall be invoiced by the Seller to the Buyer and paid by the Buyer to the Seller on a bi-weekly basis. In the event that the Seller does not provide Transition Services for an entire month, the Monthly Fee will be prorated to include only the number of days in the month the Seller provided Transition Services. Except for the Monthly Fee, the Salary Fee and the Other Compensation Fee the Buyer shall not be responsible for any other costs, fees or expenses incurred by the Seller in connection with the provision of the Transition Services.
1057478.8
2
1.6 Salary Fee; Other Compensation Fee. The Buyer will have no responsibility for payment of the Salary Fee or the Other Compensation Fee on or after the Nursing Services Termination Date. Buyer shall only be responsible for that portion of any Other Compensation Fee attributable to the Nursing Employees. For the avoidance of doubt, Buyer shall only be responsible for payment of the pro rata portion of health, dental or other benefits offered by the Seller represented by the proportion of such costs attributable to the Nursing Employees compared to such costs attributable to all of Seller’s employees participating in such benefits. 1.7 License. The Seller hereby grants to the Buyer an irrevocable license to use the names “Care Resource”, “Home Care Resource”, “Home Health Resource” and “Care Giver Resource” to conduct business for transition purposes during the term of this Agreement. 1.8 Further Assurances. From the Closing Date up to and including the date that this Agreement expires or is earlier terminated pursuant to Section 1.10, the Seller shall use commercially reasonable efforts to comply with any instructions provided by the Buyer that are necessary or desirable for the Seller to adequately provide such Transition Services so long as such instructions are in compliance with applicable Law and consistent with the terms of the Purchase Agreement. 1.9 Books and Records. The Buyer and Seller agree that complete and accurate books will be maintained with regard to the operation of the Business. 1.10 Term and Termination. This Agreement will become effective on the Closing Date and will automatically terminate six (6) months from the Closing Date (the “Termination Date”). Notwithstanding the foregoing, if, within thirty (30) days prior to the Termination Date, the Buyer provides written notice to the Seller of its intention to extend the term of this Agreement for an additional period of up to sixty (60) days, the Termination Date will automatically be extended for an additional sixty (60) days. This Agreement may be terminated by the written mutual consent of both parties. ARTICLE II MISCELLANEOUS 2.1 No Assignment. The Buyer may, with the prior consent of the Seller, assign its rights under this Agreement to any lender of the Buyer, to any Affiliate of the Buyer or in connection with any sale by the Buyer of all or substantially all of its assets, provided such assignee agrees to be bound by the terms of this Agreement. The Seller may not assign this Agreement, or the Seller’s rights and obligations hereunder, without the prior written consent of the Buyer. 2.2 Integration, Amendment and Waiver. This Agreement, together with the Purchase Agreement and Schedule A and Schedule B hereto, contains the entire understanding between the parties with regard to the subject matter contained herein and supersedes all other prior agreements, understandings, term sheets, heads of terms or letters of intent among the parties. No amendment to or modification of this Agreement will be effective unless it is in writing and signed by each of the parties. Any agreement on the part of any party to any waiver will be valid only if set forth in an instrument, in writing, signed on behalf of such party. The failure of any party to assert any of its rights hereunder will not constitute a waiver of such rights. 2.3 Construction. The parties have participated jointly in the negotiation and drafting of this Agreement. In the event an ambiguity or question of intent or interpretation arises, this Agreement will be construed as if drafted jointly by the parties and no presumption or burden of proof will arise favoring or disfavoring either party by virtue of the authorship of any of the provisions of this Agreement.
1057478.8
3
2.4 Invalidity. If any provision of this Agreement or the application thereof to any Person or circumstance is held invalid or unenforceable, the remainder of this Agreement and the application of such provision to other Persons or circumstances will not be affected thereby and, to such end, the provisions of this Agreement are agreed to be severable. 2.5 Execution in Counterparts. This Agreement may be executed in counterparts (including electronically-transmitted counterparts), each of which will be considered an original instrument, but all of which will be considered one (1) and the same agreement, and will become binding when one (1) or more counterparts have been signed by each party and delivered to the other party. 2.6 Third-Party Beneficiaries. Nothing in this Agreement, expressed or implied, is intended to or will be construed to confer upon any third person, any right, remedy or claim under or by reason of this Agreement. 2.7 Relationship of Parties. Nothing in this Agreement will be deemed or construed by the parties or any third party as creating a partnership or the relationship of principal and agent or joint venturer between the parties, it being understood and agreed that no provision contained herein, and no act of the parties, will be deemed to create any relationship between the parties other than the relationship of the Buyer and the Seller for the provision of services nor be deemed to vest any rights, interests or claims in any third parties. 2.8 Force Majeure. Any failure or omission by a party in the performance of any obligation under this Agreement will not be deemed a breach of this Agreement or create any liability, if the same arises from any cause or causes beyond the control of such party, including but not limited to, the following, which, for purposes of this Agreement will be regarded as beyond the control of each of the parties: acts of God, fire, storm, flood, earthquake, governmental regulation or direction, acts of the public enemy, war, rebellion, insurrection, riot, acts of terrorism, invasion, strike, lockout or shortage of labor; provided, however, that any party affected by any cause beyond its control will promptly notify the other party in writing of the cause and will resume performance whenever such cause is removed. 2.9 Confidentiality. Any information provided to or obtained by the parties in connection with the transactions contemplated by this Agreement will be subject to the Confidentiality Agreement, and shall be held by the parties in accordance with, and be subject to the terms of, the Confidentiality Agreement. The Parties agree to be bound by and comply with the provisions set forth in the Confidentiality Agreement as if such provisions were set forth herein, and such provisions are hereby incorporated herein by reference. Without limiting the generality of the foregoing, to the extent the Buyer determines that compliance with Health Insurance Portability and Accountability Act of 1996 (42 U.S.C. §§ 1320d-1320d-8), as amended, is required with respect to any information provided under this Agreement (including, without limitation, any Confidential Information), the Seller will enter into a business associate agreement in a form satisfactory to the Buyer upon the Buyer’s request therefor. 2.10 Notices. All notices, requests, claims, demands and other communications hereunder shall be in writing and shall be given (and will be deemed to have been duly given upon receipt) by delivery in person, by facsimile (and will be deemed to have been duly given upon receipt of confirmation of delivery), by nationally recognized overnight courier or by registered or certified mail (postage prepaid, return receipt requested) to the parties at their addresses set forth in the Purchase Agreement. 2.11 Definitions. Capitalized terms used herein and not otherwise defined will have the respective meanings ascribed to them in the Purchase Agreement. [Signature Page Follows] 1057478.8
4
SCHEDULE A LICENSES
Agency
Type
Name and Address
Expiration
License Number
Rhode Island and Providence Plantations Department of Health – Center for Health Facilities Regulation
[Home Nursing Care Provider License]1
Infusion Resource LLC 2 Hemingway Drive Riverside, RI 02915
12/31/2016
HNC02385
Rhode Island and Providence Plantations Department of Health – Center for Health Facilities Regulation
[Organized Ambulatory Care Facility License]2
Infusion Resource LLC 2 Hemingway Drive Riverside, RI 02915
12/31/2016
ACF01601
State of Connecticut – Department of Consumer Protection
Non-Resident Pharmacy Registration
Infusion Resource LLC 2 Hemingway Drive Riverside, RI 02915
8/31/2017
PCN.0002156
U.S. Drug Enforcement Administration
Controlled Substances Registration
11/30/2017
FI1075945
Centers for Medicare & Medicaid Services
Clinical Laboratory Improvement Amendments – Waiver NPI Number
Infusion Resource LLC 2 Hemingway Drive East Providence, RI 02915 Infusion Resource LLC 2 Hemingway Drive East Providence, RI 02915 Infusion Resource LLC 2 Hemingway Drive Riverside, RI 02915 Infusion Resource LLC 2 Hemingway Drive East Providence, RI 02915
n/a
41D1097908
n/a
1982864815
n/a
4107137
United States Department of Health and Human Services National Council for Prescription Drug Programs
1 2
NCPDP Number
The Buyer may not operate under this license, but it meets the definition of “License.” The Buyer may not operate under this license, but it meets the definition of “License.” SCHEDULE A
1057478.8
SCHEDULE B SERVICES 1.
Assistance with the payroll processing and administration services with respect to the Transferred Employees.
2.
Assistance with the transition of accounts payable processing and administration services. All post-Closing invoices should be sent to 1901 Campus Place, Louisville, Kentucky 40299, Attention: Stephanie Endicott and e-mailed to
[email protected].
3.
Assistance in the transition of accounting, treasury and finance services.
4.
The Seller shall provide or cause to be provided to the Buyer certain information technology, information systems, electronic connectivity, telecommunications access and connectivity, information systems (IS) operations, and similar services or assistance.
5.
Access to the Seller’s accounting software until the licensing can be transitioned pursuant to this Agreement.
6.
Assistance in the allocation of cash between the Business and the Retained Businesses, including reconciliation of cash received between pre- and post-Closing transactions.
7.
Assistance in the reopening of the Ambulatory Infusion Center.
8.
Assistance with the transition of any internet domain names, websites, webpages, social media accounts and other internet or digital media instruments in a manner that will not unreasonably disrupt either the Retained Business or the Business.
SCHEDULE B 1057478.8
Tab 15
Pre Acquisition
Care Resource, LLC*
f/k/a Infusion Resource, LLC
Bernard Lambrese Owner
Kelly Lambrese Owner
*See attached Restated Schedule 1 for ownership information
Marian Marcoccio Owner
Joe Haley Owner
Restated Schedule 1 as of December 31, 2012 Iden4fica4on of Members and Units
Member
Series A
Common**
Total
Percentage*
Bernard F. Lambrese
22,445.00
-
22445.0
12.083%
Kelly Lambrese
22,445.00
-
22445.0
12.083%
Marian Marcoccio
26,381.43
-
26381.4
14.202%
Joseph F. Haley
23,440.22
-
23440.2
12.618%
BKL, LLC
39,663.82
-
39663.8
21.352%
William F. Cesare
10,117.66
1,333.33
11451.0
6.164%
Rudy Procaccian4
10,000.00
-
10000.0
5.383%
Joseph A. Nagle
4,773.58
-
4773.6
2.570%
Andreozzi
7,494.18
-
7494.2
4.034%
Peter Fontaine
2,617.66
1,333.33
3951.0
2.127%
Paul A. Balsamo
8,782.39
1,333.33
10115.7
5.445%
Joseph J. Spicola, Jr. Noreen Ricci
2,720.61 882.42
-
2720.6 882.4
1.465% 0.475%
185,763.97
100.0%
Totals
181,763.97
4,000.00
* BDC has warrant to purchase 1% of equity of the Company for $1.00, exercisable at any 4me. ** Common Units may be subject to ves4ng
1
PharMerica Corporation (a publically-traded DE corporation) 1901 Campus Place Louisville, KY 40299 Tax ID: 87-0792558
Pharmacy Corporation of America (a private CA corporation) 1901 Campus Place Louisville, KY 40299 A wholly-owned subsidiary of PharMerica Tax ID: 95-3849613
Amerita, Inc. (a private DE corporation) 20 Fairbanks, Suite 175 Irvine, CA 92618 Tax ID: 56-2554975 A wholly-owned subsidiary of Pharmacy Corporation of America
Amerita Holdings of North Texas, Inc. (a private DE corporation) 20 Fairbanks, Suite 175 Irvine, CA 92618 Tax ID: 20-1481044 100% ownership—Amerita, Inc.
IV Solutions, Inc., DBA Amerita (a private TN corporation) 217 W Maplewood Lane Nashville, TN 37207 Tax ID: 62-1692038 A wholly-owned subsidiary of Amerita, Inc.
Amerita North Texas GP, Inc. (a private DE corporation) 20 Fairbanks, Suite 175 Irvine, CA 92618 Tax ID: 20-1481088 A wholly-owned subsidiary of Amerita Holdings of North Texas, Inc.
Central Line Infusion—Dallas Division, LTD., DBA Amerita (a Limited Partnership) 8080 Tristar Drive, Suite 120 Irving, TX 75063 Tax ID: 20-0956882 99% Limited Partnership—Amerita Holdings of North Texas, Inc. 1% Limited Partnership—Amerita North Texas GP, Inc.
Central Line Infusion, LTD., DBA Amerita (a Limited Partnership) 1301 S Coulter, Suite 201 Amarillo, TX 79106 Tax ID: 75-2552480 99% Limited Partnership Interest—Amerita Holdings of North Texas, Inc. 1% General Partnership Interest—Amerita North Texas GP, Inc.
January 13, 2016
PharMerica Corporation (1000) (DE) 87-0792558
Capital Pharmacy, LLC (2383) (TX) 27-4024135 National Pharmacy of Texas, LLC (2384) (TX) 20-8586117
PharMerica Holdings, Inc. (1500) (DE) 27-1495327
CliniCare Concepts, Inc. (3500) (FL) 57-1167052
PharMerica LongTerm Care, LLC (3000) (DE) 11-2310352
Southwest Pharmacies, Inc. (3240) (AZ) 86-0362826
Family Center Pharmacy, LLC (3230) (DE) 25-1555759
Computran Systems, Inc. (3460) (OR) 93-0675109
Insta-Care Pharmacy Services Corp. (3440) (TX) 59-1817412
Capstone Pharmacy of Delaware, LLC (3220) (DE) 52-1191584
Ark Pharmacy Services, LLC (2394) (DE) 01-0961870
99% LP
Lone Star Pharmacy LTD (TX) 26-1245637 1% GP
100% LP & GP PharMerica Prison Services Corporation (PA)
PharMerica Technology Solutions, LLC (3490) (DE) 830455841
PharMerica Professional Services, LLC (5001) (DE) 36-4773878
ContinuumCare Pharmacy LLC (2390) (DE) 27-0479950
Pharmastat Transport LTD (TX) 30-0104240
Integrity Medical Supplies, LLC (2392) (FL) 20-1466459
PharMerica Institutional Pharmacy Services, LLC (2360) (DE) 31-1537858 PharMerica East, LLC (2361) (DE) 20-1048840
LS Acquisition Company II, LLC
PharMerica Solutions Services, LLC (5000) (DE) 46-4146086
MPS Rx North Carolina, LLC (2399) (NC) 27-1922836
Goot Nursing Home Pharmacy, Inc (3250) (AZ) 86-0785205 LS Acquisition Company I, LLC
PharMerica Logistic Services, LLC (5002) (DE) 46-4154974
Pharmacy Corporation of America (3400) (CA) 95-3849613
Millennium Pharmacy Systems, LLC (2397) (DE) 25-1869539 MPS Rx Florida, LLC (2398) (FL) 26-4775411
PharMerica Drug Systems, LLC (3200) (DE) 52-1198121
Multi-Script Pharmacy, LLC (2385) (TX) 27-4024025
PharMerica Chicago, LLC (2372) (DE) 20-1693408 PharMerica Wisconsin, LLC (2364) (DE) 20-1048922 PharMerica Pennsylvania, LLC (2371) (DE) 20-1693343
ChemRx Pharmacy Services, LLC (2393) (DE) 27-3494141
Integrity Pharmacy Services, LLC (2391) (FL) 20-0988322
PharMerica Hospital Pharmacy Services, LLC (2370) (DE) 31-1537852
PMC Pharmacy Services, LLC (1960) (DE) 72-0509321
Advanced Infusion Systems, LLC (1900) (CA) 77-0295399 OncoMed Specialty, LLC (2450) (DE) 46-3896552
PharMerica Midwest, LLC (2363) (DE) 20-1048898 PMC Healthcare Pharmacies, LLC (2366) (DE) 20-1512322 PharMerica Mountain, LLC (2362) (DE) 20-1048874
PCA Acquisition, LLC (2395) (DE) 45-3935223 HealthQuest, Inc. (3405) (SC) 57-0866353 BGS Pharmacy Holding Co.,Inc. (3406) (DE) 26-2974885 PMC Ohio, LLC (2396) (DE) 45-3935333 Amerita, Inc. (2400) (DE) 56-2554975
Amerita, Inc. Legal Organization Structure
Amerita, Inc. 56-2554975 (2400) Incorp. 1-18-06 DE
100%
Houston d/b/a: Central Line Infusion
Amerita Holdings of North Texas, Inc. 20-4181044 (2402 & 2403) Incorp. 1-18-06 DE
San Antonio d/b/a: Access Therapeutics Infusion acquired 8/11/06 Austin d/b/a: Austin Parenteral Services acquired 12/12/06
100%
99% LP
Amerita North Texas GP, Inc. 20-4181088 Incorp. 1-18-06 DE
99% LP interest
Central Line Infusion Dallas Division, Ltd. d/b/a Amerita 20-0956882 (2402) (Dallas/Irving)
1% GP interest
Chattanooga d/b/a: PPS Home Infusion Pharmacy acquired 4/23/07 Central Line Infusion, LTD. d/b/a Amerita 75-2552480 (2403) (Amarillo)
Advantage Infusion Services, Inc. acquired 1/10/11 (San Antonio) 74-2715343 operationally merged into
El Paso Colorado Springs
1% GP
IV Solutions, Inc. acquired 3/1/08 (Nashville) (2401) 62-1692038
Salt Lake City d/b/a Infusion Innovations acquired 8/1/07 Denver (Centennial) (acquired from Chartwell Rocky Mountain, LLP 12/17/09) Tulsa d/b/a Saffa Infusion Pharmacy acquired 7/9/10 Infusion Services Company of NY, LLC (DE) (2410) 46-4393378 Formed 12/30/13 Coastal Pharmaceutical Services Corporation (Infusion Rx) (CA) (2404) 20-2673415 acquired 1/23/15
Alternacare Infusion Pharmacy, Inc. (KS) (2405) acquired 12/11/15 48-1163688
Corporate Structure
BGS Pharmacy Holding Company, Inc.* 26-2974885
100%
*BGS Pharmacy Holding Company, Inc. is a holding company formed for acquisition purposes. It does not provide health care services.
Spectrum Pharmacy Services, LLC 20-1889070
ONCOMED OWNERSHIP AS OF 12/6/16
Summary of Equitable Ownership
Kaveh Askari – 100%
Onco360 Holdings 1, Inc.
Onco360 Holdings 2, Inc.
Pharmacy Corp. of America
Onco360 Holdings 3, Inc.
Askari – 19% Pharamacy Corporation of America – 81%
OncoMed Specialty, LLC* 46-3896552 (10/8/13)
Sina Drug, LLC 11-3644034 (11/16/01) OncoMed The Oncology Phamacy of Buffalo, NY, LLC 27-4868532
OncoMed Pharmaceutical Services of MA, LLC 27-0919098 (9/16/09)
*OncoMed Specialty, LLC is a holding company formed for acquisition purposes. It does not provide health care services.
Tab 18
Tab 20
Tab 22
Tab 24
LEASE THIS LEASE made this 30th day of September, 2016 (the “Effective Date”), between The Revocable Trust of Robert Andreozzi and The Revocable Trust of Roberta Andreozzi,(hereinafter “Landlord”) and Amerita, Inc. (hereinafter “Tenant”). WITNESSETH In consideration of the mutual promises contained herein, and for other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the parties hereto agree as follows: 1.
REFERENCE DATA. PROPERTY location:
2 Hemingway Drive East Providence, RI 02915
LANDLORD:
Revocable Trusts of Robert and Roberta Andreozzi
LANDLORD’S ADDRESS:
60 Bay Spring Avenue B3 Barrington, RI 02806
TENANT:
Amerita, Inc., a Delaware corporation
TENANT’S ADDRESS:
7307 South Revere Parkway, Suite 200 Centennial, CO 80112
2. LEASED PREMISES. The Landlord does hereby lease to the Tenant the Premises, excepting and reserving therefrom the center walls, space for the installation of pipes, wires, conduits and ducts to serve the Premises and/or other parts of the Building for the installation of Landlord’s fixtures at such time and in such manner as will be out of Tenant’s view and behind walls and ceiling and will not interfere with Tenant’s use of the Premises. The Landlord further grants the Tenant, as an appurtenant to the Premises, the right to use the parking area in common with other Tenants, their employees and business visitors. 3. TERM. TO HAVE AND TO HOLD the Premises for a term of five (5) years, commencing on the Effective Date and expiring on September 30, 2021 unless earlier terminated pursuant to the terms herein. 4. RENT. The Tenant will pay to the Landlord rent, in advance of the first of each month the sum of Three Thousand Nine Hundred Seventy Three and 40/100 Dollars ($3,973.40) to the address set forth above for Landlord, unless otherwise directed in writing. Rent payable for any partial month will be prorated on a daily basis.
5.
OPERATING EXPENSES.
5.1 Certain Definitions. For the purpose of this Lease, the following terms shall have the meanings hereinafter set forth: (a) “Tenant’s Percentage” shall mean the percentage computed by the Landlord from time to time by dividing the gross rentable area of the Premises (approximately 4,602 square feet) by the total gross rentable area of the Property (approximately 10,000 square feet) as both are computed by Landlord, and in the event that either the gross rentable area of the Premises or the total gross rentable area of the Property is changed, Tenant’s Percentage will be appropriately adjusted and, as to the Expense Year in which such change occurs, Tenant’s Percentage shall be determined on the basis of the number of days during such Expense Year at each such percentage. (b) “Operating Expenses” shall mean the total costs and expenses paid or incurred by Landlord in connection with the operation, maintenance and repair of the Property (as that term is hereinafter defined) including, without limitation, (i) maintenance, repair and costs associated with maintaining or operating energy systems, (ii) the cost of maintenance, repair, and cleaning of the Property including the parking area, (iii) the cost of fire, extended coverage, boiler, sprinkler, apparatus, public liability, property damage, rent, earthquake and all other insurance with respect to Property, (iv) labor costs, (v) fees, charges and other costs, including consulting fees, legal fees and accounting fees, of all independent contractors engaged by landlord and reasonably charged by Landlord, with respect to Property, (vi) the cost of any capital improvements made to the Property as a labor-saving device or to effect other economies in the operation or maintenance of the Property, or made to the Property after the date of this Lease, that are required under any governmental laws or regulation that was not applicable to the Property at the time it was constructed, such cost to be amortized over the useful life per the IRS Code, (vii) any other expense of any other kind attributable to and reasonably incurred in managing, operating, maintaining and repairing the Property. (c) Notwithstanding anything to the contrary in this Lease, the definition for “Operating Expenses” shall not include: (i) capital expenses which are Landlord's obligation hereunder; (ii) real estate commissions or brokerage fees; (iii) legal fees and all other costs in connection with tenant leases and enforcing tenant obligations; (iv) costs incurred by Landlord which are reimbursed by insurance and any deductible amount excluded from insurance coverage; (v) financing transactions; (vi) refinancing fees and any late penalties; (vii) interest or amortization; (viii) depreciation and amortization of the Premises and any equipment; (ix) all amounts paid to subsidiaries or affiliates of Landlord that are in excess of competitive costs for such services; (x) costs, penalties, fines or awards and interest incurred as a result of Landlord's negligence in Landlord's operation of the Property, violations of law, negligence or inability to unwillingness to make payments and/or to file any income tax or other tax or informational returns when due; (xi) costs which are reimbursable under any contractor, manufacturer or supplier warranty or service contract; (xii) reserves of any kind, including, without limitation, replacement reserves, reserves for bad debt, reserves for lost rent or any similar charge not involving the payment of money by third parties; (xiii) Tenant benefits from any tax abatement program and from any operating expense reductions; (xiv) costs of any removal, abatement, remediation or containment of any toxic or hazardous material; (xv) costs -2-
and expenses incurred for repairs and replacements due to faulty workmanship or materials used in the construction of the building, or due to structural design defects; (xvi) or any other expenses which, in accordance with generally accepted accounting principles, consistently applied, would not normally be treated as Operating Expenses by landlords in comparable buildings. (c) “Expense Year” shall mean each twelve (12) consecutive month period commencing January 1st of each year during the Term, provided that Landlord, upon notice to Tenant, may change the Expense Year from time to time to any other twelve (12) consecutive month period and, in the event of any such change, Tenant’s proportionate share of Operating Expenses based on Tenant’s Percentage shall be equitably adjusted for the Expense Years involved in any such change. 5.2 Monthly Payment of Estimated Operating Expenses. Tenant shall pay to Landlord as additional rent, one-twelfth (1/12) of the Tenant’s Percentage of the Operating Expenses for each Expense Year on or before the first day of each month of such Expense year in an amount estimated by Landlord and billed by Landlord to Tenant. With reasonable promptness after the expiration of each Expense Year, Landlord shall furnish Tenant with a statement (herein called the “Landlord’s Expense Statement”), certified by a member of Landlord, setting forth in reasonable detail the Operating Expenses for such Expense Year, and Tenant’s proportionate share of such Operating Expenses based on Tenant’s Percentage. If the actual Operating Expenses for such Expense year exceed the estimated Operating Expenses paid by Tenant for such Expense Year, Tenant shall pay to Landlord the differences between the amount paid by Tenant and the actual Operating Expenses within thirty (30) days after the receipt of Landlord’s Expense Statement, and if the total amount paid by Tenant for any such Expense Year shall exceed the actual Operating Expenses for such Expense Year, such excess shall be credited against the next installments of the estimated Operating Expenses, due from Tenant to Landlord hereunder until exhausted. 5.3 Adjustment of Operating Expenses upon Lease Commencement or Termination. Tenant’s aforesaid proportionate share of Operating Expenses for the Expense Year in which their Lease commences or terminates shall be in the proportion that the number of days from and including the first day of the Expense Year in which the commencement or termination occurs to and including the last day of such Expense Year or Termination Date, as applicable, bears to 365; provided, however, Landlord may, pending the determination of the amount of Operating Expenses for such partial Expense Year, furnish Tenant with statements of estimated Operating Expenses, and Tenant’s proportionate share thereof for such partial Expense year. Within thirty (30) days after receipt of such estimated statement, Tenant shall remit to Landlord, as additional rent, the monthly amount of Tenant’s proportionate share of such Operating Expenses. After such Operating Expenses have been finally determined and Landlord’s Expense statement has been furnished to Tenant pursuant to Section 5.2 hereof, and if there shall have been an underpayment of Tenant’s proportionate share of Operating Expenses, Tenant shall remit the amount of such underpayment to Landlord within thirty (30) days of receipt of such underpayment to Landlord within thirty (30) days of receipt of such statement, and if there shall have been an overpayment, Landlord shall remit the amount of any such overpayment to Tenant within thirty (30) days of the issuance of such statement. -3-
5.4 Taxes and Assessments. Tenant shall pay in each Tax Year (as that term is hereinafter defined) during the Term, as additional rent, Tenant’s Proportionate Tax Share (as that term is hereinafter defined) of all real estate taxes and other ad valorem taxes (including, without limitation, special assessments) with respect to the Property, including all parcels of land and all buildings and improvements situated thereon (hereinafter collectively referred to as the “Taxes”). These Taxes include, but are not limited to all real estate taxes, sewer assessments, sewer use charges, or any other taxes of Landlord (exclusive of Landlord’s income tax) imposed by Federal, State or local taxing authorities as a substitution for or in addition to the current method of property taxation used for the funding of governmental services, and shall not include late fees, interest charges or other penalties. 5.5 Tenant’s Proportionate Tax Share. Tenant’s proportionate share of taxes (the “Proportionate Tax Share”) for any Tax Year shall be determined by applying the Tenant’s Percentage (as that term is defined in Section 5.1(a) hereof) to the total Taxes payable on the entire Property as aforesaid (as it may then be constituted) including all buildings and other improvements situated thereon for the Tax Year in question. The tax payment required hereunder shall be paid by Tenant in equal monthly installments in such amounts as are from time to time estimated and billed by Landlord during each Tax Year, each such installment being due on the first day of each month. Within ninety (90) days after Landlord’s receipt of tax bills for each Tax Year, Landlord will forward copies of tax bills and certify to Tenant: (a)
the amount of Taxes as specified above; and
(b)
the amount of Tenant’s Proportionate Tax Share.
The Tenant’s Proportionate Tax Share paid or payable for each Tax Year shall be adjusted between Landlord and Tenant, each party hereby agreeing to pay to the other, as the case may be, within ten (10) days of the aforesaid certification to Tenant, the amount necessary to effect such adjustment. The failure of Landlord to provide such certification within the time prescribed above shall not relieve Tenant of its obligations generally or for the specific Tax Year in which any such failure occurs, as provided by this Section. For the Tax Year in which the Term commences or terminates, the provision of this Section shall apply, but Tenant’s liability for its Proportionate Tax Share of any Taxes for such year shall be subject to a pro rata adjustment based upon the number of days of such Tax Year falling within the Term during which Tenant occupies the Premises. “Tax Year” means each twelve (12) month period (deemed, for the purposes of this section, to have 365 days) established as the real estate Tax Year by the taxing authorities having lawful jurisdiction over the Property. 6. Changes and Additions to Property. Landlord hereby reserves the right at any time and from time to time to make changes or revisions in the Property, excluding the Premises, but shall not impair Tenant’s ability to use and operate the Premises for its permitted use, -4-
including additions thereto and alterations thereof notwithstanding that such activities to be undertaken by Landlord may necessitate the alteration or rearrangement of all or portions of the parking and Common Areas. Landlord agrees not to add or change occupancy that requires more parking than is allowed by current tenant zoning configuration. Landlord ‘agrees to provide a child friendly environment by not renting/leasing to any tenant/lessee who would operate an adult oriented business (i. e. adult movie store, liquor store, etc.). Landlord agrees not to rent/lease space to a tenant who would operate a competing business to the business normally conducted by Tenant. 7. Use. The Premises shall be used and occupied by Tenant solely for medical professional services including, without limitation, operating a home infusion pharmacy with licensed home nursing services, the operation of an ambulatory infusion suite, the provision of pharmacy services, warehousing, storage, office and other uses incidental thereto. In using or occupying the Premises for such purpose, Tenant shall not use the same in any way which will cause discomfort or annoyance to any other Tenants or occupants of the Property or which, in Landlord’s reasonable judgment, may effect the reputation or appearance of the Property or tend to degrade the economic status of the Property or interfere with its most effective operation. Tenant accepts the Premises in the condition in which they are on the date of commencement of the term hereof. Both Landlord and Tenant acknowledge that the Premises are in good order and condition and sufficient for the uses intended by Tenant as of the Effective Date. Tenant agrees that it has full adequate opportunity to inspect the Premises and has done so to its satisfaction. Landlord has made and Tenant has relied on no representations and warranties, whether express or implied, as to the condition of the Premises or their suitability for Tenants use other than those which may be specifically set forth in this Lease. Landlord covenants that it has good right, full power and lawful authority to lease the Premises in the manner aforesaid. 8. Tenant’s Covenants. Tenant covenants with Landlord that during the term and for such further time as Tenant or anyone claiming by, through or under it, shall hold the Premises or any part thereof: (A) Tenant will promptly pay the rent and additional rent to Landlord at the address from time to time designated for the sending of notices to Landlord at the times and in the manner aforesaid. The Premises are to be provided with a separate meter at Tenant’s expense and Tenant will pay to the utility company all bills for heat, water, sewer use and electricity furnished to the Premises as they become due and payable. (B) Tenant shall keep and maintain the Premises together with all electrical, plumbing, heat and other mechanical installations therein that exclusively service the Premises, including the door of the Premises and the plate glass and other glass of the Premises (including replacement) in good order, condition and repair, at its own expense; Tenant shall keep and maintain the heating, ventilating and air conditioning (HVAC) equipment in good order, condition or repair, at its own expense; and shall, at the end of the term or sooner termination, peaceably surrender or deliver up the Premises and all erections, alterations and additions made to or upon the same, to Landlord, broom clean and in the same repair and condition, in all respects, as the Premises were in on the Effective Date and as such erections, alterations and -5-
additions were when completed, reasonable wear and tear, casualty and those obligations that are not Tenant’s responsibility under this Lease only accepted, and (except as elsewhere provided herein) will remove all personal property, goods and effects belonging to Tenant or to anyone claiming through or under Tenant, including, without limitation, all of its trade fixtures and signs, and also will remove all lettering if any, painted by Tenant on any door with or without Landlord’s consent. Tenant shall be responsible for all damage or injury to the Premises caused by Tenant’s installation or removal of furniture, fixtures or equipment. Tenant will not make any structural change in, or addition to, the Premises without first obtaining, on each occasion, Landlord’s consent in writing, which shall not be unreasonably withheld, conditioned or delayed, and then only at Tenant’s expense, and in a lawful manner and upon which reasonable terms and conditions as Landlord shall, by such writing approve, such approval not to be unreasonably withheld, conditioned or delayed. Any such approved alteration or addition shall be in keeping with existing improvements. Landlord shall, upon expiration of the Term, retain as its property, without cost to it, any alterations or additions so made. Tenant will, upon the reasonable request of Landlord, deliver to landlord in writing a schedule setting forth the details and location of all such alterations or additions. (C) Tenant shall not assign, mortgage, pledge or encumber this Lease nor underlet all or any part of the Premises without, on each occasion, obtaining the prior written consent of the Landlord (such consent not to be unreasonably withheld); consent by Landlord to any assignment, mortgage, pledge or subletting shall not constitute a waiver of the necessity of such consent to any subsequent assignment or subletting. Tenant shall remain primarily liable upon all the terms, conditions and covenants thereof and will bind any assignee or sublessees to the terms and provisions of this Lease. Notwithstanding anything in the Lease to the contrary, Tenant may, without Landlord’s approval, assign this Lease or sublease the Premises, in whole or in part, to any parent company of Tenant, any subsidiary of Tenant or any affiliate of Tenant, or in connection with a merger or consolidation of Tenant, or to an entity that has purchased all of the Tenant’s stock or all or substantially all of Tenant’s assets. The term “affiliate” means, any person or entity directly or indirectly controlling, controlled by, or under common control with Tenant. For the purposes hereof, “control” shall be deemed to mean ownership of not less than 50% of all of the voting stock of a corporation or not less than 50% of all of the legal and equitable interest in any other business entity if Tenant is not a corporation. (D) Tenant shall not permit the Premises to be utilized for any use or purpose other than as stated in Paragraph seven (7) hereof and the listing of any names other than that of Tenant, whether on the doors of the Premises, or otherwise, shall not operate to vest any right or interest in this Lease or in the Premises to such named person to be deemed to be the written consent of the Landlord, it being expressly understood that any such listing is a privilege’ extended by Landlord revocable at will by written notice to Tenant. (E) Tenant, at their sole expense, shall comply with all laws, orders and regulations of Federal, State, County and Town authorities, and with any direction of any public officer or officers, pursuant to law, which shall impose any violation, order or duty upon Landlord or Tenant with respect to the Tenant’s specific occupation of the Premises, or the use of occupation thereof; Tenant shall not do or permit to be done any act or thing upon the Premises, which will invalidate, or be in conflict with, fire insurance policies covering the Building and fixtures and property therein, and shall not do, or permit to be done, any act or -6-
thing upon the Premises which shall or might subject Landlord to any liability or responsibility for injury to any person or persons or to property by reason of any business or operation being carried on upon the Premises or for any other reason; and Tenant, at its sole expense, shall comply with all rules, orders, regulations or requirements of any Board of Fire Underwriters, rating bureau or any other similar body relating to Tenant’s specific use of the Premises, and shall not do or permit anything to be done, in or upon the Premises, or bring or keep anything therein, except as now or hereafter permitted by the authority having jurisdiction and then only in such quantity and manner of storage as not to increase the rate for the fire insurance applicable to the Property, or use the Premises in a manner which shall increase the rate of fire insurance on the Building, or on property located therein, over the rate in effect at the commencement of this Lease. If by reason of failure of Tenant to comply with the provision of this Paragraph including, but not limited to, the use to which Tenant puts the Premises, the fire insurance rate shall, at the beginning of this Lease or at any time thereafter be higher than it otherwise would be, then Tenant shall reimburse Landlord, as additional rent hereunder, for that part of all fire insurance premiums thereafter paid by Landlord, which shall have been charged because of such failure or use by Tenant, and shall make such reimbursement upon the first day of the month following such outlay by Landlord. In any action or proceeding wherein Landlord and Tenant are parties, a schedule or “make up” of rate for the Property or Premises issued by anybody making fire insurance rates for the Premises, shall be conclusive evidence of the facts therein stated and of the several items and changes in the fire insurance rate then applicable to the Premises relating to the Tenant’s specific use of the occupancy. Tenant shall not bring or permit to be brought or kept in or on the Premises any inflammable, combustible or explosive fluid, material, chemical or substance, or cause or permit any odors of cooking or other processes, or any unusual or other objectionable odors to permeate from the Premises. That the Premises are being used for the purpose set forth in Paragraph Seven (7) hereof shall not relieve Tenant from the foregoing duties, obligations and expenses. Notwithstanding anything to the contrary in this Lease, Landlord shall, at its sole cost and expense, bear the cost of compliance with all laws, orders and regulations of Federal, State, County and Town authorities that are generally applicable to the Premises, would be applicable to similar tenants in the Premises or that do not arise out of Tenant’s specific use and occupancy of the Premises. (F) Except as modified by statue, all merchandise, furniture, fixtures and property of any kind which may be on or about the Premises shall be at the sole risk and hazard of Tenant, and if the whole or any part thereof shall be destroyed or damaged by fire, water or otherwise or by the use or abuse of water or by the leaking or busting of water pipes, or in any other way or manner, no part or such loss or damage will be charged or borne by landlord in any case whatever except those caused by the willful acts, omission, fault, misconduct or negligence of the Landlord, servants, employees, agents, visitors, or licensees. (G) Except to the extent liability is waived under Section 12(B) below, Tenant shall indemnify and hold Landlord harmless against any and all claims, liabilities, damages and losses, including expenses incidental to the defense of same, resulting from injury or death of any person or damage to property occurring on or about the Premises or in conjunction with Tenant's use and occupancy of the Premises, unless caused by the negligent acts or willful misconduct of Landlord. In addition, Landlord shall indemnify and hold Tenant harmless against any and all claims, liabilities, damages and losses, including expenses incidental to the -7-
defense of same, resulting from injury or death of any person or damage to property attributable to Landlord’s negligence or willful misconduct.
(H) Landlord or its representatives during business hours and after telephonic message, shall have the right without charge to it and without reduction in rent, at reasonable times and in such manner as not unreasonable to interfere with Tenant’s business, to enter to view the Premises and, if Landlord so elects, to maintain, use, repair, replace, relocate or introduce pipes, ducts, wires, meters and any other Landlord’s fixtures (provided such fixtures are out of view and behind sheetrock walls and ceilings) serving or to serve the Premises if Landlord, so elects, to make such repairs, installations, additions and alterations which are the responsibility of Tenant to make and which Tenant fails promptly to do, which latter repairs, installations, additions and alterations will be made at the expense of Tenant, and, in case of an emergency, whether resulting from circumstances in the Premises or in the Building, Landlord or its representative may enter the Premises (forcibly, if necessary) at any time to take such measures as may be needed to cope with such emergency; Landlord may during the six (6) months next preceding the expiration of the Term, show the Premises to persons wishing to lease same. Landlord may show the Premises to persons wishing to purchase same, in accordance with the provisions of this paragraph, provided Landlord gives 24 hour notice to Tenant. Notwithstanding anything in this Section or in this Lease to the contrary, in no event shall Landlord have the right to enter the Premises without being accompanied by a licensed pharmacist employed by Tenant who will be available during regular business hours, excepting only cases of emergency. (I) Tenant shall carry and keep in force, at its own expense, with respect to the Premises, a policy or policies of public liability and property damage insurance within an insurance company or companies reasonably satisfactory to Landlord. Such policies shall name the Landlord as an insured party as its interest may appear and shall be in the following minimum amounts: Personal Injury including death - $1,000,000.00: Property Damage $80,000.00. The certificates of such policy or policies evidencing such coverage together with an endorsement thereon evidencing payment of premium or other satisfactory proof thereof shall be delivered to Landlord upon request. (J) Tenant shall not overload, damage or deface the Premises nor suffer or permit same to be done, nor commit waste nor permit any hole to be drilled or made in the stone or brickwork of the Building. (K) Tenant covenants that such rules and regulations as the Landlord from time to time hereafter may make, applicable to all Tenants of the Property .and shall be reasonable and non-discriminatory and uniformly enforced by Landlord being in the judgment of the Landlord necessary for the reputation, safety, care or cleanliness of the Property and Premises or the operation and maintenance of the Property and its equipment, or for the comfort of the Tenants, shall be faithfully observed and performed by the Tenant and by the agents, employees, servants, licensees, invites, and visitors of the Tenant,: and all such rules and regulations are hereby made a part of this Aptsec.as fully, to all intents and purposes, as if herein set forth. The Landlord, however, shall have the right to change said rules; provided, however, -8-
that Tenant shall not be required to comply with any subsequently enacted rule that materially increases Tenant’s obligations under this Lease. (L) Tenant will not place or suffer to be placed or maintained on the exterior of the Premises or anywhere within the Property, any signs, advertising matter or thing of any kind and will not place or maintain any decoration, lettering or advertising matter on the glass of any window or door of the Premises without first obtaining Landlord’s written approval thereof, which will not be unreasonably withheld, delayed or conditioned; Tenant further agrees to maintain any such approved sign, decoration, lettering, advertising matter other than in good condition and repair at all times; and, Tenant agrees that all signs, advertising matter or any other thing of any kind must comply with the provisions of the City of East Providence Ordinances. (M) Tenant shall not do or suffer anything to be done whereby the Premises or the Property may be encumbered by any material man’s or mechanic’s lien and shall, whenever and as often as any such lien is filed purporting to be for labor or material furnished to the Tenant, discharge the same of record within thirty (30) days after the date of filing. 9. Subordination. This Lease is and shall be subject and subordinate to all mortgages which may now or hereafter affect the Premises or the Property and to all renewals, modifications, consolidations, replacements, and extensions of such mortgages provided that each such mortgagee enters into an agreement with the Tenant by the terms of which such mortgagee will agree, so long as Tenant performs all of its covenants hereunder and agrees to attorn, to recognize the rights of the Tenant under this Lease, to accept the Tenant as Tenant of the Premises under the terms and conditions of this Lease and to perform Landlord’s obligations hereunder in the event of acquisition of title by such mortgagee through foreclosure proceedings or otherwise; which agreement shall be made expressly binding upon the successors and assigns of the mortgagee and upon anyone purchasing the Premises at any foreclosure sale. In confirmation of such subordination, the Tenant shall, on demand execute promptly any certificate that the Landlord may request. From time to time, the Tenant, on at least fifteen (15) days’ prior written request by Landlord, will deliver to Landlord a statement in writing certifying that this Lease is unmodified and in full force and effect (or if there shall have been modifications, that the same is in full force and effect as modified and stating the modifications) and the dates to which the rent and other charges have been paid and stating whether or not Landlord is in default in performance of any covenants, agreements or conditions contained in this Lease and if so, specifying each such default of which Tenant may have knowledge. 10. Trade Fixtures and Equipment. Any trade fixtures or equipment installed in or attached to the Premises by and at the expense of Tenant and all other property of Tenant which was personal property prior to its installation, regardless of how attached or affixed to the Premises, shall remain the property of Tenant and Tenant shall, except as otherwise provided herein or by agreement of the parties, have the right, at any time and from time to time to remove any and all of its trade fixtures, equipment and said property which it may have installed in or attached to the Premises, during the term (or during the renewal or extension thereof) or within a reasonable time after any permitted holding over; but Tenant shall promptly repair in a workmanlike manner any damage resulting from such removal, shall plug or close in an approved manner any connection to sources of gas, air, water, electricity or heat to the .cooling
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ducts and shall leave the Premises underfaced in appearance and not in any state of depreciation as a result of such removal. 11.
Eminent Domain.
(A) That in case the Premises or any part thereof shall be taken for any street or other public use, by action of the Municipality or other authorities, or shall receive any direct or consequential damage for which the Landlord or the Tenant shall be entitled to compensation by, reason of anything lawfully done in pursuance of any public authority, after the execution hereof and before the expiration of said Term, then this Lease and the said Term shall terminate at the election of the Landlord or Tenant, and such election may be made in case of any such taking notwithstanding the entire interest of the Landlord may have been divested by such taking, and if it shall not so elect then in case of any such taking or destruction of, or damage of the Premises, rendering the same or any part thereof unfit for use and occupation, a just proportion of the rent hereinbefore reserved according to the nature and extent of the injury sustained by the Premises, shall be suspended or abated until the Premises or, in case of such taking, what may remain thereof, shall have been put in proper condition for use and occupation provided, however, that should twenty (20%) percent of the Premises or (unless Landlord furnishes equivalent space) of Tenant’s parking area be so rendered untenantable, then the Tenant shall also have the option to terminate the Lease. Any election to terminate by either party shall be made not later than thirty (30) days after it receives notice of such taking, action or the occurrence of such damage; (B) The Landlord reserves and excepts from this Lease all rights to damages to the Premises or any part thereof, or the leasehold hereby created heretofore accrued or hereafter to accrue by reason of any taking for public use of the Premises or any portion thereof, or right appurtenant thereto, or privilege or easement in, through, or over the same, and by way of confirmation of the foregoing the Tenant hereby grants all rights to such damages heretofore accrued or hereafter accruing during the term of any extension thereto to the Landlord, to have and to hold for the Landlord, its successors arid assigns forever. 12. Fire and Other Damage. If the Premises shall be partially damaged by fire or other cause without the fault or neglect of Tenant, Tenant’s servants, employees, agents, visitors or licensees, the damages shall be repaired by and at the expense of the Landlord and the rent until such repairs shall be made, apportioned according to the part of the Premises which is usable by Tenant for its permitted use. But if such partial damage is due to the fault or neglect of Tenant, Tenant’s servants, employees, agents, visitors or licensees, the damage shall be repaired by Landlord but there shall be’ no apportionment or abatement of rent. Such repairs shall be made promptly, subject to reasonable delay which may arise by reason of adjustment of insurance on the part of Landlord or Tenant, and for reasonable delay on account of “labor troubles” or any other cause beyond Landlord’s control. Landlord shall not be liable for any inconvenience or annoyance to Tenant or injury to the business of Tenant resulting from reasonable delays in repairing such damage. If the Premises are totally damaged or are rendered wholly untenantable by fire or other cause, and if Landlord shall decide not to restore or not to rebuild the same, or if the Premises shall be so damaged that Landlord shall decide to demolish it (whether or not Landlord thereafter decides -10-
to rebuild it), Landlord or Tenant may, within sixty (60) days after such fire or other cause, give each other a notice in writing of such decision and thereupon the Term shall expire upon the thirtieth (30th) day after such notice is given, and Tenant shall vacate the Premises and surrender the same to Landlord. If the Premises are totally damaged or are rendered wholly untenantable by fire or other cause so that it cannot reasonably be expected to be restored or rebuilt within a three (3)month period, Tenant may within sixty (60) days of the occurrence of such damage, terminate this Lease upon fifteen (15) days’ prior notice in writing to Landlord and thereafter shall vacate the Premises and surrender the same to Landlord. If Tenant shall not be in default under this Lease then, upon the termination of this Lease under the conditions herein provided for, Tenant’s liability for rent shall cease as of the day following the casualty. (B) Notwithstanding anything contrary contained in the Lease, Landlord and Tenant mutually waive their respective rights of recovery against each other for any loss that could be insured by fire, extended coverage, All Risks, Special Form or other property insurance, irrespective of either party’s negligence and irrespective of whether such policies are actually in place. Each party shall obtain any special endorsements required by their insurer to evidence compliance with the aforementioned waiver. 13. Default. Provided also, and these presents are upon this condition that if Tenant shall neglect or fail to perform or observe any of the covenants or undertakings herein on its part to be performed and observed for a period of thirty (30) days (thirty (30) days if such default be in the payment of any installment of rent or any additional rent due) shall promptly after receipt of notice of such default commence and diligently proceed to cure such default, or if the estate hereby created shall be taken by execution or by other process of law and not redeemed by Tenant within fifteen (15) days thereafter, or if proceedings for corporate reorganization or arrangement under the Bankruptcy Laws of the United States, or any laws amendatory thereof or supplemental thereto, shall be filed by or against Tenant and a decree entered for such reorganization or arrangement, or if any assignment shall be made of Tenant’s property for the benefit of creditors, or if any proceedings are instituted by or against Tenant under any Bankruptcy or Insolvency Law, or if a receiver for Tenant or other similar officer shall be appointed (and if any said proceedings which are instituted against Tenant or the said appointment of any receiver or other similar officer shall not be contested and dismissed within thirty (30) days after the institution or appointment thereof) Landlord may upon an additional ten (10) days’ notice, immediately or at any time thereafter (notwithstanding any license or waiver of any former breach or waiver of the benefit hereof or consent in a former instance) and without demand or notice, in person or by agent or attorney, enter the Premises or any part thereof and repossess the same as of its former estate, or terminate by written notice to Tenant and in either event expel Tenant and those claiming through or under it and remove their effects (forcibly, if necessary) without being deemed guilty or any manner of trespass and without prejudice to any remedy which otherwise might be used for arrears of rent or breach of covenant, and upon entry of notice as aforesaid this Lease shall terminate. 14. Landlord’s Remedies. If the Lease shall be terminated as hereinbefore provided in Paragraph 13 hereof, Tenant shall forthwith pay to Landlord as damages all sums which were due prior to the date of such termination.
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Tenant also agrees (i) to indemnify and save Landlord harmless from and against all reasonable expenses which Landlord may incur, including, without limitations, legal expenses, attorneys’ fees, brokerage fees, and the cost of putting the Premises in good order or preparing the same for rental and (ii) that Landlord may re-let the Premises or any part or parts thereof, either in the name of Landlord or otherwise for a term or terms which may, at Landlord’s option, be less than or exceed the period which would otherwise have constituted the balance of the term and of any extension thereof and may grant concessions or free rent. The failure of or refusal of Landlord to relet the Premises or any part or parts thereof shall not release or affect Tenant’s liability for damages but, without limiting the foregoing, Landlord agrees to use reasonable efforts to re-let the Premises. Any such liquidated damages shall be paid in monthly installments by Tenant on the rent day specified in this Lease and suit brought to collect the amount of deficiency for any month shall not prejudice in any way the right of Landlord to collect the deficiency for any subsequent month by a similar proceeding. Landlord at Landlord’s option may make such alterations, repairs, replacements and decorations on the Premises as Landlord in Landlord’s reasonable judgment considers advisable and necessary for the purpose of re-letting the Premises and the making of such alterations or decorations ‘,shall not operate or be construed to release Tenant from liability hereunder. Landlord shall in no event be liable in any way for failure to collect the rent thereof under such re-letting. Mention in this Lease of any particular remedy shall not preclude Landlord from any other remedy in law or in equity. In the event of ‘any default by Tenant in the payment of rent, Tenant will, in addition, reimburse Landlord for all reasonable expenses incurred by Landlord in collecting such rent or in obtaining possession of or in re-letting the Premises, or in defending any action, including expenses for reasonable counsel fees and commissions. Tenant further agrees that, if on termination of this Lease by expiration or otherwise, Tenant shall fail to remove any of its property from the Premises, Landlord shall be authorized, in its sole option, and in Tenant’s name an on its behalf, either (i) to cause such property to be removed and placed in storage for the account and at the expense of Tenant; or (ii) to sell such property at public or private sale with or without notice, and to apply the proceeds thereof, after the payment of all expenses of removal, storage and sale, to the indebtedness, if any, of Tenant to landlord, the surplus, if any, to be paid to Tenant. Notwithstanding anything to the contrary in this Lease, Landlord shall use commercially reasonable efforts to mitigate its damages upon the occurrence and continuation of a default by Tenant. 15. Quiet Enjoyment. Tenant shall, upon paying the rent reserved hereunder and observing and performing all of the terms, covenants and conditions of Tenant’s part to be observed and performed, peaceably and quietly have and hold, the Premises, without hindrance or molestation by any person or persons lawfully claiming by, through or under Landlord, subject, however, to the terms of this Lease. 16. Notices. All notices shall be given by registered or certified mail, return receipt requested or by nationally recognized overnight commercial courier with receipt acknowledge, and all notices for the Landlord shall be addressed to the Landlord, to the address listed herein, and to Tenant at the address listed herein.
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17. Entire Agreement. This Lease sets forth the entire agreement between the parties hereto and cannot be modified or amended except in writing duly executed by the respective parties. 18. Partial Invalidity. The invalidity of one or more phrases, sentences, clauses, or paragraphs contained in this Lease shall not affect the remaining portions of this Lease or any part thereof, and in the event that any one or more of the phrases, sentences, clauses or paragraphs contained in this Lease should be declared invalid by the final order, decree or judgment of a court of competent jurisdiction, this Lease shall be construed as if such invalid phrases, sentences, clauses or paragraphs had not been inserted in this Lease. 19. Holdover. If the Tenant remains in the Premises beyond the expiration of this Lease and without Landlord’s consent, such holding over shall not be deemed to create any tenancy, but the Tenant shall be a Tenant at sufferance only, at a daily rate equal to one and one half (1-1/2) times the rent and other charges under this Lease. However, all conditions of this Lease to be performed by Tenant shall continue in force. 20. Consent. Whenever’ the consent of either party is required under this Lease it shall not be unreasonably withheld, delayed or conditioned. 21. Non-Waiver Provision. No assent, express or implied, by the Landlord to any breach of any agreement or condition herein contained on the part of the Tenant to be performed or observed, and no waiver, expressed or’ implied, of any such agreement or condition shall be deemed to be a waiver of or assent to any succeeding breach of the same or any other agreement or condition; the acceptance by the Landlord of rent or other payment hereunder or silence by the Landlord as to any breach shall not be construed as waiving any of the Landlord’s rights hereunder unless such waiver shall be in writing. No payment by the Tenant or acceptance by the Landlord of a lesser amount than shall be due the Landlord from the Tenant shall be deemed to be anything but payment on account, and the acceptance by the Landlord of a check for a lesser amount with an endorsement or statement thereon or upon a letter accompanying said check that said lesser amount is payment in full shall not be deemed an accord and satisfaction, and the Landlord may accept said check without prejudice to recover the balance due or pursue any other remedy. 22. Persons and Property Bound. The word “Landlord” wherever used herein shall comprehend and bind the Landlord, its heirs, legal representatives, successors and assigns and the word “Tenant” wherever used herein, shall comprehend and bind the Tenant, its heirs, legal representatives, successors and assigns, or those in any manner claiming through or under said Tenant, in each and every case where the context so allows or admits and whether so expressed or not. Tenant hereby agrees for itself and each succeeding holder of the Tenant’s interest, or any portion thereof, hereunder, that any judgment, decree or award obtained against the Landlord or any succeeding owner of the Landlord’s interest, which is in any manner related to this Lease, the Premises or the Tenant’s “s use or occupancy of the Premises or the common areas of the Premises owned by the Landlord, whether at law or in equity, shall be satisfied out of the Landlord’s equity in the Property to the extent then owned by the Landlord or such succeeding owner, and further agrees to look only to such assets and to no other assets of the Landlord, or such succeeding owner for satisfaction. -13-
23.
Deposit. [Reserved]
24. Counterparts and Headnotes. This Lease is executed in duplicate, both copies of which are identical, and either one of which is to be deemed to be complete in itself and may be introduced in evidence or used for any purpose without the production of the other copy. The headnotes throughout this Lease are for convenience or reference only, and shall in no way be held or deemed to define, limit, explain, describe, modify or add to the interpretation, construction or meaning of any provision of this Lease. 25. Governing Law. This Lease and the performance thereof will be governed, interpreted, construed and regulated by the laws of the State of Rhode Island. 26. Lease not to be Recorded. Tenant agrees that it will not record this Lease. Both parties shall upon the request of either, execute and deliver a memorandum or short form of this Lease in such form, if any, as may be permitted by applicable statute. If this Lease is terminated before the Term expires the parties shall execute, deliver and record an instrument acknowledging such fact and the actual date of termination of this Lease, and Tenant hereby appoints Landlord its attorney-in-fact, coupled with an interest, with full power of substitution, to execute such instrument. 27. Option. Tenant having at all times faithfully performed all of the terms and conditions of this Lease by it to be performed shall have the option to extend and renew this Lease for two additional terms of five years by giving Landlord written notice in the manner herein provided for in Paragraph 16 at least six (6) months prior to the expiration of the original term and six months prior to the expiration of each extension term. All of the terms and conditions of this Lease shall continue in force during the extended period ‘except that the annual base rent payable by Tenant for each such extension period shall be agreed upon by Landlord and Tenant. 28. Termination Right. Provided that Tenant is not in default beyond any applicable notice and cure period provided for herein, Tenant shall have the right to terminate this Lease at any time during the Term by providing Landlord with advance written notice of not less than 1 year, such termination to be effective upon the date set forth in Tenant’s written notice. [Signature Page Follows]
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Tab 26
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L'6Rft>f<.fi t,-6tJ BY-LAWS OF [NEWCO] ARTICLE I Stockholders Section 1.01. Annual Meetings. The annual meeting of the stockholders of the Corporation for the election of Directors and for the transaction of such other business as properly may come before such meeting shall be held at such place, either within or without the State of Delaware, or, within the sole discretion of the Board of Directors, by remote electronic communication technologies and at such date and at such time, as may be fixed from time to time by resolution of the Board of Directors and set forth in the notice or waiver of notice of the meeting. Section 1.02. Special Meetings. Special meetings of the stockholders may be called at any time by the Chairman of the Board, Chief Executive Officer (or, in the event of his or her absence or disability, by the President or any Executive Vice President), or by the Board of Directors. A special meeting shall be called by the Chairman of the Board, Chief Executive Officer (or, in the event of his or her absence or disability, by the President or any Executive Vice President), or by the Secretary of the Corporation pursuant to a resolution approved by a majority of the entire Board of Directors. Such special meetings of the stockholders shall be held at such places, within or without the State of Delaware, or, within the sole discretion of the Board of Directors, by remote electronic communication technologies, as shall be specified in the respective notices or waivers of notice thereof. Any power of the stockholders of the Corporation to call a special meeting is specifically denied. Section 1.03. Notice Of Meetings; Waiver. (a) The Secretary of the Corporation or any Assistant Secretary shall cause notice ofthe place, if any, date and hour of each meeting of the stockholders, and, in the case of a special meeting, the purpose or purposes for which such meeting is called, and the means of remote communications, if any, by which stockholders and proxy holders may be deemed to be present in person and vote at such meeting, to be given personally by mail or by electronic transmission, or as otherwise provided in these By-Laws or permitted by applicable law, not fewer than ten (10) nor more than sixty (60) days prior to the meeting, to each stockholder of record entitled to vote at such meeting. If such notice is mailed, it shall be deemed to have been given personally to a stockholder when deposited in the United States mail, postage prepaid, directed to the stockholder at his or her address as it appears on the record of stockholders of the Corporation, or, if a stockholder shall have filed with the Secretary of the Corporation a written request that notices to such stockholder be mailed to some other address, then directed to such stockholder at such other address. Such further notice shall be given as may be required by law. (b) A written waiver of any notice of any annual or special meeting signed by the person entitled thereto, or a waiver by electronic transmission by the person entitled to notice, shall be deemed equivalent to notice. Neither the business to be transacted at, nor the purpose of, any annual or special meeting of the stockholders need be specified in a waiver of notice. Attendance of a stockholder at a meeting of stockholders shall constitute a waiver of notice of such meeting, except when the stockholder attends a meeting for the express purpose of objecting, at the beginning of the meeting, to the transaction of any business on the ground that the meeting is not lawfully called or convened. (c) For notice given by electronic transmission to a stockholder to be effective, such stockholder must consent to the Corporation's giving notice by that particular form of electronic transmission. A stockholder may revoke consent to receive notice by electronic transmission by written notice to the Corporation. A stockholder's consent to notice by electronic transmission is automatically revoked if the Corporation is unable to deliver two consecutive electronic transmission notices and such inability becomes known to the Secretary of the Corporation, any Assistant Secretary, the transfer agent or other person responsible for giving notice. (d) Notices are also deemed given (i) if by facsimile, when faxed to a number where the stockholder has consented to receive notice; (ii) if by electronic mail, when mailed electronically to an electronic mail address at which the stockholder has consented to receive such notice; (iii) if by posting on an electronic network (such as a website or chatroom) together with a separate notice to the stockholder of such specific posting, upon the later to
occur of(A) such posting or (B) the giving ofthe separate notice of such posting; or (iv) ifby any other form of electronic communication, when directed to the stockholder in the manner consented to by the stockholder. (e) If a stockholder meeting is to be held via electronic communications and stockholders will take action at such meeting, the notice of such meeting must: (i) specifY the means of remote communications, if any, by which stockholders and proxy holders may be deemed to be present and vote at such meeting; and (ii) provide the information required to access the stockholder list. A waiver of notice may be given by electronic transmission. Section 1.04. Quorum. Except as otherwise required by law or by the Certificate of Incorporation, at each meeting of stockholders the presence in person or by proxy of the holders of record of a majority in voting power of the shares entitled to vote at such meeting shall constitute a quorum for the transaction of business at such meeting. Shares of its own stock belonging to the Corporation or to another corporation, if a majority of the shares entitled to vote in the election of directors of such other corporation is held, directly or indirectly, by the Corporation, shall neither be entitled to vote nor be counted for quorum purposes; provided, however, that the foregoing shall not limit the right of the Corporation or any subsidiary of the Corporation to vote stock, including but not limited to its own stock, held by it in a fiduciary capacity. Section 1.05. Voting. If, pursuant to Section 5.05 of these By-Laws, a record date has been fixed, every holder of record of shares entitled to vote at a meeting of stockholders shall be entitled to one ( 1) vote for each share outstanding in his or her name on the books of the Corporation at the close of business on such record date (or such other number of votes per share as may be specified in the Certificate of Incorporation). If no record date has been fixed, then every holder of record of shares entitled to vote at a meeting of stockholders shall be entitled to one (1) vote for each share of stock (or such other number of votes as may be specified in the Certificate of Incorporation) standing in his or her name on the books of the Corporation at the close of business on the day next preceding the day on which notice of the meeting is given, or, if notice is waived, at the close of business on the day next preceding the day on which the meeting is held. Except as otherwise provided by law or by the Certificate of Incorporation, a nominee for Director shall be elected to the Board of Directors if the votes cast for such nominee's election exceed the votes cast against such nominee's election and all other questions shall be decided by the vote of the holders of a majority in voting power of the shares of stock present in person or by proxy at the meeting and entitled to vote on the question; provided, however, that directors shall be elected by a plurality of the votes cast at any meeting of stockholders for which (i) the Secretary of the Corporation receives a notice that a stockholder has nominated a person for election to the Board of Directors in compliance with the advance notice requirements for stockholder nominees for Director set forth in Section 1.10 of these By-Laws and (ii) such nomination has not been withdrawn by such stockholder on or prior to the day next preceding the date the Corporation first mails its notice of meeting for such meeting to the stockholders (a "contested election"). If directors are to be elected by a plurality of the votes cast, stockholders shall not be permitted to vote against a nominee. Section 1.06. Voting By Ballot. A vote of the stockholders on an election of Directors need not be taken by written ballot or by electronic transmission unless otherwise required by law. Any vote not required to be taken by ballot or by electronic transmission may be conducted in any manner approved by the Board of Directors prior to the meeting at which such vote is taken. Section 1.07. Adjournment. If a quorum is not present at any meeting of the stockholders, the stockholders present in person or by proxy shall have the power to adjourn any such meeting from time to time until a quorum is present. Notice of any adjourned meeting of the stockholders of the Corporation need not be given if the place, if any, date and hour thereof are announced at the meeting at which the adjournment is taken, provided, however, that if the adjournment is for more than thirty (30) days, or if after the adjournment a new record date for the adjourned meeting is fixed pursuant to Section 5.05 of these By-Laws, a notice of the adjourned meeting, conforming to the requirements of Section 1.03 hereof, shall be given to each stockholder of record entitled to vote at such meeting. At any adjourned meeting at which a quorum is present, any business may be transacted that might have been transacted on the original date of the meeting. Section 1.08. Proxies. Any stockholder entitled to vote at any meeting of the stockholders may authorize another person or persons to vote at any such meeting and express such vote on behalf of him or her by proxy. A stockholder may authorize a valid proxy by executing a written instrument signed by such stockholder, or by causing his or her signature to be affixed to such writing by any reasonable means including, but not limited to, by facsimile signature, or by transmitting or authorizing the transmission of any other means of electronic transmission
to the person designated as the holder of the proxy, a proxy solicitation firm or a like authorized agent. No such proxy shall be voted or acted upon after the expiration of three (3) years from the date of such proxy, unless such proxy provides for a longer period. Every proxy shall be revocable at the pleasure of the stockholder executing it, except in those cases where applicable law provides that a proxy shall be irrevocable. A stockholder may revoke any proxy which is not irrevocable by attending the meeting and voting in person or by filing with the Secretary of the Corporation either an instrument in writing revoking the proxy or another duly executed proxy bearing a later date. Proxies by electronic transmission must either set forth or be submitted with information from which it can be determined that the electronic transmission was authorized by the stockholder. Any copy, facsimile telecommunication or other reliable reproduction of a writing or transmission created pursuant to this section may be substituted or used in lieu of the original writing or transmission for any and all purposes for which the original writing or transmission could be used, provided that such copy, facsimile telecommunication or other reproduction shall be a complete reproduction of the entire original writing or transmission. Section 1.09. Organization; Procedure; Conduct of Meeting. At every meeting of stockholders the presiding officer shall be the Chairman of the Board or, in the event of his or her absence or disability, a presiding officer chosen by the Board of Directors. The Secretary of the Corporation, or in the event ofhis or her absence or disability, an Assistant Secretary, if any, or if there be no Assistant Secretary, in the absence of the Secretary of the Corporation, an appointee of the presiding officer, shall act as Secretary of the meeting. The Board of Directors may adopt by resolution such rules and regulations for the conduct of the meeting of stockholders as it shall deem appropriate. Except to the extent inconsistent with such rules and regulations as adopted by the Board of Directors, the person presiding over any meeting of stockholders shall have the right and authority to convene and to adjourn the meeting, to prescribe such rules, regulations and procedures and to do all such acts as, in the judgment of such presiding person, are appropriate for the proper conduct of the meeting. Such rules, regulations or procedures, whether adopted by the Board of Directors or prescribed by the presiding person of the meeting, may include, without limitation, the following: (i) the establishment of an agenda or order ofbusiness for the meeting; (ii) rules and procedures for maintaining order at the meeting and the safety of those present; (iii) limitations on attendance at or participation in the meeting to stockholders of record of the Corporation, their duly authorized and constituted proxies or such other persons as the presiding person of the meeting shall determine; (iv) restrictions on entry to the meeting after the time fixed for the commencement thereof; and (v) limitations on the time allotted to questions or comments by participants. The presiding person at any meeting of stockholders, in addition to making any other determinations that may be appropriate to the conduct of the meeting, shall, if the facts warrant, determine and declare to the meeting that a matter or business was not properly brought before the meeting and if such presiding person should so determine, such presiding person shall so declare to the meeting and any such matter or business not properly brought before the meeting shall not be transacted or considered. Unless and to the extent determined by the Board of Directors or the person presiding over the meeting, meetings of stockholders shall not be required to be held in accordance with the rules of parliamentary procedure. Section 1.1 0. Notice Of Stockholder Business And Nominations. (a) Annual Meetings Of Stockholders.
(i)
Nominations of persons for election to the Board of Directors of the Corporation and the proposal of business to be considered by the stockholders may be made at an annual meeting of stockholders (A) by or at the direction of the Board of Directors or the Chairman of the Board, or (B) by any stockholder of the Corporation who is entitled to vote at the meeting, who complies with the notice procedures set forth in clauses (ii) and (iii) of this paragraph and who was a stockholder of record at the time such notice is delivered to the Secretary of the Corporation.
(ii)
For nominations or other business to be properly brought before an annual meeting by a stockholder, pursuant to clause (B) of paragraph (a)(i) of this Section 1.1 0, the stockholder must have given timely notice thereof in writing to the Secretary ofthe Corporation. To be timely, a stockholder's notice shall be delivered to the Secretary of the Corporation at the principal executive offices of the Corporation not fewer than ninety (90) days nor more than one hundred twenty (120) days prior to the first anniversary of the preceding year's annual meeting; PROVIDED, that in the case of the annual meeting occurring in 2008 or if the date of the annual meeting is more than thirty (30) days before or more than seventy (70) days after such anniversary date, notice by the stockholder to be timely must be so delivered not earlier than one hundred twenty (120) days prior to such annual meeting and not later than the close of business on the later of the ninetieth (90th) day prior to such
annual meeting or the tenth (lOth) day following the day on which public announcement of the date of such meeting is first made. In no event shall the adjournment or postponement of an annual meeting commence a new time period for the giving of a stockholder's notice as described above. Such stockholder's notice shall set forth (A) as to each person whom the stockholder proposes to nominate for election or reelection as a Director (x) all information relating to such person that is required to be disclosed in solicitations of proxies for election of Directors, or is otherwise required, in each case pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), or any successor provisions, including such person's written consent to being named in the proxy statement as a nominee and to serving as a Director if elected, and (y) a statement whether such person, if elected, intends to tender, promptly following such person's election or reelection, an irrevocable resignation effective upon such person's failure to receive the required vote for reelection at the next meeting at which such person would face reelection and upon acceptance of such resignation by the Board of Directors, in accordance with the Section 2.13 of these By-Laws; (B) as to any other business that the stockholder proposes to bring before the meeting, a brief description of the business desired to be brought before the meeting, the text of the proposal or business (including the text of any resolutions proposed for consideration and in the event that such business includes a proposal to amend the By-Laws of the Corporation, the language of the proposed amendment), the reasons for conducting such business at the meeting and any material interest in such business of such stockholder and of any beneficial owner on whose behalf the proposal is made; and (C) as to the stockholder giving the notice and any beneficial owner on whose behalf the nomination or proposal is made (1) the name and address of such stockholder, as they appear on the Corporation's books, and of such beneficial owner, (2) the class and number of shares of the Corporation which are owned of record by such stockholder and beneficially by such beneficial owner, (3) a representation that the stockholder is a holder of record of stock of the Corporation entitled to vote at such meeting and intends to appear in person or by proxy at the meeting to propose such business or nomination, and (4) a representation whether the stockholder or the beneficial owner, if any, intends or is part of a group which intends (i) to deliver a proxy statement and/or form of proxy to holders of at least the percentage of the Corporation's outstanding capital stock required to approve or adopt the proposal or elect the nominee and/or (ii) otherwise to solicit proxies from stockholders in support of such proposal or nomination. The Corporation may require any proposed nominee to furnish such other information as it may reasonably require to determine the eligibility of such proposed nominee to serve as a director of the Corporation. (iii) Notwithstanding anything in the second sentence ofparagraph (a)(ii) of this Section 1.10 to the contrary, in the event that the number of Directors to be elected to the Board of Directors of the Corporation is increased and there is no public announcement naming all of the nominees for Director or specifying the size of the increased Board of Directors made by the Corporation at least one hundred (1 00) days prior to the first anniversary of the preceding year's annual meeting, a stockholder's notice under this paragraph shall also be considered timely, but only with respect to nominees for any new positions created by such increase, if it shall be delivered to the Secretary of the Corporation at the principal executive offices of the Corporation not later than the close of business on the tenth (I Oth) day following the day on which such public announcement is first made by the Corporation. (iv) The foregoing notice requirements of this Section I.IO shall be deemed satisfied by a stockholder if the stockholder has notified the Corporation of his, her or its intention to present a proposal or nomination at an annual meeting in compliance with applicable rules and regulations promulgated under the Exchange Act and such stockholder's proposal or nomination has been included in a proxy statement that has been prepared by the Corporation to solicit proxies for such annual meeting. (b) Special Meetings Of Stockholders. Only such business as shall have been brought before the special meeting of the stockholders pursuant to the Corporation's notice of meeting pursuant to Section 1.03 of these ByLaws shall be conducted at such meeting. Nominations of persons for election to the Board of Directors may be made at a special meeting of stockholders at which Directors are to be elected pursuant to the Corporation's notice of meeting (I) by or at the direction of the Board of Directors or (2) provided that the Board of Directors has determined that directors shall be elected at such meeting, by any stockholder of the Corporation who is entitled to vote at the meeting, who complies with the notice procedures set forth in this Section I.I 0 and who is a stockholder
of record at the time such notice is delivered to the Secretary of the Corporation. Nominations by stockholders of persons for election to the Board of Directors may be made at such special meeting of stockholders if the stockholder's notice as required by paragraph (a)(ii) ofthis Section 1.10 shall be delivered to the Secretary of the Corporation at the principal executive offices of the Corporation not earlier than the one hundred and twentieth (I 20th) day prior to such special meeting and not later than the close of business on the later of the ninetieth (90th) day prior to such special meeting or the tenth (lOth) day following the day on which public announcement is first made of the date of the special meeting and of the nominees proposed by the Board of Directors to be elected at such meeting. In no event shall the adjournment or postponement of a special meeting commence a new time period for the giving of a stockholder's notice as described above. (c) General.
(i)
Only persons who are nominated in accordance with the procedures set forth in this Section 1.10 shall be eligible to serve as Directors and only such business shall be conducted at a meeting of stockholders as shall have been brought before the meeting in accordance with the procedures set forth in this Section 1.10. Except as otherwise provided by law, the Certificate of Incorporation or these By-Laws, the Chairman of the meeting shall have the power and duty to determine whether a nomination or any business proposed to be brought before the meeting was made in accordance with the procedures set forth in this Section 1.10 and, if any proposed nomination or business is not in compliance with this Section 1.1 0, to declare that such defective proposal or nomination shall be disregarded.
(ii)
For purposes of this Section 1.1 0, "public announcement" shall mean disclosure in a press release reported by the Dow Jones News Service, Associated Press or comparable national news service or in a document publicly filed by the Corporation with the Securities and Exchange Commission pursuant to Section 13, 14, or 15(d) of the Exchange Act.
(iii)
Notwithstanding the foregoing provisions of this Section 1.1 0, a stockholder shall also comply with all applicable requirements of the Exchange Act and the rules and regulations thereunder with respect to the matters set forth in this Section 1.10. Nothing in this Section 1.10 shall be deemed to affect any rights (A) of stockholders to request inclusion of proposals in the Corporation's proxy statement pursuant to Rule 14a-8 under the Exchange Act, or (B) of the holders of any series of Preferred Stock, if any, to elect Directors if so provided under any applicable Preferred Stock Certificate of Designations (as defmed in the Certificate oflncorporation).
(iv) Notwithstanding the foregoing provisions of this Section 1.1 0, unless otherwise required by law, if the stockholder (or a qualified representative of the stockholder) does not appear at the annual or special meeting of stockholders of the Corporation to present a nomination or proposed business, such nomination shall be disregarded and such proposed business shall not be transacted, notwithstanding that proxies in respect of such vote may have been received by the Corporation. For purposes of this Section 1.1 0, to be considered a qualified representative of the stockholder, a person must be authorized by a writing executed by such stockholder or an electronic transmission delivered by such stockholder to act for such stockholder as proxy at the meeting of stockholders and such person must produce such writing or electronic transmission, or a reliable reproduction of the writing or electronic transmission, at the meeting of stockholders. Section 1.11. List of Stockholders Entitled to Vote. The Secretary shall prepare and make, at least ten (10) days before every meeting of stockholders, a complete list of the stockholders entitled to vote at the meeting, arranged in alphabetical order, and showing the address of each stockholder and the number of shares registered in the name of each stockholder. Such list shall be open to the examination of any stockholder, for any purpose germane to the meeting at least ten (1 0) days prior to the meeting (i) on a reasonably accessible electronic network, provided that the information required to gain access to such list is provided with the notice of meeting or (ii) during ordinary business hours at the principal place of business of the Corporation. The list shall also be produced and kept at the time and place of the meeting during the whole time thereof and may be inspected by any stockholder who is present. Section 1.12. Inspectors OfElections. Preceding any meeting ofthe stockholders, the Board ofDirectors shall appoint one (1) or more persons to act as Inspectors of Elections, and may designate one (1) or more alternate
inspectors. In the event no inspector or alternate is able to act, the person presiding at the meeting shall appoint one (I) or more inspectors to act at the meeting. Each inspector, before entering upon the discharge of the duties of an inspector, shall take and sign an oath faithfully to execute the duties of inspector with strict impartiality and according to the best of his or her ability. The inspector shall: (a) ascertain the number of shares outstanding and the voting power of each; (b) determine the shares represented at a meeting and the validity of proxies and ballots; (c) specifY the information relied upon to determine the validity of electronic transmissions in accordance with Section 1.08 hereof; (d) count all votes and ballots; (e) determine and retain for a reasonable period a record of the disposition of any challenges made to any determination by the inspectors;
(f) certifY his or her determination of the number of shares represented at the meeting, and his or her count of all votes and ballots; (g) appoint or retain, in his or her discretion, other persons or entities to assist in the performance of the duties of inspector; and (h) when determining the shares represented and the validity of proxies and ballots, be limited to an examination of the proxies, any envelopes submitted with those proxies, any information provided in accordance with Section 1.08 of these By-Laws, ballots and the regular books and records of the Corporation. The inspector may consider other reliable information for the limited purpose of reconciling proxies and ballots submitted by or on behalf of banks, brokers or their nominees or a similar person which represent more votes than the holder of a proxy is authorized by the record owner to cast or more votes than the stockholder holds of record. If the inspector considers other reliable information as outlined in this section, the inspector, at the time of his or her certification pursuant to paragraph (f) of this section, shall specifY the precise information considered, the person or persons from whom the information was obtained, when this information was obtained, the means by which the information was obtained, and the basis for the inspector's belief that such information is accurate and reliable. Section l.l3. Opening And Closing Of Polls. The date and time for the opening and the closing of the polls for each matter to be voted upon at a stockholder meeting shall be announced at the meeting by the person presiding over the meeting. The inspector shall be prohibited from accepting any ballots, proxies or votes or any revocations thereof or changes thereto after the closing of the polls, unless the Delaware Court of Chancery upon application by a stockholder shall determine otherwise. ARTICLE II Board Of Directors Section 2.01. General Powers. Except as may otherwise be provided by law, the Certificate oflncorporation or these By-Laws, the property, affairs and business of the Corporation shall be managed by or under the direction of the Board of Directors and the Board of Directors may exercise all the powers of the Corporation. Section 2.02. Number Of Directors. Subject to the rights of the holders of any class or series of Preferred Stock, if any, the number of Directors shall be fixed from time to time exclusively pursuant to a resolution adopted by a majority of the entire Board of Directors; provided, however, that the Board of Directors shall at no time consist of fewer than three (3) Directors. Section 2.03. The Chairman Of The Board. The Directors shall elect from among the members of the Board a "Chairman of the Board." The Board of Directors may, by resolution, deem the Chairman ofthe Board to be an officer of the Corporation. The Chairman of the Board shall have such duties and powers as set forth in these ByLaws or as shall otherwise be conferred upon the Chairman of the Board from time to time by the Board of Directors. The Chairman of the Board may be the Chief Executive Officer of the Corporation. The Chairman of the Board shall, if present, preside over all meetings of the Stockholders and of the Board of Directors. The Board of
Directors shall by resolution establish a procedure to provide for an acting Chairman of the Board in the event the most recently elected Chairman of the Board is unable to serve or act in that capacity. Section 2.04. Regular Meetings. The meeting of the Board of Directors for the purpose of electing officers and for the transaction of such other business as may come before the meeting may be held at such places within or without the State of Delaware and at such times as the Board may from time to time determine, and if so determined notice thereof need not be given. The Board of Directors from time to time may by resolution provide for the holding of regular meetings and fix the place (which may be within or without the State of Delaware) and the date and hour of such meetings. Notice of regular meetings need not be given, provided, however, that if the Board of Directors shall fix or change the time or place of any regular meeting, notice of such action shall be mailed promptly, or sent by telephone, including a voice messaging system or other system or technology designed to record and communicate messages, telegraph, facsimile, electronic mail or other electronic means, to each Director who shall not have been present at the meeting at which such action was taken, addressed to him or her at his or her usual place of business, or shall be delivered to him or her personally. Notice of such action need not be given to any Director who attends the first regular meeting after such action is taken without protesting the lack of notice to him or her, prior to or at the commencement of such meeting, or to any Director who submits a waiver of notice, whether before or after such meeting. Section 2.05. Special Meetings; Notice. Special meetings of the Board of Directors shall be held whenever called by the Chairman of the Board, Chief Executive Officer (or, in the event of his or her absence or disability, by the President or any Executive Vice President), or by the Board of Directors pursuant to the following sentence, at such place (within or without the State of Delaware), date and hour as may be specified in the respective notices or waivers of notice of such meetings. Special meetings of the Board of Directors also may be held whenever called pursuant to a resolution approved by a majority of the entire Board of Directors. Special meetings of the Board of Directors may be called on twenty-four (24) hours' notice, if notice is given to each Director personally or by telephone, including a voice messaging system, or other system or technology designed to record and communicate messages, facsimile, electronic mail or other electronic means, or on five (5) days' notice, if notice is mailed to each Director, addressed to him or her at his or her usual place of business or to such other address as any Director may request by notice to the Secretary. Notice of any special meeting need not be given to any Director who attends such meeting without protesting the lack of notice to him or her, prior to or at the commencement of such meeting, or to any Director who submits a signed waiver of notice, whether before or after such meeting, and any business may be transacted thereat. Section 2.06. Quorum; Voting. At all meetings of the Board of Directors, the presence of a majority of the total authorized number of Directors shall constitute a quorum for the transaction of business. Except as otherwise required by law or the Certificate of Incorporation, the vote of a majority of the Directors present at any meeting at which a quorum is present shall be the act ofthe Board of Directors. Section 2.07. Adjournment. A majority of the Directors present, whether or not a quorum is present, may adjourn any meeting of the Board of Directors to another time or place. No notice need be given of any adjourned meeting unless the time and place of the adjourned meeting are not announced at the time of adjournment, in which case notice conforming to the requirements of Section 2.04 of these By-Laws shall be given to each Director. Section 2.08. Action Without A Meeting. Any action required or permitted to be taken at any meeting of the Board of Directors may be taken without a meeting if all members of the Board of Directors consent thereto in writing or by electronic transmission, and such writing, writings or electronic transmission or transmissions are filed with the minutes of proceedings of the Board of Directors in accordance with applicable law. Section 2.09. Regulations; Manner Of Acting. To the extent consistent with applicable law, the Certificate of Incorporation and these By-Laws, the Board of Directors may adopt by resolution such rules and regulations for the conduct of meetings of the Board of Directors and for the management of the property, affairs and business of the Corporation as the Board of Directors may deem appropriate. The Directors shall act only as a Board of Directors and the individual Directors shall have no power in their individual capacities unless expressly authorized by the Board of Directors. Section 2.10. Action By Telephonic Communications. Members of the Board of Directors may participate in a meeting of the Board of Directors by means of conference telephone or other communications equipment by means
of which all persons participating in the meeting can hear each other, and participation in a meeting pursuant to this provision shall constitute presence in person at such meeting. Section 2.11. Resignations. Any Director may resign at any time by submitting an electronic transmission or by delivering a written notice of resignation, signed by such Director, to the Chairman of the Board or the Secretary. Unless otherwise specified therein, such resignation shall take effect upon delivery. Section 2.12. Removal Of Directors. Subject to the rights of the holders of any class or series of Preferred Stock, if any, to elect additional Directors under specified circumstances, any Director may be removed at any time, with or without cause, upon the affmnative vote of the holders of a majority of the combined voting power of the then outstanding stock of the Corporation entitled to vote generally in the election of Directors. Any vacancy in the Board of Directors caused by any such removal shall be filled in the manner provided in the Certificate of Incorporation. Section 2.13. Reelection; Resignation. In the event an incumbent director running for reelection in an uncontested election fails to receive the required vote as set forth in Section 1.05 of these By-Laws and has submitted a letter of resignation to the Board of Directors, the effectiveness of which is conditioned on such failure and the acceptance of such resignation by the Board of Directors, then the Board of Directors shall designate a committee of non-management Directors to make a recommendation to the Board of Directors as to whether to accept or reject the resignation, or whether other action should be taken. The Board of Directors shall consider the committee's recommendation and publicly disclose its decision whether to accept or reject the resignation and its rationale within 120 days following the date of the certification of the election results. The Director whose resignation is at issue shall not be a member of such committee or participate in the Board's decision with respect to his or her resignation. Section 2.14. Compensation. The amount, if any, which each Director shall be entitled to receive as compensation for such Director's services as such shall be fixed from time to time by resolution of the Board of Directors. Nothing herein contained shall be construed to preclude any director from serving the Corporation in any other capacity as an officer, agent or otherwise, and receiving compensation therefore. Section 2.15. Reliance On Accounts And Reports, Etc. A Director, or a member of any committee designated by the Board of Directors shall, in the performance of such Director's or member's duties, be fully protected in relying in good faith upon the records of the Corporation and upon information, opinions, reports or statements presented to the Corporation by any of the Corporation's officers or employees, or committees designated by the Board of Directors, or by any other person as to the matters the Director or the member reasonably believes are within such other person's professional or expert competence and who the Director or member reasonably believes or determines has been selected with reasonable care by or on behalf of the Corporation. ARTICLE III Committees Section 3.0 1. Committees. The Board of Directors may designate from among its members one (1) or more committees of the Board of Directors, each committee to consist of such number of Directors as from time to time may be fixed by the Board of Directors. Any such committee shall serve at the pleasure of the Board of Directors. Each such committee shall have the powers and duties delegated to it by the Board of Directors, subject to the limitations set forth in applicable Delaware law. The Board of Directors may appoint a Chairman of any committee, who shall preside at meetings of any such committee. The Board of Directors may elect one or more of its members as alternate members of any such committee who may take the place of any absent member or members at any meeting of such committee, upon request of the Chairman of the Board or the Chairman of such committee. Section 3.02. Powers. Each committee shall have and may exercise such powers of the Board of Directors as may be provided by resolution or resolutions of the Board of Directors. No committee shall have the power or authority: to approve or adopt, or recommend to the stockholders, any action or matter expressly required by the Delaware General Corporation Law to be submitted to the stockholders for approval; or to adopt, amend or repeal the By-Laws of the Corporation.
Section 3.03. Proceedings. Each such committee may fix its own rules of procedure and may meet at such place (within or without the State of Delaware), at such time and upon such notice, if any, as it shall determine from time to time. Each such committee shall keep minutes of its proceedings and shall report such proceedings to the Board of Directors at the meeting of the Board of Directors next following any such proceedings. Section 3.04. Quorum and Manner of Acting. Except as may be otherwise provided in the resolution creating such committee, at all meetings of any committee, the presence of members (or alternate members) constituting a majority of the total authorized membership of such committee shall constitute a quorum for the transaction of business. The act of the majority of the members present at any meeting at which a quorum is present shall be the act of such committee. Any action required or permitted to be taken at any meeting of any such committee may be taken without a meeting, if all members of such committee shall consent to such action in writing or by electronic transmission and such writing, writings or electronic transmission or transmissions are filed with the minutes of the proceedings of the committee in accordance with applicable law. The members of any such committee shall act only as a committee, and the individual members of such committee shall have no power in their individual capacities unless expressly authorized by the Board of Directors. Section 3.05. Action by Telephonic Communications. Unless otherwise provided by the Board of Directors, members of any committee may participate in a meeting of such committee by means of conference telephone or other communications equipment by means of which all persons participating in the meeting can hear each other, and participation in a meeting pursuant to this provision shall constitute presence in person at such meeting. Section 3.06. Resignations. Any member (and any alternate member) of any committee may resign at any time by delivering a written notice of resignation, signed by such member, to the Board of Directors or the Chairman of the Board. Unless otherwise specified therein, such resignation shall take effect upon delivery. Section 3.07. Removal. Any member (and any alternate member) of any committee may be removed at any time, either for or without cause, by the Board of Directors. Section 3.08. Vacancies. If any vacancy shall occur in any committee, by reason of disqualification, death, resignation, removal or otherwise, the remaining members (and any alternate members) shall continue to act, and any such vacancy may be filled by the Board of Directors. ARTICLE IV Officers Section 4.0 1. Chief Executive Officer. The Board of Directors shall select a Chief Executive Officer to serve at the pleasure of the Board of Directors who shall (a) supervise the carrying out of policies adopted or approved by the Board of Directors, (b) exercise a general supervision and superintendence over all the business and affairs of the Corporation, and (c) possess such other powers and perform such other duties as may be assigned to him or her by these By-Laws, as may from time to time be assigned by the Board of Directors and as may be incident to the office of Chief Executive Officer. Section 4.02. Secretary Of The Corporation. The Board of Directors shall appoint a Secretary of the Corporation to serve at the pleasure of the Board of Directors. The Secretary of the Corporation shall (a) keep minutes of all meetings of the stockholders and of the Board of Directors, (b) authenticate records of the Corporation and (c) in general, have such powers and perform such other duties as may be assigned to him or her by these ByLaws, as may from time to time be assigned to him or her by the Board of Directors or the Chief Executive Officer and as may be incident to the office of Secretary of the Corporation. Section 4.03. Other Officers Elected By Board Of Directors. At any meeting of the Board of Directors, the Board of Directors may elect a President, Vice Presidents, a Chief Financial Officer, a Treasurer, Assistant Treasurers, Assistant Secretaries, or such other officers of the Corporation as the Board of Directors may deem necessary, to serve at the pleasure of the Board of Directors. Other officers elected by the Board of Directors shall have such powers and perform such duties as may be assigned to such officers by or pursuant to authorization of the Board of Directors or by the Chief Executive Officer.
Section 4.04. Other Officers. The Board of Directors may authorize the Corporation to elect or appoint other officers, including Vice Presidents, Assistant Treasurers, Assistant Secretaries and other officers of the Corporation, each of whom shall serve at the pleasure of the Corporation. Officers elected or appointed by the Corporation shall have such powers and perform such duties as may be assigned to them by the Corporation. Section 4.05. Removal And Resignation; Vacancies. Any officer may be removed for or without cause at any time by the Board of Directors. Any officer may resign at any time by delivering a written notice of resignation, signed by such officer, to the Board of Directors, the Chief Executive Officer or the Secretary. Unless otherwise specified therein, such resignation shall take effect upon delivery. Any vacancy occurring in any office of the Corporation by death, resignation, removal or otherwise shall be filled by or pursuant to authorization of the Board of Directors. Section 4.06. Authority And Duties Of Officers. The officers of the Corporation shall have such authority and shall exercise such powers and perform such duties as may be specified in these By-Laws, except that in any event each officer shall exercise such powers and perform such duties as may be required by law. ARTICLE V Capital Stock Section 5.01. Certificates Of Stock, Uncertificated Shares. Any or all classes and series of shares of the Corporation, or any part thereof, may be represented by uncertificated shares to the extent determined by the Board of Directors, except that shares represented by a certificate that is issued and outstanding shall continue to be represented thereby until the certificate is surrendered to the Corporation. Within a reasonable time after the issuance of uncertificated shares, the Corporation shall send to the registered owner thereof a written notice containing the information required to be set forth or stated on certificates pursuant to Delaware General Corporation Law. The rights and obligations of the holders of shares represented by certificates and the rights and obligations of the holders ofuncertificated shares of the same class and series shall be identical. Section 5.02. Signatures; Facsimile. All signatures on the certificate referred to in Section 5.01 of these ByLaws may be in facsimile, engraved or printed form, to the extent permitted by law. In case any officer, transfer agent or registrar who has signed, or whose facsimile, engraved or printed signature has been placed upon a certificate, shall have ceased to be such officer, transfer agent or registrar before such certificate is issued, it may be issued by the Corporation with the same effect as if he or she were such officer, transfer agent or registrar at the date of issue. Section 5.03. Lost, Stolen Or Destroyed Certificates. The Board of Directors may direct that a new certificate be issued in place of any certificate theretofore issued by the Corporation alleged to have been lost, stolen or destroyed, upon delivery to the Corporation of an affidavit of the owner or owners of such certificate, setting forth such allegation. The Corporation may require the owner of such lost, stolen or destroyed certificate, or his or her legal representative, to give the Corporation a bond sufficient to indemnify it against any claim that may be made against it on account of the alleged loss, theft or destruction of any such certificate or the issuance of any such new certificate. Section 5.04. Transfer Of Stock. Upon surrender to the Corporation or the transfer agent of the Corporation of a certificate for shares, duly endorsed or accompanied by appropriate evidence of succession, assignment or authority to transfer, the Corporation shall cancel the old certificate and record the transaction upon its books. Within a reasonable time after the transfer ofuncertificated stock, the Corporation shall send to the registered owner thereof a written notice containing the information required to be set forth or stated on certificates pursuant to the Delaware General Corporation Law. Subject to the provisions of the Certificate oflncorporation and these By-Laws, the Board of Directors may prescribe such additional rules and regulations as it may deem appropriate relating to the issue, transfer and registration of shares of the Corporation. Section 5.05. Record Date. In order to determine the stockholders entitled to notice of or to vote at any meeting of stockholders or any adjournment thereof, the Board of Directors may fix, in advance, a record date, which record date shall not precede the date on which the resolution fixing the record date is adopted by the Board of Directors, and which shall not be more than sixty (60) nor fewer than ten (10) days before the date of such
meeting. A determination of stockholders of record entitled to notice of or to vote at a meeting of stockholders shall apply to any adjournment of the meeting, provided, however, that the Board of Directors may fix a new record date for the adjourned meeting. In order that the Corporation may determine the stockholders entitled to receive payment of any dividend or other distribution or allotment of any rights of the stockholders entitled to exercise any rights in respect of any change, conversion or exchange of stock, or for the purpose of any other lawful action, the Board of Directors may fix a record date, which record date shall not precede the date upon which the resolution fixing the record date is adopted, and which record date shall be not more than sixty (60) days prior to such action. If no record date is fixed, the record date for determining stockholders for any such purpose shall be at the close of business on the day on which the Board of Directors adopts the resolution relating thereto. Section 5.06. Registered Stockholders. Prior to due surrender of a certificate for registration of transfer, the Corporation may treat the registered owner as the person exclusively entitled to receive dividends and other distributions, to vote, to receive notice and otherwise to exercise all the rights and powers of the owner of the shares represented by such certificate, and the Corporation shall not be bound to recognize any equitable or legal claim to or interest in such shares on the part of any other person, whether or not the Corporation shall have notice of such claim or interests. Whenever any transfer of shares shall be made for collateral security, and not absolutely, it shall be so expressed in the entry of the transfer if, when the certificates are presented to the Corporation for transfer or uncertificated shares are requested to be transferred, both the transferor and transferee request the Corporation to do so. Section 5.07. Transfer Agent And Registrar. The Board of Directors may appoint one (1) or more transfer agents and one ( 1) or more registrars, and may require all certificates representing shares to bear the signature of any such transfer agents or registrars. ARTICLE VI Indemnification Section 6.01. Nature Oflndemnity. The Corporation shall, to the fullest extent permitted by law as it presently exists and may hereafter be amended, indemnifY any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding (a "Proceeding"), whether civil, criminal, administrative or investigative, by reason of the fact that he or she (or a person for whom he or she is the legal representative) is or was a Director or officer of the Corporation, or, while a Director or officer of the Corporation, is or was serving at the request of the Corporation as a Director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, or by reason of any action alleged to have been taken or omitted in such capacity, and may indemnifY any person who was or is a party or is threatened to be made a party to such a Proceeding by reason of the fact that he or she is or was an employee or agent of the Corporation, against expenses (including attorneys' fees), judgments, fines and amounts paid in settlement actually and reasonably incurred by him or her or on his or her behalf in connection with such Proceeding and any appeal therefrom, if he or she acted in good faith and in a manner he or she reasonably believed to be in or not opposed to the best interests of the Corporation, and, with respect to any criminal Proceeding, had no reasonable cause to believe his or her conduct was unlawful; except that in the case of a Proceeding by or in the right of the Corporation to procure a judgment in its favor (1) such indemnification shall be limited to expenses (including attorneys' fees) actually and reasonably incurred by such person in the defense or settlement of such Proceeding, and (2) no indemnification shall be made in respect of any claim, issue or matter as to which such person shall have been adjudged to be liable to the Corporation unless and only to the extent that the Delaware Court of Chancery or the court in which such Proceeding was brought shall determine upon application that, despite the adjudication of liability but in view of all the circumstances of the case, such person is fairly and reasonably entitled to indemnity for such expenses which the Delaware Court of Chancery or such other court shall deem proper. Notwithstanding the foregoing, but subject to Section 6.05 of these By-Laws, the Corporation shall not be obligated to indemnifY a Director or officer of the Corporation in respect of a Proceeding (or part thereof) instituted by such Director or officer, unless such Proceeding (or part thereof) has been authorized in the specific case by the Board of Directors. The termination of any Proceeding by judgment, order settlement, conviction, or upon a plea of nolo contendere or its equivalent, shall not, of itself, create a presumption that the person did not act in good faith and in a manner which he or she reasonably believed to be in or not opposed to the best interests of the Corporation, and, with respect to any criminal Proceeding, had reasonable cause to believe that his or her conduct was unlawful.
Section 6.02. Successful Defense. To the extent that a present or former Director or officer of the Corporation has been successful on the merits or otherwise in defense of any Proceeding referred to in Section 6.01 hereof or in defense of any claim, issue or matter therein, such person shall be indemnified against expenses (including attorneys' fees) actually and reasonably incurred by such person in connection therewith. Section 6.03. Determination That Indemnification Is Proper. Any indemnification of a present or former Director or officer of the Corporation under Section 6.01 hereof (unless ordered by a court) shall be made by the Corporation unless a determination is made that indemnification of the present or former Director or officer is not proper in the circumstances because he or she has not met the applicable standard of conduct set forth in Section 6.01 hereof. Any indemnification of a present or former employee or agent of the Corporation under Section 6.01 hereof (unless ordered by a court) may be made by the Corporation upon a determination that indemnification of the present or former employee or agent is proper in the circumstances because he or she has met the applicable standard of conduct set forth in Section 6.01 hereof. Any such determination shall be made, with respect to a person who is a Director or officer at the time of such determination, ( 1) by a majority vote of the Directors who are not parties to such Proceeding, even though less than a quorum, or (2) by a committee of such Directors designated by majority vote of such Directors, even though less than a quorum, or (3) ifthere are no such Directors, or if such Directors so direct, by independent legal counsel in a written opinion, or (4) by the stockholders. Section 6.04. Advance Payment Of Expenses. To the fullest extent not prohibited by law, expenses (including attorneys' fees) incurred by a current or former Director or officer in defending any civil, criminal, administrative or investigative Proceeding shall be paid by the Corporation in advance of the fmal disposition of such Proceeding; provided, however, that such advancement of expenses shall, to the extent required by law, be made only upon receipt of an undertaking by or on behalf of such Director or officer to repay such amount if it shall ultimately be determined that such person is not entitled to be indemnified by the Corporation as authorized in this Article. Section 6.05. Procedure For Indemnification Of Directors And Officers. Any indemnification of a Director or officer of the Corporation under Sections 6.01 and 6.02, or advance of costs, charges and expenses to a Director or officer under Section 6.04 of these By-Laws, shall be made promptly, and in any event within thirty (30) days, upon the written request of the Director or officer. If a determination by the Corporation that the Director or officer is entitled to indemnification pursuant to this Article VI is required, and the Corporation fails to respond within thirty (30) days to a written request for indemnity, the Corporation shall be deemed to have approved such request. Ifthe Corporation denies a written request for indemnity or advancement of expenses, in whole or in part, or if payment in full pursuant to such request is not made within thirty (30) days, the right to indemnification or advances as granted by this Article VI shall be enforceable by the Director or officer in any court of competent jurisdiction. Such person's costs and expenses incurred in connection with successfully establishing his or her right to indemnification or advancement, in whole or in part, in any such Proceeding shall also be indemnified by the Corporation. It shall be a defense to any such Proceeding (other than an action brought to enforce a claim for. the advance of costs, charges and expenses under Section 6.04 of these By-Laws where the required undertaking, if any, has been received by the Corporation) that the claimant has not met the standard of conduct set forth in Section 6.01 of these By-Laws, but the burden of proving such defense shall be on the Corporation. Neither the failure of the Corporation (including its Board of Directors, its independent legal counsel, and its stockholders) to have made a determination prior to the commencement of such action that indemnification of the claimant is proper in the circumstances because he or she has met the applicable standard of conduct set forth in Section 6.01 of these By-Laws, nor the fact that there has been an actual determination by the Corporation (including its Board of Directors, its independent legal counsel, and its stockholders) that the claimant has not met such applicable standard of conduct, shall be a defense to the action or create a presumption that the claimant has not met the applicable standard of conduct. Section 6.06. Survival; Preservation Of Other Rights. The foregoing indemnification provisions shall be deemed to be a contract between the Corporation and each Director, officer, employee and agent who serves in any such capacity at any time while these provisions as well as the relevant provisions of the Delaware General Corporation Law are in effect and any repeal or modification thereof shall not affect any right or obligation then existing with respect to any state of facts then or previously existing or any Proceeding previously or thereafter brought or threatened based in whole or in part upon any such state of facts. Such a "contract right" may not be modified retroactively without the consent of such Director, officer, employee or agent. The indemnification provided by this Article VI shall not be deemed exclusive of any other rights to which those indemnified may be entitled under any By-Law, agreement, vote of stockholders or disinterested Directors or otherwise, both as to action
in such person's official capacity and as to action in another capacity while holding such office, and shall continue as to a person who has ceased to be a Director, officer, employee or agent and shall inure to the benefit of the heirs, executors and administrators of such a person. Section 6.07. Insurance. The Corporation may purchase and maintain insurance on behalf of any person who is or was or has agreed to become a Director, officer, employee or agent of the Corporation, or is or was serving at the request of the Corporation as a Director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise against any liability asserted against such person and incurred by such person or on such person's behalf in any such capacity, or arising out of such person's status as such, whether or not the Corporation would have the power to indemnify him or her against such liability under the provisions of this Article VI. Section 6.08. Severability. If this Article VI or any portion hereof shall be invalidated on any ground by any court of competent jurisdiction, then the Corporation shall nevertheless indemnify each Director or officer and may indemnify each employee or agent of the Corporation as to costs, charges and expenses (including attorneys' fees), judgments, fines and amounts paid in settlement with respect to a Proceeding, whether civil, criminal, administrative or investigative, including a Proceeding by or in the right of the Corporation, to the fullest extent permitted by any applicable portion of this Article VI that shall not have been invalidated and to the fullest extent permitted by applicable law. ARTICLE VII Offices Section 7.01. Initial Registered Office. The registered office of the Corporation in the State of Delaware shall be located at [Corporation Trust Center, 1209 Orange Street,] in the City of [Wilmington, County of New Castle, 19801]. Section 7.02. Other Offices. The Corporation may maintain offices or places of business at such other locations within or without the State of Delaware as the Board of Directors may from time to time determine or as the business of the Corporation may require. ARTICLE VIII General Provisions Section 8.01. Dividends. Subject to any applicable provisions oflaw and the Certificate oflncorporation, dividends upon the shares of the Corporation may be declared by the Board of Directors at any regular or special meeting of the Board of Directors and any such dividend may be paid in cash, property, or shares of the Corporation's capital stock. A member of the Board of Directors, or a member of any committee designated by the Board of Directors shall be fully protected in relying in good faith upon the records of the Corporation and upon such information, opinions, reports or statements presented to the Corporation by any of its officers or employees, or committees of the Board of Directors, or by any other person as to matters the Director reasonably believes are within such other person's professional or expert competence and who has been selected with reasonable care by or on behalf of the Corporation, as to the value and amount of the assets, liabilities and/or net profits ofthe Corporation, or any other facts pertinent to the existence and amount of surplus or other funds from which dividends might properly be declared and paid. Section 8.02. Execution Of Instruments. The Board of Directors may authorize, or provide for the authorization of, officers, employees or agents to enter into any contract or execute and deliver any instrument in the name and on behalf of the Corporation. Any such authorization must be in writing or by electronic transmission and may be general or limited to specific contracts or instruments. Section 8.03. Voting As Stockholder. Unless otherwise determined by resolution of the Board of Directors, the Chief Executive Officer, the President, any Executive Vice President or any Senior Vice President shall have full power and authority on behalf of the Corporation to attend any meeting of stockholders of any entity in which the Corporation may hold securities, and to act, vote (or execute proxies to vote) and exercise in person or by proxy all
other rights, powers and privileges incident to the ownership of such securities. Such officers acting on behalf of the Corporation shall have full power and authority to execute any instrument expressing consent to or dissent from any action of any such entity without a meeting. The Board of Directors may by resolution from time to time confer such power and authority upon any other person or persons. ARTICLE IX Amendment Of By-Laws These By-Laws may be amended, altered or repealed by resolution adopted (i) by a majority of the Board of Directors at any special or regular meeting of the Board of Directors if, in the case of such special meeting only, notice of such amendment, alteration or repeal is contained in the notice or waiver of notice of such meeting or (ii) at any regular or special meeting of the stockholders upon the affirmative vote of the holders of three-fourths (3/4) or more of the combined voting power of the outstanding shares of the Corporation entitled to vote generally in the election of Directors if, in the case of such special meeting only, notice of such amendment, alteration or repeal is contained in the notice or waiver of notice of such meeting. ARTICLE X Construction In the event of any conflict between the provisions of these By-Laws as in effect from time to time and the provisions of the Certificate of Incorporation of the Corporation as in effect from time to time, the provisions of such Certificate of Incorporation shall be controlling.
Tab 27
UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549
FORM 10-Q (Mark One) ☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2015 or ☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from
to
.
Commission File Number: 001-33380
PHARMERICA CORPORATION (Exact name of registrant as specified in its charter) Delaware 87-0792558 (State or Other Jurisdiction of Incorporation or Organization) (I.R.S. Employer Identification No.) 1901 Campus Place Louisville, KY (Address of Principal Executive Offices)
40299 (Zip Code)
(502) 627-7000 (Registrant's Telephone Number, Including Area Code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. ☒ Yes ☐ No Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). ☒ Yes ☐ No Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. Large accelerated filer ☒
Accelerated filer☐
Non-accelerated filer ☐ (Do not check if a smaller reporting company)
Smaller reporting company ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ☐ Yes ☒ No Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Class of Common Stock Common stock, $0.01 par value
Outstanding at October 30, 2015 30,454,732 shares
PHARMERICA CORPORATION FORM 10-Q TABLE OF CONTENTS Page PART I. FINANCIAL INFORMATION Item 1.
Financial Statements (Unaudited) Condensed Consolidated Statements of Operations - For the Three and Nine Months Ended September 30, 2014 and 2015
3
Condensed Consolidated Balance Sheets - As of December 31, 2014 (As Adjusted) and September 30, 2015
4
Condensed Consolidated Statements of Cash Flows - For the Three and Nine Months Ended September 30, 2014 and 2015
5
Condensed Consolidated Statement of Stockholders' Equity - For the Nine Months Ended September 30, 2015
6
Notes to Condensed Consolidated Financial Statements
7
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
19
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
35
Item 4.
Controls and Procedures
35
PART II. OTHER INFORMATION
36
Item 1.
Legal Proceedings
36
Item 1A
Risk Factors
36
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
36
Item 4.
Mine Safety Disclosures
36
Item 6.
Exhibits
37
SIGNATURES
38
Exhibit Index
39 2
PHARMERICA CORPORATION CONDENSED CONSOLIDATED INCOME STATEMENTS For the Three and Nine Months Ended September 30, 2014 and 2015 (Unaudited) (In millions, except share and per share amounts)
Revenues Cost of goods sold Gross profit Selling, general and administrative expenses Amortization expense Merger, acquisition, integration costs and other charges Settlement, litigation and other related charges Restructuring and impairment charges Hurricane Sandy disaster costs Operating income Interest expense, net Loss on extinguishment of debt Income before income taxes Provision for income taxes Net income
Three Months Ended September 30, 2014 2015 $ 470.2 $ 498.8 387.2 420.2 83.0 78.6 56.0 52.7 4.9 7.0 3.8 8.0 1.1 2.1 0.1 0.2 0.1 17.1 8.5 2.1 2.1 4.3 10.7 6.4 2.2 3.4 $ 8.5 $ 3.0
Nine Months Ended September 30, 2014 2015 $ 1,371.0 $ 1,507.8 1,126.1 1,259.4 244.9 248.4 171.1 167.1 13.6 20.6 10.3 15.2 28.9 11.3 3.2 0.3 0.1 0.1 17.7 33.8 6.9 5.4 4.3 6.5 28.4 2.9 13.5 $ 3.6 $ 14.9
Earnings per common share: Basic Diluted
$ $
$ $
Shares used in computing earnings per common share: Basic Diluted
0.28 0.28 30,073,133 30,595,302
$ $
0.10 0.10 30,431,845 30,896,294
See accompanying Notes to Condensed Consolidated Financial Statements 3
0.12 0.12 29,944,875 30,502,928
$ $
0.49 0.48 30,336,548 30,798,834
PHARMERICA CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS As of December 31, 2014 and September 30, 2015 (Unaudited) (In millions, except share and per share amounts) (As Adjusted) December 31, 2014
September 30, 2015
ASSETS Current assets: Cash and cash equivalents Accounts receivable, net Inventory Deferred tax assets, net Income taxes receivable Prepaids and other assets
$
Equipment and leasehold improvements Accumulated depreciation
33.3 195.4 135.5 42.8 90.3 497.3
$
196.4 (125.0) 71.4
Goodwill Intangible assets, net Other $
323.6 177.6 4.1 1,074.0
40.0 195.8 117.5 37.2 9.2 52.6 452.3 210.3 (138.8) 71.5
$
341.8 165.2 29.2 1,060.0
LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable Salaries, wages and other compensation Current portion of long-term debt Income taxes payable Other accrued liabilities
$
Long-term debt Other long-term liabilities Deferred tax liabilities Commitments and contingencies (See Note 5) Stockholders' equity: Preferred stock, $0.01 par value per share; 1,000,000 shares authorized and no shares issued, December 31, 2014 and September 30, 2015 Common stock, $0.01 par value per share; 175,000,000 shares authorized; 32,725,786 and 33,227,551 shares issued as of December 31, 2014 and September 30, 2015, respectively Capital in excess of par value Retained earnings Treasury stock at cost, 2,617,305 and 2,774,268 shares at December 31, 2014 and September 30, 2015, respectively $ See accompanying Notes to Condensed Consolidated Financial Statements 4
96.0 35.1 6.3 2.3 38.5 178.2
$
83.3 34.3 11.4 38.2 167.2
344.4 57.6 15.7
326.0 55.7 14.2
-
-
0.3 394.1 117.0 (33.3) 478.1 1,074.0 $
0.3 402.3 131.9 (37.6) 496.9 1,060.0
PHARMERICA CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS For the Three and Nine Months Ended September 30, 2014 and 2015 (Unaudited) (In millions) Three Months Ended September 30, 2014 2015 Cash flows provided by (used in) operating activities: Net income Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation Amortization Merger, acquisition, integration costs and other charges Stock-based compensation and deferred compensation Amortization of deferred financing fees Deferred income taxes (Gain) Loss on disposition of equipment Loss (Gain) on acquisition/disposition Loss on debt extinguishment Other Change in operating assets and liabilities: Accounts receivable, net Inventory Prepaids and other assets Accounts payable Salaries, wages and other compensation Other accrued and long-term liabilities Change in income taxes payable (receivable) Excess tax benefit from stock-based compensation Net cash provided by (used in) operating activities
$
8.5
$
Nine Months Ended September 30, 2014 2015 3.0
$
3.6
$
14.9
4.9 4.9 1.8 0.5 (4.0) 0.1 4.3 -
5.7 7.0 1.7 0.1 2.1 -
14.5 13.6 2.5 5.7 1.8 (3.3) (0.1) (0.2) 4.3 0.1
17.2 20.6 5.4 0.4 4.6 0.1 0.1
(1.7) 14.9 (15.1) (2.4) 5.2 (5.7) 3.7 (0.2) 19.7
3.4 17.5 (7.7) 3.6 2.1 0.2 (1.0) (0.2) 37.5
10.4 (16.3) (26.2) (22.9) (2.7) 16.6 (0.4) (3.4) (2.4)
1.2 18.1 12.3 (11.9) (0.9) (10.2) (10.0) (2.3) 59.6
Cash flows provided by (used in) investing activities: Purchase of equipment and leasehold improvements Acquisitions, net of cash acquired Cash proceeds from the sale of assets Cash proceeds from dispositions Net cash used in investing activities
(6.2) (107.2) (113.4)
(6.6) (0.3) 0.1 (6.8)
(19.0) (124.8) 0.1 0.4 (143.3)
(17.6) (20.9) 0.2 (38.3)
Cash flows provided by (used in) financing activities: Repayments of long-term debt Borrowing of long-term debt Net activity of long-term revolving credit facility Payment of debt issuance costs Issuance of common stock Purchase of treasury stock Excess tax benefit from stock-based compensation Repayments of capital lease obligations Net cash provided by (used in) financing activities
(225.0) 225.0 92.0 (2.7) 0.4 (0.2) 0.2 89.7
(2.8) (9.0) (0.4) 0.2 (12.0)
(231.3) 225.0 135.9 (2.7) 3.4 (5.1) 3.4 128.6
(2.8) (10.0) 0.7 (4.3) 2.3 (0.5) (14.6)
18.7 21.3
(17.1) 24.2
6.7 33.3
Change in cash and cash equivalents Cash and cash equivalents at beginning of period
(4.0) 11.1
Cash and cash equivalents at end of period
$
7.1
$
40.0
$
7.1
$
40.0
Supplemental information: Cash paid for interest Cash paid for taxes
$ $
1.9 1.0
$ $
3.2 2.4
$ $
5.6 5.7
$ $
6.2 19.4
See accompanying Notes to Condensed Consolidated Financial Statements 5
PHARMERICA CORPORATION CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY For the Nine Months Ended September 30, 2015 (Unaudited) (In millions, except share amounts)
Balance at December 31, 2014 Net income Exercise of stock options and tax components of stock-based awards, net Vested restricted stock units Vested performance stock units Treasury stock at cost Stock-based compensation - non-vested restricted stock Stock-based compensation - stock options Balance at September 30, 2015
Common Stock Shares Amount 30,108,481 $ 0.3 139,133 219,625 143,007 (156,963) 30,453,283
$
Capital in Excess of Par Value $ 394.1
Retained Earnings $ 117.0 14.9
-
2.8 -
-
0.3
5.3 0.1 402.3
131.9
$
$
See accompanying Notes to Condensed Consolidated Financial Statements 6
Treasury Stock $ (33.3) $ (4.3)
$
(37.6) $
Total 478.1 14.9 2.8 (4.3) 5.3 0.1 496.9
PHARMERICA CORPORATION 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 leading provider of pharmacy services. The Corporation serves the long-term care, hospital pharmacy management services, specialty home infusion and specialty oncology pharmacy markets. The Corporation operates 94 institutional pharmacies, 15 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. 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. 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, 2014, included in the Corporation's Annual Report on Form 10-K. The balance sheet as of December 31, 2014 has been derived from the audited consolidated financial statements adjusted for acquisition related measurement period adjustments. 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, the valuation of long-lived assets and goodwill, and accounting for income taxes. 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.
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). 7
PHARMERICA CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (Unaudited) NOTE 1—ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) The financial liabilities recorded at fair value at December 31, 2014 and September 30, 2015 are set forth in the tables below (dollars in millions):
As of December 31, 2014 Financial Liability Deferred Compensation Plan Contingent Consideration Mandatorily Redeemable Interest
As of September 30, 2015 Financial Liability Deferred Compensation Plan Contingent Considerations Mandatorily Redeemable Interest
Liability $
Level 1 (8.0) $ (1.1) (8.3)
Liability $
Level 2 -
$
Level 1 (7.9) $ (9.0) (7.0)
(8.0) $ Level 2
-
$
Valuation Technique
Level 3 (1.1) (8.3)
Valuation Technique
Level 3 (7.9) $ -
A C C
(9.0) (7.0)
A C C
The deferred compensation plan liability represents an unfunded 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 the Corporation's acquisition of an institutional pharmacy business purchased in 2013 and two infusion businesses purchased in 2014 and 2015. 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 current and other 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"), purchased on December 6, 2013. 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's fair value of the liability at September 30, 2015. For the year ended December 31, 2014 and the nine months ended September 30, 2015, 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 consideration and mandatorily redeemable interest identified as Level 3 for the year ended December 31, 2014 and the nine months ended September 30, 2015 (in millions): Contingent Consideration Beginning balance, December 31, 2013 Additions from business acquisitions Change in fair value Balance, December 31, 2014 Additions from business acquisitions Change in fair value Balance, September 30, 2015
$
$
0.7 $ 1.1 (0.7) 1.1 7.9 9.0 $
Mandatorily Redeemable Interest 8.2 0.1 8.3 (1.3) 7.0
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 carrying amount of the Corporation's debt approximates fair value due to the interest being set at variable market interest rates (Level 2). 8
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 a 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 aging accounts receivable. This review is focused primarily on trends in private and other payers, PDP's, 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 institutional 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): (As Adjusted) December 31, 2014 $ 153.2 30.5 30.6 24.5 11.7 3.0 (58.1) $ 195.4
Institutional healthcare providers Medicare Part D Private payer and other Insured Medicaid Medicare Allowance for doubtful accounts
0 to 60 days 61 to 120 days Over 120 days
September 30, 2015 $ 157.3 27.4 30.2 25.4 10.0 3.2 (57.7) $ 195.8
58.8% 17.2% 24.0% 100.0%
58.9% 15.2% 25.9% 100.0%
The following is a summary of activity in the Corporation's allowance for doubtful accounts (dollars in millions): Beginning Balance Allowance for doubtful accounts: Year ended December 31, 2014 Nine months ended September 30, 2015
$ $
56.7 58.1
Charges to Costs and Expenses $ $
23.2 9.5
Write-offs $ $
Ending Balance
(21.8) $ (9.9) $
58.1 57.7
Goodwill and Other Intangibles The Corporation's policy is to perform a quantitative assessment of its institutional pharmacy and specialty infusion reporting units to determine whether it is more likely than not (defined as having a likelihood of more than 50 percent) that the fair value of a reporting unit is less than its carrying amount. The Corporation performed a quantitative assessment as of December 31, 2014. The fair values of the institutional pharmacy and specialty infusion reporting units as calculated for the analysis were approximately 48.2% and 13.1%, respectively, greater than book value as of December 31, 2014. The Corporation also performed a qualitative assessment of its specialty oncology reporting unit as of December 31, 2014 and did not find it necessary to perform the first step of the two-step impairment test based on that analysis. There were no impairment triggering events during the nine months ended September 30, 2015. The Corporation's finite-lived intangible assets are comprised primarily of trade names, customer relationship assets, limited distributor relationships, doctor and insurer relationships and non-compete agreements. Finite-lived intangible assets are amortized on a straight-line basis over the course of their lives ranging from 5 to 20 years. For impairment reviews, intangible assets are reviewed on a specific pharmacy basis or as a group of pharmacies depending on the intangible assets under review. The Corporation's goodwill and intangible assets are further described in Note 3. Restructuring and Impairment Charges Restructuring and impairment charges in the condensed consolidated financial statements represent amounts expensed for purposes of realigning corporate and pharmacy locations.
9
PHARMERICA CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (Unaudited) NOTE 1—ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Mandatorily Redeemable Interest The Corporation acquired 37.5% of the membership interests of Onco while also obtaining control of the business. The subsidiary is consolidated in the Corporation's condensed consolidated financial statements and the mandatorily redeemable interest is classified as debt within other long-term liabilities in the condensed consolidated balance sheets. Measurement Period Adjustments For the nine months ended September 30, 2015, the Corporation has adjusted certain amounts on the condensed consolidated balance sheet as of December 31, 2014 as a result of measurement period adjustments related to acquisitions completed in the prior year (See Note 2). NOTE 2—ACQUISITIONS 2015 Acquisition The Corporation through its wholly owned subsidiary, Amerita, acquired Coastal Pharmaceutical Services Corporation ("InfusionRx Acquisition") on January 28, 2015. The InfusionRx Acquisition had an estimated purchase price of $27.9 million, comprised of a net cash payment of $20.0 million and an estimated fair value of contingent consideration of $7.9 million. The resulting amount of goodwill and identifiable intangibles related to this transaction in the aggregate were $18.1 million and $8.2 million, respectively. The Corporation believes the resulting amount of goodwill reflects its expectation of synergistic benefits of the acquisition. Tax deductible goodwill associated with the acquisition was $18.1 million as of September 30, 2015. The net assets and operating results of the acquisition have been included in the Corporation's condensed consolidated financial statements from the date of acquisition. 2014 Acquisitions During the year ended December 31, 2014, the Corporation completed acquisitions of four long-term care businesses and one infusion business (collectively the "2014 Acquisitions"), none of which were individually significant to the Corporation. The 2014 Acquisitions required cash payments of approximately $115.2 million in the aggregate. The resulting amount of goodwill and identifiable intangibles related to these transactions in the aggregate were $40.9 million and $61.4 million, respectively. The Corporation believes the resulting amount of goodwill reflects its expectation of synergistic benefits of the acquisitions. Tax deductible goodwill associated with the 2014 Acquisitions was $30.7 million as of September 30, 2015. The net assets and operating results of the 2014 Acquisitions have been included in the Corporation's condensed consolidated financial statements from their respective dates of acquisition. Amounts contingently payable related to the 2014 Acquisitions, representing payments originating from an earn-out provision of the infusion acquisition, were $1.1 million as of December 31, 2014 and September 30, 2015. The amounts recognized as of the acquisition dates for the 2014 Acquisitions, on a combined basis, for assets acquired and liabilities assumed are as follows (dollars in millions): Amounts Recognized as of Acquisition Date Accounts receivable Inventory Deferred tax assets – current Other current assets Equipment and leasehold improvements Deferred tax assets Identifiable intangibles Goodwill Total Assets
$
Current liabilities Other long-term liabilities Total Liabilities
26.7 6.8 1.8 3.1 4.8 8.2 61.4 34.9 147.7
Measurement Period Adjustments $
26.4 6.9 33.3
Total purchase price, less cash acquired
$ 10
114.4
As Adjusted
(0.3) $ (0.2) (0.1) (3.5) 6.0 1.9 1.6 (0.5) 1.1
$
0.8
26.4 6.6 1.8 3.0 4.8 4.7 61.4 40.9 149.6 28.0 6.4 34.4
$
115.2
PHARMERICA CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (Unaudited) NOTE 2—ACQUISITIONS (Continued) Pro forma financial statements are not presented on the 2014 and 2015 acquisitions as the results are not material to the Corporation's condensed consolidated financial statements. Other For the three months ended September 30, 2014 and September 30, 2015, the Corporation incurred $3.7 million and $7.6 million, respectively, and $10.0 million and $14.7 million for the nine months ended September 30, 2014 and September 30, 2015, respectively, of acquisition-related costs, which have been classified as a component of merger, acquisition, integration costs and other charges. NOTE 3—GOODWILL AND INTANGIBLES As of December 31, 2014 (as adjusted) and September 30, 2015 the carrying amount of goodwill was $323.6 million and $341.8 million, respectively. The following table presents the components of the Corporation's finite lived intangible assets (dollars in millions): Balance at Balance at December 31, September 30, 2014 Additions 2015 $ 177.5 $ 7.0 $ 184.5 62.2 0.6 62.8 19.9 0.6 20.5 259.6 8.2 267.8 (82.0) (20.6) (102.6) $ 177.6 $ (12.4) $ 165.2
Finite Lived Intangible Assets Customer relationships Trade name Non-compete agreements Sub Total Accumulated amortization Net intangible assets
Amortization expense relating to finite-lived intangible assets was $4.9 million and $7.0 million for the three months ended September 30, 2014 and 2015, respectively. Amortization expense relating to finite-lived intangible assets was $13.6 million and $20.6 million for the nine months ended September 30, 2014 and 2015, respectively. NOTE 4—CREDIT AGREEMENT On September 17, 2014, the Corporation entered into a credit agreement 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 (the "Credit Agreement"). The Credit Agreement consists of a $225.0 million term loan facility and a $310.0 million revolving credit facility. The terms and conditions of the Credit Agreement are customary to facilities of this nature. As of September 30, 2015, $222.2 million was outstanding under the term loan facility and $115.0 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, 2014 Term Debt - payable to lenders at LIBOR plus applicable margin (2.19% as of September 30, 2015), matures September 17, 2019 $ Revolving Credit Facility payable to lenders, interest at LIBOR plus applicable margin (2.15% of September 30, 2015), matures September 17, 2019 Capital lease obligations Total debt Less: Current portion of long-term debt Total long-term debt
$
225.0
September 30, 2015 $
125.0 0.7 350.7 6.3 344.4
222.2 115.0 0.2 337.4 11.4
$
326.0
The Corporation's indebtedness has the following maturities as of September 30, 2015 (dollars in millions):
Year Ending December 31, 2015 2016 2017 2018
Term Debt $ 2.8 11.3 11.3 11.3
Revolving Credit Facility $
-
Capital Lease Obligations $ 0.2 -
Total Maturities $ 3.0 11.3 11.3 11.3
2019 $ 11
185.5 222.2
$
115.0 115.0
$
0.2
$
300.5 337.4
PHARMERICA CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (Unaudited) NOTE 4—CREDIT AGREEMENT (Continued) 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, 2015 was $3.0 million. After giving effect to the letters of credit, total availability under the revolving credit facility was $192.0 million as of September 30, 2015. 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 result 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 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, 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 October 29, 2013, a complaint was filed in the United States District Court for the Southern District of Florida by Pines Nursing Homes (77), Inc. as a putative class action against the Corporation. The complaint alleged that the Corporation sent unsolicited advertisements promoting the Corporation's goods or services by facsimile to individuals or entities, and that such communications did not include an opt-out clause, all in violation of the federal Telephone Consumer Protection Act ("TCPA"). The Complaint did not specify the amount of damages sought, but the TCPA provides a statutory remedy of $500 per facsimile communication sent in violation of the statute, which may be trebled in the event of a willful violation. On August 18, 2014, the Corporation entered into a Settlement Agreement with the putative class and class counsel resolving all claims raised in the complaint. The parties moved on September 8, 2014 for, among other things, certification of the putative class for the purposes of effectuating the settlement and preliminary approval of the parties' settlement, and have requested a hearing on that motion. On June 26, 2015 the court granted the Joint Motion for Preliminary Approval of the parties settlement and the court has scheduled the final approval hearing for November 12, 2015. On November 20, 2013 a complaint filed by a relator, Robert Gadbois, on behalf of the U.S. Government and various state governments, was unsealed by the United States District for the District of Rhode Island against the Corporation alleging that the Corporation dispensed controlled and noncontrolled substances in violation of the CSA 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 has appealed the court's decision. The Corporation intends to continue to defend the case vigorously. 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 alleging that the Corporation violated the FCA and Federal Anti-Kickback Statute through its agreements to provide prescription drugs to nursing homes under certain Medicare and Medicaid programs. 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. The Corporation intends to vigorously defend itself against these allegations. 12
PHARMERICA CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (Unaudited) NOTE 5—COMMITMENTS AND CONTINGENCIES (Continued) On January 31, 2014, a relator, Frank Kurnik, on behalf of the U.S. Government and various state governments served its complaint filed in the United States District for the District of South Carolina alleging that the Corporation solicited and received remuneration in violation of the Federal AntiKickback Statute from drug manufacturer Amgen in exchange for preferring and promoting Amgen's drug Aranesp over a competing drug called Procrit. The U.S. Government and the various states declined to intervene in the case. On April 7, 2014, the Corporation moved to dismiss the complaint and on July 23, 2014, the motion was denied. On January 13, 2015, the Corporation again moved to dismiss the complaint and on March 23, 2015, the second motion was denied. On April 2, 2015, the Corporation moved the court to reconsider its denial of the second motion to dismiss and that motion was denied. The Corporation intends to vigorously defend itself against these allegations. The U.S. Department of Justice, through the U.S. Attorney's Office for the Western District of Virginia, investigated whether the Company's activities in connection with the agreements it had with the manufacturer of the pharmaceutical Depakote violated the False Claims Act or the Anti-Kickback Statute. The Company cooperated with this investigation and believes that it has complied with applicable laws and regulations with respect to this matter. On May 29, 2014, the United States District Court for the Western District of Virginia entered an order unsealing two previously partially sealed qui tam complaints, entitled United States, et al., ex rel. Spetter v. Abbott Laboratories. Inc., Omnicare, Inc., and PharMerica Corp., No. 1:07-cv-00006 and United States, et al., ex rel. McCoyd v. Abbott Laboratories, Omnicare, Inc., PharMerica Corp., and Miles White, No. 1:07-cv-0008. The Corporation entered into a settlement agreement on October 6, 2015 with the Government including the Department of Justice, with approvals from the National Association of Medicaid Fraud Control and the Department of Health and Human Services Office of Inspector General. In the settlement, the Corporation agreed to pay $9.3 million to resolve the matter which was previously accrued for in the condensed consolidated balance sheet of the Corporation. 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 Amended Prime Vendor Agreement ("Amended PVA"). The Corporation subsequently filed a First Amended Verified Complaint on September 26, 2014 asserting additional breaches of the Amended 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. All these receivables totaled $53.0 million and were included in prepaids and other assets in the accompanying condensed consolidated balance sheet as of December 31, 2014. During the period of January 1, 2015 through March 31, 2015, an additional $18.5 million, net of payments received, of certain rebates and guarantees owed by ABDC under the Amended PVA were recognized which brought the total receivable to $71.5 million at March 31, 2015 and September 30, 2015. On March, 2, 2015, the Corporation notified ABDC of its intent to terminate the Amended PVA effective April 1, 2015. The Corporation also announced that it had entered into a Prime Vendor Agreement with Cardinal Health ("Cardinal") effective April 1, 2015. On March 3, 2015, the Corporation received a letter from ABDC terminating the Amended PVA effective immediately based upon the Corporation's alleged failure to pay certain disputed miscellaneous charges and the Corporation's signing of the Cardinal PVA. The Corporation believes ABDC did not have the right to immediately terminate the contract pursuant to the terms of the Amended PVA. On March 6 and March 13, 2015, the Corporation withheld from ABDC normal recurring payments for drug purchases of approximately $48.8 million. The following table represents all receivables, whether previously disputed or not, due and owing from ABDC at September 30, 2015 and the related amounts allegedly payable to ABDC, which have been offset resulting in a net receivable at September 30, 2015 of $22.7 million. This net receivable is included in other assets in the accompanying condensed consolidated balance sheet as of September 30, 2015. Presented in the condensed consolidated balance sheet, the following amounts are offset as of September 30, 2015 (in millions):
Gross Amount of Recognized Asset
Description
Gross Liability Offset in the Condensed Consolidated Balance Sheet
Net Amount of Asset Presented in the Condensed Consolidated Balance Sheet
Rebates & Other Receivables
$
71.5
$
(48.8) $
22.7
Total
$
71.5
$
(48.8) $
22.7
The Corporation will have claims for additional damages resulting from ABDC's breaches of the Amended 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, likely longer than 12 months. 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, 2015, the Corporation had accrued approximately $39.9 million in the aggregate related to the legal actions and investigations. 13
PHARMERICA CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (Unaudited) NOTE 5—COMMITMENTS AND CONTINGENCIES (Continued) California Medicaid On August 14, 2013, the California Department of Health Care Service ("DHCS") announced its intent to implement a ten percent (10%) reimbursement reduction for numerous healthcare providers, including long term care pharmacies. The DHCS implemented the reduction prospectively beginning in the first quarter of 2014. In addition, the DHCS implemented, beginning October 2015, recouping a percentage of provider payments representing a ten percent (10%) reduction on certain drug reimbursements retroactive to June 1, 2011 through February 6, 2014. The Corporation has previously recorded a $3.3 million liability and reduction of revenue for the expected amount of recoveries from June 1, 2011 through December 31, 2013. NOTE 6—MERGER, ACQUISITION, INTEGRATION COSTS AND OTHER CHARGES Merger, acquisition, integration costs and other charges combined were $3.8 million and $8.0 million for the three months ended September 30, 2014 and 2015, respectively, and $10.3 million and $15.2 million for the nine months ended September 30, 2014 and 2015, respectively. Merger, integration costs and other charges for the three months ended September 30, 2014 and 2015 were $0.1 million and $0.4 million, respectively, and $0.3 million and $0.5 million for the nine months ended September 30, 2014 and 2015, respectively. Acquisition related costs for the three months ended September 30, 2014 and 2015 were $3.7 million and $7.6 million, respectively, and $10.0 million and $14.7 million for the nine months ended September 30, 2014 and 2015, respectively. NOTE 7—RESTRUCTURING COSTS AND OTHER CHARGES In July 2013, the Corporation commenced the implementation of its restructuring plan as a result of the loss of two of the Corporation's significant customers, Kindred Healthcare ("Kindred") and Golden Living. The plan is a major initiative primarily designed to optimize operational efficiency while ensuring that the Corporation remains well-positioned to serve its clients and achieve sustainable, long-term growth. The Corporation's restructuring plan includes steps to right size its cost structure by adjusting its workforce and facility plans to reflect anticipated business needs. In addition, in the third quarter ended September 30, 2015, the Corporation began a restructuring and centralization initiative related to its specialty pharmacy business. The initiative is not expected to be material to the financial statements. The Corporation recorded restructuring costs and other related charges of approximately of $0.1 million and $0.2 million during the three months ended September 30, 2014 and 2015, respectively, and $3.2 million and $0.3 million for the nine months ended September 30, 2014 and 2015, 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, 2014 $ 0.3 1.1 $ 1.4
Employee Severance and related costs Facility costs
Accrual $ $
0.3 0.3
Balance at Utilized September 30, Amounts 2015 $ (0.6) $ (0.4) 0.7 $ (1.0) $ 0.7
The liability at September 30, 2015 represents amounts not yet paid relating to actions taken in connection with the restructuring plan (primarily lease payments and severance costs). 14
PHARMERICA CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (Unaudited) NOTE 8—COMMON STOCK, PREFERRED STOCK, TREASURY STOCK, STOCK-BASED COMPENSATION AND OTHER BENEFITS 2015 Omnibus Incentive Plan Effective April 29, 2015, the Corporation adopted the PharMerica Corporation 2015 Omnibus Incentive Plan (the "Omnibus Plan") under which the Corporation is authorized to grant equity-based and other awards to its employees, officers, directors, and consultants. The Omnibus Plan replaced the Amended and Restated PharMerica Corporation 2007 Omnibus Incentive Plan (the "Prior Plan"). The Corporation has reserved 2,000,000 shares of its common stock for awards to be granted under the Omnibus Plan, subject to certain increases and reductions for grants under the Prior Plan. The following shares shall be added back to the number of shares available for grant under the Omnibus Plan: (i) shares covered by an award that expire or are forfeited, canceled, surrendered, or otherwise terminated without the issuance of such shares; (ii) shares covered by an award that are settled only in cash; and (iii) shares withheld by the Corporation or any subsidiary to satisfy a tax withholding obligation with respect to full value awards granted pursuant to the Omnibus Plan. However, shares surrendered for the payment of the exercise price under stock options (or options outstanding under the Prior Plan), shares repurchased by us with option proceeds (or option proceeds under the Prior Plan), and shares withheld for taxes upon exercise or vesting of an award other than a full value award (or an award other than a full value award under the Prior Plan), will not again be available for issuance under the Omnibus Plan. In addition, if a stock appreciation right ("SAR") (or SAR under the Prior Plan) is exercised and settled in shares, all of the shares underlying the SAR will be counted against the Omnibus Plan limit regardless of the number of shares used to settle the SAR. The Omnibus Plan provides for certain limits on issuances of certain types of awards and awards to certain recipients. The Omnibus Plan prohibits share recycling for stock options and stock appreciation rights, meaning that shares used to pay the exercise price or tax withholding for those awards are not added back to the share reserve. The Corporation's Compensation Committee administers the Omnibus Plan and has the authority to determine the recipient of the awards, the types of awards, the number of shares covered, and the terms and conditions of the awards. The Omnibus Plan allows for grants of incentive stock options, nonqualified stock options, stock appreciation rights, restricted share and restricted stock units, deferred shares, performance awards, including cash bonus awards, and other stock-based awards. The Corporation's Compensation Committee may condition the vesting, exercise or settlement of any award upon the achievement of one or more performance objectives. Stock options granted to officers and employees under the Omnibus Plan generally vest in four equal annual installments and have a term of seven years. The restricted stock units granted to officers generally vest in three equal annual installments. The restricted stock units granted to members of the Board of Directors vest in one annual installment. The performance share units granted under the Omnibus Plan vest based upon the achievement of a target amount of the Corporation's adjusted earnings before interest, income taxes, depreciation and amortization, which reinforces the importance of achieving the Corporation's profitability objectives. The performance is generally measured over a three-year period. As of September 30, 2015, total shares available for grants of stock-based awards pursuant to the Omnibus Plan were 1,851,155 shares. 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 was 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, 2015. 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, 2015, the Corporation repurchased no shares of common stock. The Corporation may redeem shares from employees upon the vesting of the Corporation's stock awards for minimum statutory tax withholding purposes and to cover option exercise costs. The Corporation redeemed 156,963 shares from the vesting of certain awards and exercise of certain stock options, for an aggregate price of approximately $4.3 million during the nine months ended September 30, 2015. These shares have also been designated by the Corporation as treasury stock. 15
PHARMERICA CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (Unaudited) NOTE 8—COMMON STOCK, PREFERRED STOCK, TREASURY STOCK, STOCK-BASED COMPENSATION AND OTHER BENEFITS (Continued) Stock Option Activity Stock options were not granted to officers and employees during 2014 or the nine months ended September 30, 2015. The following table summarizes option activity for the periods presented:
Outstanding shares at December 31, 2014 Exercised Canceled Expired Outstanding shares at September 30, 2015 Exercisable shares at September 30, 2015
WeightedAverage Exercise Number of Price Shares Per Share 913,209 $ 14.62 (139,133) 15.43 (122,268) 11.74 (303) 13.42 651,505 $ 14.30 651,505 $ 14.30
WeightedAverage Aggregate Remaining Intrinsic Value Term (in millions) 2.1 years $ 5.6
1.55 years $ 1.55 years $
9.2 9.2
Nonvested Shares The following table summarizes nonvested share activity for the periods presented: WeightedAverage Number of Grant Date Shares Fair Value 942,021 $ 18.00 171,619 28.87 155,831 26.60 (6,929) 22.58 (362,632) 16.23 899,910 $ 22.24
Outstanding shares at December 31, 2014 Granted - Restricted Stock Units Granted - Performance Share Units Forfeited Vested Outstanding shares at September 30, 2015
The weighted average remaining term and intrinsic value of non-vested shares as of September 30, 2015 was 2.9 years and $25.6 million, respectively. 16
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): 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 Nine Months Ended September 30, 30, 2014 2015 2014 2015 $ 2.2 $ 3.4 $ 2.9 $ 13.5 20.6% 53.1% 44.6% 47.5%
Provision for income taxes Total provision as a percentage of pre-tax income
The increase in our provision for income taxes as a percentage of pre-tax income for the nine months ended September 30, 2015 compared to the comparable 2014 period was due primarily to increases in the amount of pre-tax income as well as certain non-deductible employee compensation costs and discrete items. The provision for income taxes for the nine months ended September 30, 2014 was significantly impacted by the Corporation's $26.6 million of legal charges. The effective tax rates in 2015 are higher than the federal statutory rate largely as a result of the combined impact of state and local taxes, various non-deductible expenses, and discrete events. The discrete events for the nine months ended September 30, 2015 included a non-deductible $4.4 million legal charge and $1.2 million of other items. 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 tax basis of the Corporation's tax deductible goodwill was approximately $145.3 million and $152.6 million at December 31, 2014 and September 30, 2015, 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, 2015, the Corporation has $20.4 million ($7.1 million tax benefit) of federal net operating loss carryforwards available related to a 2014 acquisition. The Corporation's ability to utilize these loss carryovers is limited, but the Corporation expects that it will be able to use the recorded amount which takes into account the limitations of the carryforwards. Accordingly, the Corporation has not recorded any valuation allowance for the associated deferred tax asset. The Corporation has state net operating loss carryforwards representing a tax benefit of $3.6 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 $27.1 million at December 31, 2014 (as adjusted) and $23.0 million at September 30, 2015, net of state valuation allowances of $4.1 million as of both periods. As of December 31, 2014 and September 30, 2015, 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 2012 through 2014. The IRS completed its audit of the Corporation's consolidated U.S. income tax return for the 2011 tax year in February 2014. 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 2009. 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. 17
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, 2014 2015 Numerator: Numerator for basic and diluted earnings per share - net income Denominator: Denominator for basic earnings per share - weighted average shares Effect of dilutive securities (stock options, restricted stock units and performance share units) Denominator for earnings per diluted share - adjusted weighted average shares Basic earnings per share Earnings per diluted share Unexercised employee stock options and unvested restricted shares excluded from the effect of dilutive securities above (a)
$
$ $
8.5
$
3.0
Nine Months Ended September 30, 2014 2015 $
3.6
$
14.9
30,073,133
30,431,845
29,944,875
30,336,548
522,169 30,595,302 0.28 0.28
464,449 30,896,294 0.10 0.10
558,053 30,502,928 0.12 0.12
462,286 30,798,834 0.49 0.48
465,377
$ $
197
$ $
481,844
$ $
504
(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. 18
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS This Quarterly Report on Form 10-Q contains forward-looking statements, within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which reflect the Corporation's current estimates, expectations and projections about the Corporation's future results, performance, prospects and opportunities. Forward looking statements include, among other things, the information concerning the Corporation's possible future results of operations including revenues, costs of goods sold, and gross margin, business and growth strategies, financing plans, the Corporation's competitive position and the effects of competition, the projected growth of the industries in which we operate, and the Corporation's ability to consummate strategic acquisitions. Forward-looking statements include statements that are not historical facts and can be identified by forward-looking words such as "anticipate," "believe," "could," "estimate," "expect," "intend," "plan," "may," "should," "will," "would," "project," and similar expressions. These forward-looking statements are based upon information currently available to the Corporation and are subject to a number of risks, uncertainties and other factors that could cause the Corporation's actual results, performance, prospects or opportunities to differ materially from those expressed in, or implied by, these forward-looking statements. Important factors that could cause the Corporation's actual results to differ materially from the results referred to in the forward-looking statements the Corporation makes in this report include: • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • •
the Corporation's access to capital, credit ratings, indebtedness, and ability to raise additional financings and operate under the terms of the Corporation's debt obligations; anti-takeover provisions of the Delaware General Corporation Law, which in concert with our certificate of incorporation and our by-laws could delay or deter a change in control; the effects of adverse economic trends or intense competition in the markets in which we operate; the Corporation's risk of loss of revenues due to a customer or owner of skilled nursing facility entering the institutional pharmacy business; the effects of the loss of a large customer and the Corporation's ability to adequately restructure its operations to offset the loss; the demand for the Corporation's products and services; the risk of retaining existing customers and service contracts and the Corporation's ability to attract new customers for growth of the Corporation's business; the effects of renegotiating contract pricing relating to significant customers and suppliers, including the hospital pharmacy business which is substantially dependent on service provided to one customer; the impacts of cyber security risks and/or incidents; the effects of a failure in the security or stability of our technology infrastructure, or the infrastructure of one or more of our key vendors, or a significant failure or disruption in service; the effects of an increase in credit risk, loss or bankruptcy of or default by any significant customer, supplier, or other entity relevant to the Corporation's operations; the Corporation's ability to successfully pursue the Corporation's development and acquisition activities and successfully integrate new operations and systems, including the realization of anticipated revenues, economies of scale, cost savings, and productivity gains associated with such operations; the Corporation's ability to control costs, particularly labor and employee benefit costs, rising pharmaceutical costs, and regulatory compliance costs; the effects of healthcare reform and government regulations, including interpretation of regulations and changes in the nature and enforcement of regulations governing the healthcare and institutional pharmacy services industries including the dispensing of antipsychotic prescriptions; changes in the reimbursement rates or methods of payment from Medicare and Medicaid and other third party payers to both us and our customers; the potential impact of state government budget shortfalls and their ability to pay the Corporation and its customers for services provided; the Corporation's ability, and the ability of the Corporation's customers, to comply with Medicare or Medicaid reimbursement regulations or other applicable laws; the effects of changes in the interest rate on the Corporation's outstanding floating rate debt instrument and the increases in interest expense, including increases in interest rate terms on any new debt financing; further consolidation of managed care organizations and other third party payers; political and economic conditions nationally, regionally, and in the markets in which the Corporation operates; natural disasters, war, civil unrest, terrorism, fire, floods, tornadoes, earthquakes, hurricanes, epidemic, pandemic, catastrophic event or other matters beyond the Corporation's control; increases in energy costs, including state and federal taxes, and the impact on the costs of delivery expenses and utility expenses; elimination of, changes in, or the Corporation's failure to satisfy pharmaceutical manufacturers' rebate programs; the Corporation's ability to attract and retain key executives, pharmacists, and other healthcare personnel; the Corporation's risk of loss not covered by insurance; the outcome of litigation to which the Corporation is a party from time to time, including adverse results in material litigation or governmental inquiries including the possible insufficiency of any accruals established by the Corporation from time to time; changes in accounting rules and standards, audits, compliance with the Sarbanes-Oxley Act, and regulatory investigations; changes in market conditions that would result in the impairment of goodwill or other assets of the Corporation; changes in market conditions in which we operate that would influence the value of the Corporation's stock; the uncertainty as to the long-term value of the Corporation's common stock; the Corporation's ability to anticipate a shift in demand for generic drug equivalents and the impact on the financial results including the negative impact on brand drug rebates; the effect on prescription volumes and the Corporation's net revenues and profitability if the safety risk profiles of drugs increase or if drugs are withdrawn from the market, including as a result of manufacturing issues, or if prescription drugs transition to over-the-counter products; the effects on the Corporation's results of operations related to interpretations of accounting principles by the SEC staff that may differ from those of management; 19
• • • • • •
the potential impact of the litigation proceedings with ABDC regarding the Amended PVA; the Corporation's ability to comply with the terms of its Memorandum of Agreement with the DEA and the Corporate Integrity Agreement with the OIG; the Corporation's ability to collect outstanding receivables; changes in tax laws and regulations; the effects of changes to critical accounting estimates; and other factors, risks and uncertainties referenced in the Corporation's filings with the Commission, including the "Risk Factors" set forth in the Corporation's Annual Report on Form 10-K for the year ended December 31, 2014.
YOU ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON ANY FORWARD-LOOKING STATEMENTS, ALL OF WHICH SPEAK ONLY AS OF THE DATE OF THIS QUARTERLY REPORT. EXCEPT AS REQUIRED BY LAW, WE UNDERTAKE NO OBLIGATION TO PUBLICLY UPDATE OR RELEASE ANY REVISIONS TO THESE FORWARD-LOOKING STATEMENTS TO REFLECT ANY EVENTS OR CIRCUMSTANCES AFTER THE DATE OF THIS QUARTERLY REPORT OR TO REFLECT THE OCCURRENCE OF UNANTICIPATED EVENTS. ALL SUBSEQUENT WRITTEN AND ORAL FORWARD-LOOKING STATEMENTS ATTRIBUTABLE TO US OR ANY PERSON ACTING ON THE CORPORATION'S BEHALF ARE EXPRESSLY QUALIFIED IN THEIR ENTIRETY BY THE CAUTIONARY STATEMENTS CONTAINED OR REFERRED TO IN THIS SECTION AND IN OUR RISK FACTORS SET FORTH IN PART I, ITEM 1A OF THE CORPORATION'S ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2014 AND IN OTHER REPORTS FILED WITH THE SEC BY THE CORPORATION. 20
General The condensed consolidated financial statements and Management's Discussion and Analysis of Financial Condition and Results of Operations included in this quarterly report on Form 10-Q as of and for the three and nine months ended September 30, 2015, reflect the financial position, results of operations, and cash flows of the Corporation. Unless the context otherwise requires, all references to "we," "us," "our," and "Corporation" refer to PharMerica Corporation and its subsidiaries. Institutional Pharmacy Business Our core business provides pharmacy products and services to residents and patients in skilled nursing facilities, nursing centers, assisted living facilities, hospitals, and other long-term alternative care settings. We purchase, repackage, and dispense prescription and non-prescription pharmaceuticals in accordance with physician orders and deliver such medication to healthcare facilities for administration to individual patients and residents. Depending on the specific location, we service healthcare facilities typically within a radius of 120 miles or less of our pharmacy locations at least once each day. We provide 24-hour, seven-day per week on-call pharmacist services for emergency dispensing, delivery, and/or consultation with the facility's staff or the resident's attending physician. We also provide various supplemental healthcare services that complement our institutional pharmacy services. We offer prescription and non-prescription pharmaceuticals to our customers through unit dose or modified unit dose packaging, dispensing, and delivery systems, typically in a 14 to 30 day supply. Unit dose medications are packaged for dispensing in individual doses as compared to bulk packaging used by most retail pharmacies. The customers we serve prefer the unit dose delivery system over the bulk delivery system employed by retail pharmacies because it improves control over the storage and ordering of drugs and reduces errors in drug administration in healthcare facilities. Nursing staff in our customers' facilities administer the pharmaceuticals to individual patients and residents. The Corporation also utilizes an on-site dispensing system, with real time data transfer between the system and the Corporation, which provides timely medication administration in emergency and first dose situations. We also offer clinical pharmacy programs that encompass a wide range of drug therapy and disease management protocols, including protocols for anemia treatment, infectious diseases, wound care, nutritional support, renal dosing, and therapeutic substitution. Our computerized dispensing and delivery systems are designed to improve efficiency and control over distribution of medications to patients and residents. We provide computerized physician orders and medication administration records for patients or residents on a monthly basis as requested. Data from these records are formulated into monthly management reports on patient and resident care and quality assurance. This system improves efficiencies in nursing time, reduces drug waste, and helps to improve patient outcomes. Hospital Pharmacy Management Services We also provide hospital pharmacy management services. These services generally entail the overall management of the hospital pharmacy operations, including the ordering, receipt, storage, and dispensing of pharmaceuticals to the hospital's patients pursuant to the clinical guidelines established by the hospital. We offer the hospitals a wide range of regulatory and financial management services, including inventory control, budgetary analysis, staffing optimization, and assistance with obtaining and maintaining applicable regulatory licenses, certifications, and accreditations. We work with the hospitals to develop and implement pharmacy policies and procedures, including drug formulary development and utilization management. We also offer clinical pharmacy programs that encompass a wide range of drug therapy and disease management protocols, including protocols for anemia treatment, infectious diseases, wound care, nutritional support, renal dosing, and therapeutic substitution. The hospital pharmacy management services business is comprised of a few customers, of which, our largest service is to the majority of the Kindred Healthcare ("Kindred") hospitals. Consultant Pharmacist Services Federal and state regulations mandate that long-term care facilities, in addition to providing a source of pharmaceuticals, retain consultant pharmacist services to monitor and report on prescription drug therapy in order to maintain and improve the quality of resident care. On September 30, 2008, the United States Department of Health and Human Services Office of Inspector General ("OIG") published OIG Supplemental Compliance Program Guidance for Nursing Homes. With quality of care being the first risk area identified, the supplemental guidance is part of a series of recent government efforts focused on improving quality of care at skilled nursing and long-term care facilities. The guidance contains compliance recommendations and an expanded discussion of risk areas. The guidance stressed that facilities must provide pharmaceutical services to meet the needs of each resident and should be mindful of potential quality of care problems when implementing policies and procedures on proper medication management. It further stated that facilities can reduce risk by educating staff on medication management and improper pharmacy kickbacks for consultant pharmacists and that facilities should review the total compensation paid to consultant pharmacists to ensure it is not structured in a way that reflects the volume or value of particular drugs prescribed or administered to residents. We provide consultant pharmacist services to approximately 67% of our patients serviced. The services offered by our consultant pharmacists include: · · · · ·
Monthly reviews of each resident's drug regimen to assess the appropriateness and efficiency of drug therapies, including the review of medical records, monitoring drug interactions with other drugs or food, monitoring laboratory test results, and recommending alternative therapies; Participation on quality assurance and other committees of our customers, as required or requested by such customers; Monitoring and reporting on facility-wide drug utilization; Development and maintenance of pharmaceutical policy and procedure manuals; and Assistance with federal and state regulatory compliance pertaining to resident care.
Medical Records The Corporation provides medical records services, which includes the completion and maintenance of medical record information for patients in the Corporation's customers' facilities. The medical records services include: · · · · ·
Real-time access to medication and treatment administration records, physician order sheets and psychotropic drug monitoring sheets; Online ordering to save time and resources; A customized database with the medication profiles of each resident's medication safety, efficiency and regulatory compliance; Web-based individual patient records detailing each prescribed medicine; and Electronic medical records to improve information to make it more legible and instantaneous.
21
Specialty Infusion Services The Corporation provides specialty infusion services focused on providing complex pharmaceutical products and clinical services to patients in client facilities, hospice, and outside of hospital or nursing home settings. We offer high-touch clinical services to patients with acute or chronic conditions. The delivery of specialty infusion therapy requires comprehensive planning and monitoring which is provided through our registered nursing staff. Our nursing staff performs an initial patient assessment, provides therapy specific training and education, administers therapy and monitors for potential side effects. We also provide extensive clinical monitoring and patient follow-up to ensure patient therapy adherence and proactively manage patients' conditions. An in-network strategy facilitates easier decision-making for referral sources and provides us with the ability to pre-authorize patients, auto adjudicate, and bill electronically, enabling faster prescription turnaround. Specialty Oncology Pharmacy We provide dispensing of oncology drugs, care management and other related services to patients, oncology practices, and hospitals. These services encompass clinical coordination and review, compliance to appropriate oncology protocols, patient assistance with outside funding, and timely delivery of medication. We coordinate the administration of medications to the physician's office or directly to the patient at the appropriate point of treatment. We work directly with the payers to bill insurance companies for the medication provided, ensuring all prior authorizations and approvals are obtained. These services offer physicians an alternative to the traditional buy-and-bill distribution model, allowing them to outsource drug procurement, inventory management, and prescription administration. Suppliers/Inventory We obtain pharmaceutical and other products from Cardinal Health ("Cardinal") and other contracts negotiated directly with pharmaceutical manufacturers for discounted prices. The Corporation entered into a Prime Vendor Agreement with Cardinal effective April 1, 2015. The loss of a supplier could adversely affect our business if alternate sources of supply are unavailable. We seek to maintain an on-site inventory of pharmaceuticals and supplies to ensure prompt delivery to our customers. Cardinal maintains local distribution facilities in most major geographic markets in which we operate. In addition, beginning in the fourth quarter of 2013, we began supplying many of our pharmacies with select products from a distribution center operated by a third-party logistics company. Brand to Generic Conversions The following table summarizes the material brand-to-generic conversions expected to occur in 2015 through 2018: 2015 Patanol (Q4) Renagel (Q4) Renvela(Q4)
2016 Gleevec (Q1) Nuedexta (Q1) Combivent (Q2) Crestor (Q2) Cubicin (Q2) Tamiflu (Q3) Kaletra (Q4) Seroquel XR (Q4) Zetia (Q4)
2017 Azilect (Q1) Vytorin (Q2)
2018 Nasonex (Q2)
(Number in parentheses refers to the expected quarter of conversion)
When a branded drug shifts to a generic, initial pricing of the generic drug in the market will vary depending on the number of manufacturers launching their generic version of the drug. Historically a shift from brand-to-generic decreased our revenue and improved our gross margin from sales of these classes of drugs during the initial time period a brand drug has a generic alternative. However, recent experience has indicated that the third-party payers may reduce their reimbursements to the Corporation faster than previously experienced. In addition, the number of generic manufacturers entering the market impacts the overall cost and reimbursement of generic drugs. This acceleration in the reimbursement reduction and the number of generic manufacturers have resulted in margin compression much earlier than we have historically experienced. Due to the unique nature of the brand-to-generic conversion, management cannot estimate the future financial impact of the brand-to-generic conversions on the Corporation's results of operations. Supplier and Manufacturer Rebates We currently receive rebates from certain manufacturers and distributors of pharmaceutical products for achieving targets of market share or purchase volumes. Rebates are designed to prefer, protect, or maintain a manufacturer's products that are dispensed by the pharmacy under its formulary. Rebates for brand name products are generally based upon achieving a defined market share tier within a therapeutic class and can be based on either purchasing volumes or actual prescriptions dispensed. Rebates for generic products are more likely to be based on achieving purchasing volume requirements. 2010 Health Care Reform Legislation The Patient Protection and Affordable Care Act and the reconciliation law known as Health Care and Education Affordability Reconciliation Act (combined we refer to both Acts as the "2010 Health Care Reform Legislation") were enacted in March 2010. State participation in the expansion of Medicaid under the 2010 Health Care Reform Legislation is voluntary. Three key provisions of the 2010 Health Care Reform Legislation that are relevant to the Corporation are: (i) the gradual modification to the calculation of the Federal Upper Limit ("FUL") for drug prices and the definition of Average Manufacturer's Price ("AMP"), (ii) the closure, over time, of the Medicare Part D coverage gap, which is otherwise known as the "Donut Hole," and (iii) short cycle dispensing. Regulations under the 2010 Health Care Reform Legislation are expected to continue being drafted, released, and finalized throughout the
next several years. 22
FUL and AMP Changes The reimbursement rates for pharmacy services under Medicaid are determined on a state-by-state basis subject to review by Centers for Medicare and Medicaid Services ("CMS") and applicable federal law. Although Medicaid programs vary from state to state, they generally provide for the payment of certain pharmacy services, up to the established limits, at rates determined in accordance with each state's regulations. Federal regulations and the regulations of certain states establish "upper limits" for reimbursement of certain prescription drugs under Medicaid (these upper limits being the "FUL"). The 2010 Health Care Reform Legislation amended the Deficit Reduction Act of 2005 (the "DRA") to change the definition of the FUL by requiring the calculation of the FUL as no less than 175% of the weighted average, based on utilization, of the most recently reported monthly AMP for pharmaceutically and therapeutically equivalent multi-source drugs available through retail community pharmacies nationally. In addition, the definition of AMP changed to reflect net sales only to drug wholesalers that distribute to retail community pharmacies and to retail community pharmacies that directly purchase from drug manufacturers. Further, the 2010 Health Care Reform Legislation continues the current statutory exclusion of prompt pay discounts offered to wholesalers and adds three other exclusions to the AMP definition: (i) bona fide services fees;(ii) reimbursement for unsalable returned goods (recalled, expired, damaged, etc.); and (iii) payments from and rebates/discounts to certain entities not conducting business as a wholesaler or retail community pharmacy. In addition to reporting monthly, the manufacturers are required to report the total number of units used to calculate each monthly AMP. CMS will use this information when it establishes FULs as a result of the new volume-weighted requirements pursuant to the 2010 Health Care Reform Legislation. In September 2011, CMS issued the first draft FUL reimbursement files for multiple source drugs, including the draft methodology used to calculate the FULs in accordance with the 2010 Health Care Reform Legislation. CMS continues to release this monthly data and a three-month rolling average and is expected to do so going forward. CMS has not posted monthly AMPs for individual drugs, but only posted the weighted average of monthly AMPs in a FUL group and the calculation methodology. CMS has stated that AMP-based FULSs will be published at or about the same time that CMS publishes the Medicaid Covered Outpatient Drug final rule. On August 4, 2015, the Office of the Management and Budget (the "OMB") received the Medicaid Covered Outpatient Drug final rule for final review. The OMB website stated that it expected final action on this rule in August 2015; however, final action has not yet been taken. CMS will continue to post draft monthly FULs. The Corporation will continue to analyze the draft monthly FULs, including the relationship of those FULs to the National Average Drug Acquisition pricing. Part D Coverage Gap Starting on January 1, 2011, the Medicare Coverage Gap Discount Program (the "Program") requires drug manufacturers to provide a 50% discount on the negotiated ingredient cost to certain Medicare Part D beneficiaries for certain drugs and biologics purchased during the coverage gap (this is exclusive of the pharmacy dispensing fee). In addition, the 2010 Health Care Reform Legislation requires Medicare to close or eliminate the coverage gap entirely by fiscal year 2020 by gradually reducing the coinsurance percentage for both drugs covered and not covered by the Program for each applicable beneficiary. At this time, the Corporation is unable to fully evaluate the impact of the changes to the coverage gap to its business. Short Cycle Dispensing and Dispensing Fees Pursuant to the 2010 Health Care Reform Legislation, Prescription Drug Plans ("PDPs") are required, under Medicare Part D and Medicare Advantage prescription drug plans ("Medicare Advantage" or "MAPDs") to utilize specific, uniform dispensing techniques, such as weekly, daily, or automated dose dispensing, when dispensing covered Medicare Part D drugs to beneficiaries who reside in a long-term care facility to reduce waste associated with 30 to 90 day prescriptions for such beneficiaries. Pursuant to CMS issued regulation, beginning January 1, 2013, pharmacies dispensing to long-term care facilities must dispense no more than 14-day supplies of brand-name oral solid medications covered by Medicare Part D. The Corporation fully implemented short cycle dispensing on January 1, 2013. The impact of short cycle dispensing has not had a material adverse impact on the Corporation's results of operations. In a February 12, 2015 Final Rule entitled "Medicare Program: Contract Year 2016 Policy and Technical Changes to the Medicare Advantage and the Medicare Prescription Drug Benefit Programs", CMS finalized a regulation, effective January 1, 2016, prohibiting financial arrangements that penalize more efficient long-term care dispensing techniques (e.g., dispensing a three day supply over a 14-day supply) through pro-rated dispensing fees based on a day's supply or quantity dispensed. CMS also finalized a requirement that, effective January 1, 2016, any differences in payment methodologies among long-term care pharmacies incentivize more efficient dispensing techniques. The Corporation is unable to evaluate the full impact of these changes on its business at this time. Medicare Part D Changes In a May 23, 2014 Final Rule entitled "Medicare Program: Contract Year 2015 Policy and Technical Changes to the Medicare Advantage and the Medicare Prescription Drug Benefit Programs," CMS finalized a requirement that applicable January 1, 2016 and enforceable June 1, 2016, certain prescribers of Part D covered drugs must be enrolled as Medicare providers (or be granted a valid opt-out affidavit on file with a Part A or Part B Medicare Administrative Contractor) in order for a claim to be covered under Medicare Part D. CMS also finalized several specific requirements to reduce prescriber fraud, waste, and abuse. The Corporation is unable to evaluate the full impact of these changes on its business at this time. 23
CIA and DEA MOA In May 2015, the Corporation entered into a five-year corporate integrity agreement ("CIA") with the OIG and a Memorandum of Agreement ("MOA") with the Drug Enforcement Agency ("DEA") concurrent with the execution of settlement agreements with the OIG and the DEA settling alleged Controlled Substance Act ("CSA") violations and associated False Claims Act allegations. The CIA requires the Corporation, among other things to: (i) create procedures designed to ensure it complies with the CSA and related regulations; (ii) retain an independent review organization to review the Corporation's compliance with the terms of the CIA and report to the OIG regarding that compliance; and (iii) provide training for certain Corporation employees as to the Corporation's requirements under the CSA. If the Corporation fails to comply with the terms of the CIA, it may be required to pay certain monetary penalties. Furthermore, if the Corporation commits a material breach of the CIA, the OIG may exclude the Corporation from participating in federal healthcare programs. Any such exclusion would result in the revocation or termination of contracts and/or licenses and potentially have a material adverse effect on our financial condition, results of operations and business prospects. The MOA provides for an independent obligation for the Corporation to comply with all requirements of the CSA, specifically relating to the dispensing of Scheduled prescription drugs. If the Corporation fails to comply with the terms of the MOA, the DEA may suspend a Corporation's pharmacy's DEA Certificate of Registration and begin an administrative hearing process pursuant to 21 U.S.C. § 824. Any such suspension would prohibit the Corporation's pharmacy from dispensing Scheduled prescription drugs and would lead to the revocation or termination of contracts and/or licenses and potentially have a materially adverse effect on our financial condition, results of operation and business prospects. 24
Critical Accounting Estimates The preparation of financial statements in accordance with U.S. GAAP requires us to make estimates and assumptions that affect reported amounts and related disclosures. Management considers an accounting estimate to be critical if: • •
It requires assumptions to be made that were uncertain at the time the estimate was made; and Changes in the estimate or different estimates could have a material impact on our condensed consolidated results of operations or financial condition.
The critical accounting estimates discussed below are not intended to be a comprehensive list of all of the Corporation's accounting policies that require estimates. Management believes that of the significant accounting policies, discussed in Note 1 of the condensed consolidated financial statements included in this report, the estimates discussed below involve a higher degree of judgment and complexity. Management believes the current assumptions and other considerations used to estimate amounts reflected in the condensed consolidated financial statements are appropriate. However, if actual experience differs from the assumptions and other considerations used in estimating amounts reflected in the condensed consolidated financial statements, the resulting changes could have a material adverse effect on the condensed consolidated results of operations and financial condition of the Corporation. Allowance for doubtful accounts and provision for doubtful accounts Accounts receivable primarily consist of amounts due from PDP's under Medicaid Part D, long-term care institutions, respective state Medicaid programs, private payers and third party insurance companies. Our ability to collect outstanding receivables is critical to our results of operations and cash flows. We establish an allowance for doubtful accounts to reduce the carrying value of our receivables to their estimated net realizable value. In addition, certain drugs dispensed are subject to being returned and the responsible paying parties are due a credit for such returns. Our quarterly provision for doubtful accounts included in our condensed consolidated statements of operations is as follows (dollars in millions): 2014 Amount First Quarter Second Quarter Third Quarter Fourth Quarter
$
5.6 5.7 5.3 6.6
2015 % of Revenues 1.2% 1.3 1.1 1.3
Amount First Quarter Second Quarter Third Quarter
$
% of Revenues
5.0 3.0 1.5
1.0% 0.6 0.3
The following table shows our pharmacy revenue days outstanding reflected in our net accounts receivable as of the quarters indicated: 2014 37.7 37.0 36.7 34.9
First Quarter Second Quarter Third Quarter Fourth Quarter
2015 34.0 35.4 35.5
The following table shows our summarized aging categories by quarter:
First 56.7% 17.7 25.6
0 to 60 days 61 to 120 days Over 120 days
2014 Second Third 53.9% 57.3% 17.3 16.9 28.8 25.8
Fourth 58.8% 17.2 24.0
First 61.4% 15.8 22.8
2015 Second 60.0% 15.7 24.3
Third 58.9% 15.2 25.9
The following table shows our allowance for doubtful accounts as a percent of gross accounts receivable (dollars in millions):
Allowance First Quarter $ Second Quarter Third Quarter Fourth Quarter
2014 Gross Accounts Receivable
% of Gross Accounts Receivable
57.7 $
242.2
23.8%
60.3
246.5
57.4 58.1
Allowance
2015 Gross Accounts Receivable
% of Gross Accounts Receivable
59.7 $
259.2
23.0%
24.5
First Quarter $ Second Quarter
58.8
257.9
22.8
272.4
21.1
Third Quarter
57.7
253.5
22.8
253.5
22.9
We recognize revenues at the time services are provided or products are delivered. A significant portion of our revenues are billed to PDPs under Medicare Part D, state Medicaid programs, long-term care institutions, third party insurance companies, and private payers. Some claims are electronically adjudicated through online processing at the point the prescriptions are dispensed such that our operating system is automatically updated with the actual amounts to be reimbursed. As a result, our revenues and the associated receivables are based upon the actual reimbursements to be received. For claims that are adjudicated on-line and are rejected or otherwise denied upon submission, the Corporation provides contractual allowances based upon historical trends, contractual reimbursement terms and other factors which may impact ultimate reimbursement. Amounts are adjusted to actual reimbursed amounts based upon cash receipts.
25
A summary of revenues by payer type follows (dollars in millions):
Medicare Part D Institutional healthcare providers Medicaid Private and other Insured Medicare Hospital management fees Total
Three Months Ended September 30, 2014 2015 % of % of Amount Revenues Amount Revenues $ 214.6 45.6% $ 234.6 47.0% 110.4 23.5 114.5 23.0 39.5 8.4 34.3 6.9 19.5 4.1 19.9 4.0 64.8 13.8 74.2 14.9 5.9 1.3 5.7 1.1 15.5 3.3 15.6 3.1 $ 470.2 100.0% $ 498.8 100.0%
Medicare Part D Institutional healthcare providers Medicaid Private and other Insured Medicare Hospital management fees Total
Nine Months Ended September 30, 2014 2015 % of % of Amount Revenues Amount Revenues $ 618.2 45.1% $ 703.2 46.6% 337.3 24.6 354.1 23.5 122.9 9.0 110.8 7.4 59.0 4.3 61.6 4.0 173.1 12.6 215.0 14.3 16.3 1.2 16.3 1.1 44.2 3.2 46.8 3.1 $ 1,371.0 100.0% $ 1,507.8 100.0%
Inventory and cost of drugs dispensed We have inventory located at each of our institutional pharmacy, specialty infusion, and specialty oncology locations as well as our drug distribution center. Our inventory is valued at the lower of first-in, first-out cost or market. The inventory consists of prescription drugs, over the counter products and intravenous solutions. Our inventory relating to controlled substances is maintained on a manually prepared perpetual system to the extent required by the Drug Enforcement Agency and state board of pharmacies. All other inventory is maintained on a periodic system, through the performance of, at a minimum, quarterly physical inventory at the end of each quarter. All inventory counts are reconciled to the balance sheet account and differences are adjusted through cost of goods sold. In addition, we record an amount of potential returns of prescription drugs based on historical rates of returns and record an estimate for rebates associated with inventory remaining at the end of each period. As of December 31, 2014 and September 30, 2015, our inventories were $135.5 million and $117.5 million, respectively. The inventory days on hand were as follows for the periods presented:
First Quarter Second Quarter Third Quarter Fourth Quarter
2014 26.0 35.1 31.7 29.1
2015 26.1 29.6 25.7
Goodwill and other intangible assets Goodwill represents the excess of the purchase price over the fair value of the net assets of acquired companies. Our intangible assets are comprised primarily of trade names, customer relationship assets, and non-compete agreements. Our goodwill as of December 31, 2014 (as adjusted) and September 30, 2015 was $323.6 million and $341.8 million, respectively. The Corporation's policy is to perform a quantitative assessment of its institutional pharmacy and specialty infusion reporting units to determine whether it is more likely than not (defined as having a likelihood of more than 50 percent) that the fair value of a reporting unit is less than its carrying amount. The Corporation performed a quantitative assessment as of December 31, 2014. The institutional pharmacy and specialty infusion reporting unit's fair value as calculated for the analysis were approximately 48.2% and 13.1%, respectively, greater than book value at December 31, 2014. As a result of the excess on the specialty infusion unit not being significant, the Corporation continues to closely monitor the results of the specialty infusion reporting unit. The specialty infusion reporting unit had goodwill with a carrying value of $57.7 million at December 31, 2014. The Corporation also performed a qualitative assessment of its specialty oncology reporting unit as of December 31, 2014 and did not find it necessary to perform the first step of the two-step impairment test based on that analysis. There were no impairment triggering events during the nine months ended September 30, 2015. Accounting for income taxes We assess the likelihood that deferred tax assets will be realized from future taxable income. A valuation allowance is provided for 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. Our net deferred tax asset balances as of
December 31, 2014 and September 30, 2015 were $27.1 million and $23.0 million, respectively. Our valuation allowances for state deferred tax assets in our condensed consolidated balance sheets as of December 31, 2014 and September 30, 2015 were $4.1 million. 26
Definitions Listed below are definitions of terms used by the Corporation in managing the business. The definitions are necessary to the understanding of the Management's Discussion and Analysis section of this document. Gross profit per prescription dispensed: Represents the gross profit divided by the total prescriptions dispensed. Gross profit margin: Represents the gross profit per prescription dispensed divided by the revenue per prescription dispensed. Prescriptions dispensed: Represents a prescription filled for an individual patient. A prescription will usually be for a 14 or 30 day period and will include only one drug type. Revenue per prescription dispensed: Represents the revenue divided by the total prescriptions dispensed. 27
Results of Operations The following table presents selected consolidated comparative results of operations and statistical information for the periods presented (dollars in millions, except per prescription and per patient amounts, and prescriptions in thousands):
Revenues Cost of goods sold
Three Months Ended September 30, Nine Months Ended September 30, Increase Increase 2014 (Decrease) 2015 2014 (Decrease) 2015 % of % of % of % of Amount Revenues Amount Revenues Amount Revenues Amount Revenues $ 470.2 100.0 $ 28.6 6.1% $ 498.8 100.0 $1,371.0 100.0 $136.8 10.0% $1,507.8 100.0
Gross profit $
387.2 83.0
82.3
33.0
17.7 $ (4.4)
8.5 (5.3 )% $
420.2 78.6
Pharmacy (in whole numbers except where indicated) Financial data Prescriptions dispensed (in thousands) 8,492 (284) (3.3 ) % 8,208 Revenue per prescription dispensed $ 55.37 $ 5.40 9.8% $ 60.77 Gross profit per prescription dispensed $ 9.77 $ (0.19) (1.9 )% $ 9.58 Gross profit margin 17.7% (1.9 )% (10.7 )% 15.8% Generic dispensing rate 85.1% 1.4% 1.6% 86.5%
84.2
1,126.1
15.8 $ 244.9
82.1
133.3
17.9 $
3.5
11.8
1,259.4
83.5
1.4% $ 248.4
16.5
25,511
202
$ 53.74
$ 4.90
9.1% $ 58.64
$
$ 0.06
6.3% $
9.60 17.9% 84.9%
(1.4) 1.0%
0.8%
25,713
9.66
(7.8 )%
16.5%
1.2%
85.9%
Revenues Revenues increased $28.6 million for the three months ended September 30, 2015 compared to the three months ended September 30, 2014 which was driven by recent acquisitions, growth in the Corporation's specialty pharmacy businesses, and branded drug inflation. The increase of $28.6 million is comprised of a favorable rate variance of approximately $44.3 million or $5.40 increase per prescription dispensed, partially offset by an unfavorable volume variance of approximately $15.7 million or 284,000 fewer prescriptions dispensed. The revenue per prescription dispensed increase was due to the increased volume in the Corporation's specialty pharmacy businesses, which carries higher revenue per script and branded drug inflation. Revenues increased $136.8 million for the nine months ended September 30, 2015 compared to the nine months ended September 30, 2014 which was driven by recent acquisitions, growth in the Corporation's specialty pharmacy businesses, and branded drug inflation. The increase of $136.8 million is comprised of a favorable rate variance of approximately $126.0 million or $4.90 increase per prescription dispensed, along with a favorable volume variance of approximately $10.8 million or 202,000 more prescriptions dispensed. The revenue per prescription dispensed increase was due to the increased volume in the Corporation's specialty pharmacy businesses, which carries higher revenue per script and branded drug inflation. Gross Profit Gross profit for the three months ended September 30, 2015 was $78.6 million or $9.58 per prescription dispensed compared to $83.0 million or $9.77 per prescription dispensed for the three months ended September 30, 2014. The decrease in gross profit was primarily driven by lower volumes resulting from an improvement in the Corporation's client mix and higher drug costs under the Corporation's prime vendor agreement. Gross profit margin for the three months ended September 30, 2015 was 15.8% compared to 17.7% for the three months ended September 30, 2014. The gross profit margin was adversely impacted by the increased volume in the Corporation's specialty pharmacy businesses, which carry lower profit margins as well as volume decreases in the long-term care pharmacy business and higher drug costs under the Corporation's prime vendor agreement. Gross profit for the nine months ended September 30, 2015 was $248.4 million or $9.66 per prescription dispensed compared to $244.9 million or $9.60 per prescription dispensed for the nine months ended September 30, 2014. The increase in gross profit was driven by 2014 acquisitions, growth in the Corporation's specialty pharmacy businesses, and branded drug inflation. The increase in gross profit was partially offset by volume decreases in the longterm care pharmacy business and higher drug costs under the Corporation's prime vendor agreement. Gross profit margin for the nine months ended September 30, 2015 was 16.5% compared to 17.9% for the nine months ended September 30, 2014. The gross profit margin was adversely impacted by the increased volume in the Corporation's specialty pharmacy businesses, which carry lower profit margins as well as volume decreases in the long-term care pharmacy business and higher drug costs under the Corporation's prime vendor agreement. Selling, General and Administrative Expenses Selling, general and administrative expenses were $52.7 million, or 10.6% of revenues, for the three months ended September 30, 2015 compared to $56.0 million, or 11.9% of revenues, for the three months ended September 30, 2014. The decrease of $3.3 million was due to cost improvements and a reduction in bad debt expense as the Corporation improved its client mix.
Selling, general and administrative expenses were $167.1 million, or 11.1% of revenues, for the nine months ended September 30, 2015 compared to $171.1 million, or 12.5% of revenues, for the nine months ended September 30, 2014. The decrease of $4.0 million was due to cost improvements and a reduction in bad debt expense as the Corporation improved its client mix. 28
Depreciation and Amortization Depreciation expense was $5.7 million for the three months ended September 30, 2015 as compared to $4.9 million for the three months ended September 30, 2014 and $17.2 million for the nine months ended September 30, 2015 as compared to $14.5 million for the nine months ended September 30 2014. Depreciation expense increased $0.8 million for the three months and $2.7 million for the nine months, due to depreciation expense recognized on the assets acquired through the 2014 Acquisitions as well as additions to fixed assets. Amortization expense was $7.0 million for the three months ended September 30, 2015 compared to $4.9 million for the three months ended September 30, 2014 and $20.6 million for the nine months ended September 30, 2015 as compared to $13.6 million for the nine months ended September 30, 2014. The increase of $2.1 million for the three months and $7.0 million for the nine months, was due primarily to the amortization expense recognized on intangibles acquired through the 2014 and 2015 acquisitions. Settlement, Litigation and Other Related Charges Settlement, litigation and other related charges were $2.1 million for the three months ended September 30, 2015 compared to $1.1 million for the three months ended September 30, 2014 and were $11.3 million for the nine months ended September 30, 2015 as compared to $28.9 million for the nine months ended September 30, 2014. These costs relate to the Corporation's defense and settlement of certain governmental investigations and other litigation. Restructuring and Impairment Charges Restructuring and impairment charges were $0.2 million for the three months ended September 30, 2015 compared to $0.1 million for the three months ended September 30, 2014 and were $0.3 million for the nine months ended September 30, 2015 compared to $3.2 million for the nine months ended September 30, 2014. These costs are part of the Corporation's initiative to realign the organization in connection with the loss of two significant customers, which were primarily recognized in 2014, along with the specialty infusion restructuring and centralization initiative in 2015. Merger, Acquisition, Integration Costs and Other Charges Merger, acquisition, integration costs and other charges were $8.0 million for the three months ended September 30, 2015 compared to $3.8 million for the three months ended September 30, 2014 and were $15.2 million for the nine months ended September 30, 2015 compared to $10.3 million for the nine months ended September 30, 2014. The increase was related to costs associated with the 2014 and 2015 acquisitions. Interest Expense Interest expense was $2.1 million for the three months ended September 30, 2015 and 2014 and was $5.4 for the nine months ended September 30, 2015 compared to $6.9 million for the nine months ended September 30, 2014. The decrease was primarily due to lower interest rates as a result of the new credit agreement signed in 2014, along with lower amortization of deferred financing costs. Tax Provision The effective tax rate for the nine months ended September 30, 2015 was 47.5%, comprised of the 35.0% federal statutory rate and 2.2% for the state rate, and 10.3% for discrete events. The discrete events included a non-deductible $4.4 million legal charge and $1.2 million of other items. Excluding the impact of the discrete events, the provision for income taxes as a percentage of pre-tax income would have been 37.2%. The effective tax rate excluding discrete events for the nine months ended September 30, 2014 was 37.0%. The increase in the effective tax rate excluding the impact of the discrete events between the two periods was primarily the result of an increase in certain non-deductible employee compensation costs. 29
Liquidity and Capital Resources Cash Flows - The following table presents selected data from our condensed consolidated statements of cash flows for the periods presented (dollars in millions):
Net cash provided by (used in) operating activities Net cash used in investing activities Net cash provided by (used in) financing activities Net change in cash and cash equivalents Cash and cash equivalents at beginning of period Cash and cash equivalents at end of period
$
$
Three Months Ended September 30, 2014 2015 19.7 $ 37.5 $ (113.4) (6.8) 89.7 (12.0) (4.0) 18.7 11.1 21.3 7.1 $ 40.0 $
Nine Months Ended September 30, 2014 2015 (2.4) $ 59.6 (143.3) (38.3) 128.6 (14.6) (17.1) 6.7 24.2 33.3 7.1 $ 40.0
Operating Activities – Cash provided by operating activities aggregated $37.5 million for the three months ended September 30, 2015 and $59.6 million for the nine months ended September 30, 2015 compared to $19.7 million for the three months ended September 30, 2014 and cash used in operating activities of $2.4 million for the nine months ended September 30, 2014. The increase in cash from operating activities is due primarily to the $48.8 million in ABDC drug purchase payments withheld, the Corporation's inventory purchasing strategy and new prime vendor agreement, and an increase in net income in the nine months ended September 30, 2015, which were partially offset by an increase in ABDC rebates receivable. Investing Activities – Cash used in investing activities aggregated $6.8 million and $38.3 million for the three and nine months ended September 30, 2015, respectively, compared to $113.4 million and $143.3 million for the three and nine months ended September 30, 2014, respectively. The decrease is due to the acquisitions completed by the Corporation in the third quarter of 2014. Financing Activities – Cash used in financing activities aggregated $12.0 million for the three months ended September 30, 2015 and $14.6 million for the nine months ended September 30, 2015 compared to cash provided by financing activities of $89.7 million and $128.6 million for the three and nine months ended September 30, 2014, respectively. The decrease in cash provided by financing activities is due primarily to borrowings on the revolving credit facility to fund 2014 Acquisitions, along with term and revolving credit facility payments in the third quarter of 2015. Credit Agreement On September 17, 2014, the Corporation entered into a Credit Agreement by and among the Corporation, the lenders named therein, 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 (the "Credit Agreement"). The Credit Agreement consists of a $225.0 million term loan facility and a $310.0 million revolving credit facility. The terms and conditions of the Credit Agreement are customary to facilities of this nature. Unless terminated earlier, the Credit Agreement will mature on September 17, 2019, and the principal amount outstanding thereunder, together with all accrued unpaid interest and other amounts owed thereunder, if any, will be payable in full on such date. The Credit Agreement requires term loan principal payments by the Corporation in an amount of $2.8 million each quarter beginning September 2015 through September 2019. The final principal repayment installment of term loans shall be repaid on the term maturity date, September 17, 2019. In addition, the term loan is subject to certain prepayment obligations relating to certain asset sales, certain casualty losses and the incurrence of certain indebtedness. The Corporation had a total of $222.2 million outstanding of term debt under the Credit Agreement and $115.0 million outstanding under the revolving portion of the Credit Agreement as of September 30, 2015. The Credit Agreement provides for the issuance of letters of credit which, when issued, constitute usage and reduce availability on the revolving portion of the Credit Agreement. The amount of letters of credit outstanding as of September 30, 2015 was $3.0 million. After giving effect to the letters of credit and amounts outstanding under the revolving credit agreement, total availability under the revolving credit facility was $192.0 million as of September 30, 2015. The Corporation was compliant with all debt covenant requirements at September 30, 2015. Drug Wholesaler Agreement We obtain pharmaceutical and other products from Cardinal pursuant to a Prime Vendor Agreement with Cardinal effective April 1, 2015. The Corporation also obtains pharmaceutical and other products for discounted prices directly from pharmaceutical manufacturers. While the loss of a supplier could adversely affect our business if alternate sources of supply are unavailable, numerous sources of supply are generally available to us and we have not experienced any difficulty in obtaining pharmaceuticals or other products and supplies to conduct our business. The Corporation seeks to maintain an on-site inventory of pharmaceuticals and supplies to ensure prompt delivery to our customers. Cardinal maintains local distribution facilities in most geographic markets in which we operate. 30
Treasury Stock 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 was used. On July 2, 2012 the Board of Directors authorized an increase to the remaining portion of the existing stock 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, 2015. 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 three months ended September 30, 2015, the Corporation repurchased no shares of common stock. The Corporation may redeem shares from employees upon the vesting of the Corporation's stock awards for minimum statutory tax withholding purposes and to cover option exercise costs. The Corporation redeemed 156,963 shares from the vesting of certain awards and the exercise of certain stock options, for an aggregate price of approximately $4.3 million during the nine months ended September 30, 2015. These shares have also been designated by the Corporation as treasury stock. 31
Supplemental Quarterly Information The following tables represent the results of the Corporation's quarterly operations for the year ended December 31, 2014 and for the first, second and third quarters of 2015 (in millions, except where indicated):
Revenues Cost of goods sold Gross profit Selling, general and administrative Amortization expense Merger, acquisition, integration costs, and other charges Settlement, litigation and other related charges Restructuring and impairment charges Hurricane Sandy disaster costs Operating income (loss) Interest expense, net Loss on debt extinguishment Income (loss) before income taxes Provision (benefit) for income taxes Net income (loss)
First $ 452.2 372.2 80.0 57.2 4.4
First $ 511.6 423.0 88.6 59.0 6.6
2015 Quarters Second Third $ 497.5 $ 498.8 416.3 420.2 81.2 78.6 55.4 52.7 7.0 7.0
1.5
3.8
3.3
3.8
3.4
8.0
$
1.2 1.9 10.3 2.5 7.8 3.0 4.8
$
26.6 1.2 0.1 (9.7) 2.3 (12.0) (2.3) (9.7)
$
1.1 0.1 17.1 2.1 4.3 10.7 2.2 8.5
$
8.4 0.1 (1.8) 12.7 3.0 9.7 6.5 3.2
$
2.3 0.1 16.8 1.4 15.4 5.8 9.6
$
6.9 8.5 1.9 6.6 4.3 2.3
$
2.1 0.2 0.1 8.5 2.1 6.4 3.4 3.0
Earnings (loss) per share (1): Basic Diluted
$ $
0.16 0.16
$ $
(0.32) (0.32)
$ $
0.28 0.28
$ $
0.11 0.10
$ $
0.32 0.31
$ $
0.08 0.07
$ $
0.10 0.10
Adjusted diluted earnings per diluted share (1)(2):
$
0.37
$
0.40
$
0.45
$
0.45
$
0.48
$
0.37
$
0.39
Balance sheet data: Cash and cash equivalents Working capital (3) Goodwill (3) Intangible assets, net Total assets (3) Long-term debt Total stockholders' equity Supplemental information: Adjusted EBITDA(2) Adjusted EBITDA Margin (2) Adjusted EBITDA per prescription dispensed (2) Net cash provided by (used in) operating activities Net cash used in investing activities Net cash (used in) provided by financing activities
29.8 30.4 $ $ $ $ $ $ $
12.7 273.4 282.7 131.9 868.6 230.9 470.0
$ $ $ $ $ $ $
30.0 30.0
30.1 30.6
30.1 30.7
30.2 30.7
30.4 30.8
30.4 30.9
11.1 310.3 286.9 130.4 922.5 268.9 462.2
$ 7.1 $ 335.1 $ 319.5 $ 184.1 $ 1,045.5 $ 360.9 $ 472.7
$ 33.3 $ 319.1 $ 323.6 $ 177.6 $ 1,074.0 $ 350.7 $ 478.1
$ 25.2 $ 292.8 $ 341.9 $ 179.2 $ 1,044.9 $ 325.5 $ 487.1
$ 21.3 $ 293.5 $ 341.9 $ 172.2 $ 1,062.3 $ 349.3 $ 492.1
$ 40.0 $ 285.1 $ 341.8 $ 165.2 $ 1,060.0 $ 337.4 $ 496.9
$
29.7 $ 6.6%
30.6 $ 6.8%
33.0 $ 7.0%
37.3 $ 7.1%
37.4 $ 7.3%
33.2 $ 6.7%
33.3 6.7%
$
3.45
$
3.64
$
3.89
$
3.93
$
4.13
$
3.93
$
4.06
$ $
4.4 (16.3)
$ $
(26.5) (13.6)
$ $
19.7 (113.4)
$ $
50.8 (13.7)
$ $
44.3 (25.0)
$ $
(22.2) (6.5)
$ $
37.5 (6.8)
$
0.4
$
38.5
$
89.7
$
(10.9)
$
(27.4)
$
24.8
$
(12.0)
Statistical information (in whole numbers except where indicated) Volume information Prescriptions dispensed (in thousands) Revenue per prescription dispensed $ Gross profit per prescription dispensed $ Gross profit margin Generic drug dispensing rate Inventory days on hand Revenue days outstanding
(3)
Fourth $ 523.5 429.1 94.4 65.2 6.5
5.0
Shares used in computing earnings (loss) per share: Basic Diluted
(1) (2)
2014 Quarters Second Third $ 448.6 $ 470.2 366.7 387.2 81.9 83.0 57.9 56.0 4.3 4.9
8,608
8,411
8,492
9,491
9,053
8,452
8,208
52.53 $ 9.29 $ 17.7% 84.5% 26.0 37.7
53.33 $ 9.74 $ 18.3% 85.0% 35.1 37.0
55.37 $ 9.77 $ 17.7% 85.1% 31.7 36.7
55.16 $ 9.95 $ 18.0% 84.9% 29.1 34.9
56.51 $ 9.79 $ 17.3% 85.3% 26.1 34.0
58.86 $ 9.61 $ 16.3% 86.0% 29.6 35.4
60.77 9.58 15.8% 86.5% 25.7 35.5
The Corporation has never declared a cash dividend. Earnings (loss) per common share in actual cents. See "Use of Non-GAAP Measures for Measuring Quarterly Results" for a definition and Reconciliation of Adjusted Earnings Per Diluted Common Share to Earnings (Loss) Per Diluted Common Share, and for Reconciliation of Net Income (Loss) to Adjusted EBITDA and Adjusted EBITDA Margin. As adjusted, see Note 2—Acquisitions in the Condensed Consolidated Financial Statements.
32
Use of Non-GAAP Measures for Measuring Quarterly Results The Corporation calculates Adjusted EBITDA as provided in the reconciliation below and calculates Adjusted EBITDA Margin by taking Adjusted EBITDA and dividing it by revenues adjusted for the contractual amount associated with the California Medicaid estimated recoupment. The Corporation calculates and uses Adjusted EBITDA as an indicator of its ability to generate cash from reported operating results. The measurement is used in concert with net income (loss) and cash flows from operating activities, which measure actual cash generated in the period. In addition, the Corporation believes that Adjusted EBITDA and Adjusted EBITDA Margin are supplemental measurement tools used by analysts and investors to help evaluate overall operating performance and the ability to incur and service debt and make capital expenditures. In addition, Adjusted EBITDA, as defined in the Credit Agreement, is used in conjunction with the Corporation's debt leverage ratio and this calculation sets the applicable margin for the quarterly interest charge. Adjusted EBITDA, as defined in the Credit Agreement, is not the same calculation as this Adjusted EBITDA table. Adjusted EBITDA presented herein does not represent funds available for the Corporation's discretionary use and is not intended to represent or to be used as a substitute for net income (loss) or cash flows from (used in) operating activities data as measured under U.S. GAAP. The items excluded from Adjusted EBITDA but included in the calculation of the Corporation's reported net income (loss) and cash flows from (used in) operating activities are significant components of the accompanying condensed consolidated statements of operations and cash flows and must be considered in performing a comprehensive assessment of overall financial performance. The Corporation's calculation of Adjusted EBITDA may not be consistent with calculations of EBITDA used by other companies. The following are reconciliations of Adjusted EBITDA to the Corporation's net income (loss) and net operating cash flows for the periods presented. The Corporation calculates and uses adjusted diluted earnings per share, which is exclusive of the impact of merger, acquisition, integration costs and other charges, settlement, litigation costs and other related charges, Hurricane Sandy disaster costs, restructuring and impairment charges, stock-based compensation and deferred compensation, loss on debt extinguishment, and impact of discrete items on tax provision ("the Excluded Items") as an indicator of its core operating results. The measurement is used in concert with net income and diluted earnings per share, which measure actual earnings per share generated in the period. The Corporation believes the exclusion of these charges in expressing earnings per share provides management with a useful measure to assess period to period comparability and is useful to investors in evaluating the Corporation's operating results from period to period. Adjusted diluted earnings per share after giving effect to the Excluded Items does not represent the amount that effectively accrues directly to stockholders (i.e., such costs are a reduction in earnings and stockholders' equity) and is not intended to represent or to be used as a substitute for diluted earnings per share as measured under U.S. GAAP. The Excluded Items are significant components of the accompanying condensed consolidated statements of operations and must be considered in performing a comprehensive assessment of overall financial performance. The following is a reconciliation of adjusted diluted earnings per share to the Corporation's U.S. GAAP earnings (loss) per diluted common share for the periods presented. 33
Unaudited Reconciliation of Net Income (Loss) to Adjusted EBITDA (dollars in millions) 2014 Quarters Second Third $ (9.7) $ 8.5
First $ 4.8
Net income (loss) Add: Interest expense, net Merger, acquisition, integration costs and other charges Settlement, litigation and other related charges Restructuring and impairment charges Loss on extinguishment of debt Hurricane Sandy disaster costs Stock-based compensation and deferred compensation Provision (benefit) for income taxes Depreciation and amortization expense Adjusted EBITDA $ Adjusted EBITDA Margin
Fourth $ 3.2
First $ 9.6
2015 Quarters Second Third $ 2.3 $ 3.0
2.5
2.3
2.1
3.0
1.4
1.9
2.1
5.0
1.5
3.1
3.3
3.8
3.4
8.0
1.2
26.6
1.1
8.4
2.3
6.9
2.1
1.9 -
1.2 0.1
0.1 4.3 -
0.1 (1.8)
0.1 -
-
0.2 0.1
2.1 3.0
1.8 (2.3)
1.8 2.2
2.3 6.5
2.0 5.8
1.7 4.3
1.7 3.4
9.2 29.7 $ 6.6%
9.1 30.6 $ 6.8%
9.8 33.0 $ 7.0%
12.3 37.3 $ 7.1%
12.4 37.4 $ 7.3%
12.7 33.2 $ 6.7%
12.7 33.3 6.7%
Unaudited Reconciliation of Adjusted EBITDA to Net Operating Cash Flows (dollars in millions)
Adjusted EBITDA Interest expense, net Merger, acquisition, integration costs and other charges Provision for bad debt Amortization of deferred financing fees (Gain) loss on disposition of equipment (Gain) loss on acquisition Provision (benefit) for income taxes Deferred income taxes Changes in federal and state income tax payable (receivable) Excess tax benefit from stock-based compensation Changes in assets and liabilities Other Net Cash Flows Provided by (Used in) Operating Activities
2014 Quarters 2015 Quarters First Second Third Fourth First Second Third $ 29.7 $ 30.6 $ 33.0 $ 37.3 $ 37.4 $ 33.2 $ 33.3 (2.5) (2.3) (2.1) (3.0) (1.4) (1.9) (2.1) (5.6) 5.6 0.7 (0.1) (0.3) (3.0) 4.0
(29.4) 5.7 0.6 2.3 (3.3)
(4.3) 5.3 0.5 0.1 (2.2) (4.0)
(11.8) 6.6 0.1 (6.5) 1.0
(6.2) 5.0 0.1 0.1 (5.8) 2.3
(10.3) 3.0 0.2 (4.3) 0.2
(10.4) 1.5 0.1 (3.4) 2.1
(1.3)
(2.8)
3.7
7.6
0.1
(9.1)
(1.0)
(2.7) (20.2) 0.1
(0.5) (27.4) -
(0.2) (10.1) -
19.1 0.4
(1.9) 14.6 -
(0.2) (33.1) 0.1
(0.2) 17.6 -
(22.2) $
37.5
$
4.4
$
(26.5) $
19.7
$
50.8
$
44.3
$
Unaudited Reconciliation of Diluted Earnings (Loss) Per Share to Adjusted Diluted Earnings Per Share 2014 Quarters Second Third
First Diluted earnings (loss) per share $ Add: Diluted earnings per share impact of: Merger, acquisition, integration costs and other charges Settlement, litigation and other related charges Restructuring and impairment charges Loss on extinguishment of debt Hurricane Sandy disaster costs Stock-based compensation and deferred compensation Impact of discrete items on tax provision Adjusted diluted earnings per share
$
0.16
$
(0.32) $
Fourth
0.28
$
0.10
2015 Quarters Second
First $
0.31
$
0.07
Third $
0.10
0.10
0.03
0.06
0.08
0.08
0.07
0.17
0.03 0.04 -
0.61 0.03 -
0.02 0.09
0.11 -
0.05 -
0.13 -
0.04 0.01 -
-
-
-
-
-
-
0.04
0.04
0.04
0.04
0.04
0.04
0.37
$
0.01 0.40 34
$
(0.04) 0.45 $
(0.04) 0.05 0.15 0.45
$
0.48
$
0.06 0.37
$
0.03 0.39
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
During the reporting period, there have been no material changes in the disclosures set forth in Part II, Item 7a in our Form 10-K for the year ended December 31, 2014. Item 4.
Controls and Procedures
Evaluation of Disclosure Controls and Procedures The Corporation has carried out an evaluation under the supervision and with the participation of management, including the Corporation's Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Corporation's "disclosure controls and procedures" as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act") as of the end of the period covered by this report. The Corporation's disclosure controls and procedures are designed so that information required to be disclosed in the Corporation's reports filed under the Exchange Act, such as this Quarterly Report on Form 10-Q, is recorded, processed, summarized and reported within the time periods specified in the Commission's rules and forms. The Corporation's disclosure controls and procedures are also intended to ensure that such information is accumulated and communicated to the Corporation's management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives, and management necessarily is required to use its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. Based upon this evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of September 30, 2015, the Corporation's disclosure controls and procedures are effective to provide reasonable assurance that information required to be disclosed in the reports that the Corporation files and submits under the Exchange Act is recorded, processed, summarized and reported as and when required and such information is accumulated and communicated as appropriate to allow timely decisions regarding required disclosures. Changes in Internal Control Over Financial Reporting There have been no changes in the Corporation's internal control over financial reporting during the quarter ended September 30, 2015, that have materially affected, or are reasonably likely to materially affect, the Corporation's internal control over financial reporting. 35
PART II. OTHER INFORMATION Item 1.
Legal Proceedings
The information called for by this item is incorporated herein by reference to Note 5 included in Part I, Item 1, Financial Statements (Unaudited) Notes to Condensed Consolidated Financial Statements. Item 1A.
Risk Factors
Except as set forth below, there have been no material changes in our risk factors from those disclosed in the Corporation's Annual Report on Form 10-K for the year ended December 31, 2014. We encourage you to read these risk factors, together with the risk factor below, in their entirety. If we fail to comply with the terms of our Corporate Integrity Agreement with the OIG or Memorandum of Agreement with the DEA, it could subject us to substantial monetary penalties or suspension or termination from participation in federal healthcare programs. In May 2015, the Corporation entered into a five-year corporate integrity agreement ("CIA") with the United States Department of Health and Human Services Office of Inspector General ("OIG") and a Memorandum of Agreement ("MOA") with the Drug Enforcement Agency ("DEA") concurrent with the execution of settlement agreements with the OIG and the DEA settling alleged Controlled Substance Act ("CSA") violations and associated False Claims Act allegations. The CIA requires the Corporation, among other things to: (i) create procedures designed to ensure it complies with the CSA and related regulations; (ii) retain an independent review organization to review the Corporation's compliance with the terms of the CIA and report to the OIG regarding that compliance; and (iii) provide training for certain Corporation employees as to the Corporation's requirements under the CSA. If the Corporation fails to comply with the terms of the CIA, it may be required to pay certain monetary penalties. The imposition of monetary penalties would adversely affect our profitability. Furthermore, if the Corporation commits a material breach of the CIA, the OIG may exclude the Corporation from participating in federal healthcare programs. Any such exclusion would result in the revocation or termination of contracts and/or licenses and potentially have a material adverse effect on our financial condition, results of operations and business prospects. The MOA provides for an independent obligation for the Corporation to comply with all requirements of the CSA, specifically relating to the dispensing of scheduled prescription drugs. If the Corporation fails to comply with the terms of the MOA, the DEA may suspend a Corporation's pharmacy's DEA Certificate of Registration and begin an administrative hearing process pursuant to 21 U.S.C. § 824. Any such suspension would prohibit the Corporation's pharmacy from dispensing Scheduled prescription drugs and would lead to the revocation or termination of contracts and/or licenses and potentially have a materially adverse effect on our financial condition, results of operation and business prospects. Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
In August 2010, the Board of Directors authorized a share repurchase program of up to $25.0 million of the Corporation's common stock, of which $10.5 million was 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. The Corporation did not repurchase any common stock shares under this program during the nine months ended September 30, 2015. Additionally, the Corporation may redeem shares from employees upon vesting of the Corporation's stock awards for minimum statutory tax withholding purposes and to cover option exercise costs. The Corporation redeemed 156,963 shares from the vesting of certain awards and the exercise of certain stock options, for an aggregate price of approximately $4.3 million during the nine months ended September 30, 2015. These shares have been designated by the Corporation as treasury stock. The following table summarizes our share repurchase activity by month for the three months ended September 30, 2015:
July 1, 2015 - July 31, 2015 August 1, 2015 - August 31, 2015
277 8,456
(1) $ (1)
35.28 34.08
Approximate Dollar Value of Shares that may yet be Purchased under the Plans or Programs (in millions) - $ 19.7 19.7
September 1, 2015 - September 30, 2015
3,746
(1)
31.34
-
Period
Total Number of Shares Purchased
Weighted Average Price Paid per Share
Total Number of Shares Purchased as Part of a Publicly Announced Plans or Programs (2)
19.7
(1)
The Corporation repurchased 12,479 shares of common stock in connection with the vesting of certain stock awards to cover minimum statutory withholding taxes.
(2)
On August 24, 2010, the Board of Directors announced a share repurchase program whereby the Corporation is authorized to purchase up to $25.0 million of the Corporation's common stock, of which $10.5 million was 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. The Corporation did not repurchase any common stock shares under this program during the nine months ended September 30, 2015.
Item 4.
Mine Safety Disclosures
Not Applicable 36
Item 6.
Exhibits
Exhibit No. 10.28*
Corporate Integrity Agreement, dated May 14, 2015, by and between PharMerica Corporation and the Office of Inspector General of the United States Department of Health and Human Services.
10.29*
Memorandum of Agreement, dated May 14, 2015, by and between PharMerica Corporation and the United States Department of Justice, Drug Enforcement Administration.
31.1*
Certification of Chief Executive Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2*
Certification of Chief Financial Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1*
Certification of Chief Executive Officer, pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2*
Certification of Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS
XBRL Instance Document.
101.SCH
XBRL Taxonomy Extension Schema Document.
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document.
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document.
101.LAB
XBRL Taxonomy Extension Label Linkbase Document.
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document.
*
Furnished herewith.
37
SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. PHARMERICA CORPORATION Date: November 6, 2015
/s/ Gregory S. Weishar Gregory S. Weishar Chief Executive Officer and Director
Date: November 6, 2015
/s/ David W. Froesel, Jr. David W. Froesel, Jr. Executive Vice President, Chief Financial Officer and Treasurer /s/ Berard E. Tomassetti Berard E. Tomassetti Senior Vice President and Chief Accounting Officer
Date: November 6, 2015
38
Exhibit Index Exhibit No.
Description
10.28
Corporate Integrity Agreement, dated May 14, 2015, by and between PharMerica Corporation and the Office of Inspector General of the United States Department of Health and Human Services.
10.29
Memorandum of Agreement, dated May 14, 2015, by and between PharMerica Corporation and the United States Department of Justice, Drug Enforcement Administration.
31.1
Certification of Chief Executive Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2
Certification of Chief Financial Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1
Certification of Chief Executive Officer, pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2
Certification of Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS
XBRL Instance Document.
101.SCH
XBRL Taxonomy Extension Schema Document.
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document.
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document.
101.LAB
XBRL Taxonomy Extension Label Linkbase Document.
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document.
39
U.S. DEPARTMENT OF JUSTICE DRUG ENFORCEMENT ADMINISTRATION MEMORANDUM OF AGREEMENT
This Memorandum of Agreement ("Agreement") is entered into by and between the United States Department of Justice, Drug Enforcement Administration (hereinafter "DEA") and PHARMERICA CORPORATION (hereinafter "PMC"), each a "Party" and collectively hereinafter the "Parties". I. APPLICABILITY This Agreement shall be applicable to PHARMERICA CORPORATION and any PHARMERICA retail pharmacies, current or future, within the United States, registered with DEA to dispense, distribute, or otherwise handle controlled substances or List I chemicals. Unless specifically stated herein, nothing contained in this Agreement will lessen, supplant or expand PMC's legal obligations under any statute, regulation, or law. II. BACKGROUND Based on investigations conducted by the DEA at eleven PHARMERICA retail pharmacies, under DEA Registration Numbers BV5369740, BP5312121, BP6553677, BP9444136, BP5703788, BP5723449, FK0624571, FP0954568, BG5758113, FP0640537 and BP5704324, the United States of America, acting through the United States Attorney's Offices for the Eastern District of Wisconsin, the Eastern and Western Districts of Virginia, and the District of Rhode Island, contends that it had certain civil penalty claims against PMC. PharMerica acknowledges that its pharmacies, to include PharMerica Pharmacies specified in the above paragraph, on some occasions during the Covered Conduct period, dispensed controlled substances in a manner not consistent with its obligations under the CSA and the CSA's implementing regulations. To avoid the delay, uncertainty, inconvenience, and expense of protracted litigation of the above referenced claims, PMC, DEA, and the U.S. Attorney's Office for the Eastern District of Virginia and the Western District of Virginia, entered into Settlement Agreements on January 8, 2014 and April 15, 2014, respectively. Contemporaneous to this Agreement, PMC, DEA, and the U.S. Attorney's Offices for the Eastern District of Wisconsin and the District of Rhode Island are also entering into a Settlement Agreement.
III. TERMS AND CONDITIONS A.
Intention of Parties to Effect Settlement
Based on PMC's acceptance of responsibility as stated in the Settlement Agreements, PMC agreed to enter into a compliance agreement, also referred to as "Memorandum of Agreement", as required by the DEA. B.
Covered Conduct
For purposes of this Agreement, "Covered Conduct" shall mean the following conduct, whether it occurred at any of the PMC pharmacy locations listed above or at any other PMC Pharmacy locations throughout the United States. (1)
PMC dispensed Schedule II controlled substances and failed to obtain valid prescriptions written by a practitioner, as required per 21 U.S.C.
§ 829(a), such violations included: (a)
PMC initiated partially or fully pre-populated templates/forms, transmitted via facsimile, for a practitioner to sign. Under these circumstances, the practitioner had yet made the determination, in the usual course of practice, that there was a legitimate medical purpose for the prescription. PMC's practice failed to meet the requirements of 21 U.S.C. § 829 (a) and 21 C.F.R. § 1306.04(a);
(b)
PMC dispensed Schedule II controlled substances and failed to obtain a written prescription prior to the dispensation took place in
that a signed prescription was obtained after the fact, as required per 21 U.S.C. § 829(a) and 21 C.F.R. § 1306.11(a); (c)
PMC dispensed Schedule II controlled substances pursuant to orders from long term care facilities that failed to include required
elements, such as the patient's address, quantity prescribed, dosage form, practitioner's name, practitioner's address, practitioner's signature, and DEA registration number, in violation of 21 U.S.C. § 829 (a) and 21 C.F.R. § 1306.05(a); (2)
PMC dispensed Schedule II controlled substances "refills" to patients without obtaining a new prescription. The refilling of a Schedule II
controlled substance is prohibited. PMC failed to meet the requirements of 21 U.S.C. § 829 (a) and 21 C.F.R. § 1306.12(a).
(3)
PMC dispensed partially filled Schedule II controlled substances and failed to record on the prescription whether the patient was "terminally
ill" or a "LTCF patient", as required per 21 U.S.C. § 829 (a) an d 21 C.F.R. § 1306.13(b). In addition, for each partial filling, PMC failed to record on the back of the prescription (or on another appropriate record, uniformly maintained, and readily retrievable) the date of the partial filling, quantity dispensed, remaining quantity authorized to be dispensed, and the identification of the dispensing pharmacist. (4)
PMC dispensed partially filled Schedule II controlled substances in excess of the total quantity prescribed and for a period that exceeded 60
days from the issue date, both in violation of 21 U.S.C. § 829 (a) and 21 C.F.R. § 1306.13(b). (5)
PMC dispensed emergency Schedule II controlled substances in violation of 21 U.S.C. § 829 (a) and 21 C.F.R. § 1306.11(d), and such
violations included: (a) PMC failed to receive an oral authorization of a prescribing individual, as required by U.S.C. § 829 (a) an d 21 C.F.R. § 1306.11(d); (b) PMC dispensed emergency Schedule II controlled substances and failed to dispense the quantities limited to the amount adequate to treat the patient during the emergency period, as required per 21 U.S.C. § 829 (a) and 21 C.F.R. § 1306.11(d)(1); and (c) PMC dispensed emergency Schedule II controlled substances and failed to notify the nearest office of the Administration when the practitioner failed to deliver the written prescription to the pharmacy within 7 days after authorizing an emergency oral prescription, as required per 21 U.S.C. § 829 (a) and 21 C.F.R. § 1306.11(d)(4).
(d) PMC dispensed emergency Schedule II controlled substances based on the oral authorization by a practitioner and failed to immediately reduce the oral prescription to writing with all of the information required, as required per 21 U.S.C. § 829 (a) and 21 C.F.R. § 1306.11(d)(2). (6)
PMC dispensed Schedule II controlled substances from emergency kits placed at long-term care facilities and failed to receive an oral
authorization of a prescribing individual practitioner, as required per 21 U.S.C. § 829 (a) and 21 C.F.R. § 1306.11(d). (7)
PMC pharmacists failed to exercise their corresponding responsibility to ensure that controlled substances were dispensed pursuant to
prescriptions that were valid under 21 C.F.R. § 1306.05, and as required per 21 U.S.C. § 829 (a) and 21 C.F.R. § 1306.04(a). (8)
PMC placed Schedule II controlled substances in emergency kits at long-term care facilities and later filed a DEA form 106 acknowledging
that some controlled substances were missing. PMC failed to provide effective controls and procedures to guard against diversion or theft of controlled substances from emergency kits located at long-term care facilities as required per 21 C.F.R. § 1301.71(a). (9)
PMC dispensed Schedule III-V controlled substances in violation of 21 C.F.R. § 829(b)(c) and 21 C.F.R. § 1306.21(a), and such violations
included: (a) PMC dispensed Schedule III–V controlled substances pursuant to Physician's Orders faxed by nurses and failed to obtain a paper prescription signed by a practitioner, or a facsimile of a signed paper prescription, or an oral prescription made by an individual practitioner and promptly reduced to writing; (b)
PMC dispensed Schedule III-V controlled substances in emergency kits at long-term care facilities and failed to obtain a paper
prescription signed by a practitioner, or a facsimile of a signed paper prescription, or an oral prescription made by an individual practitioner and promptly reduced to writing, as required per 21 C.F.R. § 829(b)(c) and 21 C.F.R. § 1306.21(a); (c)
PMC dispensed Schedule III-V controlled substances pursuant to prescriptions with missing essential elements, such as the patient's
address, quantity prescribed, dosage form, number of refills, practitioner's name, practitioner's address, practitioner's signature, and DEA registration number, as required per 21 U.S.C. § 829 (b)(c) and 21 C.F.R. § 1306.05(a) (d)
PMC dispensed Schedule III-V controlled substances pursuant to orders from long term care facilities that did not include the
required elements of a prescription, such as the patient's address, quantity prescribed, dosage form, number of refills, practitioner's name, practitioner's address, practitioner's signature, and DEA registration number, as required per 21 U.S.C. § 829 (b)(c) a n d 21 C.F.R. § 1306.05(a). (10)
PMC failed to maintain, on a current basis, a complete and accurate record of each substance received, dispensed, or otherwise disposed of
by him/her, as required per 21 U.S.C. § 827(a)(3) and 21 C.F.R. § 1304.21(a). (11)
PMC failed to record on Copy 1 and 2 of DEA Forms 222 the number of commercial containers furnished and the dates on which the
containers were shipped to the purchaser, as required per 21 U.S.C. § 828 and 21 U.S.21 C.F.R. § 1305.13(b).
(12)
PMC failed to record on Copy 3 of DEA Forms 222 the number of commercial containers furnished and the dates on which the containers
were received by the purchaser, as required per 21 U.S.C. § 828 and 21 C.F.R. § 1305.13(e). (13)
PMC failed to submit to the Virginia Prescription Monitoring Program all controlled substances dispensed as required per Title 54.1-2521
of the Code of Virginia. C.
Term of Agreement
The obligations contained in this Agreement shall remain in full force and effect for a period of three (3) years from the effective date of this Agreement. D.
Obligations of PHARMERICA (1)
PMC shall dispense Schedule II controlled substances only pursuant to valid prescriptions written, signed, and dated on the day signed, by a
practitioner, as required per 21 U.S.C. § 829(a) and 21 C.F.R. § 1306.11(a). (2) (3)
PMC shall not dispense "refills" of Schedule II controlled substance prescriptions. PMC shall not dispense Schedule II controlled substances to a hospice patient pursuant to a faxed prescription that fails to indicate that it
was written for a hospice patient. (4)
In the case of an emergency situation, as defined by 21 C.F.R. § 290.10 , PMC shall only dispense a Schedule II controlled substance upon
receiving oral authorization of a prescribing individual practitioner, as per 21 U.S.C. § 829(a) and 21 C.F.R. § 1306.11, provided that: (a)
The quantity prescribed and dispensed is limited to the amount adequate to treat the patient during the emergency period
(dispensing beyond the emergency period must be pursuant to a paper or electronic prescription signed by the prescribing individual practitioner); (b)
The prescription shall be immediately reduced to writing by the pharmacist and shall contain all information required in 21 C.F.R. §
1306.05, except for the signature of the prescribing individual practitioner; (c)
If the prescribing individual practitioner is not known to the pharmacist, he must make a reasonable effort to determine that the oral
authorization came from a registered individual practitioner, which may include a callback to the prescribing individual practitioner using his phone number as listed in the telephone directory and/or other good faith efforts to insure his identity; and (d)
Within 7 days after authorizing an emergency oral prescription, the prescribing individual practitioner shall cause a written
prescription for the emergency quantity prescribed to be delivered to the dispensing pharmacist. In addition to conforming to the requirements of 21 C.F.R. §1306.05, the prescription shall have written on its face "Authorization for Emergency Dispensing," and the date of the oral order. The paper prescription may be delivered to the pharmacist in person or by mail, but if delivered by mail it must be postmarked within the 7-day period. Upon receipt, the dispensing pharmacist must attach this paper prescription to the oral emergency prescription that had earlier been reduced to writing. For electronic prescriptions, the pharmacist must annotate the record of the electronic prescription with the original authorization and date of the oral order. The pharmacist must notify the nearest office of the Drug Enforcement Administration if the prescribing individual practitioner fails to deliver a written prescription to him; failure of the pharmacist to do so shall void the authority conferred by this paragraph to dispense without a written prescription of a prescribing individual practitioner. (5)
PMC shall not partially fill Schedule II controlled substances without recording on the prescription whether the patient is "terminally ill" or
an "LTCF patient." In addition, for each partial filling dispensed, PMC shall record on the back of the paper prescription (or on another appropriate record, uniformly maintained, and readily retrievable) the date of the partial filling, quantity dispensed, remaining quantity authorized to be dispensed, and the identification of the dispensing pharmacist. Information pertaining to current Schedule II prescriptions for patients in a LTCF or for patients with a medical diagnosis documenting a terminal illness may be maintained in a computerized system if this system has the capability to permit: (a)
Output (display or printout) of the original prescription number, date of issue, identification of prescribing individual practitioner, identification of
patient, address of the LTCF or address of the hospital or residence of the patient, identification of medication authorized (to include dosage, form, strength and quantity), listing of the partial fillings that have been dispensed under each prescription and the information required in 21 C.F.R. § 1306.13(b). (b)
Immediate (real time) updating of the prescription record each time a partial filling of the prescription is conducted.
(c)
Retrieval of partially filled Schedule II prescription information is the same as required by 21 C.F.R. § 1306.22(b)(4) and (5) for Schedule III and IV
prescription refill information.
(6)
By no later than March 1, 2015, PMC shall implement systems to allow for the recording of partial fillings as a subset of the original
prescription number such as .01, .02, .03, etc. After this date, PMC shall not use a new serial number (prescription number) for each partial filling dispensed under the original prescription number. (7)
PMC shall not partially fill Schedule II controlled substances in excess of the total quantity prescribed by the practitioner or for a period that
exceeds 60 days from the issue date of the prescription. (8)
PMC shall partially fill Schedule II controlled substances that were prescribed by a practitioner in the case of an emergency, as defined by 21
C.F.R. § 290.10, in compliance with 21 C.F.R. 1306.13. (9)
PMC shall not fill a Schedule III-V controlled substance prescription that does not conform to the requirements of 21 C.F.R. § 1306.05 ,
including but not limited to obtaining a paper prescription signed by a practitioner; a facsimile of a signed paper prescription; an oral prescription made by an individual practitioner and promptly reduced to writing; or an electronic prescription which meets the requirements of 21 C.F.R. §1306.08. (10)
PMC shall not knowingly fill an invalid prescription or a prescription that it reasonably believes was issued for other than a legitimate
medical purpose or by a practitioner acting outside the usual course of professional practice. (11)
PMC shall not initiate partially or fully pre-populated templates/forms for a practitioner to sign, as PMC may not be characterized as the
prescribing practitioner's agent for purposes of preparing the prescriptions. (12)
PMC shall implement procedures to verify that the DEA registration number for the issuing prescriber of each controlled substance
prescription is a valid, DEA registration number, independent of calling local DEA offices. Such verification shall be performed periodically using the NTIS or similar-reliable third party database where DEA registration changes are recorded. PMC is not precluded from contacting any DEA office to verify the legitimacy of a DEA registration, however, it is understood that the verification of a DEA registration number alone does not fulfill all the obligations of a pharmacist's corresponding responsibility. (13)
PMC shall direct and train its pharmacists to fill prescriptions in accordance with the terms of this Agreement and that their responsibility
under federal law requires them not to fill a prescription that such pharmacist knows or has reason to know was issued for other than a legitimate medical purpose or by a practitioner acting outside the usual course of professional practice. (14)
PMC shall implement and maintain policies and procedures to ensure that Schedule II-V controlled substances are only dispensed pursuant
to valid prescriptions and proper oral authorizations by a prescribing practitioner. (15)
In connection with PMC's recordkeeping requirements pursuant to 21 C.F.R. § 1306.04, PMC agrees to implement no later than March 1,
2015 and thereafter to maintain records regarding the dispensing of controlled substances in electronic format, in addition to the regularly maintained paper files, including records relating to partial fillings of Schedule II controlled substance prescriptions and refills of Schedule III-V controlled substance prescriptions. These records shall be made available to DEA Special Agents, Task Force Officers or Diversion Investigators, upon demand, without the need for a warrant or subpoena, provided that the DEA Special Agents, Task Force Officers or Diversion Investigators present appropriate identification. PMC shall provide electronic reports of dispensing on an ad hoc basis in response to DEA requests within a reasonable time. (16)
By no later than March 1, 2015 PMC shall implement, and thereafter shall maintain, systems to allow for the maintenance on a current basis
of a complete and accurate record of each substance received, dispensed, or otherwise disposed of. (17)
PMC shall maintain a compliance program in an effort to detect and prevent diversion of controlled substances as required under the CSA
and applicable DEA regulations. This program shall include procedures to identify the common signs associated with the diversion of controlled substances. The program shall also include the routine and periodic training of all PMC pharmacy employees responsible for dispensing controlled substances on the elements of the compliance program and their responsibilities under the CSA and applicable DEA regulations. (18)
PMC shall maintain a Department of Compliance which includes employees with pharmacy-related training and managerial experience,
who shall be trained in relevant diversion-related issues to coordinate compliance efforts related to controlled substances. The director of the compliance department shall report directly to the Board of Directors and not simultaneously be an employee of PharMerica's legal department, including but not limited to the general counsel. Within one (1) month of the effective date of this Agreement, PMC will identify the director of the compliance department as a dedicated point of contact (including a name, title, address, telephone number and dedicated email address) for DEA. The point of contact will be responsible for the implementation of PMC's obligations listed in this Memorandum of Agreement and on-going monitoring of its level of compliance. (19)
PMC agrees that DEA personnel, during the term of this Memorandum of Agreement, may enter the PMC's registered locations at any time
during regular operating hours upon presentation of a Notice of Inspection to verify compliance with this memorandum. (20)
PMC shall abide by all state specific Prescription Drug Monitoring program regulations, to the extent required under applicable state law,
contain the correct valid, and active practitioners DEA Registration number.
(21)
PMC shall abide by all regulations relating to the transfer of original prescription information for controlled substances listed in Schedule
III, IV or V, as required by 21 C.F.R. § 1306.25. (22)
PMC shall abide by all regulations relating to the registration and recordkeeping for Automated Dispensing Systems maintained at Long
Term Care Facilities, as required by 21 C.F.R. § 1301.17(c), 1301.27, and 1304.04(a)(2). (23)
Upon the acquisition of a pharmacy, the newly acquired pharmacy shall adhere to the requirements of the CSA and its implementing
regulations prior to dispensing any controlled substance medications and PharMerica shall take measures otherwise to bring the acquired pharmacy into compliance with the non-CSA provisions of this MOA within a reasonable time.
E.
Release by DEA
In consideration of the fulfillment of the obligations of PMC under this Agreement, DEA hereby releases and agrees to refrain from filing any administrative actions against PMC based on the Covered Conduct or similar conduct at any other PMC pharmacy on or before the effective date of this agreement, within DEA's enforcement authority under 21 U.S.C. Sections 823 and 824. Notwithstanding the release by DEA contained in the Paragraph, DEA reserves the right to seek to admit evidence of the Covered Conduct in any other administrative proceedings. Further, nothing in this Paragraph shall prohibit any other agency within the Department of Justice, any State attorney general, or any other law enforcement, administrative, or regulatory agency of the United States or any State or political subdivision thereof ("law enforcement agency"), from initiating administrative, civil, or criminal proceedings with respect to the Covered Conduct. DEA shall, as obligated in fulfilling its statutory duties, assist and cooperate with any law enforcement agency that initiates an investigation, action, or proceeding, involving the Covered Conduct. At PMC's request DEA agrees to disclose the terms of this Agreement to any other law enforcement agency and will represent that PMC's compliance with this Agreement adequately addressed the allegations raised in the administrative proceedings by DEA as defined in the Covered Conduct. F.
Release by PMC
PMC fully and finally releases the United States of America, its agencies, employees, servants, and agents from any claims (including attorney's fees, costs, and expenses of every kind and however denominated) which PMC has asserted, could have asserted, or may assert in the future against the United States of America, its agencies, employees, servants, and agents, related to the Covered Conduct and the United States investigation and prosecution thereof. G.
Reservation of Claims
Notwithstanding any term of the Agreement, specifically reserved and excluded from the scope and terms of the Agreement as to any entity or person (including PMC) are the following:
a)
Any civil, criminal, or administrative liability arising under Title 26, U.S. Code (Internal Revenue Code);
b) Any liability to the United States (or its agencies) for any conduct other than the Covered Conduct subject to paragraph 5 of the Agreement;
c)
Any liability based upon such obligations as are created by this Agreement.
IV. MISCELLANEOUS A.
Binding on Successors This Agreement is binding on PMC, and its respective successors, heirs, transferees, and assigns.
B.
Costs
Each Party to this Agreement shall bear its own legal and other costs incurred in connection with this matter, including the preparation and performance of this Agreement. C.
No Additional Releases
This Agreement is intended to be for the benefit of the Parties and the Released Parties only and by this instrument the Parties do not release any claims against any other person or entity other than the Released Parties. D.
Effect of Agreement
This Agreement constitutes the complete agreement between the Parties. All material representations, understandings, and promises of the Parties are contained in this Agreement, and each of the Parties expressly agrees and acknowledges that, other than those statements expressly set forth in this Agreement, it is not relying on any statement, whether oral or written, of any person or entity with respect to its entry into this Agreement or to the consummation of the transactions contemplated by this Agreement. Any modifications to this Agreement shall be set forth in writing and signed by all Parties. PMC represents that this Agreement is entered into with advice of counsel and knowledge of the events described herein. PMC further represents that this Agreement is voluntarily entered into in order to avoid litigation, without any degree of duress or compulsion. By executing this Agreement, Pharmerica waives all rights to seek judicial review or to challenge or contest the validity of any terms or conditions of this Agreement.
E.
Execution of Agreement
This Agreement shall become effective on the date of signing by the last signatory (the "Effective Date") and remain in effect for a period of three (3) years from the Effective Date. DEA agrees to notify PMC immediately when the final signatory has executed this Agreement. F.
Breach of Agreement
Only material and systemic violations of the provisions of this Agreement may constitute a breach of the Agreement. Parties shall have a reasonable time to cure any such violation. G.
Effect of Breach Violation of any material term of this Agreement may result in the immediate suspension of Pharmerica's DEA Certificate of Registration and in an
administrative hearing, all pursuant to 21 U.S.C. § 824. Further, nothing in this Agreement shall be construed as a waiver on the part of the Drug Enforcement Administration of its authority to utilize any other grounds for revocation or denial of a DEA registration.
H.
Disclosure PMC and DEA may each disclose the existence of this Agreement and information about this Agreement to the public without restriction.
I.
Execution in Counterparts
This Agreement may be executed in counterparts, each of which constitutes an original, and all of which shall constitute one and the same agreement.
J.
Authorizations
The individuals signing this Agreement on behalf of PMC represent and warrant that they are authorized by PMC to execute this Agreement. The individuals signing this Agreement on behalf of DEA represent and warrant that they are signing this Agreement in their official capacity and that they are authorized by DEA to execute this Agreement.
UNITED STATES OF AMERICA
DATED:
5-14-15
/s/ Dennis A. Wichern Dennis A. Wichern Special Agent in Charge Chicago Field Division United States Drug Enforcement Administration
DATED:
___5-14-15
/s/ Karl C. Colder Karl C. Colder Special Agent in Charge Washington Field Division United States Drug Enforcement Administration
PHARMERICA CORPORATION
DATED:
5/11/15
/s/ Michael R. Manthei Michael R. Manthei Jeremy M. Sternberg HOLLAND & KNIGHT LLP
DATED:
5/11/15
/s/ Thomas Caneris Thomas Caneris Vice President and General Counsel PharMerica Corporation
Exhibit 31.1 CERTIFICATION I, Gregory S. Weishar, certify that: 1. I have reviewed this quarterly report on Form 10-Q of PharMerica Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d -15(f)) for the registrant and have: a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c. Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d. Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and 5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions): a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. DATE: November 6, 2015 /s/ Gregory S. Weishar Chief Executive Officer and Director
Exhibit 31.2 CERTIFICATION I, David W. Froesel, Jr., certify that: 1. I have reviewed this quarterly report on Form 10-Q of PharMerica Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a -15(f) and 15d -15(f)) for the registrant and have: a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c. Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d. Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and 5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions): a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. DATE: November 6, 2015 /S/ David W. Froesel, JR. Executive Vice President, Chief Financial Officer and Treasurer
Exhibit 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of PharMerica Corporation (the “Corporation”) on Form 10-Q for the quarter ended September 30, 2015 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Gregory S. Weishar, Chief Executive Officer and Director of the Corporation, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Corporation. /s/ Gregory W. Weishar Gregory S. Weishar Chief Executive Officer and Director November 6, 2015
Exhibit 32.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of PharMerica Corporation (the “Corporation”) on Form 10-Q for the quarter ended September 30, 2015 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, David W. Froesel, Jr., Executive Vice President and Chief Financial Officer of the Corporation, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Corporation. /s/ David W. Froesel, Jr. David W. Froesel, Jr. Executive Vice President, Chief Financial Officer and Treasurer November 6, 2015
UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549
FORM 10-K (Mark One) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the year ended December 31, 2014 or TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to . Commission File Number: 001-33380
PHARMERICA CORPORATION (Exact name of registrant as specified in its charter) Delaware (State or Other Jurisdiction of Incorporation or Organization)
87-0792558 (I.R.S. Employer Identification No.)
1901 Campus Place Louisville, KY (Address of Principal Executive Offices)
40299 (Zip Code)
(502) 627-7000 (Registrant’s Telephone Number, Including Area Code) Securities registered pursuant to Section 12(b) of the Act: Title of each class Common stock $0.01 par value
Name of exchange on which registered New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: N/A (Title of class) Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes
No No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes No Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. Large accelerated filer Non-accelerated filer (Do not check if a smaller reporting company)
Accelerated filer Smaller reporting company
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes
No
The aggregate market value of the voting and non-voting common equity of the registrant held by non-affiliates as of June 30, 2014 was $831,220,514. Class of Common Stock Common stock, $0.01 par value
Outstanding at February 20, 2015 30,154,068 DOCUMENTS INCORPORATED BY REFERENCE
Part III of this Form 10-K incorporates certain information by reference from registrant’s definitive proxy statement for the 2015 annual meeting of stockholders, which proxy statement will be filed no later than 120 days after the close of the registrant’s fiscal year ended December 31, 2014.
PHARMERICA CORPORATION FORM 10-K INDEX Page Part I Item 1. Item 1A. Item 1B. Item 2. Item 3. Item 4.
Business Risk Factors Unresolved Staff Comments Properties Legal Proceedings Mine Safety Disclosures
Part II Item 5. Item 6. Item 7. Item 7A. Item 8. Item 9. Item 9A. Item 9B.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Selected Financial Data Management’s Discussion and Analysis of Financial Condition and Results of Operations Quantitative and Qualitative Disclosures About Market Risk Financial Statements and Supplementary Data Changes in and Disagreements With Accountants on Accounting and Financial Disclosure Controls and Procedures Other Information
Part III Item 10. Item 11. Item 12. Item 13. Item 14.
Directors, Executive Officers and Corporate Governance Executive Compensation Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Certain Relationships and Related Transactions, and Director Independence Principal Accounting Fees and Services
90 90 90 90 90
Part IV Item 15.
Exhibits, Financial Statement Schedules
91
3 14 23 24 24 26
2
27 31 36 54 F-1 88 88 89
Index
Part I Item 1.
Business
Overview Formed in 2006, PharMerica Corporation (the “Corporation,” “we,” “us,” or “our”), a Delaware Corporation, is an institutional 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 98 institutional pharmacies and 14 specialty infusion centers and 5 specialty oncology pharmacies in 45 states. The Corporation’s customers are typically institutional healthcare providers, such as skilled nursing facilities, nursing centers, assisted living facilities, hospitals, individuals receiving in-home care and other long-term alternative care providers. The Corporation is generally the primary source of supply of pharmaceuticals to its customers. The Corporation also provides pharmacy management services to 89 hospitals in the United States.
Institutional Pharmacy Business Our core business provides pharmacy products and services to residents and patients in skilled nursing facilities, nursing centers, assisted living facilities, hospitals, and other long-term alternative care settings. We purchase, repackage, and dispense prescription and non-prescription pharmaceuticals in accordance with physician orders and deliver such medication to healthcare facilities for administration to individual patients and residents. Depending on the specific location, we service healthcare facilities typically within a radius of 120 miles or less of our pharmacy locations at least once each day. We provide 24-hour, seven-day per week on-call pharmacist services for emergency dispensing, delivery, and/or consultation with the facility’s staff or the resident’s attending physician. We also provide various supplemental healthcare services that complement our institutional pharmacy services. We offer prescription and non-prescription pharmaceuticals to our customers through unit dose or modified unit dose packaging, dispensing, and delivery systems, typically in a 14 to 30 day supply. Unit dose medications are packaged for dispensing in individual doses as compared to bulk packaging used by most retail pharmacies. The customers we serve prefer the unit dose delivery system over the bulk delivery system employed by retail pharmacies because it improves control over the storage and ordering of drugs and reduces errors in drug administration in healthcare facilities. Nursing staff in our customers’ facilities administer the pharmaceuticals to individual patients and residents. The Corporation also utilizes an on-site dispensing system, with real time data transfer between the system and the Corporation, which provides timely medication administration in emergency and first dose situations. We also offer clinical pharmacy programs that encompass a wide range of drug therapy and disease management protocols, including protocols for anemia treatment, infectious diseases, wound care, nutritional support, renal dosing, and therapeutic substitution. Our computerized dispensing and delivery systems are designed to improve efficiency and control over distribution of medications to patients and residents. We provide computerized physician orders and medication administration records for patients or residents on a monthly basis as requested. Data from these records are formulated into monthly management reports on patient and resident care and quality assurance. This system improves efficiencies in nursing time, reduces drug waste, and helps to improve patient outcomes. Hospital Pharmacy Management Services We also provide hospital pharmacy management services. These services generally entail the overall management of the hospital pharmacy operations, including the ordering, receipt, storage, and dispensing of pharmaceuticals to the hospital’s patients pursuant to the clinical guidelines established by the hospital. We offer the hospitals a wide range of regulatory and financial management services, including inventory control, budgetary analysis, staffing optimization, and assistance with obtaining and maintaining applicable regulatory licenses, certifications, and accreditations. We work with the hospitals to develop and implement pharmacy policies and procedures, including drug formulary development and utilization management. We also offer clinical pharmacy programs that encompass a wide range of drug therapy and disease management protocols, including protocols for anemia treatment, infectious diseases, wound care, nutritional support, renal dosing, and therapeutic substitution. The hospital pharmacy management services business is comprised of a few customers, of which, our largest service is to the majority of the Kindred hospitals. 3
Index
Consultant Pharmacist Services Federal and state regulations mandate that long-term care facilities, in addition to providing a source of pharmaceuticals, retain consultant pharmacist services to monitor and report on prescription drug therapy in order to maintain and improve the quality of resident care. On September 30, 2008, the United States Department of Health and Human Services Office of Inspector General (“OIG”) published OIG Supplemental Compliance Program Guidance for Nursing Homes. With quality of care being the first risk area identified, the supplemental guidance is part of a series of government efforts focused on improving quality of care at skilled nursing and long-term care facilities. The guidance contains compliance recommendations and an expanded discussion of risk areas. The guidance stressed that facilities must provide pharmaceutical services to meet the needs of each resident and should be mindful of potential quality of care problems when implementing policies and procedures on proper medication management. It further stated that facilities can reduce risk by educating staff on medication management and improper pharmacy kickbacks for consultant pharmacists and that facilities should review the total compensation paid to consultant pharmacists to ensure it is not structured in a way that reflects the volume or value of particular drugs prescribed or administered to residents. We provide consultant pharmacist services to approximately 67% of our patients serviced. The services offered by our consultant pharmacists include: • • • • •
Monthly reviews of each resident’s drug regimen to assess the appropriateness and efficiency of drug therapies, including the review of medical records, monitoring drug interactions with other drugs or food, monitoring laboratory test results, and recommending alternative therapies; Participation on quality assurance and other committees of our customers, as required or requested by such customers; Monitoring and reporting on facility-wide drug utilization; Development and maintenance of pharmaceutical policy and procedure manuals; and Assistance with federal and state regulatory compliance pertaining to resident care.
Medical Records The Corporation provides medical records services, which includes the completion and maintenance of medical record information for patients in the Corporation’s customer’s facilities. The medical records services include: • • • • •
Real-time access to medication and treatment administration records, physician order sheets and psychotropic drug monitoring sheets; Online ordering to save time and resources; A customized database with the medication profiles of each resident’s medication safety, efficiency and regulatory compliance; Web-based individual patient records detailing each prescribed medicine; and Electronic medical records to improve information to make it more legible and instantaneous.
Specialty Infusion Services The Corporation provides specialty infusion services focused on providing complex pharmaceutical products and clinical services to patients in client facilities, hospice, and outside of hospital or nursing home settings. We offer high-touch clinical services to patients with acute or chronic conditions. The delivery of specialty infusion therapy requires comprehensive planning and monitoring which is provided through our registered nursing staff. Our nursing staff performs an initial patient assessment, provides therapy specific training and education, administers therapy and monitors for potential side effects. We also provide extensive clinical monitoring and patient follow-up to ensure patient therapy adherence and proactively manage patients’ conditions. An in-network strategy facilitates easier decision-making for referral sources and provides us with the ability to pre-authorize patients, auto adjudicate, and bill electronically, enabling faster prescription turnaround.
Specialty Oncology Pharmacy We provide dispensing of oncology drugs, care management and other related services to patients, oncology practices, and hospitals. These services encompass clinical coordination and review, compliance to appropriate oncology protocols, patient assistance with outside funding, and timely delivery of medication. We coordinate the administration of medications to the physician’s office or directly to the patient at the appropriate point of treatment. We work directly with the payers to bill insurance companies for the medication provided, ensuring all prior authorizations and approvals are obtained. These services offer physicians an alternative to the traditional buy-andbill distribution model, allowing them to outsource drug procurement, inventory management, and prescription administration. 4
Index
Our Business Focus Drive Scale Economies. We will focus on consistently providing quality pharmaceutical services to our customers at competitive prices and delivery of prescriptions in a timely and effective manner. Our business seeks to implement innovative and cost-effective solutions to improve the provision of medication to our customers and the residents and patients that they serve. Focus on Organic Growth through New Sales and Client Retention. We aim to grow our business through expansion in our existing markets and by servicing new customers. We believe our industry has underlying market growth potential attributable to both an increase in drug utilization as well as the general aging population of the United States. Acquire Competitors. We also intend to expand our market share through selected geographic expansion in markets not currently served by us and through strategic acquisitions in existing and underserved markets. The Corporation currently operates in 45 states. We believe that there are growth opportunities in several other markets. There are numerous businesses in our markets, mostly small or regional companies that lack the scale that we believe will be necessary to ultimately compete in a market that is national in scope. We intend to actively seek opportunities to acquire companies. Since its formation in 2006, the Corporation has acquired 16 institutional pharmacy businesses, two specialty infusion services business and one specialty oncology pharmacy.
Sales and Marketing We sell our products and services through a national sales force. The sales force is organized by both geographic lines and size of client. We believe this helps us to maximize coverage, manage costs, and align more effectively with our operating regions. Our sales representatives specialize in the products and services we offer and the markets in which we operate. Their knowledge permits us to meet the unique needs of our customers while maintaining profitable relationships.
Customers Institutional Care Settings. Our customers are typically institutional healthcare providers, such as skilled nursing facilities, nursing centers, assisted living facilities and other long-term alternative care settings. We are generally the primary source of pharmaceuticals for our customers. Our customers depend on institutional pharmacies like us to provide the necessary pharmacy products and services and to play an integral role in monitoring patient medication regimens and safety. We dispense pharmaceuticals in patient specific packaging in accordance with physician instructions. During 2013, revenues from Kindred Healthcare (“Kindred”) facilities represented approximately 9.2% of the Corporation’s total revenues. Kindred did not renew the Corporation's contract for pharmacy services and the contract expired on December 31, 2013. As of January 1, 2014, we no longer provide institutional pharmacy services to Kindred. Specialty Infusion Services. At December 31, 2014, the Corporation provided specialty infusion services to patients in 14 states with acute or chronic conditions in a setting outside of a hospital or nursing home. Specialty Oncology Services. At December 31, 2014, the Corporation provided specialty oncology medication services to patients in 44 states with acute and chronic conditions in a hospital or physician practice or the home setting. Hospital Pharmacy Management Services. At December 31, 2014, the Corporation provided hospital pharmacy management services to Kindred and other customers at 89 locations.
Suppliers/Inventory We obtain pharmaceutical and other products from AmerisourceBergen Drug Corporation ("ABDC") and other contracts negotiated directly with pharmaceutical manufacturers for discounted prices. The loss of a supplier could adversely affect our business if alternate sources of supply are unavailable. We seek to maintain an on-site inventory of pharmaceuticals and supplies to ensure prompt delivery to our customers. ABDC maintains local distribution facilities in most major geographic markets in which we operate. In addition, beginning in the fourth quarter of 2013, we began supplying many of our pharmacies with select products from a distribution center operated by a third-party logistics company. 5
Index
The Corporation and ABDC are parties to certain legal proceedings with respect to the Amended Prime Vendor Agreement, as amended by the First Amendment to the Amended Prime Vendor Agreement (the “Amended PVA”) as further described in Note 6 of the consolidated financial statements. On March 2, 2015, the corporation provided ABDC with a notice of termination of the Amended PVA effective April 1, 2015. On February 27, 2015, we signed a new Prime Vendor Agreement with Cardinal Health. See Item 9B below.
Brand versus Generic The following table summarizes the Corporation’s generic drug dispensing rate: 2012 83.3%
2013 83.4%
2014 84.9%
The following table summarizes the material brand-to-generic conversions expected to occur in 2015 through 2018: 2015 Colcrys (Q1) Copaxone (Q1) Invega (Q1) Lumigan (Q1) Renegal (Q1) Abilify (Q2)* Renvela (Q2) Zyvox (Q2)* Aggrenox (Q3) Exelon (Q3)* Namenda IR (Q3)* Patanol (Q4) Avodart (Q4)
2016 Gleevec (Q1) Nuedexta (Q1) Combivent (Q2) Crestor (Q2) Cubicin (Q2) Lantus (Q2)* Advair Diskus (Q3)* Tamiflu (Q3) Azilect (Q4) Zetia (Q4)
2017 Symbicort (Q3) Namenda XR (Q4)* Seroquel XR (Q4)
2018 Novolog (Q1) Spiriva (Q1) Nasonex (Q2)
* These represent the most significant brand-to-generic conversions (Number in parentheses refers to the expected quarter of conversion)
When a branded drug shifts to a generic, initial pricing of the generic drug in the market will vary depending on the number of manufacturers launching their generic version of the drug. Historically, a shift from brand-to-generic decreased our revenue and improved our gross margin from sales of these classes of drugs during the initial time period that a brand drug has a generic alternative. However, recent experience has indicated that the third-party payers may reduce their reimbursements to the Corporation faster than previously experienced. In addition, the number of generic manufacturers entering the market impacts the overall cost and reimbursement of generic drugs. This acceleration in the reimbursement reduction and the number of generic manufacturers have resulted in margin compression much earlier than we have historically experienced. Due to the unique nature of the brand-to-generic conversion, management cannot estimate the future financial impact of the brand-to-generic conversions on the Corporation’s results of operations. 6
Index
Supplier and Manufacturer Rebates We currently receive rebates from certain manufacturers and distributors of pharmaceutical products for achieving targets of market share or purchase volumes. Rebates are designed to prefer, protect, or maintain a manufacturer’s products that are dispensed by the pharmacy under its formulary. Rebates for brand name products are generally based upon achieving a defined market share tier within a therapeutic class and can be based on either purchasing volumes or actual prescriptions dispensed. Rebates for generic products are more likely to be based on achieving purchasing volume requirements.
Information Technology Computerized medical records and documentation are an integral part of our distribution system. We primarily utilize a proprietary information technology infrastructure that automates order entry of medications, dispensing of medications, invoicing, and payment processing. These systems provide consulting drug review, electronic medication management, medical records, and regulatory compliance information to help ensure patient safety. These systems also support verification of eligibility and electronic billing capabilities for the Corporation’s pharmacies. They also provide order entry, shipment, billing, reimbursement and collection of service fees for medications, specialty services and other services rendered. Based upon our electronic records, we are able to provide reports to our customers and management on patient care and quality assurance. These reports help to improve efficiency in patient care, reduce drug waste, and improve patient outcomes. We expect to continue to invest in technologies that help critical information access and system availability.
Sources of Pharmacy Revenues We receive payment for our services from third party payers, including Medicare Part D Plans, government reimbursement programs under Medicare and Medicaid, and non-government sources such as institutional healthcare providers, commercial insurance companies, health maintenance organizations, preferred provider organizations, private payers, and contracted providers. The sources and amounts of our revenues will be determined by a number of factors, including the mix of our customers’ patients, brand to generic conversions and the rates and changes of reimbursement among payers. Changes in our customers’ censuses, the case mix of the patients, brand and generic dispensing rates, and the payer mix among private pay, Medicare Part D, institutional healthcare providers, and Medicaid, will affect our profitability. A summary of revenue by payer type for the years ended December 31, are as follows (dollars in millions): 2012
Medicare Part D Institutional healthcare providers Medicaid Private and other Insured Medicare Hospital management fees Total
2013
$
Amount 873.0
% of Revenues 47.6% $
Amount 813.7
$
561.4 165.9 84.7 79.5 4.2 63.9 1,832.6
30.6 9.1 4.6 4.3 0.3 3.5 100.0% $
519.2 157.0 77.2 113.0 15.5 62.3 1,757.9
2014 % of Revenues 46.3% $
Amount 866.0
29.5 9.0 4.4 6.4 0.9 3.5 100.0% $
459.7 167.1 81.9 239.0 21.9 58.9 1,894.5
% of Revenues 45.7% 24.3 8.8 4.3 12.6 1.2 3.1 100.0%
The change in the revenue by payer type, as a percent of total revenue, over the three year period is a result of the 2012 acquisition of Amerita and the 2013 acquisition of Onco, both of which are more heavily weighted to insured and Medicare payer sources.
Competition We face a highly competitive environment in the institutional pharmacy market. In each geographic market, there are national, regional and local institutional pharmacies that provide services comparable to those offered by our pharmacies which may have greater financial and other resources than we do and may be more established in the markets they serve than we are. In addition, owners of skilled nursing facilities are also entering the institutional pharmacy market, particularly in areas of their geographic concentration. On a nationwide basis, there is one larger competitor in the institutional pharmacy industry, Omnicare, Inc. We believe that the competitive factors most important to our business are pricing, quality and the range of services offered, clinical expertise, ease of doing business with the provider and the ability to develop and maintain relationships with customers. Because relatively few barriers to entry exist in the local markets we serve, we have encountered and will continue to encounter substantial competition from local market entrants. 7
Index
Patents, Trademarks and Licenses We use a number of trademarks and service marks. All of the principal trademarks and service marks used in the course of our business have been registered in the United States or are the subject of pending applications for registration. We have various proprietary products, processes, software and other intellectual property that are used either to facilitate the conduct of our business or that are made available as products or services to customers. We generally seek to protect such intellectual property through a combination of trade secret, patent and copyright laws and through confidentiality and other contractually imposed protections. Although we believe that our products and processes do not infringe upon the intellectual property rights of any third parties, third parties may assert infringement claims against us from time to time.
Seasonality Our largest customers in institutional pharmacy services are skilled nursing facilities. Both prescription and non-prescription drug sales at skilled nursing facilities are affected by the timing and severity of the cold/flu season and other seasonality of the long-term care facilities industry, however seasonality does not have a material effect on the Corporation’s consolidated financial results.
Working Capital For information about the Corporation’s practices relating to working capital items, see Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources”.
Employees As of December 31, 2014, we had approximately 6,000 employees which included approximately 1,200 part-time employees. The Corporation had approximately 330 employees that were covered by collective bargaining agreements as of December 31, 2014. As of December 31, 2014, we employed approximately 1,500 licensed pharmacists. We believe that our relationships with our employees are good. Government Regulation
General Extensive federal, state and local regulations govern institutional pharmacies and the healthcare facilities that they serve. These regulations cover licenses, staffing qualifications, conduct of operations, reimbursement, recordkeeping and documentation requirements and the confidentiality and security of health-related information. Our institutional pharmacies are also subject to federal and state laws that regulate financial arrangements between healthcare providers, including the federal anti-kickback statutes and the federal physician self-referral laws.
Licensure, Certification and Regulation States generally require that the state board of pharmacy license a pharmacy operating within the state. Many states also regulate out-of-state pharmacies that deliver prescription products to patients or residents in their states. We have the necessary pharmacy state licenses, or pending applications, for each pharmacy we operate. Our pharmacies are also registered with the appropriate federal and state authorities pursuant to statutes governing the regulation of controlled substances. In addition, pharmacists, nurses and other healthcare professionals who provide services on our behalf are in most cases required to obtain and maintain professional licenses and are subject to state regulation regarding professional standards of conduct. The Drug Enforcement Agency (the “DEA”), the U.S. Food and Drug Administration (the “FDA”), and various state regulatory authorities regulate the distribution of pharmaceutical products and controlled substances. These laws impose a host of requirements on the pharmaceutical supply channel, including providers of institutional pharmacy services. Under the Comprehensive Drug Abuse Prevention and Control Act of 1970, as a dispenser of controlled substances, we must register with the DEA, file reports of inventories and transactions and provide adequate security measures. In addition, we are required to comply with all the relevant requirements of the Controlled Substances Act for the transfer and shipment of pharmaceuticals. The FDA, DEA, and state regulatory authorities have broad enforcement powers, including the ability to seize or recall products and impose significant criminal, civil and administrative sanctions for violations of these laws and regulations. We have received all necessary regulatory approvals and believe that our pharmacy operations are in substantial compliance with applicable federal and state good manufacturing practice requirements. 8
Index
Client long-term care facilities are separately required to be licensed in the states in which they operate and, if serving Medicaid or Medicare patients, must be certified to be in compliance with applicable program participation requirements. Client facilities are also subject to the nursing home reforms of the Omnibus Budget Reconciliation Act of 1987, as amended, which imposed strict compliance standards relating to quality of care for facility operations, including vastly increased documentation and reporting requirements.
Laws Affecting Referrals and Business Practices We are subject to federal and state laws that govern financial and other arrangements between healthcare providers. These laws prohibit certain direct and indirect payments or fee-splitting arrangements between healthcare providers that are designed to induce or encourage the referral of patients to, or the recommendation of, a particular provider for medical products and services. These laws include: • •
the federal “anti-kickback” statute, which prohibits, among other things, knowingly or willfully soliciting, receiving, offering or paying remuneration “including any kickback, bribe or rebate” directly or indirectly in return for or to induce the referral of an individual to a person for the furnishing or arranging for the furnishing of any item or service for which payment may be made in whole or in part under Medicare, Medicaid or other federal healthcare programs; and the federal “Stark laws” which prohibit, with limited exceptions, the referral of patients by physicians for certain designated health services, to an entity with which the physician has a financial relationship.
These laws impact the relationships that we may have with potential referral sources. We have a variety of relationships with potential referral sources, including hospitals and skilled nursing facilities with which we have contracted to provide pharmacy services. With respect to the anti-kickback statute, the OIG has enacted safe harbor regulations that outline practices that are deemed protected from prosecution. While we endeavor to comply with the applicable safe harbors, certain of our current arrangements, none of which is material to us, may not qualify for safe harbor protection. Failure to meet a safe harbor does not mean that the arrangement necessarily violates the anti-kickback statute, but may subject the arrangement to greater scrutiny. In addition, as a means of providing guidance to healthcare providers, the OIG issues a variety of sub-regulatory guidance including Special Fraud Alerts, Special Advisory Bulletins, Advisory Opinions, and other compliance guidance documents. This guidance does not have the force of law, but identifies features of arrangements or transactions that may indicate that the arrangements or transactions violate the anti kickback statute or other federal health care laws. While we believe our practices comply with the anti-kickback statute, we cannot assure our practices that are outside of a safe harbor will not be found to violate the anti-kickback statute. In addition to federal law, many states have enacted similar statutes that are not necessarily limited to items or services for which payment is made by federal healthcare programs. Violations of these laws may result in fines, imprisonment, denial of payment for services and exclusion from the Medicare and Medicaid programs and other statefunded programs. Other provisions in the Social Security Act and in other federal and state laws authorize the imposition of penalties, including criminal and civil fines and exclusions from participation in Medicare, Medicaid and other federal healthcare programs for false claims, improper billing and other offenses. These laws include the federal False Claims Act, under which private parties have the right to bring “qui tam” whistleblower lawsuits against companies that submit false claims for payments to the government. Recent changes to the False Claims Act, expanding liability to certain additional parties and circumstances, may make these qui tam law lawsuits more prevalent. Some states have adopted similar state whistleblower and false claims laws. In addition, a number of states have undertaken enforcement actions against pharmaceutical manufacturers involving pharmaceutical marketing programs, including looking at relationships with pharmacies and programs containing incentives for pharmacists to dispense one particular product rather than another. These enforcement actions arose under various state laws including fraud and abuse laws and consumer protection laws which generally prohibit false advertising and deceptive trade practices. In the ordinary course of business, we are regularly and currently subject to inquiries, investigations and audits by federal and state agencies that oversee applicable healthcare program participation and payment regulations. We believe that the regulatory environment surrounding most segments of the healthcare industry remains intense. Federal and state governments continue to impose intensive enforcement policies resulting in a significant number of inspections, citations for regulatory deficiencies and other regulatory sanctions including demands for refund of overpayments, terminations from the Medicare and Medicaid programs, bars on Medicare and Medicaid payments and fines. Such sanctions could have a material adverse effect on our financial condition, results of operation and liquidity. 9
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We believe our contract arrangements with other healthcare providers and our pharmaceutical suppliers and our pharmacy practices are in substantial compliance with applicable federal and state laws. These laws may, however, be interpreted in the future in a manner inconsistent with our interpretation and application.
State Laws Affecting Access to Services Some states have enacted “freedom of choice” or “any willing provider” requirements as part of their state Medicaid programs or in separate legislation. These laws may preclude a nursing center from requiring their patients and residents to purchase pharmacy or other ancillary medical services or supplies from particular providers that have a supplier relationship with the nursing center. Limitations such as these may increase the competition which we face in providing services to nursing center residents.
HIPAA The Federal Health Insurance Portability and Accountability Act of 1996, commonly known as “HIPAA,” mandates the adoption of regulations aimed at standardizing transaction formats and billing codes for documenting medical services, dealing with claims submissions and protecting the privacy and security of individually identifiable health information. HIPAA regulations that standardize transactions and code sets require standard formatting for healthcare providers, like us, that submit claims electronically. The HIPAA privacy regulations apply to “protected health information,” or “PHI,” which is defined generally as individually identifiable health information transmitted or maintained in any form or medium, excluding certain education records and student medical records. The privacy regulations seek to limit the use and disclosure of most paper and oral communications, as well as those in electronic form, regarding an individual’s past, present or future physical or mental health or condition, or relating to the provision of healthcare to the individual or payment for that healthcare, if the individual can or may be identified by such information. HIPAA provides for the imposition of civil or criminal penalties if PHI is improperly disclosed. HIPAA’s security regulations require us to ensure the confidentiality, integrity and availability of all electronic protected health information that we create, receive, maintain or transmit. We must protect against reasonably anticipated threats or hazards to the security of such information and the unauthorized use or disclosure of such information. In addition to HIPAA, we are subject to state privacy laws and other state privacy or health information requirements not preempted by HIPAA, including those which may furnish greater privacy protection for individuals than HIPAA. The scope of our operations involving health information is broad and the nature of those operations is complex. Although we believe that our contract arrangements with healthcare payers and providers and our business practices are in compliance with applicable federal and state electronic transmissions, privacy and security of health information laws, the requirements of these laws, including HIPAA, are complicated and are subject to interpretation. In addition, state regulation of matters also covered by HIPAA, especially the privacy standards, is increasing, and determining which state laws are preempted by HIPAA is a matter of interpretation. Failure to comply with HIPAA or similar state laws could subject us to loss of customers, denial of the right to conduct business, civil damages, fines, criminal penalties and other enforcement actions. The Health Information Technology for Economic and Clinical Health Act (“HITECH”), part of the American Recovery and Reinvestment Act of 2009, changed several aspects of HIPAA including, without limitation, the following: (i) applies HIPAA security provisions and penalties directly to business associates of covered entities; (ii) requires certain notifications in the event of a security breach involving PHI; (iii) restricts certain unauthorized disclosures; (iv) changes the treatment of certain marketing activities; and (v) strengthens enforcement activities. In addition, the Secretary issued an interim final rule on August 24, 2009 that requires notifications for certain unpermitted disclosures of PHI. The final rule was issued on January 17, 2013.
2010 Health Care Reform Legislation The Patient Protection and Affordable Care Act and the reconciliation law known as Health Care and Education Affordability Reconciliation Act (combined we refer to both Acts as the “2010 Health Care Reform Legislation”) were enacted in March 2010. State participation in the expansion of Medicaid under the 2010 Health Care Reform Legislation is voluntary. Three key provisions of the 2010 Health Care Reform Legislation that are relevant to the Corporation are: (i) the gradual modification to the calculation of the Federal Upper Limit (“FUL”) for drug prices and the definition of Average Manufacturer’s Price (“AMP”), (ii) the closure, over time, of the Medicare Part D coverage gap, which is otherwise known as the “Donut Hole,” and (iii) short cycle dispensing. Regulations under the 2010 Health Care Reform Legislation are expected to continue being drafted, released, and finalized throughout the next several years. 10
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FUL and AMP Changes The 2010 Health Care Reform Legislation amended the Deficit Reduction Act of 2005 (the “DRA”) to change the definition of the FUL by requiring the calculation of the FUL as no less than 175% of the weighted average, based on utilization, of the most recently reported monthly AMP for pharmaceutically and therapeutically equivalent multisource drugs available through retail community pharmacies nationally. In addition, the definition of AMP changed to reflect net sales only to drug wholesalers that distribute to retail community pharmacies and to retail community pharmacies that directly purchase from drug manufacturers. Further, the 2010 Health Care Reform Legislation continues the current statutory exclusion of prompt pay discounts offered to wholesalers and adds three other exclusions to the AMP definition: (i) bona fide services fees;(ii) reimbursement for unsalable returned goods (recalled, expired, damaged, etc.); and (iii) payments from and rebates/discounts to certain entities not conducting business as a wholesaler or retail community pharmacy. In addition to reporting monthly, the manufacturers are required to report the total number of units used to calculate each monthly AMP. Centers for Medicare and Medicaid Services (“CMS”) will use this information when it establishes FULs as a result of the new volume-weighted requirements pursuant to the 2010 Health Care Reform Legislation. In September 2011, CMS issued the first draft FUL reimbursement files for multiple source drugs, including the draft methodology used to calculate the FULs in accordance with the Health Care Legislation. CMS continues to release this monthly data and a three-month rolling average and is expected to do so going forward. CMS has not posted monthly AMPs for individual drugs, but only posted the weighted average of monthly AMPs in a FUL group and the calculation methodology. The Office of Information and Regulatory Affairs website states that the final AMP was expected June 2014, but to date has not been released. Further, CMS has stated that AMP-based FULs will be published at or about the same time that CMS publishes the Medicaid Covered Outpatient Drug final rule, which, according to the latest unified agenda, is expected in April 2015. CMS will continue to post draft monthly FULs. The Corporation will continue to analyze the draft monthly FULs, including the relationship of those FULs to the National Average Drug Acquisition pricing.
Part D Coverage Gap Starting on January 1, 2011, the Medicare Coverage Gap Discount Program (the “Program”) requires drug manufacturers to provide a 50% discount on the negotiated ingredient cost to certain Medicare Part D beneficiaries for certain drugs and biologics purchased during the coverage gap (this is exclusive of the pharmacy dispensing fee). In addition, the 2010 Health Care Reform Legislation requires Medicare to close or eliminate the coverage gap entirely by fiscal year 2020 by gradually reducing the coinsurance percentage for both drugs covered and not covered by the Program for each applicable beneficiary. At this time, the Corporation is unable to fully evaluate the impact of the changes to the coverage gap to its business.
Short Cycle Dispensing and Dispensing Fees Pursuant to the 2010 Health Care Reform Legislation, Prescription Drug Plans (“PDPs”) are required, under Medicare Part D and Medicare Advantage prescription drug plans (“Medicare Advantage” or “MAPDs”) to utilize specific, uniform dispensing techniques, such as weekly, daily, or automated dose dispensing, when dispensing covered Medicare Part D drugs to beneficiaries who reside in a long-term care facility to reduce waste associated with 30 to 90 day prescriptions for such beneficiaries. Pursuant to CMS issued regulation, beginning January 1, 2013, pharmacies dispensing to long-term care facilities must dispense no more than 14-day supplies of brand-name oral solid medications covered by Medicare Part D. The Corporation fully implemented short cycle dispensing on January 1, 2013. The impact of short cycle dispensing has not had a material adverse impact on the Corporation’s results of operations. In a February 12, 2015 Final Rule entitled "Medicare Program: Contract Year 2016 Policy and Technical Changes to the Medicare Advantage and the Medicare Prescription Drug Benefit Programs", CMS finalized a regulation, effective January 1, 2016, prohibiting financial arrangements that penalize more efficient long-term care dispensing techniques (e.g., dispensing a three day supply over a 14 day supply) through pro-rated dispensing fees based on a day's supply or quantity dispensed. CMS also finalized a requirement that, effective January 1, 2016, any differences in payment methodologies among long-term care pharmacies incentivize more efficient dispensing techniques. The Corporation is unable to evaluate the full impact of these changes on its business at this time. 11
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Medicare Part D Changes In a May 23, 2014 Final Rule entitled “Medicare Program: Contract Year 2015 Policy and Technical Changes to the Medicare Advantage and the Medicare Prescription Drug Benefit Programs,” CMS finalized a requirement that, effective June 1, 2015 and enforceable December 1, 2015, all prescribers of Part D covered drugs must be enrolled as Medicare providers (or be granted a valid opt-out affidavit on file with a Part A or Part B Medicare Administrative Contractor) in order for a claim to be covered under Medicare Part D. CMS also finalized several specific requirements to reduce prescriber fraud, waste, and abuse. The Corporation is unable to evaluate the full impact of these changes on its business at this time.
Overview of Reimbursement Medicare is a federal program that provides certain hospital and medical insurance benefits to persons age 65 and over and to certain disabled persons. Medicaid is a medical assistance program administered by each state that provides healthcare benefits to certain indigent patients. Within the Medicare and Medicaid statutory framework, there are substantial areas subject to administrative rulings, interpretations, and discretion that may affect payments made under Medicare and Medicaid. We receive payment for our services from institutional healthcare providers, commercial Medicare Part D Plans, third party payer government reimbursement programs such as Medicare and Medicaid, and other non-government sources such as commercial insurance companies, health maintenance organizations, preferred provider organizations, and contracted providers. With respect to our skilled nursing facilities customers, their residents are covered by Medicare Part A, Part B and Part D Plans, Medicaid, insurance, and other private payers (including managed care).
Medicare The Medicare program consists of four parts: (i) Medicare Part A, which covers, among other things, in-patient hospital, skilled nursing facilities, home healthcare, and certain other types of healthcare services; (ii) Medicare Part B, which covers physicians’ services, outpatient services, and certain items and services provided by medical suppliers such as intravenous therapy; (iii) Medicare Part C or Medicare Advantage, a managed care option for beneficiaries who are entitled to Medicare Part A and enrolled in Medicare Part B, and (iv) Medicare Part D, which provides coverage for prescription drugs that are not otherwise covered under Medicare Part A or Part B for those beneficiaries that enroll.
Part A The Balanced Budget Act of 1997 (the “BBA”) mandated the Prospective Payment System (“PPS”) for Medicare-eligible enrolled residents in skilled nursing facilities. Under PPS, Medicare pays skilled nursing facilities a fixed fee per patient per day for extended care services to patients, covering substantially all items and services furnished during such enrollee’s stay. Such services and items include pharmacy services and prescription drugs. We bill skilled nursing facilities based upon a negotiated fee schedule and are paid based on those contractual relationships. We do not receive direct payment from Medicare for patients covered under the Medicare Part A benefit. We classify the revenues recognized from these payers as Institutional Healthcare Providers. Federal legislation continues to focus on reducing Medicare and Medicaid program expenditures. Such decreases may directly impact the Corporation’s customers and their Medicare reimbursement. Given the changing nature of these rules, we are unable at this time to fully evaluate the impact on our business. Any evaluation of budgeting, cost-cutting, and financing of health care must also consider the new federal administration and the impact its proposed health care policies could have on any future cost considerations.
Part D Medicare Part D provides coverage for prescription drugs that are not otherwise covered under Medicare Part A or Part B for those beneficiaries that enroll. Under Medicare Part D, beneficiaries may enroll in prescription drug plans offered by private commercial insurers who contract with CMS (or in a “fallback” plan offered on behalf of the government through a contractor, to the extent private entities fail to offer a plan in a given area), which provide coverage of outpatient prescription drugs (collectively, “Part D Plans”). Part D Plans include both plans providing the drug benefit on a standalone basis and Medicare Advantage plans providing drug coverage as a supplement to an existing medical benefit under that Medicare Advantage plan. Medicare beneficiaries generally have to pay a premium to enroll in a Part D Plan, with the premium amount varying from one Part D Plan to another, although CMS provides various federal subsidies to Part D Plans to reduce the cost to beneficiaries. 12
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Part D Plans are required to make available certain drugs on their formularies. Dually-eligible residents in nursing centers generally are entitled to have their prescription drug costs covered by a Part D Plan, provided that the prescription drugs which they are taking are either on the Part D Plan’s formulary or an exception to the Part D Plan’s formulary is granted. CMS reviews the formularies of Part D Plans and requires these formularies to include the types of drugs most commonly used by Medicare beneficiaries. CMS also reviews the formulary exceptions criteria of the Part D Plans that provide for coverage of drugs determined by the Part D Plan to be medically appropriate for the enrollee; however there currently is not a separate formulary for long-term care residents. We obtain reimbursement for drugs we provide to enrollees of the given Part D Plan in accordance with the terms of agreements negotiated between us and the Part D Plan. The Medicare Part D final rule prohibits Part D plans from paying for drugs and services not specifically called for by the BBA. Medicare Part D does not alter federal reimbursement for residents of nursing centers whose stay at the nursing center is covered under Medicare Part A. Accordingly, Medicare’s fixed per diem payments to nursing centers under PPS will continue to include a portion attributable to the expected cost of drugs provided to such residents. We will, therefore, continue to receive reimbursement for drugs provided to such residents from the nursing center in accordance with the terms of our agreements with each nursing center. In addition, we receive rebates from pharmaceutical manufacturers for undertaking certain activities that the manufacturers believe may increase the likelihood that we will dispense their products. CMS continues to question whether institutional pharmacies should be permitted to receive these access/performance rebates from manufacturers with respect to prescriptions covered under Medicare Part D, but has not prohibited the receipt of such rebates. CMS defines these as rebates a manufacturer provides to long-term care pharmacies that are designed to “prefer, protect, or maintain” that manufacturer’s product selection by the long-term care pharmacy or to increase the volume of that manufacturer’s products that are dispensed by the pharmacy under its formulary. CMS, in 2007, required PDPs to have policies and systems in place as part of their drug utilization management programs to protect beneficiaries and reduce costs when long-term care pharmacies receive incentives to move market share through access/performance rebates. The elimination or substantial reduction of manufacturer rebates, if not offset by other reimbursement, would have a material adverse effect on our business.
Medicaid The reimbursement rate for pharmacy services under Medicaid is determined on a state-by-state basis subject to review by CMS and applicable federal law. Although Medicaid programs vary from state to state, they generally provide for the payment of certain pharmacy services, up to established limits, at rates determined in accordance with each state’s regulations. The federal Medicaid statute specifies a variety of requirements that a state plan must meet, including the requirements related to eligibility, coverage for services, payment, and admissions. For residents that are eligible for Medicaid only, and are not dual eligibles covered under Medicare Part D, we bill the individual state Medicaid program or in certain circumstances the state’s designated managed care or other similar organizations. Federal regulations and the regulations of certain states establish “upper limits” for reimbursement of certain prescription drugs under Medicaid. In most states, pharmacy services are priced at the lower of “usual and customary” charges or cost, which generally is defined as a function of average wholesale price and may include a profit percentage plus a dispensing fee. Most states establish a fixed dispensing fee per prescription that is adjusted to reflect associated cost. Over the last several years, state Medicaid programs have lowered reimbursement through a variety of mechanisms, principally higher discounts off average wholesale price levels, expansion of the number of medications subject to federal upper limit pricing, and general reductions in contract payment methodology to pharmacies.
Environmental Matters In operating our facilities, historically we have not encountered any material difficulties effecting compliance with applicable pollution control laws. No material capital expenditures for environmental control facilities are expected. While we cannot predict the effect which any future legislation, regulations or interpretations may have upon our operations, we do not anticipate any changes regarding pollution control laws that would have a material adverse impact on the Corporation.
Available Information We make available free of charge on or through our web site, at www.pharmerica.com, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with the Securities and Exchange Commission (“SEC”). Additionally, the public may read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Room 1580, Washington, D.C., 20549. Information regarding operation of the Public Reference Room is available by calling the SEC at 1-800-SEC-0330. Information that we file with the SEC is also available at the SEC’s web site at www.sec.gov. Our SEC filings are available to the public through the New York Stock Exchange (“NYSE”), 20 Broad Street, New York, New York, 10005. Our Common Stock is listed on the NYSE and trades under the symbol “PMC”. The certifications of our Chief Executive Officer and Chief Financial Officer required under Section 302 of the Sarbanes-Oxley Act have been filed as Exhibits 31.1 and 31.2 to this Annual Report on Form 10-K. 13
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Item 1A.
Risk Factors
You should consider carefully the risks described below, together with all of the other information, in evaluating the Corporation and its common stock. If any of the risks described below actually occur, it could have a material adverse effect on the Corporation’s business, results of operations, financial condition and stock price. Risk Factors Relating to Our Business
Financial soundness of our customers and suppliers may adversely affect our results of operations. If our customers’ operating and financial performance deteriorates, or if they are unable to make scheduled payments or obtain credit, our customers may not be able to pay, or may delay payment of accounts receivable owed to us. Any inability of customers to pay us for our products and services may adversely affect our earnings and cash flow. Additionally, both state and federal government sponsored payers, as a result of budget deficits or reductions, may seek to reduce their healthcare expenditures resulting in the long-term care customers renegotiating their contracts with us. Any reduction in payments by such government sponsored payers may adversely affect our earnings and cash flow. Also some of our customers’ real estate is owned by Real Estate Investment Trusts limiting their ability to renegotiate rental costs furthering their desire to reduce other controllable costs, such as pharmacy costs.
Intense competition may erode our profit margins. The distribution of pharmaceuticals to healthcare facilities is highly competitive. In each geographic market, there are national, regional and local institutional pharmacies and numerous local retail pharmacies, which provide services comparable to those offered by our pharmacies and may be more established in the markets they serve than we are. We also compete against regional and local pharmacies that specialize in long-term care. Many of our competitors have equal or greater resources and access to capital than the Corporation. In addition, local pharmacies have strong personal relationships with their customers. Because relatively few barriers to entry exist in the local markets we serve, we may encounter substantial competition from local market entrants. In addition, owners of skilled nursing facilities, including prior and current customers, are also entering the institutional pharmacy market, particularly in areas of their geographic concentration. Consolidation within the institutional pharmacy industry may also lead to increased competition. Competitive pricing pressures may adversely affect our earnings and cash flow. We compete based on innovation and service as well as price. To attract new clients and retain existing clients, we must continually meet service expectations of our clients and customers. We cannot be sure that we will continue to remain competitive with the service to our clients at our current levels of profitability.
If we lose relationships with one or more key pharmaceutical manufacturers or if the payments made or discounts provided by pharmaceutical manufacturers decline, our business and financial results could be adversely affected. We maintain contractual relationships with numerous pharmaceutical manufacturers that may provide us with, among other things: • • •
discounts for drugs we purchase to be dispensed from our institutional pharmacies; rebates based upon distributions of drugs from our institutional pharmacies; and administrative fees for managing rebate programs.
If several of these contractual relationships are terminated or materially altered by the pharmaceutical manufacturers, our business and financial results could be materially adversely affected. In addition, formulary fee programs have been the subject of debate in federal and state legislatures and various other public and governmental forums. Changes in existing laws or regulations or in interpretations of existing laws or regulations or the adoption of new laws or regulations relating to any of these programs may materially adversely affect our business. CMS has questioned whether long-term care pharmacies should be permitted to receive discounts, rebates and other price concessions from pharmaceutical manufacturers with respect to prescriptions covered under the Medicare Part D benefit. Our business would be adversely affected if CMS should take any action that has the effect of eliminating or significantly reducing the rebates that we receive from pharmaceutical manufacturers. 14
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Our operating revenue and profitability may suffer upon the occurrence of the loss of certain customers. We have a number of customers that own or operate numerous facilities in our institutional pharmacy segment. In addition, our hospital revenues are primarily derived from one large multi-facility customer. If we are not able to continue these relationships or are only able to continue these relationships on less favorable terms than the ones currently in place, our operating revenues and results of operations would be materially impacted. There can be no assurance that these customers will not terminate all or a portion of their contracts with the Corporation.
Home infusion joint ventures formed with hospitals could adversely affect our financial results. The home infusion industry is currently seeing renewed activity in the formation of equity-based infusion joint ventures formed with hospitals. This activity stems, in part, from hospitals seeking to position themselves for new paradigms in the delivery of coordinated healthcare and new methods of payment, including an emerging interdisciplinary care model that is being labeled an “accountable care organization”. These organizations are encouraged by the 2010 Health Care Reform Legislation. These entities are being designed in order to save money and improve quality of care by better integrating care, with the healthcare provider possibly sharing in the financial benefits of the improved efficiency. Participation in equity-based joint ventures offers hospitals and other providers an opportunity to more efficiently transfer patients to less expensive care settings, while keeping the patient within its network. Additionally, it provides many hospitals with a mechanism to invest accumulated profits in a growing sector with attractive margins. If home infusion joint ventures continue to expand and we lose referrals as a result, our financial condition, results of operations and liquidity could be adversely affected.
Our operating revenue and profitability may suffer because of an increase in our generic dispensing rate. A shift in prescriptions dispensed from brand-to-generic and a decline in generic reimbursement rates from the PDP/PBMs may affect our operating revenue. When a branded drug shifts to a generic, initial pricing of the generic drug in the market will vary depending on the number of manufacturers launching their generic version of the drug. Historically a shift from brand-to-generic decreased our revenues and improved our gross margin from sales of these classes of drugs during the initial time period a brand drug has a generic alternative. However, recent experience has indicated that the third-party payers may reduce their reimbursements to the Corporation faster than previously experienced. This acceleration in the reimbursement reduction and the number of generic manufacturers have resulted in margin compression as multi-source alternatives have become available much earlier than we have historically experienced. In addition, the number of generic manufacturers entering the market impacts the overall cost and reimbursement of generic drugs. Due to the unique nature of the brand-to-generic conversion, management cannot estimate the future financial impact of the brandto-generic conversions on its results of operations.
If we fail to comply with complex and rapidly evolving laws and regulations, we could suffer penalties, be required to pay substantial damages or make significant changes to our operations. We are subject to numerous federal and state regulations. If we fail to comply with existing or future applicable laws and regulations, we could suffer civil or criminal penalties, including the loss of our licenses to operate our institutional pharmacies and our ability to participate in federal and state healthcare programs. As a consequence of the severe penalties we could face, we must devote significant operational and managerial resources to complying with these laws and regulations. Although we believe that we are substantially compliant with all existing statutes and regulations applicable to our business, different interpretations and enforcement policies of these laws and regulations could subject our current practices to allegations of impropriety or illegality, or could require us to make significant changes to our operations. In addition, we cannot predict the impact of future legislation and regulatory changes on our business or assure that we will be able to obtain or maintain the regulatory approvals required to operate our business. As a result of political, economic, and regulatory influences, the healthcare delivery industry in the United States is under intense scrutiny and subject to fundamental changes. We cannot predict which reform proposals will be adopted, when they may be adopted, or what impact they may have on us. The costs associated with complying with federal and state regulations could be significant and the failure to comply with any such legal requirements could have a material adverse effect on our financial condition, results of operations, and liquidity. 15
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Pharmaceutical products can develop unexpected safety or efficacy concerns. Unexpected safety or efficacy concerns can arise with respect to marketed products, whether or not scientifically justified, leading to product recalls, withdrawals or declining sales. If we fail to or do not promptly withdraw pharmaceutical products upon a recall by a drug manufacturer, our business and results of operations could be negatively impacted.
Legal and regulatory changes reducing reimbursement rates for pharmaceuticals and/or medical treatments or services may reduce our profitability. Both our own profit margins and the profit margins of our customers may be adversely affected by laws and regulations reducing reimbursement rates and charges. The sources and amounts of our revenues are determined by a number of factors, including licensed bed capacity and occupancy rates of our customers, the number of drugs administered to patients, the mix of pharmaceuticals dispensed, whether the drugs are brand or generic, and the rates of reimbursement among payers. Changes in the number of drugs administered to patients, as well as payer mix among private pay, Medicare and Medicaid, in our customers’ facilities will significantly affect our earnings and cash flow.
Further modifications to the Medicare Part D program may reduce revenue and impose additional costs to the industry. The Medicare Prescription Drug Improvement and Modernization Act of 2003 or MMA included a major expansion of the Medicare program with the addition of a prescription drug benefit under the new Medicare Part D program. The continued impact of these regulations depends upon a variety of factors, including our ongoing relationships with the Part D Plans and the patient mix of our customers. Future modifications to the Medicare Part D program may reduce revenue and impose additional costs to the industry. In addition, we cannot assure you that Medicare Part D and the regulations promulgated under Medicare Part D will not have a material adverse effect on our institutional pharmacy business.
Possible changes in, or our failure to satisfy our manufacturers’ rebate programs could adversely affect our results of operations. There can be no assurance that pharmaceutical manufacturers will continue to offer these rebates or that they will not change the terms upon which rebates are offered. A decrease in prescription volumes dispensed or a decrease in the number of brand or generic drugs which participate in rebate programs and are used by the geriatric population could affect our ability to satisfy our manufacturers’ rebate programs. The termination of such programs or our failure to satisfy the criterion for earning rebates may have an adverse affect on our cost of goods sold, financial condition, results of operations and liquidity.
Changes in Medicaid reimbursement may reduce our revenue. The 2010 Health Care Reform Legislation amended DRA to change the definition of the FUL by requiring the calculation of the FUL as no less than 175% of the weighted average, based on utilization, of the most recently reported monthly AMP for pharmaceutically and therapeutically equivalent multi-source drugs available through retail community pharmacies nationally. In addition, the definition of AMP changed to reflect net sales only to drug wholesalers that distribute to retail community pharmacies and to retail community pharmacies that directly purchase from drug manufacturers. Further, the 2010 Health Care Reform Legislation continues the current statutory exclusion of prompt pay discounts offered to wholesalers and adds three other exclusions to the AMP definition: i) bona fide services fees; ii) reimbursement for unsalable returned goods (recalled, expired, damaged, etc.); and iii) payments from and rebates/discounts to certain entities not conducting business as a wholesaler or retail community pharmacy. In addition to reporting monthly, the manufacturers are required to report the total number of units used to calculate each monthly AMP. CMS will use this information when it establishes FULs as a result of the new volume-weighted requirements pursuant to the 2010 Health Care Reform Legislation. In September 2011, CMS issued the first draft FUL reimbursement files for multiple source drugs, including the draft methodology used to calculate the FULs in accordance with the Health Care Legislation. CMS continues to release this monthly data and a three-month rolling average and is expected to do so going forward. CMS has not posted monthly AMPs for individual drugs, but only posted the weighted average of monthly AMPs in a FUL group and the calculation methodology. The Office of Information and Regulatory Affairs website states that the final AMP was expected June 2014, but to date has not been released. Further, CMS has stated that AMP-based FULs will be published at or about the same time that CMS publishes the Medicaid Covered Outpatient Drug final rule, which, according to the latest unified agenda, is expected in April 2015. CMS will continue to post draft monthly FULs. The Corporation will continue to analyze the draft monthly FULs, including the relationship of those FULs to the National Average Drug Acquisition pricing. 16
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Adverse results in material litigation matters or governmental inquiries could have a material adverse effect upon the Corporation’s business. The Corporation may from time to time become subject in the ordinary course of business to material legal action related to, among other things, intellectual property disputes, professional liability and employee-related matters, as well as inquiries from governmental agencies and Medicare or Medicaid carriers requesting comment and information on allegations of billing irregularities and other matters that are brought to their attention through billing audits, third parties or other sources. The healthcare industry is subject to substantial federal and state government regulation and audit. Legal actions could result in substantial monetary damages as well as damage to the Corporation’s reputation with customers, which could have a material adverse effect upon our financial condition, results of operations, and liquidity.
If we or our customers fail to comply with Medicare and Medicaid regulations, we may be subjected to penalties or loss of eligibility to participate in these programs. The Medicare and Medicaid programs are highly regulated. These programs are also subject to frequent and substantial changes. If we or our customers’ facilities fail to comply with applicable reimbursement laws and regulations, whether purposely or inadvertently, our reimbursement under these programs could be curtailed or reduced and our eligibility to continue to participate in these programs could be adversely affected. Federal or state governments may also impose other penalties on us for failure to comply with the applicable reimbursement regulations. Failure by our customers to comply with these or future laws and regulations could result in our inability to provide pharmacy services to these customers and their residents. We do not believe that we have taken any actions that could subject us to material penalties under these rules and regulations. Among these laws is the federal anti-kickback statute. This statute prohibits anyone from knowingly and willfully soliciting, receiving, offering or paying any remuneration with the intent to refer, or to arrange for the referral or order of, services or items payable under a federal healthcare program. Courts have interpreted this statute broadly. Violations of the anti-kickback statute may be punished by a criminal fine of up to $25,000 for each violation or imprisonment, civil money penalties of up to $50,000 per violation and damages of up to three times the total amount of the remuneration and/or exclusion from participation in federal healthcare programs, including Medicare and Medicaid. This law impacts the relationships that we may have with potential referral sources. We have a variety of relationships with potential referral sources, including hospitals and skilled nursing facilities with which we have contracted to provide pharmacy services. The OIG, among other regulatory agencies, is responsible for identifying and eliminating fraud, abuse or waste. The OIG carries out this responsibility through a nationwide program of audits, investigations and inspections. The OIG has promulgated safe harbor regulations that outline practices that are deemed protected from prosecution under the anti-kickback statute. While we endeavor to comply with the applicable safe harbors, certain of our current arrangements may not qualify for safe harbor protection. Failure to meet a safe harbor does not mean that the arrangement necessarily violates the anti-kickback statute, but may subject the arrangement to greater scrutiny. It cannot be assured that practices outside of a safe harbor will not be found to violate the anti-kickback statute. The anti-kickback statute and similar state laws and regulations are expansive. We do not always have the benefit of significant regulatory or judicial interpretation of these laws and regulations. In the future, different interpretations or enforcement of these laws and regulations could subject our current or past practices to allegations of impropriety or illegality, or could require us to make changes in our facilities, equipment, personnel, services, capital expenditure programs and operating expenses. A determination that we have violated these laws, or the public announcement that we are being investigated for possible violations of these laws, could have a material adverse effect on our business, financial condition, results of operations or prospects and our business reputation could suffer significantly. If we fail to comply with the anti-kickback statute or other applicable laws and regulations, we could be subjected to liabilities, including criminal penalties, civil penalties (including the loss of our licenses to operate one or more facilities), and exclusion of one or more facilities from participation in the Medicare, Medicaid and other federal and state healthcare programs. In addition, we are unable to predict whether other legislation or regulations at the federal or state level will be adopted, what form such legislation or regulations may take or their impact.
Continuing government and private efforts to contain healthcare costs may reduce our future revenue. We could be adversely affected by the continuing efforts of government and private payers to contain healthcare costs. To reduce healthcare costs, payers seek to lower reimbursement rates, limit the scope of covered services and negotiate reduced or capped pricing arrangements. While many of the proposed policy changes would require congressional approval to implement, we cannot assure you that reimbursement payments under governmental and private third party payer programs will remain at levels comparable to present levels or will be sufficient to cover the costs allocable to patients eligible for reimbursement under these programs. Any changes that lower reimbursement rates under Medicare, Medicaid or private pay programs could result in a substantial reduction in our net operating revenues. Our operating margins may continue to be under pressure because of deterioration in reimbursement, changes in payer mix and growth in operating expenses in excess of increases, if any, in payments by third party payers. 17
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Healthcare reform could adversely affect the liquidity of our customers which would have an adverse effect on their ability to make timely payments to us for our products and services. Healthcare reform and legislation may have an adverse effect on our business through decreasing funds available to our customers. Limitations or restrictions on Medicare and Medicaid payments to our customers could adversely impact the liquidity of our customers, resulting in their inability to pay us, or to timely pay us, for our products and services. This inability could have a material adverse effect on our financial condition, results of operations, and liquidity.
The changing U.S. healthcare industry and increasing enforcement environment may negatively impact our business. Our products and services are part of the structure of the healthcare financing and reimbursement system currently existing in the United States. In recent years, the healthcare industry has undergone significant changes in an effort to reduce costs and government spending. These changes include an increased reliance on managed care, cuts in Medicare funding affecting our healthcare provider customer base and consolidation of competitors, suppliers and customers. We expect the healthcare industry to continue to change significantly in the future. Some of these potential changes, such as a reduction in governmental support of healthcare services or adverse changes in legislation or regulations governing prescription drug pricing, healthcare services or mandated benefits, may cause healthcare providers to reduce the amount of our products and services they purchase or the price they are willing to pay for our products and services. If we are unable to adjust to changes in the healthcare environment, it could have a material adverse effect on our financial condition, results of operations and liquidity. Further, both federal and state government agencies have increased their focus on and coordination of civil and criminal enforcement efforts in the healthcare area. The OIG and the U.S. Department of Justice have, from time to time, established national enforcement initiatives, targeting all providers of a particular type, that focus on specific billing practices or other suspected areas of abuse. In addition, under the federal False Claims Act, private parties have the right to bring “qui tam” whistleblower lawsuits against companies that submit false claims for payments to the government. A number of states have adopted similar state whistleblower and false claims provisions. We do not believe that we have taken any actions that could subject us to material penalties under these provisions.
Further consolidation of managed care organizations and other third-party payers may adversely affect our profits. Managed care organizations and other third-party payers have continued to consolidate in order to enhance their ability to influence the delivery of healthcare services. Consequently, the healthcare needs of a large percentage of the U.S. population are increasingly served by a small number of managed care organizations. These organizations generally enter into service agreements with a limited number of providers for needed services. In addition, private payers, including managed care payers, increasingly are demanding discounted fee structures. To the extent that these organizations terminate us as a preferred provider, engage our competitors as a preferred or exclusive provider or demand discounted fee structures, our liquidity and results of operations could be materially and adversely affected.
If we or our customers fail to comply with licensure requirements, laws and regulations in respect of healthcare fraud or other applicable laws and regulations, we could suffer penalties or be required to make significant changes to our operations. Our pharmacies must be licensed by the state board of pharmacy in the state in which they operate. Many states also regulate out-of-state pharmacies that are delivering prescription products to patients or residents in their states. The failure to obtain or renew any required regulatory approvals or licenses could adversely impact the operation of our business. In addition, the healthcare facilities we service are also subject to extensive federal, state and local regulations and are required to be licensed in the states in which they are located. The failure by these healthcare facilities to comply with these or future regulations or to obtain or renew any required licenses could result in our inability to provide pharmacy services to these facilities and their residents and could have a material adverse effect on our financial condition, results of operations and liquidity. While we believe that we are in substantial compliance with all applicable laws, many of the regulations applicable to us, including those relating to marketing incentives offered by pharmaceutical suppliers, and rebates paid by pharmaceutical manufacturers are vague or indefinite and have not been interpreted by the courts. They may be interpreted or applied by a prosecutorial, regulatory or judicial authority in a manner that could require us to make changes in our operations. These changes may be material and may require the expenditure of material funds to implement. We believe that the regulatory environment surrounding most segments of the healthcare industry remains intense. Federal and state governments continue to impose intensive enforcement policies resulting in a significant number of inspections, citations of regulatory deficiencies and other regulatory sanctions including demands for refund of overpayments, terminations from the Medicare and Medicaid programs, bans on Medicare and Medicaid payments and fines. If we or our customers fail to comply with the extensive applicable laws and regulations, we could become ineligible to receive government program reimbursement, suffer civil or criminal penalties or be required to make significant changes to our operations. In addition, we could be forced to expend considerable resources responding to an investigation or other enforcement action under these laws or regulations regardless of whether we have actually been involved in any violations or wrongdoing. 18
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Federal and state medical privacy regulations may increase the costs of operations and expose us to civil and criminal sanctions. We must comply with extensive federal and state requirements regarding the transmission and retention of health information. The Health Insurance Portability and Accountability Act of 1996 and its implementing regulations, referred to as HIPAA, was enacted to ensure that employees can retain and at times transfer their health insurance when they change jobs, to enhance the privacy and security of personal health information and to simplify healthcare administrative processes. HIPAA requires the adoption of standards for the exchange of electronic health information. The HITECH, part of the American Recovery and Reinvestment Act of 2009, changed several aspects of HIPAA including, without limitation, the following: (i) applies HIPAA security provisions and penalties directly to business associates of covered entities; (ii) requires certain notifications in the event of a security breach involving PHI; (iii) restricts certain unauthorized disclosures; (iv) changes the treatment of certain marketing activities; and (v) strengthens enforcement activities. In addition, the Secretary of Health and Human Services issued an interim final rule on August 24, 2009 that requires notifications for certain unpermitted disclosures of PHI. The final rule was issued on January 17, 2013. Failure to comply with either HIPAA or HITECH could result in fines and penalties that could have a material adverse effect on our results of operations, financial condition, and liquidity.
Acquisitions, investments and strategic alliances that we have made or may make in the future may use significant resources, may be unsuccessful and could expose us to unforeseen liabilities. We have made and anticipate that we may continue to make acquisitions of, investments in and strategic alliances with complementary businesses to enable us to capitalize on our position in the geographic markets in which we operate and to expand our businesses in new geographic markets. At any particular time, we may be in various stages of assessment, discussion and negotiation with regard to one or more potential acquisitions, investments or strategic alliances, not all of which, if any, will be consummated. Our acquisition program and strategy has and may lead us to contemplate acquisitions of companies in bankruptcy or financial distress, all of which entail additional risks and uncertainties. Such risks and uncertainties include, without limitation, that, before assets may be acquired, customers may leave in search of more stable providers and vendors may terminate key relationships. Also, assets are generally acquired on an “as is” basis, with no recourse to the seller if the assets are not as valuable as may be represented. Finally, while bankrupt companies may be acquired for comparatively little money, the cost of continuing the operations may significantly exceed expectations. Our growth plans rely, in part, on the successful completion of future acquisitions. If we are unsuccessful, our business would suffer. We intend to make public disclosure of pending and completed acquisitions when appropriate or required by applicable securities laws and regulations. Acquisitions may involve significant cash expenditures, debt incurrence, additional operating losses, amortization of certain intangible assets of acquired companies, and expenses that could have a material adverse effect on our financial condition, results of operations and liquidity. Acquisitions involve numerous risks and uncertainties, including, without limitation: • • • • • •
difficulties integrating acquired operations, personnel and information systems, or in realizing projected efficiencies and cost savings; diversion of management’s time from existing operations; potential loss of key employees or customers of acquired companies; inaccurate assessment of assets and liabilities and exposure to undisclosed or unforeseen liabilities of acquired companies, including liabilities for failure to comply with healthcare laws; increases in our indebtedness and a limitation on our ability to access additional capital when needed; and failure to operate acquired facilities profitably or to achieve improvements in their financial performance. 19
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Risks generally associated with our sophisticated information systems may adversely affect our results of operations. We rely on sophisticated information systems in our business to obtain, rapidly process, analyze, and manage data to facilitate the dispensing of prescription and nonprescription pharmaceuticals in accordance with physician orders and deliver those medications to patients and long-term care residents on a timely basis; to manage the accurate billing and collections for thousands of customers; and to process payments to suppliers. Our business and results of operations may be materially adversely affected if these systems are interrupted for any reason, including cyber security threats, or damaged or if they fail for an extended period of time. Significant disruptions to our infrastructure or any of our facilities due to failure of technology or some other catastrophic event could adversely impact our business.
We purchase a significant portion of our pharmaceutical products from one supplier. We are required to purchase a substantial amount of our pharmaceutical products from ABDC, pursuant to the Amended PVA. If ABDC fails to deliver products in accordance with the Amended PVA, there can be no assurance that our operations would not be disrupted or that we could obtain the products at similar cost or at all. In this event, failure to satisfy our customers’ requirements would result in defaults under these customer contracts subjecting us to damages and the potential termination of those contracts. Such events could have a material adverse effect on our financial condition, results of operations and liquidity. In addition, under the terms of the Amended PVA, the Corporation is limited in our ability to negotiate potentially better pricing and other terms with other drug distributors, which could negatively impact our competitive position. On March 2, 2015, we provided ABDC with a notice of termination of the Amended PVA effective April 1, 2015. We have entered into a new Prime Vendor Agreement with Cardinal Health effective April 1, 2015. See Item 9B below.
A loss in rebates and other pricing terms under the Amended PVA may adversely impact our financial results. On January 4, 2011, the Corporation entered into the Amended PVA for Long-Term Care Pharmacies. On January 25, 2013 the Corporation renegotiated its Amended PVA with ABDC effective January 1, 2013. The Amended PVA modifies the previous agreement, which was set to expire September 30, 2013 and extends its term until September 30, 2016. The First Amendment requires the Corporation to purchase certain levels of brand and non-injectable generic drugs from ABDC. The Amended PVA does provide the flexibility for the Corporation to contract with other suppliers. If the Corporation fails to adhere to the contractual purchase provisions ABDC has the ability to increase the Corporation's drug pricing under the terms of the Amended PVA. On September 10, 2014, the Corporation filed a Complaint in Jefferson Circuit Court in Louisville, Kentucky against ABDC for breach of the Amended PVA. The Corporation subsequently filed a First Amended Complaint asserting additional breaches of the Amended PVA. The amounts disputed by ABDC generally relate to certain rebates owed by ABDC under the Amended PVA, which are $8.5 million, $12.3 million, and $20.0 million for the second quarter of 2014, the third quarter of 2014 and the fourth quarter of 2014, respectively. The Corporation believes the aggregate amount of its claims were $40.8 million as of December 31, 2014 which is reflected as a receivable and included in prepaids and other assets in the accompanying consolidated balance sheet. The Corporation will have claims for additional damages resulting from ABDC's breaches of the Amended PVA. The Corporation intends to vigorously pursue its claims. 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, likely longer than 12 months. The Corporation cannot provide any assurances about the outcome of the litigation. A loss in rebates and/or other pricing terms under the Amended PVA may adversely impact our financial results. On March 2, 2015, the Corporation provided ABDC with a notice of termination of the Amended PVA effective April 1, 2015. We have entered into a new Prime Vendor Agreement with Cardinal Health effective April 1, 2015. See Item 9B below.
Prescription volumes may decline, and our net revenues and profitability may be negatively impacted, if products are withdrawn from the market or if increased safety risk profiles of specific drugs result in utilization decreases. We dispense significant volumes of drugs from our pharmacies. These volumes are the basis for our net revenues and profitability. When increased safety risk profiles of specific drugs or classes of drugs result in utilization decreases, physicians may cease writing or reduce the numbers of prescriptions written for these drugs. Additionally, negative press regarding drugs with higher safety risk profiles may result in reduced consumer demand for such drugs. On occasion, products are withdrawn by their manufacturers. In cases where there are no acceptable prescription drug equivalents or alternatives for these prescription drugs, our volumes, net revenues, profitability and cash flows may decline. 20
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We could be required to record a material non-cash charge to income if our recorded goodwill or intangible assets are impaired, or if we shorten intangible asset useful lives. We have $317.7 million of goodwill and $177.6 million of recorded intangible assets on our consolidated balance sheet as of December 31, 2014. Our intangible assets primarily represent the value of client relationships that were recorded from past acquisitions. Under current accounting rules, intangible assets are amortized over their useful lives. These assets may become impaired with the loss of significant clients. If the carrying amount of the assets exceeds the undiscounted pre-tax expected future cash flows from the lowest appropriate asset grouping, we would be required to record a non-cash impairment charge to our consolidated income statements in the amount the carrying value of these assets exceeds its fair value. In addition, while the intangible assets may not be impaired, the useful lives are subject to continual assessment, taking into account historical and expected losses of relationships that were in the base at time of acquisition. This assessment may result in a reduction of the remaining weighted average useful life of these assets, resulting in potentially significant increases to non-cash amortization expense that is charged to our consolidated income statements. A goodwill or intangible asset impairment charge, or a reduction of useful lives, could have a material effect on our results of operations.
We are highly dependent on our senior management team and our pharmacy professionals. We are highly dependent upon the members of our senior management and our pharmacists and other pharmacy professionals. Our business is managed by a small number of senior management personnel. If we were unable to retain these persons, we might be materially adversely affected due to the limited pool of senior management personnel with significant experience in our industry. Accordingly, we believe we could experience significant difficulty in replacing key management personnel. We expect that any employment contracts we enter into with our key management personnel will be subject to termination without cause by either party. Moreover, although the majority of the members of our senior management team have significant experience in the industry, they will need time to fully assess and understand our business and operations. We can offer no assurance how long these members of senior management will choose to remain with us. In addition, our continued success depends on our ability to attract and retain pharmacists and other pharmacy professionals. Competition for qualified pharmacists and other pharmacy professionals is intense. The loss of pharmacy personnel or the inability to attract or retain sufficient numbers of qualified pharmacy professionals could adversely affect our business. Although we generally have been able to meet our staffing requirements for pharmacists and other pharmacy professionals, our inability to do so in the future could have a material adverse effect on our financial condition, results of operations and liquidity.
Our revenues and volume trends may be adversely affected by certain factors relevant to the markets in which we have pharmacies, including weather conditions and other natural disasters, some of which may not be covered by insurance. Our revenues and volume trends will be predicated on many factors, including physicians’ pharmaceutical decisions on patients, payer programs, seasonal and severe weather conditions including the effects of extreme low temperatures, hurricanes and tornadoes, earthquakes, current local economic and demographic changes, some of which may not be covered by insurance. Any of these factors could have a material adverse effect on our revenues and volume trends, and many of these factors will not be within the control of our management. These factors may also have an effect on our customers and their ability to continue to operate. For further discussion, see Note 9.
There are inherent uncertainties involved in estimates, judgments, and assumptions used in the determination of our litigation-related accruals and the preparation of financial statements in accordance with generally accepted accounting principles in the United States (U.S. GAAP). Any changes in estimates, judgments, and assumptions could have a material adverse effect on the Company's financial position, results of operations, or cash flows. Our financial statements filed with the SEC are prepared in accordance with U.S. GAAP, and the preparation of such financial statements includes making estimates, judgments, and assumptions that affect reported amounts of assets, liabilities, and related reserves, revenues, expenses, and income. We evaluate our exposure to legal proceedings and establish reserves for the estimated liabilities in accordance with U.S. GAAP. Assessing and predicting the outcome of these matters involves substantial uncertainties. Unexpected outcomes in these legal proceedings, or changes in management's evaluations or predictions and accompanying changes in established reserves, could have a material adverse impact on our financial results. Estimates are inherently subject to change in the future, and such changes could result in corresponding changes to the amounts of assets, liabilities, income, or expenses and likewise could have an adverse effect on our financial position, results of operations, or cash flows. 21
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Risk Factors Relating to Ownership of Our Common Stock and Our Senior Secured Credit Facility
Certain provisions of our certificate of incorporation and bylaws and provisions of Delaware law could delay or prevent a change of control that stockholders favor. Provisions of our certificate of incorporation and bylaws may discourage, delay or prevent a merger or other change of control that stockholders may consider favorable or may impede the ability of the holders of our common stock to change our management and Board of Directors. The provisions of our certificate of incorporation and bylaws, among other things: • • • • •
prohibit stockholder action except at an annual or special meeting. Specifically, this means our stockholders are unable to act by written consent; regulate how stockholders may present proposals or nominate directors for election at annual meetings of stockholders. Advance notice of such proposals or nominations is required; regulate how special meetings of stockholders may be called. Our stockholders do not have the right to call special meetings; authorize our board of directors to issue preferred stock in one or more series, without stockholder approval. Under this authority, our Board of Directors adopted the Rights Agreement which could ensure continuity of management by rendering it more difficult for a potential acquirer to obtain control of us; and require an affirmative vote of the holders of three-quarters or more of the combined voting power of our common stock entitled to vote in the election of our directors in order for the stockholders to amend our bylaws.
In addition, because we have not chosen to be exempt from Section 203 of the Delaware General Corporation Law (“DGCL”), this provision could also delay or prevent a change of control that some stockholders may view as favorable. Section 203 provides that unless board and/or stockholder approval is obtained pursuant to the requirements of the statute, persons that acquire, or are affiliated with a person that acquires, more than 15% of the outstanding voting stock of a Delaware corporation shall not engage in any business combination with that corporation, including by merger, consolidation or acquisitions of additional shares, for a three-year period following the date on which that person or its affiliate becomes the holder of more than 15% of the corporation’s outstanding voting stock.
The market price and trading volume of our common stock may be volatile. The market price of our common stock could fluctuate significantly for many reasons, including, without limitation the following: • • • • •
as a result of the risk factors listed in this document; actual or anticipated fluctuations in our results of operations; for reasons unrelated to our specific performance, such as reports by industry analysts, investor perceptions, or negative announcements by our customers or competitors regarding their own performance; regulatory changes that could impact our business or that of our customers; and general economic and industry conditions.
In addition, when the market price of a company’s common stock drops significantly, stockholders often institute securities class action lawsuits against the company. A lawsuit against us could cause us to incur substantial costs and could divert the time and attention of our management and other resources.
Acquisitions, investments and strategic alliances we may make in the future may need to be financed by borrowings under the Credit Agreement for which funds may not be made available by certain participants. We have made and anticipate that we may continue to make acquisitions of, investments in and strategic alliances with complementary businesses to enable us to capitalize on our position in the geographic markets in which we operate and to expand our business in new geographic markets. Our growth plans rely, in part, on the successful completion of future acquisitions. At any particular time, we may need to finance such acquisitions and strategic alliances with borrowings under the Credit Agreement. The financial markets are very volatile and certain participants in our Credit Agreement may not be able to participate in funding their commitments under the revolving line of credit. If we are unsuccessful in obtaining the financing, our business would be impacted. 22
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We are exposed to interest rate changes. We are exposed to market risk related to changes in interest rates. As of December 31, 2014, we had outstanding debt of $350.0 million outstanding under our Credit Agreement and revolver, all of which was subject to variable rates of interest. See Item 7A, “Quantitative and Qualitative Disclosures about Market Risk.”
We have indebtedness, which restricts our ability to pay cash dividends and has a negative impact on our financing options and liquidity. We have $350.0 million in indebtedness outstanding as of December 31, 2014 under our Credit Agreement and revolver. We also have $1.3 million in capital lease obligations at December 31, 2014. On September 17, 2014, the Corporation entered into a Credit Agreement by and among the Corporation, the lenders named therein, 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 (the "Credit Agreement"). The Credit Agreement replaced the $450.0 million five-year credit agreement dated as of May 2, 2011, among the Corporation, Citibank, N.A., as Administrative Agent, and certain lenders. The Credit Agreement consists of a $225.0 million term loan facility and a $310.0 million revolving credit facility. The terms and conditions of the Credit Agreement are customary to facilities of this nature. Unless terminated earlier, the Credit Agreement will mature on September 17, 2019, and the principal amount outstanding thereunder, together with all accrued unpaid interest and other amounts owed thereunder, if any, will be payable in full on such date. The Credit Agreement also contains financial covenants that require us to satisfy certain financial tests and maintain certain financial ratios, including a maximum of debt to EBITDA ratio. The Credit Agreement limits our ability to declare and pay dividends or other distributions on our shares of common stock. If our lenders permit us to declare dividends, the dividend amounts, if any, will be determined by our Board of Directors, which will consider a number of factors, including our financial condition, capital requirements, funds generated from operations, future business prospects, applicable contractual restrictions and any other factors our Board of Directors may deem relevant. The amount of this outstanding indebtedness could limit our ability to pay cash dividends and to obtain additional financing in the future for working capital, capital expenditure and acquisition purposes. A significant portion of our cash flows will be dedicated to debt service and will be unavailable for investment, capital expenditures or other operating expenses. As a result of these and other factors, we cannot assure you that our business will generate sufficient cash flows from operations or that future borrowings will be available to us in amounts sufficient to enable us to pay our indebtedness or to fund our other liquidity needs. If we do not generate or are unable to borrow sufficient amounts of cash on satisfactory terms to meet these needs, we may need to seek to refinance all or a portion of our indebtedness on or before maturity, sell assets, curtail discretionary capital expenditures or seek additional capital. There can be no assurance that additional capital will be available to us on acceptable terms, or at all, which could adversely impact our business, results of operations, liquidity, capital resources, and financial condition. We anticipate that future earnings will be used principally to support operations and finance the growth of our business. Thus, we do not intend to pay dividends or other cash distributions on our common stock in the foreseeable future. See Part II, Item 5 “Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.” See Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.” Item 1B.
Unresolved Staff Comments
None. 23
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Item 2.
Properties
We have facilities including offices and key operating facilities in various locations throughout the United States. The Corporation’s corporate headquarters are located in Louisville, Kentucky. In addition to the pharmacies listed below, the Corporation also has multiple facilities throughout the nation with several overhead and administrative functions. As of December 31, 2014, all facilities were leased. We consider all of these facilities to be suitable and adequate. The following table presents certain information with respect to operating leases of our pharmacies identified by the Corporation as properties as of December 31, 2014:
Item 3.
Property
# of Facilities
Square Footage
Alabama Arizona Arkansas California Colorado
3 5 1 9 4
33,594 31,249 6,850 91,151 32,054
Connecticut Delaware Florida Georgia
1 1 6 2
15,600 5,739 64,530 33,202
Hawaii Idaho Illinois Indiana Iowa
5 1 1 1 1
15,506 4,031 15,495 20,386 6,250
Kansas
1
9,977
Kentucky Louisiana Maine Maryland Massachusetts Michigan
2 1 1 2 2 2
43,500 4,914 10,200 7,700 33,722 13,720
Minnesota
1
6,727
Property Mississippi Missouri Montana Nebraska Nevada New Hamphire New Jersey New Mexico New York North Carolina Ohio Oklahoma Pennsylvania Rhode Island South Carolina South Dakota Tennessee Texas Utah Virginia Washington West Virginia Wisconsin
# of Facilities
Square Footage
1 1 1 1 2
11,600 4,090 2,440 5,120 8,250
1 1 1 4
7,500 14,309 4,798 81,431
3 2 2 12 1
21,250 28,050 12,786 79,062 9,415
2
20,350
2 5 13 3 2 2
11,050 47,919 92,320 18,002 15,807 12,973
1 1
8,900 3,750
Legal Proceedings
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 Coiporation alleging that the Corporation violated the FCA and Federal Anti-Kickback Statute through its agreements to provide prescription drugs to nursing homes under certain Medicare and Medicaid programs. 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. The Corporation intends to vigorously defend itself against these allegations. 24
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On March 6, 2012, a relator, Fox, a former Part D Plan Sponsor, filed a complaint against the Corporation in the United States District Court for the Southern District of Ohio. Fox filed an amended complaint on October 2,2012. The case was transferred to the United States District Court for the Western District of Virginia on March 27, 2013. Fox alleged that the Corporation engaged in a variety of schemes relating to the dispensing of atypical antipsychotics and the drug Depakote, including allegedly dispensing drugs for unapproved uses, allegedly receiving illegal kickbacks in the form of rebates, and other alleged violations. Fox also alleges that the Corporation improperly inflated dispensing fees by splitting prescriptions into partial fills. The United States declined to intervene on September 8, 2014. Fox voluntarily dismissed its complaint on December 15, 2014. On June 10, 2013, the United States District Court for the Eastern District of Wisconsin unsealed two consolidated qui tam complaints filed in 2009 and 2011 by relators who are former employees of the Corporation and a company acquired by the Corporation. The United States, acting through the U.S. Attorney's Office in Wisconsin, intervened in part and declined to intervene in part and filed its complaint in intervention on August 9, 2013, when the matter was formally brought to the Corporation's attention. The Government's complaint seeks statutory fines for the Corporation's alleged dispensing of Schedule II controlled substances without a valid prescription in violation of the CSA. It also seeks monetary damages and equitable relief alleging that this conduct caused false claims to be submitted in violation of the Federal False Claims Act (the "FCA"). The Corporation moved to dismiss the government's complaint for failure to state a claim upon which relief may be granted but the Court denied the Corporation's motion on September 3, 2014. With regard to the portion of the relators' complaint on which the Government did not intervene, on November 15, 2013, the relators dismissed their claims against the Corporation alleging that the Corporation submitted false claims to Medicare Part D and to Medicaid for drugs in connection with which the Corporation allegedly received kickbacks from the manufacturer in the form of market share rebates and other remuneration, all in violation of the Federal Anti Kickback Statute (the "AKS/FCA" claims). The United States stipulated to the dismissal of those and other non-intervened counts, and the Court approved the dismissal without prejudice of those counts on November 20, 2013. The relators pursued their claim under the retaliatory termination provisions of the FCA. On September 3, 2014, the Court denied the Corporation's motion to dismiss the relators' retaliatory termination claim. The Corporation intends to vigorously defend itself in both matters. On November 20, 2013 the complaint filed 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 against the Corporation alleging that the Corporation dispensed controlled and non-controlled substances in violation of the CSA and in violation of state dispensing laws. Relator alleges 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 has appealed the court's decision. The Corporation intends to continue to defend the case vigorously. On October 29, 2013, a complaint was filed in the United States District Court for the Southern District of Florida by Pines Nursing Homes (77), Inc. as a putative class action against the Corporation. The complaint alleged that the Corporation sent unsolicited advertisements promoting the Corporation's goods or services by facsimile to individuals or entities, and that such communications did not include an opt-out clause, all in violation of the federal Telephone Consumer Protection Act ("TCPA"). The Complaint did not specify the amount of damages sought, but the TCPA provides a statutory remedy of $500 per facsimile communication sent in violation of the statute, which may be trebled in the event of a willful violation. On August 18, 2014, the Corporation entered into a Settlement Agreement with the putative class and class counsel resolving all claims raised in the complaint. The parties moved on September 8, 2014 for, among other things, certification of the putative class for the purposes of effectuating the settlement and preliminary approval of the parties' settlement, and have requested a hearing on that motion. No hearing has yet been set on that motion and the Corporation awaits a decision on the motion for preliminary approval of the settlement. 25
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On January 31, 2014, a relator, Frank Kurnik, on behalf of the U.S. Government and various state governments served its complaint filed in the United States District Court for the District of South Carolina alleging that the Corporation solicited and received remuneration in violation of the Federal Anti-Kickback Statute from drug manufacturer Amgen in exchange for preferring and promoting Amgen's drug Aranesp over a competing drug called Procrit. The U.S. Government and the various states declined to intervene in the case. On April 7, 2014, the Corporation moved to dismiss the complaint and on July 23, 2014, the motion was denied. The Corporation again moved to dismiss the case on jurisdictional grounds on January 13, 2015. That motion is pending. The Corporation intends to vigorously defend itself against these allegations. The U.S. Department of Justice, through the U.S. Attorney's Office for the Western District of Virginia, is investigating whether the Corporation's activities in connection with the agreements it had with the manufacturer of the pharmaceutical Depakote violated the Anti-Kickback Statute and, hence, that certain claims for Depakote that the Corporation submitted to federal health care programs violated the Federal False Claims Act. The Corporation is cooperating with this investigation and believes it has complied with all applicable laws and regulations. On May 29, 2014, the United States District Court for the Western District of Virginia entered an order (the "May 29 Order") unsealing two previously partially sealed qui tam complaints, entitled United States, et al., ex rel. Spetter v. Abbott Laboratories. Inc., Omnicare, Inc., and PharMerica Corp., No. l:07-cv-00006 and United States, et al., ex rel. McCoyd v. Abbott Laboratories, Omnicare, Inc., PharMerica Corp., and Miles White, No. l:07-cv-0008. The May 29 Order also unsealed the government's notice of intervention and granted the Government 120 days to serve its Complaint in Intervention. That deadline has since been extended to March 23, 2015 as to PharMerica only. As was indicated during the investigation, the complaints allege that certain agreements that the Corporation had with the manufacturer of Depakote violated the Anti-Kickback Statute and, hence, those certain claims for Depakote that the Corporation submitted to federal health care programs violated the Federal False Claims Act and the analogous statutes of 27 states. The Corporation intends to vigorously defend itself. On September 10, 2014 the Corporation filed a Complaint in Jefferson Circuit Court in Louisville, Kentucky against ABDC for breach of the Amended PVA. The Corporation subsequently filed a First Amended Complaint asserting additional breaches of the Amended PVA and filed a motion seeking a preliminary injunction enjoining ABDC from instituting certain drug substitution programs. On September 10, 2014, ABDC filed suit in the Court of Chancery of the State of Delaware seeking a declaration that it is not in breach of the Amended PVA. The Delaware proceeding was voluntarily dismissed on November 20, 2014. On November 24, 2014, the Jefferson Circuit Court issued a temporary injunction against ABDC. That order was subsequently over-ruled by the Court of Appeals on February 13, 2015. The Corporation has appealed the decision of the Court of Appeals to the Kentucky Supreme Court. On February 24, 2015, the Kentucky Supreme Court stayed the Appellate Court's ruling until the Kentucky Supreme Court has an opportunity to rule on the matter. The amounts disputed by ABDC generally relate to certain rebates owed by ABDC under the Amended PVA. Rebates receivable from ABDC are $8.5 million, $12.3 million, and $20.0 million for the second quarter of 2014, the third quarter of 2014, and the fourth quarter of 2014, respectively, in the aggregate total $40.8 million at December 31, 2014. The Corporation will have claims for additional damages resulting from ABDC's breaches of the Amended PVA. On March 2, 2015, the Corporation provided ABDC with a notice of termination of the Amended PVA effective April 1, 2015. The Corporation intends to vigorously pursue its claims. 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 proceedings with ABDC could continue for an extended period of time, likely longer than 12 months. The Corporation cannot provide any assurances about the outcome of the litigation. Item 4.
Mine Safety Disclosures
Not applicable. 26
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PART II Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information Our only class of common equity is our $0.01 par value common stock, which trades on the NYSE under the symbol “PMC.” The following table sets forth the high and low prices per share during the period and the closing price as of the last day of each period of our common stock as reported by the NYSE for the fiscal periods indicated. High Fiscal 2013 First Quarter Second Quarter Third Quarter Fourth Quarter Fiscal 2014 First Quarter Second Quarter Third Quarter Fourth Quarter
Low
Close
$
15.42
$
13.39
$
14.00
$
16.45
$
12.22
$
13.86
$
15.80
$
11.84
$
13.27
$
22.85
$
13.24
$
21.50
$
28.35
$
20.01
$
27.98
$
30.48
$
25.56
$
28.59
$
29.73
$
24.12
$
24.43
$
30.00
$
19.42
$
20.71
Stockholders As of January 31, 2015, we had approximately 2,600 stockholders of record of the Corporation’s common stock. Because many of our shares of common stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by these record holders. Cash Dividends The Corporation has never paid a cash dividend on its common stock and does not expect to pay cash dividends on its common stock in the foreseeable future. Our Credit Agreement also limits our ability to declare and pay dividends or other distributions on our shares of common stock. Management believes the stockholders are better served if all of the Corporation’s earnings are retained for expansion of the business. Securities authorized for issuance under equity compensation plans The Corporation has adopted the Amended and Restated PharMerica Corporation 2007 Omnibus Incentive Plan (as amended and restated, “Omnibus Plan”) under which the Corporation is authorized to grant equity-based and other awards to its employees, officers, directors and consultants. In connection with the Corporation’s 2010 Annual Meeting of Stockholders, the stockholders of the Corporation approved and adopted the amended and restated Omnibus Plan to, among other things, implement a “fungible share pool” effective as of January 1, 2010, and preserve preferential tax treatment as “qualified performance-based compensation” under Section 162(m) of the Internal Revenue Code. The Corporation has reserved 7,237,000 shares of its common stock for awards to be granted under the Omnibus Plan plus 534,642 shares reserved for substitute equity awards. Under the “fungible share pool,” one share of stock will be subtracted from the share limit for each share of stock covered by a stock option or stock appreciation right award and 1.65 shares of stock will be subtracted from the share limit for each share of stock covered by any full-value award, including restricted share awards, restricted stock units and performance share awards at target. The following shares are not available for re-grant under the Omnibus Plan: (i) shares tendered by a participant or withheld by the Corporation to pay the purchase price of a stock option award or to satisfy taxes owed with respect to an award, (ii) shares subject to a stock appreciation right that are not issued in connection with such award’s settlement upon the exercise thereof, and (iii) shares reacquired by the Corporation using cash proceeds received by the Corporation from the exercise of stock options. Effective January 1, 2010, shares subject to an award that is forfeited, expired or settled for cash, are available for re-grant under the Omnibus Plan as one share of stock for each share of stock covered by a stock option or appreciation right and 1.65 shares of stock for each share of stock covered by any other type of award. 27
Index
The following table sets forth equity compensation plan information as of December 31, 2014:
Plan Category Equity compensation plans approved by stockholders
Number of securities to be issued upon exercise of outstanding options, warrants and rights (a)
Weighted-average exercise price of outstanding options, warrants and rights (b)
1,854,779(1) $
Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) (c)
14.62(2)
2,865,608(3)
(1) Includes the following: • • • •
913,209 shares of common stock to be issued upon exercise of outstanding stock options granted under the Omnibus Plan; 446,833 shares of common stock to be issued upon vesting of performance share units under the Omnibus Plan; 7,831 shares of common stock to be issued upon vesting of restricted stock awards under the Omnibus Plan; and 486,906 shares of common stock to be issued upon vesting of restricted stock units under the Omnibus Plan.
(2) The weighted average exercise price in column (b) does not take into account the 941,570 shares of common stock potentially to be issued under restricted stock awards, performance share units and restricted stock units. (3) The 2,865,608 shares does not take into consideration the dilution of 1.65 shares of stock for any full-value award, including restricted stock awards, restricted stock units and performance share units at target. The number of shares remaining available for future issuance calculated under the fungible share pool would be 1,737,623. See Note 10 to the Consolidated Financial Statements included in this Report for information regarding the material features of the Omnibus Plan.
28
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Stock Performance Graph The following graph compares the cumulative total return on a $100 investment in each of the Common Stock of the Corporation, the Standard & Poor’s 500 Stock Index and the Standard & Poor’s Healthcare Index for the period from December 31, 2009 to December 31, 2014. This graph assumes an investment in the Corporation’s common stock and the indices of $100 on December 31, 2009 and that all dividends were reinvested:
PharMerica Corporation 100.00 114.74 92.32 60.01 72.10 72.04 80.35 89.86 95.59 78.27 68.77 79.72 89.67 88.16 87.28 83.56 135.39 176.20 180.04 153.84 130.42
December 31, 2009 March 31, 2010 June 30, 2010 September 30, 2010 December 31, 2010 March 31, 2011 June 30, 2011 September 30, 2011 December 31, 2011 March 31, 2012 June 30, 2012 September 30, 2012 December 31, 2012 March 31, 2013 June 30, 2013 September 30, 2013 December 31, 2013 March 31, 2014 June 30, 2014 September 30, 2014 December 31, 2014 Recent Sales of Unregistered Securities None. 29
S&P 500 100.00 104.87 92.43 102.34 112.78 118.90 118.43 101.46 112.78 126.31 122.16 129.20 127.90 140.72 144.05 150.80 165.76 167.91 175.79 176.87 184.64
S&P Healthcare 100.00 102.89 90.24 97.66 100.71 105.74 113.45 101.52 110.95 120.30 121.68 128.45 127.81 147.26 152.17 161.79 177.32 186.91 194.50 204.28 218.64
Index
Purchases of Equity Securities by the Issuer and Affiliated Purchasers On August 24, 2010, the Corporation announced a stock repurchase program where the Corporation is authorized to repurchase up to $25.0 million of the Corporation’s common stock, of which $10.5 million was used to purchase the Corporation’s common stock. On July 2, 2012, the Board of Directors authorized an increase to the existing stock repurchase program that will allow the Corporation to again purchase back 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 December 31, 2014. The stock repurchase program does not have an expiration date and may be limited, terminated or extended at any time without prior notice. The Corporation did not repurchase shares under this program for the three months ended December 31, 2014. Additionally, the Corporation may redeem shares from employees upon vesting of the Corporation’s stock awards for minimum statutory tax withholding purposes and exercise cost of stock options. The Corporation redeemed no shares of vested awards during the three months ended December 31, 2014. 30
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Item 6.
Selected Financial Data
The following table presents our selected historical consolidated financial and operating data. The selected historical financial and operating data should be read in conjunction with, and is qualified in its entirety by reference to, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and notes thereto included elsewhere in this Annual Report on Form 10-K (in millions, except where indicated): 31
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2010 Income statement data: Revenues Cost of goods sold Gross profit Selling, general and administrative Amortization expense Impairment of intangible assets Merger, acquisition, integration costs and other charges Settlement, litigation and other related charges Restructuring and impairment charges Hurricane Sandy disaster costs Operating income (1) Net income (7) Earnings per common share: (2) Basic Diluted Adjusted earnings per diluted common share (3) Shares used in computing earnings per common share: Basic Diluted Balance sheet data: Cash and cash equivalents Working capital (4) Goodwill (4) Intangible assets, net Total assets (4) Long-term debt, including current portion Total stockholder's equity Supplemental information: Adjusted EBITDA (3) Adjusted EBITDA Margin (3) Adjusted EBITDA per prescription dispensed (3) Net cash provided by operating activities Net cash used by investing activities Net cash (used in) provided by financing activities Statistical information (in whole numbers except where indicated) Pharmacy Volume information: Prescriptions dispensed (in thousands) Revenue per prescription dispensed (6) Gross profit per prescription dispensed (6) Gross profit margin (6) Generic drug dispensing rate (5)
$
2011 $
$ $
1,847.3 1,604.8 242.5 182.8 9.3 14.6 35.8 19.2
$ $ $
0.64 0.64 1.03
Years Ended December 31, 2012 $
$ $
2,081.1 1,786.2 294.9 216.5 11.0 5.1 16.8 (1.5) 47.0 23.4
$ $ $
0.80 0.79 1.32
30.0 30.1
$
$ $
1,832.6 1,532.4 300.2 214.7 12.3 17.8 2.1 4.5 48.8 22.9
$ $ $
0.78 0.77 1.41
29.3 29.5
2013
2014 $
$ $
1,757.9 1,430.7 327.2 225.3 15.4 8.1 19.6 4.4 (1.4) 55.8 18.9
$ $
1,894.5 1,555.2 339.3 236.3 20.1 13.6 37.3 3.3 (1.7) 30.4 6.8
$ $ $
0.64 0.63 1.83
$ $ $
0.23 0.22 1.67
29.5 29.9
29.6 30.1
30.0 30.6
$ $ $ $ $ $ $
10.8 280.9 179.4 102.2 759.7 245.6 384.4
$ $ $ $ $ $ $
17.4 348.4 214.9 100.2 834.0 300.0 413.8
$ $ $ $ $ $ $
12.3 322.1 269.4 121.9 886.3 315.5 442.6
$ $ $ $ $ $ $
24.2 259.6 282.8 136.3 900.8 231.3 462.5
$ $ $ $ $ $ $
$
83.7 4.5% 2.21 98.2 (133.2) (5.4)
$
104.5 5.0% 2.51 26.8 (64.0) 43.8
$
111.2 6.1% 2.84 85.7 (105.3) 14.5
$
132.8 7.5% 3.52 155.7 (53.7) (90.1)
$
$ $ $ $
$ $
$ $ $ $
37,826 48.84 $ 6.41 $ 13.1% 76.5%
$ $ $ $
41,677 49.93 $ 7.08 $ 14.2% 79.6%
$ $ $ $
39,212 46.74 $ 7.66 $ 16.4% 83.3%
33.3 321.5 317.7 177.6 1,068.1 351.3 478.1
$ $ $ $
130.6 6.9% 3.73 48.4 (157.0) 117.7
37,731 46.67 $ 8.75 $ 18.8% 83.4%
35,003 54.12 9.69 17.9% 84.9%
(1) Includes depreciation expense of $18.8 million, $20.1 million, $18.6 million, $19.3 million and $20.3 million for the years ended December 31, 2010, 2011, 2012, 2013 and 2014, respectively. (2) The Corporation has never declared a cash dividend. Earnings per share in whole dollars and cents. (3) See “Use of Non GAAP Measures for Measuring Annual Results” for a definition and reconciliation of Adjusted earnings per diluted common share to Earnings per diluted common share and for reconciliation of net income to Adjusted EBITDA and Adjusted EBITDA Margin. (4) As adjusted, see Note 2 - Acquisitions in the Consolidated Financial Statements (5) Single source generic drugs, previously classified as brand drugs, are now being classified as generics for purposes of the generic dispensing rate calculation in all periods. (6) Amounts in 2013 do not include the $2.9 million California Medicaid estimated recoupment. (7) Amounts in 2014 reflect a $4.3 million loss on extinguishment of debt in the third quarter 2014. 32
Index
Use of Non-GAAP Measures for Measuring Annual Results The Corporation calculates Adjusted EBITDA as provided in the reconciliation below and calculates Adjusted EBITDA Margin by taking Adjusted EBITDA and dividing it by revenues adjusted for the contractual amounts associated with the California Medicaid estimated recoupment. The Corporation calculates and uses Adjusted EBITDA as an indicator of its ability to generate cash from reported operating results. The measurement is used in concert with net income and cash flows from operating activities, which measure actual cash generated in the period. In addition, the Corporation believes that Adjusted EBITDA and Adjusted EBITDA Margin are supplemental measurement tools used by analysts and investors to help evaluate overall operating performance and the ability to incur and service debt and make capital expenditures. In addition, Adjusted EBITDA, as defined in the Credit Agreement, is used in conjunction with the Corporation’s debt leverage ratio and this calculation sets the applicable margin for the quarterly interest charge. Adjusted EBITDA, as defined in the Credit Agreement, is not the same calculation as this Adjusted EBITDA table. Adjusted EBITDA does not represent funds available for the Corporation’s discretionary use and is not intended to represent or to be used as a substitute for net income or cash flows from operating activities data as measured under U.S. generally accepted accounting principles (“U.S. GAAP”). The items excluded from Adjusted EBITDA but included in the calculation of the Corporation’s reported net income and cash flows from operating activities are significant components of the accompanying consolidated income statements and cash flows, and must be considered in performing a comprehensive assessment of overall financial performance. The Corporation’s calculation of Adjusted EBITDA may not be consistent with calculations of EBITDA used by other companies. The following are reconciliations of Adjusted EBITDA to the Corporation’s net income and net operating cash flows for the periods presented. The Corporation calculates and uses adjusted diluted earnings per share, which is exclusive of the impact of merger, acquisition, integration costs and other charges, settlement, litigation and other related costs and charges, impairment of intangible assets, restructuring and impairment charges, California Medicaid estimated recoupment, loss on debt extinguishment, Hurricane Sandy disaster costs, stock-based compensation and deferred compensation, and impacts of discrete items on tax provision (the “Excluded Items”) as an indicator of its core operating results. The measurement is used in concert with net income and diluted earnings per share, which measure actual earnings per share generated in the period. The Corporation believes the exclusion of these charges in expressing earnings per share provides management with a useful measure to assess period to period comparability and is useful to investors in evaluating the Corporation’s operating results from period to period. Adjusted diluted earnings per share after giving effect to the Excluded Items does not represent the amount that effectively accrues directly to stockholders (i.e., such costs are a reduction in earnings and stockholders’ equity) and is not intended to represent or to be used as a substitute for diluted earnings per share as measured under U.S. GAAP. The Excluded Items are significant components of the accompanying consolidated income statements and must be considered in performing a comprehensive assessment of overall financial performance. The following is a reconciliation of adjusted diluted earnings per share to the Corporation’s U.S. GAAP earnings per diluted common share for the periods presented. 33
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Reconciliation of Net Income to Adjusted EBITDA
2010 Net income Add: Interest expense, net Merger, acquisition, integration costs and other charges Settlement, litigation and other related charges California Medicaid estimated recoupment Restructuring and impairment charges Loss on extinguishment of debt Hurricane Sandy disaster costs Stock-based compensation and deferred compensation Provision for income taxes Impairment of intangible assets Depreciation and amortization expense Adjusted EBITDA Adjusted EBITDA Margin
$
$
2011 19.2
$
3.6 14.6 5.2 13.0 28.1 83.7 $ 4.5% 34
Years Ended December 31, 2012 23.4 $ 22.9 $ 8.8 16.8 (1.5) 6.0 14.8 5.1 31.1 104.5 $ 5.0%
10.0 17.8 2.1 4.5 7.1 15.9 30.9 111.2 $ 6.1%
2013
2014 18.9
$
10.6 8.1 19.6 2.9 4.4 (1.4) 8.7 26.3 34.7 132.8 $ 7.5%
6.8 9.9 12.9 37.3 3.3 4.3 (1.7) 8.0 9.4 40.4 130.6 6.9%
Index
Reconciliation of Adjusted EBITDA to Net Operating Cash Flows
2010 Adjusted EBITDA Interest expense, net Merger, acquisition, integration costs and other charges Provision for bad debt Amortization of deferred financing fees Loss on disposition of equipment Gain on acquisition Provision for income taxes Deferred income taxes Changes in federal and state income tax payable Excess tax benefit from stock-based compensation Changes in assets and liabilities Other Net Cash Flows from Operating Activities
$
2011 83.7 (3.6) (14.0) 18.5 0.6 0.3 (13.0) 12.3 (0.1) 13.5 98.2
$
$
Years Ended December 31, 2012 104.5 $ (8.8) (15.3) 24.8 0.8 0.1 (14.8) 13.9 0.2 (78.8) 0.2 26.8 $
$
2013
111.2 $ (10.0) (16.5) 25.2 1.0 0.1 (15.9) 2.8 1.1 (13.5) 0.2 85.7 $
2014 132.8 $ (10.6) (8.1) 22.5 2.3 0.6 (1.3) (26.3) 12.0 (0.4) 32.2 155.7 $
130.6 (9.9) (52.8) 23.2 1.9 (0.2) (9.4) (2.3) 7.2 (3.4) (36.9) 0.4 48.4
Reconciliation of Diluted Earnings Per Share to Adjusted Diluted Earnings Per Share
2010 Diluted earnings per share Add: Diluted earnings per share impact of: Impairment of intangible assets Merger, acquisition, integration costs and other charges Settlement, litigation and other related charges California Medicaid estimated recoupment Loss on extinguishment of debt Restructuring and impairment charges Hurricane Sandy disaster costs Stock-based compensation and deferred compensation Impact of discrete items on tax provision Adjusted diluted earnings per share
2011
$
0.64
$
0.29 0.10 1.03 35
Years Ended December 31, 2012
$
0.79
$
0.77
$
0.11 0.35 (0.03) 0.12 (0.02) 1.32 $
0.36 0.04 0.09 0.14 0.01 1.41
2013
2014
$
0.63
$
0.22
$
0.17 0.62 0.06 0.09 (0.03) 0.18 0.11 1.83 $
0.27 0.77 0.09 0.07 (0.04) 0.17 0.12 1.67
Index
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS This Annual Report on Form 10-K contains forward-looking statements, within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which reflect the Corporation’s current estimates, expectations and projections about the Corporation’s future results, performance, prospects and opportunities. Forward looking statements include, among other things, the information concerning the Corporation’s possible future results of operations including revenue, costs of goods sold, operating expenses, gross profit, and business and growth strategies, financing plans, the Corporation’s competitive position and the effects of competition, the projected growth of the industries in which we operate, and the Corporation’s ability to consummate strategic acquisitions. Forward-looking statements include statements that are not historical facts and can be identified by forward-looking words such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “plan,” “may,” “should,” “will,” “would,” “project,” and similar expressions. These forward-looking statements are based upon information currently available to the Corporation and are subject to a number of risks, uncertainties and other factors that could cause the Corporation’s actual results, performance, prospects or opportunities to differ materially from those expressed in, or implied by, these forward-looking statements. Important factors that could cause the Corporation’s actual results to differ materially from the results referred to in the forward-looking statements the Corporation makes in this report include: • • • • • • • • • • • • • • • • • • • • •
the Corporation’s access to capital, credit ratings, indebtedness, and ability to raise additional financings and operate under the terms of the Corporation’s debt obligations; anti-takeover provisions of the Delaware General Corporation Law, which in concert with our certificate of incorporation and our by-laws could delay or deter a change in control; the effects of adverse economic trends or intense competition in the markets in which we operate; the Corporation’s risk of loss of revenues due to a customer or owner of skilled nursing facility entering the institutional pharmacy business; the effects of the loss of a large customer and the Corporation's ability to adequately restructure its operations to offset the loss; the demand for the Corporation’s products and services; the risk of retaining existing customers and service contracts and the Corporation’s ability to attract new customers for growth of the Corporation’s business; the effects of renegotiating contract pricing relating to significant customers and suppliers, including the hospital pharmacy business which is substantially dependent on service provided to one customer; the impacts of cyber security risks and/or incidents; the effects of a failure in the security or stability of our technology infrastructure, or the infrastructure of one or more of our key vendors, or a significant failure or disruption in service; the effects of an increase in credit risk, loss or bankruptcy of or default by any significant customer, supplier, or other entity relevant to the Corporation’s operations; the Corporation’s ability to successfully pursue the Corporation’s development and acquisition activities and successfully integrate new operations and systems, including the realization of anticipated revenues, economies of scale, cost savings, and productivity gains associated with such operations; the Corporation’s ability to control costs, particularly labor and employee benefit costs, rising pharmaceutical costs, and regulatory compliance costs; the effects of healthcare reform and government regulations, including interpretation of regulations and changes in the nature and enforcement of regulations governing the healthcare and institutional pharmacy services industries including the dispensing of antipsychotic prescriptions; changes in the reimbursement rates or methods of payment from Medicare and Medicaid and other third party payers to both us and our customers; the potential impact of state government budget shortfalls and their ability to pay the Corporation and its customers for services provided; the Corporation’s ability, and the ability of the Corporation’s customers, to comply with Medicare or Medicaid reimbursement regulations or other applicable laws; the effects of changes in the interest rate on the Corporation’s outstanding floating rate debt instrument and the increases in interest expense, including increases in interest rate terms on any new debt financing; further consolidation of managed care organizations and other third party payers; political and economic conditions nationally, regionally, and in the markets in which the Corporation operates; natural disasters, war, civil unrest, terrorism, fire, floods, tornadoes, earthquakes, hurricanes, epidemic, pandemic, catastrophic event or other matters beyond the Corporation’s control; 36
Index
• • • • • • • • • • • • • • • •
increases in energy costs, including state and federal taxes, and the impact on the costs of delivery expenses and utility expenses; elimination of, changes in, or the Corporation’s failure to satisfy pharmaceutical manufacturers’ rebate programs; the Corporation’s ability to attract and retain key executives, pharmacists, and other healthcare personnel; the Corporation’s risk of loss not covered by insurance; the outcome of litigation to which the Corporation is a party from time to time, including adverse results in material litigation or governmental inquiries including the possible insufficiency of any accruals established by the Corporation from time to time; changes in accounting rules and standards, audits, compliance with the Sarbanes-Oxley Act, and regulatory investigations; changes in market conditions that would result in the impairment of goodwill or other assets of the Corporation; changes in market conditions in which we operate that would influence the value of the Corporation’s stock; the uncertainty as to the long-term value of the Corporation’s common stock; the Corporation’s ability to anticipate a shift in demand for generic drug equivalents and the impact on the financial results including the negative impact on brand drug rebates; the effect on prescription volumes and the Corporation’s net revenues and profitability if the safety risk profiles of drugs increase or if drugs are withdrawn from the market, including as a result of manufacturing issues, or if prescription drugs transition to over-the-counter products; the effects on the Corporation’s results of operations related to interpretations of accounting principles by the SEC staff that may differ from those of management; the potential impact of the litigation proceedings with ABDC regarding the Amended PVA; changes in tax laws and regulations; the effects of changes to critical accounting estimates; and other factors, risks and uncertainties referenced in the Corporation’s filings with the Commission, including the “Risk Factors” set forth in this Report on Form 10K for the year ended December 31, 2014.
YOU ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON ANY FORWARD-LOOKING STATEMENTS, ALL OF WHICH SPEAK ONLY AS OF THE DATE OF THIS ANNUAL REPORT. EXCEPT AS REQUIRED BY LAW, WE UNDERTAKE NO OBLIGATION TO PUBLICLY UPDATE OR RELEASE ANY REVISIONS TO THESE FORWARD-LOOKING STATEMENTS TO REFLECT ANY EVENTS OR CIRCUMSTANCES AFTER THE DATE OF THIS ANNUAL REPORT OR TO REFLECT THE OCCURRENCE OF UNANTICIPATED EVENTS. ALL SUBSEQUENT WRITTEN AND ORAL FORWARD-LOOKING STATEMENTS ATTRIBUTABLE TO US OR ANY PERSON ACTING ON THE CORPORATION’S BEHALF ARE EXPRESSLY QUALIFIED IN THEIR ENTIRETY BY THE CAUTIONARY STATEMENTS CONTAINED OR REFERRED TO IN THIS SECTION AND IN OUR RISK FACTORS SET FORTH IN PART I, ITEM 1A OF THIS REPORT ON FORM 10-K AND IN OTHER REPORTS FILED WITH THE SEC BY THE CORPORATION. The Corporation’s Business and Industry Trends 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 98 institutional pharmacies, 14 specialty infusion pharmacies and 5 specialty oncology pharmacies in 45 states. The Corporation’s customers are typically institutional healthcare providers, such as skilled nursing facilities, nursing centers, assisted living facilities, hospitals, individuals receiving in-home care and other long-term alternative care providers. The Corporation is generally the primary source of supply of pharmaceuticals to its customers. The Corporation also provides pharmacy management services to 89 hospitals in the United States. The institutional pharmacy services business is highly competitive. Competition is a significant factor that can impact the Corporation’s overall financial results, pricing to customers, and bed retention. In each geographic market, there are national, regional and local institutional pharmacies that provide services comparable to those offered by the Corporation’s pharmacies. These pharmacies may have greater financial and other resources than we do and may be more established in the markets they serve than we are. The Corporation also competes against regional and local pharmacies that specialize in the highly-fragmented long-term care markets. In the future, some of the Corporation’s customers may seek to in-source the provision of pharmaceuticals to patients in their facilities by establishing an internal pharmacy. 37
Index
A variety of factors are affecting the institutional pharmacy industry. With an aging population and the extension of drug coverage to a greater number of individuals through Medicare Part D, the consumption of pharmaceuticals by residents of long-term care facilities is likely to increase in the future. In addition, individuals are expected to enter assisted living facilities, independent living facilities and continuing care retirement communities at increasing rates. Under Medicare Part D, eligible individuals may choose to enroll in various Medicare Part D Plans to receive prescription drug coverage. Each Medicare Part D Plan determines a distinct formulary for the long-term care residents enrolled in its plan. Accordingly, institutional pharmacies have incurred increased administrative costs to manage each Part D Plan’s formulary, reimbursement and administrative processes for their long-term care enrollees. Institutional pharmacies may continue to experience increased administrative burdens and costs due to the greater complexity of the requirements for drug reimbursement. Medicare Part D also requires increased choices for patients with respect to complex drug categories and therapeutic interchange opportunities. Institutional pharmacies may realize increased revenue by providing long-term care residents with specialized services in these areas. Continued industry consolidation may also impact the dynamics of the institutional pharmacy market. In addition, our continued success depends on our ability to attract and retain pharmacists and other pharmacy professionals. Competition for qualified pharmacists and other pharmacy professionals is strong. The loss of pharmacy personnel or the inability to attract, retain or motivate sufficient numbers of qualified pharmacy professionals could adversely affect our business. Although we generally have been able to meet our staffing requirements for pharmacists and other pharmacy professionals in the past, our inability to do so in the future could have a material adverse impact on us.
Acquisitions During the Periods Presented For a discussion of acquisitions by the Corporation during the periods presented see Note 2 “Acquisitions” to our Consolidated Financial Statements included elsewhere in this Report. 38
Index
Critical Accounting Estimates The preparation of financial statements in accordance with U.S. GAAP requires us to make estimates and assumptions that affect reported amounts and related disclosures. Management considers an accounting estimate to be critical if: • •
It requires assumptions to be made that were uncertain at the time the estimate was made; and Changes in the estimate or different estimates could have a material impact on our consolidated results of operations or financial condition.
The Corporation’s management has discussed the development and selection of these critical accounting estimates with the Audit Committee of the Board of Directors and with the Corporation’s independent registered public accounting firm, and they both have reviewed the disclosure presented below relating to critical accounting estimates. The summary of critical accounting estimates is not intended to be a comprehensive list of all of the Corporation’s accounting policies that require estimates. Management believes that of the significant accounting policies, as discussed in Note 1 of the consolidated financial statements included elsewhere in this report, the estimates discussed below involve a higher degree of judgment and complexity. Management believes the current assumptions and other considerations used to estimate amounts reflected in the consolidated financial statements are appropriate. However, if actual experience differs from the assumptions and other considerations used in estimating amounts reflected in the consolidated financial statements, the resulting changes could have a material effect on the consolidated results of operations and financial condition of the Corporation. The following paragraphs present information about our critical accounting estimates, as well as the effects of hypothetical changes in the material assumptions used to develop each estimate. Our sensitivity analysis was performed assuming the assumptions listed, based upon the actual results of the Corporation for the year ended December 31, 2014, and the actual diluted shares.
Allowance for doubtful accounts and provision for doubtful accounts Accounts receivable primarily consist of amounts due from PDP’s under Medicaid Part D, long-term care institutions, the respective state Medicaid programs, private payers and third party insurance companies. Our ability to collect outstanding receivables is critical to our results of operations and cash flows. We establish an allowance for doubtful accounts to reduce the carrying value of our receivables to their estimated net realizable value. In addition, certain drugs dispensed are subject to being returned, and the responsible paying party is due a credit for such returns. Our allowance for doubtful accounts, included in our balance sheets at December 31, 2013 and 2014, was $56.7 million and $58.1 million, respectively. Our quarterly provision for doubtful accounts included in our income statements was as follows (dollars in millions): 2012 Amount First Quarter Second Quarter Third Quarter Fourth Quarter
$
2013 % of Revenues
6.2 6.2 7.3 5.5*
Amount
1.2% $ 1.4 1.7 1.3
2014 % of Revenues
5.3* 5.2 5.2 6.8
1.2% $ 1.2 1.2 1.5
% of Revenues
Amount 5.6 5.7 5.3 6.6
1.2% 1.3 1.1 1.3
*Excludes a $0.7 million and $0.2 million expense related to Hurricane Sandy for the Fourth Quarter 2012 and the First Quarter 2013, respectively. See further discussion in Note 9. 39
Index
The following table shows our revenue days outstanding reflected in our net accounts receivable as of the quarters indicated: 2012 First Quarter Second Quarter Third Quarter Fourth Quarter
2013 42.8 45.4 44.1 42.8
2014 41.6 41.6 39.8 39.0
37.7 37.0 36.7 34.9
The following table shows our summarized aging categories by quarter: 2012 First Second Third Fourth 61.5% 58.0% 58.6% 58.8% 17.3 17.7 15.7 17.1 21.2 24.3 25.7 24.1
0 to 60 days 61 to 120 days Over 120 Days
2013 First Second Third Fourth 58.0% 58.0% 56.5% 55.5% 15.8 18.2 18.0 18.8 26.2 23.8 25.5 25.7
2014 First Second Third Fourth 56.7% 53.9% 57.3% 58.8% 17.7 17.3 16.9 17.2 25.6 28.8 25.8 24.0
The following table shows our allowance for doubtful accounts as a percent of gross accounts receivable (dollars in millions): 2012 Gross Accounts Receivable
Allowance First Quarter Second Quarter Third Quarter Fourth Quarter
$
52.1 52.8 56.1 56.4
$
296.4 272.1 266.0 261.6
% of Gross Accounts Receivable 17.6% $ 19.4 21.1 21.6
2013 Gross Accounts Receivable
Allowance 55.8 54.8 54.6 56.7
$
262.1 249.5 243.1 255.4
% of Gross Accounts Receivable 21.3% $ 22.0 22.5 22.2
2014 Gross Accounts Receivable
Allowance 57.7 60.3 57.4 58.1
$
242.2 246.5 272.4 253.8
% of Gross Accounts Receivable 23.8% 24.5 21.1 22.9
If our provision as a percent of revenue increases 0.10%, our after tax income would decrease by approximately $1.2 million or $0.04 per diluted share. This is only one example of reasonably possible sensitivity scenarios. The process of determining the allowance requires us to estimate uncollectible accounts that are highly uncertain and requires a high degree of judgment. Our estimates may be impacted by economic conditions, success in collections, payer mix and trends in federal and state regulations. 40
Index
Revenue recognition/Allowance for contractual discounts We recognize revenues at the time services are provided or products are delivered. Our sources of revenues for the quarters ended March 31, June 30, September 30, and December 31, 2012, 2013, and 2014 are as follows:
2012 Medicare Part D Institutional healthcare providers Medicaid Private and other Insured Medicare Hospital management fees Total
Medicare Part D Institutional healthcare providers Medicaid Private and other Insured Medicare Hospital management fees Total
Three Months Ended March 31, 2013 2014 48.2% 44.1% 44.8% 30.0 9.6 4.7 4.1 0.2 3.2 100.0%
31.2 9.5 4.8 5.9 0.8 3.7 100.0%
25.3 9.5 4.6 11.5 1.1 3.2 100.0%
Three Months Ended September 30, 2012 2013 2014 47.4% 47.5% 45.6% 31.3 8.7 4.4 4.4 0.2 3.6 100.0%
2012
29.3 8.0 4.6 6.2 0.8 3.6 100.0%
23.5 8.4 4.1 13.8 1.3 3.3 100.0%
Three Months Ended June 30, 2013 48.1% 47.0% 30.2 9.2 4.7 4.1 0.2 3.5 100.0%
2012
2014
29.9 8.8 3.9 5.8 0.9 3.7 100.0%
44.8% 25.0 9.0 4.2 12.6 1.2 3.2 100.0%
Three Months Ended December 31, 2013 2014 46.8% 46.6% 47.3% 31.1 8.7 4.6 4.9 0.3 3.6 100.0%
27.8 9.4 4.3 7.7 1.0 3.2 100.0%
23.4 8.4 4.4 12.6 1.1 2.8 100.0%
The change in the revenue by payer type, as a percent of total revenue, over the three year period is a result of the 2012 acquisition of Amerita and the 2013 acquisition of Onco, both of which are more heavily weighted to insured and Medicare payer sources. If our reimbursement declined or was negatively impacted by 0.25% of revenues, the negative impact on net income would be $3.0 million or $0.10 per diluted common share.
Inventory and cost of drugs dispensed We have inventory located at each of our institutional pharmacy, specialty infusion, and specialty oncology locations. Our inventory is valued at the lower of first-in, first-out cost or market. The inventory consists of prescription drugs, over the counter products and intravenous solutions. Our inventory relating to controlled substances is maintained on a manually prepared perpetual system to the extent required by the Drug Enforcement Agency and state board of pharmacies. All other inventory is maintained on a periodic system, through the performance of, at a minimum, quarterly physical inventories at the end of each quarter. All inventory counts are reconciled to the balance sheet account and differences are adjusted through cost of goods sold. In addition, we record an amount of potential returns of prescription drugs based on historical rates of returns and record an estimate for rebates associated with inventory remaining at the end of each period. At December 31, 2013 (as adjusted) and 2014, our inventories on our consolidated balance sheets were $110.2 million and $135.7 million, respectively. 41
Index
Our inventory days on hand were as follows: 2012 First Quarter Second Quarter Third Quarter Fourth Quarter
2013 22.2 25.9 24.6 34.9
2014 25.4 29.6 18.1 26.2
26.0 35.1 31.7 29.1
Please refer to Note 1 to our consolidated financial statements included elsewhere in this report for a detailed discussion of our inventory. Actual inventory counts may include estimates based on amounts that may be dispensed from an open container. In addition, items are reviewed for potential obsolescence. A 1.0% error rate in the inventory value would impact net income $0.9 million or $0.03 per diluted common share.
Goodwill and other intangible assets Goodwill represents the excess of the purchase price over the fair value of the net assets of acquired companies. Our intangible assets are comprised primarily of trade names, customer relationship assets, and non-compete agreements. Our goodwill included in our accompanying consolidated balance sheets as of December 31, 2013 (as adjusted) and 2014 was $282.8 million and $317.7 million, respectively. The Corporation’s policy is to perform a quantitative assessment of its institutional pharmacy and specialty infusion reporting units to determine whether it is more likely than not (defined as having a likelihood of more than 50 percent) that the fair value of a reporting unit is less than its carrying amount. The Corporation performed a quantitative assessment as of December 31, 2014. The institutional pharmacy and specialty infusion reporting unit’s fair value as calculated for the analysis were approximately 48.2% and 13.1%, respectively, greater than current book value. While the excess on the specialty infusion reporting unit is not significant, the business was recently acquired in the fourth quarter 2012 and is performing to our expectations. In addition, if we were to assume a 100 basis point change in the key assumption, a reduction in the long-term growth rate or an increase in the discount rate used, to determine the fair value of the specialty infusion reporting unit as of December 31, 2014, the quantitative assessment of the specialty infusion reporting unit would still result in fair value in excess of the carrying value. The specialty infusion reporting unit has goodwill with a carrying value of $57.7 million. The Corporation also performed a qualitative assessment of its specialty oncology reporting unit as of December 31, 2014 and did not find it necessary to perform the first step of the two-step impairment test based on that analysis. Please refer to Note 4 to our consolidated financial statements included elsewhere in this report for a detailed roll forward of our goodwill and intangible assets. We performed our annual testing for goodwill impairment as of 2013 and 2014 and determined that no goodwill impairment existed, as described above. If actual future results are not consistent with our assumptions and estimates, we may be required to record goodwill impairment charges in the future. Our estimate of fair value of acquired assets and assumed liabilities are based upon assumptions believed to be reasonable based upon current facts and circumstances.
Accounting for income taxes The provision for income taxes is based upon the Corporation’s annual income or loss for each respective accounting period. 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 consolidated financial statements. Deferred tax assets generally represent items that will result in a tax deduction in future years for which we have already recorded the tax benefit in the accompanying consolidated income statements. The Corporation also recognizes as deferred tax assets the future tax benefits from net operating and capital loss carryforwards. Please refer to Note 11 to our consolidated financial statements included elsewhere in this report for a detailed discussion of our accounting for income taxes. We assess the likelihood that deferred tax assets will be realized from future taxable income. A valuation allowance is provided for deferred tax assets if it is more-likelythan-not that some portion or all of the net deferred tax assets will not be realized. Our deferred tax asset balances in our consolidated balance sheets as of December 31, 2013 and 2014 were $18.2 million and $30.6 million, respectively. Our valuation allowances for state deferred tax assets in our consolidated balance sheets as of the years ended December 31, 2013 and 2014 were $4.1 million. 42
Index
The first step in determining the deferred tax asset valuation allowance is identifying reporting jurisdictions where we have a history of tax and operating losses or are projected to have losses in future periods as a result of changes in operational performance. We then determine if a valuation allowance should be established against the deferred tax assets for that reporting jurisdiction. The second step is to determine the amount of valuation allowance. We will generally establish a valuation allowance equal to the net deferred tax asset (deferred tax assets less deferred tax liabilities) related to the jurisdiction identified in step one of the analysis. In certain cases, we may not reduce the valuation allowance by the amount of the deferred tax liabilities depending on the nature and timing of future taxable income attributable to deferred tax liabilities. With respect to net deferred tax assets, the Corporation considers all available positive and negative evidence to determine whether a valuation allowance is needed. This includes an analysis of net operating loss carryforwards available under law, anticipated future income or loss, as well as tax planning strategies. If the cumulative weight of evidence suggests that it is more-likely-than-not that all or some portion of the net deferred tax assets will not be realized, a full or partial valuation allowance will be recognized based upon the qualitative and quantitative evidence examined. Our deferred tax assets exceeded our deferred tax liabilities by $30.6 million as of December 31, 2014 including the impact of valuation allowances. Historically, we have produced taxable income and we expect to generate taxable income in future years. Therefore, we believe that the likelihood of our not realizing the tax benefit of our net deferred tax assets is remote. While we have generated taxable income in recent years and expect to continue to do so in the future, we have deferred tax assets in select states and for federal tax purposes for tax loss carryforwards that we expect to expire before we are able to fully use them to offset taxable income. We have recorded a valuation allowance against these deferred tax assets. If our conclusion about our ability to realize these deferred tax assets is incorrect, then our deferred tax assets would be understated or overstated at December 31, 2014. Tax benefits from uncertain tax positions are recognized in the Corporation’s consolidated financial statements if it is more-likely-than-not that the position is sustainable based on the technical merits of the position. In evaluating whether the position has met this recognition threshold, the Corporation assumes that the appropriate taxing authority has full knowledge of all relevant information. The amount of benefit recognized in the Corporation’s consolidated financial statements for a tax position meeting the recognition threshold is determined by a measurement of the largest amount of benefit that is more than 50 percent likely to be realized upon ultimate settlement. Subsequent recognition, de-recognition and measurement of uncertain tax positions are based on management’s best judgment given the facts, circumstances, and information available at the reporting date. The Internal Revenue Service (“IRS”) may propose adjustments for items we have failed to identify as tax contingencies. If the IRS were to propose and sustain assessments we would incur additional tax payments for 2012 through 2014 plus the applicable penalties and interest. The federal statute of limitations remains open for tax years 2012 through 2014. The IRS examination of the Corporation’s consolidated U.S. income tax returns for 2010 and 2011 was finalized in 2014, and the resulting adjustments have been accounted for in the 2014 provision for income taxes. State tax jurisdictions generally have statutes of limitations ranging from three to five years. The Corporation is no longer subject to state and local tax examinations by tax authorities for years before 2009. 43
Index
Definitions Listed below are definitions of terms used by the Corporation in managing the business. The definitions are necessary to the understanding of the Management’s Discussion and Analysis section of this document. Gross profit per prescription dispensed: Represents the gross profit divided by the total prescriptions dispensed. Gross profit margin: Represents the gross profit per prescription dispensed divided by the revenue per prescription dispensed. Prescriptions dispensed: Represents a prescription filled for an individual patient. A prescription will usually be for a 14 or 30 day period and will include only one drug type. Revenue per prescription dispensed: Represents the revenue divided by the total prescriptions dispensed. 44
Index
Results of Operations The following table presents selected consolidated comparative results of operations and statistical information for the periods presented (dollars in millions, except per prescription and per patient amounts, and prescriptions in thousands):
2012
Revenues Cost of goods sold Gross profit California Medicaid estimated recoupment Adjusted gross profit
Amount $ 1,832.6 1,532.4 300.2
$
300.2
Years Ended December 31, 2013 Increase (Decrease) % of Amount Revenues (4.1)% $ 1,757.9 100.0% $ 136.6 7.8% (6.6) 1,430.7 81.4 124.5 8.7 9.0% 12.1 3.7% 327.2 18.6% $
Increase (Decrease)
% of Revenues 100.0% $ 83.6 16.4% $
(74.7) (101.7) 27.0
16.4%
$
2.9 330.1
0.2 18.8%
2014 Amount $ 1,894.5 1,555.2 339.3
% of Revenues 100.0% 82.1 17.9%
339.3
17.9%
$
Pharmacy (in whole numbers except where indicated) Financial data Prescriptions dispensed (in thousands) Revenue per prescription dispensed (1) Gross profit per prescription dispensed (1) Gross profit margin (1) Generic dispensing rate
39,212 $ $
46.74 7.66 16.4% 83.3%
(1,481) $
(0.07)
$
1.09 2.4% 0.1%
(3.8)% -% $ 14.2% $ 14.6% 0.1%
37,731 46.67 8.75 18.8% 83.4%
(2,728)
(7.2) %
35,003
$
7.45
16.0%
$
0.94 (0.9) 1.5
10.7% $ (4.8) % 1.8%
$
54.12 9.69 17.9% 84.9%
(1) Amounts in 2013 do not include the $2.9 million California Medicaid estimated recoupment. Revenues Revenues increased $136.6 million for the year ended December 31, 2014 compared to the year ended December 31, 2013 as a result of the inclusion of a full year of revenues from the five acquisitions of long-term care businesses in 2013 (the “2013 Acquisitions”) and the acquisition of OncoMed Specialty, LLC (“Onco”); in addition, revenues increased as a result of the acquisitions of four long-term care businesses and one infusion business (collectively, the “2014 Acquisitions”). The increases from the 2013 Acquisitions and 2014 Acquisitions were partially offset by decreases in revenues due to the loss of Kindred as a customer. Excluding the $2.9 million California Medicaid estimated recoupment recognized in the third quarter of 2013, the remaining increase of $133.7 million is comprised of a favorable rate variance of approximately $261.0 million or $7.45 increase per prescription dispensed, partially offset by an unfavorable volume variance of $127.3 million or 2,728,000 less prescriptions dispensed. The increase in revenue per prescription dispensed is due to the Onco acquisition along with brand inflation. Revenues decreased $74.7 million for the year ended December 31, 2013 compared to the year ended December 31, 2012 due to the decrease in prescriptions dispensed, resulting from the decrease in the number of customer licensed beds serviced. The decline was partially offset by the acquisition of Amerita Inc. ("Amerita") in the fourth quarter of 2012. Excluding the $2.9 million California Medicaid estimated recoupment recorded in the third quarter of 2013, the remaining decrease of $71.8 million is comprised of an unfavorable volume variance of approximately $69.2 million or 1,481,000 less prescriptions dispensed, along with an unfavorable rate variance of approximately $2.6 million or a $0.07 decrease per prescription dispensed. Gross Profit Gross profit for the year ended December 31, 2014 was $339.3 million or $9.69 per prescription dispensed compared to $330.1 million or $8.75 per prescription dispensed, excluding the $2.9 million California Medicaid estimated recoupment, for the year ended December 31, 2013. Gross profit was favorably impacted by improved purchasing flexibility under the PVA resulting in lower costs, the 2014 Acquisitions, and the Corporation’s restructuring incentives. Gross profit margin for the year ended December 31, 2014 was 17.9% compared to 18.8%, adjusted for the California Medicaid estimated recoupment, for the year ended December 31, 2013. While gross profit margin was adversely impacted by lower margins in the Corporation’s Onco oncology business, the gross profit per prescription dispensed is favorably impacted by the acquisition of Onco on December 6, 2013. Gross profit for the year ended December 31, 2013, excluding the $2.9 million California Medicaid estimated recoupment, was $330.1 million or $8.75 per prescription dispensed compared to $300.2 million or $7.66 per prescription dispensed for the year ended December 31, 2012. Gross profit margin for the year ended December 31, 2013 was 18.8%, adjusted for the California Medicaid estimated recoupment, compared to 16.4% for the year ended December 31, 2012. Gross profit margin was positively impacted by the effects of the Corporation’s purchasing strategies. 45
Index
Selling, General and Administrative Expenses Selling, general and administrative expenses were $236.3 million for the year ended December 31, 2014 compared to $225.3 million for the year ended December 31, 2013. The increase of $11.0 million is primarily due to the 2014 Acquisitions, as well as the 2013 acquisition of Onco, along with an increase in contract labor and employee benefit costs. Selling, general and administrative expenses were $225.3 million for the year ended December 31, 2013 compared to $214.7 million for the year ended December 31, 2012. The increase of $10.6 million is due primarily to an increase of $15.8 million in labor costs, of which $12.5 million is related to the Amerita acquisition, along with a $2.3 million increase in professional fees. These increases are partially offset by a $7.1 million decrease in contracted services and $2.7 million decrease in bad debt expense. All other costs included in selling, general and administrative expenses increased approximately $2.3 million. Depreciation and Amortization Depreciation expense was $20.3 million for the year ended December 31, 2014 compared to $19.3 million for the year ended December 31, 2013. The increase of $1.0 million is due primarily to depreciation expense recognized as a result of the 2014 Acquisitions. Amortization expense was $20.1 million for the year ended December 31, 2014 compared to $15.4 million for the year ended December 31, 2013. The increase of $4.7 million of amortization expense is a result of intangible amortization related to the 2013 and 2014 Acquisitions. Depreciation expense was $19.3 million for the year ended December 31, 2013 compared to $18.6 million for the year ended December 31, 2012. The increase of $0.7 million is due primarily to depreciation expense recognized on assets acquired with Amerita and computer hardware additions purchased in the fourth quarter 2012 related to the transition of IT services from one vendor to another. Amortization expense was $15.4 million for the year ended December 31, 2013 compared to $12.3 million for the year ended December 31, 2012. The increase of $3.1 million is due primarily to the amortization expense recognized on intangibles acquired through the Amerita acquisition on December 13, 2012. Settlements, Litigation and Other Related Charges Settlements, litigation and other related charges were $37.3 million for the year ended December 31, 2014 compared to $19.6 million for the year ended December 31, 2013. These costs relate to the Corporation being the subject of certain investigations and defenses in a number of cases for which the outcome of the litigation is uncertain, which is described more fully in Note 6. Settlements, litigation and other related charges were $19.6 million for the year ended December 31, 2013 compared to $2.1 million for the year ended December 31, 2012. The costs in 2012 were previously classified under merger, acquisition costs and other charges in the Corporation’s consolidated income statements. Restructuring and Impairment Charges Restructuring and impairment charges were $3.3 million for the year ended December 31, 2014 compared to $4.4 million for the year ended December 31, 2013. The decrease of $1.1 million is due to a decrease in costs associated with the Corporation’s restructuring plan as a result of the loss of two of the Corporation’s significant customers effective December 31, 2013. These costs are expected to continue to decline in 2015. Restructuring and impairment charges were $4.4 million for the year ended December 31, 2013. There were no similar expenses in the comparable period of the prior year. Merger, Acquisition, Integration Costs and Other Charges Merger, acquisition, integration costs and other charges were $13.6 million, $8.1 million and $17.8 million for the years ended December 31, 2014, 2013 and 2012, respectively. The component of these charges related to integrating acquisitions into our business for the years ended December 31, 2014, 2013, and 2012 were $0.3 million, $3.7 million, and $7.1 million, respectively. The component of these charges related to acquiring new businesses for the years ended December 31, 2014, 2013, and 2012 were $13.3 million, $4.4 million, and $10.7 million, respectively. 46
Index
Hurricane Sandy disaster costs In October 2012, Hurricane Sandy caused significant damage on Long Island, New York and surrounding areas. The financial impacts of the storm to the Corporation’s Long Beach facility as well as damage and disruption at our customer’s facilities included lower revenue estimated at $8.6 million due to the inability to operate at full capacity during the recovery period. Hurricane Sandy disasters costs were $(1.7) million, $(1.4) million, and $4.5 million for the years ended December 31, 2014, 2013, and 2012, respectively. The Corporation expects a portion of the cost associated with Hurricane Sandy to be covered by insurance. While the exact amount has not been determined, the Corporation’s current estimate of covered losses, net of its deductible, is approximately $7.3 million. After consideration of a $7.2 million advance by the insurance carrier, the Corporation has recorded a receivable for $0.1 million which is included in prepaids and other assets in the consolidated balance sheet. The actual recovery will vary depending on the outcome of the insurance loss adjustment process. Accordingly, no offsetting benefit for insurance recoveries above the amount of the cumulative loss has been recorded. Additionally, the Corporation allocated $1.4 million of certain operating costs and $1.0 million in bad debt expense and contractual revenue adjustments in 2012, associated with lost business and customers to Hurricane Sandy disaster costs in the consolidated income statements. Interest Expense Interest expense was $9.9 million for the year ended December 31, 2014 compared to $10.6 million for the year ended December 31, 2013. The decrease was primarily due to lower interest rates on the term loan and lower amortization of deferred financing costs, both associated with the new Credit Agreement executed in the third quarter of 2014. These decreases are partially offset by larger borrowings on the revolving credit facility in 2014. Long-term debt, including the current portion, was $351.3 million and $231.3 million as of December 31, 2014 and December 31, 2013, respectively. Interest expense was $10.6 million for the year ended December 31, 2013 compared to $10.0 million for the year ended December 31, 2012. The increase was primarily due to a higher amortization of deferred financing costs, partially offset by lower interest rates on long-term debt and lower debt levels. Long-term debt, including the current portion, was $231.3 million and $315.5 million as of December 31, 2013 and December 31, 2012, respectively. Debt Extinguishment As a result of the Prior Credit Agreement, the Corporation recorded a loss on debt extinguishment of $4.3 million in the Consolidated Income Statements for the year ended December 31, 2014. The loss recorded consisted primarily of deferred financing fees associated with the Prior Credit Agreement. Tax Provision The effective tax rate for the year ended December 31, 2014 was 58.0%, which was comprised of the 35.0% federal rate, 4.0% for the state rate, and 19.0% for other permanent differences. The rate for the year ended December 31, 2014 was unfavorably impacted by the Corporation’s accrued legal settlements discussed in Note 6. For purposes of the tax provision for the year ended December 31, 2014, the Corporation has made an assumption in the absence of more definitive information that $31.5 million of the legal accrual of $45.5 million is permanently non-deductible while $14 million will likely be deductible when the lawsuits are settled. Of the $31.5 million permanently nondeductible accrual, $17 million was accrued in 2013 and $14.5 million was accrued in 2014. Accordingly, this resulted in an increase in the twelve month tax provision of approximately $5.1 million, or approximately 31.5% of pre-tax income. Ultimate amounts may differ from the estimate. The effective tax rate was favorably impacted by the Domestic Production Activities Deduction of 10.4% and federal research and development credits of 5.6%. Excluding the impact of the legal settlement accruals and other discrete items, the 2014 provision for income taxes as a percentage of pre-tax income would have been 36.5%, comprised of 35.0% federal rate, 3.1% for the state rate and (1.6%) for permanent differences. When compared to the adjusted rate for 2013 of 37.0%, as described below, the 0.5% decrease is primarily attributable to a decrease in the state rate combined with increased favorable impacts from the research and development credits and the Domestic Production Activities Deduction. The effective tax rate for the year ended December 31, 2013 was 58.2%, which was comprised of the 35.0% federal rate, 4.3% for the state rate, and 18.9% for other permanent differences. The rate for the year ended December 31, 2013 was unfavorably impacted by the Corporation’s accrued legal settlement with the Department of Justice and an increase in the valuation allowance primarily related to the deferred tax asset for state net operating losses. Exclusive of these adjustments, the effective rate for the period ended December 31, 2013 would have been 37.0%, comprised of 35.0% federal rate, 4.3% for the state rate and (2.3)% for permanent differences. 47
Index
Liquidity and Capital Resources The primary sources of liquidity for the Corporation are cash flows from operations and the availability under the Credit Agreement. Historically, the Corporation has used substantially all of its’ available cash to make acquisitions. Based upon our existing cash levels, expected operating cash flows, capital spending, potential future acquisitions, and the availability of funds under our revolving credit facility, we believe that we have the necessary financial resources to satisfy our expected short-term and long-term liquidity needs.
Cash Flows—The following table presents selected data from our consolidated statements of cash flows for the periods presented (dollars in millions): 2012 Net cash provided by operating activities Net cash used in investing activities Net cash provided by (used in) financing activities Net increase (decrease) in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year
$
$
Years Ended December 31, 2013 85.7 $ (105.3) 14.5 (5.1) 17.4 12.3 $
155.7 $ (53.7) (90.1) 11.9 12.3 24.2 $
2014 48.4 (157.0) 117.7 9.1 24.2 33.3
Operating Activities – Cash provided by operating activities aggregated $48.4 million for the year ended December 31, 2014 compared to $155.7 million for the year ended December 31, 2013. The decrease in cash provided by operating activities is due to an increase in inventory purchasing reflecting the Corporation’s purchasing strategies, an increase in accumulated rebates receivable as a result of the ABDC dispute, as discussed in Note 6, along with an increase in cash used in payment of accounts payable. Cash provided by operating activities aggregated $155.7 million for the year ended December 31, 2013 compared to $85.7 million for the year ended December 31, 2012. The increase in cash provided by operating activities is due to an overall improvement in working capital, primarily enhanced inventory management.
Investing Activities – Cash used in investing activities aggregated $157.0 million for the year ended December 31, 2014 compared to $53.7 million for the year ended December 31, 2013. The increase in cash used in investing activities is primarily due to the five businesses the Corporation acquired in 2014, partially offset by a decrease in capital expenditures. Cash used in investing activities aggregated $53.7 million for the year ended December 31, 2013 compared to $105.3 million for the year ended December 31, 2012. The decrease in cash used in investing activities is due to the decrease of cash used for acquisitions partially offset by an increase in capital expenditures.
Financing Activities – Cash provided by financing activities aggregated $117.7 million for the year ended December 31, 2014 compared to cash used in financing activities of $90.1 million for the year ended December 31, 2013. The increase in cash provided by financing activities is due primarily to borrowings on the revolving credit facility the Corporation used to complete business acquisitions in 2014. Cash used in financing activities aggregated $90.1 million for the year ended December 31, 2013 compared to cash provided by financing activities of $14.5 million for the year ended December 31, 2012. The increase in cash used in financing activities is due to the increase in term loan debt and revolving credit facility repayments during 2013 along with an increase in treasury stock repurchases. The Corporation had no amounts outstanding on its revolving credit facility at December 31, 2013. 48
Index
Credit Agreement On September 17, 2014, the Corporation entered into a credit agreement with Bank of America, N.A. as administrative agent (the “Credit Agreement”). The Credit Agreement replaced the $450.0 million five-year credit agreement dated as of May 2, 2011, among the Corporation, Citibank, N.A., as Administrative Agent, and certain lenders. The Credit Agreement consists of a $225.0 million term loan facility and a $310.0 million revolving credit facility. The terms and conditions of the Credit Agreement are customary to facilities of this nature. Unless terminated earlier, the Credit Agreement will mature on September 17, 2019, and the principal amount outstanding thereunder, together with all accrued unpaid interest and other amounts owed thereunder, if any, will be payable in full on such date. The Credit Agreement requires quarterly term loan principal payments in an amount of $2.8 million beginning September 2015 through September 2019. The final principal repayment of the term loan shall be repaid on the term maturity date, September 17, 2019. In addition, the term loan is subject to certain prepayment obligations relating to certain asset sales, certain casualty losses and the incurrence of certain indebtedness. The Corporation had a total of $225.0 million of term debt outstanding under the Credit Agreement and $125.0 million outstanding under the revolving portion of the Credit Agreement as of December 31, 2014. The Credit Agreement provides for the issuance of letters of credit which, when issued, constitute usage and reduce availability on the revolving portion of the Credit Agreement. The amount of letters of credit outstanding as of December 31, 2014 was $2.5 million. After giving effect to the letters of credit and amounts outstanding under the revolving credit agreement, total availability under the revolving credit facility was $182.5 million as of December 31, 2014. The Credit Agreement also contains financial covenants that require us to satisfy certain financial tests and maintain certain financial ratios, including a maximum of debt to EBITDA ratio. The Corporation was compliant with all debt covenant requirements at December 31, 2014. The obligations under the Credit Agreement are guaranteed by certain domestic subsidiaries of the Corporation and secured by liens on substantially all of the Corporation's assets. Drug Wholesaler Agreements On January 25, 2013 the Corporation renegotiated its Amended PVA with ABDC effective January 1, 2013. The Amended PVA modified the previous agreement, which was set to expire September 30, 2013 and extended its term until September 30, 2016. The Amended PVA requires the Corporation to purchase certain levels of brand and non-injectable generic drugs from ABDC. The Amended PVA does provide the flexibility for the Corporation to contract with other suppliers. If the Corporation fails to adhere to the contractual purchase provisions, ABDC has the ability to increase the Corporation's drug pricing under the terms of the Amended PVA. The Corporation and ABDC are parties to certain legal proceedings with respect to the Amended PVA as further described in Note 6. On March 2, 2015, the Corporation provided ABDC with a notice of termination of the Amended PVA effective April 1, 2015. We have entered into a new Prime Vendor Agreement with Cardinal Health effective April 1, 2015. See Item 9B below. The Corporation also obtains pharmaceutical and other products from contracts negotiated directly with pharmaceutical manufacturers for discounted prices. While the loss of a supplier could adversely affect our business if alternate sources of supply are unavailable, numerous sources of supply are generally available to us and we have not experienced any difficulty in obtaining pharmaceuticals or other products and supplies to conduct our business. The Corporation seeks to maintain an on-site inventory of pharmaceuticals and supplies to ensure prompt delivery to our customers. ABDC maintains local distribution facilities in most major geographic markets in which we operate. 49
Index
Treasury Stock 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 was used. On July 2, 2012, the Board of Directors authorized an increase to the remaining portion of the existing stock 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 December 31, 2014. 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 and 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 stock repurchase program would be held as treasury shares and may be used for general corporate purposes, including reissuances 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. The Corporation purchased no shares under the program during the year ended December 31, 2014. The Corporation may redeem shares from employees upon the vesting of the Corporation’s stock awards for minimum statutory tax withholding purposes and to cover option exercise costs. The Corporation redeemed 200,334 shares of certain vested awards and the exercise of certain stock options for an aggregate price of approximately $5.1 million during the year ended December 31, 2014. These shares have also been designated by the Corporation as treasury stock. As of December 31, 2014, the Corporation had a total of 2,617,305 shares held as treasury stock. Off-Balance Sheet Arrangements We do not have any off-balance sheet arrangements, other than purchase commitments and lease obligations. See “Contractual Obligations” below. Contractual Obligations The Corporation is obligated to make future payments under various contracts such as long-term purchase obligations, debt agreements, and lease agreements, and has certain commitments. The Corporation has grouped these contractual obligations and off-balance sheet arrangements into operating activities, financing activities, and investing activities in the same manner as they are classified in the Consolidated Statements of Cash Flows in order to provide a better understanding of the nature of the obligations and arrangements and to provide a basis for comparison to historical information. The table below provides a summary of contractual obligations and off-balance sheet arrangements as of December 31, 2014 (dollars in millions): 2015 Operating activities: Amended Prime Vendor Agreement (1) Non-cancelable operating leases Financing activities: Debt payments Interest payments (2) Totals (1) (2)
$
$
2016 15.5 5.6 6.1 27.2
$
$
2017 11.9 11.3 4.7 27.9
$
$
2018 7.7 11.3 4.5 23.5
$
$
2019 5.8 11.3 4.2 21.3
$
$
Thereafter 5.8 310.5 3.0 319.3
$
$
1.5 1.5
Under the First Amendment to the Amended PVA the Corporation is required to purchase a certain percentage of its drug purchases through ABDC through September 30, 2016. On March 2, 2015, the Corporation provided ABDC with a notice of termination of the Amended PVA effective April 1, 2015. We have entered into a new Prime Vendor Agreement with Cardinal Health effective April 1, 2015. See Item 9B below. Estimated interest amounts do not include interest on the revolving credit facility, as the timing and amounts are uncertain. 50
Index
Supplemental Quarterly Information The following tables represent the results of the Corporation’s quarterly operations for the years ended December 31, 2013 and 2014 (in millions, except where indicated):
Revenues $ Cost of goods sold Gross profit Selling, general and administrative Amortization expense Merger, acquisition, integration costs, and other charges Settlement, litigation and other related charges Restructuring and impairment charges Hurricane Sandy disaster costs Operating income (loss) Interest expense, net Loss on debt extinguishment Income (loss) before income taxes Provision (benefit) for income taxes Net income (loss) $
First 439.8 355.5 84.3 56.7 4.1
2013 Quarters Second Third $ 430.8 $ 436.8 348.2 357.6 82.6 79.2 55.5 55.5 3.9 3.7
Fourth $ 450.5 369.4 81.1 57.6 3.7
$
First 452.2 372.2 80.0 57.2 4.4
2014 Quarters Second Third $ 448.6 $ 470.2 366.7 387.2 81.9 83.0 57.9 56.0 4.3 4.9
$
Fourth 523.5 429.1 94.4 65.2 6.5
2.8
2.7
1.1
1.5
5.0
1.5
3.8
3.3
0.1
0.1
17.2
2.2
1.2
26.6
1.1
8.4
0.6 20.0 2.6 17.4
(0.9) 21.3 2.9 18.4
1.0 0.1 0.6 2.6 (2.0)
3.4 (1.2) 13.9 2.5 11.4
1.9 10.3 2.5 7.8
1.2 0.1 (9.7) 2.3 (12.0)
0.1 17.1 2.1 4.3 10.7
0.1 (1.8) 12.7 3.0 9.7
6.9 10.5
$
8.2 10.2
$
4.2 (6.2)
$
7.0 4.4
$
3.0 4.8
$
(2.3) (9.7)
$
2.2 8.5
$
6.5 3.2
Earnings (loss) per share (1): Basic Diluted
$ $
0.36 0.35
$ $
0.34 0.34
$ $
(0.21) (0.21)
$ $
0.15 0.15
$ $
0.16 0.16
$ $
(0.32) (0.32)
$ $
0.28 0.28
$ $
0.11 0.10
Adjusted diluted earnings per diluted share (1)(2):
$
0.46
$
0.44
$
0.49
$
0.44
$
0.37
$
0.40
$
0.45
$
0.45
Shares used in computing earnings (loss) per share: Basic 29.6 Diluted 30.1 Balance sheet data: Cash and cash equivalents Working capital (3) Goodwill (3) Intangible assets, net Total assets (3) Long-term debt Total stockholders' equity Supplemental information: Adjusted EBITDA(2) Adjusted EBITDA Margin (2) Adjusted EBITDA per prescription dispensed (2) Net cash provided by (used in) operating activities Net cash used in investing activities Net cash (used in) provided by financing activities
$ $ $ $ $ $ $
7.8 291.9 269.4 120.1 840.9 271.7 453.6
29.7 30.1 $ $ $ $ $ $ $
12.3 291.8 269.4 116.3 850.3 257.1 465.4
29.7 29.7 $ $ $ $ $ $ $
29.5 30.2
52.4 281.8 269.4 114.4 845.1 234.4 456.7
$ $ $ $ $ $ $
24.2 259.6 282.8 136.3 900.8 231.3 462.5
29.8 30.4 $ $ $ $ $ $ $
12.7 273.4 282.7 131.9 868.6 230.9 470.0
30.0 30.0 $ $ $ $ $ $ $
11.1 310.3 286.9 130.4 922.5 268.9 462.2
30.1 30.6 $ $ $ $ $ $ $
7.1 335.1 319.5 184.1 1,045.5 360.9 472.7
30.1 30.7 $ $ $ $ $ $ $
33.3 321.5 317.7 177.6 1,068.1 351.3 478.1
$
34.6 $ 7.9%
33.7 $ 7.8%
33.9 $ 7.7%
30.6 $ 6.8%
29.7 $ 6.6%
30.6 $ 6.8%
33.0 $ 7.0%
37.3 7.1%
$
3.56
$
3.58
$
3.64
$
3.30
$
3.45
$
3.64
$
3.89
$
3.93
$
47.5
$
26.4
$
78.1
$
3.7
$
4.4
$
(26.5)
$
19.7
$
50.8
$
(7.2)
$
(7.2)
$
(11.0)
$
(28.3)
$
(16.3)
$
(13.6)
$
(113.4)
$
(13.7)
$
(44.8)
$
(14.7)
$
(27.0)
$
(3.6)
$
0.4
$
38.5
$
89.7
$
(10.9)
Statistical information (in whole numbers except where indicated) Volume information Prescriptions dispensed (in thousands) 9,711 Revenue per prescription dispensed (4) $ 45.29 $ Gross profit per prescription dispensed (4) $ 8.68 $ Gross profit margin (4) 19.2% Generic drug dispensing rate 83.3% Inventory days on hand 25.4 Revenue days outstanding 41.6
9,420 45.73
9,320 $
8.77 $ 19.2% 83.3% 29.6 41.6
9,280
47.18
$
8.81 $ 18.7% 83.3% 18.1 39.8
48.87
8,608 $
9.06 $ 18.5% 83.7% 26.2 39.0
52.53
8,411 $
9.29 $ 17.7% 84.5% 26.0 37.7
53.33
8,492 $
9.74 $ 18.3% 85.0% 35.1 37.0
55.37
9,491 $
9.77 $ 17.7% 85.1% 31.7 36.7
55.16 9.95 18.0% 84.9% 29.1 34.9
(1) The Corporation has never declared a cash dividend. Earnings per common share are in actual cents. (2) See “Use of Non-GAAP Measures For Measuring Quarterly Results” for a definition and Reconciliation of Adjusted Earnings Per Diluted Common Share to Earnings Per Diluted Common Share, and for Reconciliation of Net Income to Adjusted EBITDA and Adjusted EBITDA Margin. (3) As adjusted, see Note 2—Acquisitions in the Consolidated Financial Statements. (4) The third quarter 2013 amounts do not include the $2.9 million California Medicaid estimated recoupment. 51
Index
Use of Non-GAAP Measures for Measuring Quarterly Results The Corporation calculates Adjusted EBITDA as provided in the reconciliation below and calculates Adjusted EBITDA Margin by taking Adjusted EBITDA and dividing it by revenues adjusted for the contractual amount associated with the California Medicaid estimated recoupment. The Corporation calculates and uses Adjusted EBITDA as an indicator of its ability to generate cash from reported operating results. The measurement is used in concert with net income and cash flows from operating activities, which measure actual cash generated in the period. In addition, the Corporation believes that Adjusted EBITDA and Adjusted EBITDA Margin are supplemental measurement tools used by analysts and investors to help evaluate overall operating performance and the ability to incur and service debt and make capital expenditures. In addition, Adjusted EBITDA, as defined in the Credit Agreement, is used in conjunction with the Corporation’s debt leverage ratio and this calculation sets the applicable margin for the quarterly interest charge. Adjusted EBITDA, as defined in the Credit Agreement, is not the same calculation as this Adjusted EBITDA table. Adjusted EBITDA presented herein does not represent funds available for the Corporation’s discretionary use and is not intended to represent or to be used as a substitute for net income or cash flows from operating activities data as measured under U.S. GAAP. The items excluded from Adjusted EBITDA but included in the calculation of the Corporation’s reported net income and cash flows from operating activities are significant components of the accompanying consolidated operating income statements and cash flows, and must be considered in performing a comprehensive assessment of overall financial performance. The Corporation’s calculation of Adjusted EBITDA may not be consistent with calculations of EBITDA used by other companies. The following are reconciliations of Adjusted EBITDA to the Corporation’s net income (loss) and net operating cash flows for the periods presented. The Corporation calculates and uses adjusted diluted earnings per share, which is exclusive of the impact of merger, acquisition, integration costs and other charges, settlement, litigation costs and other charges, Hurricane Sandy disaster costs, restructuring and impairment charges, California Medicaid estimated recoupment, stock-based compensation and deferred compensation, loss on debt extinguishment, and impact of discrete items on tax provision (“the Excluded Items”) as an indicator of its core operating results. The measurement is used in concert with net income and diluted earnings per share, which measure actual earnings per share generated in the period. The Corporation believes the exclusion of these charges in expressing earnings per share provides management with a useful measure to assess period to period comparability and is useful to investors in evaluating the Corporation’s operating results from period to period. Adjusted diluted earnings per share after giving effect to the Excluded Items does not represent the amount that effectively accrues directly to stockholders (i.e., such costs are a reduction in earnings and stockholders’ equity) and is not intended to represent or to be used as a substitute for diluted earnings per share as measured under U.S. GAAP. The Excluded Items are significant components of the accompanying consolidated statements of operations and must be considered in performing a comprehensive assessment of overall financial performance. The following is a reconciliation of adjusted diluted earnings per share to the Corporation’s U.S. GAAP earnings (loss) per diluted common share for the periods presented. 52
Index
Unaudited Reconciliation of Net Income (Loss) to Adjusted EBITDA 2013 Quarters Second Third $ 10.2 $ (6.2)
First Net income (loss) $ Add: Interest expense, net Merger, acquisition, integration costs and other charges Settlement, litigation and other related charges California Medicaid estimated recoupment Restructuring and impairment charges Loss on extinguishment of debt Hurricane Sandy disaster costs Stock-based compensation and deferred compensation Provision for income taxes Depreciation and amortization expense Adjusted EBITDA $ Adjusted EBITDA Margin
10.5
Fourth $
2014 Quarters Second Third $ (9.7) $ 8.5
First 4.4
$
4.8
Fourth $
3.2
2.6
2.9
2.6
2.5
2.5
2.3
2.1
3.0
2.8
2.7
1.1
1.5
5.0
1.5
3.1
3.3
0.1
0.1
17.2
2.2
1.2
26.6
1.1
8.4
-
-
2.9
-
-
-
-
-
-
-
1.0
3.4
1.9
1.2
0.1
0.1
-
-
-
-
-
-
4.3
-
0.6
(0.9)
0.1
(1.2)
-
0.1
-
(1.8)
2.2 6.9
1.8 8.2
2.4 4.2
2.3 7.0
2.1 3.0
1.8 (2.3)
1.8 2.2
2.3 6.5
8.9 34.6 $ 7.9%
8.7 33.7 $ 7.8%
8.6 33.9 $ 7.7%
8.5 30.6 $ 6.8%
9.2 29.7 $ 6.6%
9.1 30.6 $ 6.8%
9.8 33.0 $ 7.0%
12.3 37.3 7.1%
Unaudited Reconciliation of Adjusted EBITDA to Net Operating Cash Flows
First Adjusted EBITDA $ Interest expense, net Merger, acquisition, integration costs and other charges Provision for bad debt Amortization of deferred financing fees Loss (gain) on disposition of equipment Gain on acquisition Provision for income taxes Deferred income taxes Changes in federal and state income tax payable Excess tax benefit from stockbased compensation Changes in assets and liabilities Other Net Cash Flows Provided by (Used in) Operating Activities $
34.6 (2.6)
2013 Quarters Second Third $ 33.7 $ 33.9 (2.9) (2.6)
Fourth $ 30.6 $ (2.5)
First
2014 Quarters Second Third Fourth 29.7 $ 30.6 $ 33.0 $ 37.3 (2.5) (2.3) (2.1) (3.0)
(2.9) 5.3
(2.8) 5.2
(1.3) 5.2
(5.8) 6.8
(5.6) 5.6
(29.4) 5.7
(4.3) 5.3
(11.8) 6.6
0.3
0.7
0.6
0.7
0.7
0.6
0.5
0.1
(6.9) 3.6
(0.1) (8.2) (0.7)
0.4 (4.2) 3.5
0.3 (1.3) (7.0) 5.6
(0.1) (0.3) (3.0) 4.0
2.3 (3.3)
0.1 (2.2) (4.0)
(6.5) 1.0
2.9
3.2
(4.8)
(1.3)
(1.3)
(2.8)
3.7
7.6
(0.2) 13.3 0.1
(0.2) (1.7) 0.2
47.6 (0.2)
(22.2) (0.2)
(2.7) (20.2) 0.1
(0.5) (27.4) -
(0.2) (10.1) -
19.1 0.4
(26.5) $
19.7
47.5
$
26.4
$
78.1
$
3.7
$
4.4
$
$
50.8
Unaudited Reconciliation of Diluted Earnings (Loss) Per Share to Adjusted Diluted Earnings Per Share 2013 Quarters Second Third
First Diluted earnings (loss) per share $ Add: Diluted earnings per share impact of: Merger, acquisition, integration costs and other charges Settlement, litigation and other related charges California Medicaid estimated recoupment Restructuring and impairment charges Loss on extinguishment of debt Hurricane Sandy disaster costs Stock-based compensation and deferred compensation Impact of discrete items on tax provision Adjusted diluted earnings per share $
0.35
$
0.34
$
Fourth
(0.21)
$
2014 Quarters Second Third
First
0.15
$
0.16
$
Fourth
(0.32) $
0.28
$
0.10
0.06
0.06
0.03
0.03
0.10
0.03
0.06
0.08
-
-
0.56
0.05
0.03
0.61
0.02
0.11
-
-
0.07
-
-
-
-
-
-
-
0.03
0.08
0.04
0.03
-
-
-
-
-
-
-
-
0.09
-
0.01
(0.02)
-
(0.03)
-
-
-
(0.04)
0.04
0.03
0.06
0.05
0.04
0.04
0.04
0.05
-
0.03
(0.05)
0.11
-
0.01
(0.04)
0.15
0.46
$
0.44
$
0.49
$
0.44
$
0.37
$
0.40
$
0.45
$
0.45
53
Index
Item 7A.
Quantitative and Qualitative Disclosures about Market Risk
On September 17, 2014, the Corporation entered into the Credit Agreement. The Credit Agreement consists of a $225.0 million term loan facility and a $310.0 million revolving credit facility. Borrowings under the Credit Agreement bear interest at a floating rate equal to, at the Corporation's option, a base rate plus a margin between 0.50% and 1.25% per annum, or a Eurodollar Rate plus a margin between 1.50% and 2.25% per annum, in each case depending on the leverage ratio of the Corporation as defined by the Credit Agreement. The base rate is the greater of the prime lending rate in effect on such day, the federal funds effective rate plus 0.5%, and the Eurodollar Rate plus 1.0%. As of December 31, 2014, borrowings under the term loan bore interest at a rate of 2.2% per annum based upon the one month adjusted LIBO rate plus margin, and the revolving credit facility bore interest at a rate of 2.1% per annum based upon the LIBO rate plus applicable margin. Based upon the amount of variable rate debt outstanding as of December 31, 2014, a 100 basis point change in interest rates would affect the Corporation's future pretax earnings by approximately $3.5 million on an annual basis. The estimated change to the Corporation's interest expense is determined by considering the impact of hypothetical interest rates on the Corporation's borrowing cost and debt balances. These analyses do not consider the effects, if any, of the potential changes in the Corporation's credit ratings or leverage and the overall level of economic activity of the Corporation. Further, in the event of a change of significant magnitude, the Corporation's management would expect to take actions intended to further mitigate its exposure to such change. 54
Index
Item 8.
Financial Statements and Supplementary Data Index to Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm Consolidated Income Statements for the years ended December 31, 2012, 2013 and 2014 Consolidated Balance Sheets as of December 31, 2013 and 2014 Consolidated Statements of Cash Flows for the years ended December 31, 2012, 2013 and 2014 Consolidated Statements of Stockholders’ Equity for the years ended December 31, 2012, 2013 and 2014 Notes to Consolidated Financial Statements for the years ended December 31, 2012, 2013 and 2014 F-1
F-2 F-3 F-4 F-5 F-6 F-7
Index
Report of Independent Registered Public Accounting Firm The Board of Directors and Stockholders PharMerica Corporation: We have audited the accompanying consolidated balance sheets of PharMerica Corporation and subsidiaries (the Corporation) as of December 31, 2013 and 2014, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2014. We also have audited the Corporation’s internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control—Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Corporation’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Annual Report on Internal Control over Financial Reporting under Item 9A. Our responsibility is to express an opinion on these consolidated financial statements and an opinion on the Corporation’s internal control over financial reporting based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of PharMerica Corporation and subsidiaries as of December 31, 2013 and 2014, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2014, in conformity with U.S. generally accepted accounting principles. Also in our opinion, PharMerica Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control—Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission. As described in Management’s Annual Report on Internal Control over Financial Reporting under Item 9A, management has excluded the 2014 Acquisitions from its assessment of internal control over financial reporting as of December 31, 2014 because they were acquired by the Corporation in 2014. We have also excluded the 2014 Acquisitions from our audit of internal control over financial reporting. The total assets and total revenues of the 2014 Acquisitions represent approximately 3.8% and 3.6%, respectively, of the related consolidated financial statement amounts as of and for the year ended December 31, 2014. /s/ KPMG LLP Louisville, Kentucky March 2, 2015 F-2
Index
PHARMERICA CORPORATION CONSOLIDATED INCOME STATEMENTS For the Years Ended December 31, 2012, 2013 and 2014 (In millions, except share and per share amounts)
Revenues Cost of goods sold Gross profit Selling, general and administrative expenses Amortization expense Merger, acquisition, integration costs and other charges Settlement, litigation and other related charges Restructuring and impairment charges Hurricane Sandy disaster costs Operating income Interest expense, net Loss on extinguishment of debt Income before income taxes Provision for income taxes Net income
$
2012 1,832.6 1,532.4 300.2 214.7 12.3 17.8 2.1 4.5 48.8 10.0 38.8 15.9 22.9
$ $
0.78 0.77
$
Earnings per common share: Basic Diluted Shares used in computing earnings per common share: Basic Diluted
29,471,734 29,901,896 See accompanying Notes to Consolidated Financial Statements F-3
$
$
$ $
2013 1,757.9 $ 1,430.7 327.2 225.3 15.4 8.1 19.6 4.4 (1.4) 55.8 10.6 45.2 26.3 18.9 $
0.64 0.63 29,601,199 30,075,699
$ $
2014 1,894.5 1,555.2 339.3 236.3 20.1 13.6 37.3 3.3 (1.7) 30.4 9.9 4.3 16.2 9.4 6.8
0.23 0.22 29,983,428 30,649,131
Index
PHARMERICA CORPORATION CONSOLIDATED BALANCE SHEETS As of December 31, 2013 and 2014 (In millions, except share and per share amounts) (As Adjusted) December 31, 2013
December 31, 2014
ASSETS Current assets: Cash and cash equivalents Accounts receivable, net Inventory Deferred tax assets, net Income taxes receivable Prepaids and other assets (See Note 6)
$
24.2 198.6 110.2 36.9 1.9 38.8 410.6
$
33.3 195.7 135.7 42.2 90.4 497.3
Equipment and leasehold improvements Accumulated depreciation
179.4 (117.6) 61.8
196.4 (125.0) 71.4
Goodwill Intangible assets, net Other
282.8 136.3 9.3 900.8
317.7 177.6 4.1 1,068.1
$
$
LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable Salaries, wages and other compensation Current portion of long-term debt Income taxes payable Other accrued liabilities
$
Long-term debt Other long-term liabilities Deferred tax liabilities Commitments and contingencies (See Note 6) Stockholders' equity: Preferred stock, $0.01 par value per share; 1,000,000 shares authorized and no shares issued, December 31, 2013 and 2014 Common stock, $0.01 par value per share; 175,000,000 shares authorized;31,954,264 and 32,725,786 shares issued as of December 31, 2013 and 2014, respectively Capital in excess of par value Retained earnings Treasury stock at cost, 2,416,971 and 2,617,305 shares at December 31, 2013 and December 31, 2014, respectively $ See accompanying Notes to Consolidated Financial Statements F-4
78.8 38.7 12.5 21.0 151.0
$
95.5 35.1 6.4 2.3 36.5 175.8
218.8 49.8 18.7
344.9 57.7 11.6
-
-
0.3 380.2 110.2 (28.2) 462.5 900.8 $
0.3 394.1 117.0 (33.3) 478.1 1,068.1
Index
PHARMERICA CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS For the Years Ended December 31, 2012, 2013 and 2014 (In millions) 2012 Cash flows provided by (used in) operating activities: Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation Amortization Impairment charge Merger, acquisition, integration costs and other charges Hurricane Sandy disaster costs Stock-based compensation and deferred compensation Amortization of deferred financing fees Deferred income taxes Loss on disposition of equipment Gain on acquisition/disposition Loss on debt extinguishment Other Change in operating assets and liabilities: Accounts receivable, net Inventory Prepaids and other assets Accounts payable Salaries, wages and other compensation Other accrued and long-term liabilities Change in income taxes payable (receivable) Excess tax benefit from stock-based compensation Net cash provided by operating activities
$
2013 22.9
$
2014 18.9
$
6.8
18.6 12.3 1.3 1.5 7.1 1.0 2.8 0.1 0.2
19.3 15.4 0.1 0.2 8.7 2.3 12.0 0.6 (1.3) (0.1)
20.3 20.1 2.5 (1.8) 8.0 1.9 (2.3) (0.2) 4.3 0.4
35.8 (4.7) (1.3) (9.3) (3.4) (0.3) 1.1 85.7
16.5 32.7 (1.4) 17.1 (4.2) 19.3 (0.4) 155.7
29.1 (18.8) (49.2) (2.9) (4.9) 31.3 7.2 (3.4) 48.4
(20.8) (84.8) 0.3 (105.3)
(27.3) (26.5) 0.1 (53.7)
(25.6) (133.7) 0.1 2.2 (157.0)
Cash flows provided by (used in) financing activities: Repayments of long-term debt Proceeds from long-term debt Net activity of long-term revolving credit facility Payment of debt issuance costs Repayments of capital lease obligations Issuance of common stock Treasury stock at cost Excess tax benefit from stock-based compensation Net cash provided by (used in) financing activities
(6.3) 21.7 (0.1) 0.4 (1.2) 14.5
(12.5) (71.7) 9.9 (16.2) 0.4 (90.1)
(231.3) 225.0 125.0 (2.7) 3.4 (5.1) 3.4 117.7
Change in cash and cash equivalents Cash and cash equivalents at beginning of year
(5.1) 17.4
11.9 12.3
9.1 24.2
Cash flows provided by (used in) investing activities: Purchase of equipment and leasehold improvements Acquisitions, net of cash acquired Cash proceeds from the sale of assets Cash proceeds from dispositions, including insurance Net cash used in investing activities
Cash and cash equivalents at end of year
$
12.3
$
24.2
$
33.3
Supplemental information: Cash paid for interest Cash paid for taxes
$ $
9.3 12.6
$ $
8.4 18.1
$ $
7.8 5.3
See accompanying Notes to Consolidated Financial Statements F-5
Index
PHARMERICA CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY For the Years Ended December 31, 2012, 2013 and 2014 (In millions, except share amounts)
Balance at December 31, 2011 Net income Exercise of stock options and tax components of stock-based awards, net Vested restricted stock units Treasury stock at cost Stock-based compensation -non-vested restricted stock Stock-based compensation -stock options Balance at December 31, 2012 Net income Exercise of stock options and tax components of stock-based awards, net Vested restricted stock units Vested performance share units Treasury stock at cost Stock-based compensation -non-vested restricted stock Stock-based compensation -stock options Balance at December 31, 2013 Net income Exercise of stock options and tax components of stock-based awards, net Vested restricted stock units Vested performance share units Treasury stock at cost Stock-based compensation -non-vested restricted stock Stock-based compensation -stock options Balance at December 31, 2014
Common Stock Shares Amount 29,443,872 $ 0.3
Capital in Excess of Par Value $ 355.9
Retained Earnings $ 68.4 22.9
40,468 109,280 (106,165)
-
0.4 -
-
29,487,455
0.3
5.1 1.6 363.0
91.3 18.9
$
$
$
622,712 325,257 62,547 (960,678)
-
10.0 -
-
29,537,293
0.3
6.2 1.0 380.2
110.2 6.8
$
$
$
283,809 288,076 199,637 (200,334)
-
6.5 -
-
30,108,481
0.3
6.8 0.6 394.1
117.0
$
$
$
See accompanying Notes to Consolidated Financial Statements F-6
Treasury Stock $ (10.8) $
(1.2)
$
$
413.8 22.9 0.4 (1.2)
(12.0) $
5.1 1.6 442.6 18.9
(16.2)
10.0 (16.2)
(28.2) $
6.2 1.0 462.5 6.8
(5.1)
$
Total
(33.3) $
6.5 (5.1) 6.8 0.6 478.1
Index
PHARMERICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 98 institutional pharmacies, 14 specialty infusion pharmacies, and 5 specialty oncology pharmacies in 45 states. The Corporation’s customers are typically institutional healthcare providers, such as skilled nursing facilities, nursing centers, assisted living facilities, hospitals, individuals receiving in-home care and other long-term alternative care providers. The Corporation is generally the primary source of supply of pharmaceuticals to its customers. The Corporation also provides pharmacy management services to 89 hospitals in the United States. 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. Use of Estimates The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States (“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 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, the valuation of long-lived assets and goodwill and accounting for income taxes. Actual amounts may differ from these estimates. Potential risks and uncertainties, many of which are beyond the control of the Corporation, include, but are not necessarily limited to, such factors as overall economic, financial and business conditions; the overall condition of the Corporation’s customers and suppliers; the intense competition in the Corporation’s industry; the loss of one or more key pharmaceutical manufacturers; changes in manufacturers’ rebate programs; the risk of loss of revenues due to the loss of certain customers or a customer or owner of a skilled nursing facility entering the institutional pharmacy business; the effects of the loss of a large customer and the Corporation's ability to adequately restructure its operations to offset the loss; the home infusion joint ventures formed with hospitals could adversely affect the Corporation’s financial results; the decline in operating revenues and profitability with an increase in the Corporation’s generic dispensing rate; the loss of prescription volumes and revenue from pharmaceutical products that develop unexpected safety or efficacy concerns; reduction in reimbursement rates for the Corporation’s products and/or medical treatments or services may reduce profitability; modifications to the Medicare Part D program which may reduce revenue or impose additional costs; changes in Medicaid reimbursement which may reduce revenue; the payments of significant penalties and damages for failure to comply with complex and rapidly evolving laws and regulations, as well as licensure requirements; the adverse results from material litigation or governmental inquires including the possible insufficiency of any accruals established by the Corporation could have a material impact on the Corporation’s business; failure to comply with Medicare and Medicaid regulations could result in loss of eligibility to participate in these programs; efforts by payers to control costs; healthcare reform adversely impacting the liquidity of the Corporation’s customers thus affecting their ability to make timely payments to the Corporation; increasing enforcement in the U.S. healthcare industry negatively impacting the Corporation’s business; further consolidation of managed care organizations and other third-party payers adversely affecting the Corporation’s profits; Federal and state medical privacy regulations increasing costs of operations and expose the Corporation’s to civil and criminal sanctions; interruption or damage to the Corporation’s sophisticated information systems; purchasing a significant portion of the Corporation’s pharmaceutical products from one supplier; attracting and retaining key executives, pharmacists, and other healthcare personnel; revenues and volumes adversely affected by certain factors in markets in which the Corporation operates, including weather; the provisions in the Corporation’s certification of incorporation and bylaws could delay or prevent a change of control that stockholders favor; changes in volatility of the Corporation’s stock price; successfully pursuing development and acquisition activities; indebtedness that restricts the Corporation’s ability to pay cash dividends and has a negative impact on the Corporation’s financing options; exposure to changes in interest rates; the potential impact of the litigation proceedings with ABDC regarding the Amended Prime Vendor Agreement and collection of the $40.8 million included in prepaids and other assets on the consolidated balance sheets; changes to critical accounting estimates and changes in and interpretations of accounting rules and standards. F-7
Index
PHARMERICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued) NOTE 1—ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Cash and Cash Equivalents Cash and cash equivalents consist of cash on hand and cash equivalents with original maturities of three months or less. The Corporation places its cash in financial institutions that are federally insured. As of December 31, 2013 and 2014, the Corporation did not hold a material amount of funds in cash equivalent money market accounts. Management believes it effectively safeguards cash assets. 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.
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). F-8
Index
PHARMERICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued) NOTE 1—ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Financial liabilities and non-financial assets recorded at fair value at December 31, 2013 and 2014, are set forth in the tables below (dollars in millions): As of December 31, 2013 Financial Liability Deferred Compensation Plan Contingent Consideration Mandatorily Redeemable Interest As of December 31, 2014 Financial Liability Deferred Compensation Plan Contingent Consideration Mandatorily Redeemable Interest
Asset/(Liability) $ $ $
(6.9) $ (0.7) $ (8.2) $
Asset/(Liability) $ $ $
Level 1
Level 2 -
$ $ $
Level 1
(8.0) $ (1.1) $ (8.3) $
(6.9) $ - $ - $ Level 2
-
$ $ $
Valuation Technique
Level 3 (0.7) (8.2)
Valuation Technique
Level 3 (8.0) $ - $ - $
A C C
(1.1) (8.3)
A C C
The deferred compensation plan liability represents an unfunded 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 consolidated balance sheets. The contingent consideration represents future earn-outs associated with the Corporation’s acquisition of an institutional pharmacy business purchased in 2013 and an infusion business purchased in 2014. 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 long-term liabilities in the accompanying 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") purchased on December 6, 2013. 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’s fair value of the liability at December 31, 2014. For the years ended December 31, 2013 and December 31, 2014, 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 consideration and mandatorily redeemable interest identified as Level 3 for the years ended December 31, 2013 and December 31, 2014 (in millions): Contingent Consideration Beginning balance, December 31, 2012 Additions from business acquisitions Balance, December 31, 2013 Additions from business acquisitions Change in fair value Balance, December 31, 2014
$
$ F-9
- $ 0.7 0.7 1.1 (0.7) 1.1 $
Mandatorily Redeemable Interest 8.2 8.2 0.1 8.3
Index
PHARMERICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued) NOTE 1—ORGANIZATION ND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) The carrying amounts reported in the accompanying 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). 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, PDP’s, 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, 2013 Institutional healthcare providers Medicare Part D Private payer and other Insured Medicaid Medicare Allowance for doubtful accounts
$
2014 160.9 30.9 29.1 20.0 11.9 2.5 (56.7) 198.6
$ 0 to 60 days 61 to 120 days Over 120 days
$
$
55.5% 18.8% 25.7% 100.0%
153.5 30.5 30.6 24.5 11.7 3.0 (58.1) 195.7 58.8% 17.2% 24.0% 100.0%
The following is a summary of activity in the Corporation’s allowance for doubtful accounts (dollars in millions): Charges to Costs and Expenses
Beginning Balance Allowance for doubtful accounts: Year Ended December 31, 2012 Year Ended December 31, 2013 Year Ended December 31, 2014
$ $ $
48.6 56.4 56.7 F-10
$ $ $
25.9 22.7 23.2
Write-offs $ $ $
(18.1) $ (22.4) $ (21.8) $
Ending Balance 56.4 56.7 58.1
Index
PHARMERICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued) NOTE 1—ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Deferred Financing Fees The Corporation capitalizes financing fees related to acquiring or issuing new debt instruments. These expenditures include bank fees and premiums, legal costs, and filing fees. The Corporation amortizes these deferred financing fees using the effective interest method. Inventory Inventory is primarily located at the Corporation’s pharmacy locations. Inventory consists solely of finished products (primarily prescription drugs) and is valued at the lower of first-in, first-out cost (“FIFO”) or market. Physical inventories are performed at a minimum on a quarterly basis at the end of the quarter at all pharmacy sites. Cost of goods sold is adjusted based upon the results of the physical inventory counts. Equipment and Leasehold Improvements Equipment and leasehold improvements are recorded at cost on the acquisition date and are depreciated using the straight-line method over their estimated useful lives or lease term, if shorter, as follows (in years): Estimated Useful Lives Leasehold improvements Equipment and software
1-7 3-10
Expenditures for maintenance, repairs and renewals of minor items are expensed as incurred. Major rebuilds and improvements are capitalized. For the years ended December 31, 2012, 2013 and 2014, maintenance and repairs were $8.1 million, $10.0 million and $11.1 million, respectively. Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable. Recoverability of long-lived assets is assessed by a comparison of the carrying amount of the asset or asset group to the estimated future undiscounted net cash flows expected to be generated by the asset or group of assets. If estimated future undiscounted net cash flows are less than the carrying amount of the asset or group of assets, the asset is considered impaired and an expense is recorded in an amount required to reduce the carrying amount of the asset or asset group to its then fair value. The Corporation incurred no fixed asset impairment charges for the year ended December 31, 2014 and $0.1 million for the year ended December 31, 2013 associated with the Corporation's restructuring plan. The Corporation recorded $1.6 million in charges related to Hurricane Sandy for fixed assets which were destroyed in the year ended December 31, 2012. See Note 9. The Corporation’s equipment and leasehold improvements are further described in Note 3. Capitalization of Internal Software Costs The Corporation capitalizes the costs incurred during the application development stage, which includes costs to design the software configuration and interfaces, coding, installation, and testing. Costs incurred during the preliminary project stage along with post-implementation stages of internal use computer software are expensed as incurred. Capitalized development costs are amortized generally over three years and are subject to impairment evaluations. Costs incurred to maintain existing software development are expensed as incurred. The capitalization and ongoing assessment of recoverability of development costs requires judgment by management with respect to certain external factors, including, but not limited to, technological and economic feasibility and estimated economic life. For the years ended December 31, 2013 and 2014, the Corporation capitalized internally developed software costs of $13.3 million and $14.7 million, respectively. As of December 31, 2013 and 2014, net capitalized software costs, including acquired assets and amounts for projects which have not been completed, totaled $23.1 million and $29.4 million, respectively. F-11
Index
PHARMERICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued) NOTE 1—ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Goodwill and Other Intangibles The Corporation’s policy is to perform a quantitative assessment of its institutional pharmacy and specialty infusion reporting units to determine whether it is more likely than not (defined as having a likelihood of more than 50 percent) that the fair value of a reporting unit is less than its carrying amount. The Corporation performed a quantitative assessment as of December 31, 2014. The institutional pharmacy and specialty infusion reporting unit’s fair values as calculated for the analysis were approximately 48.2% and 13.1%, respectively, greater than current book value. The Corporation also performed a qualitative assessment of its specialty oncology reporting unit as of December 31, 2014 and did not find it necessary to perform the first step of the two-step impairment test based on that analysis. The Corporation’s finite-lived intangible assets are comprised primarily of trade names, customer relationship assets, limited distributor relationships, doctor and insurer relationships and non-compete agreements. Finite-lived intangible assets are amortized on a straight-line basis over the course of their lives ranging from 5 to 20 years. For impairment reviews, intangible assets are reviewed on a specific pharmacy basis or as a group of pharmacies depending on the intangible assets under review. The Corporation’s goodwill and intangible assets are further described in Note 4. Self-Insured Employee Health Benefits The Corporation is self-insured for the majority of its employee health benefits. The Corporation’s self-insurance for employee health benefits includes a stop-loss policy to limit the maximum potential liability of the Corporation for both individual and aggregate claims per year. The Corporation records a monthly expense for selfinsurance based on historical claims data and inputs from third-party administrators. For years ended December 31, 2012, 2013 and 2014, the expense for employee health benefits was $23.6 million, $22.3 million and $15.5 million, respectively, the majority of which was related to its self-insured plans. As of December 31, 2013 and 2014, the Corporation had $3.2 million and $2.2 million, respectively, recorded as a liability for self-insured employee health benefits. Supplier Rebates The Corporation receives rebates on purchases from its vendors and suppliers for achieving market share or purchase volumes. Rebates for brand name products are generally based upon achieving a defined market share tier within a therapeutic class and can be based on either purchasing volumes or actual prescriptions dispensed. Rebates for generic products are primarily based on achieving purchasing volume requirements. The Corporation generally accounts for these rebates and other incentives received from its vendors and suppliers, relating to the purchase or distribution of inventory, on an accrual basis as an estimated reduction of cost of goods sold and inventory. The estimated accrual is adjusted, if necessary, after the third party validates the appropriate data and notifies the Corporation of its agreement under the terms of the contract. The Corporation considers these rebates to represent product discounts, and as a result, the rebates are allocated as a reduction of product cost and relieved through cost of goods sold upon the sale of the related inventory or as a reduction of inventory for drugs which have not yet been sold. Delivery Expenses The Corporation incurred delivery expenses of $63.2 million, $62.0 million and $60.8 million for the years ended December 31, 2012, 2013, and 2014, respectively, to deliver products sold to its customers. Delivery expenses are reported as a component of cost of goods sold in the accompanying consolidated income statements. Stock Option Accounting The measurement and recognition of compensation cost for all share-based payment awards made to employees and non-employee directors is based on the fair value of the award. The Corporation recognizes share-based compensation costs for only those shares expected to vest on a straight-line basis over the requisite service period of the award (see Note 10). F-12
Index
PHARMERICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued) NOTE 1—ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Restructuring and Impairment Charges Restructuring and impairment charges in the consolidated financial statements represent amounts expensed for purposes of realigning corporate and pharmacy locations. Income Taxes Deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The Corporation accrues for tax obligations, as appropriate, based on facts and circumstances in the various regulatory environments. Deferred tax assets and liabilities are more fully described in Note 11. Mandatorily Redeemable Interest The Corporation acquired 37.5% of the membership interests of OncoMed Specialty, LLC (the “Onco Acquisition") while also obtaining control of the business. As further discussed in Note 2, the subsidiary is consolidated in the Corporation's consolidated financial statements and the mandatorily redeemable interest is classified as debt within other long-term liabilities in the consolidated balance sheets. Measurement Period Adjustments For the year ended December 31, 2014, the Corporation has adjusted certain amounts on the consolidated balance sheet as of December 31, 2013 as a result of measurement period adjustments related to the acquisitions occurring in 2013 (See Note 2). Recently Issued Accounting Pronouncements On May 28, 2014, the FASB issued Accounting Standard Update ("ASU") No. 2014-09, Revenue from Contracts with Customers, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The new standard is effective for the Corporation on January 1, 2017. Early application is not permitted. The standard permits the use of either the retrospective or cumulative effect transition method. The Corporation is evaluating the effect that ASU 2014-09 will have on its consolidated financial statements and related disclosures. The Corporation has not yet selected a transition method nor has it determined the effect of the standard on its ongoing financial reporting. On August 2014, the FASB issued ASU 2014-15, Presentation of Financial Statements - Going Concern (Subtopic 205-40); Disclosure of Uncertainties about an Entity's Ability to Continue as a Going Concern, which requires management of the Corporation to evaluate whether there is substantial doubt about the Company's ability to continue as a going concern. ASU 2014-15 is effective for the Company in our first quarter of fiscal 2017, with early adoption permitted. The Corporation does not expect this standard to have an impact on the consolidated financial statements upon adoption. F-13
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PHARMERICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued) NOTE 2—ACQUISITIONS
2014 Acquisitions During the year ended December 31, 2014, the Corporation completed acquisitions of four long-term care businesses and one infusion business (collectively the "2014 Acquisitions"), none of which were individually significant to the Corporation. The 2014 Acquisitions required cash payments of approximately $114.4 million in the aggregate. The resulting amount of goodwill and identifiable intangibles related to these transactions in the aggregate were $34.9 million and $61.4 million, respectively. The Corporation believes the resulting amount of goodwill reflects its expectation of synergistic benefits of the acquisitions. Tax deductible goodwill associated with the 2014 Acquisitions was $29.8 million as of December 31, 2014. The net assets and operating results of the 2014 Acquisitions have been included in the Company's consolidated financial statements from their respective dates of acquisition. Amounts contingently payable related to the 2014 Acquisitions, representing payments originating from an earn-out provision of the infusion acquisition, were $1.1 million as of December 31, 2014. The amounts recognized as of the acquisition dates for the 2014 Acquisitions, on a combined basis, for assets acquired and liabilities assumed are as follows: Amounts Recognized as of Acquisition Date Accounts receivable Inventory Deferred tax assets - current Other current assets Equipment and leasehold improvements Deferred tax assets Identifiable intangibles Goodwill Total Assets
$
Current liabilities* Other long-term liabilities* Total Liabilities
24.7 8.8 1.8 3.1 4.8 8.2 61.4 34.9 147.7 26.4 6.9 33.3
Total purchase price, less cash acquired
$
114.4
* Included in current liabilities and other long-term liabilities are $0.8 million and $0.5 million, respectively, of capital lease obligations acquired as a part of the 2014 acquisitions. The acquisitions on a combined basis had a $63.0 million impact on the consolidated revenues and $0.6 million impact on consolidated pre-tax income for the year ended December 31, 2014. Pro Forma The following unaudited pro forma condensed consolidated financial information is not intended to represent or be indicative of the condensed consolidated results of operations or financial condition of the Corporation that would have been reported had the acquisitions been completed as of the date or for the periods presented, and should not be taken as representative of the future consolidated results of operations or financial condition of the Corporation. F-14
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PHARMERICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued) NOTE 2—ACQUISITIONS (Continued) The unaudited pro forma results, which include the historical results of the Corporation as well as the effect of the acquisitions, assuming the acquisitions occurred on January 1, 2013. The results may not be indicative of future results and do not include any synergistic benefits which the Corporation may realize. Assuming an effective tax rate exclusive of discrete items for the years ended December 31, 2013 and December 31, 2014, the pro forma results would be as follows (dollars in millions, except per share amounts):
Revenues Net income
For the years ended December 31, 2013 2014 $ 1,988.4 $ 2,045.4 $ 14.3 $ 1.3
Earnings per common share: Basic Diluted
$ $
0.48 0.48
$ $
0.04 0.04
2013 Acquisitions During the year ended December 31, 2013, the Corporation completed five acquisitions of long-term care businesses (the “2013 Acquisitions”), none of which were, individually or in the aggregate, significant to the Corporation. Acquisitions of businesses required cash payments of approximately $25.8 million. The resulting amount of goodwill and identifiable intangibles related to these transactions in the aggregate was $8.0 million and $10.3 million, respectively. The net assets and operating results of acquisitions have been included in the Company’s consolidated financial statements from their respective dates of acquisition. The Corporation also recognized a bargain purchase gain related to one of the 2013 Acquisitions in the amount of $1.3 million as a result of certain deferred tax assets acquired through the business combination. This gain was recorded in selling, general and administrative expenses in the accompanying consolidated income statements. Amounts contingently payable related to the 2013 Acquisitions, representing payments originating from earnout provisions of acquisitions, were reduced to less than $0.1 million as of December 31, 2014. On December 6, 2013 the Corporation through one of its wholly owned subsidiaries, acquired 37.5% of the issued share capital of Onco for $10.8 million, net of cash acquired. The Corporation’s primary purpose in acquiring Onco was to continue to expand pharmacy services through the addition of specialty pharmacy services. The total purchase price, as determined by an independent valuation of 100% of Onco, was allocated to the net tangible and identifiable intangible assets based upon their fair values on December 6, 2013 which resulted in identifiable intangible assets of $17.3 million and goodwill of $5.2 million. The Corporation believes the resulting amount of goodwill reflects its expectation of the synergistic benefits of the acquisition. Provisions in the acquisition agreement include a mandatorily redeemable interest whereby the Corporation is required to purchase the remaining capital of Onco on the fifth anniversary of the agreement, if not purchased earlier under the provisions of the acquisition agreement. The Corporation is accounting for the mandatorily redeemable interest of $8.3 million as a debt obligation and subsequently measuring that obligation at fair value. Changes in the fair value of the related debt will be recorded as interest expense in our consolidated income statements for the respective periods. In addition, net operating profit or loss of Onco subsequent to the acquisition is recognized based upon the Corporation’s ownership interest. In addition, Onco’s results are consolidated by the Corporation with 62.5% of the net operating profit or loss subsequent to the acquisition recognized as an adjustment to interest expense on the mandatorily redeemable interest. Total measurement period adjustments for the year ended December 31, 2014 resulted in a net adjustment to goodwill of $0.5 million and were related to the 2013 Acquisitions and Onco. Pro forma financial statements are not presented on the 2013 Acquisitions and Onco, as the results are not material to the Corporation’s consolidated financial statements. F-15
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PHARMERICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued) NOTE 2—ACQUISITIONS (Continued) Other For the years ended December 31, 2012, 2013 and 2014, the Corporation incurred $10.7 million, $4.4 million, and $13.3 million, respectively, of acquisition related costs, which have been classified as a component of merger, acquisition, integration costs and other charges. NOTE 3—EQUIPMENT AND LEASEHOLD IMPROVEMENTS Equipment and leasehold improvements consist of the following (dollars in millions): December 31, 2013 Leasehold improvements Equipment and software Construction in progress
$
Accumulated depreciation Total equipment and leasehold improvements
$
2014 17.8 $ 154.1 7.5 179.4 (117.6) 61.8 $
19.6 166.1 10.7 196.4 (125.0) 71.4
Depreciation expense totaled $18.6 million, $19.3 million, and $20.3 million for the years ended December 31, 2012, 2013, and 2014, respectively. NOTE 4—GOODWILL AND INTANGIBLES The following table presents the changes in the carrying amount of goodwill for the years ended December 31, 2013 and 2014 (dollars in millions): Balance at December 31, 2012 as adjusted Goodwill acquired from 2013 acquisitions, as adjusted Balance at December 31, 2013, as adjusted Goodwill acquired from 2014 acquisitions Balance at December 31, 2014
$
$
269.4 13.4 282.8 34.9 317.7
The following table presents the components of the Corporation’s intangible assets (dollars in millions): Finite Lived Intangible Assets Customer relationships Trade name Non-compete agreements Sub Total Accumulated amortization Net intangible assets
Balance at Balance at Balance at 2012 Additions 2013 Additions 2014 $ 98.8 $ 22.4 $ 121.2 $ 56.3 $ 177.5 57.0 3.2 60.2 2.0 62.2 12.5 4.3 16.8 3.1 19.9 168.3 29.9 198.2 61.4 259.6 (46.5) (15.4) (61.9) (20.1) (82.0) $ 121.8 $ 14.5 $ 136.3 $ 41.3 $ 177.6
Amortization expense relating to finite-lived intangible assets was $12.3 million, $15.4 million, and $20.1 million for the years ended December 31, 2012, 2013 and 2014, respectively. F-16
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PHARMERICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued) NOTE 4—GOODWILL AND INTANGIBLES (Continued) Total estimated amortization expense for the Corporation’s finite-lived intangible assets for the next five years and thereafter are as follows (dollars in millions): Year Ending December 31, 2015 2016 2017 2018 2019 Thereafter
$
$
26.5 25.4 23.8 22.8 19.1 60.0 177.6
NOTE 5—CREDIT AGREEMENT On September 17, 2014, the Corporation entered into a credit agreement 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 (the "Credit Agreement"). The Credit Agreement replaced the $450.0 million five-year credit agreement dated as of May 2, 2011, among the Corporation, Citibank, N.A., as Administrative Agent, and certain lenders (the "Prior Credit Agreement"). The Credit Agreement consists of a $225.0 million term loan facility and a $310.0 million revolving credit facility. The terms and conditions of the Credit Agreement are customary to facilities of this nature. As a result of the payoff of the Prior Credit Agreement, the Corporation recorded a loss on debt extinguishment of $4.3 million in the Consolidated Income Statements during the year ended December 31, 2014. The loss recorded consisted primarily of deferred financing fees associated with the Prior Credit Agreement. As of December 31, 2014, $225.0 million was outstanding under the term loan facility and $125.0 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, 2013 Term Debt - payable to lenders at LIBOR plus applicable margin (2.16% as of December 31, 2014), matures September 17, 2019 $ Term Debt - payable to lenders at LIBOR plus applicable margin (2.67% as of December 31, 2013), terminated September 17, 2014 Revolving Credit Facility payable to lenders, interest at LIBOR plus applicable margin (2.13% as of December 31, 2014), matures September 17, 2019 Revolving Credit Facility payable to lenders, interest plus applicable margin (4.75% as of December 31, 2013), terminated September 17, 2014 Capital lease obligations Total debt Less: Current portion of long-term debt Total long-term debt $ F-17
December 31, 2014 -
$
225.0
231.3
-
-
125.0
231.3 12.5 218.8
1.3 351.3 6.4 344.9
$
Index
PHARMERICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued) NOTE 5—CREDIT AGREEMENT (Continued) The Corporation’s indebtedness has the following maturities (dollars in millions):
Year Ending December 31, 2015 2016 2017 2018 2019
Revolving Credit Facility
Term Debt $
$
5.6 11.3 11.3 11.3 185.5 225.0
$
$
125.0 125.0
Capital Lease Obligations $
$
Total Maturities 0.8 0.1 0.1 0.3 1.3
$
$
6.4 11.4 11.4 11.6 310.5 351.3
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 December 31, 2014 was $2.5 million. After giving effect to the letters of credit, total availability under the revolving credit facility was $182.5 million as of December 31, 2014. Borrowings under the Credit Agreement bear interest at a floating rate equal to, at the Corporation's option, a base rate plus a margin between 0.50% and 1.25% per annum, or a Eurodollar Rate plus a margin between 1.50% and 2.25% per annum, in each case depending on the leverage ratio of the Corporation as defined by the Credit Agreement. The base rate is the greater of the prime lending rate in effect on such day, the federal funds effective rate plus 0.5%, and the Eurodollar Rate plus 1.0%. The Credit Agreement also provides for letter of credit fees between 1.50% and 2.25% on the letter of credit exposure, depending on the leverage ratio of the Corporation, and 0.125% on the actual daily amount available to be drawn under such letter of credit. The Corporation will also pay fronting fees on the aggregate letter of credit exposure at a rate separately agreed upon between the Corporation and the issuing bank. The Credit Agreement also provides for a commitment fee payable on the unused portion of the revolving credit facility, which shall accrue at a rate per annum ranging from 0.25% to 0.35%, depending on the leverage ratio of the Corporation. The Credit Agreement contains customary affirmative and negative covenants, as well as customary events of default. The Credit Agreement also requires the Corporation to satisfy an interest coverage ratio and a leverage ratio. The interest charge coverage ratio as of the last day of any fiscal quarter can be no less than: 3.00:1.00. The Leverage Ratio as of the last day of any fiscal quarter of the Corporation cannot exceed 3.75:1.00, subject to certain exceptions for permitted acquisitions. In addition, capital expenditures (other than those funded with proceeds of asset sales or insurance) are restricted in any fiscal year to 5.0% of revenues. The Corporation was compliant with all debt covenant requirements at December 31, 2014. The obligations under the Credit Agreement are guaranteed by certain domestic subsidiaries of the Corporation and secured by liens on substantially all of the Corporation's assets. Deferred Financing Fees The Corporation capitalized a total of $2.7 million in deferred financing fees associated with the Credit Agreement and recorded them as other assets in the accompanying consolidated balance sheets. As of December 31, 2014, the Corporation had $2.6 million of unamortized deferred financing fees. F-18
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PHARMERICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued) NOTE 6—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 accrues for a liability when it is probable that such a liability has been incurred and the amount of the loss can be reasonably estimated. The Corporation is the subject of certain investigations and is a defendant in a number of cases, including those discussed below. On April 15, 2013, the U.S. Department of Justice, through the U.S. Attorney's Office for the Eastern District of Virginia, filed a complaint in the United States District Court for the Eastern District of Virginia against the Corporation's two pharmacies in Virginia Beach, Virginia and Fredericksburg, Virginia alleging that these two pharmacies failed to comply with the Controlled Substances Act ("CSA") by dispensing Schedule II drugs without a proper prescription. The parties reached a settlement in December 2013 and filed a stipulation for dismissal of the case in January 2014. Under the settlement, the Corporation paid a $1.0 million fine and will enter into a Memorandum of Agreement ("MOA") with the DEA through which it will agree to certain CSA compliance obligations. The precise terms of the MOA are currently being negotiated between the parties. In connection with the settlement, the Corporation did not admit liability for the alleged CSA violations. On June 10, 2013, the United States District Court for the Eastern District of Wisconsin unsealed two consolidated qui tam complaints filed in 2009 and 2011 by relators who are former employees of the Corporation and a company acquired by the Corporation. The United States, acting through the U.S. Attorney's Office in Wisconsin, intervened in part and declined to intervene in part and filed its complaint in intervention on August 9, 2013, when the matter was formally brought to the Corporation's attention. The Government's complaint seeks statutory fines for the Corporation's alleged dispensing of Schedule II controlled substances without a valid prescription in violation of the CSA. It also seeks monetary damages and equitable relief alleging that this conduct caused false claims to be submitted in violation of the Federal False Claims Act (the "FCA"). The Corporation moved to dismiss the Government's complaint for failure to state a claim upon which relief may be granted but the Court denied the Corporation's motion on September 3, 2014. With regard to the portion of the relators' complaint on which the Government did not intervene, on November 15, 2013, the relators dismissed their claims against the Corporation alleging that the Corporation submitted false claims to Medicare Part D and to Medicaid for drugs in connection with which the Corporation allegedly received kickbacks from the manufacturer in the form of market share rebates and other remuneration, all in violation of the Federal Anti Kickback Statute. The United States stipulated to the dismissal of those and other non-intervened counts and the Court approved the dismissal without prejudice of those counts on November 20, 2013. The relators pursued their claim under the retaliatory termination provisions of the FCA. On September 3, 2014, the Court denied the Corporation's motion to dismiss the relators' retaliatory termination claim. The Corporation intends to vigorously defend itself in both matters. On October 29, 2013, a complaint was filed in the United States District Court for the Southern District of Florida by Pines Nursing Homes (77), Inc. as a putative class action against the Corporation. The complaint alleged that the Corporation sent unsolicited advertisements promoting the Corporation's goods or services by facsimile to individuals or entities, and that such communications did not include an opt-out clause, all in violation of the federal Telephone Consumer Protection Act ("TCPA"). The Complaint did not specify the amount of damages sought, but the TCPA provides a statutory remedy of $500 per facsimile communication sent in violation of the statute, which may be trebled in the event of a willful violation. On August 18, 2014, the Corporation entered into a Settlement Agreement with the putative class and class counsel resolving all claims raised in the complaint. The parties moved on September 8, 2014 for, among other things, certification of the putative class for the purposes of effectuating the settlement and preliminary approval of the parties' settlement, and have requested a hearing on that motion. No hearing has yet been set on that motion and the Corporation awaits a decision on the motion for preliminary approval of the settlement. F-19
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PHARMERICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued) NOTE 6—COMMITMENTS AND CONTINGENCIES (Continued) On November 12, 2013, a relator, Fox Rx, Inc. ("Fox"), on behalf of the U.S. Government and various state governments and the District of Columbia, filed a complaint in the United States District Court for the Southern District of New York against the Corporation alleging that the Corporation violated the FCA by submitting false claims to Fox, other Medicare Part D sponsors and to Medicaid, by allegedly billing for expired drugs or for brand drugs when generic drugs should have been substituted. The U.S. Government declined to intervene in the case. On August 12, 2014, the court granted the Corporation's motion to dismiss the complaint. Fox filed a stipulation of dismissal and the appeal was dismissed on September 30, 2014. On November 20, 2013 the complaint filed by a relator, Robert Gadbois, on behalf of the U.S. Government and various state governments, was unsealed by the United States District for the District of Rhode Island against the Corporation alleging that the Corporation dispensed controlled and non-controlled substances in violation of the CSA 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 has appealed the court’s decision. The Corporation intends to continue to defend the case vigorously. 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 alleging that the Corporation violated the FCA and Federal Anti-Kickback Statute through its agreements to provide prescription drugs to nursing homes under certain Medicare and Medicaid programs. 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. The Corporation intends to vigorously defend itself against these allegations. On January 31, 2014, a relator, Frank Kurnik, on behalf of the U.S. Government and various state governments served its complaint filed in the United States District for the District of South Carolina alleging that the Corporation solicited and received remuneration in violation of the Federal Anti-Kickback Statute from drug manufacturer Amgen in exchange for preferring and promoting Amgen's drug Aranesp over a competing drug called Procrit. The U.S. Government and the various states declined to intervene in the case. On April 7, 2014, the Corporation moved to dismiss the complaint and on July 23, 2014, the motion was denied. The Corporation intends to vigorously defend itself against these allegations. The U.S. Department of Justice, through the U.S. Attorney's Office for the Western District of Virginia, is investigating whether the Corporation's activities in connection with the agreements it had with the manufacturer of the pharmaceutical Depakote violated the Anti-Kickback Statute and, hence, that certain claims for Depakote that the Corporation submitted to federal health care programs violated the Federal False Claims Act. The Corporation is cooperating with this investigation and believes it has complied with all applicable laws and regulations. On May 29, 2014, the United States District Court for the Western District of Virginia entered an order (the “May 29 Order”) unsealing two previously partially sealed qui tam complaints, entitled United States, et al., ex rel. Spetter v. Abbott Laboratories. Inc., Omnicare, Inc., and PharMerica Corp., No. 1:07-cv-00006 and United States, et al., ex rel. McCoyd v. Abbott Laboratories, Omnicare, Inc., PharMerica Corp., and Miles White, No. 1:07-cv-0008. The May 29 Order also unsealed the government’s notice of intervention and granted the Government 120 days to serve its Complaint in Intervention. That deadline has since been extended to March 23, 2015 as to PharMerica only. As was indicated during the investigation, the complaints allege that certain agreements that the Corporation had with the manufacturer of Depakote violated the Anti-Kickback Statute and, hence, those certain claims for Depakote that the Corporation submitted to federal health care programs violated the Federal False Claims Act and the analogous statutes of 27 states. The Corporation intends to vigorously defend itself. F-20
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PHARMERICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued) NOTE 6—COMMITMENTS AND CONTINGENCIES (Continued) On September 10, 2014, the Corporation filed a Complaint in Jefferson Circuit Court in Louisville, Kentucky against ABDC for breach of the Amended Prime Vendor Agreement ("Amended PVA"). The Corporation subsequently filed a First Amended Complaint asserting additional breaches of the Amended PVA. On November 24, 2014, the Jefferson Circuit Court issued a temporary injunction against ABDC. That order was subsequently over-ruled by the Court of Appeals on February 13, 2015. The Corporation has appealed the decision of the Court of Appeals to the Kentucky Supreme Court. On February 24, 2015, the Kentucky Supreme Court stayed the Appellate Court’s ruling until the Kentucky Supreme Court has an opportunity to rule on the matter. The amounts disputed by ABDC generally relate to certain rebates owed by ABDC under the Amended PVA. Rebates receivable from ABDC are $8.5 million, $12.3 million, and $20.0 million for the second quarter of 2014, the third quarter of 2014, and the fourth quarter 2014, respectively, which in the aggregate total $40.8 million as of December 31, 2014, are reflected as a receivable and included in prepaids and other assets in the accompanying consolidated balance sheets. The Corporation will have claims for additional damages resulting from ABCD’s breaches of the Amended 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, likely longer than 12 months. 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 December 31, 2014, the Corporation had accrued approximately $45.5 million related to the legal actions and investigations. California Medicaid On August 14, 2013, the California Department of Health Care Service ("DHCS") announced its intent to implement a ten (10) percent reimbursement reduction for numerous healthcare providers, including long term care pharmacies. The DHCS implemented the reduction prospectively beginning in the first quarter of 2014. In addition, the DHCS is expected to begin recouping a percentage of provider payments representing a ten percent (10%) reduction on certain drug reimbursements retroactive to June 1, 2011. The Corporation has previously recorded a $3.3 million liability and reduction of revenue for the expected amount of recoveries from June 1, 2011 through December 31, 2013. FUL and AMP Changes The reimbursement rates for pharmacy services under Medicaid are determined on a state-by-state basis subject to review by CMS and applicable federal law. Although Medicaid programs vary from state to state, they generally provide for the payment of certain pharmacy services, up to the established limits, at rates determined in accordance with each state's regulations. Federal regulations and the regulations of certain states establish "upper limits" for reimbursement of certain prescription drugs under Medicaid (these upper limits being the "FUL"). The 2010 Health Care Reform Legislation amended the Deficit Reduction Act of 2005 ("DRA") to change the definition of the FUL by requiring the calculation of the FUL as no less than 175 % of the weighted average, based on utilization, of the most recently reported monthly Average Manufacturer's Price ("AMP") for pharmaceutically and therapeutically equivalent multi-source drugs available through retail community pharmacies nationally. In addition, the definition of AMP changed to reflect net sales only to drug wholesalers that distribute to retail community pharmacies and to retail community pharmacies that directly purchase from drug manufacturers. Further, the 2010 Health Care Reform Legislation continues the current statutory exclusion of prompt pay discounts offered to wholesalers and adds three (3) other exclusions to the AMP definition: i) bona fide services fees; ii) reimbursement for unsalable returned goods (recalled, expired, damaged, etc.); and iii) payments from and rebates/discounts to certain entities not conducting business as a wholesaler or retail community pharmacy. In addition to reporting monthly, the manufacturers are required to report the total number of units used to calculate each monthly AMP. Centers for Medicare and Medicaid Services ("CMS") will use this information when it establishes FULs as a result of the new volume-weighted requirements pursuant to the 2010 Health Care Reform Legislation. F-21
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PHARMERICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued) NOTE 6—COMMITMENTS AND CONTINGENCIES (Continued) In September 2011, CMS issued the first draft FUL reimbursement files for multiple source drugs, including the draft methodology used to calculate the FULs in accordance with the Health Care Legislation. CMS continues to release monthly data and a three-month rolling average and is expected to do so going forward. CMS has not posted monthly AMPs for individual drugs, but only posted the weighted average of monthly AMPs in a FUL group and the calculation methodology. The Office of Information and Regulatory Affairs website states that the final rule was expected June 2014, but to date has not been released. Further, CMS has stated that AMP-based FULs will be published at or about the same time that CMS publishes the Medicaid Covered Outpatient Drug final rule, which, according to the latest unified agenda, is expected in April 2015. CMS will continue to post draft monthly FULs. The Corporation will continue to analyze the draft monthly FULs, including the relationship of those FULs to the National Average Drug Acquisition pricing. Medicare Part D Changes In a May 23, 2014 Final Rule entitled "Medicare Program: Contract Year 2015 Policy and Technical Changes to the Medicare Advantage and the Medicare Prescription Drug Benefit Programs," CMS finalized a requirement that effective June 1, 2015 and enforceable December 1, 2015, all prescribers of Part D covered drugs must be enrolled as Medicare providers (or be granted a valid opt-out affidavit on file with a Part A or Part B Medicare Administrative Contractor) in order for a claim to be covered under Medicare Part D. CMS also finalized several specific requirements to reduce prescriber fraud, waste, and abuse. The Corporation is unable to evaluate the full impact of these changes on its business at this time. In a February 12, 2015 Final Rule entitled "Medicare Program: Contract Year 2016 Policy and Technical Changes to the Medicare Advantage and the Medicare Prescription Drug Benefit Programs", CMS finalized a regulation, effective January 1, 2016, prohibiting financial arrangements that penalize more efficient long-term care dispensing techniques (e.g., dispensing a three day supply over a 14 day supply) through pro-rated dispensing fees based on a day's supply or quantity dispensed. CMS also finalized a requirement that, effective January 1, 2016, any differences in payment methodologies among long-term care pharmacies incentivize more efficient dispensing techniques. The Corporation is unable to evaluate the full impact of these changes on its business at this time. Acquisitions The Corporation has historically acquired the stock or assets of businesses with prior operating histories. Acquired companies may have unknown or contingent liabilities, including liabilities for failure to comply with healthcare laws and regulations, medical and general professional liabilities, workers’ compensation liabilities, previous tax liabilities, and unacceptable business practices. Although the Corporation institutes policies designed to conform practices to its standards following completion of acquisitions, there can be no assurance the Corporation will not become liable for past activities that may later be asserted to be improper by private plaintiffs or government agencies. While the Corporation generally seeks to obtain indemnification from prospective sellers covering such matters, there can be no assurance that any such matter will be covered by indemnification, or if covered, that such indemnification will be adequate to cover potential losses and fines. In the ordinary course of business, the Corporation enters into contracts containing standard indemnification provisions and indemnifications specific to a transaction such as business acquisitions and disposals of an operating facility. These indemnifications may cover claims against employment-related matters, governmental regulations, environmental issues, tax matters, as well as customer, third party payer, supplier, and contractual relationships. Obligations under these indemnities generally would be initiated by a breach of the terms of the contract or by a third party claim or event. Drug Wholesaler Agreements On January 25, 2013 the Corporation renegotiated its Amended PVA with ABDC effective January 1, 2013. The Amended PVA modified the previous agreement, which was set to expire September 30, 2013 and extended its term until September 30, 2016. F-22
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PHARMERICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued) NOTE 6—COMMITMENTS AND CONTINGENCIES (Continued) The Amended PVA requires the Corporation to purchase certain levels of brand and non-injectable generic drugs from ABDC. The Amended PVA does provide the flexibility for the Corporation to contract with other suppliers. If the Corporation fails to adhere to the contractual purchase provisions, ABDC has the ability to increase the Corporation's drug pricing under the terms of the Amended PVA. The Corporation and ABDC are parties to certain legal proceedings with respect to the Amended PVA as further described above. On March 2, 2015, the Corporation provided ABDC with a notice of termination of the Amended PVA effective April 1, 2015. We have entered into a new Prime Vendor Agreement with Cardinal Health effective April 1, 2015. See Note 14 Subsequent Events. Employment Agreements The Corporation has entered into employment agreements with certain of its executive officers. During the employment period, certain executive officers will be eligible to (i) participate in any short-term and long-term incentive programs established or maintained by the Corporation, (ii) participate in all incentive, savings and retirement plans and programs of the Corporation, (iii) participate, along with their dependents, in all welfare benefit plans and programs provided by the Corporation, and (iv) receive four weeks of paid vacation per calendar year. The type of compensation due to each of the executive officers in the event of the termination of their employment period varies depending on the nature of the termination. The employment agreements generally do not entitle the executive officers to any additional payment or benefits solely upon the occurrence of a change in control but do provide additional payments or benefits or both upon a termination of employment in connection with a change in control. Additionally, the vesting of certain equity based grants made to certain executive officers accelerate upon the occurrence of a change in control. Leases The Corporation leases real estate properties, buildings, vehicles, and equipment under cancelable and non-cancelable leases. The leases expire at various times and have various renewal options. Certain leases that meet the lease capitalization criteria have been recorded as an asset and liability at the net present value of the minimum lease payments at the inception of the lease. Interest rates used in computing the net present value of the lease payments are based on the Corporation’s incremental borrowing rate at the inception of the lease. The Corporation recorded the following lease expense for the periods presented (dollars in millions): 2012 Pharmacy locations and administrative offices lease expense Office equipment lease expense Total lease expense
$ $
2013 14.4 2.4 16.8
$ $
2014 15.2 2.1 17.3
$
15.8 2.3 18.1
$
Future minimum lease payments for those leases having an initial or remaining non-cancelable lease term in excess of one year are as follows for the years indicated (dollars in millions): Year Ending December 31, 2015 2016 2017 2018 2019 Thereafter Total
Operating Leases $ 15.5 11.8 7.6 5.5 5.5 1.5 $ 47.4 F-23
Capital Lease Obligations $ 0.8 0.1 0.1 0.3 $ 1.3
Total $
$
16.3 11.9 7.7 5.8 5.5 1.5 48.7
Index
PHARMERICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued) NOTE 7—MERGER, ACQUISITION, INTEGRATION COSTS AND OTHER CHARGES Merger, acquisition, integration costs and other charges were $17.8 million, $8.1 million and $13.6 million for the years ended December 31, 2012, 2013 and 2014, respectively. Merger, integration costs and other charges for the years ended December 31, 2012, 2013, and 2014 were $7.1 million, $3.7 million, and $0.3 million, respectively. Acquisition related costs for the years ended December 31, 2012, 2013, and 2014 were $10.7 million, $4.4 million, and $13.3 million, respectively. NOTE 8-RESTRUCTURING COSTS AND OTHER CHARGES In July 2013, the Corporation commenced the implementation of its restructuring plan as a result of the loss of two of the Corporation's significant customers, Kindred Healthcare and Golden Living. The plan is a major initiative primarily designed to optimize operational efficiency while ensuring that the Corporation remains well-positioned to serve its clients and achieve sustainable, long-term growth. The Corporation’s restructuring plan includes steps to right size its cost structure by adjusting its workforce and facility plans to reflect anticipated business needs. The Corporation recorded restructuring costs and other related charges of approximately $4.4 million and $3.3 million during the years ended December 31, 2013 and December 31, 2014, 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):
Employee Severance and related costs Facility costs
Balance at December 31, 2013 $ 1.8 0.8 $ 2.6
Accrual $ $
2.1 1.2 3.3
Balance at Utilized Amounts December 31, 2014 $ (3.6) $ 0.3 (0.9) 1.1 $ (4.5) $ 1.4
The liability at December 31, 2014 represents amounts not yet paid relating to actions taken in connection with the program (primarily lease payments and severance costs). NOTE 9—HURRICANE SANDY DISASTER COSTS In October 2012, Hurricane Sandy caused significant damage on Long Island, New York and surrounding areas. The financial impacts of the storm to the Corporation’s Long Beach facility as well as damage and disruption at the Corporation’s customers’ facilities have been recorded as a separate component in the consolidated income statements. The Corporation has recovered certain losses associated with Hurricane Sandy from the insurance carrier, and continues to pursue the business interruption portion of its insurance claim. While the exact amount has not been determined, the Corporation’s current estimate of covered losses, net of its deductible, is approximately $7.3 million. After consideration of a $7.2 million advance by the insurance carrier, the Corporation has recorded a receivable for $0.1 million which is included in prepaids and other assets in the consolidated balance sheets. The actual recovery will vary depending on the outcome of the insurance loss adjustment process. Accordingly, no offsetting benefit for insurance recoveries above the amount of the cumulative loss has been recorded. For the years ended December 31, 2012, 2013 and 2014, Hurricane Sandy disaster costs were $4.5 million, $(1.4) million, and $(1.7) million, respectively. For the years ended December 31, 2013 and 2014, the Corporation realized income as the insurance carrier reimbursed the Corporation for certain of the losses incurred in 2012. F-24
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PHARMERICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued) NOTE 10—COMMON STOCK, PREFERRED STOCK, TREASURY STOCK, STOCK-BASED COMPENSATION AND OTHER BENEFITS Common Stock Holders of the Corporation’s common stock are entitled to one vote for each share held of record on all matters on which stockholders may vote. There are no preemptive, conversion, redemption or sinking fund provisions applicable to the Corporation’s common stock. In the event of liquidation, dissolution or winding up, holders of common stock are entitled to share ratably in the assets available for distribution, subject to any prior rights of any holders of preferred stock then outstanding. In addition, the Corporation’s Credit Agreement imposes restrictions on its ability to pay cash dividends. Preferred Stock The certificate of incorporation authorizes the issuance of an aggregate of 1.0 million shares of preferred stock. On August 25, 2011, the Board of Directors designated 175,000 shares of preferred stock as Series A Junior Participating Preferred Stock (“Series A Junior Preferred Stock”). As of December 31, 2014, there were no shares of preferred stock outstanding. The Series A Junior Preferred Stock is entitled to receive quarterly cumulative dividends in an amount per whole share equal to the greater of $10.00 or 1,000 times the dividends declared on the Common Stock since the preceding quarterly dividend payment date, or with respect to the first quarterly dividend payment date, since the date of issuance, and a liquidation preference of a minimum of $10.00 per whole share, plus an amount equal to any accrued dividends and distributions thereon, whether or not declared, to the date of payment, and will be entitled to an aggregate payment per whole share equal to 1,000 times the amount per share distributed to the holders of Common Stock. Holders of Series A Junior Preferred Stock are entitled to vote on each matter on which holders of Common Stock are entitled to vote, and have 1,000 votes per whole share. The preferred stockholders also are entitled to certain corporate governance and special voting rights, as defined in the certificate of designation. The Corporation’s Board of Directors may, from time to time, direct the issuance of shares of preferred stock in series and may, at the time of issuance, determine the designation, powers, rights, preferences and limitations of each series. Satisfaction of any dividend preferences of outstanding preferred stock would reduce the amount of funds available for the payment of dividends on the Corporation’s shares of common stock. Holders of preferred stock may be entitled to receive a preference payment in the event of any liquidation, dissolution or winding-up of the Corporation before any payment is made to the holders of the Corporation’s common stock. Under certain circumstances, the issuance of preferred stock may render more difficult or tend to discourage a merger, tender offer or proxy contest, the assumption of control by a holder of a large block of the Corporation’s securities or the removal of incumbent management. The Board of Directors may issue shares of preferred stock with voting and conversion rights that could adversely affect the holders of common stock. Specifically, the Corporation’s certificate of incorporation authorizes the Corporation’s Board of Directors to adopt a rights plan without stockholder approval. This could delay or prevent a change in control of the Corporation or the removal of existing management. 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 was used. On July 2, 2012 the Board of Directors authorized an increase to the remaining portion of the existing stock repurchase program that allows the Corporation to 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 December 31, 2014. 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 reissuances in connection with acquisitions, employee stock option exercises or other employee stock plans. The stock repurchase program does not have an expiration date and may be limited, terminated or extended at any time without prior notice. During the year ended December 31, 2014, the Corporation repurchased no shares of common stock. F-25
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PHARMERICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued) NOTE 10—COMMON STOCK, PREFERRED STOCK, TREASURY STOCK, STOCK-BASED COMPENSATION AND OTHER BENEFITS (Continued) The Corporation may redeem shares from employees upon the vesting of the Corporation’s stock awards for minimum statutory tax withholding purposes and to cover option exercise costs. The Corporation redeemed 200,334 shares of certain vested awards and exercise of certain stock options for an aggregate price of approximately $5.1 million during year ended December 31, 2014. These shares have also been designated by the Corporation as treasury stock. As of December 31, 2014, the Corporation had a total of 2,617,305 shares held as treasury stock. Amended and Restated 2007 Omnibus Incentive Plan The Corporation has adopted the Amended and Restated PharMerica Corporation 2007 Omnibus Incentive Plan (as amended and restated, the “Omnibus Plan”) under which the Corporation is authorized to grant equity-based and other awards to its employees, officers, directors, and consultants. The Corporation has reserved 7,237,000 shares of its common stock for awards to be granted under the Omnibus Plan plus 534,642 shares reserved for substitute equity awards. Under the “fungible share pool,” one share of stock will be subtracted from the share limit for each share of stock covered by a stock option or stock appreciation right award and 1.65 shares of stock will be subtracted from the share limit for each share of stock covered by any full-value award, including restricted share awards, restricted stock units and performance share awards at target. The following shares are not available for re-grant under the Omnibus Plan: (i) shares tendered by a participant or withheld by the Corporation to pay the purchase price of a stock option award or to satisfy taxes owed with respect to an award, (ii) shares subject to a stock appreciation right that are not issued in connection with such award’s settlement upon the exercise thereof, and (iii) shares reacquired by the Corporation using cash proceeds received by the Corporation from the exercise of stock options. Effective January 1, 2010, shares subject to an award that is forfeited, expired or settled for cash, are available for re-grant under the Omnibus Plan as one share of stock for each share of stock covered by a stock option or appreciation right and 1.65 shares of stock for each share of stock covered by any other type of award. The Corporation’s Compensation Committee administers the Omnibus Plan and has the authority to determine the recipient of the awards, the types of awards, the number of shares covered, and the terms and conditions of the awards. The Omnibus Plan allows for grants of incentive stock options, non-qualified stock options, stock appreciation rights, restricted share and restricted stock units, deferred shares, performance awards, including cash bonus awards, and other stock-based awards. Stock options granted to officers and employees under the Omnibus Plan generally vest in four equal annual installments and have a term of seven years. The restricted stock units granted to officers generally vest in three equal annual installments. The restricted stock units granted to members of the Board of Directors vest in one annual installment. The performance share units granted under the Omnibus Plan vest based upon the achievement of a target amount of the Corporation’s earnings before interest, income taxes, depreciation and amortization, merger, acquisition, integration costs and other charges, Hurricane Sandy disaster costs, restructuring charges, settlements, litigation and other charges, California Medicaid estimated recoupment, and any changes in accounting principles, which reinforces the importance of achieving the Corporation’s profitability objectives. The performance is generally measured over a three-year period. As of December 31, 2014, total shares available for grants of stock-based awards pursuant to the Omnibus Plan were 2,865,608 shares. The 2,865,608 shares do not take into consideration the dilution of 1.65 shares of stock for any full-value award, including restricted stock awards, restricted stock units and performance share awards at target. The number of shares remaining available for future issuance calculated under the fungible share pool would be 1,737,623. F-26
Index
PHARMERICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued) NOTE 10—COMMON STOCK, PREFERRED STOCK, TREASURY STOCK, STOCK-BASED COMPENSATION AND OTHER BENEFITS (Continued) Stock-Based Compensation Expense The following is a summary of stock-based compensation incurred by the Corporation (dollars in millions, except per share amounts): 2012 Stock option compensation expense Nonvested stock compensation expense Total Stock Compensation Expense
$
Negative effect on diluted earnings per share
$
$
2013 1.6 5.1 6.7
$ $
(0.13) $
2014 1.0 6.2 7.2
$ $
0.6 6.8 7.4
(0.15) $
(0.15)
As of December 31, 2014, there was $7.7 million of total unrecognized compensation cost related to the Corporation’s stock compensation arrangements. Total unrecognized compensation cost will be adjusted for future changes in estimated forfeitures. Stock Option Activity The Corporation did not issue stock options during the years ended December 31, 2013 or December 31, 2014. The following table summarizes option activity for the periods presented:
Outstanding options at December 31, 2013 Exercised Canceled Expired Outstanding options at December 31, 2014 Exercisable options at December 31, 2014
WeightedAverage Number of Exercise Price Shares Per Share 1,289,573 $ 14.63 (283,809) 14.75 (88,697) 12.60 (3,858) 17.57 913,209 $ 14.62 818,558 $ 15.06
WeightedAverage Aggregate Remaining Instrinsic Value Term (in millions) 2.9 years $ 8.9
2.1 years $ 1.9 years $
5.6 4.6
The total intrinsic value of stock options exercised for the years ended December 31, 2012, 2013, and 2014 was $0.2 million, $3.5 million, and $1.6 million, respectively. Cash received from stock option exercises during the year ended December 31, 2014 was $3.4 million. The total fair value of options vested for the years ended December 31, 2012, 2013, and 2014 was $2.1 million, $1.6 million, and $0.9 million, respectively. The Corporation expects to recognize stock-based compensation expense for stock options over a remaining weighted average period of less than one year. F-27
Index
PHARMERICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued) NOTE 10—COMMON STOCK, PREFERRED STOCK, TREASURY STOCK, STOCK-BASED COMPENSATION AND OTHER BENEFITS (Continued) Nonvested Shares The following table summarizes nonvested share activity for the periods presented: WeightedNumber of Average Grant Shares Date Fair Value 1,096,674 $ 13.47 196,216 25.58 247,385 20.01 (110,992) 15.85 (487,713) 12.37 941,570 $ 18.00
Outstanding shares at December 31, 2013 Granted - Restricted Stock Units Granted - Performance Share Units Forfeited Vested Outstanding shares at December 31, 2014
The total fair value of shares vested for the years ended December 31, 2012, 2013, and 2014 was $1.4 million, $5.1 million, and $6.0 million, respectively. The weighted average remaining term and intrinsic value of nonvested shares at December 31, 2014 was 2.4 years and $19.5 million, respectively. The Corporation expects to recognize stock based compensation expense of $7.6 million for nonvested shares over a weighted average period of approximately 2.4 years. Based upon the achievement of the performance criteria at the end of the performance cycle for the performance share units issued to date, the Corporation may issue no shares or a maximum of 702,499 shares. 401(k) Plan The Corporation sponsors a salary reduction plan qualified under Section 401(k) of the Internal Revenue Code with a safe harbor matching contribution for all eligible employees, as defined in the plan document. Contributions to the plan are based upon employee contributions and the Corporation’s matching contributions. For the years ended December 31, 2012, 2013, and 2014, the Corporation’s matching contributions to the plan were $6.0 million, $5.9 million, and $5.8 million, respectively. Deferred Compensation Plans The Corporation maintains an unfunded deferred compensation plan for certain management and highly compensated employees. Under the plan, a participant may elect to defer up to 50 % of such participant’s annual base salary and up to 100 % of such participant’s annual short-term incentive program cash bonus into the plan during each plan year. In addition, the Corporation may, in its sole discretion, make discretionary contributions to a participant’s account. The Corporation also maintains a deferred compensation plan for the directors of the Corporation. The directors of the Corporation may elect to defer up to 100 % of their cash fees and their stock fees in any one year. If a director elects to defer his/her restricted share grant, the shares will be deferred as they vest until the participant elects for the deferred compensation to be a taxable event. As of December 31, 2013 and 2014, the Corporation had $6.9 million and $8.0 million, respectively, recognized as a long-term liability related to the deferred compensation plans in the accompanying consolidated balance sheets. Deferred compensation expense was $0.4 million, $1.5 million and $0.7 million for the years ended December 31, 2012, 2013, and 2014, respectively. F-28
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PHARMERICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued) NOTE 11—INCOME TAXES The provision for income taxes is based upon the Corporation’s annual income or loss before income taxes for each respective accounting period. The following table summarizes the Corporation’s provision for income taxes for the periods presented (dollars in millions): 2012 Current provision: Federal State Total Deferred provision: Federal State Total Total provision for income taxes
$
2013 11.6 1.5 13.1 1.4 1.4 2.8 15.9
$
$
2014 13.0 1.3 14.3 4.8 7.2 12.0 26.3
$
$
10.4 1.3 11.7 (2.1) (0.2) (2.3) 9.4
$
A reconciliation of the U.S. statutory rate to the Corporation’s effective tax rate is as follows for the years ended December 31: 2012 U.S. statutory rate applied to pretax income Differential arising from: State taxes Non-deductible legal expenses Domestic Production Activities Deduction Stock compensation Valuation allowances Research and development credits Other Effective tax rate
2013
2014
35.0%
35.0%
35.0%
4.2 1.7 40.9%
4.3 14.8 (4.7) 2.6 7.1 (0.9) 58.2%
4.0 31.3 (10.4) 0.2 (5.6) 3.5 58.0%
The effective tax rates in 2013 and 2014 are higher than the federal statutory rate largely as a result of the combined impact of state and local taxes and various nondeductible expenses. The effective tax rate did not change significantly from 2013 to 2014. The increase in the non-deductible legal expenses relates to the legal settlement accruals recorded in 2014. See Note 6. This increase offsets almost entirely the favorable changes in the rate for the domestic production activities deduction, stock compensation, valuation allowance, and research and development credits. 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 tax basis of the Corporation’s tax deductible goodwill was approximately $128.5 million (as adjusted) and $145.3 million at December 31, 2013 and 2014, respectively. F-29
Index
PHARMERICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued) NOTE 11—INCOME TAXES (Continued) 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 and capital loss carryforwards. As of December 31, 2014, the Corporation has federal net operating loss carryforwards of $40.1 million ($14 million deferred tax asset). These net operating loss carryforwards resulted from the stock acquisitions the Corporation completed in 2013 and 2014. These net operating losses 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. Accordingly, the Corporation has not recorded any valuation allowance for the associated deferred tax asset. The deferred tax asset for state net operating loss carryforwards is $3.1 million, net of federal impact and valuation allowances. The state net operating losses have carryforward periods ranging from 1 to 20 years depending on the taxing jurisdiction. As a result of a corporate restructuring that was implemented on January 1, 2014, separate company state taxable income was significantly reduced. This reduction in separate company state taxable income impacted the Corporation’s analysis of the realizability of separate company net operating loss carryforwards. 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. Based on the Corporation’s analysis of the impact of the corporate restructuring, a valuation allowance on the separate company state net operating loss carryforwards was recorded. The deferred tax asset for state net operating loss carryforwards totaled $3.2 million and $3.1 million at December 31, 2013 and 2014, respectively, net of valuation allowances of $4.1 million. The Corporation recognized net deferred tax assets totaling $18.2 million and $30.6 million at December 31, 2013 and 2014, respectively, net of valuation allowances of $4.1 million. Current deferred income taxes consisted of (dollars in millions):
Accrued expenses Allowance for doubtful accounts Net operating losses Other Valuation allowance Total current deferred taxes
$
$
December 31, 2013 Assets Liabilities 9.6 $ 20.8 1.0 7.2 (1.7) 36.9 $
-
December 31, 2014 Assets Liabilities 7.7 $ 22.8 13.7 (2.0) 42.2 $
$
$
-
Noncurrent deferred income taxes consisted of (dollars in millions):
Accelerated depreciation Stock-based compensation Goodwill and intangibles Net operating losses Other Valuation allowances Total noncurrent deferred taxes Noncurrent deferred taxes, net
$
$
December 31, 2013 Assets Liabilities - $ 11.2 4.8 25.4 8.0 7.5 (2.4) 17.9 $ 36.6 $ 18.7
$
$
December 31, 2014 Assets Liabilities - $ 11.4 4.6 33.0 21.2 9.1 (2.1) 32.8 $ 44.4 $ 11.6
As of December 31, 2013 and December 31, 2014, the Corporation had no reserves recorded as a liability for unrecognized tax benefits for U.S. federal and state tax jurisdictions. There were no unrecognized tax benefits at December 31, 2014 that, if recognized, would affect the tax rate. F-30
Index
PHARMERICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued) NOTE 11—INCOME TAXES (Continued) It is the Corporation’s policy to accrue interest and penalties related to liabilities for income tax contingencies in the provision for income taxes. As of December 31, 2014, the Corporation had no accrued interest or penalties related to uncertain tax positions. The federal statute of limitations remains open for tax years 2012 through 2013. The IRS completed its audit of the Corporation’s consolidated U.S. income tax returns for 2010 and 2011 in February 2014. State tax jurisdictions generally have statutes of limitations ranging from three to five years. The Corporation is no longer subject to state and local income tax examinations by tax authorities for years before 2009. 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. F-31
Index
PHARMERICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued) NOTE 12—EARNINGS PER SHARE The following table sets forth the computation of basic and diluted earnings per share (dollars in millions, except per share amounts): 2012 Numerator: Numerator for basic and earnings per diluted share - net income Denominator: Denominator for basic earnings per share - weighted average shares Effective of dilutive securities (stock options, restricted stock units and performance share units) Denominator for earnings per diluted share - adjusted weighted average shares Basic earnings per share Earnings per diluted share Unexercised employee stock options, unvested restricted shares and performance shares excluded from the effect of dilutive securities above (a) (a)
2013
$
22.9
$ $
29,471,734 430,162 29,901,896 0.78 0.77 2,574,284
2014
$
18.9
$ $
29,601,199 474,500 30,075,699 0.64 0.63 1,417,272
$
6.8
$ $
29,983,428 665,703 30,649,131 0.23 0.22 340,291
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. F-32
Index
PHARMERICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued) NOTE 13—UNAUDITED QUARTERLY FINANCIAL INFORMATION The quarterly interim information shown below has been prepared by the Corporation’s management and is unaudited. It should be read in conjunction with the audited consolidated financial statements appearing herein (dollars in millions, except per share amounts). 2013 Quarters Second Third
First Revenue Cost of goods sold Gross profit Operating income (loss) Net income (loss) Earnings (loss) per common share: Basic Diluted
$
$
$ $ $
439.8 355.5 84.3 20.0 10.5
$ $
0.36 0.35
Shares used in computing earnings (loss) per common share: Basic 29.6 Diluted 30.1
$
$ $ $
430.8 348.2 82.6 21.3 10.2
$ $
0.34 0.34
29.7 30.1
Fourth $
$ $ $
436.8 357.6 79.2 0.6 (6.2)(1)
$ $
(0.21) (0.21)
$
$ $ $
450.5 369.4 81.1 13.9 4.4
$ $
0.15 0.15
29.7 29.7
29.5 30.2
2014 Quarters Second Third
First $
$ $ $
452.2 372.2 80.0 10.3 4.8
$ $
0.16 0.16
29.8 30.4
$
$ $ $
448.6 366.7 81.9 (9.7) (9.7)(1)
$ $
(0.32) (0.32)
30.0 30.0
Fourth $
$ $ $
470.2 387.2 83.0 17.1 8.5(2)
$ $ $
523.5 429.1 94.4 12.7 3.2
$ $
0.28 0.28
$ $
0.11 0.10
30.1 30.6
30.1 30.7
(1) During the third quarter 2013 and the second quarter 2014, the Corporation recognized losses related to settlement, litigation and other charges. See Note 6. (2) During the third quarter 2014, the Corporation recognized a $4.3 loss on extinguishment of debt. NOTE 14---SUBSEQUENT EVENTS The Corporation, through its wholly owned subsidiary Amerita, completed the acquisition of a home infusion and pharmacy services business on January 23, 2015. The business provides home infusion and pharmacy services including home infusion therapies, pain management, nutritional therapies, and specialty pharmacy services. The company serves patients in their homes, doctors’ offices, and other non-hospital settings. On March 2, 2015, the Corporation provided ABDC with a notice of termination of the Amended PVA effective April 1, 2015. The Corporation entered into a new Prime Vendor Agreement with Cardinal Health effective April 1, 2015. F-33
Index
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None. Item 9A.
Controls and Procedures
Evaluation of Disclosure Controls and Procedures The Corporation has carried out an evaluation under the supervision and with the participation of management, including the Corporation’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Corporation’s “disclosure controls and procedures” as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) as of the end of the period covered by this report. The Corporation’s disclosure controls and procedures are designed so that information required to be disclosed in the Corporation’s reports filed under the Exchange Act, such as this Annual Report on Form 10-K, is recorded, processed, summarized and reported within the time periods specified in the Commission’s rules and forms. The Corporation’s disclosure controls and procedures are also intended to ensure that such information is accumulated and communicated to the Corporation’s management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives, and management necessarily is required to use its judgment in evaluating the costbenefit relationship of possible disclosure controls and procedures. Based upon this evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of December 31, 2014, the Corporation’s disclosure controls and procedures are effective to provide reasonable assurance that information required to be disclosed in the reports that the Corporation files and submits under the Exchange Act is recorded, processed, summarized and reported as and when required and such information is accumulated and communicated as appropriate to allow timely decisions regarding required disclosures. Changes in Internal Control Over Financial Reporting There have been no changes in the Corporation’s internal control over financial reporting during the quarter ended December 31, 2014, that have materially affected, or are reasonably likely to materially affect, the Corporation’s internal control over financial reporting. Management’s Annual Report on Internal Control over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Our internal control over financial reporting includes those policies and procedures that: (i)
pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Corporation;
(ii)
provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Corporation are being made only in accordance with authorizations of management and directors of the Corporation; and
(iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Corporation’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. 88
Index
Our management assessed the effectiveness of the Corporation’s internal control over financial reporting as of December 31, 2014. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework (1992). Based upon our assessment and those criteria, management has concluded that the Corporation maintained effective internal control over financial reporting as of December 31, 2014. The Corporation has excluded the 2014 Acquisitions from its assessment of internal control over financial reporting as of December 31, 2014 because they were acquired by the Corporation in 2014. The total assets and total revenues of the 2014 Acquisitions represent approximately 3.8% and 3.6%, respectively, of the related consolidated financial statement amounts as of and for the year ended December 31, 2014. The Corporation continues to integrate new acquisitions into corporate processes. No potential internal control changes due to new acquisitions would be considered material to, or are reasonably likely to materially affect, our internal control over financial reporting. The effectiveness of the Corporation’s internal control over financial reporting as of December 31, 2014 has been audited by KPMG LLP, our independent registered public accounting firm, who also audited our consolidated financial statements as of December 31, 2013 and 2014 and for each of the years in the three-year period ended December 31, 2014 included in this Annual Report on Form 10-K, as stated in their report which appears with our accompanying consolidated financial statements. Item 9B.
Other Information
On January 25, 2013, the Corporation renegotiated its Amended PVA with ABDC effective January1, 2013. The Amended PVA modified the previous agreement, which was set to expire September 30, 2013 and extended its term until September 30, 2016. The Amended PVA requires the Corporation to purchase certain levels of brand and noninjectable generic drugs from ABDC. The Amended PVA does provide the flexibility for the Corporation to contract with other suppliers. If the Corporation fails to adhere to the contractual purchase provisions, ABDC has the ability to increase the Corporation’s drug pricing under the terms of the Amended PVA. On September 10, 2014, the Corporation filed a Complaint in Jefferson Circuit Court in Louisville, Kentucky against ABDC for breach of the Amended PVA. The Corporation subsequently filed a First Amended Complaint asserting additional breaches of the Amended PVA and filed a motion seeking a preliminary injunction enjoining ABDC from instituting certain drug substitution programs. On September 10, 2014, ABDC filed suit in the Court of Chancery of the State of Delaware seeking a declaration that it is not in breach of the Amended PVA. The Delaware proceeding was voluntarily dismissed on November 20, 2014. On November 24, 2014, the Jefferson Circuit Court issued a temporary injunction against ABDC. That order was subsequently over-ruled by the Court of Appeals on February 13, 2015 and the Corporation is appealing the decision of the Court of Appeals to the Kentucky Supreme Court. On February 24, 2015, the Kentucky Supreme Court stayed the decision of the Court of Appeals until the Kentucky Supreme Court has an opportunity to rule on the matter. On March 2, 2015, the Corporation provided ABDC with a notice of termination of the Amended PVA effective April 1, 2015. The termination was for cause. On February 27, 2015, the Corporation entered into a new Prime Vendor Agreement with Cardinal Health effective April 1, 2015 through June 30, 2018. The new Prime Vendor Agreement with Cardinal Health requires the Corporation to purchase certain levels of brand and non-injectable generic drugs from Cardinal Health. The new Prime Vendor Agreement does provide flexibility for the Corporation to contract with other suppliers. 89
Index
PART III Item 10.
Directors, Executive Officers and Corporate Governance
The information required by this Item is incorporated herein by reference from the Corporation’s definitive proxy statement to be filed no later than 120 days after December 31, 2014. We refer to this proxy statement as the 2015 Proxy Statement. Item 11.
Executive Compensation
Incorporated herein by reference from the Corporation’s 2015 Proxy Statement. Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Incorporated herein by reference from the Corporation’s 2015 Proxy Statement. Item 13.
Certain Relationships and Related Transactions, and Director Independence.
Incorporated herein by reference from the Corporation’s 2015 Proxy Statement. Item 14.
Principal Accounting Fees and Services.
Incorporated herein by reference from the Corporation’s 2015 Proxy Statement. 90
Index
PART IV Item 15.
Exhibits [To be Updated]
(a) (1) All Financial Statements Consolidated financial statements filed as part of this report are listed under Part II, Item 8 of this Form 10-K. (2) Financial Statement Schedules No schedules are required because either the required information is not present or is not present in amounts sufficient to require submission of the schedule, or because the information required is included in the accompanying consolidated financial statements or the notes thereto. (3) Exhibits Exhibit No. Description 3.1
Certificate of Incorporation of the Registrant, as amended (1)
3.2
Amended and Restated By-Laws of the Registrant, as amended (21)
3.3
Series A Junior Participating Preferred Stock Certificate of Designation (16)
3.4
Certificate of Elimination of the Series A Junior Participating Preferred Stock (13)
4.1
Specimen Common Stock Certificate of the Registrant (17)
10.1
Form CEO Stock Option Award Agreement (3) †
10.2
Form Non-Qualified Stock Option Award Agreement (3) †
10.3
Employment Agreement dated July 31, 2007 between Robert McKay and PharMerica Corporation (1) †
10.4
Employment Agreement dated August 17, 2007 between Thomas Caneris and PharMerica Corporation (1) †
10.5
Form Director Non-Qualified Stock Option Award Agreement (1) †
10.6
Form of Substitution NQSO Agreement for AmerisourceBergen 2001 Grants (1) †
10.7
Form of Substitution NQSO Agreement for AmerisourceBergen 2002 Grants (1) †
10.8
Trademark License Agreement (2)
10.9
Form of Non-Qualified Stock Option Award Agreement (4) †
10.10
Form of Performance Share Award Agreement (adjusted EBITDA and adjusted ROIC) (11) †
10.11
Form of Restricted Stock Unit Award Agreement (6) †
10.12
Amended and Restated PharMerica Corporation 2007 Omnibus Incentive Plan Adopted May 26, 2010 (7) †
10.13
Form of Director Restricted Stock Unit Award Agreement (7) †
10.14
Employment Letter Agreement dated February 27, 2014 between Gregory S. Weishar and PharMerica Corporation (20) † 91
Index
10.15
Amended and Restated Prime Vendor Agreement for Long-Term Care Pharmacies dated January 1, 2011 by and between ABDC, PharMerica Corporation, Pharmacy Corporation of America and Chem Rx Pharmacy Services, LLC (9)
10.16
First Amendment to Amended and Restated Prime Vendor Agreement for Long-Term Care Pharmacies, dated as of January 1, 2013, by and between ABDC, PharMerica Corporation, Pharmacy Corporation of America and Chem Rx Pharmacy Services, LLC (10)
10.17
Credit Agreement dated September 17, 2014 among PharMerica Corporation, the Lenders named therein, and Citibank, N.A., Compass Bank, MUFG Union Bank, N.A., Suntrust Bank and U.S. Bank, National Association, as Co-Documentation Agents (23)
10.18
Form of Indemnification Agreement (12)
10.19
Employment Agreement dated March 22, 2011 between Suresh Vishnubhatla and PharMerica Corporation (12) †
10.20
Summary of 2012 Long-Term Incentive Program (18) †
10.21
Employment Agreement, dated September 27, 2012, between PharMerica Corporation and Mark Lindemoen (14)
10.22
Summary of 2013 Long-Term Incentive Program (10) †
10.23
Summary of 2014 CEO Short-Term Incentive Program and 2014 Short-Term Incentive Program †
10.24
Summary of 2014 Long-Term Incentive Program †
10.25
Amended and Restated Employment Agreement, dated effective May 30, 2014, between PharMerica Corporation and David W. Froesel, Jr. (22)
10.26
Employment Agreement, dated November 10, 2012, between PharMerica Corporation and James D. Glynn (22)
21.1
Subsidiaries of the Registrant
23.1
Consent of KPMG LLP
31.1
Certification of Chief Executive Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2
Certification of Chief Financial Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1
Certification of Chief Executive Officer, pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2
Certification of Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS
XBRL Instance Document
101.SCH
XBRL Taxonomy Extension Schema Document
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document
101.LAB
XBRL Taxonomy Extension Label Linkbase Document
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document 92
Index
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13) (14) (15) (16) (17) (18) (19) (20) (21) (22) (23) †
Filed with the Corporation’s Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on August 31, 2007, and incorporated herein by reference. Filed with the Corporation’s Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on November 9, 2007, and incorporated herein by reference. Filed with the Corporation’s Current Report on Form 8-K filed with the Securities and Exchange Commission on August 13, 2007, and incorporated herein by reference. Filed with the Corporation’s Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on May 8, 2008, and incorporated herein by reference. Filed with the Corporation’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 5, 2009, and incorporated herein by reference. Filed with the Corporation’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 4, 2010, and incorporated herein by reference. Filed with the Corporation’s Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on August 5, 2010, and incorporated herein by reference. Filed with the Corporation’s Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on November 4, 2010, and incorporated herein by reference. Filed with the Corporation’s Annual Report on Form 10-K/A filed with the Securities and Exchange Commission on May 25, 2011, and incorporated herein by reference. Filed with the Corporation’s Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on May 1, 2013, and incorporated herein by reference. Filed with the Corporation’s Current Report on Form 8-K filed with the Securities and Exchange Commission on March 9, 2009, and incorporated herein by reference. Filed with the Corporation’s Schedule 14D-9 filed with the Securities and Exchange Commission on September 20, 2011, and incorporated herein by reference. Filed with the Corporation’s Current Report on Form 8-K file with the Securities and Exchange Commission on April 2, 2012, and incorporated herein by reference. Filed with the Corporation’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 7, 2013, and incorporated herein by reference. Filed with the Corporation’s Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on November 5, 2013, and incorporated herein by reference. Filed with the Corporation’s Current Report on Form 8-K filed with the Securities and Exchange Commission on August 25, 2011, and incorporated herein by reference. Filed with Amendment No. 2 to the Corporation’s Registration Statement on Form S-4/S-1 (Reg. No 333-142940) filed with the Securities and Exchange Commission on June 27, 2007, and incorporated herein by reference. Filed with the Corporation’s Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on May 2, 2012, and incorporated herein by reference. Filed with the Corporation’s Annual Report on Form 10-K with the Securities and Exchange Commission on February 24, 2011, and incorporated herein by reference. Filed with the Corporation’s Current Report on Form 8-K filed with the Securities and Exchange Commission on March 5, 2014, and incorporated herein by reference. Filed with the Corporation’s Current Report on Form 8-K filed with the Securities and Exchange Commission on March 17, 2014, and incorporated herein by reference. Filed with the Corporation’s Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on August 5, 2014, and incorporated herein by reference. Filed with the Corporation’s Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on November 6, 2014, and incorporated herein by reference. Management contract or compensatory plan or arrangement. 93
Index
SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. PHARMERICA CORPORATION Date: March 2, 2015
By:
/S/ GREGORY S. WEISHAR Gregory S. Weishar Chief Executive Officer and Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Signature
Title
Date
/S/ GREGORY S. WEISHAR (Gregory S. Weishar)
Chief Executive Officer and Director
March 2, 2015
/S/ DAVID W. FROESEL, JR. (David W. Froesel, Jr.)
Executive Vice President, Chief Financial Officer and Treasurer
March 2, 2015
Senior Vice President and Chief Accounting Officer
March 2, 2015
/S/ FRANK E. COLLINS (Frank E. Collins)
Director
March 2, 2015
/S/ W. ROBERT DAHL JR. (W. Robert Dahl Jr.)
Director
March 2, 2015
/S/ MARJORIE W. DORR (Marjorie W. Dorr)
Director
March 2, 2015
/S/ DR. THOMAS P. GERRITY (Dr. Thomas P. Gerrity)
Director
March 2, 2015
/S/ THOMAS P. MAC MAHON (Thomas P. Mac Mahon)
Director
March 2, 2015
/S/ GEOFFREY G. MEYERS (Geoffrey G. Meyers)
Director
March 2, 2015
/S/ DR. ROBERT A. OAKLEY (Dr. Robert A. Oakley)
Director
March 2, 2015
/S/ PATRICK G. LEPORE (Patrick G. LePore)
Director
March 2, 2015
/S/ BERARD E. TOMASSETTI (Berard E. Tomassetti)
94
Index
EXHIBIT INDEX Exhibit No. Description 10.23
Summary of 2014 CEO Short-Term Incentive Program and 2014 Short-Term Incentive Program †
10.24
Summary of 2014 Long-Term Incentive Program †
21.1
Subsidiaries of the Registrant
23.1
Consent of KPMG LLP
31.1
Certification of Chief Executive Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2
Certification of Chief Financial Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1
Certification of Chief Executive Officer, pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2
Certification of Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS
XBRL Instance Document.
101.SCH
XBRL Taxonomy Extension Schema Document.
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document.
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document.
101.LAB
XBRL Taxonomy Extension Label Linkbase Document.
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document. 95
Exhibit 10.23 PHARMERICA CORPORATION SUMMARY OF 2014 SHORT-TERM INCENTIVE PROGRAM – CEO AND 2014 SHORT-TERM INCENTIVE PROGRAM 2014 Short-Term Incentive Program – CEO On March 11, 2014, the Board of Directors of PharMerica Corporation (the “Corporation”), upon recommendation of the Compensation Committee, adopted the 2014 Short-Term Incentive Program (the “CEO STIP”) under the PharMerica Corporation 2007 Omnibus Incentive Plan, as amended (the “Omnibus Plan”), for the Corporation’s Chief Executive Officer, Mr. Gregory Weishar. The CEO STIP provides for a performance-based annual cash award to Mr. Weishar. Performance Cycle. The STIP performance cycle is for the current year, beginning on January 1, 2014 and ending on December 31, 2014. Maximum Award. If the Corporation’s Adjusted EBITDA (as defined below) is equal to or greater than a target Adjusted EBITDA for the 2014 fiscal year, then Mr. Weishar is eligible to receive a payment under the CEO STIP equal to the lesser of (i) 2.2% of Adjusted EBITDA for the 2014 fiscal year; or (ii) $2 million (the “Maximum Award”). The Compensation Committee, in its sole discretion, may decrease the Maximum Award based on its assessment of the Corporation’s performance, the Chief Executive Officer’s individual performance, or any other factors it considers relevant, however in no event may the Compensation Committee reduce the Maximum Award below the annual bonus amount for the Chief Executive Officer (the “Bonus Amount”). Bonus Amount. The target Bonus Amount for Mr. Weishar is 125% of 2014 Base Salary. Fifty percent (50%) of the target Bonus Amount is based on the Corporation’s performance and 50% of the target Bonus Amount is based on individual performance goals. The Corporation must at least meet threshold Adjusted EBITDA of 80.0% of the target Adjusted EBITDA amount in order for any payment to be made under the individual performance-based component. The Corporation’s performance will be measured by comparing the Corporation’s annual earnings before interest, taxes, depreciation and amortization, and other amounts as reported in the Corporation’s disclosures in its Form 10-K as of and for the year ended December 31, 2014, except that there shall not be an add-back for stock based and deferred compensation (“Adjusted EBITDA”), to a target Adjusted EBITDA for the entire 2014 fiscal year. Individual performance will be measured by comparing certain individual performance metrics to the target individual performance metrics determined by the Compensation Committee.
The actual Bonus Amount is based on the percentage of the performance target achieved. Generally, the percentage of the Bonus Amount earned at the end of the performance cycle will be determined according to the following schedule; however the actual Bonus Amount will be interpolated between the percentages set forth in the chart based on actual results: Performance Achievement < 80.0% of Performance Target 80.0% of Performance Target 90.0% of Performance Target 96.0% of Performance Target 100.0% of Performance Target 105.0% of Performance Target 110.0% of Performance Target 115.0% of Performance Target 120.0% of Performance Target > 120.0% of Performance Target
Payout Level 0.0% of Award Target 40.0% of Award Target 70.0% of Award Target 88.0% of Award Target 100.0% of Award Target 118.8% of Award Target 137.5% of Award Target 156.3% of Award Target 175.0% of Award Target 175.0% of Award Target
2014 Short-Term Incentive Program On March 11, 2014, the Board of Directors of the Corporation, upon recommendation of the Compensation Committee, adopted the 2014 Short-Term Incentive Program (the “STIP”) under the Omnibus Plan. The STIP provides for performance-based annual cash awards to the Corporation’s executive officers, and certain other officers and employees of the Corporation. The STIP advances the Corporation’s commitment to performance-based compensation practices by providing participants an opportunity to earn annual cash bonuses upon achievement of certain pre-established short-term performance objectives. Eligibility. Officers and employees of the Corporation may receive STIP cash awards as determined by the Board of Directors or the Compensation Committee. Performance Cycle. The STIP performance cycle is for the current year, beginning on January 1, 2014 and ending on December 31, 2014. Award Targets. The amount of the awards under the STIP are based on individual participant bonus targets. Individual participant bonus targets are established for each participant by the Compensation Committee, in the case of the senior executive officers reporting to the Chief Executive Officer, and by the Chief Executive Officer, for other participants, based upon a determination of the appropriate bonus target amounts which will enable the Corporation to remain competitive, to retain and recruit top employees, and to align such employee’s interests with certain strategic initiatives of the Corporation. Individual non-executive participant bonus targets range from 5% to 100% of base salary on December 31, 2014, with targets for the Corporation’s executive officers between 25% and 125% of base salary.
The Compensation Committee established the bonus targets under the STIP for the Corporation’s fiscal 2013 Named Executive Officers, other than the principal executive officer, as follows: Executive David Froesel Robert McKay Thomas Caneris
Title Executive Vice President, Chief Financial Officer and Treasurer Senior Vice President of Purchasing and Trade Relations Senior Vice President, General Counsel, Chief Compliance Officer and Secretary
Bonus Target 80% of base salary 65% of base salary 70% of base salary
Performance Criteria. The performance criteria under the STIP is divided into a company performance-based component and individual/group performance-based component for different employees. The breakdown for the Named Executive Officers, other than the Chief Executive Officer, is as set forth in the chart below. The Corporation must at least meet threshold Adjusted EBITDA of 80.0% of target in order for any payment to be made to a Named Executive Officer under the individual/group performancebased components of the STIP. Executive David Froesel Robert McKay Thomas Caneris
Title Executive Vice President, Chief Financial Officer and Treasurer Senior Vice President of Purchasing and Trade Relations Senior Vice President, General Counsel, Chief Compliance Officer and Secretary
Company Performance
Individual/Group Performance 50% 50% 50% 50% 50% 50%
Under the STIP, company performance will be measured by comparing the Corporation’s Adjusted EBITDA, to a target Adjusted EBITDA for the entire 2014 fiscal year. Individual/group performance will be measured by comparing certain individual/group performance metrics to target individual/group performance metrics established by the Corporation’s Compensation Committee in consultation with the Chief Executive Officer for the Named Executive Officers other than the Chief Executive Officer.
Award Payouts. Award payout levels are based on the percentage of the performance target achieved. Generally, the percentage of the award earned at the end of the performance cycle will be determined according to the following schedule; however the actual award payout will be interpolated between the percentages set forth in the chart based on actual results: Performance Achievement < 80.0% of Performance Target 80.0% of Performance Target 90.0% of Performance Target 96.0% of Performance Target 100.0% of Performance Target 105.0% of Performance Target 110.0% of Performance Target 115.0% of Performance Target 120.0% of Performance Target > 120.0% of Performance Target
Payout Level 0.0% of Award Target 40.0% of Award Target 70.0% of Award Target 88.0% of Award Target 100.0% of Award Target 118.8% of Award Target 137.5% of Award Target 156.3% of Award Target 175.0% of Award Target 175.0% of Award Target
Payment of Awards. Payment of STIP awards will be made in cash. Awards will be paid on a specific date by which the Compensation Committee reasonably expects that the Corporation’s Adjusted EBITDA for the year on which the award was based will have been reported. The Corporation will make the payment of the STIP awards to participants as soon as administratively practicable following the date of the award determination. Vesting and Forfeiture. STIP participants must remain continuously employed full-time by the Corporation until the award payment date in order to be entitled to receive a payout of an STIP award. Other Terms & Provisions. STIP participants are not permitted to transfer STIP awards, except by will or the laws of descent and distribution. The Corporation is entitled to withhold from any payments of awards under the STIP any and all amounts required to be withheld for federal, state and local withholding taxes. The Compensation Committee has the discretion to change terms and conditions of STIP awards as it deems necessary to ensure that the STIP awards satisfy all requirements for “performancebased compensation” within the meaning of Section 162(m)(4)(c) of the Internal Revenue Code.
Exhibit 10.24 PHARMERICA CORPORATION SUMMARY OF 2014 LONG-TERM INCENTIVE PROGRAM 2014 Long-Term Incentive Program On March 11, 2014, the Board of Directors of the Corporation, upon recommendation of the Compensation Committee, adopted the 2014 Long-Term Incentive Program (the “LTIP”) under the Omnibus Plan to provide, restricted stock units and performance share unit awards to the Corporation’s executives and certain other officers and employees based on pre-established performance objectives and goals. The LTIP advances the Corporation’s commitment to performance-based compensation practices by providing participants an opportunity to earn equity-based awards upon the achievement of certain pre-established long-term performance objectives. The LTIP also is designed to drive consistent growth of the Corporation over a multiple-year performance period. Performance Cycle. LTIP performance cycle begins on January 1, 2014 and ends on December 31, 2016. Award Targets. The amount of the awards under the LTIP are based on individual participant bonus targets and company performance criteria. Individual participant bonus targets are established by the Compensation Committee for each participant based upon the Compensation Committee’s determination of the appropriate bonus target amounts that will enable the Corporation to remain competitive and retain and recruit top employees. The Compensation Committee established the bonus targets under the LTIP for the Corporation’s principal executive officer, principal financial officer, and other fiscal 2013 Named Executive Officers as follows: Executive Gregory S. Weishar David Froesel Robert McKay Thomas Caneris
Title Chief Executive Officer Executive Vice President, Chief Financial Officer and Treasurer Senior Vice President of Purchasing and Trade Relations Senior Vice President, General Counsel, Chief Compliance Officer and Secretary
Bonus Target 299% of base salary 175% of base salary 115% of base salary 138% of base salary
The Compensation Committee established the 2014 LTIP awards for the fiscal 2013 Named Executive Officers in the following amounts as a percentage of the bonus target: 50% restricted stock units and 50% performance share units.
On March 11, 2014, the Board of Directors, upon recommendation of the Compensation Committee, awarded restricted stock units under the LTIP for the Corporation’s principal executive officer, principal financial officer, and other fiscal 2013 Named Executive Officers as follows: Executive Gregory S. Weishar David Froesel Robert McKay Thomas Caneris
Title Chief Executive Officer Executive Vice President, Chief Financial Officer and Treasurer Senior Vice President of Purchasing and Trade Relations Senior Vice President, General Counsel, Compliance Officer and Secretary
Restricted Stock Units (50% of Bonus Target) 50,798 17,316 6,803 8,961
Performance Criteria. The LTIP performance criteria for the performance share units are tied to company performance. Company performance will be measured for purposes of the performance share units by comparing the Corporation’s Adjusted EBITDA at the end of the performance cycle to a target end-of-performance cycle Adjusted EBITDA set by the Compensation Committee and by comparing the Corporation’s adjusted diluted earnings per share (“Adjusted Diluted EPS”) at the end of the performance cycle to a target end-of-performance cycle Adjusted Diluted EPS set by the Compensation Committee. With respect to all Named Executive Officers, the Adjusted EBITDA target accounts for 70% of their respective performance target and the remaining 30% is determined by achievement of a target measure of Adjusted Diluted EPS. Award Payouts. Award payouts for the performance share units are based on the percentage of the performance target achieved. Generally, the percentage of the award earned at the end of the performance cycle based on the performance target, excluding the Adjusted Diluted EPS component, shall be determined according to the following schedule; however the actual LTIP award payout will be interpolated between the percentages set forth in the chart based on actual results: Performance Level < 85.0% of Performance Target 85.0% of Performance Target 91.0% of Performance Target 100.0% of Performance Target 109.0% of Performance Target 115.0% of Performance Target > 115.0% of Performance Target
Payout Level 0.0% of Award Target 50.0% of Award Target 70.0% of Award Target 100.0% of Award Target 130.0% of Award Target 150.0% of Award Target 150.0% of Award Target
Generally, the percentage of the award earned at the end of the performance cycle based on the based on the percentage of the Adjusted Diluted EPS performance target achieved shall be determined according to the following schedule; however the actual LTIP award payout will be interpolated between the percentages set forth in the chart based on actual results: Performance Level < 85.0% of Performance Target 85.0% of Performance Target 91.0% of Performance Target 100.0% of Performance Target 109.0% of Performance Target 115.0% of Performance Target > 115.0% of Performance Target
Payout Level 0.0% of Award Target 50.0% of Award Target 70.0% of Award Target 100.0% of Award Target 130.0% of Award Target 150.0% of Award Target 150.0% of Award Target
Award Agreements. Awards of restricted stock units and performance share units are made under the LTIP pursuant to award agreements with each recipient on the terms described in this Current Report on Form 8-K. Payment of Awards. Performance share unit awards will be distributed on a specific date by which the Compensation Committee reasonably expects it will be able to determine whether and the extent that the performance target applicable to such award was met. The Corporation will make the distribution of the performance share unit awards to participants as soon as administratively practicable following the date of the award determination. Vesting and Forfeiture. Recipients of LTIP awards generally must remain continuously employed full-time by the Corporation until the date designated for payout under the applicable award agreement for the LTIP period. Exceptions may be provided for termination of employment by reason of death, disability, without cause, retirement and change in control. The restricted stock units will generally vest in three equal annual installments beginning on the first anniversary of the grant date.
Change in Control. In the event of a change in control (“CIC”), acceleration of vesting of restricted stock units will occur if an employee is terminated by the Company without “cause” or the employee voluntarily terminates employment with “good reason” during the 24 month period following a CIC (“Qualifying Termination”). Vesting of restricted stock units will accelerate immediately regardless of a Qualifying Termination if the acquirer does not assume the restricted stock unit awards. If the acquirer assumes the restricted stock unit awards, restricted stock units will continue to vest according to their original vesting schedules; provided that vesting will subsequently accelerate upon a Qualifying Termination within 24 months after the CIC, and unvested restricted stock units would be forfeited upon any other termination (unless otherwise specified by the terms of an employment agreement). With respect to performance share units, in the event of a Qualifying Termination, performance shares units will be converted to time-based restricted stock units at the CIC assuming achievement of 100% the performance targets. Such restricted stock units will have the same terms of the restricted stock units granted pursuant to the 2014 LTIP and shall be deemed to have been granted as of March 11, 2014. Other Terms & Provisions. Participants are not permitted to transfer LTIP awards, except by will or the laws of descent and distribution. The Corporation is entitled to withhold from any payments of awards under the LTIP or the Omnibus Plan any and all amounts required to be withheld for federal, state and local withholding taxes. The Compensation Committee has the discretion to change terms and conditions of LTIP awards as it deems necessary to ensure that the LTIP awards satisfy all requirements for “performance-based compensation” within the meaning of Section 162(m)(4)(c) of the Internal Revenue Code. In addition to the above conditions, payment of any incentive award is contingent upon the participant executing a written agreement to protect company assets.
Exhibit 21.1 List of Subsidiaries Name of Entity PharMerica Holdings, Inc.
Place of Incorporation Delaware
Exhibit 23.1 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Board of Directors PharMerica Corporation We consent to the incorporation by reference in the Registration Statements, on Form S-8 (Nos. 333-145137 and 333-195971) of PharMerica Corporation of our report dated March 2, 2015 with respect to the consolidated financial statements as of December 31, 2013 and 2014 and for each of the years in the three year period ended December 31, 2014 and the effectiveness of internal control over financial reporting as of December 31, 2014, which report appears in this Form 10-K. Our report dated March 2, 2015, on the effectiveness of internal control over financial reporting as of December 31, 2014, contains an explanatory paragraph that states management has excluded the 2014 Acquisitions from its assessment of internal control over financial reporting as of December 31, 2014 and that we have excluded the 2014 Acquisitions from our audit of internal control over financial reporting. /s/ KPMG LLP Louisville, Kentucky March 2, 2015
Exhibit 31.1 CERTIFICATION I, Gregory S. Weishar, certify that: 1. I have reviewed this annual report on Form 10-K of PharMerica Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d -15(f)) for the registrant and have: a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b.Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c. Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d.Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and 5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions): a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. DATE: March 2, 2015 /s/ GREGORY S. WEISHAR Chief Executive Officer and Director
Exhibit 31.2 CERTIFICATION I, David W. Froesel, Jr., certify that: 1. I have reviewed this annual report on Form 10-K of PharMerica Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a -15(f) and 15d -15(f)) for the registrant and have: a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c. Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d. Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and 5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions): a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and b.Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. DATE: March 2, 2015 /S/ DAVID W. FROESEL, JR. Executive Vice President, Chief Financial Officer and Treasurer
Exhibit 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of PharMerica Corporation (the “Corporation”) on Form 10-K for the year ended December 31, 2014 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Gregory S. Weishar, Chief Executive Officer and Director of the Corporation, certify, pursuant to18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Corporation. /S/ GREGORY W. WEISHAR Gregory S. Weishar Chief Executive Officer and Director March 2, 2015
Exhibit 32.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of PharMerica Corporation (the “Corporation”) on Form 10-K for the year ended December 31, 2014 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, David W. Froesel, Jr., Executive Vice President and Chief Financial Officer of the Corporation, certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Corporation. /S/ DAVID W. FROESEL, JR. David W. Froesel, Jr.Executive Vice President, Chief Financial Officer and Treasurer March 2, 2015
UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549
FORM 10-K (Mark One) ☒ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the year ended December 31, 2015 or ☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to . Commission File Number: 001-33380 PHARMERICA CORPORATION (Exact name of registrant as specified in its charter) Delaware (State or Other Jurisdiction of Incorporation or Organization)
87-0792558 (I.R.S. Employer Identification No.)
1901 Campus Place Louisville, KY (Address of Principal Executive Offices)
40299 (Zip Code)
(502) 627-7000 (Registrant's Telephone Number, Including Area Code) Securities registered pursuant to Section 12(b) of the Act: Title of each class Common stock $0.01 par value
Name of exchange on which registered New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: N/A (Title of class) Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐ No ☒ Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒ Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐ Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☒ Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. Large accelerated filer T Non-accelerated filer ☐ (Do not check if a smaller reporting company)
Accelerated filer ☐ Smaller reporting company ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒ The aggregate market value of the voting and non-voting common equity of the registrant held by non-affiliates as of June 30, 2015 was $979,005,881. Class of Common Stock Common stock, $0.01 par value
Outstanding at February 19, 2016 30,517,083
DOCUMENTS INCORPORATED BY REFERENCE Part III of this Form 10-K incorporates certain information by reference from registrant's definitive proxy statement for the 2016 annual meeting of stockholders, which proxy statement will be filed no later than 120 days after the close of the registrant's fiscal year ended December 31, 2015.
PHARMERICA CORPORATION FORM 10-K INDEX Page Part I Item 1. Item 1A. Item 1B. Item 2. Item 3. Item 4.
Business Risk Factors Unresolved Staff Comments Properties Legal Proceedings Mine Safety Disclosures
Part II Item 5. Item 6. Item 7. Item 7A. Item 8. Item 9. Item 9A. Item 9B.
Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Selected Financial Data Management's Discussion and Analysis of Financial Condition and Results of Operations Quantitative and Qualitative Disclosures About Market Risk Financial Statements and Supplementary Data Changes in and Disagreements With Accountants on Accounting and Financial Disclosure Controls and Procedures Other Information
Part III Item 10. Item 11. Item 12. Item 13. Item 14.
Directors, Executive Officers and Corporate Governance Executive Compensation Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Certain Relationships and Related Transactions, and Director Independence Principal Accounting Fees and Services
71 71 71 71 71
Part IV Item 15.
Exhibits, Financial Statement Schedules
72
3 13 20 21 21 22
2
23 26 29 44 F-1 70 70 70
Part I Item 1.
Business
Overview Formed in 2006, PharMerica Corporation (the "Corporation," "we," "us," or "our"), a Delaware Corporation, is an institutional 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 94 institutional pharmacies, 17 specialty infusion centers and 5 specialty oncology pharmacies in 45 states. The Corporation's customers are typically institutional healthcare providers, such as skilled nursing facilities, assisted living facilities, hospitals, individuals receiving in-home care and patients with cancer. Institutional Pharmacy Business Our core business provides pharmacy products and services to residents and patients in skilled nursing facilities, nursing centers, assisted living facilities, hospitals, and other long-term alternative care settings. We purchase, repackage, and dispense prescription and non-prescription pharmaceuticals in accordance with physician orders and deliver such medication to healthcare facilities for administration to individual patients and residents. Depending on the specific location, we service healthcare facilities typically within a radius of 120 miles or less of our pharmacy locations at least once each day. We provide 24-hour, seven-day per week on-call pharmacist services for emergency dispensing, delivery, and/or consultation with the facility's staff or the resident's attending physician. We also provide various supplemental healthcare services that complement our institutional pharmacy services. We offer prescription and non-prescription pharmaceuticals to our customers through unit dose or modified unit dose packaging, dispensing, and delivery systems, typically in a 14 to 30 day supply. Unit dose medications are packaged for dispensing in individual doses as compared to bulk packaging used by most retail pharmacies. The customers we serve prefer the unit dose delivery system over the bulk delivery system employed by retail pharmacies because it improves control over the storage and ordering of drugs and reduces errors in drug administration in healthcare facilities. Nursing staff in our customers' facilities administer the pharmaceuticals to individual patients and residents. The Corporation also utilizes an on-site dispensing system, with real time data transfer between the system and the Corporation, which provides timely medication administration in emergency and first dose situations. We also offer clinical pharmacy programs that encompass a wide range of drug therapy and disease management protocols, including protocols for anemia treatment, infectious diseases, wound care, nutritional support, renal dosing, and therapeutic substitution. Our computerized dispensing and delivery systems are designed to improve efficiency and control over distribution of medications to patients and residents. We provide computerized physician orders and medication administration records for patients or residents on a monthly basis as requested. Data from these records are formulated into monthly management reports on patient and resident care and quality assurance. This system improves efficiencies in nursing time, reduces drug waste, and helps to improve patient outcomes. Hospital Pharmacy Management Services We also provide hospital pharmacy management services. These services generally entail the overall management of the hospital pharmacy operations, including the ordering, receipt, storage, and dispensing of pharmaceuticals to the hospital's patients pursuant to the clinical guidelines established by the hospital. We offer the hospitals a wide range of regulatory and financial management services, including inventory control, budgetary analysis, staffing optimization, and assistance with obtaining and maintaining applicable regulatory licenses, certifications, and accreditations. We work with the hospitals to develop and implement pharmacy policies and procedures, including drug formulary development and utilization management. We also offer clinical pharmacy programs that encompass a wide range of drug therapy and disease management protocols, including protocols for anemia treatment, infectious diseases, wound care, nutritional support, renal dosing, and therapeutic substitution. The hospital pharmacy management services business is comprised of a few customers, of which, our largest service is to the majority of the Kindred Healthcare Inc. ("Kindred") hospitals. Consultant Pharmacist Services Federal and state regulations mandate that long-term care facilities, in addition to providing a source of pharmaceuticals, retain consultant pharmacist services to monitor and report on prescription drug therapy in order to maintain and improve the quality of resident care. On September 30, 2008, the United States Department of Health and Human Services Office of Inspector General ("OIG") published OIG Supplemental Compliance Program Guidance for Nursing Homes. With quality of care being the first risk area identified, the supplemental guidance is part of a series of government efforts focused on improving quality of care at skilled nursing and long-term care facilities. The guidance contains compliance recommendations and an expanded discussion of risk areas. The guidance stressed that facilities must provide pharmaceutical services to meet the needs of each resident and should be mindful of potential quality of care problems when implementing policies and procedures on proper medication management. It further stated that facilities can reduce risk by educating staff on medication management and improper pharmacy kickbacks for consultant pharmacists and that facilities should review the total compensation paid to consultant pharmacists to ensure it is not structured in a way that reflects the volume or value of particular drugs prescribed or administered to residents. We provide consultant pharmacist services to approximately 67% of our patients serviced. The services offered by our consultant pharmacists include: • • • • •
Monthly reviews of each resident's drug regimen to assess the appropriateness and efficiency of drug therapies, including the review of medical records, monitoring drug interactions with other drugs or food, monitoring laboratory test results, and recommending alternative therapies; Participation on quality assurance and other committees of our customers, as required or requested by such customers; Monitoring and reporting on facility-wide drug utilization; Development and maintenance of pharmaceutical policy and procedure manuals; and Assistance with federal and state regulatory compliance pertaining to resident care. 3
Medical Records The Corporation provides medical records services, which includes the completion and maintenance of medical record information for patients in the Corporation's customer's facilities. The medical records services include: • • • • •
Real-time access to medication and treatment administration records, physician order sheets and psychotropic drug monitoring sheets; Online ordering to save time and resources; A customized database with the medication profiles of each resident's medication safety, efficiency and regulatory compliance; Web-based individual patient records detailing each prescribed medicine; and Electronic medical records to improve information to make it more legible and instantaneous.
Specialty Infusion Services The Corporation provides specialty infusion services focused on providing complex pharmaceutical products and clinical services to patients in client facilities, hospice, and outside of hospital or nursing home settings. We offer high-touch clinical services to patients with acute or chronic conditions. The delivery of specialty infusion therapy requires comprehensive planning and monitoring which is provided through our registered nursing staff. Our nursing staff performs an initial patient assessment, provides therapy specific training and education, administers therapy and monitors for potential side effects. We also provide extensive clinical monitoring and patient follow-up to ensure patient therapy adherence and proactively manage patients' conditions. An innetwork strategy facilitates easier decision-making for referral sources and provides us with the ability to pre-authorize patients, auto adjudicate, and bill electronically, enabling faster prescription turnaround. Specialty Oncology Pharmacy We provide dispensing of oncology drugs, care management and other related services to patients, oncology practices, and hospitals. These services encompass clinical coordination and review, compliance with appropriate oncology protocols, patient assistance with outside funding, and timely delivery of medication. We coordinate the administration of medications to the physician's office or directly to the patient at the appropriate point of treatment. We work directly with the payers to bill insurance companies for the medication provided, ensuring all prior authorizations and approvals are obtained. These services offer physicians an alternative to the traditional buy-and-bill distribution model, allowing them to outsource drug procurement, inventory management, and prescription administration. Our Business Focus Drive Scale Economies. We focus on consistently providing quality pharmaceutical services to our customers at competitive prices and delivery of prescriptions in a timely and effective manner. Our business seeks to implement innovative and cost-effective solutions to improve the provision of medication to our customers and the residents and patients that they serve. Focus on Organic Growth through New Sales and Client Retention. We aim to grow our business through expansion in our existing markets and by servicing new customers. We believe our industry has underlying market growth potential attributable to both an increase in drug utilization as well as the general aging population of the United States. Acquire Competitors. We also intend to expand our market share through selected geographic expansion in markets not currently served by us and through strategic acquisitions in existing and underserved markets. The Corporation currently operates in 45 states. We believe that there are growth opportunities in several other markets. There are numerous businesses in our markets, mostly small or regional companies that lack the scale that we believe will be necessary to ultimately compete in a market that is national in scope. We intend to actively seek opportunities to acquire companies. Since its formation in 2006, the Corporation has acquired 19 institutional pharmacy businesses, four specialty infusion services businesses, one specialty oncology pharmacy and one hospital services business. Sales and Marketing We sell our products and services through a national sales force. The sales force is organized by both geographic lines and size of client. We believe this helps us to maximize coverage, manage costs, and align more effectively with our operating regions. Our sales representatives specialize in the products and services we offer and the markets in which we operate. Their knowledge permits us to meet the unique needs of our customers while maintaining profitable relationships. Customers Institutional Care Settings. At December 31, 2015, the Corporation provided institutional pharmacy services to patients in 45 states. Our customers are typically institutional healthcare providers, such as skilled nursing facilities, nursing centers, assisted living facilities and other long-term alternative care settings. We are generally the primary source of pharmaceuticals for our customers. Our customers depend on institutional pharmacies like us to provide the necessary pharmacy products and services and to play an integral role in monitoring patient medication regimens and safety. We dispense pharmaceuticals in patient specific packaging in accordance with physician instructions. Specialty Infusion Services. At December 31, 2015, the Corporation provided specialty infusion services to patients in 14 states with acute or chronic conditions in a setting outside of a hospital or nursing home. Specialty Oncology Services. At December 31, 2015, the Corporation provided specialty oncology medication services to patients in 46 states with acute and chronic conditions in a hospital or physician practice or the home setting. 4
Suppliers/Inventory We obtain pharmaceutical and other products from Cardinal Health ("Cardinal Health") and other contracts negotiated directly with pharmaceutical manufacturers for discounted prices. The Corporation entered into a Prime Vendor Agreement with Cardinal effective April 1, 2015 ("Cardinal Health PVA"). The initial term of the agreement is through June 30, 2018 and contains one year automatic renewal provisions. The Cardinal Health PVA requires the Corporation to purchase certain levels of brand and non-injectable generic drugs from Cardinal Health. The Cardinal Health PVA does provide flexibility for the Corporation to contract with other suppliers. Under the agreement, the Corporation is entitled to certain rebates based on drug purchases. The loss of a supplier could adversely affect our business if alternate sources of supply are unavailable or if available are significantly more expensive. We seek to maintain an on-site inventory of pharmaceuticals and supplies to ensure prompt delivery to our customers. Cardinal Health maintains local distribution facilities in most major geographic markets in which we operate. In addition, we supply many of our pharmacies with select products from a distribution center operated by a third-party logistics company. Brand to Generic Conversions The following table summarizes the Corporation's generic drug dispensing rate: 2013 83.4%
2014 84.9%
2015 86.0%
The following table summarizes the material brand-to-generic conversions expected to occur in 2016 through 2019: 2016 Gleevec (Q1)* Combivent (Q2)* Crestor (Q2)* Cubicin (Q2)* Tamiflu (Q3) Kaletra (Q4) Norvir (Q4) Seroquel XR (Q4)* Zetia (Q4)*
2017
2018 Sensipar (Q1)* Nasonex (Q2)
Azilect( Q1) Vytorin (Q2) Reyataz (Q4)
2019 Renexa (Q1)* Lyrica (Q2)* Vesicare (Q2)*
* These represent the most significant brand-to-generic conversions (Number in parentheses refers to the expected quarter of conversion)
When a branded drug shifts to a generic, initial pricing of the generic drug in the market will vary depending on the number of manufacturers launching their generic version of the drug. Historically, a shift from brand-to-generic decreased our revenue and improved our gross margin from sales of these classes of drugs during the initial time period that a brand drug has a generic alternative. Third-party payers may reduce their reimbursements to the Corporation after the initial period. In addition, the number of generic manufacturers entering the market impacts the overall cost and reimbursement of generic drugs. This acceleration in the reimbursement reduction and the number of generic manufacturers generally result in margin compression. Due to the unique nature of the brand-to-generic conversion, management cannot estimate the future financial impact of the brand-to-generic conversions on the Corporation's results of operations. Supplier and Manufacturer Rebates We currently receive rebates from certain manufacturers and distributors of pharmaceutical products for achieving targets of market share or purchase volumes. Rebates are designed to prefer, protect, or maintain a manufacturer's products that are dispensed by the pharmacy under its formulary. Rebates for brand name products are generally based upon achieving a defined market share tier within a therapeutic class and can be based on either purchasing volumes or actual prescriptions dispensed. Rebates for generic products are more likely to be based on achieving purchasing volume requirements. Information Technology Computerized medical records and documentation are an integral part of our distribution system. We primarily utilize a proprietary information technology infrastructure that automates order entry of medications, dispensing of medications, invoicing, and payment processing. These systems provide consulting drug review, electronic medication management, medical records, and regulatory compliance information to help ensure patient safety. These systems also support verification of eligibility and electronic billing capabilities for the Corporation's pharmacies. They also provide order entry, shipment, billing, reimbursement and collection of service fees for medications, specialty services and other services rendered. Based upon our electronic records, we are able to provide reports to our customers and management on patient care and quality assurance. These reports help to improve efficiency in patient care, reduce drug waste, and improve patient outcomes. We expect to continue to invest in technologies that help critical information access and system availability. 5
Sources of Pharmacy Revenues We receive payment for our services from third party payers, including Medicare Part D Plans, government reimbursement programs under Medicare and Medicaid, and non-government sources such as institutional healthcare providers, commercial insurance companies, health maintenance organizations, preferred provider organizations, private payers, and contracted providers. The sources and amounts of our revenues will be determined by a number of factors, including the mix of our customers' patients, brand to generic conversions and the rates and changes of reimbursement among payers. Changes in our customers' censuses, the case mix of the patients, brand and generic dispensing rates, and the payer mix among private pay, Medicare Part D, institutional healthcare providers, and Medicaid, will affect our profitability. A summary of revenue by payer type for the years ended December 31, are as follows (dollars in millions): 2013
Medicare Part D Institutional healthcare providers Medicaid Private and other Insured Medicare Hospital management fees Total
$
$
Amount 813.7 519.2 157.0 77.2 113.0 15.5 62.3 1,757.9
2014 % of Revenues 46.3% $ 29.5 9.0 4.4 6.4 0.9 3.5 100.0% $
Amount 866.0 459.7 167.1 81.9 239.0 21.9 58.9 1,894.5
2015 % of Revenues 45.7% $ 24.3 8.8 4.3 12.6 1.2 3.1 100.0% $
Amount 951.3 469.8 150.1 79.4 291.0 22.2 64.7 2,028.5
% of Revenues 46.9% 23.2 7.4 3.9 14.4 1.1 3.1 100.0%
The change in the revenue by payer type, as a percent of total revenue, over the three year period is a result of the 2012 acquisition of Amerita, subsequent infusion acquisitions made by Amerita and the 2013 acquisition of Onco, all of which are more heavily weighted to insured payer sources. Competition We face a highly competitive environment in the institutional pharmacy market. In each geographic market, there are national, regional and local institutional pharmacies that provide services comparable to those offered by our pharmacies which may have greater financial and other resources than we do and may be more established in the markets they serve than we are. In addition, owners of skilled nursing facilities are also entering the institutional pharmacy market, particularly in areas of their geographic concentration. On a nationwide basis, there is one larger competitor in the institutional pharmacy industry, Omnicare, Inc., a division of CVS Health (NYSE: CVS). We believe that the competitive factors most important to our business are pricing, quality and the range of services offered, clinical expertise, ease of doing business with the provider and the ability to develop and maintain relationships with customers. Because relatively few barriers to entry exist in the local markets we serve, we have encountered and will continue to encounter substantial competition from local market entrants. Patents, Trademarks and Licenses We use a number of trademarks and service marks. All of the principal trademarks and service marks used in the course of our business have been registered in the United States or are the subject of pending applications for registration. We have various proprietary products, processes, software and other intellectual property that are used either to facilitate the conduct of our business or that are made available as products or services to customers. We generally seek to protect such intellectual property through a combination of trade secret, patent and copyright laws and through confidentiality and other contractually imposed protections. Although we believe that our products and processes do not infringe upon the intellectual property rights of any third parties, third parties may assert infringement claims against us from time to time. Seasonality Our largest customers in institutional pharmacy services are skilled nursing facilities. Both prescription and non-prescription drug sales at skilled nursing facilities are affected by the timing and severity of the cold/flu season and other seasonality of the long-term care facilities industry, however seasonality does not have a material effect on the Corporation's consolidated financial results. Working Capital For information about the Corporation's practices relating to working capital items, see Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources". Employees As of December 31, 2015, we had approximately 5,800 employees which included approximately 1,200 part-time employees. The Corporation had approximately 300 employees that were covered by collective bargaining agreements as of December 31, 2015. As of December 31, 2015, we employed approximately 1,700 licensed pharmacists. We believe that our relationships with our employees are good. 6
Government Regulation General Extensive federal, state and local regulations govern institutional pharmacies and the healthcare facilities that they serve. These regulations cover licenses, staffing qualifications, conduct of operations, reimbursement, record keeping and documentation requirements and the confidentiality and security of health-related information. Our institutional pharmacies are also subject to federal and state laws that regulate financial arrangements between healthcare providers, including the federal anti-kickback statutes and the federal physician self-referral laws. Licensure, Certification and Regulation States generally require that the state board of pharmacy license a pharmacy operating within the state. Many states also regulate out-of-state pharmacies that deliver prescription products to patients or residents in their states. We have the necessary pharmacy state licenses, or pending applications, for each pharmacy we operate. Our pharmacies are also registered with the appropriate federal and state authorities pursuant to statutes governing the regulation of controlled substances. In addition, pharmacists, nurses and other healthcare professionals who provide services on our behalf are in most cases required to obtain and maintain professional licenses and are subject to state regulation regarding professional standards of conduct. The Drug Enforcement Agency (the "DEA"), the U.S. Food and Drug Administration (the "FDA"), and various state regulatory authorities regulate the distribution of pharmaceutical products and controlled substances. These laws impose a host of requirements on the pharmaceutical supply channel, including providers of institutional pharmacy services. Under the Comprehensive Drug Abuse Prevention and Control Act of 1970, as a dispenser of controlled substances, we must register with the DEA, file reports of inventories and transactions and provide adequate security measures. In addition, we are required to comply with all the relevant requirements of the Controlled Substances Act for the transfer and shipment of pharmaceuticals. The FDA, DEA, and state regulatory authorities have broad enforcement powers, including the ability to seize or recall products and impose significant criminal, civil and administrative sanctions for violations of these laws and regulations. We have received all necessary regulatory approvals and believe that our pharmacy operations are in substantial compliance with applicable federal and state good manufacturing practice requirements. Client long-term care facilities are separately required to be licensed in the states in which they operate and, if serving Medicaid or Medicare patients, must be certified to be in compliance with applicable program participation requirements. Client facilities are also subject to the nursing home reforms of the Omnibus Budget Reconciliation Act of 1987, as amended, which imposed strict compliance standards relating to quality of care for facility operations, including vastly increased documentation and reporting requirements. Laws Affecting Referrals and Business Practices We are subject to federal and state laws that govern financial and other arrangements between healthcare providers. These laws prohibit certain direct and indirect payments or fee-splitting arrangements between healthcare providers that are designed to induce or encourage the referral of patients to, or the recommendation of, a particular provider for medical products and services. These laws include: •
•
the federal "anti-kickback" statute, which prohibits, among other things, knowingly or willfully soliciting, receiving, offering or paying remuneration "including any kickback, bribe or rebate" directly or indirectly in return for or to induce the referral of an individual to a person for the furnishing or arranging for the furnishing of any item or service for which payment may be made in whole or in part under Medicare, Medicaid or other federal healthcare programs; and the federal "Stark laws" which prohibit, with limited exceptions, the referral of patients by physicians for certain designated health services, to an entity with which the physician has a financial relationship. 7
These laws impact the relationships that we may have with potential referral sources. We have a variety of relationships with potential referral sources, including hospitals and skilled nursing facilities with which we have contracted to provide pharmacy services. With respect to the anti-kickback statute, the OIG has enacted safe harbor regulations that outline practices that are deemed protected from prosecution. While we endeavor to comply with the applicable safe harbors, certain of our current arrangements, none of which is material to us, may not qualify for safe harbor protection. Failure to meet a safe harbor does not mean that the arrangement necessarily violates the anti-kickback statute, but may subject the arrangement to greater scrutiny. In addition, as a means of providing guidance to healthcare providers, the OIG issues a variety of sub-regulatory guidance including Special Fraud Alerts, Special Advisory Bulletins, Advisory Opinions, and other compliance guidance documents. This guidance does not have the force of law, but identifies features of arrangements or transactions that may indicate that the arrangements or transactions violate the anti kickback statute or other federal health care laws. While we believe our practices comply with the anti-kickback statute, we cannot assure our practices that are outside of a safe harbor will not be found to violate the anti-kickback statute. In addition to federal law, many states have enacted similar statutes that are not necessarily limited to items or services for which payment is made by federal healthcare programs. Violations of these laws may result in fines, imprisonment, denial of payment for services and exclusion from the Medicare and Medicaid programs and other state-funded programs. Other provisions in the Social Security Act and in other federal and state laws authorize the imposition of penalties, including criminal and civil fines and exclusions from participation in Medicare, Medicaid and other federal healthcare programs for false claims, improper billing and other offenses. These laws include the federal False Claims Act, under which private parties have the right to bring "qui tam" whistleblower lawsuits against companies that submit false claims for payments to the government. Recent changes to the False Claims Act, expanding liability to certain additional parties and circumstances, may make these qui tam law lawsuits more prevalent. Some states have adopted similar state whistleblower and false claims laws. In addition, a number of states have undertaken enforcement actions against pharmaceutical manufacturers involving pharmaceutical marketing programs, including looking at relationships with pharmacies and programs containing incentives for pharmacists to dispense one particular product rather than another. These enforcement actions arose under various state laws including fraud and abuse laws and consumer protection laws which generally prohibit false advertising and deceptive trade practices. In the ordinary course of business, we are regularly and currently subject to inquiries, investigations and audits by federal and state agencies that oversee applicable healthcare program participation and payment regulations. We believe that the regulatory environment surrounding most segments of the healthcare industry remains intense. Federal and state governments continue to impose intensive enforcement policies resulting in a significant number of inspections, citations for regulatory deficiencies and other regulatory sanctions including demands for refund of overpayments, terminations from the Medicare and Medicaid programs, bars on Medicare and Medicaid payments and fines. Such sanctions could have a material adverse effect on our financial condition, results of operation and liquidity. We believe our contract arrangements with other healthcare providers and our pharmaceutical suppliers and our pharmacy practices are in substantial compliance with applicable federal and state laws. These laws may, however, be interpreted in the future in a manner inconsistent with our interpretation and application. State Laws Affecting Access to Services Some states have enacted "freedom of choice" or "any willing provider" requirements as part of their state Medicaid programs or in separate legislation. These laws may preclude a nursing center from requiring their patients and residents to purchase pharmacy or other ancillary medical services or supplies from particular providers that have a supplier relationship with the nursing center. Limitations such as these may increase the competition which we face in providing services to nursing center residents. HIPAA The Federal Health Insurance Portability and Accountability Act of 1996, commonly known as "HIPAA," mandates the adoption of regulations aimed at standardizing transaction formats and billing codes for documenting medical services, dealing with claims submissions and protecting the privacy and security of individually identifiable health information. HIPAA regulations that standardize transactions and code sets require standard formatting for healthcare providers, like us, that submit claims electronically. The HIPAA privacy regulations apply to "protected health information," or "PHI," which is defined generally as individually identifiable health information transmitted or maintained in any form or medium, excluding certain education records and student medical records. The privacy regulations seek to limit the use and disclosure of most paper and oral communications, as well as those in electronic form, regarding an individual's past, present or future physical or mental health or condition, or relating to the provision of healthcare to the individual or payment for that healthcare, if the individual can or may be identified by such information. HIPAA provides for the imposition of civil or criminal penalties if PHI is improperly disclosed. 8
HIPAA's security regulations require us to ensure the confidentiality, integrity and availability of all electronic protected health information that we create, receive, maintain or transmit. We must protect against reasonably anticipated threats or hazards to the security of such information and the unauthorized use or disclosure of such information. In addition to HIPAA, we are subject to state privacy laws and other state privacy or health information requirements not preempted by HIPAA, including those which may furnish greater privacy protection for individuals than HIPAA. The scope of our operations involving health information is broad and the nature of those operations is complex. Although we believe that our contract arrangements with healthcare payers and providers and our business practices are in compliance with applicable federal and state electronic transmissions, privacy and security of health information laws, the requirements of these laws, including HIPAA, are complicated and are subject to interpretation. In addition, state regulation of matters also covered by HIPAA, especially the privacy standards, is increasing, and determining which state laws are preempted by HIPAA is a matter of interpretation. Failure to comply with HIPAA or similar state laws could subject us to loss of customers, denial of the right to conduct business, civil damages, fines, criminal penalties and other enforcement actions. The Health Information Technology for Economic and Clinical Health Act ("HITECH"), part of the American Recovery and Reinvestment Act of 2009, changed several aspects of HIPAA including, without limitation, the following: (i) applies HIPAA security provisions and penalties directly to business associates of covered entities; (ii) requires certain notifications in the event of a security breach involving PHI; (iii) restricts certain unauthorized disclosures; (iv) changes the treatment of certain marketing activities; and (v) strengthens enforcement activities. In addition, the Secretary of the United States Department of Health and Human Services issued an interim final rule on August 24, 2009 that requires notifications for certain unpermitted disclosures of PHI. The final rule was issued on January 17, 2013. 2010 Health Care Reform Legislation The Patient Protection and Affordable Care Act and the reconciliation law known as Health Care and Education Affordability Reconciliation Act (combined we refer to both Acts as the "2010 Health Care Reform Legislation") were enacted in March 2010. State participation in the expansion of Medicaid under the 2010 Health Care Reform Legislation is voluntary. Three key provisions of the 2010 Health Care Reform Legislation that are relevant to the Corporation are: (i) the gradual modification to the calculation of the Federal Upper Limit ("FUL") for drug prices and the definition of Average Manufacturer's Price ("AMP"), (ii) the closure, over time, of the Medicare Part D coverage gap, which is otherwise known as the "Donut Hole," and (iii) short cycle dispensing. Regulations under the 2010 Health Care Reform Legislation are expected to continue being drafted, released, and finalized throughout the next several years. FUL and AMP Changes The reimbursement rates for pharmacy services under Medicaid are determined on a state-by-state basis subject to review by Centers for Medicare and Medicaid Services ("CMS") and applicable federal law. Although Medicaid programs vary from state to state, they generally provide for the payment of certain pharmacy services, up to the established limits, at rates determined in accordance with each state's regulations. Federal regulations and the regulations of certain states establish "upper limits" for reimbursement of certain prescription drugs under Medicaid (these upper limits being the "FUL"). The 2010 Health Care Reform Legislation amended the Deficit Reduction Act of 2005 (the "DRA") to change the definition of the FUL by requiring the calculation of the FUL as no less than 175% of the weighted average, based on utilization, of the most recently reported monthly AMP for pharmaceutically and therapeutically equivalent multi-source drugs available through retail community pharmacies nationally. In addition, the definition of AMP changed to reflect net sales only to drug wholesalers that distribute to retail community pharmacies and to retail community pharmacies that directly purchase from drug manufacturers. Further, the 2010 Health Care Reform Legislation continues the current statutory exclusion of prompt pay discounts offered to wholesalers and adds three other exclusions to the AMP definition: (i) bona fide services fees;(ii) reimbursement for unsalable returned goods (recalled, expired, damaged, etc.); and (iii) payments from and rebates/discounts to certain entities not conducting business as a wholesaler or retail community pharmacy. 9
On February 1, 2016, CMS released a Final Rule titled Medicaid Program; Covered Outpatient Drugs. This Final Rule details the types of sales that are to be included and excluded in determining AMP. Moreover, consistent with the 2010 Health Care Reform Legislation, the Final Rule calculates the FULs at 175% of the weighted average, determined based on the basis of utilization, of the most recently reported monthly AMP. As an exception, however, if the AMP-based FUL is lower than the National Average Drug Acquisition Cost ("NADAC"), the FULs will be set at the drug's NADAC. This Final Rule will be effective on April 1, 2016. CMS has stated that it plans to publish the draft FULs in accordance with the Final Rule for two months before finalizing the FULs. The final FULs will be published in late March 2016 and will be effective April 1, 2016 to coincide with the effective date of the Final Rule. States will have 30 days following this effective date to implement the FULs. CMS will update the FULs on a monthly basis thereafter, which will become effective on the first date of the month following their publication. Again, states will then have 30 days after the effective date of the monthly updates to implement the new FULs. The Final Rule also changed how states reimburse pharmacies. The Final Rule now requires states to pay pharmacies based on the actual acquisition cost of the drug, as opposed to the estimated acquisition cost. Moreover, the Final Rule requires states to consider the sufficiency of both the ingredient cost reimbursement and dispensing fee reimbursement when proposing changes to either of these components of reimbursement for Medicaid covered drugs. CMS will continue to post draft monthly FULs. The Corporation will continue to analyze the effect of these changes on its business, results of operations, and liquidity. Short Cycle Dispensing and Dispensing Fees Pursuant to the 2010 Health Care Reform Legislation, Prescription Drug Plans ("PDPs") are required, under Medicare Part D and Medicare Advantage prescription drug plans ("Medicare Advantage" or "MAPDs") to utilize specific, uniform dispensing techniques, such as weekly, daily, or automated dose dispensing, when dispensing covered Medicare Part D drugs to beneficiaries who reside in a long-term care facility to reduce waste associated with 30 to 90 day prescriptions for such beneficiaries. Pursuant to CMS issued regulation, beginning January 1, 2013, pharmacies dispensing to long-term care facilities must dispense no more than 14-day supplies of brand-name oral solid medications covered by Medicare Part D. The Corporation fully implemented short cycle dispensing on January 1, 2013. The impact of short cycle dispensing has not had a material adverse impact on the Corporation's results of operations. Medicare Part D Changes In a February 12, 2015 Final Rule entitled "Medicare Program: Contract Year 2016 Policy and Technical Changes to the Medicare Advantage and the Medicare Prescription Drug Benefit Programs", CMS finalized a regulation, effective January 1, 2016, prohibiting financial arrangements that penalize more efficient long-term care dispensing techniques (e.g., dispensing a 3 day supply over a 14 day supply) through pro-rated dispensing fees based on a day's supply or quantity dispensed. CMS also finalized a requirement that, effective January 1, 2016, any differences in payment methodologies among long-term care pharmacies incentivize more efficient dispensing techniques. The Corporation is unable to evaluate the full impact of these changes on its business at this time. CIA and DEA MOA In May 2015, the Corporation entered into a five-year Corporate Integrity Agreement ("CIA") with United States Department of Health and Human Services Office of the Inspector General ("OIG") and a Memorandum of Agreement ("MOA") with the Drug Enforcement Agency ("DEA") concurrent with the execution of settlement agreements with the OIG and the DEA settling alleged Controlled Substance Act ("CSA") violations and associated False Claims Act allegations. The CIA requires the Corporation, among other things to : (i) create procedures designed to ensure it complies with the CSA and related regulations, (ii) retain an independent review organization to review the Corporation's compliance with the terms of the CIA and report to the OIG regarding that compliance; and (iii) provide training for certain Corporation employees as to the Corporation's requirements under the CSA. If the Corporation fails to comply with the terms of the CIA, it may be required to pay certain monetary penalties. Furthermore, if the Corporation commits a material breach of the CIA, the OIG may exclude the Corporation from participating in federal healthcare programs. Any such exclusion would result in the revocation or termination of contracts and/or licenses and potentially have a material adverse effect on our financial condition, results of operations and business prospects. The MOA requires the Corporation to comply with all requirements of the CSA, specifically relating to the dispensing of scheduled prescription drugs. If the Corporation fails to comply with the terms of the MOA, the DEA may suspend a Corporation's pharmacy DEA Certificate of Registration and begin an administrative hearing process pursuant to 21 U.S.C. Section 824. Any such suspension would prohibit the Corporation's pharmacy from dispensing scheduled prescription drugs and would lead to the revocation or termination of contracts and/or licenses and potentially have a materially adverse effect on our financial condition, results of operations and business prospects. 10
Overview of Reimbursement Medicare is a federal program that provides certain hospital and medical insurance benefits to persons age 65 and over and to certain disabled persons. Medicaid is a medical assistance program administered by each state that provides healthcare benefits to certain indigent patients. Within the Medicare and Medicaid statutory framework, there are substantial areas subject to administrative rulings, interpretations, and discretion that may affect payments made under Medicare and Medicaid. We receive payment for our services from institutional healthcare providers, commercial Medicare Part D Plans, third party payer government reimbursement programs such as Medicare and Medicaid, and other non-government sources such as commercial insurance companies, health maintenance organizations, preferred provider organizations, and contracted providers. With respect to our skilled nursing facilities customers, their residents are covered by Medicare Part A, Part B and Part D Plans, Medicaid, insurance, and other private payers (including managed care). Medicare The Medicare program consists of four parts: (i) Medicare Part A, which covers, among other things, in-patient hospital, skilled nursing facilities, home healthcare, and certain other types of healthcare services; (ii) Medicare Part B, which covers physicians' services, outpatient services, and certain items and services provided by medical suppliers such as intravenous therapy; (iii) Medicare Part C or Medicare Advantage, a managed care option for beneficiaries who are entitled to Medicare Part A and enrolled in Medicare Part B, and (iv) Medicare Part D, which provides coverage for prescription drugs that are not otherwise covered under Medicare Part A or Part B for those beneficiaries that enroll. Part A The Balanced Budget Act of 1997 (the "BBA") mandated the Prospective Payment System ("PPS") for Medicare-eligible enrolled residents in skilled nursing facilities. Under PPS, Medicare pays skilled nursing facilities a fixed fee per patient per day for extended care services to patients, covering substantially all items and services furnished during such enrollee's stay. Such services and items include pharmacy services and prescription drugs. We bill skilled nursing facilities based upon a negotiated fee schedule and are paid based on those contractual relationships. We do not receive direct payment from Medicare for patients covered under the Medicare Part A benefit. We classify the revenues recognized from these payers as Institutional Healthcare Providers. Federal legislation continues to focus on reducing Medicare and Medicaid program expenditures. Such decreases may directly impact the Corporation's customers and their Medicare reimbursement. Given the changing nature of these rules, we are unable at this time to fully evaluate the impact on our business. Any evaluation of budgeting, cost-cutting, and financing of health care must also consider the impact of legislation and the impact its proposed health care policies could have on any future cost considerations. Part D Medicare Part D provides coverage for prescription drugs that are not otherwise covered under Medicare Part A or Part B for those beneficiaries that enroll. Under Medicare Part D, beneficiaries may enroll in prescription drug plans offered by private commercial insurers who contract with CMS (or in a "fallback" plan offered on behalf of the government through a contractor, to the extent private entities fail to offer a plan in a given area), which provide coverage of outpatient prescription drugs (collectively, "Part D Plans"). Part D Plans include both plans providing the drug benefit on a standalone basis and Medicare Advantage plans providing drug coverage as a supplement to an existing medical benefit under that Medicare Advantage plan. Medicare beneficiaries generally have to pay a premium to enroll in a Part D Plan, with the premium amount varying from one Part D Plan to another, although CMS provides various federal subsidies to Part D Plans to reduce the cost to beneficiaries. Part D Plans are required to make available certain drugs on their formularies. Dually-eligible residents in nursing centers generally are entitled to have their prescription drug costs covered by a Part D Plan, provided that the prescription drugs which they are taking are either on the Part D Plan's formulary or an exception to the Part D Plan's formulary is granted. CMS reviews the formularies of Part D Plans and requires these formularies to include the types of drugs most commonly used by Medicare beneficiaries. CMS also reviews the formulary exceptions criteria of the Part D Plans that provide for coverage of drugs determined by the Part D Plan to be medically appropriate for the enrollee; however there currently is not a separate formulary for long-term care residents. We obtain reimbursement for drugs we provide to enrollees of the given Part D Plan in accordance with the terms of agreements negotiated between us and the Part D Plan. The Medicare Part D final rule prohibits Part D plans from paying for drugs and services not specifically called for by the BBA. 11
Medicare Part D does not alter federal reimbursement for residents of nursing centers whose stay at the nursing center is covered under Medicare Part A. Accordingly, Medicare's fixed per diem payments to nursing centers under PPS will continue to include a portion attributable to the expected cost of drugs provided to such residents. We will, therefore, continue to receive reimbursement for drugs provided to such residents from the nursing center in accordance with the terms of our agreements with each nursing center. In addition, we receive rebates from pharmaceutical manufacturers for undertaking certain activities that the manufacturers believe may increase the likelihood that we will dispense their products. CMS continues to question whether institutional pharmacies should be permitted to receive these access/performance rebates from manufacturers with respect to prescriptions covered under Medicare Part D, but has not prohibited the receipt of such rebates. CMS defines these as rebates a manufacturer provides to long-term care pharmacies that are designed to "prefer, protect, or maintain" that manufacturer's product selection by the long-term care pharmacy or to increase the volume of that manufacturer's products that are dispensed by the pharmacy under its formulary. CMS, in 2007, required PDPs to have policies and systems in place as part of their drug utilization management programs to protect beneficiaries and reduce costs when long-term care pharmacies receive incentives to move market share through access/performance rebates. The elimination or substantial reduction of manufacturer rebates, if not offset by other reimbursement, would have a material adverse effect on our business. Medicaid The reimbursement rate for pharmacy services under Medicaid is determined on a state-by-state basis subject to review by CMS and applicable federal law. Although Medicaid programs vary from state to state, they generally provide for the payment of certain pharmacy services, up to established limits, at rates determined in accordance with each state's regulations. The federal Medicaid statute specifies a variety of requirements that a state plan must meet, including the requirements related to eligibility, coverage for services, payment, and admissions. For residents that are eligible for Medicaid only, and are not dual eligibles covered under Medicare Part D, we bill the individual state Medicaid program or in certain circumstances the state's designated managed care or other similar organizations. Federal regulations and the regulations of certain states establish "upper limits" for reimbursement of certain prescription drugs under Medicaid. In most states, pharmacy services are priced at the lower of "usual and customary" charges or cost, which generally is defined as a function of average wholesale price and may include a profit percentage plus a dispensing fee. Most states establish a fixed dispensing fee per prescription that is adjusted to reflect associated cost. Over the last several years, state Medicaid programs have lowered reimbursement through a variety of mechanisms, principally higher discounts off average wholesale price levels, expansion of the number of medications subject to federal upper limit pricing, and general reductions in contract payment methodology to pharmacies. Environmental Matters In operating our facilities, historically we have not encountered any material difficulties effecting compliance with applicable pollution control laws. No material capital expenditures for environmental control facilities are expected. While we cannot predict the effect which any future legislation, regulations or interpretations may have upon our operations, we do not anticipate any changes regarding pollution control laws that would have a material adverse impact on the Corporation. Available Information We make available free of charge on or through our web site, at www.pharmerica.com, our annual reports on Form 10-K, quarterly reports on Form 10Q, current reports on Form 8-K and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with the Securities and Exchange Commission ("SEC"). Additionally, the public may read and copy any materials we file with the SEC at the SEC's Public Reference Room at 100 F Street, NE, Room 1580, Washington, D.C., 20549. Information regarding operation of the Public Reference Room is available by calling the SEC at 1-800-SEC-0330. Information that we file with the SEC is also available at the SEC's web site at www.sec.gov. Our SEC filings are available to the public through the New York Stock Exchange ("NYSE"), 20 Broad Street, New York, New York, 10005. Our Common Stock is listed on the NYSE and trades under the symbol "PMC". The certifications of our Chief Executive Officer and Chief Financial Officer required under Section 302 of the Sarbanes-Oxley Act have been filed as Exhibits 31.1 and 31.2 to this Annual Report on Form 10-K. 12
Item 1A.
Risk Factors
You should consider carefully the risks described below, together with all of the other information, in evaluating the Corporation and its common stock. If any of the risks described below actually occur, it could have a material adverse effect on the Corporation's business, results of operations, financial condition and stock price. Risk Factors Relating to Our Business Financial soundness of our customers and suppliers may adversely affect our results of operations. If our customers' operating and financial performance deteriorates, or if they are unable to make scheduled payments or obtain credit, our customers may not be able to pay, or may delay payment of accounts receivable owed to us. Any inability of customers to pay us for our products and services may adversely affect our earnings and cash flow. Additionally, both state and federal government sponsored payers, as a result of budget deficits or reductions, may seek to reduce their healthcare expenditures resulting in the long-term care customers renegotiating their contracts with us. Any reduction in payments by such government sponsored payers may adversely affect our earnings and cash flow. Also some of our customers' real estate is owned by Real Estate Investment Trusts limiting their ability to renegotiate rental costs furthering their desire to reduce other controllable costs, such as pharmacy costs. Intense competition may erode our profit margins. The distribution of pharmaceuticals to healthcare facilities is highly competitive. In each geographic market, there are national, regional and local institutional pharmacies and numerous local retail pharmacies, which provide services comparable to those offered by our pharmacies and may be more established in the markets they serve than we are. We also compete against regional and local pharmacies that specialize in long-term care. Many of our competitors have equal or greater resources and access to capital than the Corporation. In addition, local pharmacies have strong personal relationships with their customers. Because relatively few barriers to entry exist in the local markets we serve, we may encounter substantial competition from local market entrants. In addition, owners of skilled nursing facilities, including prior and current customers, are also entering the institutional pharmacy market, particularly in areas of their geographic concentration. Consolidation within the institutional pharmacy industry may also lead to increased competition. Competitive pricing pressures may adversely affect our earnings and cash flow. We compete based on innovation and service as well as price. To attract new clients and retain existing clients, we must continually meet service expectations of our clients and customers. We cannot be sure that we will continue to remain competitive with the service to our clients at our current levels of profitability. If we lose relationships with one or more key pharmaceutical manufacturers or if the payments made or discounts provided by pharmaceutical manufacturers decline, our business and financial results could be adversely affected. We maintain contractual relationships with numerous pharmaceutical manufacturers that may provide us with, among other things: • • •
discounts for drugs we purchase to be dispensed from our institutional pharmacies; rebates based upon distributions of drugs from our institutional pharmacies; and administrative fees for managing rebate programs.
If several of these contractual relationships are terminated or materially altered by the pharmaceutical manufacturers, our business and financial results could be materially adversely affected. In addition, formulary fee programs have been the subject of debate in federal and state legislatures and various other public and governmental forums. Changes in existing laws or regulations or in interpretations of existing laws or regulations or the adoption of new laws or regulations relating to any of these programs may materially adversely affect our business. CMS has questioned whether long-term care pharmacies should be permitted to receive discounts, rebates and other price concessions from pharmaceutical manufacturers with respect to prescriptions covered under the Medicare Part D benefit. Our business would be adversely affected if CMS should take any action that has the effect of eliminating or significantly reducing the rebates that we receive from pharmaceutical manufacturers. Our operating revenue and profitability may suffer upon the occurrence of the loss of certain customers. We have a number of customers that own or operate numerous facilities in our institutional pharmacy segment. In addition, our hospital revenues are primarily derived from one large multi-facility customer. If we are not able to continue these relationships or are only able to continue these relationships on less favorable terms than the ones currently in place, our operating revenues and results of operations would be materially impacted. There can be no assurance that these customers will not terminate all or a portion of their contracts with the Corporation. Home infusion joint ventures formed with hospitals could adversely affect our financial results. The home infusion industry is currently seeing renewed activity in the formation of equity-based infusion joint ventures formed with hospitals. This activity stems, in part, from hospitals seeking to position themselves for new paradigms in the delivery of coordinated healthcare and new methods of payment, including an emerging interdisciplinary care model that is being labeled an "accountable care organization". These organizations are encouraged by the 2010 Health Care Reform Legislation. These entities are being designed in order to save money and improve quality of care by better integrating care, with the healthcare provider possibly sharing in the financial benefits of the improved efficiency. Participation in equity-based joint ventures offers hospitals and other providers an opportunity to more efficiently transfer patients to less expensive care settings, while keeping the patient within its network. Additionally, it provides many hospitals with a mechanism to invest accumulated profits in a growing sector with attractive margins. If home infusion joint ventures continue to expand and we lose referrals as a result, our financial condition, results of operations and liquidity could be adversely affected. 13
Our operating revenue and profitability may suffer because of an increase in our generic dispensing rate. A shift in prescriptions dispensed from brand-to-generic and a decline in generic reimbursement rates from the Prescription Drug Plans ("PDPs")/Prescription Benefit Managers ("PBMs") may affect our operating revenue. When a branded drug shifts to a generic, initial pricing of the generic drug in the market will vary depending on the number of manufacturers launching their generic version of the drug. Historically a shift from brand-to-generic decreased our revenues and improved our gross margin from sales of these classes of drugs during the initial time period a brand drug has a generic alternative. However, recent experience has indicated that the third-party payers may reduce their reimbursements to the Corporation faster than previously experienced. This acceleration in the reimbursement reduction and the number of generic manufacturers have resulted in margin compression as multi-source alternatives have become available much earlier than we have historically experienced. In addition, the number of generic manufacturers entering the market impacts the overall cost and reimbursement of generic drugs. Due to the unique nature of the brand-to-generic conversion, management cannot estimate the future financial impact of the brand-to-generic conversions on its results of operations. If we fail to comply with complex and rapidly evolving laws and regulations, we could suffer penalties, be required to pay substantial damages or make significant changes to our operations. We are subject to numerous federal and state regulations. If we fail to comply with existing or future applicable laws and regulations, we could suffer civil or criminal penalties, including the loss of our licenses to operate our institutional pharmacies and our ability to participate in federal and state healthcare programs. As a consequence of the severe penalties we could face, we must devote significant operational and managerial resources to complying with these laws and regulations. Although we believe that we are substantially compliant with all existing statutes and regulations applicable to our business, different interpretations and enforcement policies of these laws and regulations could subject our current practices to allegations of impropriety or illegality, or could require us to make significant changes to our operations. In addition, we cannot predict the impact of future legislation and regulatory changes on our business or assure that we will be able to obtain or maintain the regulatory approvals required to operate our business. As a result of political, economic, and regulatory influences, the healthcare delivery industry in the United States is under intense scrutiny and subject to fundamental changes. We cannot predict which reform proposals will be adopted, when they may be adopted, or what impact they may have on us. The costs associated with complying with federal and state regulations could be significant and the failure to comply with any such legal requirements could have a material adverse effect on our financial condition, results of operations, and liquidity. Pharmaceutical products can develop unexpected safety or efficacy concerns. Unexpected safety or efficacy concerns can arise with respect to marketed products, whether or not scientifically justified, leading to product recalls, withdrawals or declining sales. If we fail to or do not promptly withdraw pharmaceutical products upon a recall by a drug manufacturer, our business and results of operations could be negatively impacted. Legal and regulatory changes reducing reimbursement rates for pharmaceuticals and/or medical treatments or services may reduce our profitability. Both our own profit margins and the profit margins of our customers may be adversely affected by laws and regulations reducing reimbursement rates and charges. The sources and amounts of our revenues are determined by a number of factors, including licensed bed capacity and occupancy rates of our customers, the number of drugs administered to patients, the mix of pharmaceuticals dispensed, whether the drugs are brand or generic, and the rates of reimbursement among payers. Changes in the number of drugs administered to patients, as well as payer mix among private pay, Medicare and Medicaid, in our customers' facilities will significantly affect our earnings and cash flow. Further modifications to the Medicare Part D program may reduce revenue and impose additional costs to the industry. The Medicare Prescription Drug Improvement and Modernization Act of 2003 or MMA included a major expansion of the Medicare program with the addition of a prescription drug benefit under the new Medicare Part D program. The continued impact of these regulations depends upon a variety of factors, including our ongoing relationships with the Part D Plans and the patient mix of our customers. Future modifications to the Medicare Part D program may reduce revenue and impose additional costs to the industry. In addition, we cannot assure you that Medicare Part D and the regulations promulgated under Medicare Part D will not have a material adverse effect on our institutional pharmacy business. Possible changes in, or our failure to satisfy our manufacturers' rebate programs could adversely affect our results of operations. There can be no assurance that pharmaceutical manufacturers will continue to offer these rebates or that they will not change the terms upon which rebates are offered. A decrease in prescription volumes dispensed or a decrease in the number of brand or generic drugs which participate in rebate programs and are used by the geriatric population could affect our ability to satisfy our manufacturers' rebate programs. The termination of such programs or our failure to satisfy the criterion for earning rebates may have an adverse effect on our cost of goods sold, financial condition, results of operations and liquidity. Changes in Medicaid reimbursement may reduce our revenue. The 2010 Health Care Reform Legislation amended DRA to change the definition of the FUL by requiring the calculation of the FUL as no less than 175% of the weighted average, based on utilization, of the most recently reported monthly AMP for pharmaceutically and therapeutically equivalent multisource drugs available through retail community pharmacies nationally. In addition, the definition of AMP changed to reflect net sales only to drug wholesalers that distribute to retail community pharmacies and to retail community pharmacies that directly purchase from drug manufacturers. Further, the 2010 Health Care Reform Legislation continues the current statutory exclusion of prompt pay discounts offered to wholesalers and adds three other exclusions to the AMP definition: i) bona fide services fees; ii) reimbursement for unsalable returned goods (recalled, expired, damaged, etc.); and iii) payments from and rebates/discounts to certain entities not conducting business as a wholesaler or retail community pharmacy. 14
On February 1, 2016, CMS released a Final Rule titled Medicaid Program; Covered Outpatient Drugs. This Final Rule details the types of sales that are to be included and excluded in determining AMP. Moreover, consistent with the 2010 Health Care Reform Legislation, the Final Rule calculates the FULs at 175% of the weighted average, determined based on the basis of utilization, of the most recently reported monthly AMP. As an exception, however, if the AMP-based FUL is lower than the National Average Drug Acquisition Cost ("NADAC"), the FULs will be set at the drug's NADAC. This Final Rule will be effective on April 1, 2016. CMS has stated that it plans to publish the draft FULs in accordance with the Final Rule for two months before finalizing the FULs. The final FULs will be published in late March 2016 and will be effective April 1, 2016 to coincide with the effective date of the Final Rule. States will have 30 days following this effective date to implement the FULs. CMS will update the FULs on a monthly basis thereafter, which will become effective on the first date of the month following their publication. Again, states will then have 30 days after the effective date of the monthly updates to implement the new FULs. The Final Rule also changed how states reimburse pharmacies. The Final Rule now requires states to pay pharmacies based on the actual acquisition cost of the drug, as opposed to the estimated acquisition cost. Moreover, the Final Rule requires states to consider the sufficiency of both the ingredient cost reimbursement and dispensing fee reimbursement when proposing changes to either of these components of reimbursement for Medicaid covered drugs. CMS will continue to post draft monthly FULs. The Corporation will continue to analyze the effect of these changes on its business, results of operations, and liquidity. Adverse results in material litigation matters or governmental inquiries could have a material adverse effect upon the Corporation's business. The Corporation may from time to time become subject in the ordinary course of business to material legal action related to, among other things, intellectual property disputes, professional liability and employee-related matters, as well as inquiries from governmental agencies and Medicare or Medicaid carriers requesting comment and information on allegations of billing irregularities and other matters that are brought to their attention through billing audits, third parties or other sources. The healthcare industry is subject to substantial federal and state government regulation and audit. Legal actions could result in substantial monetary damages as well as damage to the Corporation's reputation with customers, which could have a material adverse effect upon our financial condition, results of operations, and liquidity. If we or our customers fail to comply with Medicare and Medicaid regulations, we may be subjected to penalties or loss of eligibility to participate in these programs. The Medicare and Medicaid programs are highly regulated. These programs are also subject to frequent and substantial changes. If we or our customers' facilities fail to comply with applicable reimbursement laws and regulations, whether purposely or inadvertently, our reimbursement under these programs could be curtailed or reduced and our eligibility to continue to participate in these programs could be adversely affected. Federal or state governments may also impose other penalties on us for failure to comply with the applicable reimbursement regulations. Failure by our customers to comply with these or future laws and regulations could result in our inability to provide pharmacy services to these customers and their residents. We do not believe that we have taken any actions that could subject us to material penalties under these rules and regulations. Among these laws is the federal anti-kickback statute. This statute prohibits anyone from knowingly and willfully soliciting, receiving, offering or paying any remuneration with the intent to refer, or to arrange for the referral or order of, services or items payable under a federal healthcare program. Courts have interpreted this statute broadly. Violations of the anti-kickback statute may be punished by a criminal fine of up to $25,000 for each violation or imprisonment, civil money penalties of up to $50,000 per violation and damages of up to three times the total amount of the remuneration and/or exclusion from participation in federal healthcare programs, including Medicare and Medicaid. This law impacts the relationships that we may have with potential referral sources. We have a variety of relationships with potential referral sources, including hospitals and skilled nursing facilities with which we have contracted to provide pharmacy services. The OIG, among other regulatory agencies, is responsible for identifying and eliminating fraud, abuse or waste. The OIG carries out this responsibility through a nationwide program of audits, investigations and inspections. The OIG has promulgated safe harbor regulations that outline practices that are deemed protected from prosecution under the anti-kickback statute. While we endeavor to comply with the applicable safe harbors, certain of our current arrangements may not qualify for safe harbor protection. Failure to meet a safe harbor does not mean that the arrangement necessarily violates the anti-kickback statute, but may subject the arrangement to greater scrutiny. It cannot be assured that practices outside of a safe harbor will not be found to violate the anti-kickback statute. The anti-kickback statute and similar state laws and regulations are expansive. We do not always have the benefit of significant regulatory or judicial interpretation of these laws and regulations. In the future, different interpretations or enforcement of these laws and regulations could subject our current or past practices to allegations of impropriety or illegality, or could require us to make changes in our facilities, equipment, personnel, services, capital expenditure programs and operating expenses. A determination that we have violated these laws, or the public announcement that we are being investigated for possible violations of these laws, could have a material adverse effect on our business, financial condition, results of operations or prospects and our business reputation could suffer significantly. If we fail to comply with the anti-kickback statute or other applicable laws and regulations, we could be subjected to liabilities, including criminal penalties, civil penalties (including the loss of our licenses to operate one or more facilities), and exclusion of one or more facilities from participation in the Medicare, Medicaid and other federal and state healthcare programs. In addition, we are unable to predict whether other legislation or regulations at the federal or state level will be adopted, what form such legislation or regulations may take or their impact. Continuing government and private efforts to contain healthcare costs may reduce our future revenue. We could be adversely affected by the continuing efforts of government and private payers to contain healthcare costs. To reduce healthcare costs, payers seek to lower reimbursement rates, limit the scope of covered services and negotiate reduced or capped pricing arrangements. While many of the proposed policy changes would require congressional approval to implement, we cannot assure you that reimbursement payments under governmental and private third party payer programs will remain at levels comparable to present levels or will be sufficient to cover the costs allocable to patients eligible for reimbursement under these programs. Any changes that lower reimbursement rates under Medicare, Medicaid or private pay programs could result in a substantial reduction in our net operating revenues. Our operating margins may continue to be under pressure because of deterioration in reimbursement, changes in payer mix and growth in operating expenses in excess of increases, if any, in payments by third party payers. 15
Healthcare reform could adversely affect the liquidity of our customers which would have an adverse effect on their ability to make timely payments to us for our products and services. Healthcare reform and legislation may have an adverse effect on our business through decreasing funds available to our customers. Limitations or restrictions on Medicare and Medicaid payments to our customers could adversely impact the liquidity of our customers, resulting in their inability to pay us, or to timely pay us, for our products and services. This inability could have a material adverse effect on our financial condition, results of operations, and liquidity. The changing U.S. healthcare industry and increasing enforcement environment may negatively impact our business. Our products and services are part of the structure of the healthcare financing and reimbursement system currently existing in the United States. In recent years, the healthcare industry has undergone significant changes in an effort to reduce costs and government spending. These changes include an increased reliance on managed care, cuts in Medicare funding affecting our healthcare provider customer base and consolidation of competitors, suppliers and customers. We expect the healthcare industry to continue to change significantly in the future. Some of these potential changes, such as a reduction in governmental support of healthcare services or adverse changes in legislation or regulations governing prescription drug pricing, healthcare services or mandated benefits, may cause healthcare providers to reduce the amount of our products and services they purchase or the price they are willing to pay for our products and services. If we are unable to adjust to changes in the healthcare environment, it could have a material adverse effect on our financial condition, results of operations and liquidity. Further, both federal and state government agencies have increased their focus on and coordination of civil and criminal enforcement efforts in the healthcare area. The OIG and the U.S. Department of Justice have, from time to time, established national enforcement initiatives, targeting all providers of a particular type, that focus on specific billing practices or other suspected areas of abuse. In addition, under the federal False Claims Act, private parties have the right to bring "qui tam" whistleblower lawsuits against companies that submit false claims for payments to the government. A number of states have adopted similar state whistleblower and false claims provisions. We do not believe that we have taken any actions that could subject us to material penalties under these provisions. Further consolidation of managed care organizations and other third-party payers may adversely affect our profits. Managed care organizations and other third-party payers have continued to consolidate in order to enhance their ability to influence the delivery of healthcare services. Consequently, the healthcare needs of a large percentage of the U.S. population are increasingly served by a small number of managed care organizations. These organizations generally enter into service agreements with a limited number of providers for needed services. In addition, private payers, including managed care payers, increasingly are demanding discounted fee structures. To the extent that these organizations terminate us as a preferred provider, engage our competitors as a preferred or exclusive provider or demand discounted fee structures, our liquidity and results of operations could be materially and adversely affected. If we or our customers fail to comply with licensure requirements, laws and regulations in respect of healthcare fraud or other applicable laws and regulations, we could suffer penalties or be required to make significant changes to our operations. Our pharmacies must be licensed by the state board of pharmacy in the state in which they operate. Many states also regulate out-of-state pharmacies that are delivering prescription products to patients or residents in their states. The failure to obtain or renew any required regulatory approvals or licenses could adversely impact the operation of our business. In addition, the healthcare facilities we service are also subject to extensive federal, state and local regulations and are required to be licensed in the states in which they are located. The failure by these healthcare facilities to comply with these or future regulations or to obtain or renew any required licenses could result in our inability to provide pharmacy services to these facilities and their residents and could have a material adverse effect on our financial condition, results of operations and liquidity. While we believe that we are in substantial compliance with all applicable laws, many of the regulations applicable to us, including those relating to marketing incentives offered by pharmaceutical suppliers, and rebates paid by pharmaceutical manufacturers are vague or indefinite and have not been interpreted by the courts. They may be interpreted or applied by a prosecutorial, regulatory or judicial authority in a manner that could require us to make changes in our operations. These changes may be material and may require the expenditure of material funds to implement. We believe that the regulatory environment surrounding most segments of the healthcare industry remains intense. Federal and state governments continue to impose intensive enforcement policies resulting in a significant number of inspections, citations of regulatory deficiencies and other regulatory sanctions including demands for refund of overpayments, terminations from the Medicare and Medicaid programs, bans on Medicare and Medicaid payments and fines. If we or our customers fail to comply with the extensive applicable laws and regulations, we could become ineligible to receive government program reimbursement, suffer civil or criminal penalties or be required to make significant changes to our operations. In addition, we could be forced to expend considerable resources responding to an investigation or other enforcement action under these laws or regulations regardless of whether we have actually been involved in any violations or wrong-doing. Federal and state medical privacy regulations may increase the costs of operations and expose us to civil and criminal sanctions. We must comply with extensive federal and state requirements regarding the transmission and retention of health information. The Health Insurance Portability and Accountability Act of 1996 and its implementing regulations, referred to as HIPAA, was enacted to ensure that employees can retain and at times transfer their health insurance when they change jobs, to enhance the privacy and security of personal health information and to simplify healthcare administrative processes. HIPAA requires the adoption of standards for the exchange of electronic health information. The HITECH, part of the American Recovery and Reinvestment Act of 2009, changed several aspects of HIPAA including, without limitation, the following: (i) applies HIPAA security provisions and penalties directly to business associates of covered entities; (ii) requires certain notifications in the event of a security breach involving PHI; (iii) restricts certain unauthorized disclosures; (iv) changes the treatment of certain marketing activities; and (v) strengthens enforcement activities. In addition, the Secretary of Health and Human Services issued an interim final rule on August 24, 2009 that requires notifications for certain unpermitted disclosures of PHI. The final rule was issued on January 17, 2013. Failure to comply with either HIPAA or HITECH could result in fines and penalties that could have a material adverse effect on our results of operations, financial condition, and liquidity. 16
If we fail to comply with the terms of our Corporate Integrity Agreement with the OIG or Memorandum of Agreement with the DEA, it could subject us to substantial monetary penalties or suspension or termination from participation in federal healthcare programs. In May 2015, the Corporation entered into a five-year CIA with the OIG and a MOA with the DEA concurrent with the execution of settlement agreements with the OIG and the DEA settling alleged CSA violations and associated False Claims Act allegations. The CIA requires the Corporation, among other things to: (i) create procedures designed to ensure it complies with the CSA and related regulations; (ii) retain an independent review organization to review the Corporation's compliance with the terms of the CIA and report to the OIG regarding that compliance; and (iii) provide training for certain Corporation employees and the Board of Directors as to the Corporation's requirements under the CSA. If the Corporation fails to comply with the terms of the CIA, it may be required to pay certain monetary penalties. The imposition of monetary penalties would adversely affect our profitability. Furthermore, if the Corporation commits a material breach of the CIA, the OIG may exclude the Corporation from participating in federal healthcare programs. Any such exclusion would result in the revocation or termination of contracts and/or licenses and potentially have a material adverse effect on our financial condition, results of operations and business prospects. The MOA requires the Corporation to comply with all requirements of the CSA, specifically relating to the dispensing of scheduled prescription drugs. If the Corporation fails to comply with the terms of the MOA, the DEA may suspend a Corporation's pharmacy DEA Certificate of Registration and begin an administrative hearing process pursuant to 21 U.S.C. Section 824. Any such suspension would prohibit the Corporation's pharmacy from dispensing scheduled prescription drugs and would lead to the revocation or termination of contracts and/or licenses and potentially have a materially adverse effect on our financial condition, results of operation and business prospects. Acquisitions, investments and strategic alliances that we have made or may make in the future may use significant resources, may be unsuccessful and could expose us to unforeseen liabilities. We have made and anticipate that we may continue to make acquisitions of, investments in and strategic alliances with complementary businesses to enable us to capitalize on our position in the geographic markets in which we operate and to expand our businesses in new geographic markets. At any particular time, we may be in various stages of assessment, discussion and negotiation with regard to one or more potential acquisitions, investments or strategic alliances, not all of which, if any, will be consummated. Our acquisition program and strategy has and may lead us to contemplate acquisitions of companies in bankruptcy or financial distress, all of which entail additional risks and uncertainties. Such risks and uncertainties include, without limitation, that, before assets may be acquired, customers may leave in search of more stable providers and vendors may terminate key relationships. Also, assets are generally acquired on an "as is" basis, with no recourse to the seller if the assets are not as valuable as may be represented. Finally, while bankrupt companies may be acquired for comparatively little money, the cost of continuing the operations may significantly exceed expectations. Our growth plans rely, in part, on the successful completion of future acquisitions. If we are unsuccessful, our business would suffer. We intend to make public disclosure of pending and completed acquisitions when appropriate or required by applicable securities laws and regulations. Acquisitions may involve significant cash expenditures, debt incurrence, additional operating losses, amortization of certain intangible assets of acquired companies, and expenses that could have a material adverse effect on our financial condition, results of operations and liquidity. Acquisitions involve numerous risks and uncertainties, including, without limitation: • • • • • •
difficulties integrating acquired operations, personnel and information systems, or in realizing projected efficiencies and cost savings; diversion of management's time from existing operations; potential loss of key employees or customers of acquired companies; inaccurate assessment of assets and liabilities and exposure to undisclosed or unforeseen liabilities of acquired companies, including liabilities for failure to comply with healthcare laws; increases in our indebtedness and a limitation on our ability to access additional capital when needed; and failure to operate acquired facilities profitably or to achieve improvements in their financial performance.
Risks generally associated with our sophisticated information systems may adversely affect our results of operations. We rely on sophisticated information systems in our business to obtain, rapidly process, analyze, and manage data to facilitate the dispensing of prescription and non-prescription pharmaceuticals in accordance with physician orders and deliver those medications to patients and long-term care residents on a timely basis; to manage the accurate billing and collections for thousands of customers; and to process payments to suppliers. Our business and results of operations may be materially adversely affected if these systems are interrupted for any reason, including cyber security threats, or damaged or if they fail for an extended period of time. Significant disruptions to our infrastructure or any of our facilities due to failure of technology or some other catastrophic event could adversely impact our business. Cybersecurity attacks or other data security incidents could disrupt our operations and expose us to regulatory fines or penalties, liability or reputational damage. In the ordinary course of our business, we process, store and transmit data, which may include sensitive personal information as well as proprietary or confidential information relating to our business or third parties. Although we have information technology security systems, a successful cybersecurity attack or other data security incident could result in the misappropriation of confidential or personal information, create system interruptions, or deploy malicious software that attacks our systems. Such an attack or incident could result in business interruptions from the disruption of our information technology systems or negative publicity resulting in reputational damage with our customers, shareholders and other stakeholders. In addition, the unauthorized dissemination of sensitive personal information or proprietary or confidential information could expose us or other third-parties to regulatory fines or penalties, litigation and potential liability, or otherwise harm our business. We purchase a significant portion of our pharmaceutical products from one supplier and receive a significant amount of rebates from the same supplier. Effective April 1, 2015, we entered into a new Prime Vendor Agreement to purchase our pharmaceutical products from Cardinal Health. If Cardinal Health fails to deliver products in accordance with the agreement, there can be no assurance that our operations would not be disrupted or that we could obtain the products at similar cost or at all. In this event, failure to satisfy our customers' requirements would result in defaults under these customer contracts subjecting us to damages and the potential termination of those contracts. Such events could have a material adverse effect on our financial condition, results of operations and liquidity. The Cardinal Health PVA requires the Corporation to purchase certain levels of brand and non-injectable generic drugs from Cardinal Health. The Cardinal Health PVA does provide flexibility for the Corporation to contract with other suppliers. Under the agreement, the Corporation is entitled to certain rebates based on drug purchases.
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A loss in rebates and other pricing terms under the Previous PVA may adversely impact our financial results. The Corporation previously had a Prime Vendor Agreement (the "Previous PVA") with AmerisourceBergen Drug Corporation ("ABDC"). As a result of ABDC's failure to comply with certain pricing and rebate provisions of the Previous PVA, 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. All these receivables totaled $53.0 million and were included in prepaids and other assets in the accompanying consolidated balance sheet as of December 31, 2014. During the period of January 1, 2015 through December 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 and which is included in other long-term assets in the accompanying consolidated balance sheet as of December 31, 2015; these amounts are currently in dispute and are the subject of litigation between the parties. 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. Prescription volumes may decline, and our net revenues and profitability may be negatively impacted, if products are withdrawn from the market or if increased safety risk profiles of specific drugs result in utilization decreases. We dispense significant volumes of drugs from our pharmacies. These volumes are the basis for our net revenues and profitability. When increased safety risk profiles of specific drugs or classes of drugs result in utilization decreases, physicians may cease writing or reduce the numbers of prescriptions written for these drugs. Additionally, negative press regarding drugs with higher safety risk profiles may result in reduced consumer demand for such drugs. On occasion, products are withdrawn by their manufacturers. In cases where there are no acceptable prescription drug equivalents or alternatives for these prescription drugs, our volumes, net revenues, profitability and cash flows may decline. We could be required to record a material non-cash charge to income if our recorded goodwill or intangible assets are impaired, or if we shorten intangible asset useful lives. We have $371.0 million of goodwill and $190.2 million of recorded intangible assets on our consolidated balance sheet as of December 31, 2015. Our intangible assets primarily represent the value of client relationships that were recorded from past acquisitions. Under current accounting rules, intangible assets are amortized over their useful lives. These assets may become impaired with the loss of significant clients. If the carrying amount of the assets exceeds the undiscounted pre-tax expected future cash flows from the lowest appropriate asset grouping, we would be required to record a non-cash impairment charge to our consolidated income statements in the amount the carrying value of these assets exceeds its fair value. In addition, while the intangible assets may not be impaired, the useful lives are subject to continual assessment, taking into account historical and expected losses of relationships that were in the base at time of acquisition. This assessment may result in a reduction of the remaining weighted average useful life of these assets, resulting in potentially significant increases to non-cash amortization expense that is charged to our consolidated income statements. A goodwill or intangible asset impairment charge, or a reduction of useful lives, could have a material effect on our results of operations. We are highly dependent on our senior management team and our pharmacy professionals. We are highly dependent upon the members of our senior management and our pharmacists and other pharmacy professionals. Our business is managed by a small number of senior management personnel. If we were unable to retain these persons, we might be materially adversely affected due to the limited pool of senior management personnel with significant experience in our industry. Accordingly, we believe we could experience significant difficulty in replacing key management personnel. We expect that any employment contracts we enter into with our key management personnel will be subject to termination without cause by either party. Moreover, although the majority of the members of our senior management team have significant experience in the industry, they will need time to fully assess and understand our business and operations. We can offer no assurance how long these members of senior management will choose to remain with us. In addition, our continued success depends on our ability to attract and retain pharmacists and other pharmacy professionals. Competition for qualified pharmacists and other pharmacy professionals is intense. The loss of pharmacy personnel or the inability to attract or retain sufficient numbers of qualified pharmacy professionals could adversely affect our business. Although we generally have been able to meet our staffing requirements for pharmacists and other pharmacy professionals, our inability to do so in the future could have a material adverse effect on our financial condition, results of operations and liquidity. Our revenues and volume trends may be adversely affected by certain factors relevant to the markets in which we have pharmacies, including weather conditions and other natural disasters, some of which may not be covered by insurance. Our revenues and volume trends will be predicated on many factors, including physicians' pharmaceutical decisions on patients, payer programs, seasonal and severe weather conditions including the effects of extreme low temperatures, hurricanes and tornadoes, earthquakes, current local economic and demographic changes, some of which may not be covered by insurance. Any of these factors could have a material adverse effect on our revenues and volume trends, and many of these factors will not be within the control of our management. These factors may also have an effect on our customers and their ability to continue to operate. For further discussion, see Note 9. There are inherent uncertainties involved in estimates, judgments, and assumptions used in the determination of our litigation-related accruals and the preparation of financial statements in accordance with generally accepted accounting principles in the United States (U.S. GAAP). Any changes in estimates, judgments, and assumptions could have a material adverse effect on the Corporation's financial position, results of operations, or cash flows. Our financial statements filed with the SEC are prepared in accordance with U.S. GAAP, and the preparation of such financial statements includes making estimates, judgments, and assumptions that affect reported amounts of assets, liabilities, and related reserves, revenues, expenses, and income. We evaluate our exposure to legal proceedings and establish reserves for the estimated liabilities in accordance with U.S. GAAP. Assessing and predicting the outcome of these matters involves substantial uncertainties. Unexpected outcomes in these legal proceedings, or changes in management's evaluations or predictions and accompanying changes in established reserves, could have a material adverse impact on our financial results. Estimates are inherently subject to change in the future, and such changes could result in corresponding changes to the amounts of assets, liabilities, income, or expenses and likewise could have an adverse effect on our financial position, results of operations, or cash flows. 18
Risk Factors Relating to Ownership of Our Common Stock and Our Senior Secured Credit Facility Certain provisions of our certificate of incorporation and bylaws and provisions of Delaware law could delay or prevent a change of control that stockholders favor. Provisions of our certificate of incorporation and bylaws may discourage, delay or prevent a merger or other change of control that stockholders may consider favorable or may impede the ability of the holders of our common stock to change our management and Board of Directors. The provisions of our certificate of incorporation and bylaws, among other things: • • • • •
prohibit stockholder action except at an annual or special meeting. Specifically, this means our stockholders are unable to act by written consent; regulate how stockholders may present proposals or nominate directors for election at annual meetings of stockholders. Advance notice of such proposals or nominations is required; regulate how special meetings of stockholders may be called. Our stockholders do not have the right to call special meetings; authorize our board of directors to issue preferred stock in one or more series, without stockholder approval. Under this authority, our Board of Directors adopted the Rights Agreement which could ensure continuity of management by rendering it more difficult for a potential acquirer to obtain control of us; and require an affirmative vote of the holders of three-quarters or more of the combined voting power of our common stock entitled to vote in the election of our directors in order for the stockholders to amend our bylaws.
In addition, because we have not chosen to be exempt from Section 203 of the Delaware General Corporation Law ("DGCL"), this provision could also delay or prevent a change of control that some stockholders may view as favorable. Section 203 provides that unless board and/or stockholder approval is obtained pursuant to the requirements of the statute, persons that acquire, or are affiliated with a person that acquires, more than 15% of the outstanding voting stock of a Delaware corporation shall not engage in any business combination with that corporation, including by merger, consolidation or acquisitions of additional shares, for a three-year period following the date on which that person or its affiliate becomes the holder of more than 15% of the corporation's outstanding voting stock. The market price and trading volume of our common stock may be volatile. The market price of our common stock could fluctuate significantly for many reasons, including, without limitation the following: • • • • •
as a result of the risk factors listed in this document; actual or anticipated fluctuations in our results of operations; for reasons unrelated to our specific performance, such as reports by industry analysts, investor perceptions, or negative announcements by our customers or competitors regarding their own performance; regulatory changes that could impact our business or that of our customers; and general economic and industry conditions.
In addition, when the market price of a company's common stock drops significantly, stockholders often institute securities class action lawsuits against the company. A lawsuit against us could cause us to incur substantial costs and could divert the time and attention of our management and other resources. Acquisitions, investments and strategic alliances we may make in the future may need to be financed by borrowings under the Credit Agreement for which funds may not be made available by certain participants. We have made and anticipate that we may continue to make acquisitions of, investments in and strategic alliances with complementary businesses to enable us to capitalize on our position in the geographic markets in which we operate and to expand our business in new geographic markets. Our growth plans rely, in part, on the successful completion of future acquisitions. At any particular time, we may need to finance such acquisitions and strategic alliances with borrowings under the Credit Agreement. The financial markets are very volatile and certain participants in our Credit Agreement may not be able to participate in funding their commitments under the revolving line of credit. If we are unsuccessful in obtaining the financing, our business would be adversely impacted. We are exposed to interest rate changes. We are exposed to market risk related to changes in interest rates. As of December 31, 2015, we had outstanding debt of $426.4 million outstanding under our Credit Agreement and revolver, all of which was subject to variable rates of interest. See Item 7A, "Quantitative and Qualitative Disclosures about Market Risk." We have indebtedness, which restricts our ability to pay cash dividends and has a negative impact on our financing options and liquidity. We have $426.4 million in indebtedness outstanding as of December 31, 2015 under our Credit Agreement and revolver. We also have $0.9 million in capital lease obligations at December 31, 2015. 19
On September 17, 2014, the Corporation entered into a $535.0 million Credit Agreement by and among the Corporation, the lenders named therein, 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 (the "Credit Agreement"). The Credit Agreement replaced the $450.0 million five-year credit agreement dated as of May 2, 2011, among the Corporation, Citibank, N.A., as Administrative Agent, and certain lenders. The Credit Agreement consists of a $225.0 million term loan facility and a $310.0 million revolving credit facility. The terms and conditions of the Credit Agreement are customary to facilities of this nature. Unless terminated earlier, the Credit Agreement will mature on September 17, 2019, and the principal amount outstanding thereunder, together with all accrued unpaid interest and other amounts owed thereunder, if any, will be payable in full on such date. The Credit Agreement also contains financial covenants that require us to satisfy certain financial tests and maintain certain financial ratios. The Credit Agreement limits our ability to declare and pay dividends or other distributions on our shares of common stock. If our lenders permit us to declare dividends, the dividend amounts, if any, will be determined by our Board of Directors, which will consider a number of factors, including our financial condition, capital requirements, funds generated from operations, future business prospects, applicable contractual restrictions and any other factors our Board of Directors may deem relevant. The amount of this outstanding indebtedness could limit our ability to pay cash dividends and to obtain additional financing in the future for working capital, capital expenditure and acquisition purposes. A significant portion of our cash flows will be dedicated to debt service and will be unavailable for investment, capital expenditures or other operating expenses. As a result of these and other factors, we cannot assure you that our business will generate sufficient cash flows from operations or that future borrowings will be available to us in amounts sufficient to enable us to pay our indebtedness or to fund our other liquidity needs. If we do not generate or are unable to borrow sufficient amounts of cash on satisfactory terms to meet these needs, we may need to seek to refinance all or a portion of our indebtedness on or before maturity, sell assets, curtail discretionary capital expenditures or seek additional capital. There can be no assurance that additional capital will be available to us on acceptable terms, or at all, which could adversely impact our business, results of operations, liquidity, capital resources, and financial condition. We anticipate that future earnings will be used principally to support operations and finance the growth of our business. Thus, we do not intend to pay dividends or other cash distributions on our common stock in the foreseeable future. See Part II, Item 5 "Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities." See Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources." Item 1B.
Unresolved Staff Comments
We received a comment letter from the Securities and Exchange Commission ("SEC") Division of Corporate Finance, dated November 24, 2015 with respect to our Annual Report on Form 10-K for the year ended December 31, 2014 and our Quarterly Report on Form 10-Q for the quarter ended September 30, 2015. We submitted a response to that initial comment letter and have received follow-up comments and submitted responses to the follow-up comments as well. As of the date of this Report, we believe that the only comments that remain open relate to our accounting for the $71.5 million receivable from ABDC as of September 30, 2015 and the withholding of approximately $48.8 million of normal recurring payments due to ABDC. We will continue to cooperate with the SEC to resolve these remaining comments. Although we do not currently believe it to be necessary, it is possible that the ultimate resolution of these remaining comments could result in an adjustment to our accounting treatment of such amounts, which may affect the presentation of our financial statements. 20
Item 2.
Properties
We have facilities including offices and key operating facilities in various locations throughout the United States. The Corporation's corporate headquarters are located in Louisville, Kentucky. In addition to the pharmacies listed below, the Corporation also has multiple facilities throughout the nation with several overhead and administrative functions. As of December 31, 2015, all facilities were leased. We consider all of these facilities to be suitable and adequate. The following table presents certain information with respect to operating leases of our pharmacies identified by the Corporation as properties as of December 31, 2015: # of Facilities
Property Alabama Arizona Arkansas California Colorado Connecticut Delaware Florida Georgia Hawaii Idaho Illinois Indiana Iowa Kansas Kentucky Louisiana Maine Maryland Massachusetts Michigan Minnesota Item 3.
Square Footage 2 4 2 10 4 1 1 6 2 5 1 1 1 1 2 3 1 1 1 2 3 1
Property
20,330 28,536 8,850 88,427 32,054 12,600 5,739 61,101 33,202 15,506 4,031 15,495 20,386 6,250 10,494 29,924 4,914 10,200 8,584 33,722 56,720 6,727
Mississippi Missouri Montana Nebraska Nevada New Hampshire New Jersey New Mexico New York North Carolina Ohio Oklahoma Pennsylvania Rhode Island South Carolina South Dakota Tennessee Texas Utah Virginia Washington West Virginia Wisconsin
# of Facilities
Square Footage 1 1 1 1 2 1 2 1 5 3 2 2 8 1 2 2 5 13 2 2 2 1 1
11,600 4,090 2,440 5,120 9,373 7,500 14,310 4,798 91,331 21,250 28,050 12,786 52,545 9,415 20,350 11,050 47,919 93,189 15,002 15,807 12,973 8,900 3,750
Legal Proceedings
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 alleging that the Corporation violated the Federal False Claims Act ("FCA") and Federal Anti-Kickback Statute through its agreements to provide prescription drugs to nursing homes under certain Medicare and Medicaid programs. 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 December 22, 2015, Silver and the Corporation filed a joint motion with the court for an order dismissing with prejudice all successor liability claims against the Corporation for or regarding the conduct of Chem Rx Corporation. The court has not yet ruled on the motion or entered the order of dismissal. The Corporation intends to vigorously defend itself against these allegations. On November 20, 2013, a complaint filed 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 against the Corporation alleging that the Corporation dispensed controlled and non-controlled substances in violation of the CSA 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 plans to file a petition with the U.S. Supreme Court for a writ of certiorari asking the Supreme Court to review the First Circuit's decision. The Corporation otherwise intends to continue to defend the case vigorously. On October 29, 2013, a complaint was filed in the United States District Court for the Southern District of Florida by Pines Nursing Homes (77), Inc. as a putative class action against the Corporation. The complaint alleged that the Corporation sent unsolicited advertisements promoting the Corporation's goods or services by facsimile to individuals or entities, and that such communications did not include an opt-out clause, all in violation of the federal Telephone Consumer Protection Act ("TCPA"). The Complaint did not specify the amount of damages sought, but the TCPA provides a statutory remedy of $500 per facsimile communication sent in violation of the statute, which may be trebled in the event of a willful violation. On August 18, 2014, the Corporation entered into a Settlement Agreement with the putative class and class counsel resolving all claims raised in the complaint. The parties moved on September 8, 2014 for, among other things, certification of the putative class for the purposes of effectuating the settlement and preliminary approval of the parties' settlement. On June 26, 2015, the Court granted preliminary approval of the settlement and the Court approved the settlement on November 12, 2015. The matter is concluded. 21
On January 31, 2014, a relator, Frank Kurnik, on behalf of the U.S. Government and various state governments served its complaint filed in the United States District Court for the District of South Carolina alleging that the Corporation solicited and received remuneration in violation of the Federal AntiKickback Statute from drug manufacturer Amgen in exchange for preferring and promoting Amgen's drug Aranesp over a competing drug called Procrit. The Complaint was served on the Corporation on January 31, 2014 and subsequently amended on April 24, 2014. The U.S. Government has declined to intervene in the case. The Corporation's motion to dismiss the case was denied by the Court on July 24, 2014. On January 13, 2015, the Corporation again moved to dismiss the complaint and on March 23, 2015, the second motion was denied. On April 2, 2015, the Corporation moved the court to reconsider its denial of the second motion to dismiss and that motion was denied. On December 2, 2015, the Corporation and the Department of Justice settled this matter for $2.5 million plus the relator's attorney fees of approximately $2.0 million which was previously accrued for in the consolidated balance sheets of the Corporation. The U.S. Department of Justice, through the U.S. Attorney's Office for the Western District of Virginia, investigated whether the Corporation's activities in connection with the agreements it had with the manufacturer of the pharmaceutical Depakote violated the False Claims Act or the Anti-Kickback Statute. The Corporation cooperated with this investigation and believes it has complied with applicable laws and regulations with respect to this matter. On May 29, 2014, the United States District Court for the Western District of Virginia entered an order unsealing two previously partially sealed qui tam complaints, entitled United States, et al., ex rel. Spetter v. Abbott Laboratories. Inc., Omnicare, Inc., and PharMerica Corp., No. l:07-cv-00006 and United States, et al., ex rel. McCoyd v. Abbott Laboratories, Omnicare, Inc., PharMerica Corp., and Miles White, No. l:07-cv-0008. The Corporation entered into a settlement agreement on October 6, 2015 with the Government including the Department of Justice, with approvals from the National Association of Medicaid Fraud Control and the Department of Health and Human Services Office of Inspector General. In the settlement, the Corporation agreed to pay $9.2 million to resolve the matter which was previously accrued for in the consolidated balance sheets of the Corporation. On September 10, 2014, the Corporation filed a Complaint in Jefferson Circuit Court in Louisville, Kentucky against ABDC for failure of ABDC to comply with certain pricing and rebate provisions of the Previous PVA. The Corporation subsequently filed a First Amended Verified Complaint on September 26, 2014 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 accompanying consolidated balance sheet as of December 31, 2014. During the period of January 1, 2015 through December 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. 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 a 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 $48.8 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. All receivables, whether previously disputed or not, due and owing from ABDC at December 31, 2015 and the related amounts allegedly payable to ABDC of $48.8 million, were offset resulting in a net receivable at December 31, 2015 of $23.5 million. This net receivable is included in other assets in the accompanying consolidated balance sheets as of December 31, 2015. 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, likely longer than 12 months. The Corporation cannot provide any assurances about the outcome of the litigation. Item 4.
Mine Safety Disclosures
Not applicable. 22
PART II Item 5.
Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information Our only class of common equity is our $0.01 par value common stock, which trades on the NYSE under the symbol "PMC". The following table sets forth the high and low prices per share during the period and the closing price as of the last day of each period of our common stock as reported by the NYSE for the fiscal periods indicated. High
Low
Close
Fiscal 2014 First Quarter Second Quarter Third Quarter Fourth Quarter
$ $ $ $
28.35 30.48 29.73 30.00
$ $ $ $
20.01 25.56 24.12 19.42
$ $ $ $
27.98 28.59 24.43 20.71
Fiscal 2015 First Quarter Second Quarter Third Quarter Fourth Quarter
$ $ $ $
28.32 33.87 28.71 35.47
$ $ $ $
27.98 33.24 27.57 34.46
$ $ $ $
28.19 33.30 28.47 35.00
Stockholders As of February 19, 2016, we had approximately 2400 stockholders of record of the Corporation's common stock. Because many of our shares of common stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by these record holders. Cash Dividends The Corporation has never paid a cash dividend on its common stock and does not expect to pay cash dividends on its common stock in the foreseeable future. Our Credit Agreement also limits our ability to declare and pay dividends or other distributions on our shares of common stock. Management believes the stockholders are better served if all of the Corporation's earnings are retained for expansion of the business. Securities authorized for issuance under equity compensation plans Effective April 29, 2015, the Corporation adopted the PharMerica Corporation 2015 Omnibus Incentive Plan (the "Omnibus Plan") under which the Corporation is authorized to grant equity-based and other awards to its employees, officers, directors, and consultants. The Omnibus Plan replaced the Amended and Restated PharMerica Corporation 2007 Omnibus Incentive Plan (the "Prior Plan"). The Corporation has reserved 2,000,000 shares of its common stock for awards to be granted under the Omnibus Plan, subject to certain increases and reductions for grants under the Prior Plan. The following shares shall be added back to the number of shares available for grant under the Omnibus Plan: (i) shares covered by an award that expire or are forfeited, canceled, surrendered, or otherwise terminated without the issuance of such shares; (ii) shares covered by an award that are settled only in cash; and (iii) shares withheld by the Corporation or any subsidiary to satisfy a tax withholding obligation with respect to full value awards granted pursuant to the Omnibus Plan. However, shares surrendered for the payment of the exercise price under stock options (or options outstanding under the Prior Plan), shares repurchased by us with option proceeds (or option proceeds under the Prior Plan), and shares withheld for taxes upon exercise or vesting of an award other than a full value award (or an award other than a full value award under the Prior Plan), will not again be available for issuance under the Omnibus Plan. In addition, if a stock appreciation right ("SAR") (or SAR under the Prior Plan) is exercised and settled in shares, all of the shares underlying the SAR will be counted against the Omnibus Plan limit regardless of the number of shares used to settle the SAR. The Omnibus Plan provides for certain limits on issuances of certain types of awards and awards to certain recipients. The Omnibus Plan prohibits share recycling for stock options and stock appreciation rights, meaning that shares used to pay the exercise price or tax withholding for those awards are not added back to the share reserve. The Corporation's Compensation Committee administers the Omnibus Plan and has the authority to determine the recipient of the awards, the types of awards, the number of shares covered, and the terms and conditions of the awards. The Omnibus Plan allows for grants of incentive stock options, nonqualified stock options, stock appreciation rights, restricted share and restricted stock units, deferred shares, performance awards, including cash bonus awards, and other stock-based awards. The Corporation's Compensation Committee may condition the vesting, exercise or settlement of any award upon the achievement of one or more performance objectives. Stock options granted to officers and employees under the Omnibus Plan generally vest in four equal annual installments and have a term of seven years. The restricted stock units granted to officers generally vest in three equal annual installments. The restricted stock units granted to members of the Board of Directors vest in one annual installment. The performance share units granted under the Omnibus Plan vest based upon the achievement of a target amount of the Corporation's adjusted earnings before interest, income taxes, depreciation and amortization, which reinforces the importance of achieving the Corporation's profitability objectives. The performance is generally measured over a three-year period. 23
The following table sets forth equity compensation plan information as of December 31, 2015: Number of securities remaining available for Number of future securities to Weightedissuance be average under equity issued upon exercise compensation exercise of price of plans outstanding outstanding (excluding options, options, securities warrants and warrants and reflected in rights rights column (a)) (a) (b) (c) 1,539,607 (1) $ 14.34 (2) 1,817,038
Plan Category Equity compensation plans approved by stockholders (1) Includes the following: • • • •
638,741 shares of common stock to be issued upon exercise of outstanding stock options granted under the Omnibus Plan; 456,784 shares of common stock to be issued upon vesting of performance share units under the Omnibus Plan; 7,831 shares of common stock to be issued upon vesting of restricted stock awards under the Omnibus Plan; and 436,251 shares of common stock to be issued upon vesting of restricted stock units under the Omnibus Plan.
(2) The weighted average exercise price in column (b) does not take into account the 900,866 shares of common stock potentially to be issued under restricted stock awards, performance share units and restricted stock units. See Note 10 to the Consolidated Financial Statements included in this Report for information regarding the material features of the Omnibus Plan. Stock Performance Graph The following graph compares the cumulative total return on a $100 investment in each of the Common Stock of the Corporation, the Standard & Poor's 500 Stock Index and the Standard & Poor's Healthcare Index for the period from December 31, 2010 to December 31, 2015. This graph assumes an investment in the Corporation's common stock and the indices of $100 on December 31, 2010 and that all dividends were reinvested:
24
PharMerica Corporation 100.00 99.91 111.44 124.63 132.58 108.56 95.37 110.57 124.37 122.27 121.05 115.90 187.77 244.37 249.69 213.36 180.87 246.20 290.83 248.65 305.68
December 31, 2010 March 31, 2011 June 30, 2011 September 30, 2011 December 31, 2011 March 31, 2012 June 30, 2012 September 30, 2012 December 31, 2012 March 31, 2013 June 30, 2013 September 30, 2013 December 31, 2013 March 31, 2014 June 30, 2014 September 30, 2014 December 31, 2014 March 31, 2015 June 30, 2015 September 30, 2015 December 31, 2015
S&P 500 100.00 105.42 105.01 89.96 100.00 111.99 108.31 114.55 113.40 124.77 127.72 133.71 146.97 148.88 155.87 156.82 163.71 164.43 164.05 152.67 162.52
S&P Healthcare 100.00 104.99 112.65 100.81 110.18 119.46 120.83 127.55 126.91 146.23 151.10 160.65 176.08 185.59 193.14 202.85 217.11 230.48 236.08 210.01 234.23
Recent Sales of Unregistered Securities None. Purchases of Equity Securities by the Issuer and Affiliated Purchasers On August 24, 2010, the Corporation announced a stock repurchase program under which the Corporation is authorized to repurchase up to $25.0 million of the Corporation's common stock, of which $10.5 million was used to purchase the Corporation's common stock. On July 2, 2012, the Board of Directors authorized an increase to the existing stock repurchase program that allows the Corporation to again purchase back 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 December 31, 2015. The stock repurchase program does not have an expiration date and may be limited, terminated or extended at any time without prior notice. The Corporation did not repurchase shares under this program for the three months ended December 31, 2015. Additionally, the Corporation may redeem shares from employees upon vesting of the Corporation's stock awards for minimum statutory tax withholding purposes and exercise cost of stock options. The Corporation redeemed 2,607 shares of vested awards during the three months ended December 31, 2015. The following table summarizes our share repurchase activity by month for the three months ended December 31, 2015:
Period October 1, 2015 - October 31, 2015 November 1, 2015 - November 30, 2015 December 1, 2015 - December 31, 2015
Total Number of Shares Purchased
Weighted Average Price Paid per Share
2,607 -
(1) $ (1) (1)
34.35 -
Total Number of Shares Purchased as Part of a Publicly Announced Plans or Programs (2)
Approximate Dollar Value of Shares that may yet be Purchased under the Plans or Programs (in millions) - $ 19.7 19.7 19.7
(1)
The Corporation repurchased 2,607 shares of common stock in connection with the vesting of certain stock awards to cover minimum statutory withholding taxes.
(2)
On August 24, 2010, the Board of Directors announced a share repurchase program whereby the Corporation is authorized to purchase up to $25.0 million of the Corporation's common stock, of which $10.5 million was 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. The Corporation did not repurchase any common stock shares under this program during the three months ended December 31, 2015.
25
Item 6.
Selected Financial Data
The following table presents our selected historical consolidated financial and operating data. The selected historical financial and operating data should be read in conjunction with, and is qualified in its entirety by reference to, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our consolidated financial statements and notes thereto included elsewhere in this Annual Report on Form 10-K (in millions, except where indicated):
2011 Income statement data: Revenues Cost of goods sold Gross profit Selling, general and administrative Amortization expense Impairment of intangible assets Merger, acquisition, integration costs and other charges Settlement, litigation and other related charges Restructuring and impairment charges Hurricane Sandy disaster costs (recoveries) Operating income (1) Net income (6) Earnings per common share: (2) Basic Diluted Adjusted earnings per diluted common share (3) Shares used in computing earnings per common share: Basic Diluted Balance sheet data: Cash and cash equivalents Working capital (4) Goodwill (4) Intangible assets, net Total assets (4) Long-term debt, including current portion Total stockholders' equity Supplemental information: Adjusted EBITDA (3) Adjusted EBITDA Margin (3) Adjusted EBITDA per prescription dispensed (3) Net cash provided by operating activities Net cash used by investing activities Net cash provided by (used in) financing activities Statistical information (in whole numbers except where indicated) Pharmacy Volume information: Prescriptions dispensed (in thousands) Revenue per prescription dispensed (5) Gross profit per prescription dispensed (5) Gross profit margin (5) Generic drug dispensing rate
$
$ $ $ $ $
2012
2,081.1 1,786.2 294.9 216.5 11.0 5.1 16.8 (1.5) 47.0 23.4 0.80 0.79 1.32
$
Years Ended December 31, 2013 2014 $
$ $
1,832.6 1,532.4 300.2 214.7 12.3 17.8 2.1 4.5 48.8 22.9
$ $ $
0.78 0.77 1.41
$ $ $
29.3 29.5
$ $
29.5 29.9
1,757.9 1,430.7 327.2 225.3 15.4 8.1 19.6 4.4 (1.4) 55.8 18.9 0.64 0.63 1.83
$
$ $ $ $ $
29.6 30.1
17.4 348.4 214.9 100.2 834.0 300.0 413.8
$ $ $ $ $ $ $
12.3 322.1 269.4 121.9 886.3 315.5 442.6
$ $ $ $ $ $ $
24.2 259.6 282.8 136.3 900.8 231.3 462.5
$ $ $ $ $ $ $
$
104.5 5.0% 2.51 26.8 (64.0) 43.8
$
111.2 6.1% 2.84 85.7 (105.3) 14.5
$
132.8 7.5% 3.52 155.7 (53.7) (90.1)
$
$ $
$ $ $ $
41,677 49.93 $ 7.08 $ 14.2% 79.6%
$ $ $ $
39,212 46.74 $ 7.66 $ 16.4% 83.3%
1,894.5 1,555.2 339.3 236.3 20.1 13.6 37.3 3.3 (1.7) 30.4 6.8 0.23 0.22 1.69
$
$ $ $ $ $
30.0 30.6
$ $ $ $ $ $ $
$ $ $ $
2015
$ $ $ $
37,731 46.67 $ 8.75 $ 18.8% 83.4%
33.3 319.1 323.6 177.6 1,074.0 350.7 478.1 130.6 6.9% 3.73 48.4 (157.0) 117.7
2,028.5 1,693.4 335.1 222.5 28.6 21.3 13.3 0.5 (4.9) 53.8 35.1 1.16 1.14 1.69 30.4 30.8
$ $ $ $ $ $ $ $
23.1 342.1 371.0 190.2 1,153.7 427.3 519.4
$ $ $ $
141.0 7.0% 4.13 18.5 (104.1) 75.4
35,003 54.12 $ 9.69 $ 17.9% 84.9%
34,124 59.37 9.75 16.4% 86.0%
(1) Includes depreciation expense of $20.1 million, $18.6 million, $19.3 million, $20.3 million and $23.1 million for the years ended December 31, 2011, 2012, 2013, 2014 and 2015, respectively. (2) The Corporation has never declared a cash dividend. Earnings per share in whole dollars and cents. (3) See "Use of Non GAAP Measures for Measuring Annual Results" for a definition and reconciliation of Adjusted earnings per diluted common share to Earnings per diluted common share and for reconciliation of net income to Adjusted EBITDA and Adjusted EBITDA Margin. (4) As adjusted, see Note 2 - Acquisitions in the Consolidated Financial Statements (5) Amounts in 2013 do not include the $2.9 million estimated California Medicaid recoupment and in 2015 do not include the $2.5 million California Medicaid recoupment reversal. (6) Amounts in 2014 reflect a $4.3 million loss on extinguishment of debt in the third quarter 2014.
26
Use of Non-GAAP Measures for Measuring Annual Results The Corporation calculates Adjusted EBITDA as provided in the reconciliation below and calculates Adjusted EBITDA Margin by taking Adjusted EBITDA and dividing it by revenues adjusted for the contractual amounts associated with the California Medicaid estimated recoupment. The Corporation calculates and uses Adjusted EBITDA as a performance measure. The measurement is used in concert with net income and cash flows from operating activities, which measure actual cash generated in the period. In addition, the Corporation believes that Adjusted EBITDA and Adjusted EBITDA Margin are supplemental measurement tools used by analysts and investors to help evaluate overall operating performance and the ability to incur and service debt and make capital expenditures. In addition, Adjusted EBITDA, as defined in the Credit Agreement, is used in conjunction with the Corporation's debt leverage ratio and this calculation sets the applicable margin for the quarterly interest charge. Adjusted EBITDA, as defined in the Credit Agreement, is not the same calculation as this Adjusted EBITDA table. Adjusted EBITDA does not represent funds available for the Corporation's discretionary use and is not intended to represent or to be used as a substitute for net income or cash flows from operating activities data as measured under U.S. generally accepted accounting principles ("U.S. GAAP"). The items excluded from Adjusted EBITDA but included in the calculation of the Corporation's reported net income and cash flows from operating activities are significant components of the accompanying consolidated income statements and cash flows, and must be considered in performing a comprehensive assessment of overall financial performance. The Corporation's calculation of Adjusted EBITDA may not be consistent with calculations of EBITDA used by other companies. The following are reconciliations of Adjusted EBITDA to the Corporation's net income and net operating cash flows for the periods presented. The Corporation calculates and uses adjusted diluted earnings per share, which is exclusive of the impact of merger, acquisition, integration costs and other charges, settlement, litigation and other related costs and charges, impairment of intangible assets, restructuring and impairment charges, California Medicaid estimated recoupment and subsequent reversal, loss on debt extinguishment, Hurricane Sandy disaster costs, stock-based compensation and deferred compensation, and impacts of discrete items on tax provision (the "Excluded Items") as an indicator of its core operating results. The measurement is used in concert with net income and diluted earnings per share, which measure actual earnings per share generated in the period. The Corporation believes the exclusion of these charges in expressing earnings per share provides investors and management with a useful measure to assess period to period comparability and is useful to investors in evaluating the Corporation's operating results from period to period. Adjusted diluted earnings per share after giving effect to the Excluded Items does not represent the amount that effectively accrues directly to stockholders (i.e., such costs are a reduction in earnings and stockholders' equity) and is not intended to represent or to be used as a substitute for diluted earnings per share as measured under U.S. GAAP. The Excluded Items are significant components of the accompanying consolidated income statements and must be considered in performing a comprehensive assessment of overall financial performance. The following is a reconciliation of adjusted diluted earnings per share to the Corporation's U.S. GAAP earnings per diluted common share for the periods presented. Reconciliation of Net Income to Adjusted EBITDA
2011 Net income Add: Interest expense, net Merger, acquisition, integration costs and other charges Settlement, litigation and other related charges California Medicaid estimated recoupment and subsequent reversal Restructuring and impairment charges Loss on extinguishment of debt Hurricane Sandy disaster costs (recoveries) Stock-based compensation and deferred compensation Provision for income taxes Impairment of intangible assets Depreciation and amortization expense Adjusted EBITDA Adjusted EBITDA Margin
$
2012 23.4
$
8.8 16.8 (1.5)
10.0 17.8 2.1
6.0 14.8 5.1 31.1 104.5 $ 5.0%
$
Years Ended December 31, 2013 2014 22.9 $ 18.9 $ 6.8 10.6 8.1 19.6
4.5 7.1 15.9 30.9 111.2 $ 6.1%
2.9 4.4 (1.4) 8.7 26.3 34.7 132.8 $ 7.5%
2015 $
35.1
9.9 12.9 37.3 3.3 4.3 (1.7) 8.0 9.4 40.4 130.6 $ 6.9%
6.6 21.3 13.3 (2.5) 0.5 (4.9) 7.8 12.1 51.7 141.0 7.0%
Reconciliation of Adjusted EBITDA to Net Operating Cash Flows
2011 Adjusted EBITDA Interest expense, net Merger, acquisition, integration costs and other charges Provision for bad debt Amortization of deferred financing fees Loss on disposition of equipment Gain (loss) on acquisition Provision for income taxes Deferred income taxes Changes in federal and state income tax payable Excess tax benefit from stock-based compensation Changes in assets and liabilities Other Net Cash Flows from Operating Activities
$
$
2012
104.5 (8.8) (15.3) 24.8 0.8 0.1 (14.8) 13.9 0.2 (78.8) 0.2 26.8 27
$
$
Years Ended December 31, 2013
111.2 (10.0) (16.5) 25.2 1.0 0.1 (15.9) 2.8 1.1 (13.5) 0.2 85.7
$
$
132.8 $ (10.6) (8.1) 22.5 2.3 0.6 (1.3) (26.3) 12.0 (0.4) 32.2 155.7 $
2014 130.6 $ (9.9) (52.8) 23.2 1.9 (0.2) (9.4) (2.3) 7.2 (3.4) (36.9) 0.4 48.4 $
2015 141.0 (6.6) (27.7) 7.9 0.6 (0.4) (12.1) 4.0 (10.7) (2.4) (75.1) 18.5
Reconciliation of Diluted Earnings Per Share to Adjusted Diluted Earnings Per Share
2011 Diluted earnings per share Add: Diluted earnings per share impact of: Impairment of intangible assets Merger, acquisition, integration costs and other charges Settlement, litigation and other related charges California Medicaid estimated recoupment (reversal) Loss on extinguishment of debt Restructuring and impairment charges Hurricane Sandy disaster costs (recoveries) Stock-based compensation and deferred compensation Impact of discrete items and non-recurring charges on tax provision Adjusted diluted earnings per share
$
2012 0.79
$
0.11 0.35 (0.03) 0.12
$
(0.02) 1.32 28
Years Ended December 31, 2013 0.77
$
0.36 0.04 0.09 0.14
$
0.01 1.41
0.63
$
0.17 0.62 0.06 0.09 (0.03) 0.18
$
0.11 1.83
2014
2015 0.22
$
0.27 0.77 0.09 0.07 (0.04) 0.17
$
0.14 1.69
1.14 0.43 0.27 (0.05) 0.01 (0.10) 0.16
$
(0.17) 1.69
Item 7.
Management's Discussion and Analysis of Financial Condition and Results of Operations
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS This Annual Report on Form 10-K contains forward-looking statements, within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which reflect the Corporation's current estimates, expectations and projections about the Corporation's future results, performance, prospects and opportunities. Forward looking statements include, among other things, the information concerning the Corporation's possible future results of operations including revenue, costs of goods sold, operating expenses, gross profit, and business and growth strategies, financing plans, the Corporation's competitive position and the effects of competition, the projected growth of the industries in which we operate, and the Corporation's ability to consummate strategic acquisitions. Forward-looking statements include statements that are not historical facts and can be identified by forward-looking words such as "anticipate," "believe," "could," "estimate," "expect," "intend," "plan," "may," "should," "will," "would," "project," and similar expressions. These forward-looking statements are based upon information currently available to the Corporation and are subject to a number of risks, uncertainties and other factors that could cause the Corporation's actual results, performance, prospects or opportunities to differ materially from those expressed in, or implied by, these forward-looking statements. Important factors that could cause the Corporation's actual results to differ materially from the results referred to in the forward-looking statements the Corporation makes in this report include: • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • •
the Corporation's access to capital, credit ratings, indebtedness, and ability to raise additional financings and operate under the terms of the Corporation's debt obligations; anti-takeover provisions of the Delaware General Corporation Law, which in concert with our certificate of incorporation and our by-laws could delay or deter a change in control; the effects of adverse economic trends or intense competition in the markets in which we operate; the Corporation's risk of loss of revenues due to a customer or owner of skilled nursing facility entering the institutional pharmacy business; the effects of the loss of a large customer and the Corporation's ability to adequately restructure its operations to offset the loss; the demand for the Corporation's products and services; the risk of retaining existing customers and service contracts and the Corporation's ability to attract new customers for growth of the Corporation's business; the effects of renegotiating contract pricing relating to significant customers and suppliers, including the hospital pharmacy business which is substantially dependent on service provided to one customer; the impacts of cyber security risks and/or incidents; the effects of a failure in the security or stability of our technology infrastructure, or the infrastructure of one or more of our key vendors, or a significant failure or disruption in service; the effects of an increase in credit risk, loss or bankruptcy of or default by any significant customer, supplier, or other entity relevant to the Corporation's operations; the Corporation's ability to successfully pursue the Corporation's development and acquisition activities and successfully integrate new operations and systems, including the realization of anticipated revenues, economies of scale, cost savings, and productivity gains associated with such operations; the Corporation's ability to control costs, particularly labor and employee benefit costs, rising pharmaceutical costs, and regulatory compliance costs; the effects of healthcare reform and government regulations, including interpretation of regulations and changes in the nature and enforcement of regulations governing the healthcare and institutional pharmacy services industries including the dispensing of antipsychotic prescriptions; changes in the reimbursement rates or methods of payment from Medicare and Medicaid and other third party payers to both us and our customers; the potential impact of state government budget shortfalls and their ability to pay the Corporation and its customers for services provided; the Corporation's ability, and the ability of the Corporation's customers, to comply with Medicare or Medicaid reimbursement regulations or other applicable laws; the effects of changes in the interest rate on the Corporation's outstanding floating rate debt instrument and the increases in interest expense, including increases in interest rate terms on any new debt financing; further consolidation of managed care organizations and other third party payers; political and economic conditions nationally, regionally, and in the markets in which the Corporation operates; natural disasters, war, civil unrest, terrorism, fire, floods, tornadoes, earthquakes, hurricanes, epidemic, pandemic, catastrophic event or other matters beyond the Corporation's control; increases in energy costs, including state and federal taxes, and the impact on the costs of delivery expenses and utility expenses; elimination of, changes in, or the Corporation's failure to satisfy pharmaceutical manufacturers' rebate programs; the Corporation's ability to attract and retain key executives, pharmacists, and other healthcare personnel; the Corporation's risk of loss not covered by insurance; the outcome of litigation to which the Corporation is a party from time to time, including adverse results in material litigation or governmental inquiries including the possible insufficiency of any accruals established by the Corporation from time to time; changes in accounting rules and standards, audits, compliance with the Sarbanes-Oxley Act, and regulatory investigations; changes in market conditions that would result in the impairment of goodwill or other assets of the Corporation; changes in market conditions in which we operate that would influence the value of the Corporation's stock; the uncertainty as to the long-term value of the Corporation's common stock; the Corporation's ability to anticipate a shift in demand for generic drug equivalents and the impact on the financial results including the negative impact on brand drug rebates; the effect on prescription volumes and the Corporation's net revenues and profitability if the safety risk profiles of drugs increase or if drugs are withdrawn from the market, including as a result of manufacturing issues, or if prescription drugs transition to over-the-counter products; the effects on the Corporation's results of operations related to interpretations of accounting principles by the SEC staff that may differ from those of management; the potential impact of the litigation proceedings with ABDC regarding the Previous PVA; 29
• • • • •
the Corporation's ability to comply with the terms of its Memorandum of Agreement with the DEA and the Corporate Integrity Agreement with the OIG; the Corporation's ability to collect outstanding receivables; changes in tax laws and regulations; the effects of changes to critical accounting estimates; and other factors, risks and uncertainties referenced in the Corporation's filings with the Commission, including the "Risk Factors" set forth in this Report on Form 10-K for the year ended December 31, 2015.
YOU ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON ANY FORWARD-LOOKING STATEMENTS, ALL OF WHICH SPEAK ONLY AS OF THE DATE OF THIS ANNUAL REPORT. EXCEPT AS REQUIRED BY LAW, WE UNDERTAKE NO OBLIGATION TO PUBLICLY UPDATE OR RELEASE ANY REVISIONS TO THESE FORWARD-LOOKING STATEMENTS TO REFLECT ANY EVENTS OR CIRCUMSTANCES AFTER THE DATE OF THIS ANNUAL REPORT OR TO REFLECT THE OCCURRENCE OF UNANTICIPATED EVENTS. ALL SUBSEQUENT WRITTEN AND ORAL FORWARD-LOOKING STATEMENTS ATTRIBUTABLE TO US OR ANY PERSON ACTING ON THE CORPORATION'S BEHALF ARE EXPRESSLY QUALIFIED IN THEIR ENTIRETY BY THE CAUTIONARY STATEMENTS CONTAINED OR REFERRED TO IN THIS SECTION AND IN OUR RISK FACTORS SET FORTH IN PART I, ITEM 1A OF THIS REPORT ON FORM 10-K AND IN OTHER REPORTS FILED WITH THE SEC BY THE CORPORATION. 30
The Corporation's Business and Industry Trends 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 94 institutional pharmacies, 17 specialty infusion pharmacies and 5 specialty oncology pharmacies in 45 states. The Corporation's customers are typically institutional healthcare providers, such as skilled nursing facilities, nursing centers, assisted living facilities, hospitals, individuals receiving in-home care and other long-term alternative care providers. The Corporation is generally the primary source of supply of pharmaceuticals to its customers. The institutional pharmacy services business is highly competitive. Competition is a significant factor that can impact the Corporation's overall financial results, pricing to customers, and bed retention. In each geographic market, there are national, regional and local institutional pharmacies that provide services comparable to those offered by the Corporation's pharmacies. These pharmacies may have greater financial and other resources than we do and may be more established in the markets they serve than we are. The Corporation also competes against regional and local pharmacies that specialize in the highly-fragmented long-term care markets. In the future, some of the Corporation's customers may seek to in-source the provision of pharmaceuticals to patients in their facilities by establishing an internal pharmacy. A variety of factors are affecting the institutional pharmacy industry. With an aging population and the extension of drug coverage to a greater number of individuals through Medicare Part D, the consumption of pharmaceuticals by residents of long-term care facilities is likely to increase in the future. In addition, individuals are expected to enter assisted living facilities, independent living facilities and continuing care retirement communities at increasing rates. Under Medicare Part D, eligible individuals may choose to enroll in various Medicare Part D Plans to receive prescription drug coverage. Each Medicare Part D Plan determines a distinct formulary for the long-term care residents enrolled in its plan. Accordingly, institutional pharmacies have incurred increased administrative costs to manage each Part D Plan's formulary, reimbursement and administrative processes for their long-term care enrollees. Institutional pharmacies may continue to experience increased administrative burdens and costs due to the greater complexity of the requirements for drug reimbursement. Medicare Part D also requires increased choices for patients with respect to complex drug categories and therapeutic interchange opportunities. Institutional pharmacies may realize increased revenue by providing long-term care residents with specialized services in these areas. Continued industry consolidation may also impact the dynamics of the institutional pharmacy market. In addition, our continued success depends on our ability to attract and retain pharmacists and other pharmacy professionals. Competition for qualified pharmacists and other pharmacy professionals is strong. The loss of pharmacy personnel or the inability to attract, retain or motivate sufficient numbers of qualified pharmacy professionals could adversely affect our business. Although we generally have been able to meet our staffing requirements for pharmacists and other pharmacy professionals in the past, our inability to do so in the future could have a material adverse impact on us. Acquisitions During the Periods Presented For a discussion of acquisitions by the Corporation during the periods presented see Note 2 "Acquisitions" to our Consolidated Financial Statements included elsewhere in this Report. 31
Critical Accounting Estimates The preparation of financial statements in accordance with U.S. GAAP requires us to make estimates and assumptions that affect reported amounts and related disclosures. Management considers an accounting estimate to be critical if: • •
It requires assumptions to be made that were uncertain at the time the estimate was made; and Changes in the estimate or different estimates could have a material impact on our consolidated results of operations or financial condition.
The summary of critical accounting estimates is not intended to be a comprehensive list of all of the Corporation's accounting policies that require estimates. Management believes that of the significant accounting policies, as discussed in Note 1 of the consolidated financial statements included elsewhere in this report, the estimates discussed below involve a higher degree of judgment and complexity. Management believes the current assumptions and other considerations used to estimate amounts reflected in the consolidated financial statements are appropriate. However, if actual experience differs from the assumptions and other considerations used in estimating amounts reflected in the consolidated financial statements, the resulting changes could have a material effect on the consolidated results of operations and financial condition of the Corporation. The following paragraphs present information about our critical accounting estimates, as well as the effects of hypothetical changes in the material assumptions used to develop each estimate. Our sensitivity analysis was performed assuming the assumptions listed, based upon the actual results of the Corporation for the year ended December 31, 2015, and the actual diluted shares. Allowance for doubtful accounts and provision for doubtful accounts Accounts receivable primarily consist of amounts due from PDPs under Medicaid Part D, long-term care institutions, the respective state Medicaid programs, private payers and third party insurance companies. Our ability to collect outstanding receivables is critical to our results of operations and cash flows. We establish an allowance for doubtful accounts to reduce the carrying value of our receivables to their estimated net realizable value. In addition, certain drugs dispensed are subject to being returned, and the responsible paying party is due a credit for such returns. Our allowance for doubtful accounts, included in our balance sheets at December 31, 2014 (as adjusted) and 2015, was $58.1 million and $49.3 million, respectively. Our quarterly provision for doubtful accounts included in our income statements was as follows (dollars in millions): 2013 Amount First Quarter Second Quarter Third Quarter Fourth Quarter
$
2014 % of Revenues
5.3* 5.2 5.2 6.8
Amount
1.2% $ 1.2 1.2 1.5
2015 % of Revenues
5.6 5.7 5.3 6.6
% of Revenues
Amount
1.2% $ 1.3 1.1 1.3
5.0 3.0 1.5 (1.6)**
1.0% 0.6 0.3 (0.3)
*Excludes $0.2 million expense related to Hurricane Sandy for the First Quarter 2013. See further discussion in Note 9. **In the fourth quarter of 2015, the Corporation reversed an allowance of $4.6 million related to a customer's outstanding receivable for which a settlement payment was received which significantly exceeded the existing net receivable. The following table shows our revenue days outstanding reflected in our net accounts receivable as of the quarters indicated: 2013 First Quarter Second Quarter Third Quarter Fourth Quarter
2014 41.6 41.6 39.8 39.0
2015 37.7 37.0 36.7 34.9
34.0 35.4 35.5 34.7
The following table shows our summarized aging categories by quarter:
0 to 60 days 61 to 120 days Over 120 Days
2013 2014 2015 First Second Third Fourth First Second Third Fourth First Second Third Fourth 58.0% 58.0% 56.5% 55.5% 56.7% 53.9% 57.3% 58.8% 61.4% 60.0% 58.9% 62.0% 15.8 18.2 18.0 18.8 17.7 17.3 16.9 17.2 15.8 15.7 15.2 15.0 26.2 23.8 25.5 25.7 25.6 28.8 25.8 24.0 22.8 24.3 25.9 23.0 32
The following table shows our allowance for doubtful accounts as a percent of gross accounts receivable (dollars in millions):
Allowance First Quarter $ Second Quarter Third Quarter Fourth Quarter
55.8
2013 Gross Accounts Receivable $
54.8 54.6 56.7
% of Gross Accounts Receivable
Allowance
262.1
21.3% $
57.7
249.5 243.1 255.4
22.0 22.5 22.2
60.3 57.4 58.1
2014 Gross Accounts Receivable $
% of Gross Accounts Receivable
Allowance
242.2
23.8% $
59.7
246.5 272.4 253.8
24.5 21.1 22.9
58.8 57.7 49.3
2015 Gross Accounts Receivable $
% of Gross Accounts Receivable
259.2
23.0%
257.9 253.5 249.8
22.8 22.8 19.7
If our provision as a percent of revenue increases 0.10%, our after tax income would decrease by approximately $1.3 million or $0.04 per diluted share. This is only one example of reasonably possible sensitivity scenarios. The process of determining the allowance requires us to estimate uncollectible accounts that are highly uncertain and requires a high degree of judgment. Our estimates may be impacted by economic conditions, success in collections, payer mix and trends in federal and state regulations. Revenue recognition/Allowance for contractual discounts We recognize revenues at the time services are provided or products are delivered. Our sources of revenues for the quarters ended March 31, June 30, September 30, and December 31, 2013, 2014, and 2015 are as follows:
Medicare Part D Institutional healthcare providers Medicaid Private and other Insured Medicare Hospital management fees Total
Three Months Ended March 31, 2013 2014 2015 44.1% 44.8% 46.3% 31.2 25.3 23.9 9.5 9.5 8.1 4.8 4.6 4.5 5.9 11.5 13.2 0.8 1.1 1.0 3.7 3.2 3.0 100.0% 100.0% 100.0%
Medicare Part D Institutional healthcare providers Medicaid Private and other Insured Medicare Hospital management fees Total
Three Months Ended September 30, 2013 2014 2015 47.5% 45.6% 47.0% 29.3 23.5 23.0 8.0 8.4 6.9 4.6 4.1 4.0 6.2 13.8 14.9 0.8 1.3 1.1 3.6 3.3 3.1 100.0% 100.0% 100.0%
Three Months Ended June 30, 2014 2015 47.0% 44.8% 46.5% 29.9 25.0 23.7 8.8 9.0 7.1 3.9 4.2 3.7 5.8 12.6 14.7 0.9 1.2 1.1 3.7 3.2 3.2 100.0% 100.0% 100.0%
2013
Three Months Ended December 31, 2013 2014 2015 46.6% 47.3% 47.7% 27.8 23.4 22.2 9.4 8.4 7.6 4.3 4.4 3.4 7.7 12.6 14.6 1.0 1.1 1.1 3.2 2.8 3.4 100.0% 100.0% 100.0%
The change in the revenue by payer type, as a percent of total revenue, over the three year period is a result of the 2012 acquisition of Amerita, subsequent infusion acquisitions made by Amerita and the 2013 acquisition of Onco, all of which are more heavily weighed to insured payer sources. If our reimbursement declined or was negatively impacted by 0.25% of revenues, the negative impact on net income would be $3.2 million or $0.10 per diluted common share. Inventory and cost of drugs dispensed We have inventory located at each of our institutional pharmacy, specialty infusion, and specialty oncology locations. Our inventory is valued at the lower of first-in, first-out cost or market. The inventory consists of prescription drugs, over the counter products and intravenous solutions. Our inventory relating to controlled substances is maintained on a manually prepared perpetual system to the extent required by the Drug Enforcement Agency and state board of pharmacies. All other inventory is maintained on a periodic system, through the performance of, at a minimum, quarterly physical inventories at the end of each quarter. All inventory counts are reconciled to the balance sheet account and differences are adjusted through cost of goods sold. In addition, we record an amount of potential returns of prescription drugs based on historical rates of returns and record an estimate for rebates associated with inventory remaining at the end of each period. At December 31, 2014 (as adjusted) and 2015, our inventories in our consolidated balance sheets were $135.5 million and $155.2 million, respectively. Our inventory days on hand were as follows: 2013 First Quarter Second Quarter Third Quarter Fourth Quarter
2014 25.4 29.6 18.1 26.2
2015 26.0 35.1 31.7 29.1
26.1 29.6 25.7 32.9
Please refer to Note 1 to our consolidated financial statements included elsewhere in this report for a detailed discussion of our inventory.
33
Actual inventory counts may include estimates based on amounts that may be dispensed from an open container. In addition, items are reviewed for potential obsolescence. A 1.0% error rate in the inventory value would impact net income $1.0 million or $0.03 per diluted common share. Goodwill and other intangible assets Goodwill represents the excess of the purchase price over the fair value of the net assets of acquired companies. Our intangible assets are comprised primarily of trade names, customer relationship assets, and non-compete agreements. Our goodwill included in our accompanying consolidated balance sheets as of December 31, 2014 (as adjusted) and 2015 was $323.6 million and $371.0 million, respectively. The Corporation's policy is to perform a qualitative assessment of its institutional pharmacy and a quantitative assessment of its specialty infusion and specialty oncology reporting units to determine whether it is more likely than not (defined as having a likelihood of more than 50 percent) that the fair value of a reporting unit is less than its carrying amount. The Corporation performed the qualitative assessment of its institutional pharmacy reporting unit at December 31, 2015 and did not find it necessary to perform the first step of the two-step impairment analysis. The Corporation also performed the quantitative assessments as of December 31, 2015 for its specialty infusion and specialty oncology reporting units. The specialty infusion and specialty oncology reporting unit's fair value as calculated were approximately 23.8 % and 175.7 %, respectively, greater than current book value. Please refer to Note 4 to our consolidated financial statements included elsewhere in this report for a detailed roll forward of our goodwill and intangible assets. We performed our annual testing for goodwill impairment as of 2014 and 2015 and determined that no goodwill impairment existed, as described above. If actual future results are not consistent with our assumptions and estimates, we may be required to record goodwill impairment charges in the future. Our estimate of fair value of acquired assets and assumed liabilities are based upon assumptions believed to be reasonable based upon current facts and circumstances. Recently Issued Accounting Pronouncements In April 2015, the FASB issued Accounting Standards Update ("ASU") 2015-03 "Simplifying the Presentation of Debt Issuance Costs". The update requires debt issuance costs related to a recognized debt liability to be presented in the balance sheet as a direct deduction from the carrying amount of the related debt liability instead of being presented as an asset. Debt disclosures will include the face amount of the debt liability and the effective interest rate. The update is effective for fiscal years beginning after December 15, 2015. Early adoption is permitted for financial statements that have not been previously issued. The Corporation has elected not to early adopt the provisions of ASU 2015-03. In February 2015, the FASB issued ASU 2015-02 "Amendments to the Consolidation Analysis". The amendments in this update change the analysis that a reporting entity must conduct to determine whether limited partnerships and similar legal entities should be consolidated. The guidance responds to public concerns that current accounting for certain legal entities might require a reporting entity to consolidate another legal entity in situations in which the reporting entity's contractual rights do not give it the ability to act primarily on its own behalf, the reporting entity does not hold a majority of the legal entity's voting rights, or the reporting entity is not exposed to a majority of the legal entity's economic benefits or obligations. The update is effective for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2015. Early adoption is permitted, including adoption in an interim period. The Corporation does not anticipate that the adoption of this standard will have a material impact on its consolidated financial statements. In May 2014, the FASB issued ASU 2014-09, "Revenue from Contracts with Customers", which provides guidance for revenue recognition. The standard's core principle is that a company should recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. This ASU also requires additional disclosures. In July 2015, the FASB approved a one-year delay in the effective date of ASU 2014-09 to annual reporting periods beginning after December 15, 2017, although early adoption would be permitted for annual reporting periods beginning after December 15, 2016. The Corporation is currently in the process of evaluating the impact of adoption of this ASU on its consolidated financial statements. In November 2015, the FASB issued ASU 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 elected not to early adopt the guidance. The Corporation is currently in the process of evaluating the impact of adoption of this ASU on its consolidated financial statements. 34
Definitions Listed below are definitions of terms used by the Corporation in managing the business. The definitions are necessary to the understanding of the Management's Discussion and Analysis section of this document. Gross profit per prescription dispensed: Represents the gross profit divided by the total prescriptions dispensed. Gross profit margin: Represents the gross profit per prescription dispensed divided by the revenue per prescription dispensed. Prescriptions dispensed: Represents a prescription filled for an individual patient. A prescription will usually be for a 14 or 30 day period and will include only one drug type. Revenue per prescription dispensed: Represents the revenue divided by the total prescriptions dispensed. Results of Operations The following table presents selected consolidated comparative results of operations and statistical information for the periods presented (dollars in millions, except per prescription and per patient amounts, and prescriptions in thousands):
2013
Revenues Cost of goods sold
Amount $ 1,757.9 1,430.7
Gross profit 327.2 California Medicaid estimated recoupment and reversal 2.9 Adjusted gross profit $ 330.1 Pharmacy (in whole numbers except where indicated) Financial data Prescriptions dispensed (in thousands) 37,731 Revenue per prescription dispensed (1) $ 46.67 Gross profit per prescription dispensed (1) $ 8.75 Gross profit margin (1) Generic dispensing rate
18.8% 83.4%
Years Ended December 31, 2014 Increase (Decrease) 2015 % of % of Amount Revenues Amount Revenues 7.8% $ 1,894.5 100.0% $ 134.0 7.1% $ 2,028.5 100.0% 8.7 1,555.2 82.1 138.2 8.9 1,693.4 83.5
Increase (Decrease)
% of Revenues 100.0% $ 136.6 81.4 124.5 18.6 % $
12.1
3.7%
0.2 18.8%
339.3 $ 339.3
(2,728)
(7.2 ) %
17.9 % $
(4.2)
(1.2 )%
17.9%
(2.5) $ 332.6
35,003
(879)
(2.5)
$
7.45
16.0%
$ 54.12
$
5.25
9.70
$
0.94
10.7%
$
$
0.06
0.6
(0.9)% 1.5%
(4.8 )% 1.8%
9.69 17.9% 84.9%
335.1
(1.5 )% 1.1%
(8.4 )% 1.3%
16.5 % (0.1) 16.4%
34,124 $ 59.37 $
9.75 16.4% 86.0%
(1) Amounts in 2013 do not include the $2.9 million estimated California Medicaid recoupment and in 2015 do not include $2.5 million California Medicaid recoupment reversal. Revenues Revenues increased $134.0 million for the year ended December 31, 2015 compared to the year ended December 31, 2014 which was driven by recent acquisitions, growth in the Corporation's specialty pharmacy businesses, and branded drug inflation. Excluding the $2.5 million California Medicaid recoupment reversal recognized in the fourth quarter of 2015, the remaining increase of $131.5 million is comprised of a favorable rate variance of approximately $179.1 million or $5.25 increase per prescription dispensed, partially offset by an unfavorable volume variance of $47.6 million or 879,000 less prescriptions dispensed. The increase in revenue per prescription dispensed is due to an increase in specialty oncology per prescription drug price along with brand inflation. Revenues increased $136.6 million for the year ended December 31, 2014 compared to the year ended December 31, 2013 as a result of the inclusion of a full year of revenues from the five acquisitions of long-term care businesses in 2013 (the "2013 Acquisitions") and the acquisition of OncoMed Specialty, LLC ("Onco"); in addition, revenues increased as a result of the acquisitions of four long-term care businesses and one infusion business (collectively, the "2014 Acquisitions"). The increases from the 2013 Acquisitions and 2014 Acquisitions were partially offset by decreases in revenues due to the loss of Kindred as a customer. Excluding the $2.9 million California Medicaid estimated recoupment recognized in the third quarter of 2013, the remaining increase of $133.7 million is comprised of a favorable rate variance of approximately $261.0 million or $7.45 increase per prescription dispensed, partially offset by an unfavorable volume variance of $127.3 million or 2,728,000 less prescriptions dispensed. The increase in revenue per prescription dispensed is due to the Onco acquisition along with brand inflation.
35
Gross Profit Gross profit for the year ended December 31, 2015 was $332.6 million or $9.75 per prescription dispensed, excluding the reversal of the $2.5 million California Medicaid estimated recoupment, compared to $339.3 million or $9.69 per prescription dispensed for the year ended December 31, 2014. Gross profit margin for the year ended December 31, 2015 was 16.4% compared to 17.9% for the year ended December 31, 2014. Gross profit margin was adversely impacted by ABDC's termination of the Previous PVA and the Corporation entering into the Cardinal Health PVA. Gross profit for the year ended December 31, 2014 was $339.3 million or $9.69 per prescription dispensed compared to $330.1 million or $8.75 per prescription dispensed, excluding the $2.9 million California Medicaid estimated recoupment, for the year ended December 31, 2013. Gross profit was favorably impacted by improved purchasing flexibility under the Previous PVA resulting in lower costs, the 2014 Acquisitions, and the Corporation's restructuring incentives. Gross profit margin for the year ended December 31, 2014 was 17.9% compared to 18.8%, adjusted for the California Medicaid estimated recoupment, for the year ended December 31, 2013. While gross profit margin was adversely impacted by lower margins in the Corporation's Onco oncology business, the gross profit per prescription dispensed is favorably impacted by the acquisition of Onco on December 6, 2013. Selling, General and Administrative Expenses Selling, general and administrative expenses were $222.5 million for the year ended December 31, 2015 compared to $236.3 million for the year ended December 31, 2014. The decrease of $13.8 million is primarily due to a decrease in bad debt expense of $15.3 million as the Corporation improved its client mix and reversed an allowance of $4.6 million related to a customer account for which the Corporation received a significant settlement payment. These decreases are partially offset by an increase in depreciation expense and contract labor costs. Selling, general and administrative expenses were $236.3 million for the year ended December 31, 2014 compared to $225.3 million for the year ended December 31, 2013. The increase of $11.0 million is primarily due to the 2014 Acquisitions, as well as the 2013 acquisition of Onco, along with an increase in contract labor and employee benefit costs. Depreciation and Amortization Depreciation expense was $23.1 million for the year ended December 31, 2015 compared to $20.3 million for the year ended December 31, 2014. The increase of $2.8 million is due primarily to depreciation expense recognized on the assets acquired through the 2014 Acquisitions as well as additions to fixed assets. Amortization expense was $28.6 million for the year ended December 31, 2015 compared to $20.1 million for the year ended December 31, 2014. The increase of $8.5 million is due primarily to amortization expense recognized on intangible assets acquired through the 2014 Acquisitions and 2015 Acquisitions. Depreciation expense was $20.3 million for the year ended December 31, 2014 compared to $19.3 million for the year ended December 31, 2013. The increase of $1.0 million is due primarily to depreciation expense recognized as a result of the 2014 Acquisitions. Amortization expense was $20.1 million for the year ended December 31, 2014 compared to $15.4 million for the year ended December 31, 2013. The increase of $4.7 million of amortization expense is a result of intangible amortization related to the 2013 Acquisitions and 2014 Acquisitions. Settlements, Litigation and Other Related Charges Settlements, litigation and other related charges were $13.3 million for the year ended December 31, 2015 compared to $37.3 million for the year ended December 31, 2014. These costs relate to the Corporation's defense of certain investigations and litigations in a number of cases for which the outcome of the litigation is uncertain, which is described more fully in Note 6. Settlements, litigation and other related charges were $37.3 million for the year ended December 31, 2014 compared to $19.6 million for the year ended December 31, 2013. 36
Restructuring and Impairment Charges Restructuring and impairment charges were $0.5 million for the year ended December 31, 2015 compared to $3.3 million for the year ended December 31, 2014. These costs are part of the Corporation's initiative to realign the organization in connection with the loss of two significant customers in 2014. The amounts recognized in 2015 relate to the Corporation's specialty infusion business restructuring and centralization initiative. Restructuring and impairment charges were $3.3 million for the year ended December 31, 2014 compared to $4.4 million for the year ended December 31, 2013. The decrease of $1.1 million is due to a decrease in costs associated with the Corporation's restructuring plan relating to the loss of two of the Corporation's significant customers effective December 31, 2013. Merger, Acquisition, Integration Costs and Other Charges Merger, acquisition, integration costs and other charges were $21.3 million for the year ended December 31, 2015 compared to $13.6 million for the year ended December 31, 2014. The increase was related to costs associated with the 2014 Acquisitions and 2015 Acquisitions. Merger, acquisition, integration costs and other charges were $13.6 million, for the year ended December 31, 2014 compared to $8.1 million for the years ended December 31, 2013. The increase was related to costs associated with the 2014 Acquisitions. Hurricane Sandy disaster costs (recoveries) In October 2012, Hurricane Sandy caused significant damage on Long Island, New York and surrounding areas. The financial impacts of the storm to the Corporation's Long Beach facility as well as damage and disruption at our customer's facilities have been recorded as a separate component in the consolidated income statements. Hurricane Sandy disaster costs (recoveries) were $(4.9) million, $(1.7) million, and $(1.4) million for the years ended December 31, 2015, 2014, and 2013, respectively. The Corporation has recovered certain losses associated with Hurricane Sandy from the insurance carrier and settled both tangible property losses and the business interruption portion of its insurance claim during the year ended December 31, 2015. The Corporation's settlement of covered losses was equal to $6.9 million for business interruption and $5.3 million for other losses. After consideration of a $7.2 million advance by the insurance carrier, the Corporation received a final payment of $5.0 million. During the year ended December 31, 2015, the Corporation realized $4.9 million as income which is shown in the Hurricane Sandy disaster costs (recoveries) line item of the consolidated income statements for the year ended December 31, 2015. The cash payment is shown on the consolidated cash flow statement in both operating and investing cash flows, recognizing the amounts that were reimbursed related to the fixed asset losses in investing activities. Interest Expense Interest expense was $6.6 million for the year ended December 31, 2015 compared to $9.9 million for the years ended December 31, 2014. The decrease was primarily due to lower amortization of deferred financing costs and net activity associated with the mandatorily redeemable interest liability, partially offset by an increase in interest on the revolving credit facility due to a higher outstanding balance primarily to fund acquisitions. Long-term debt, including the current portion, was $427.3 million and $350.7 million as of December 31, 2015 and December 31, 2014 (as adjusted), respectively. Interest expense was $9.9 million for the year ended December 31, 2014 compared to $10.6 million for the year ended December 31, 2013. The decrease was primarily due to lower interest rates on the term loan and lower amortization of deferred financing costs, both associated with the Credit Agreement (as defined in Note 5 to the consolidated financial statements) which became effective in the third quarter of 2014. These decreases are partially offset by larger borrowings on the revolving credit facility in 2014. 37
Debt Extinguishment As a result of the Prior Credit Agreement, the Corporation recorded a loss on debt extinguishment of $4.3 million in the consolidated income statements for the year ended December 31, 2014. The loss recorded consisted primarily of deferred financing fees associated with the Prior Credit Agreement. Tax Provision The effective tax rate for the year ended December 31, 2015 was 25.7%, which was comprised of the 35.0% federal rate, 3.2% for the state rate, and (12.5%) for other permanent differences and discrete items. The rate for the year ended December 31, 2015 was favorably impacted by the legal settlements with the Department of Justice being treated as deductible for income tax purposes. For purposes of the tax provision for the year ended December 31, 2015, the Corporation has made a determination based on a third-party evaluation that $23.5 million of the legal settlement related to the Department of Justice lawsuit will be deductible as paid during the next three years. Accordingly, this resulted in a decrease in the twelve month tax provision of approximately $9.2 million, or approximately 19.4% of pre-tax income. The effective tax rate was also favorably impacted by the Domestic Production Activities Deduction of 1.0% and the federal research and development credits of 0.6%. The Domestic Production Activities Deduction had a lower favorable effect on the effective tax rate in the current year due to the favorable legal settlement item noted above as well as other favorable current year temporary differences reducing 2015 taxable income. Excluding the impact of the legal expenses and other discrete items, the normalized 2015 provision for income taxes as a percentage of pre-tax income would have been 37.0%, comprised of 35.0% federal rate, 2.9% for the state rate and (0.9)% for permanent differences. When compared to the normalized rate for 2014 of 36.5%, the 0.5% increase is primarily attributable to decreases in the Domestic Production Activities Deduction caused by a decrease in taxable income and an increase in the 162(m) compensation limitation related adjustment. The effective tax rate for the year ended December 31, 2014 was 58.0%, which was comprised of the 35.0% federal rate, 5.1% for the state rate, and 17.9% for other permanent differences. The rate for the year ended December 31, 2014 was unfavorably impacted by the Corporation's accrued legal settlements for the Department of Justice and Drug Enforcement Agency. The total unfavorable amount related to accrued legal settlements was a $5.1 million impact on tax, or 31.3%. The effective tax rate was favorably impacted by the Domestic Production Activities Deduction of 7.1% and federal research and development credits of 1.5%. Excluding the impact of the legal settlement accruals and other discrete items, the effective rate for the period ended December 31, 2014 would have been 36.5%, comprised of 35.0% federal rate, 3.1% for the state rate and (1.6)% for permanent differences. 38
Liquidity and Capital Resources The primary sources of liquidity for the Corporation are cash flows from operations and the availability under the Credit Agreement. Historically, the Corporation has used substantially all of its available cash to make acquisitions. Based upon our existing cash levels, expected operating cash flows, capital spending, potential future acquisitions, and the availability of funds under our revolving credit facility, we believe that we have the necessary financial resources to satisfy our expected short-term and long-term liquidity needs. Cash Flows—The following table presents selected data from our consolidated statements of cash flows for the periods presented (dollars in millions):
2013 Net cash provided by operating activities Net cash used in investing activities Net cash provided by (used in) financing activities Net increase (decrease) in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year
$
$
Years Ended December 31, 2014
155.7 (53.7) (90.1) 11.9 12.3 24.2
$
$
48.4 $ (157.0) 117.7 9.1 24.2 33.3 $
2015 18.5 (104.1) 75.4 (10.2) 33.3 23.1
Operating Activities – Cash provided by operating activities aggregated $18.5 million for the year ended December 31, 2015 compared to $48.4 million for the year ended December 31, 2014. The $29.9 million decrease in cash provided by operating activities is due to a slight increase in trade accounts receivable, an increase in income tax receivables, and legal settlement payments of $23.4 million that were made in 2015. Additionally, the prime vendor payment to Cardinal Health is payable every Friday. The payment due on New Year's Day, January 1, 2016, was accelerated to Thursday, December 31, 2015, in accordance with the terms of the contract. The amount of the payment was $21.0 million. These decreases were partially offset by $48.8 million in ABDC drug purchase payments withheld in the first quarter of 2015 and an increase in net income for the year ended December 31, 2015. Cash provided by operating activities aggregated $48.4 million for the year ended December 31, 2014 compared to $155.7 million for the year ended December 31, 2013. The decrease in cash provided by operating activities is due to an increase in inventory purchasing reflecting the Corporation's purchasing strategies, an increase in accumulated rebates receivable as a result of the ABDC dispute, as discussed in Note 6, along with an increase in cash used in payment of accounts payable. Investing Activities – Cash used in investing activities aggregated $104.1 million for the year ended December 31, 2015 compared to $157.0 million for the year ended December 31, 2014. The decrease in cash used in investing activities is due to less cash needed to complete acquisitions during the year ended December 31, 2015, along with the insurance recovery received as a result of the Hurricane Sandy settlement as further discussed in Note 9. Cash used in investing activities aggregated $157.0 million for the year ended December 31, 2014 compared to $53.7 million for the year ended December 31, 2013. The increase in cash used in investing activities is primarily due to the five businesses the Corporation acquired in 2014, partially offset by a decrease in capital expenditures. Financing Activities – Cash provided by financing activities aggregated $75.4 million for the year ended December 31, 2015 as compared to $117.7 million for the year ended December 31, 2014. The decrease in cash provided by financing activities is due to the net activity in 2015 on the term loan and the revolving credit facility being less than it was in 2014. Cash provided by financing activities aggregated $117.7 million for the year ended December 31, 2014 compared to cash used in financing activities of $90.1 million for the year ended December 31, 2013. The increase in cash provided by financing activities is due primarily to borrowings on the revolving credit facility the Corporation used to complete business acquisitions in 2014. Credit Agreement On September 17, 2014, the Corporation entered into a $535.0 million Credit Agreement with Bank of America, N.A. as administrative agent (the "Credit Agreement"). The Credit Agreement replaced the $450.0 million five-year credit agreement dated as of May 2, 2011, among the Corporation, Citibank, N.A., as Administrative Agent, and certain lenders. The Credit Agreement consists of a $225.0 million term loan facility and a $310.0 million revolving credit facility. The terms and conditions of the Credit Agreement are customary to facilities of this nature. Unless terminated earlier, the Credit Agreement will mature on September 17, 2019, and the principal amount outstanding thereunder, together with all accrued unpaid interest and other amounts owed thereunder, if any, will be payable in full on such date. The Credit Agreement requires quarterly term loan principal payments in an amount of $2.8 million beginning September 2015 through September 2019. The final principal repayment of the term loan shall be repaid on the term maturity date, September 17, 2019. In addition, the term loan is subject to certain prepayment obligations relating to certain asset sales, certain casualty losses and the incurrence of certain indebtedness. The Corporation had a total of $219.4 million of term debt outstanding under the Credit Agreement and $207.0 million outstanding under the revolving portion of the Credit Agreement as of December 31, 2015. The Credit Agreement provides for the issuance of letters of credit which, when issued, constitute usage and reduce availability on the revolving portion of the Credit Agreement. The amount of letters of credit outstanding as of December 31, 2015 was $2.8 million. After giving effect to the letters of credit and amounts outstanding under the revolving credit agreement, total availability under the revolving credit facility was $100.2 million as of December 31, 2015. The Credit Agreement also contains financial covenants that require us to satisfy certain financial tests and maintain certain financial ratios. The Corporation was compliant with all debt covenant requirements at December 31, 2015. The obligations under the Credit Agreement are guaranteed by certain domestic subsidiaries of the Corporation and secured by liens on substantially all of the Corporation's assets. 39
Drug Wholesaler Agreements We obtain pharmaceutical and other products from Cardinal Health pursuant to the Cardinal Health PVA effective April 1, 2015. The Corporation also obtains pharmaceutical and other products for discounted prices directly from pharmaceutical manufacturers. While the loss of a supplier could adversely affect our business if alternate sources of supply are unavailable or if available are significantly more expensive, numerous sources of supply are generally available to us and we have not experienced any difficulty in obtaining pharmaceuticals or other products and supplies to conduct our business. The Corporation seeks to maintain an on-site inventory of pharmaceuticals and supplies to ensure prompt delivery to our customers. Cardinal Health maintains local distribution facilities in most geographic markets in which we operate. Treasury Stock 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 was used. On July 2, 2012, the Board of Directors authorized an increase to the remaining portion of the existing stock 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 December 31, 2015. 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 and 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 stock repurchase program would be held as treasury shares and may be used for general corporate purposes, including reissuances 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. The Corporation purchased no shares under the program during the year ended December 31, 2015. The Corporation may redeem shares from employees upon the vesting of the Corporation's stock awards for minimum statutory tax withholding purposes and to cover option exercise costs. The Corporation redeemed 159,570 shares of certain vested awards and the exercise of certain stock options for an aggregate price of approximately $4.3 million during the year ended December 31, 2015. These shares have also been designated by the Corporation as treasury stock. As of December 31, 2015, the Corporation had a total of 2,776,875 shares held as treasury stock. Off-Balance Sheet Arrangements We do not have any off-balance sheet arrangements, other than purchase commitments and lease obligations. See "Contractual Obligations" below. Contractual Obligations The Corporation is obligated to make future payments under various contracts such as long-term purchase obligations, debt agreements, and lease agreements, and has certain commitments. The Corporation has grouped these contractual obligations and off-balance sheet arrangements into operating activities, financing activities, and investing activities in the same manner as they are classified in the Consolidated Statements of Cash Flows in order to provide a better understanding of the nature of the obligations and arrangements and to provide a basis for comparison to historical information. The table below provides a summary of contractual obligations and off-balance sheet arrangements as of December 31, 2015 (dollars in millions): 2016 Operating activities: Prime Vendor Agreement (1) Non-cancelable operating and capital leases Financing activities: Debt payments Interest payments (2) Totals (1) (2)
$
$
2017 -
$
2018 -
$
2019 -
$
2020 -
$
Thereafter -
$
-
19.1
18.6
16.4
10.3
10.3
6.9
11.3 5.3 35.7
11.3 5.0 34.9
11.3 4.7 32.4
392.5 3.4 406.2
10.3
6.9
$
$
$
$
$
Under the Cardinal Health PVA, the Corporation is required to purchase a certain percentage of its drug purchases through Cardinal Health through June 30, 2018. Estimated interest amounts do not include interest on the revolving credit facility, as the timing and amounts are uncertain. 40
Supplemental Quarterly Information The following tables represent the results of the Corporation's quarterly operations for the years ended December 31, 2014 and 2015 (in millions, except where indicated): 2014 Quarters 2015 Quarters First Second Third Fourth First Second Third Fourth Revenues $ 452.2 $ 448.6 $ 470.2 $ 523.5 $ 511.6 $ 497.5 $ 498.8 $ 520.6 Cost of goods sold 372.2 366.7 387.2 429.1 423.0 416.3 420.2 433.9 Gross profit 80.0 81.9 83.0 94.4 88.6 81.2 78.6 86.7 Selling, general and administrative 57.2 57.9 56.0 65.2 59.0 55.4 52.7 55.4 Amortization expense 4.4 4.3 4.9 6.5 6.6 7.0 7.0 8.0 Merger, acquisition, integration costs, and other charges 5.0 1.5 3.8 3.3 3.8 3.4 8.0 6.1 Settlement, litigation and other related charges 1.2 26.6 1.1 8.4 2.3 6.9 2.1 2.0 Restructuring and impairment charges 1.9 1.2 0.1 0.1 0.1 0.2 0.2 Hurricane Sandy disaster costs (recoveries) 0.1 (1.8) 0.1 (5.0) Operating income (loss) 10.3 (9.7) 17.1 12.7 16.8 8.5 8.5 20.0 Interest expense, net 2.5 2.3 2.1 3.0 1.4 1.9 2.1 1.2 Loss on debt extinguishment 4.3 Income (loss) before income taxes 7.8 (12.0) 10.7 9.7 15.4 6.6 6.4 18.8 Provision (benefit) for income taxes 3.0 (2.3) 2.2 6.5 5.8 4.3 3.4 (1.4) Net income (loss) $ 4.8 $ (9.7) $ 8.5 $ 3.2 $ 9.6 $ 2.3 $ 3.0 $ 20.2 Earnings (loss) per share (1): Basic Diluted
$ $
0.16 0.16
$ $
(0.32) (0.32)
$ $
0.28 0.28
$ $
0.11 0.10
$ $
0.32 0.31
$ $
0.08 0.07
$ $
0.10 0.10
$ $
0.66 0.66
Adjusted diluted earnings per diluted share (1)(2):
$
0.38
$
0.41
$
0.44
$
0.46
$
0.48
$
0.38
$
0.38
$
0.45
Shares used in computing earnings (loss) per share: Basic Diluted Balance sheet data: Cash and cash equivalents Working capital (3) Goodwill (3) Intangible assets, net Total assets (3) Long-term debt Total stockholders' equity Supplemental information: Adjusted EBITDA(2) Adjusted EBITDA Margin (2) Adjusted EBITDA per prescription dispensed (2) Net cash provided by (used in) operating activities Net cash used in investing activities Net cash (used in) provided by financing activities Statistical information (in whole numbers except where indicated) Volume information Prescriptions dispensed (in thousands) Revenue per prescription dispensed (4) Gross profit per prescription dispensed (4) Gross profit margin (4) Generic drug dispensing rate Inventory days on hand Revenue days outstanding
29.8 30.4
30.0 30.0
30.1 30.6
30.1 30.7
30.2 30.7
30.4 30.8
30.4 30.9
30.4 31.0
$ $ $ $ $ $ $
12.7 273.4 282.7 131.9 868.6 230.9 470.0
$ $ $ $ $ $ $
11.1 310.3 286.9 130.4 922.5 268.9 462.2
$ 7.1 $ 335.1 $ 319.5 $ 184.1 $ 1,045.5 $ 360.9 $ 472.7
$ 33.3 $ 319.1 $ 323.6 $ 177.6 $ 1,074.0 $ 350.7 $ 478.1
$ 25.2 $ 292.8 $ 341.9 $ 179.2 $ 1,044.9 $ 325.5 $ 487.1
$ 21.3 $ 293.5 $ 341.9 $ 172.2 $ 1,062.3 $ 349.3 $ 492.1
$ 40.0 $ 285.1 $ 341.8 $ 165.2 $ 1,060.0 $ 337.4 $ 496.9
$ 23.1 $ 342.1 $ 371.0 $ 190.2 $ 1,153.7 $ 427.3 $ 519.4
$
29.7 6.6% 3.45 4.4 (16.3) 0.4
$
30.6 6.8% 3.64 (26.5) (13.6) 38.5
$
$
$
$
$
$
$ $ $ $
$ $ $ $
$ $ $ $
33.0 7.0% 3.89 19.7 (113.4) 89.7
$ $ $ $
37.3 7.1% 3.93 50.8 (13.7) (10.9)
$ $ $ $
37.4 7.3% 4.13 44.3 (25.0) (27.4)
$ $ $ $
33.2 6.7% 3.93 (22.2) (6.5) 24.8
$ $ $ $
33.3 6.7% 4.06 37.5 (6.8) (12.0)
$ $ $ $
37.1 7.1% 4.41 (41.1) (65.8) 90.0
8,608 8,411 8,492 9,491 9,053 8,452 8,208 8,411 $ 52.53 $ 53.33 $ 55.37 $ 55.16 $ 56.51 $ 58.86 $ 60.77 $ 61.60 $ 9.29 $ 9.74 $ 9.77 $ 9.95 $ 9.79 $ 9.61 $ 9.58 $ 10.01 17.7% 18.3% 17.7% 18.0% 17.3% 16.3% 15.8% 16.3% 84.5% 85.0% 85.1% 84.9% 85.3% 86.0% 86.5% 86.3% 26.0 35.1 31.7 29.1 26.1 29.6 25.7 32.9 37.7 37.0 36.7 34.9 34.0 35.4 35.5 34.7
(1) The Corporation has never declared a cash dividend. Earnings per common share are in actual cents. (2) See "Use of Non-GAAP Measures For Measuring Quarterly Results" for a definition and Reconciliation of Adjusted Earnings Per Diluted Common Share to Earnings Per Diluted Common Share, and for Reconciliation of Net Income to Adjusted EBITDA and Adjusted EBITDA Margin. (3) As adjusted, see Note 2—Acquisitions in the Consolidated Financial Statements. (4) The fourth quarter 2015 amounts do not include the $2.5 million California Medicaid recoupment reversal. 41
Use of Non-GAAP Measures for Measuring Quarterly Results The Corporation calculates Adjusted EBITDA as provided in the reconciliation below and calculates Adjusted EBITDA Margin by taking Adjusted EBITDA and dividing it by revenues adjusted for the contractual amount associated with the California Medicaid estimated recoupment. The Corporation calculates and uses Adjusted EBITDA as a performance measure. The measurement is used in concert with net income and cash flows from operating activities, which measure actual cash generated in the period. In addition, the Corporation believes that Adjusted EBITDA and Adjusted EBITDA Margin are supplemental measurement tools used by analysts and investors to help evaluate overall operating performance and the ability to incur and service debt and make capital expenditures. In addition, Adjusted EBITDA, as defined in the Credit Agreement, is used in conjunction with the Corporation's debt leverage ratio and this calculation sets the applicable margin for the quarterly interest charge. Adjusted EBITDA, as defined in the Credit Agreement, is not the same calculation as this Adjusted EBITDA table. Adjusted EBITDA presented herein does not represent funds available for the Corporation's discretionary use and is not intended to represent or to be used as a substitute for net income or cash flows from operating activities data as measured under U.S. GAAP. The items excluded from Adjusted EBITDA but included in the calculation of the Corporation's reported net income and cash flows from operating activities are significant components of the accompanying consolidated operating income statements and cash flows, and must be considered in performing a comprehensive assessment of overall financial performance. The Corporation's calculation of Adjusted EBITDA may not be consistent with calculations of EBITDA used by other companies. The following are reconciliations of Adjusted EBITDA to the Corporation's net income (loss) and net operating cash flows for the periods presented. The Corporation calculates and uses adjusted diluted earnings per share, which is exclusive of the impact of merger, acquisition, integration costs and other charges, settlement, litigation costs and other charges, Hurricane Sandy disaster costs, restructuring and impairment charges, California Medicaid estimated recoupment, stock-based compensation and deferred compensation, loss on debt extinguishment, and impact of discrete items on tax provision ("the Excluded Items") as an indicator of its core operating results. The measurement is used in concert with net income and diluted earnings per share, which measure actual earnings per share generated in the period. The Corporation believes the exclusion of these charges in expressing earnings per share provides investors and management with a useful measure to assess period to period comparability and is useful to investors in evaluating the Corporation's operating results from period to period. Adjusted diluted earnings per share after giving effect to the Excluded Items does not represent the amount that effectively accrues directly to stockholders (i.e., such costs are a reduction in earnings and stockholders' equity) and is not intended to represent or to be used as a substitute for diluted earnings per share as measured under U.S. GAAP. The Excluded Items are significant components of the accompanying consolidated statements of operations and must be considered in performing a comprehensive assessment of overall financial performance. The following is a reconciliation of adjusted diluted earnings per share to the Corporation's U.S. GAAP earnings (loss) per diluted common share for the periods presented. Unaudited Reconciliation of Net Income (Loss) to Adjusted EBITDA (dollars in millions)
First Net income (loss) $ Add: Interest expense, net Merger, acquisition, integration costs and other charges Settlement, litigation and other related charges California Medicaid recoupment Restructuring and impairment charges Loss on extinguishment of debt Hurricane Sandy disaster costs (recoveries) Stock-based compensation and deferred compensation Provision (benefit) for income taxes Depreciation and amortization expense Adjusted EBITDA $ Adjusted EBITDA Margin
4.8
2014 Quarters Second Third $ (9.7) $ 8.5
Fourth $ 3.2
First $
9.6
2015 Quarters Second Third $ 2.3 $ 3.0
$
Fourth 20.2
2.5
2.3
2.1
3.0
1.4
1.9
2.1
1.2
5.0
1.5
3.1
3.3
3.8
3.4
8.0
6.1
1.2
26.6
1.1
8.4
2.3
6.9
2.1
2.0
-
-
-
-
-
-
-
1.9
1.2
0.1
0.1
0.1
-
0.2
0.2
-
-
4.3
-
-
-
-
-
-
0.1
-
-
-
0.1
(5.0)
2.1
1.8
1.8
2.3
2.0
1.7
1.7
2.4
3.0
(2.3)
2.2
6.5
5.8
4.3
3.4
(1.4)
9.2 29.7 $ 6.6%
9.1 30.6 $ 6.8%
(1.8)
9.8 33.0 $ 7.0% 42
12.3 37.3 $ 7.1%
12.4 37.4 $ 7.3%
12.7 33.2 $ 6.7%
12.7 33.3 $ 6.7%
(2.5)
13.9 37.1 7.1%
Unaudited Reconciliation of Adjusted EBITDA to Net Operating Cash Flows (dollars in millions)
Adjusted EBITDA Interest expense, net Merger, acquisition, integration costs and other charges Provision for bad debt Amortization of deferred financing fees Loss (gain) on disposition of equipment (Gain) loss on acquisition Provision (benefit) for income taxes Deferred income taxes Changes in federal and state income tax payable (receivable) Excess tax benefit from stockbased compensation Changes in assets and liabilities Other Net Cash Flows Provided by (Used in) Operating Activities
$
First 29.7 (2.5)
2014 Quarters Second Third $ 30.6 $ 33.0 (2.3) (2.1)
Fourth $ 37.3 $ (3.0)
2015 Quarters First Second Third Fourth 37.4 $ 33.2 $ 33.3 $ 37.1 (1.4) (1.9) (2.1) (1.2)
(5.6) 5.6
(29.4) 5.7
(4.3) 5.3
(11.8) 6.6
(6.2) 5.0
(10.3) 3.0
(10.4) 1.5
(0.8) (1.6)
0.7
0.6
0.5
0.1
0.1
0.2
0.1
0.2
-
0.1
-
0.1 -
-
-
(0.1) (0.3)
(0.1) (0.4)
(3.0) 4.0
2.3 (3.3)
(2.2) (4.0)
(6.5) 1.0
(5.8) 2.3
(4.3) 0.2
(3.4) 2.1
1.4 (0.6)
(1.3)
(2.8)
3.7
7.6
0.1
(9.1)
(1.0)
(0.7)
(2.7)
(0.5)
(0.2)
-
(1.9)
(0.2)
(0.2)
(0.1)
(20.2) 0.1
(27.4) -
(10.1) -
19.1 0.4
14.6 -
(33.1) 0.1
17.6 -
(74.2) (0.1)
(22.2) $
37.5
$
4.4
$
(26.5)
$
19.7
$
50.8
$
44.3
$
$
(41.1)
Unaudited Reconciliation of Diluted Earnings (Loss) Per Share to Adjusted Diluted Earnings Per Share (dollars in millions) 2014 Quarters Second Third
First Diluted earnings (loss) per share $ Add: Diluted earnings per share impact of: Merger, acquisition, integration costs and other charges Settlement, litigation and other related charges California Medicaid recoupment Restructuring and impairment charges Loss on extinguishment of debt Hurricane Sandy disaster costs (recoveries) Stock-based compensation and deferred compensation Impact of discrete items and non-recurring charges on tax provision Adjusted diluted earnings per share $
0.16
$
(0.32)
$
Fourth
0.28
$
2015 Quarters Second Third
First
0.10
$
0.31
$
0.07
$
Fourth
0.10
$
0.66
0.10
0.03
0.06
0.08
0.08
0.07
0.17
0.11
0.03
0.61
0.02
0.11
0.05
0.13
0.04
0.05
-
-
-
-
-
-
-
0.04
0.03
-
-
-
-
0.01
-
-
-
0.09
-
-
-
-
-
-
-
-
-
-
-
0.04
0.04
0.04
0.05
0.04
0.04
0.04
0.04
0.01
0.02
(0.05)
0.16
-
0.07
0.02
(0.26)
0.38
$
0.41
$
0.44
43
(0.04)
$
0.46
$
0.48
$
0.38
$
0.38
(0.05)
(0.10)
$
0.45
Item 7A.
Quantitative and Qualitative Disclosures about Market Risk
On September 17, 2014, the Corporation entered into the Credit Agreement. The Credit Agreement consists of a $225.0 million term loan facility and a $310.0 million revolving credit facility. Borrowings under the Credit Agreement bear interest at a floating rate equal to, at the Corporation's option, a base rate plus a margin between 0.50% and 1.25% per annum, or a Eurodollar Rate plus a margin between 1.50% and 2.25% per annum, in each case depending on the leverage ratio of the Corporation as defined by the Credit Agreement. The base rate is the greater of the prime lending rate in effect on such day, the federal funds effective rate plus 0.5%, and the Eurodollar Rate plus 1.0%. As of December 31, 2015, borrowings under the term loan bore interest at a rate of 2.4% per annum based upon the one month adjusted LIBO rate plus margin, and the revolving credit facility bore interest at a rate of 2.4% per annum based upon the LIBO rate plus applicable margin. Based upon the amount of variable rate debt outstanding as of December 31, 2015, a 100 basis point change in interest rates would affect the Corporation's future pre-tax earnings by approximately $4.2 million on an annual basis. The estimated change to the Corporation's interest expense is determined by considering the impact of hypothetical interest rates on the Corporation's borrowing cost and debt balances. These analyses do not consider the effects, if any, of the potential changes in the Corporation's credit ratings or leverage and the overall level of economic activity of the Corporation. Further, in the event of a change of significant magnitude, the Corporation's management would expect to take actions intended to further mitigate its exposure to such change. 44
Item 8.
Financial Statements and Supplementary Data Index to Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm Consolidated Income Statements for the years ended December 31, 2013, 2014 and 2015 Consolidated Balance Sheets as of December 31, 2014 and 2015 Consolidated Statements of Cash Flows for the years ended December 31, 2013, 2014 and 2015 Consolidated Statements of Stockholders' Equity for the years ended December 31, 2013, 2014 and 2015 Notes to Consolidated Financial Statements for the years ended December 31, 2013, 2014 and 2015
F-1
F-2 F-3 F-4 F-5 F-6 F-7
Report of Independent Registered Public Accounting Firm The Board of Directors and Stockholders PharMerica Corporation: We have audited the accompanying consolidated balance sheets of PharMerica Corporation and subsidiaries (the Corporation) as of December 31, 2014 and 2015, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 2015. We also have audited the Corporation's internal control over financial reporting as of December 31, 2015, based on criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Corporation's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Management's Annual Report on Internal Control over Financial Reporting under Item 9A. Our responsibility is to express an opinion on these consolidated financial statements and an opinion on the Corporation's internal control over financial reporting based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of PharMerica Corporation and subsidiaries as of December 31, 2014 and 2015, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2015, in conformity with U.S. generally accepted accounting principles. Also in our opinion, PharMerica Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2015, based on criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. As described in Management's Annual Report on Internal Control over Financial Reporting under Item 9A, management has excluded the 2015 Acquisitions from its assessment of internal control over financial reporting as of December 31, 2015 because they were acquired by the Corporation in 2015. We have also excluded the 2015 Acquisitions from our audit of internal control over financial reporting. The total assets and total revenues of the 2015 Acquisitions represent approximately 6.7% and 1.3%, respectively, of the related consolidated financial statement amounts as of and for the year ended December 31, 2015. /s/ KPMG LLP Louisville, Kentucky February 26, 2016 F-2
PHARMERICA CORPORATION CONSOLIDATED INCOME STATEMENTS For the Years Ended December 31, 2013, 2014 and 2015 (In millions, except share and per share amounts)
Revenues Cost of goods sold Gross profit Selling, general and administrative expenses Amortization expense Merger, acquisition, integration costs and other charges Settlement, litigation and other related charges Restructuring and impairment charges Hurricane Sandy disaster costs (recoveries) Operating income Interest expense, net Loss on extinguishment of debt Income before income taxes Provision for income taxes Net income
$
$
Earnings per common share: Basic Diluted
2013 1,757.9 1,430.7 327.2 225.3 15.4 8.1 19.6 4.4 (1.4) 55.8 10.6 45.2 26.3 18.9
$ $
Shares used in computing earnings per common share: Basic Diluted
0.64 0.63 29,601,199 30,075,699
See accompanying Notes to Consolidated Financial Statements F-3
$
$
$ $
2014 1,894.5 $ 1,555.2 339.3 236.3 20.1 13.6 37.3 3.3 (1.7) 30.4 9.9 4.3 16.2 9.4 6.8 $
0.23 0.22 29,983,428 30,649,131
$ $
2015 2,028.5 1,693.4 335.1 222.5 28.6 21.3 13.3 0.5 (4.9) 53.8 6.6 47.2 12.1 35.1
1.16 1.14 30,363,588 30,767,366
PHARMERICA CORPORATION CONSOLIDATED BALANCE SHEETS As of December 31, 2014 and 2015 (In millions, except share and per share amounts) (As Adjusted) December 31, 2014
December 31, 2015
ASSETS Current assets: Cash and cash equivalents Accounts receivable, net Inventory Deferred tax assets, net Income taxes receivable Prepaids and other assets
$
Equipment and leasehold improvements Accumulated depreciation
33.3 195.4 135.5 42.8 90.3 497.3
$
196.4 (125.0) 71.4
Goodwill Intangible assets, net Other long-term assets (See Note 6) $
323.6 177.6 4.1 1,074.0
23.1 200.5 155.2 41.8 10.5 52.4 483.5 218.5 (144.0) 74.5
$
371.0 190.2 34.5 1,153.7
LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable Salaries, wages and other compensation Current portion of long-term debt Income taxes payable Other accrued liabilities
$
Long-term debt Other long-term liabilities Deferred tax liabilities Commitments and contingencies (See Note 6) Stockholders' equity: Preferred stock, $0.01 par value per share; 1,000,000 shares authorized and no shares issued, December 31, 2014 and 2015 Common stock, $0.01 par value per share; 175,000,000 shares authorized; 32,725,786 and 33,237,732 shares issued as of December 31, 2014 and 2015, respectively Capital in excess of par value Retained earnings Treasury stock at cost, 2,617,305 and 2,776,875 shares at December 31, 2014 and December 31, 2015, respectively $ See accompanying Notes to Consolidated Financial Statements F-4
96.0 35.1 6.3 2.3 38.5 178.2
$
71.7 30.6 11.6 27.5 141.4
344.4 57.6 15.7
415.7 56.5 20.7
-
-
0.3 394.1 117.0 (33.3) 478.1 1,074.0 $
0.3 404.6 152.1 (37.6) 519.4 1,153.7
PHARMERICA CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS For the Years Ended December 31, 2013, 2014 and 2015 (In millions) 2013 Cash flows provided by (used in) operating activities: Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation Amortization Impairment charge Merger, acquisition, integration costs and other charges Hurricane Sandy disaster costs (recoveries) Stock-based compensation and deferred compensation Amortization of deferred financing fees Deferred income taxes Loss on disposition of equipment Gain on acquisition/disposition Loss on debt extinguishment Other Change in operating assets and liabilities: Accounts receivable, net Inventory Prepaids and other assets Accounts payable Salaries, wages and other compensation Other accrued and long-term liabilities Change in income taxes payable (receivable) Excess tax benefit from stock-based compensation Net cash provided by operating activities
$
2014 18.9
$
2015 6.8
$
35.1
19.3 15.4 0.1 0.2 8.7 2.3 12.0 0.6 (1.3) (0.1)
20.3 20.1 2.5 (1.8) 8.0 1.9 (2.3) (0.2) 4.3 0.4
23.1 28.6 7.8 0.6 4.0 (0.4) -
16.5 32.7 (1.4) 17.1 (4.2) 19.3 (0.4) 155.7
29.1 (18.8) (49.2) (2.9) (4.9) 31.3 7.2 (3.4) 48.4
(2.4) (15.9) 4.2 (24.0) (4.7) (24.4) (10.7) (2.4) 18.5
Cash flows provided by (used in) investing activities: Purchase of equipment and leasehold improvements Hurricane Sandy insurance recovery Acquisitions, net of cash acquired Cash proceeds from the sale of assets Cash proceeds from dispositions, including insurance Net cash used in investing activities
(27.3) (26.5) 0.1 (53.7)
(25.6) (133.7) 0.1 2.2 (157.0)
(23.9) 3.3 (83.6) 0.1 (104.1)
Cash flows provided by (used in) financing activities: Repayments of long-term debt Proceeds from long-term debt Net activity of long-term revolving credit facility Payment of debt issuance costs Repayments of capital lease obligations Issuance of common stock Treasury stock at cost Excess tax benefit from stock-based compensation Net cash provided by (used in) financing activities
(12.5) (71.7) 9.9 (16.2) 0.4 (90.1)
(231.3) 225.0 125.0 (2.7) 3.4 (5.1) 3.4 117.7
(5.6) 82.0 0.1 0.8 (4.3) 2.4 75.4
11.9 12.3
9.1 24.2
(10.2) 33.3
Change in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year
$
24.2
$
33.3
$
23.1
Supplemental information: Cash paid for interest Cash paid for taxes
$ $
8.4 18.1
$ $
7.8 5.3
$ $
8.5 19.4
See accompanying Notes to Consolidated Financial Statements F-5
PHARMERICA CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY For the Years Ended December 31, 2013, 2014 and 2015 (In millions, except share amounts)
Balance at December 31, 2012 Net income Exercise of stock options and tax components of stock-based awards, net Vested restricted stock units Vested performance share units Treasury stock at cost Stock-based compensation -non-vested restricted stock Stock-based compensation -stock options Balance at December 31, 2013 Net income Exercise of stock options and tax components of stock-based awards, net Vested restricted stock units Vested performance share units Treasury stock at cost Stock-based compensation -non-vested restricted stock Stock-based compensation -stock options Balance at December 31, 2014 Net income Exercise of stock options and tax components of stock-based awards, net Vested restricted stock units Vested performance share units Treasury stock at cost Stock-based compensation -non-vested restricted stock Stock-based compensation -stock options Balance at December 31, 2015
Common Stock Shares Amount 29,487,455 $ 0.3
622,712 325,257 62,547 (960,678) 29,537,293
$
$
10.0 -
-
0.3
6.2 1.0 380.2
110.2 6.8
$
$
$
-
6.5 -
-
0.3
6.8 0.6 394.1
117.0 35.1
149,314 219,625 143,007 (159,570) 30,460,857
Retained Earnings $ 91.3 18.9
-
283,809 288,076 199,637 (200,334) 30,108,481
Capital in Excess of Par Value $ 363.0
$
$
-
2.9 -
-
0.3
7.5 0.1 404.6
152.1
$
$
See accompanying Notes to Consolidated Financial Statements F-6
Treasury Stock $ (12.0) $
$
(16.2)
10.0 (16.2)
(28.2) $
6.2 1.0 462.5 6.8
(5.1)
$
(33.3) $
(4.3)
$
Total 442.6 18.9
(37.6) $
6.5 (5.1) 6.8 0.6 478.1 35.1 2.9 (4.3) 7.5 0.1 519.4
PHARMERICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 94 institutional pharmacies, 17 specialty infusion pharmacies, and 5 specialty oncology pharmacies in 45 states. The Corporation's customers are typically institutional healthcare providers, such as skilled nursing facilities, nursing centers, assisted living facilities, hospitals, individuals receiving in-home care and other long-term alternative care providers. The Corporation is generally the primary source of supply of pharmaceuticals to its customers. 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. Use of Estimates The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States ("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 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. Potential risks and uncertainties, many of which are beyond the control of the Corporation, include, but are not necessarily limited to, such factors as overall economic, financial and business conditions; the overall condition of the Corporation's customers and suppliers; the intense competition in the Corporation's industry; the loss of one or more key pharmaceutical manufacturers; changes in manufacturers' rebate programs; the risk of loss of revenues due to the loss of certain customers or a customer or owner of a skilled nursing facility entering the institutional pharmacy business; the effects of the loss of a large customer and the Corporation's ability to adequately restructure its operations to offset the loss; the home infusion joint ventures formed with hospitals could adversely affect the Corporation's financial results; the decline in operating revenues and profitability with an increase in the Corporation's generic dispensing rate; the loss of prescription volumes and revenue from pharmaceutical products that develop unexpected safety or efficacy concerns; reduction in reimbursement rates for the Corporation's products and/or medical treatments or services may reduce profitability; modifications to the Medicare Part D program which may reduce revenue or impose additional costs; changes in Medicaid reimbursement which may reduce revenue; the payments of significant penalties and damages for failure to comply with complex and rapidly evolving laws and regulations, as well as licensure requirements; the adverse results from material litigation or governmental inquires including the possible insufficiency of any accruals established by the Corporation could have a material impact on the Corporation's business; failure to comply with Medicare and Medicaid regulations could result in loss of eligibility to participate in these programs; efforts by payers to control costs; healthcare reform adversely impacting the liquidity of the Corporation's customers thus affecting their ability to make timely payments to the Corporation; increasing enforcement in the U.S. healthcare industry negatively impacting the Corporation's business; further consolidation of managed care organizations and other third-party payers adversely affecting the Corporation's profits; Federal and state medical privacy regulations increasing costs of operations and exposing the Corporation to civil and criminal sanctions; interruption or damage to the Corporation's sophisticated information systems; purchasing a significant portion of the Corporation's pharmaceutical products from one supplier; attracting and retaining key executives, pharmacists, and other healthcare personnel; revenues and volumes adversely affected by certain factors in markets in which the Corporation operates, including weather; the provisions in the Corporation's certification of incorporation and bylaws could delay or prevent a change of control that stockholders favor; changes in volatility of the Corporation's stock price; successfully pursuing development and acquisition activities; indebtedness that restricts the Corporation's ability to pay cash dividends and has a negative impact on the Corporation's financing options; exposure to changes in interest rates; the potential impact of the litigation proceedings with AmerisourceBergen Drug Corporation ("ABDC") regarding the Previous Prime Vendor Agreement ("Previous PVA") and collection of the $23.5 million included in other long-term assets on the accompanying consolidated balance sheets; the Corporation's ability to collect outstanding receivables, changes in tax laws and regulations, changes to critical accounting estimates and changes in and interpretations of accounting rules and standards. Cash and Cash Equivalents Cash and cash equivalents consist of cash on hand and cash equivalents with original maturities of three months or less. The Corporation places its cash in financial institutions that are federally insured. As of December 31, 2014 and 2015, the Corporation did not hold a material amount of funds in cash equivalent money market accounts. F-7
PHARMERICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) NOTE 1—ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) 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. 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).
Financial liabilities and non-financial assets recorded at fair value at December 31, 2014 and 2015, are set forth in the tables below (dollars in millions): As of December 31, 2014 Financial Liability Deferred Compensation Plan Contingent Consideration Mandatorily Redeemable Interest
Asset/(Liability)
As of December 31, 2015 Financial Liability Deferred Compensation Plan Contingent Consideration Mandatorily Redeemable Interest
Asset/(Liability)
$ $ $
$ $ $
Level 1
(8.0) $ (1.1) $ (8.3) $
(8.2) $ (11.5) $ (5.8) $
Level 2 -
$ $ $
Level 1
(8.0) $ - $ - $ Level 2
-
$ $ $
Valuation Technique
Level 3
(8.2) $ - $ - $
(1.1) (8.3) Level 3 (11.5) (5.8)
A C C Valuation Technique A C C
The deferred compensation plan liability represents an unfunded 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 consolidated balance sheets. The contingent consideration represents future earn-outs associated with the Corporation's acquisition of an infusion business and a hospital services business both purchased in 2015. 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 long-term liabilities in the accompanying 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") purchased on December 6, 2013. 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 as of December 31, 2015. F-8
PHARMERICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) NOTE 1—ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) For the years ended December 31, 2014 and December 31, 2015, 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 consideration and mandatorily redeemable interest identified as Level 3 for the years ended December 31, 2014 and December 31, 2015 (in millions): Mandatorily Redeemable Interest
Contingent Consideration Beginning balance, December 31, 2013 Additions from business acquisitions Change in fair value Balance, December 31, 2014 Additions from business acquisitions Subtractions from business acquisitions Change in fair value Balance, December 31, 2015
$
$
0.7 $ 1.1 (0.7) 1.1 11.9 (1.1) (0.4) 11.5 $
8.2 0.1 8.3 (2.5) 5.8
The carrying amounts reported in the accompanying 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). 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): (As Adjusted) December 31, 2014 $ 153.2 30.5 30.6 24.5 11.7 3.0 (58.1) $ 195.4
Institutional healthcare providers Medicare Part D Private payer and other Insured Medicaid Medicare Allowance for doubtful accounts
0 to 60 days 61 to 120 days Over 120 days
58.8% 17.2% 24.0% 100.0% F-9
December 31, 2015 $ 145.9 30.2 26.8 31.1 12.6 3.2 (49.3) $ 200.5 62.0% 15.0% 23.0% 100.0%
PHARMERICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) NOTE 1—ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) The following is a summary of activity in the Corporation's allowance for doubtful accounts (dollars in millions):
Beginning Balance Allowance for doubtful accounts: Year Ended December 31, 2013 Year Ended December 31, 2014 Year Ended December 31, 2015
$ $ $
56.4 56.7 58.1
Charges Included in Selling, General & Administrative Expenses $ $ $
22.7 23.2 7.9
Write-offs $ $ $
Ending Balance
(22.4) $ (21.8) $ (16.7) $
56.7 58.1 49.3
In the fourth quarter of 2015, the Corporation reversed an allowance of $4.6 million related to a customer's outstanding receivable for which a settlement payment was received which significantly exceeded the existing net receivable. This reversal is reflected in the "Charges Included in Selling, General & Administrative Expenses" column above. Deferred Financing Fees The Corporation capitalizes financing fees related to acquiring or issuing new debt instruments. These expenditures include bank fees and premiums, legal costs, and filing fees. The Corporation amortizes these deferred financing fees using the effective interest method. Inventory Inventory is primarily located at the Corporation's pharmacy locations. Inventory consists solely of finished products (primarily prescription drugs) and is valued at the lower of first-in, first-out ("FIFO") cost or market. Physical inventories are performed at a minimum on a quarterly basis at the end of the quarter at all pharmacy sites. Cost of goods sold is adjusted based upon the results of the physical inventory counts. Equipment and Leasehold Improvements Equipment and leasehold improvements are recorded at cost on the acquisition date and are depreciated using the straight-line method over their estimated useful lives or lease term, if shorter, as follows (in years): Estimated Useful Lives Leasehold improvements Equipment and software
1-7 3-10
Expenditures for maintenance, repairs and renewals of minor items are expensed as incurred. Major rebuilds and improvements are capitalized. For the years ended December 31, 2013, 2014 and 2015, maintenance and repairs were $10.0 million, $11.1 million and $12.5 million, respectively. Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable. Recoverability of long-lived assets is assessed by a comparison of the carrying amount of the asset or asset group to the estimated future undiscounted net cash flows expected to be generated by the asset or group of assets. If estimated future undiscounted net cash flows are less than the carrying amount of the asset or group of assets, the asset is considered impaired and an expense is recorded in an amount required to reduce the carrying amount of the asset or asset group to its then fair value. The Corporation incurred $0.1 million for the year ended December 31, 2013 and no fixed asset impairment charges for the years ended December 31, 2014 and 2015. The Corporation's equipment and leasehold improvements are further described in Note 3. F-10
PHARMERICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) NOTE 1—ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Capitalization of Internal Software Costs The Corporation capitalizes the costs incurred during the application development stage, which includes costs to design the software configuration and interfaces, coding, installation, and testing. Costs incurred during the preliminary project stage along with post-implementation stages of internal use computer software are expensed as incurred. Capitalized development costs are amortized generally over three years and are subject to impairment evaluations. Costs incurred to maintain existing software development are expensed as incurred. The capitalization and ongoing assessment of recoverability of development costs requires judgment by management with respect to certain external factors, including, but not limited to, technological and economic feasibility and estimated economic life. For the years ended December 31, 2014 and 2015, the Corporation capitalized internally developed software costs of $14.7 million and $14.3 million, respectively. As of December 31, 2014 and 2015, net capitalized software costs, including acquired assets and amounts for projects which have not been completed, totaled $29.4 million and $32.6 million, respectively. Goodwill and Other Intangibles The Corporation's policy is to perform a qualitative assessment of its institutional pharmacy and a quantitative assessment of its specialty infusion and specialty oncology reporting units to determine whether it is more likely than not (defined as having a likelihood of more than 50 percent) that the fair value of a reporting unit is less than its carrying amount. The Corporation performed the qualitative assessment of its institutional pharmacy at December 31, 2015 and did not find it necessary to perform the first step of the two-step impairment review process based on that analysis. The Corporation also performed the quantitative assessments as of December 31, 2015 for its specialty infusion and specialty oncology reporting units. The specialty infusion and specialty oncology reporting unit's fair values as calculated were approximately 23.8 % and 175.7 %, respectively, greater than current book value. The Corporation's finite-lived intangible assets are comprised primarily of trade names, customer relationship assets, limited distributor relationships, doctor and insurer relationships and non-compete agreements. Finite-lived intangible assets are amortized on a straight-line basis over the course of their lives ranging from 5 to 20 years. For impairment reviews, intangible assets are reviewed on a specific pharmacy basis or as a group of pharmacies depending on the intangible assets under review. The Corporation's goodwill and intangible assets are further described in Note 4. Self-Insured Employee Health Benefits The Corporation is self-insured for the majority of its employee health benefits. The Corporation's self-insurance for employee health benefits includes a stop-loss policy to limit the maximum potential liability of the Corporation for both individual and aggregate claims per year. The Corporation records a monthly expense for self-insurance based on historical claims data and inputs from third-party administrators. For years ended December 31, 2013, 2014 and 2015, the expense for employee health benefits was $22.3 million, $15.5 million and $15.7 million, respectively, the majority of which was related to its selfinsured plans. As of December 31, 2014 and 2015, the Corporation had $2.2 million and $1.8 million, respectively, recorded as a liability for self-insured employee health benefits. Supplier Rebates The Corporation receives rebates on purchases from select vendors and suppliers for achieving market share or purchase volumes. Rebates for brand name products are generally based upon achieving a defined market share tier within a therapeutic class and can be based on either purchasing volumes or actual prescriptions dispensed. Rebates for generic products are primarily based on achieving purchasing volume requirements, or in the case of the Prime Vendor Agreement with Cardinal Health ("Cardinal Health PVA"), contractually based requirements. The Corporation generally accounts for these rebates and other incentives received from its vendors and suppliers, relating to the purchase or distribution of inventory, on an accrual basis as an estimated reduction of cost of goods sold and inventory. The estimated accrual is adjusted, if necessary, after the third party validates the appropriate data and notifies the Corporation of its agreement under the terms of the contract. The Corporation considers these rebates to represent product discounts, and as a result, the rebates are allocated as a reduction of product cost and relieved through cost of goods sold upon the sale of the related inventory or as a reduction of inventory for drugs which have not yet been sold. Delivery Expenses The Corporation incurred delivery expenses of $62.0 million, $60.8 million and $56.6 million for the years ended December 31, 2013, 2014, and 2015, respectively, to deliver products sold to its customers. Delivery expenses are reported as a component of cost of goods sold in the accompanying consolidated income statements. Stock Option Accounting The measurement and recognition of compensation cost for all share-based payment awards made to employees and non-employee directors is based on the fair value of the award. The Corporation recognizes share-based compensation costs for only those shares expected to vest on a straight-line basis over the requisite service period of the award (see Note 10). F-11
PHARMERICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) NOTE 1—ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Restructuring and Impairment Charges Restructuring and impairment charges in the consolidated financial statements represent amounts expensed for purposes of realigning corporate and pharmacy locations. Income Taxes Deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The Corporation accrues for tax obligations, as appropriate, based on facts and circumstances in the various tax jurisdictions. Deferred tax assets and liabilities are more fully described in Note 11. Mandatorily Redeemable Interest On December 6, 2013, the Corporation acquired 37.5% of the membership interests of OncoMed Specialty, LLC (the "Onco Acquisition") while also obtaining control of the business. The subsidiary is consolidated in the Corporation's consolidated financial statements and the mandatorily redeemable interest is classified as debt within other long-term liabilities in the consolidated balance sheets. Measurement Period Adjustments For the year ended December 31, 2015, the Corporation has adjusted certain amounts on the consolidated balance sheet as of December 31, 2014 as a result of measurement period adjustments related to the acquisitions occurring in 2014 (See Note 2). Recently Issued Accounting Pronouncements In April 2015, the FASB issued Accounting Standards Update ("ASU") 2015-03 "Simplifying the Presentation of Debt Issuance Costs". The update requires debt issuance costs related to a recognized debt liability to be presented in the balance sheet as a direct deduction from the carrying amount of the related debt liability instead of being presented as an asset. Debt disclosures will include the face amount of the debt liability and the effective interest rate. The update is effective for fiscal years beginning after December 15, 2015. Early adoption is permitted for financial statements that have not been previously issued. The Corporation has elected not to early adopt the provisions of ASU 2015-03. In February 2015, the FASB issued ASU 2015-02 "Amendments to the Consolidation Analysis". The amendments in this update change the analysis that a reporting entity must conduct to determine whether limited partnerships and similar legal entities should be consolidated. The guidance responds to public concerns that current accounting for certain legal entities might require a reporting entity to consolidate another legal entity in situations in which the reporting entity's contractual rights do not give it the ability to act primarily on its own behalf, the reporting entity does not hold a majority of the legal entity's voting rights, or the reporting entity is not exposed to a majority of the legal entity's economic benefits or obligations. The update is effective for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2015. Early adoption is permitted, including adoption in an interim period. The Corporation does not anticipate that the adoption of this standard will have a material impact on its consolidated financial statements. In May 2014, the FASB issued ASU 2014-09, "Revenue from Contracts with Customers", which provides guidance for revenue recognition. The standard's core principle is that a company should recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. This ASU also requires additional disclosures. In July 2015, the FASB approved a one-year delay in the effective date of ASU 2014-09 to annual reporting periods beginning after December 15, 2017, although early adoption would be permitted for annual reporting periods beginning after December 15, 2016. The Corporation is currently in the process of evaluating the impact of adoption of this ASU on its consolidated financial statements. In November 2015, the FASB issued ASU 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 elected not to early adopt the guidance. The Corporation is currently in the process of evaluating the impact of adoption of this ASU on its consolidated financial statements. F-12
PHARMERICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) NOTE 2—ACQUISITIONS 2015 Acquisitions During the year ended December 31, 2015, the Corporation completed acquisitions of two long-term care businesses, two infusion businesses and one hospital services business (collectively the "2015 Acquisitions"), none of which were individually significant to the Corporation. The 2015 Acquisitions had an estimated purchase price of $82.6 million, comprised of a net cash payment of $70.7 million and an estimated fair value of contingent consideration of $11.9 million. The resulting amount of goodwill and identifiable intangibles related to these transactions in the aggregate were $47.4 million and $41.2 million, respectively. The Corporation believes the resulting amount of goodwill reflects its expectation of synergistic benefits of the acquisitions. Tax deductible goodwill associated with the acquisitions was $40.4 million as of December 31, 2015. The net assets and operating results of the 2015 Acquisitions have been included in the Corporation's consolidated financial statements from the respective dates of acquisition. Amounts contingently payable related to the 2015 Acquisitions, representing payments originating from earn-out provisions of the infusion acquisition and hospital services acquisition, were $11.5 million as of December 31, 2015. The 2015 Acquisitions on a combined basis increased consolidated revenues by $25.6 million and increased consolidated pre-tax income by $6.7 million for the year ended December 31, 2015. 2014 Acquisitions During the year ended December 31, 2014, the Corporation completed acquisitions of four long-term care businesses and one infusion business (collectively the "2014 Acquisitions"), none of which were individually significant to the Corporation. The 2014 Acquisitions required cash payments of approximately $115.2 million in the aggregate. The resulting amount of goodwill and identifiable intangibles related to these transactions in the aggregate were $40.8 million and $61.4 million, respectively. The Corporation believes the resulting amount of goodwill reflects its expectation of synergistic benefits of the acquisitions. Tax deductible goodwill associated with the 2014 Acquisitions was $30.7 million as of December 31, 2015. The net assets and operating results of the 2014 Acquisitions have been included in the Corporation's consolidated financial statements from their respective dates of acquisition. There were no amounts contingently payable related to the 2014 Acquisitions as of December 31, 2015. The amounts recognized related to the 2014 Acquisitions, on a combined basis, for assets acquired and liabilities assumed are as follows (dollars in millions): Amounts Recognized as of Acquisition Date Accounts receivable Inventory Deferred tax assets - current Other current assets Equipment and leasehold improvements Deferred tax assets Identifiable intangibles Goodwill Total Assets
$
Current liabilities Other long-term liabilities Total Liabilities
26.7 6.8 1.8 3.1 4.8 8.2 61.4 34.9 147.7
Measurement Period Adjustments $
26.4 6.9 33.3
Total purchase price, less cash acquired
$
114.4
As Adjusted
(0.3) $ (0.2) 0.6 (0.1) 5.9 5.9 1.5 3.6 5.1
$
0.8
26.4 6.6 2.4 3.0 4.8 8.2 61.4 40.8 153.6 27.9 10.5 38.4
$
115.2
The 2014 Acquisitions on a combined basis increased consolidated revenues by $63.0 million and increased consolidated pre-tax income by $0.6 million for the year ended December 31, 2014. During the year ended December 31, 2015, two of the long-term care acquisitions were consolidated into existing pharmacies of the Corporation. Pro Forma Pro forma financial statements are not presented on the 2014 Acquisitions and 2015 Acquisitions as the results are not material to the Corporation's consolidated financial statements. Other For the years ended December 31, 2013, 2014 and 2015, the Corporation incurred $5.9 million, $13.3 million, and $20.5 million, respectively, of acquisition related costs, which have been classified as a component of merger, acquisition, integration costs and other related charges. F-13
PHARMERICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) NOTE 3—EQUIPMENT AND LEASEHOLD IMPROVEMENTS Equipment and leasehold improvements consist of the following (dollars in millions): December 31, 2014 2015 Leasehold improvements Equipment and software Construction in progress
$
Accumulated depreciation Total equipment and leasehold improvements
19.6 $ 166.1 10.7 196.4 (125.0) 71.4 $
$
20.4 185.7 12.4 218.5 (144.0) 74.5
Depreciation expense totaled $19.3 million, $20.3 million, and $23.1 million for the years ended December 31, 2013, 2014, and 2015, respectively. NOTE 4—GOODWILL AND INTANGIBLES The following table presents the changes in the carrying amount of goodwill for the years ended December 31, 2014 and 2015 (dollars in millions): Balance at December 31, 2013 as adjusted Goodwill acquired from 2014 acquisitions, as adjusted Balance at December 31, 2014, as adjusted Goodwill acquired from 2015 acquisitions Balance at December 31, 2015
$
$
282.8 40.8 323.6 47.4 371.0
The following table presents the components of the Corporation's intangible assets (dollars in millions): Finite Lived Intangible Assets Customer relationships Trade name Non-compete agreements Sub Total Accumulated amortization Net intangible assets
Balance at Balance at Balance at 2013 Additions 2014 Additions 2015 $ 121.2 $ 56.3 $ 177.5 $ 39.3 $ 216.8 60.2 2.0 62.2 0.9 63.1 16.8 3.1 19.9 1.0 20.9 198.2 61.4 259.6 41.2 300.8 (61.9) (20.1) (82.0) (28.6) (110.6) $ 136.3 $ 41.3 $ 177.6 $ 12.6 $ 190.2
Amortization expense relating to finite-lived intangible assets was $15.4 million, $20.1 million, and $28.6 million for the years ended December 31, 2013, 2014 and 2015, respectively. Total estimated amortization expense for the Corporation's finite-lived intangible assets for the next five years and thereafter are as follows (dollars in millions): Year Ending December 31, 2016 2017 2018 2019 2020 Thereafter
$
$
F-14
32.3 30.6 29.3 25.7 23.8 48.5 190.2
PHARMERICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) NOTE 5—CREDIT AGREEMENT On September 17, 2014, the Corporation entered into a credit agreement 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 (the "Credit Agreement"). The Credit Agreement replaced the $450.0 million five-year credit agreement dated as of May 2, 2011, among the Corporation, Citibank, N.A., as Administrative Agent, and certain lenders (the "Prior Credit Agreement"). The Credit Agreement consists of a $225.0 million term loan facility and a $310.0 million revolving credit facility. The terms and conditions of the Credit Agreement are customary to facilities of this nature. As a result of the payoff of the Prior Credit Agreement, the Corporation recorded a loss on debt extinguishment of $4.3 million in the Consolidated Income Statements during the year ended December 31, 2014. The loss recorded consisted primarily of unamortized deferred financing fees associated with the Prior Credit Agreement. As of December 31, 2015, $219.4 million was outstanding under the term loan facility and $207.0 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, 2014 Term Debt - payable to lenders at LIBOR plus applicable margin (2.42% as of December 31, 2015), matures September 17, 2019 Revolving Credit Facility payable to lenders, interest at LIBOR plus applicable margin (2.39% as of December 31, 2015), matures September 17, 2019 Capital lease obligations Total debt Less: Current portion of long-term debt Total long-term debt
$
225.0
$
125.0 0.7 350.7 6.3 344.4
December 31, 2015 $
219.4
$
207.0 0.9 427.3 11.6 415.7
The Corporation's indebtedness has the following maturities (dollars in millions):
Year Ending December 31, 2016 2017 2018 2019 2020
Term Debt $ 11.3 11.3 11.3 185.5 $ 219.4
Revolving Credit Facility $
$
207.0 207.0
Capital Lease Obligations $ 0.3 0.3 0.1 0.1 0.1 $ 0.9
Total Maturities $ 11.6 11.6 11.4 392.6 0.1 $ 427.3
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 December 31, 2015 was $2.8 million. After giving effect to the letters of credit, total availability under the revolving credit facility was $100.2 million as of December 31, 2015. Borrowings under the Credit Agreement bear interest at a floating rate equal to, at the Corporation's option, a base rate plus a margin between 0.50% and 1.25% per annum, or a Eurodollar Rate plus a margin between 1.50% and 2.25% per annum, in each case depending on the leverage ratio of the Corporation as defined by the Credit Agreement. The base rate is the greater of the prime lending rate in effect on such day, the federal funds effective rate plus 0.5%, and the Eurodollar Rate plus 1.0%. The Credit Agreement also provides for letter of credit fees between 1.50% and 2.50% on the letter of credit exposure, depending on the leverage ratio of the Corporation, and 0.125% on the actual daily amount available to be drawn under such letter of credit. The Corporation will also pay fronting fees on the aggregate letter of credit exposure at a rate separately agreed upon between the Corporation and the issuing bank. The Credit Agreement also provides for a commitment fee payable on the unused portion of the revolving credit facility, which shall accrue at a rate per annum ranging from 0.25% to 0.35%, depending on the leverage ratio of the Corporation. The Credit Agreement contains customary affirmative and negative covenants, as well as customary events of default. The Credit Agreement also requires the Corporation to satisfy an interest coverage ratio and a leverage ratio. The interest charge coverage ratio as of the last day of any fiscal quarter can be no less than: 3.00:1.00. The Leverage Ratio as of the last day of any fiscal quarter of the Corporation cannot exceed 3.75:1.00, subject to certain exceptions for permitted acquisitions. In addition, capital expenditures (other than those funded with proceeds of asset sales or insurance) are restricted in any fiscal year to 5.0% of revenues. The obligations under the Credit Agreement are guaranteed by certain domestic subsidiaries of the Corporation and secured by liens on substantially all of the Corporation's assets. Deferred Financing Fees The Corporation capitalized a total of $2.7 million in deferred financing fees associated with the Credit Agreement and recorded them as other longterm assets in the accompanying consolidated balance sheets. As of December 31, 2015, the Corporation had $2.0 million of unamortized deferred financing fees. F-15
PHARMERICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) NOTE 6—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 result 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 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, 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 June 10, 2013, the United States District Court for the Eastern District of Wisconsin unsealed two consolidated qui tam complaints filed in 2009 and 2011 by relators who are former employees of the Corporation and a company acquired by the Corporation. The United States, acting through the U.S. Attorney's Office in Wisconsin, intervened in part and declined to intervene in part and filed its complaint in intervention on August 9, 2013, when the matter was formally brought to the Corporation's attention. The Government's complaint sought statutory fines for the Corporation's alleged dispensing of Schedule II controlled substances without a valid prescription in violation of the Controlled Substances Act ("CSA"). It also sought monetary damages and equitable relief alleging that this conduct caused false claims to be submitted in violation of the Federal False Claims Act (the "FCA"). On November 15, 2013, the relators and the government stipulated to the dismissal of the portions of their complaints as to which the government did not intervene. The Court approved the dismissal without prejudice of those counts on November 20, 2013. The relators pursued their claim under the retaliatory termination provisions of the FCA. On May 12, 2015 and May 14, 2015, the Corporation entered into settlements with relator for the retaliatory termination claim and with the relator and the United States, respectively, settling the alleged CSA violations and the associated FCA claims. In addition, the Corporation entered into a Memorandum of Agreement with the Drug Enforcement Administration through which it agreed to certain CSA compliance obligations. The court entered its order of dismissal on June 15, 2015. In connection with the settlement of this matter, the Corporation also entered into a Corporate Integrity Agreement ("CIA") with the Department of Health and Human Services Office of the Inspector General ("OIG") with a term of five years from May 11, 2015. Pursuant to the CIA, the Corporation is required, among other things, to (i) create procedures designed to ensure that it complies with the CSA and related regulations; (ii) retain an independent review organization to review the Corporation's compliance with the terms of the CIA and report to OIG regarding that compliance; and (iii) provide training for certain Corporation employees and the Board of Directors as to the Corporation's requirements under the CSA. The requirements of the CIA will result in increased costs to maintain the Corporation's compliance program and greater scrutiny by federal regulatory authorities. Violations of the CIA could subject the Corporation to significant monetary penalties. On October 29, 2013, a complaint was filed in the United States District Court for the Southern District of Florida by Pines Nursing Homes (77), Inc. as a putative class action against the Corporation. The complaint alleged that the Corporation sent unsolicited advertisements promoting the Corporation's goods or services by facsimile to individuals or entities, and that such communications did not include an opt-out clause, all in violation of the federal Telephone Consumer Protection Act ("TCPA"). The Complaint did not specify the amount of damages sought, but the TCPA provides a statutory remedy of $500 per facsimile communication sent in violation of the statute, which may be trebled in the event of a willful violation. On August 18, 2014, the Corporation entered into a Settlement Agreement with the putative class and class counsel resolving all claims raised in the complaint. The parties moved on September 8, 2014 for, among other things, certification of the putative class for the purposes of effectuating the settlement and preliminary approval of the parties' settlement. On June 26, 2015, the Court granted preliminary approval of the settlement and the Court approved the settlement on November 12, 2015. The matter is concluded. On November 20, 2013, the complaint filed 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 against the Corporation alleging that the Corporation dispensed controlled and non-controlled substances in violation of the CSA 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 plans to file a petition with the U.S. Supreme Court for a writ of certiorari asking the Supreme Court to review the First Circuit's decision. The Corporation otherwise intends to continue to defend the case vigorously. 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 alleging that the Corporation violated the FCA and Federal Anti-Kickback Statute through its agreements to provide prescription drugs to nursing homes under certain Medicare and Medicaid programs. 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 December 22, 2015, Silver and the Corporation filed a joint motion with the court for an order dismissing with prejudice all successor liability claims against the Corporation for or regarding the conduct of Chem Rx Corporation. The court has not yet ruled on the motion or entered the order of dismissal. The Corporation intends to vigorously defend itself against the remaining allegations in the case. F-16
PHARMERICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) NOTE 6—COMMITMENTS AND CONTINGENCIES (Continued) On January 31, 2014, a relator, Frank Kurnik, on behalf of the U.S. Government and various state governments served its complaint filed in the United States District for the District of South Carolina alleging that the Corporation solicited and received remuneration in violation of the Federal Anti-Kickback Statute from drug manufacturer Amgen in exchange for preferring and promoting Amgen's drug Aranesp over a competing drug called Procrit. The Complaint was served on the Corporation on January 31, 2014 and subsequently amended on April 24, 2014. The U.S. Government has declined to intervene in the case. The Corporation's motion to dismiss the case was denied by the Court on July 24, 2014. The Court of Appeals affirmed the trial court's decision. On January 13, 2015, the Corporation again moved to dismiss the complaint and on March 23, 2015, the second motion was denied. On April 2, 2015, the Corporation moved the court to reconsider its denial of the second motion to dismiss and that motion was denied. On December 2, 2015, the Corporation and the Department of Justice settled this matter for $2.5 million plus the relator's attorney fees of approximately $2.0 million which was previously accrued for in the consolidated balance sheets of the Corporation. The U.S. Department of Justice, through the U.S. Attorney's Office for the Western District of Virginia, investigated whether the Corporation's activities in connection with the agreements it had with the manufacturer of the pharmaceutical Depakote violated the False Claims Act or the Anti-Kickback Statute. The Corporation cooperated with this investigation and believes that it has complied with applicable laws and regulations with respect to this matter. On May 29, 2014, the United States District Court for the Western District of Virginia entered an order unsealing two previously partially sealed qui tam complaints, entitled United States, et al., ex rel. Spetter v. Abbott Laboratories. Inc., Omnicare, Inc., and PharMerica Corp., No. 1:07-cv-00006 and United States, et al., ex rel. McCoyd v. Abbott Laboratories, Omnicare, Inc., PharMerica Corp., and Miles White, No. 1:07-cv-0008. The Corporation entered into a settlement agreement on October 6, 2015 with the Government including the Department of Justice, with approvals from the National Association of Medicaid Fraud Control and the Department of Health and Human Services Office of Inspector General. In the settlement, the Corporation agreed to pay $9.2 million to resolve the matter. On September 10, 2014, the Corporation filed a Complaint in Jefferson Circuit Court in Louisville, Kentucky against ABDC for failure of ABDC to comply with certain pricing and rebate provisions of the Previous PVA. The Corporation subsequently filed a First Amended Verified Complaint on September 26, 2014 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 accompanying 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. 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 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 $48.8 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. The following table represents all receivables, whether previously disputed or not, due and owing from ABDC at December 31, 2015 and the related amounts allegedly payable to ABDC of $48.8 million, which have been offset resulting in a net receivable at December 31, 2015 of $23.5 million. This net receivable is included in other long-term assets in the accompanying consolidated balance sheet as of December 31, 2015. F-17
PHARMERICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) NOTE 6—COMMITMENTS AND CONTINGENCIES (Continued) Presented in the consolidated balance sheet, the following amounts are recorded as of December 31, 2015 (dollars in millions):
Gross Amount of Recognized Asset
Description
Gross Liability Offset in the Consolidated Balance Sheet
Net Amount of Asset Presented in the Consolidated Balance Sheet
Rebates & Other Receivables (long-term)
$
72.3
$
(48.8) $
23.5
Total
$
72.3
$
(48.8) $
23.5
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, likely longer than 12 months. 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 December 31, 2015, the Corporation had accrued approximately $28.0 million related to the pending legal actions and investigations. California Medicaid On August 14, 2013, the California Department of Health Care Service ("DHCS") announced its intent to implement a ten (10) percent reimbursement reduction for numerous healthcare providers, including long term care pharmacies, retroactive to June 1, 2011. The Corporation estimated its total liability to be approximately $3.3 million which was recorded as a reduction to revenue in the third quarter of 2013. The DHCS implemented the reduction prospectively beginning in the first quarter of 2014; however, the price reduction retroactive to June 1, 2011 was not implemented until the fourth quarter of 2015. The Corporation had overestimated the retroactive component of the recoupment and therefore, $2.5 million of the original accrual was reversed in the fourth quarter of 2015. Leases The Corporation leases real estate properties, buildings, vehicles, and equipment under cancelable and non-cancelable leases. The leases expire at various times and have various renewal options. Certain leases that meet the lease capitalization criteria have been recorded as an asset and liability at the net present value of the minimum lease payments at the inception of the lease. Interest rates used in computing the net present value of the lease payments are based on the Corporation's incremental borrowing rate at the inception of the lease. The Corporation recorded the following lease expense for the periods presented (dollars in millions): 2013 Pharmacy locations and administrative offices lease expense Office equipment lease expense Total lease expense
$ $
2014 15.2 2.1 17.3
$ $
2015 15.8 2.3 18.1
$
15.8 2.4 18.2
$
Future minimum lease payments for those leases having an initial or remaining non-cancelable lease term in excess of one year are as follows for the years indicated (dollars in millions): Operating Leases $ 18.8 18.3 16.3 10.2 10.2 6.9 $ 80.7
Year Ending December 31, 2016 2017 2018 2019 2020 Thereafter Total F-18
Capital Lease Obligations $ 0.3 0.3 0.1 0.1 0.1 $ 0.9
Total $
$
19.1 18.6 16.4 10.3 10.3 6.9 81.6
PHARMERICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) NOTE 7—MERGER, ACQUISITION, INTEGRATION COSTS AND OTHER CHARGES (Continued) Merger, acquisition, integration costs and other charges were $8.1 million, $13.6 million and $21.3 million for the years ended December 31, 2013, 2014 and 2015, 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. NOTE 8-RESTRUCTURING COSTS AND OTHER CHARGES In July 2013, the Corporation commenced the implementation of its restructuring plan as a result of the loss of two of the Corporation's significant customers, Kindred and Golden Living. The plan was a major initiative primarily designed to optimize operational efficiency while ensuring that the Corporation remains well-positioned to serve its clients and achieve sustainable, long-term growth. The Corporation's restructuring plan included steps to right size its cost structure by adjusting its workforce and facility plans to reflect anticipated business needs. In addition, in the year ended December 31, 2015, the Corporation began a restructuring and centralization initiative related to its specialty pharmacy business. The initiative is not expected to be material to the financial statements. The Corporation recorded restructuring costs and other related charges of approximately $4.4 million, $3.3 million and $0.5 million during the years ended December 31,2013, 2014, and 2015, 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, 2014 $ 0.3 1.1 $ 1.4
Employee Severance and related costs Facility costs
Accrual $ $
0.3 0.2 0.5
Balance at Utilized December 31, Amounts 2015 $ (0.3) $ 0.3 (0.6) 0.7 $ (0.9) $ 1.0
The liability at December 31, 2015 represents amounts not yet paid relating to actions taken in connection with the program (primarily lease payments and severance costs). NOTE 9—HURRICANE SANDY DISASTER COSTS (RECOVERIES) In October 2012, Hurricane Sandy caused significant damage on Long Island, New York and surrounding areas. The financial impacts of the storm to the Corporation's Long Beach facility as well as damage and disruption at the Corporation's customers' facilities have been recorded as a separate component in the consolidated income statements. For the years ended December 31, 2013, 2014 and 2015, Hurricane Sandy disaster costs (recoveries) were $(1.4) million, $(1.7) million, and $(4.9) million, respectively. The Corporation has recovered certain losses associated with Hurricane Sandy from the insurance carrier, and settled both losses and the business interruption portion of its insurance claim during the year ended December 31, 2015. The Corporation's settlement of covered losses was equal to $6.9 million for business interruption and $5.3 million for other losses. After consideration of a $7.2 million advance by the insurance carrier, the Corporation received a final payment of $5.0 million. During the year ended December 31, 2015, the Corporation realized $4.9 million as income which is shown in the Hurricane Sandy disaster costs line item of the consolidated income statement for the year ended December 31, 2015. The cash payment is shown on the consolidated cash flow statement in both operating and investing cash flows, recognizing the amounts that were reimbursed related to the fixed asset losses in investing activities. F-19
PHARMERICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) NOTE 10—COMMON STOCK, PREFERRED STOCK, TREASURY STOCK, STOCK-BASED COMPENSATION AND OTHER BENEFITS Common Stock Holders of the Corporation's common stock are entitled to one vote for each share held of record on all matters on which stockholders may vote. There are no preemptive, conversion, redemption or sinking fund provisions applicable to the Corporation's common stock. In the event of liquidation, dissolution or winding up, holders of common stock are entitled to share ratably in the assets available for distribution, subject to any prior rights of any holders of preferred stock then outstanding. In addition, the Corporation's Credit Agreement imposes restrictions on its ability to pay cash dividends. Preferred Stock The certificate of incorporation authorizes the issuance of an aggregate of 1,000,000 million shares of preferred stock. On August 25, 2011, the Board of Directors designated 175,000 shares of preferred stock as Series A Junior Participating Preferred Stock ("Series A Junior Preferred Stock"). As of December 31, 2015, there were no shares of preferred stock outstanding. The Series A Junior Preferred Stock is entitled to receive quarterly cumulative dividends in an amount per whole share equal to the greater of $10.00 or 1,000 times the dividends declared on the Common Stock since the preceding quarterly dividend payment date, or with respect to the first quarterly dividend payment date, since the date of issuance, and a liquidation preference of a minimum of $10.00 per whole share, plus an amount equal to any accrued dividends and distributions thereon, whether or not declared, to the date of payment, and will be entitled to an aggregate payment per whole share equal to1,000 times the amount per share distributed to the holders of Common Stock. Holders of Series A Junior Preferred Stock are entitled to vote on each matter on which holders of Common Stock are entitled to vote, and have 1,000 votes per whole share. The preferred stockholders also are entitled to certain corporate governance and special voting rights, as defined in the certificate of designation. The Corporation's Board of Directors may, from time to time, direct the issuance of shares of preferred stock in series and may, at the time of issuance, determine the designation, powers, rights, preferences and limitations of each series. Satisfaction of any dividend preferences of outstanding preferred stock would reduce the amount of funds available for the payment of dividends on the Corporation's shares of common stock. Holders of preferred stock may be entitled to receive a preference payment in the event of any liquidation, dissolution or winding-up of the Corporation before any payment is made to the holders of the Corporation's common stock. Under certain circumstances, the issuance of preferred stock may render more difficult or tend to discourage a merger, tender offer or proxy contest, the assumption of control by a holder of a large block of the Corporation's securities or the removal of incumbent management. The Board of Directors may issue shares of preferred stock with voting and conversion rights that could adversely affect the holders of common stock. Specifically, the Corporation's certificate of incorporation authorizes the Corporation's Board of Directors to adopt a rights plan without stockholder approval. This could delay or prevent a change in control of the Corporation or the removal of existing management. 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 was used. On July 2, 2012 the Board of Directors authorized an increase to the remaining portion of the existing stock repurchase program that allows the Corporation to 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 December 31, 2015. 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 reissuances in connection with acquisitions, employee stock option exercises or other employee stock plans. The stock repurchase program does not have an expiration date and may be limited, terminated or extended at any time without prior notice. During the year ended December 31, 2015, the Corporation repurchased no shares of common stock. The Corporation may redeem shares from employees upon the vesting of the Corporation's stock awards for minimum statutory tax withholding purposes and to cover option exercise costs. The Corporation redeemed 159,570 shares of certain vested awards and exercise of certain stock options for an aggregate price of approximately $4.3 million during year ended December 31, 2015. These shares have also been designated by the Corporation as treasury stock. As of December 31, 2015, the Corporation had a total of 2,776,875 shares held as treasury stock. F-20
PHARMERICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) NOTE 10—COMMON STOCK, PREFERRED STOCK, TREASURY STOCK, STOCK-BASED COMPENSATION AND OTHER BENEFITS (Continued) 2015 Omnibus Incentive Plan Effective April 29, 2015, the Corporation adopted the PharMerica Corporation 2015 Omnibus Incentive Plan (the "Omnibus Plan") under which the Corporation is authorized to grant equity-based and other awards to its employees, officers, directors, and consultants. The Omnibus Plan replaced the Amended and Restated PharMerica Corporation 2007 Omnibus Incentive Plan (the "Prior Plan"). The Corporation has reserved 2,000,000 shares of its common stock for awards to be granted under the Omnibus Plan, subject to certain increases and reductions for grants under the Prior Plan. The following shares shall be added back to the number of shares available for grant under the Omnibus Plan: (i) shares covered by an award that expire or are forfeited, canceled, surrendered, or otherwise terminated without the issuance of such shares; (ii) shares covered by an award that are settled only in cash; and (iii) shares withheld by the Corporation or any subsidiary to satisfy a tax withholding obligation with respect to full value awards granted pursuant to the Omnibus Plan. However, shares surrendered for the payment of the exercise price under stock options (or options outstanding under the Prior Plan), shares repurchased by us with option proceeds (or option proceeds under the Prior Plan), and shares withheld for taxes upon exercise or vesting of an award other than a full value award (or an award other than a full value award under the Prior Plan), will not again be available for issuance under the Omnibus Plan. In addition, if a stock appreciation right ("SAR") (or SAR under the Prior Plan) is exercised and settled in shares, all of the shares underlying the SAR will be counted against the Omnibus Plan limit regardless of the number of shares used to settle the SAR. The Omnibus Plan provides for certain limits on issuances of certain types of awards and awards to certain recipients. The Omnibus Plan prohibits share recycling for stock options and stock appreciation rights, meaning that shares used to pay the exercise price or tax withholding for those awards are not added back to the share reserve. The Corporation's Compensation Committee administers the Omnibus Plan and has the authority to determine the recipient of the awards, the types of awards, the number of shares covered, and the terms and conditions of the awards. The Omnibus Plan allows for grants of incentive stock options, nonqualified stock options, stock appreciation rights, restricted share and restricted stock units, deferred shares, performance awards, including cash bonus awards, and other stock-based awards. The Corporation's Compensation Committee may condition the vesting, exercise or settlement of any award upon the achievement of one or more performance objectives. Stock options granted to officers and employees under the Omnibus Plan generally vest in four equal annual installments and have a term of seven years. The restricted stock units granted to officers generally vest in three equal annual installments. The restricted stock units granted to members of the Board of Directors vest in one annual installment. The performance share units granted under the Omnibus Plan vest based upon the achievement of a target amount of the Corporation's adjusted earnings before interest, income taxes, depreciation and amortization, which reinforces the importance of achieving the Corporation's profitability objectives. The performance is generally measured over a three-year period. As of December 31, 2015, total shares available for grants of stock-based awards pursuant to the Omnibus Plan were 1,817,038 shares. Stock-Based Compensation Expense The following is a summary of stock-based compensation incurred by the Corporation (dollars in millions, except per share amounts): 2013 Stock option compensation expense Nonvested stock compensation expense Total Stock Compensation Expense
$
Effect on diluted earnings per share
2014 $
$
1.0 6.2 7.2
$
(0.15)
$
$
2015 0.6 6.8 7.4
$ $
(0.15) $
As of December 31, 2015, there was $10.2 million of total unrecognized compensation cost related to the Corporation's stock compensation arrangements. Total unrecognized compensation cost will be adjusted for future changes in estimated forfeitures. F-21
0.1 7.5 7.6 (0.15)
PHARMERICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) NOTE 10—COMMON STOCK, PREFERRED STOCK, TREASURY STOCK, STOCK-BASED COMPENSATION AND OTHER BENEFITS (Continued) Stock Option Activity The Corporation did not issue stock options during the years ended December 31, 2014 or December 31, 2015. The following table summarizes option activity for the periods presented:
Outstanding options at December 31, 2014 Exercised Canceled Expired Outstanding options at December 31, 2015 Exercisable options at December 31, 2015
WeightedAverage Number of Exercise Price Shares Per Share 913,209 $ 14.62 (149,314) 15.28 (124,851) 11.74 (303) 13.42 638,741 $ 14.34 638,741 $ 14.34
WeightedAverage Aggregate Remaining Intrinsic Value Term (in millions) 2.1 years $ 5.6
1.3 years $ 1.3 years $
13.2 13.2
The total intrinsic value of stock options exercised for the years ended December 31, 2013, 2014, and 2015 was $3.5 million, $1.6 million, and $1.3 million, respectively. Cash received from stock option exercises during the year ended December 31, 2015 was $0.8 million. The total fair value of options vested for the years ended December 31, 2013, 2014, and 2015 was $1.6 million, $0.9 million, and $0.4 million, respectively. The Corporation fully recognized stock-based compensation expense for all stock options awarded. Nonvested Shares The following table summarizes nonvested share activity for the periods presented: WeightedNumber of Average Grant Shares Date Fair Value 942,021 $ 18.00 172,097 28.88 156,309 26.62 (6,929) 22.58 (362,632) 16.23 900,866 $ 22.26
Outstanding shares at December 31, 2014 Granted - Restricted Stock Units Granted - Performance Share Units Forfeited Vested Outstanding shares at December 31, 2015
The total fair value of shares vested for the years ended December 31, 2013, 2014, and 2015 was $5.1 million, $6.0 million, and $5.9 million, respectively. The weighted average remaining term and intrinsic value of nonvested shares at December 31, 2015 was 2.6 years and $31.5 million, respectively. The Corporation expects to recognize stock based compensation expense of $10.2 million for nonvested shares over a weighted average period of approximately 2.4 years. Based upon the achievement of the performance criteria at the end of the performance cycle for the performance share units issued to date, the Corporation may issue no shares or a maximum of 685,176 shares. 401(k) Plan The Corporation sponsors a salary reduction plan qualified under Section 401(k) of the Internal Revenue Code with a safe harbor matching contribution for all eligible employees, as defined in the plan document. Contributions to the plan are based upon employee contributions and the Corporation's matching contributions. For the years ended December 31, 2013, 2014, and 2015, the Corporation's matching contributions to the plan were $5.9 million, $5.8 million, and $6.3 million, respectively. F-22
PHARMERICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) NOTE 10—COMMON STOCK, PREFERRED STOCK, TREASURY STOCK, STOCK-BASED COMPENSATION AND OTHER BENEFITS (Continued) Deferred Compensation Plans The Corporation maintains a deferred compensation plan for certain management and highly compensated employees. Under the plan, a participant may elect to defer up to 50% of such participant's annual base salary and up to 100% of such participant's annual short-term incentive program cash bonus into the plan during each plan year. The Corporation also maintains a deferred compensation plan for the directors of the Corporation. The directors of the Corporation may elect to defer up to 100% of their cash fees and their stock fees in any one year. If a director elects to defer his/her restricted share grant, the shares will be deferred as they vest until the participant elects for the deferred compensation to be a taxable event. As of December 31, 2014 and 2015, the Corporation had $8.0 million and $8.2 million, respectively, recognized as a long-term liability related to the deferred compensation plans in the accompanying consolidated balance sheets. Deferred compensation expense was $1.5 million, $0.7 million and $0.2 million for the years ended December 31, 2013, 2014, and 2015, respectively. NOTE 11—INCOME TAXES The provision for income taxes is based upon the Corporation's annual income or loss before income taxes for each respective accounting period. The following table summarizes the Corporation's provision for income taxes for the periods presented (dollars in millions): 2013 Current provision: Federal State Total Deferred provision (benefit): Federal State Total Total provision for income taxes
$
2014 13.0 1.3 14.3 4.8 7.2 12.0 26.3
$
$
2015 10.4 1.3 11.7
$
6.7 1.4 8.1
(2.1) (0.2) (2.3) 9.4 $
$
5.1 (1.1) 4.0 12.1
A reconciliation of the U.S. statutory rate to the Corporation's effective tax rate is as follows for the years ended December 31: 2013 U.S. statutory rate applied to pretax income Differential arising from: State taxes Non-deductible legal expenses Deductible legal expenses Domestic Production Activities Deduction Stock compensation 162(m) compensation Valuation allowances Federal and state tax true-ups Research and development credits Other Effective tax rate
2014
2015
35.0%
35.0%
35.0%
4.3 14.8 (2.9) 2.6 0.3 7.0 (2.3) (0.6) 58.2%
5.1 31.3 (7.1) 1.2 0.2 (8.2) (1.5) 2.0 58.0%
3.2 3.3 (19.4) (1.0) 1.9 (0.6) 0.9 (0.6) 3.0 25.7%
The effective tax rates in 2014 are higher than the federal statutory rate largely as a result of the combined impact of state and local taxes and various non-deductible expenses. Conversely, the effective tax rate in 2015 is lower than the federal statutory rate largely as a result of the impact of deductible legal expenses. The effective tax rate decreased from 2014 to 2015. The change in the Corporation's opinion on the deductibility of legal expenses after consulting with third party experts between years is the primary driver of this decrease. The deductible legal expenses relate to settlements entered into with the Department of Justice. These settlements were treated as nondeductible when accrued in 2014. In 2015, the settlement process has been completed and the Corporation has concluded the expenses are deductible. The decrease in the Domestic Production Activities Deduction was a direct result of the legal settlements being deductible in 2015 and other favorable timing differences. While the dollar amount of the research credit in 2015 remained comparable to 2014, the rate impact of the research credit was diluted by the increased pre-tax book income in 2015 as compared to 2014. The increase in pre-tax book income in 2015 as compared to 2014 of $31.0 million is directly related to the significant amount of legal expenses incurred in 2014 of $28.5 million. 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 tax basis of the Corporation's tax deductible goodwill was approximately $146.3 million (as adjusted) and $171.1 million at December 31, 2014 and 2015, respectively. F-23
PHARMERICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) NOTE 11—INCOME TAXES (Continued) 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 and capital loss carryforwards. As of December 31, 2015, the Corporation has federal net operating loss carryforwards of $21.0 million ($7.3 million deferred tax asset). These net operating loss carryforwards resulted from the stock acquisitions the Corporation completed in 2013 and 2014. These net operating losses are subject to limitations under IRC 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 deferred tax asset for state net operating loss carryforwards is $4.1 million, net of federal impact and valuation allowances. As a result of a corporate restructuring that was implemented on January 1, 2014, separate company state taxable income was significantly reduced. This reduction in separate company state taxable income impacted the Corporation's analysis of the realizability of separate company net operating loss carryforwards. 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. Based on the Corporation's analysis of the impact of the corporate restructuring, a valuation allowance on the separate company state net operating loss carryforwards was recorded. The deferred tax asset for state net operating loss carryforwards totaled $3.1 million and $4.1 million at December 31, 2014 and 2015, net of valuation allowances of $4.1 million and $3.8 million, respectively. The Corporation recognized net deferred tax assets totaling $27.1 million and $21.1 million at December 31, 2014 (as adjusted) and 2015, net of valuation allowances of $4.1 million and $3.8 million, respectively. Current deferred income taxes consisted of (dollars in millions):
Accrued expenses Allowance for doubtful accounts Net operating losses Other Valuation allowance Total current deferred taxes Current deferred taxes, net
December 31, 2014 Assets Liabilities 7.7 $ 22.9 14.2 (2.0) 42.8 $ $ 42.8
$
$
December 31, 2015 Assets Liabilities 7.5 $ 18.4 19.0 0.8 (2.3) 42.6 $ 0.8 $ 41.8
$
$
Noncurrent deferred income taxes consisted of (dollars in millions):
Accelerated depreciation Stock-based compensation Goodwill and intangibles Net operating losses Other Valuation allowances Total noncurrent deferred taxes Noncurrent deferred taxes, net
$
$
December 31, 2014 Assets Liabilities - $ 11.4 4.6 33.0 17.1 9.1 (2.1) 28.7 $ 44.4 $ 15.7
$
$
December 31, 2015 Assets Liabilities - $ 13.1 4.8 33.9 15.2 9.7 1.9 (1.5) 28.2 $ 48.9 $ 20.7
As of December 31, 2014 and December 31, 2015, the Corporation had no reserves recorded as a liability for unrecognized tax benefits for U.S. federal and state tax jurisdictions. There were no unrecognized tax benefits at December 31, 2015 that, if recognized, would affect the tax rate. It is the Corporation's policy to accrue interest and penalties related to liabilities for income tax contingencies in the provision for income taxes. As of December 31, 2015, the Corporation had no accrued interest or penalties related to uncertain tax positions. The federal statute of limitations remains open for tax years 2012 through 2014. The IRS completed its audit of the Corporation's consolidated U.S. income tax returns for 2010 and 2011 in February 2014 and the Corporation has not been notified of any additional IRS tax audits. State tax jurisdictions generally have statutes of limitations ranging from three to five years. The Corporation is no longer subject to state and local income tax examinations by tax authorities for years before 2010. 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. During 2015, the New York Department of Taxation and Finance closed its audit on the Corporation's 2010-2013 tax returns that resulted in an immaterial amount of additional tax, penalties and interest which has been accounted for in the current year tax provision. One of the company's subsidiaries is currently under exam by the state of Tennessee. F-24
PHARMERICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) NOTE 12—EARNINGS PER SHARE The following table sets forth the computation using the treasury share method of basic and diluted earnings per share (dollars in millions, except per share amounts): 2013 Numerator: Numerator for basic and earnings per diluted share - net income Denominator: Denominator for basic earnings per share - weighted average shares Effect of dilutive securities (stock options, restricted stock units and performance share units) Denominator for earnings per diluted share - adjusted weighted average shares Basic earnings per share Earnings per diluted share Unexercised employee stock options, unvested restricted shares and performance shares excluded from the effect of dilutive securities above (a) (a)
2014
$
18.9
$ $
29,601,199 474,500 30,075,699 0.64 0.63
2015
$
6.8
$ $
29,983,428 665,703 30,649,131 0.23 0.22
1,417,272
$
35.1
$ $
30,363,588 403,778 30,767,366 1.16 1.14
340,291
291,679
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. NOTE 13—UNAUDITED QUARTERLY FINANCIAL INFORMATION The quarterly interim information shown below has been prepared by the Corporation's management and is unaudited. It should be read in conjunction with the audited consolidated financial statements appearing herein (dollars in millions, except per share amounts). 2014 Quarters Second Third
First Revenue Cost of goods sold Gross profit Operating income (loss) Net income (loss) Earnings (loss) per common share: Basic Diluted
$
$
$ $ $
452.2 372.2 80.0 10.3 4.8
$ $ $
448.6 366.7 81.9 (9.7) (9.7)
$ $
0.16 0.16
$ $
(0.32) $ (0.32) $
Shares used in computing earnings (loss) per common share: Basic 29.8 Diluted 30.4 (1)
30.0 30.0
$ $ $ $
Fourth
470.2 387.2 83.0 17.1 8.5(1)
0.28 0.28
30.1 30.6
$
$
$ $ $
523.5 429.1 94.4 12.7 3.2
$ $
0.11 0.10
30.1 30.7
$
$ $ $
511.6 423.0 88.6 16.8 9.6
$ $
0.32 0.31
30.2 30.7
During the third quarter 2014, the Corporation recognized a $4.3 million loss on extinguishment of debt. F-25
2015 Quarters Second Third
First
$
$ $ $
497.5 416.3 81.2 8.5 2.3
$ $
0.08 0.07
30.4 30.8
Fourth $
$ $ $
498.8 420.2 78.6 8.5 3.0
$ $ $
520.6 433.9 86.7 20.0 20.2
$ $
0.10 0.10
$ $
0.66 0.66
30.4 30.9
30.4 31.0
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None. Item 9A.
Controls and Procedures
Evaluation of Disclosure Controls and Procedures The Corporation has carried out an evaluation under the supervision and with the participation of management, including the Corporation's Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Corporation's "disclosure controls and procedures" as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act") as of the end of the period covered by this report. The Corporation's disclosure controls and procedures are designed so that information required to be disclosed in the Corporation's reports filed under the Exchange Act, such as this Annual Report on Form 10-K, is recorded, processed, summarized and reported within the time periods specified in the Commission's rules and forms. The Corporation's disclosure controls and procedures are also intended to ensure that such information is accumulated and communicated to the Corporation's management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives, and management necessarily is required to use its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. Based upon this evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of December 31, 2015, the Corporation's disclosure controls and procedures are effective to provide reasonable assurance that information required to be disclosed in the reports that the Corporation files and submits under the Exchange Act is recorded, processed, summarized and reported as and when required and such information is accumulated and communicated as appropriate to allow timely decisions regarding required disclosures. Changes in Internal Control Over Financial Reporting There have been no changes in the Corporation's internal control over financial reporting during the quarter ended December 31, 2015, that have materially affected, or are reasonably likely to materially affect, the Corporation's internal control over financial reporting. Management's Annual Report on Internal Control over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Our internal control over financial reporting includes those policies and procedures that: (i)
pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Corporation;
(ii)
provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Corporation are being made only in accordance with authorizations of management and directors of the Corporation; and
(iii)
provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Corporation's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Our management assessed the effectiveness of the Corporation's internal control over financial reporting as of December 31, 2015. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal ControlIntegrated Framework (2013). Based upon our assessment and those criteria, management has concluded that the Corporation maintained effective internal control over financial reporting as of December 31, 2015. The Corporation has excluded the 2015 Acquisitions from its assessment of internal control over financial reporting as of December 31, 2015 because they were acquired by the Corporation in 2015. The total assets and total revenues of the 2015 Acquisitions represent approximately 6.7% and 1.3%, respectively, of the related consolidated financial statement amounts as of and for the year ended December 31, 2015. The Corporation continues to integrate new acquisitions into corporate processes. No potential internal control changes due to new acquisitions would be considered material to, or are reasonably likely to materially affect, our internal control over financial reporting. The effectiveness of the Corporation's internal control over financial reporting as of December 31, 2015 has been audited by KPMG LLP, our independent registered public accounting firm, who also audited our consolidated financial statements as of December 31, 2014 and 2015 and for each of the years in the three-year period ended December 31, 2015 included in this Annual Report on Form 10-K, as stated in their report which appears with our accompanying consolidated financial statements. Item 9B.
Other Information
None. 70
PART III Item 10.
Directors, Executive Officers and Corporate Governance
The information required by this Item is incorporated herein by reference from the Corporation's definitive proxy statement to be filed no later than 120 days after December 31, 2015. We refer to this proxy statement as the 2016 Proxy Statement. Item 11.
Executive Compensation
Incorporated herein by reference from the Corporation's 2016 Proxy Statement. Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Incorporated herein by reference from the Corporation's 2016 Proxy Statement. Item 13.
Certain Relationships and Related Transactions, and Director Independence.
Incorporated herein by reference from the Corporation's 2016 Proxy Statement. Item 14.
Principal Accounting Fees and Services.
Incorporated herein by reference from the Corporation's 2016 Proxy Statement. 71
PART IV Item 15.
Exhibits
(a) (1) All Financial Statements Consolidated financial statements filed as part of this report are listed under Part II, Item 8 of this Form 10-K. (2) Financial Statement Schedules No schedules are required because either the required information is not present or is not present in amounts sufficient to require submission of the schedule, or because the information required is included in the accompanying consolidated financial statements or the notes thereto. (3) Exhibits Exhibit No.
Description
3.1
Certificate of Incorporation of the Registrant, as amended (1)
3.2
Amended and Restated By-Laws of the Registrant, as amended (17)
3.3
Series A Junior Participating Preferred Stock Certificate of Designation (13)
3.4
Certificate of Elimination of the Series A Junior Participating Preferred Stock (11)
4.1
Specimen Common Stock Certificate of the Registrant (14)
10.1
Form CEO Stock Option Award Agreement (3) †
10.2
Form Non-Qualified Stock Option Award Agreement (3) †
10.3
Employment Agreement dated July 31, 2007 between Robert McKay and PharMerica Corporation (1) †
10.4
Employment Agreement dated August 17, 2007 between Thomas Caneris and PharMerica Corporation (1) †
10.5
Form Director Non-Qualified Stock Option Award Agreement (1) †
10.6
Form of Substitution NQSO Agreement for AmerisourceBergen 2001 Grants (1) †
10.7
Form of Substitution NQSO Agreement for AmerisourceBergen 2002 Grants (1) †
10.8
Trademark License Agreement (2)
10.9
Form of Non-Qualified Stock Option Award Agreement (4) †
10.10
Form of Performance Share Award Agreement (adjusted EBITDA and adjusted ROIC) (9) †
10.11
Form of Restricted Stock Unit Award Agreement (5) †
10.12
Amended and Restated PharMerica Corporation 2007 Omnibus Incentive Plan Adopted May 26, 2010 (6) †
10.13
PharMerica Corporation 2015 Omnibus Incentive Plan Adopted Effective April 29, 2015 (22) †
10.14
Form of Director Restricted Stock Unit Award Agreement (6) † 72
10.15
Employment Letter Agreement dated February 27, 2014 between Gregory S. Weishar and PharMerica Corporation (16) †
10.16
Amended and Restated Prime Vendor Agreement for Long-Term Care Pharmacies dated January 1, 2011 by and between ABDC, PharMerica Corporation, Pharmacy Corporation of America and Chem Rx Pharmacy Services, LLC (7)
10.17
First Amendment to Amended and Restated Prime Vendor Agreement for Long-Term Care Pharmacies, dated as of January 1, 2013, by and between ABDC, PharMerica Corporation, Pharmacy Corporation of America and Chem Rx Pharmacy Services, LLC (8)
10.18
Prime Vendor Agreement, dated April 1, 2015, between PharMerica Corporation and Cardinal Health (20)
10.19
Credit Agreement dated September 17, 2014 among PharMerica Corporation, the Lenders named therein, and Bank of America, N.A., as Administrative Agent (19)
10.20
Form of Indemnification Agreement (10)
10.21
Employment Agreement dated March 22, 2011 between Suresh Vishnubhatla and PharMerica Corporation (10) †
10.22
Summary of 2012 Long-Term Incentive Program (15) †
10.23
Employment Agreement, dated September 27, 2012, between PharMerica Corporation and Mark Lindemoen (12)
10.24
Summary of 2013 Long-Term Incentive Program (8) †
10.25
Summary of 2014 CEO Short-Term Incentive Program and 2014 Short-Term Incentive Program (23) †
10.26
Summary of 2014 Long-Term Incentive Program (23) †
10.27
Summary of 2015 CEO Short-Term Incentive Program and 2015 Short-Term Incentive Program (20) †
10.28
Summary of 2015 Long-Term Incentive Program (20) †
10.29
Amended and Restated Employment Agreement, dated effective May 30, 2014, between PharMerica Corporation and David W. Froesel, Jr. (18)
10.30
Employment Agreement, dated November 10, 2012, between PharMerica Corporation and James D. Glynn (18)
10.31
Corporate Integrity Agreement, dated May 14, 2015, by and between PharMerica Corporation and the Office of Inspector General of the United States Department of Health and Human Services (21)
10.32
Memorandum of Agreement, dated May 14, 2015, by and between PharMerica Corporation and the United States Department of Justice, Drug Enforcement Administration (21)
21.1
Subsidiaries of the Registrant
23.1
Consent of KPMG LLP
31.1
Certification of Chief Executive Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2
Certification of Chief Financial Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1
Certification of Chief Executive Officer, pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2
Certification of Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS
XBRL Instance Document
101.SCH XBRL Taxonomy Extension Schema Document 101.CAL XBRL Taxonomy Extension Calculation Linkbase Document 101.DEF XBRL Taxonomy Extension Definition Linkbase Document 101.LAB XBRL Taxonomy Extension Label Linkbase Document 101.PRE XBRL Taxonomy Extension Presentation Linkbase Document 73
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13) (14) (15) (16) (17) (18) (19) (20) (21) (22) (23) †
Filed with the Corporation's Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on August 31, 2007, and incorporated herein by reference. Filed with the Corporation's Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on November 9, 2007, and incorporated herein by reference. Filed with the Corporation's Current Report on Form 8-K filed with the Securities and Exchange Commission on August 13, 2007, and incorporated herein by reference. Filed with the Corporation's Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on May 8, 2008, and incorporated herein by reference. Filed with the Corporation's Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 4, 2010, and incorporated herein by reference. Filed with the Corporation's Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on August 5, 2010, and incorporated herein by reference. Filed with the Corporation's Annual Report on Form 10-K/A filed with the Securities and Exchange Commission on May 25, 2011, and incorporated herein by reference. Filed with the Corporation's Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on May 1, 2013, and incorporated herein by reference. Filed with the Corporation's Current Report on Form 8-K filed with the Securities and Exchange Commission on March 9, 2009, and incorporated herein by reference. Filed with the Corporation's Schedule 14D-9 filed with the Securities and Exchange Commission on September 20, 2011, and incorporated herein by reference. Filed with the Corporation's Current Report on Form 8-K file with the Securities and Exchange Commission on April 2, 2012, and incorporated herein by reference. Filed with the Corporation's Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 7, 2013, and incorporated herein by reference. Filed with the Corporation's Current Report on Form 8-K filed with the Securities and Exchange Commission on August 25, 2011, and incorporated herein by reference. Filed with Amendment No. 2 to the Corporation's Registration Statement on Form S-4/S-1 (Reg. No 333-142940) filed with the Securities and Exchange Commission on June 27, 2007, and incorporated herein by reference. Filed with the Corporation's Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on May 2, 2012, and incorporated herein by reference. Filed with the Corporation's Current Report on Form 8-K filed with the Securities and Exchange Commission on March 5, 2014, and incorporated herein by reference. Filed with the Corporation's Current Report on Form 8-K filed with the Securities and Exchange Commission on March 17, 2014, and incorporated herein by reference. Filed with the Corporation's Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on August 5, 2014, and incorporated herein by reference. Filed with the Corporation's Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on November 6, 2014, and incorporated herein by reference. Filed with the Corporation's Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on May 7, 2015, and incorporated herein by reference. Filed with the Corporation's Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on November 6, 2015, and incorporated herein by reference. Filed with the Corporation's Definitive Proxy Statement on Schedule 14A filed with the Securities and Exchange Commission on April 30, 2015, and incorporated herein by reference. Filed with the Corporation's Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 3, 2015, and incorporated herein by reference. Management contract or compensatory plan or arrangement. 74
SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. PHARMERICA CORPORATION Date: February 26, 2016
By:
/S/ GREGORY S. WEISHAR Gregory S. Weishar Chief Executive Officer and Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Signature
Title
Date
/S/ GREGORY S. WEISHAR (Gregory S. Weishar)
Chief Executive Officer and Director
February 26, 2016
/S/ DAVID W. FROESEL, JR. (David W. Froesel, Jr.)
Executive Vice President, Chief Financial Officer and Treasurer
February 26, 2016
Senior Vice President and Chief Accounting Officer
February 26, 2016
/S/ FRANK E. COLLINS (Frank E. Collins)
Director
February 26, 2016
/S/ W. ROBERT DAHL JR. (W. Robert Dahl Jr.)
Director
February 26, 2016
/S/ MARJORIE W. DORR (Marjorie W. Dorr)
Director
February 26,2016
/S/ DR. THOMAS P. GERRITY (Dr. Thomas P. Gerrity)
Director
February 26, 2016
/S/ THOMAS P. MAC MAHON (Thomas P. Mac Mahon)
Director
February 26, 2016
/S/ GEOFFREY G. MEYERS (Geoffrey G. Meyers)
Director
February 26, 2016
/S/ DR. ROBERT A. OAKLEY (Dr. Robert A. Oakley)
Director
February 26, 2016
/S/ PATRICK G. LEPORE (Patrick G. LePore)
Director
February 26, 2016
/S/ BERARD E. TOMASSETTI (Berard E. Tomassetti)
75
EXHIBIT INDEX Exhibit No.
Description
21.1
Subsidiaries of the Registrant
23.1
Consent of KPMG LLP
31.1
Certification of Chief Executive Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2
Certification of Chief Financial Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1
Certification of Chief Executive Officer, pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2
Certification of Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS
XBRL Instance Document.
101.SCH XBRL Taxonomy Extension Schema Document. 101.CAL XBRL Taxonomy Extension Calculation Linkbase Document. 101.DEF XBRL Taxonomy Extension Definition Linkbase Document. 101.LAB XBRL Taxonomy Extension Label Linkbase Document. 101.PRE XBRL Taxonomy Extension Presentation Linkbase Document. 76
Exhibit 31.1 CERTIFICATION I, Gregory S. Weishar, certify that: 1. I have reviewed this annual report on Form 10-K of PharMerica Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d -15(f)) for the registrant and have: a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c. Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d. Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. DATE: February 26, 2016 /S/ GREGORY S. WEISHAR Chief Executive Officer and Director
Exhibit 31.2 CERTIFICATION I, David W. Froesel, Jr., certify that: 1. I have reviewed this annual report on Form 10-K of PharMerica Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a -15(f) and 15d -15(f)) for the registrant and have: a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c. Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d. Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.
DATE: February 26, 2016 /S/ DAVID W. FROESEL, JR. Excecutive Vice President, Chief Financial Officer and Treasurer
Exhibit 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of PharMerica Corporation (the "Corporation") on Form 10-K for the year ended December 31, 2015 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Gregory S. Weishar, Chief Executive Officer and Director of the Corporation, certify, pursuant to18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Corporation. /S/ GREGORY S. WEISHAR Gregory S. Weishar Chief Executive Officer and Director February 26, 2016
Exhibit 32.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of PharMerica Corporation (the "Corporation") on Form 10-K for the year ended December 31, 2015 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, David W. Froesel, Jr., Executive Vice President, Chief Financial Officer and Treasurer of the Corporation, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Corporation. /S/ DAVID W. FROESEL, JR. David W. Froesel, Jr. Executive Vice President, Chief Financial Officer and Treasurer February 26, 2016
Exhibit 23.1
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Board of Directors PharMerica Corporation We consent to the incorporation by reference in the Registration Statements (Nos. 333-206452, 333-145137 and 333-195971) on Form S-8 of PharMerica Corporation of our report dated February 26, 2016 with respect to the consolidated balance sheets of PharMerica Corporation and subsidiaries as of December 31, 2014 and 2015 and the related consolidated statements of income, stockholders' equity and cash flows for each of the years in the three year period ended December 31, 2015 and the effectiveness of internal control over financial reporting as of December 31, 2015, which report appears in the December 31, 2015 annual report on Form 10-K of PharMerica Corporation. Our report dated February 26, 2016, on the effectiveness of internal control over financial reporting as of December 31, 2015, contains an explanatory paragraph that states management has excluded the 2015 Acquisitions from its assessment of internal control over financial reporting as of December 31, 2015 and that we have excluded the 2015 Acquisitions from our audit of internal control over financial reporting. /s/ KPMG LLP Louisville, Kentucky February 26, 2016
Exhibit 21.1 List of Subsidiaries Name of Entity PharMerica Holdings, Inc.
Place of Incorporation Delaware
UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549
FORM 10-Q (Mark One) ☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2015 or ☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from
to
.
Commission File Number: 001-33380
PHARMERICA CORPORATION (Exact name of registrant as specified in its charter) Delaware 87-0792558 (State or Other Jurisdiction of Incorporation or Organization) (I.R.S. Employer Identification No.) 1901 Campus Place Louisville, KY (Address of Principal Executive Offices)
40299 (Zip Code)
(502) 627-7000 (Registrant's Telephone Number, Including Area Code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. ☒ Yes ☐ No Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). ☒ Yes ☐ No Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. Large accelerated filer ☒
Accelerated filer☐
Non-accelerated filer ☐ (Do not check if a smaller reporting company)
Smaller reporting company ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ☐ Yes ☒ No Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Class of Common Stock Common stock, $0.01 par value
Outstanding at October 30, 2015 30,454,732 shares
PHARMERICA CORPORATION FORM 10-Q TABLE OF CONTENTS Page PART I. FINANCIAL INFORMATION Item 1.
Financial Statements (Unaudited) Condensed Consolidated Statements of Operations - For the Three and Nine Months Ended September 30, 2014 and 2015
3
Condensed Consolidated Balance Sheets - As of December 31, 2014 (As Adjusted) and September 30, 2015
4
Condensed Consolidated Statements of Cash Flows - For the Three and Nine Months Ended September 30, 2014 and 2015
5
Condensed Consolidated Statement of Stockholders' Equity - For the Nine Months Ended September 30, 2015
6
Notes to Condensed Consolidated Financial Statements
7
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
19
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
35
Item 4.
Controls and Procedures
35
PART II. OTHER INFORMATION
36
Item 1.
Legal Proceedings
36
Item 1A
Risk Factors
36
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
36
Item 4.
Mine Safety Disclosures
36
Item 6.
Exhibits
37
SIGNATURES
38
Exhibit Index
39 2
PHARMERICA CORPORATION CONDENSED CONSOLIDATED INCOME STATEMENTS For the Three and Nine Months Ended September 30, 2014 and 2015 (Unaudited) (In millions, except share and per share amounts)
Revenues Cost of goods sold Gross profit Selling, general and administrative expenses Amortization expense Merger, acquisition, integration costs and other charges Settlement, litigation and other related charges Restructuring and impairment charges Hurricane Sandy disaster costs Operating income Interest expense, net Loss on extinguishment of debt Income before income taxes Provision for income taxes Net income
Three Months Ended September 30, 2014 2015 $ 470.2 $ 498.8 387.2 420.2 83.0 78.6 56.0 52.7 4.9 7.0 3.8 8.0 1.1 2.1 0.1 0.2 0.1 17.1 8.5 2.1 2.1 4.3 10.7 6.4 2.2 3.4 $ 8.5 $ 3.0
Nine Months Ended September 30, 2014 2015 $ 1,371.0 $ 1,507.8 1,126.1 1,259.4 244.9 248.4 171.1 167.1 13.6 20.6 10.3 15.2 28.9 11.3 3.2 0.3 0.1 0.1 17.7 33.8 6.9 5.4 4.3 6.5 28.4 2.9 13.5 $ 3.6 $ 14.9
Earnings per common share: Basic Diluted
$ $
$ $
Shares used in computing earnings per common share: Basic Diluted
0.28 0.28 30,073,133 30,595,302
$ $
0.10 0.10 30,431,845 30,896,294
See accompanying Notes to Condensed Consolidated Financial Statements 3
0.12 0.12 29,944,875 30,502,928
$ $
0.49 0.48 30,336,548 30,798,834
PHARMERICA CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS As of December 31, 2014 and September 30, 2015 (Unaudited) (In millions, except share and per share amounts) (As Adjusted) December 31, 2014
September 30, 2015
ASSETS Current assets: Cash and cash equivalents Accounts receivable, net Inventory Deferred tax assets, net Income taxes receivable Prepaids and other assets
$
Equipment and leasehold improvements Accumulated depreciation
33.3 195.4 135.5 42.8 90.3 497.3
$
196.4 (125.0) 71.4
Goodwill Intangible assets, net Other $
323.6 177.6 4.1 1,074.0
40.0 195.8 117.5 37.2 9.2 52.6 452.3 210.3 (138.8) 71.5
$
341.8 165.2 29.2 1,060.0
LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable Salaries, wages and other compensation Current portion of long-term debt Income taxes payable Other accrued liabilities
$
Long-term debt Other long-term liabilities Deferred tax liabilities Commitments and contingencies (See Note 5) Stockholders' equity: Preferred stock, $0.01 par value per share; 1,000,000 shares authorized and no shares issued, December 31, 2014 and September 30, 2015 Common stock, $0.01 par value per share; 175,000,000 shares authorized; 32,725,786 and 33,227,551 shares issued as of December 31, 2014 and September 30, 2015, respectively Capital in excess of par value Retained earnings Treasury stock at cost, 2,617,305 and 2,774,268 shares at December 31, 2014 and September 30, 2015, respectively $ See accompanying Notes to Condensed Consolidated Financial Statements 4
96.0 35.1 6.3 2.3 38.5 178.2
$
83.3 34.3 11.4 38.2 167.2
344.4 57.6 15.7
326.0 55.7 14.2
-
-
0.3 394.1 117.0 (33.3) 478.1 1,074.0 $
0.3 402.3 131.9 (37.6) 496.9 1,060.0
PHARMERICA CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS For the Three and Nine Months Ended September 30, 2014 and 2015 (Unaudited) (In millions) Three Months Ended September 30, 2014 2015 Cash flows provided by (used in) operating activities: Net income Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation Amortization Merger, acquisition, integration costs and other charges Stock-based compensation and deferred compensation Amortization of deferred financing fees Deferred income taxes (Gain) Loss on disposition of equipment Loss (Gain) on acquisition/disposition Loss on debt extinguishment Other Change in operating assets and liabilities: Accounts receivable, net Inventory Prepaids and other assets Accounts payable Salaries, wages and other compensation Other accrued and long-term liabilities Change in income taxes payable (receivable) Excess tax benefit from stock-based compensation Net cash provided by (used in) operating activities
$
8.5
$
Nine Months Ended September 30, 2014 2015 3.0
$
3.6
$
14.9
4.9 4.9 1.8 0.5 (4.0) 0.1 4.3 -
5.7 7.0 1.7 0.1 2.1 -
14.5 13.6 2.5 5.7 1.8 (3.3) (0.1) (0.2) 4.3 0.1
17.2 20.6 5.4 0.4 4.6 0.1 0.1
(1.7) 14.9 (15.1) (2.4) 5.2 (5.7) 3.7 (0.2) 19.7
3.4 17.5 (7.7) 3.6 2.1 0.2 (1.0) (0.2) 37.5
10.4 (16.3) (26.2) (22.9) (2.7) 16.6 (0.4) (3.4) (2.4)
1.2 18.1 12.3 (11.9) (0.9) (10.2) (10.0) (2.3) 59.6
Cash flows provided by (used in) investing activities: Purchase of equipment and leasehold improvements Acquisitions, net of cash acquired Cash proceeds from the sale of assets Cash proceeds from dispositions Net cash used in investing activities
(6.2) (107.2) (113.4)
(6.6) (0.3) 0.1 (6.8)
(19.0) (124.8) 0.1 0.4 (143.3)
(17.6) (20.9) 0.2 (38.3)
Cash flows provided by (used in) financing activities: Repayments of long-term debt Borrowing of long-term debt Net activity of long-term revolving credit facility Payment of debt issuance costs Issuance of common stock Purchase of treasury stock Excess tax benefit from stock-based compensation Repayments of capital lease obligations Net cash provided by (used in) financing activities
(225.0) 225.0 92.0 (2.7) 0.4 (0.2) 0.2 89.7
(2.8) (9.0) (0.4) 0.2 (12.0)
(231.3) 225.0 135.9 (2.7) 3.4 (5.1) 3.4 128.6
(2.8) (10.0) 0.7 (4.3) 2.3 (0.5) (14.6)
18.7 21.3
(17.1) 24.2
6.7 33.3
Change in cash and cash equivalents Cash and cash equivalents at beginning of period
(4.0) 11.1
Cash and cash equivalents at end of period
$
7.1
$
40.0
$
7.1
$
40.0
Supplemental information: Cash paid for interest Cash paid for taxes
$ $
1.9 1.0
$ $
3.2 2.4
$ $
5.6 5.7
$ $
6.2 19.4
See accompanying Notes to Condensed Consolidated Financial Statements 5
PHARMERICA CORPORATION CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY For the Nine Months Ended September 30, 2015 (Unaudited) (In millions, except share amounts)
Balance at December 31, 2014 Net income Exercise of stock options and tax components of stock-based awards, net Vested restricted stock units Vested performance stock units Treasury stock at cost Stock-based compensation - non-vested restricted stock Stock-based compensation - stock options Balance at September 30, 2015
Common Stock Shares Amount 30,108,481 $ 0.3 139,133 219,625 143,007 (156,963) 30,453,283
$
Capital in Excess of Par Value $ 394.1
Retained Earnings $ 117.0 14.9
-
2.8 -
-
0.3
5.3 0.1 402.3
131.9
$
$
See accompanying Notes to Condensed Consolidated Financial Statements 6
Treasury Stock $ (33.3) $ (4.3)
$
(37.6) $
Total 478.1 14.9 2.8 (4.3) 5.3 0.1 496.9
PHARMERICA CORPORATION 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 leading provider of pharmacy services. The Corporation serves the long-term care, hospital pharmacy management services, specialty home infusion and specialty oncology pharmacy markets. The Corporation operates 94 institutional pharmacies, 15 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. 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. 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, 2014, included in the Corporation's Annual Report on Form 10-K. The balance sheet as of December 31, 2014 has been derived from the audited consolidated financial statements adjusted for acquisition related measurement period adjustments. 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, the valuation of long-lived assets and goodwill, and accounting for income taxes. 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.
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). 7
PHARMERICA CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (Unaudited) NOTE 1—ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) The financial liabilities recorded at fair value at December 31, 2014 and September 30, 2015 are set forth in the tables below (dollars in millions):
As of December 31, 2014 Financial Liability Deferred Compensation Plan Contingent Consideration Mandatorily Redeemable Interest
As of September 30, 2015 Financial Liability Deferred Compensation Plan Contingent Considerations Mandatorily Redeemable Interest
Liability $
Level 1 (8.0) $ (1.1) (8.3)
Liability $
Level 2 -
$
Level 1 (7.9) $ (9.0) (7.0)
(8.0) $ Level 2
-
$
Valuation Technique
Level 3 (1.1) (8.3)
Valuation Technique
Level 3 (7.9) $ -
A C C
(9.0) (7.0)
A C C
The deferred compensation plan liability represents an unfunded 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 the Corporation's acquisition of an institutional pharmacy business purchased in 2013 and two infusion businesses purchased in 2014 and 2015. 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 current and other 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"), purchased on December 6, 2013. 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's fair value of the liability at September 30, 2015. For the year ended December 31, 2014 and the nine months ended September 30, 2015, 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 consideration and mandatorily redeemable interest identified as Level 3 for the year ended December 31, 2014 and the nine months ended September 30, 2015 (in millions): Contingent Consideration Beginning balance, December 31, 2013 Additions from business acquisitions Change in fair value Balance, December 31, 2014 Additions from business acquisitions Change in fair value Balance, September 30, 2015
$
$
0.7 $ 1.1 (0.7) 1.1 7.9 9.0 $
Mandatorily Redeemable Interest 8.2 0.1 8.3 (1.3) 7.0
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 carrying amount of the Corporation's debt approximates fair value due to the interest being set at variable market interest rates (Level 2). 8
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 a 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 aging accounts receivable. This review is focused primarily on trends in private and other payers, PDP's, 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 institutional 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): (As Adjusted) December 31, 2014 $ 153.2 30.5 30.6 24.5 11.7 3.0 (58.1) $ 195.4
Institutional healthcare providers Medicare Part D Private payer and other Insured Medicaid Medicare Allowance for doubtful accounts
0 to 60 days 61 to 120 days Over 120 days
September 30, 2015 $ 157.3 27.4 30.2 25.4 10.0 3.2 (57.7) $ 195.8
58.8% 17.2% 24.0% 100.0%
58.9% 15.2% 25.9% 100.0%
The following is a summary of activity in the Corporation's allowance for doubtful accounts (dollars in millions): Beginning Balance Allowance for doubtful accounts: Year ended December 31, 2014 Nine months ended September 30, 2015
$ $
56.7 58.1
Charges to Costs and Expenses $ $
23.2 9.5
Write-offs $ $
Ending Balance
(21.8) $ (9.9) $
58.1 57.7
Goodwill and Other Intangibles The Corporation's policy is to perform a quantitative assessment of its institutional pharmacy and specialty infusion reporting units to determine whether it is more likely than not (defined as having a likelihood of more than 50 percent) that the fair value of a reporting unit is less than its carrying amount. The Corporation performed a quantitative assessment as of December 31, 2014. The fair values of the institutional pharmacy and specialty infusion reporting units as calculated for the analysis were approximately 48.2% and 13.1%, respectively, greater than book value as of December 31, 2014. The Corporation also performed a qualitative assessment of its specialty oncology reporting unit as of December 31, 2014 and did not find it necessary to perform the first step of the two-step impairment test based on that analysis. There were no impairment triggering events during the nine months ended September 30, 2015. The Corporation's finite-lived intangible assets are comprised primarily of trade names, customer relationship assets, limited distributor relationships, doctor and insurer relationships and non-compete agreements. Finite-lived intangible assets are amortized on a straight-line basis over the course of their lives ranging from 5 to 20 years. For impairment reviews, intangible assets are reviewed on a specific pharmacy basis or as a group of pharmacies depending on the intangible assets under review. The Corporation's goodwill and intangible assets are further described in Note 3. Restructuring and Impairment Charges Restructuring and impairment charges in the condensed consolidated financial statements represent amounts expensed for purposes of realigning corporate and pharmacy locations.
9
PHARMERICA CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (Unaudited) NOTE 1—ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Mandatorily Redeemable Interest The Corporation acquired 37.5% of the membership interests of Onco while also obtaining control of the business. The subsidiary is consolidated in the Corporation's condensed consolidated financial statements and the mandatorily redeemable interest is classified as debt within other long-term liabilities in the condensed consolidated balance sheets. Measurement Period Adjustments For the nine months ended September 30, 2015, the Corporation has adjusted certain amounts on the condensed consolidated balance sheet as of December 31, 2014 as a result of measurement period adjustments related to acquisitions completed in the prior year (See Note 2). NOTE 2—ACQUISITIONS 2015 Acquisition The Corporation through its wholly owned subsidiary, Amerita, acquired Coastal Pharmaceutical Services Corporation ("InfusionRx Acquisition") on January 28, 2015. The InfusionRx Acquisition had an estimated purchase price of $27.9 million, comprised of a net cash payment of $20.0 million and an estimated fair value of contingent consideration of $7.9 million. The resulting amount of goodwill and identifiable intangibles related to this transaction in the aggregate were $18.1 million and $8.2 million, respectively. The Corporation believes the resulting amount of goodwill reflects its expectation of synergistic benefits of the acquisition. Tax deductible goodwill associated with the acquisition was $18.1 million as of September 30, 2015. The net assets and operating results of the acquisition have been included in the Corporation's condensed consolidated financial statements from the date of acquisition. 2014 Acquisitions During the year ended December 31, 2014, the Corporation completed acquisitions of four long-term care businesses and one infusion business (collectively the "2014 Acquisitions"), none of which were individually significant to the Corporation. The 2014 Acquisitions required cash payments of approximately $115.2 million in the aggregate. The resulting amount of goodwill and identifiable intangibles related to these transactions in the aggregate were $40.9 million and $61.4 million, respectively. The Corporation believes the resulting amount of goodwill reflects its expectation of synergistic benefits of the acquisitions. Tax deductible goodwill associated with the 2014 Acquisitions was $30.7 million as of September 30, 2015. The net assets and operating results of the 2014 Acquisitions have been included in the Corporation's condensed consolidated financial statements from their respective dates of acquisition. Amounts contingently payable related to the 2014 Acquisitions, representing payments originating from an earn-out provision of the infusion acquisition, were $1.1 million as of December 31, 2014 and September 30, 2015. The amounts recognized as of the acquisition dates for the 2014 Acquisitions, on a combined basis, for assets acquired and liabilities assumed are as follows (dollars in millions): Amounts Recognized as of Acquisition Date Accounts receivable Inventory Deferred tax assets – current Other current assets Equipment and leasehold improvements Deferred tax assets Identifiable intangibles Goodwill Total Assets
$
Current liabilities Other long-term liabilities Total Liabilities
26.7 6.8 1.8 3.1 4.8 8.2 61.4 34.9 147.7
Measurement Period Adjustments $
26.4 6.9 33.3
Total purchase price, less cash acquired
$ 10
114.4
As Adjusted
(0.3) $ (0.2) (0.1) (3.5) 6.0 1.9 1.6 (0.5) 1.1
$
0.8
26.4 6.6 1.8 3.0 4.8 4.7 61.4 40.9 149.6 28.0 6.4 34.4
$
115.2
PHARMERICA CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (Unaudited) NOTE 2—ACQUISITIONS (Continued) Pro forma financial statements are not presented on the 2014 and 2015 acquisitions as the results are not material to the Corporation's condensed consolidated financial statements. Other For the three months ended September 30, 2014 and September 30, 2015, the Corporation incurred $3.7 million and $7.6 million, respectively, and $10.0 million and $14.7 million for the nine months ended September 30, 2014 and September 30, 2015, respectively, of acquisition-related costs, which have been classified as a component of merger, acquisition, integration costs and other charges. NOTE 3—GOODWILL AND INTANGIBLES As of December 31, 2014 (as adjusted) and September 30, 2015 the carrying amount of goodwill was $323.6 million and $341.8 million, respectively. The following table presents the components of the Corporation's finite lived intangible assets (dollars in millions): Balance at Balance at December 31, September 30, 2014 Additions 2015 $ 177.5 $ 7.0 $ 184.5 62.2 0.6 62.8 19.9 0.6 20.5 259.6 8.2 267.8 (82.0) (20.6) (102.6) $ 177.6 $ (12.4) $ 165.2
Finite Lived Intangible Assets Customer relationships Trade name Non-compete agreements Sub Total Accumulated amortization Net intangible assets
Amortization expense relating to finite-lived intangible assets was $4.9 million and $7.0 million for the three months ended September 30, 2014 and 2015, respectively. Amortization expense relating to finite-lived intangible assets was $13.6 million and $20.6 million for the nine months ended September 30, 2014 and 2015, respectively. NOTE 4—CREDIT AGREEMENT On September 17, 2014, the Corporation entered into a credit agreement 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 (the "Credit Agreement"). The Credit Agreement consists of a $225.0 million term loan facility and a $310.0 million revolving credit facility. The terms and conditions of the Credit Agreement are customary to facilities of this nature. As of September 30, 2015, $222.2 million was outstanding under the term loan facility and $115.0 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, 2014 Term Debt - payable to lenders at LIBOR plus applicable margin (2.19% as of September 30, 2015), matures September 17, 2019 $ Revolving Credit Facility payable to lenders, interest at LIBOR plus applicable margin (2.15% of September 30, 2015), matures September 17, 2019 Capital lease obligations Total debt Less: Current portion of long-term debt Total long-term debt
$
225.0
September 30, 2015 $
125.0 0.7 350.7 6.3 344.4
222.2 115.0 0.2 337.4 11.4
$
326.0
The Corporation's indebtedness has the following maturities as of September 30, 2015 (dollars in millions):
Year Ending December 31, 2015 2016 2017 2018
Term Debt $ 2.8 11.3 11.3 11.3
Revolving Credit Facility $
-
Capital Lease Obligations $ 0.2 -
Total Maturities $ 3.0 11.3 11.3 11.3
2019 $ 11
185.5 222.2
$
115.0 115.0
$
0.2
$
300.5 337.4
PHARMERICA CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (Unaudited) NOTE 4—CREDIT AGREEMENT (Continued) 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, 2015 was $3.0 million. After giving effect to the letters of credit, total availability under the revolving credit facility was $192.0 million as of September 30, 2015. 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 result 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 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, 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 October 29, 2013, a complaint was filed in the United States District Court for the Southern District of Florida by Pines Nursing Homes (77), Inc. as a putative class action against the Corporation. The complaint alleged that the Corporation sent unsolicited advertisements promoting the Corporation's goods or services by facsimile to individuals or entities, and that such communications did not include an opt-out clause, all in violation of the federal Telephone Consumer Protection Act ("TCPA"). The Complaint did not specify the amount of damages sought, but the TCPA provides a statutory remedy of $500 per facsimile communication sent in violation of the statute, which may be trebled in the event of a willful violation. On August 18, 2014, the Corporation entered into a Settlement Agreement with the putative class and class counsel resolving all claims raised in the complaint. The parties moved on September 8, 2014 for, among other things, certification of the putative class for the purposes of effectuating the settlement and preliminary approval of the parties' settlement, and have requested a hearing on that motion. On June 26, 2015 the court granted the Joint Motion for Preliminary Approval of the parties settlement and the court has scheduled the final approval hearing for November 12, 2015. On November 20, 2013 a complaint filed by a relator, Robert Gadbois, on behalf of the U.S. Government and various state governments, was unsealed by the United States District for the District of Rhode Island against the Corporation alleging that the Corporation dispensed controlled and noncontrolled substances in violation of the CSA 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 has appealed the court's decision. The Corporation intends to continue to defend the case vigorously. 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 alleging that the Corporation violated the FCA and Federal Anti-Kickback Statute through its agreements to provide prescription drugs to nursing homes under certain Medicare and Medicaid programs. 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. The Corporation intends to vigorously defend itself against these allegations. 12
PHARMERICA CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (Unaudited) NOTE 5—COMMITMENTS AND CONTINGENCIES (Continued) On January 31, 2014, a relator, Frank Kurnik, on behalf of the U.S. Government and various state governments served its complaint filed in the United States District for the District of South Carolina alleging that the Corporation solicited and received remuneration in violation of the Federal AntiKickback Statute from drug manufacturer Amgen in exchange for preferring and promoting Amgen's drug Aranesp over a competing drug called Procrit. The U.S. Government and the various states declined to intervene in the case. On April 7, 2014, the Corporation moved to dismiss the complaint and on July 23, 2014, the motion was denied. On January 13, 2015, the Corporation again moved to dismiss the complaint and on March 23, 2015, the second motion was denied. On April 2, 2015, the Corporation moved the court to reconsider its denial of the second motion to dismiss and that motion was denied. The Corporation intends to vigorously defend itself against these allegations. The U.S. Department of Justice, through the U.S. Attorney's Office for the Western District of Virginia, investigated whether the Company's activities in connection with the agreements it had with the manufacturer of the pharmaceutical Depakote violated the False Claims Act or the Anti-Kickback Statute. The Company cooperated with this investigation and believes that it has complied with applicable laws and regulations with respect to this matter. On May 29, 2014, the United States District Court for the Western District of Virginia entered an order unsealing two previously partially sealed qui tam complaints, entitled United States, et al., ex rel. Spetter v. Abbott Laboratories. Inc., Omnicare, Inc., and PharMerica Corp., No. 1:07-cv-00006 and United States, et al., ex rel. McCoyd v. Abbott Laboratories, Omnicare, Inc., PharMerica Corp., and Miles White, No. 1:07-cv-0008. The Corporation entered into a settlement agreement on October 6, 2015 with the Government including the Department of Justice, with approvals from the National Association of Medicaid Fraud Control and the Department of Health and Human Services Office of Inspector General. In the settlement, the Corporation agreed to pay $9.3 million to resolve the matter which was previously accrued for in the condensed consolidated balance sheet of the Corporation. 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 Amended Prime Vendor Agreement ("Amended PVA"). The Corporation subsequently filed a First Amended Verified Complaint on September 26, 2014 asserting additional breaches of the Amended 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. All these receivables totaled $53.0 million and were included in prepaids and other assets in the accompanying condensed consolidated balance sheet as of December 31, 2014. During the period of January 1, 2015 through March 31, 2015, an additional $18.5 million, net of payments received, of certain rebates and guarantees owed by ABDC under the Amended PVA were recognized which brought the total receivable to $71.5 million at March 31, 2015 and September 30, 2015. On March, 2, 2015, the Corporation notified ABDC of its intent to terminate the Amended PVA effective April 1, 2015. The Corporation also announced that it had entered into a Prime Vendor Agreement with Cardinal Health ("Cardinal") effective April 1, 2015. On March 3, 2015, the Corporation received a letter from ABDC terminating the Amended PVA effective immediately based upon the Corporation's alleged failure to pay certain disputed miscellaneous charges and the Corporation's signing of the Cardinal PVA. The Corporation believes ABDC did not have the right to immediately terminate the contract pursuant to the terms of the Amended PVA. On March 6 and March 13, 2015, the Corporation withheld from ABDC normal recurring payments for drug purchases of approximately $48.8 million. The following table represents all receivables, whether previously disputed or not, due and owing from ABDC at September 30, 2015 and the related amounts allegedly payable to ABDC, which have been offset resulting in a net receivable at September 30, 2015 of $22.7 million. This net receivable is included in other assets in the accompanying condensed consolidated balance sheet as of September 30, 2015. Presented in the condensed consolidated balance sheet, the following amounts are offset as of September 30, 2015 (in millions):
Gross Amount of Recognized Asset
Description
Gross Liability Offset in the Condensed Consolidated Balance Sheet
Net Amount of Asset Presented in the Condensed Consolidated Balance Sheet
Rebates & Other Receivables
$
71.5
$
(48.8) $
22.7
Total
$
71.5
$
(48.8) $
22.7
The Corporation will have claims for additional damages resulting from ABDC's breaches of the Amended 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, likely longer than 12 months. 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, 2015, the Corporation had accrued approximately $39.9 million in the aggregate related to the legal actions and investigations. 13
PHARMERICA CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (Unaudited) NOTE 5—COMMITMENTS AND CONTINGENCIES (Continued) California Medicaid On August 14, 2013, the California Department of Health Care Service ("DHCS") announced its intent to implement a ten percent (10%) reimbursement reduction for numerous healthcare providers, including long term care pharmacies. The DHCS implemented the reduction prospectively beginning in the first quarter of 2014. In addition, the DHCS implemented, beginning October 2015, recouping a percentage of provider payments representing a ten percent (10%) reduction on certain drug reimbursements retroactive to June 1, 2011 through February 6, 2014. The Corporation has previously recorded a $3.3 million liability and reduction of revenue for the expected amount of recoveries from June 1, 2011 through December 31, 2013. NOTE 6—MERGER, ACQUISITION, INTEGRATION COSTS AND OTHER CHARGES Merger, acquisition, integration costs and other charges combined were $3.8 million and $8.0 million for the three months ended September 30, 2014 and 2015, respectively, and $10.3 million and $15.2 million for the nine months ended September 30, 2014 and 2015, respectively. Merger, integration costs and other charges for the three months ended September 30, 2014 and 2015 were $0.1 million and $0.4 million, respectively, and $0.3 million and $0.5 million for the nine months ended September 30, 2014 and 2015, respectively. Acquisition related costs for the three months ended September 30, 2014 and 2015 were $3.7 million and $7.6 million, respectively, and $10.0 million and $14.7 million for the nine months ended September 30, 2014 and 2015, respectively. NOTE 7—RESTRUCTURING COSTS AND OTHER CHARGES In July 2013, the Corporation commenced the implementation of its restructuring plan as a result of the loss of two of the Corporation's significant customers, Kindred Healthcare ("Kindred") and Golden Living. The plan is a major initiative primarily designed to optimize operational efficiency while ensuring that the Corporation remains well-positioned to serve its clients and achieve sustainable, long-term growth. The Corporation's restructuring plan includes steps to right size its cost structure by adjusting its workforce and facility plans to reflect anticipated business needs. In addition, in the third quarter ended September 30, 2015, the Corporation began a restructuring and centralization initiative related to its specialty pharmacy business. The initiative is not expected to be material to the financial statements. The Corporation recorded restructuring costs and other related charges of approximately of $0.1 million and $0.2 million during the three months ended September 30, 2014 and 2015, respectively, and $3.2 million and $0.3 million for the nine months ended September 30, 2014 and 2015, 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, 2014 $ 0.3 1.1 $ 1.4
Employee Severance and related costs Facility costs
Accrual $ $
0.3 0.3
Balance at Utilized September 30, Amounts 2015 $ (0.6) $ (0.4) 0.7 $ (1.0) $ 0.7
The liability at September 30, 2015 represents amounts not yet paid relating to actions taken in connection with the restructuring plan (primarily lease payments and severance costs). 14
PHARMERICA CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (Unaudited) NOTE 8—COMMON STOCK, PREFERRED STOCK, TREASURY STOCK, STOCK-BASED COMPENSATION AND OTHER BENEFITS 2015 Omnibus Incentive Plan Effective April 29, 2015, the Corporation adopted the PharMerica Corporation 2015 Omnibus Incentive Plan (the "Omnibus Plan") under which the Corporation is authorized to grant equity-based and other awards to its employees, officers, directors, and consultants. The Omnibus Plan replaced the Amended and Restated PharMerica Corporation 2007 Omnibus Incentive Plan (the "Prior Plan"). The Corporation has reserved 2,000,000 shares of its common stock for awards to be granted under the Omnibus Plan, subject to certain increases and reductions for grants under the Prior Plan. The following shares shall be added back to the number of shares available for grant under the Omnibus Plan: (i) shares covered by an award that expire or are forfeited, canceled, surrendered, or otherwise terminated without the issuance of such shares; (ii) shares covered by an award that are settled only in cash; and (iii) shares withheld by the Corporation or any subsidiary to satisfy a tax withholding obligation with respect to full value awards granted pursuant to the Omnibus Plan. However, shares surrendered for the payment of the exercise price under stock options (or options outstanding under the Prior Plan), shares repurchased by us with option proceeds (or option proceeds under the Prior Plan), and shares withheld for taxes upon exercise or vesting of an award other than a full value award (or an award other than a full value award under the Prior Plan), will not again be available for issuance under the Omnibus Plan. In addition, if a stock appreciation right ("SAR") (or SAR under the Prior Plan) is exercised and settled in shares, all of the shares underlying the SAR will be counted against the Omnibus Plan limit regardless of the number of shares used to settle the SAR. The Omnibus Plan provides for certain limits on issuances of certain types of awards and awards to certain recipients. The Omnibus Plan prohibits share recycling for stock options and stock appreciation rights, meaning that shares used to pay the exercise price or tax withholding for those awards are not added back to the share reserve. The Corporation's Compensation Committee administers the Omnibus Plan and has the authority to determine the recipient of the awards, the types of awards, the number of shares covered, and the terms and conditions of the awards. The Omnibus Plan allows for grants of incentive stock options, nonqualified stock options, stock appreciation rights, restricted share and restricted stock units, deferred shares, performance awards, including cash bonus awards, and other stock-based awards. The Corporation's Compensation Committee may condition the vesting, exercise or settlement of any award upon the achievement of one or more performance objectives. Stock options granted to officers and employees under the Omnibus Plan generally vest in four equal annual installments and have a term of seven years. The restricted stock units granted to officers generally vest in three equal annual installments. The restricted stock units granted to members of the Board of Directors vest in one annual installment. The performance share units granted under the Omnibus Plan vest based upon the achievement of a target amount of the Corporation's adjusted earnings before interest, income taxes, depreciation and amortization, which reinforces the importance of achieving the Corporation's profitability objectives. The performance is generally measured over a three-year period. As of September 30, 2015, total shares available for grants of stock-based awards pursuant to the Omnibus Plan were 1,851,155 shares. 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 was 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, 2015. 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, 2015, the Corporation repurchased no shares of common stock. The Corporation may redeem shares from employees upon the vesting of the Corporation's stock awards for minimum statutory tax withholding purposes and to cover option exercise costs. The Corporation redeemed 156,963 shares from the vesting of certain awards and exercise of certain stock options, for an aggregate price of approximately $4.3 million during the nine months ended September 30, 2015. These shares have also been designated by the Corporation as treasury stock. 15
PHARMERICA CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (Unaudited) NOTE 8—COMMON STOCK, PREFERRED STOCK, TREASURY STOCK, STOCK-BASED COMPENSATION AND OTHER BENEFITS (Continued) Stock Option Activity Stock options were not granted to officers and employees during 2014 or the nine months ended September 30, 2015. The following table summarizes option activity for the periods presented:
Outstanding shares at December 31, 2014 Exercised Canceled Expired Outstanding shares at September 30, 2015 Exercisable shares at September 30, 2015
WeightedAverage Exercise Number of Price Shares Per Share 913,209 $ 14.62 (139,133) 15.43 (122,268) 11.74 (303) 13.42 651,505 $ 14.30 651,505 $ 14.30
WeightedAverage Aggregate Remaining Intrinsic Value Term (in millions) 2.1 years $ 5.6
1.55 years $ 1.55 years $
9.2 9.2
Nonvested Shares The following table summarizes nonvested share activity for the periods presented: WeightedAverage Number of Grant Date Shares Fair Value 942,021 $ 18.00 171,619 28.87 155,831 26.60 (6,929) 22.58 (362,632) 16.23 899,910 $ 22.24
Outstanding shares at December 31, 2014 Granted - Restricted Stock Units Granted - Performance Share Units Forfeited Vested Outstanding shares at September 30, 2015
The weighted average remaining term and intrinsic value of non-vested shares as of September 30, 2015 was 2.9 years and $25.6 million, respectively. 16
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): 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 Nine Months Ended September 30, 30, 2014 2015 2014 2015 $ 2.2 $ 3.4 $ 2.9 $ 13.5 20.6% 53.1% 44.6% 47.5%
Provision for income taxes Total provision as a percentage of pre-tax income
The increase in our provision for income taxes as a percentage of pre-tax income for the nine months ended September 30, 2015 compared to the comparable 2014 period was due primarily to increases in the amount of pre-tax income as well as certain non-deductible employee compensation costs and discrete items. The provision for income taxes for the nine months ended September 30, 2014 was significantly impacted by the Corporation's $26.6 million of legal charges. The effective tax rates in 2015 are higher than the federal statutory rate largely as a result of the combined impact of state and local taxes, various non-deductible expenses, and discrete events. The discrete events for the nine months ended September 30, 2015 included a non-deductible $4.4 million legal charge and $1.2 million of other items. 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 tax basis of the Corporation's tax deductible goodwill was approximately $145.3 million and $152.6 million at December 31, 2014 and September 30, 2015, 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, 2015, the Corporation has $20.4 million ($7.1 million tax benefit) of federal net operating loss carryforwards available related to a 2014 acquisition. The Corporation's ability to utilize these loss carryovers is limited, but the Corporation expects that it will be able to use the recorded amount which takes into account the limitations of the carryforwards. Accordingly, the Corporation has not recorded any valuation allowance for the associated deferred tax asset. The Corporation has state net operating loss carryforwards representing a tax benefit of $3.6 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 $27.1 million at December 31, 2014 (as adjusted) and $23.0 million at September 30, 2015, net of state valuation allowances of $4.1 million as of both periods. As of December 31, 2014 and September 30, 2015, 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 2012 through 2014. The IRS completed its audit of the Corporation's consolidated U.S. income tax return for the 2011 tax year in February 2014. 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 2009. 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. 17
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, 2014 2015 Numerator: Numerator for basic and diluted earnings per share - net income Denominator: Denominator for basic earnings per share - weighted average shares Effect of dilutive securities (stock options, restricted stock units and performance share units) Denominator for earnings per diluted share - adjusted weighted average shares Basic earnings per share Earnings per diluted share Unexercised employee stock options and unvested restricted shares excluded from the effect of dilutive securities above (a)
$
$ $
8.5
$
3.0
Nine Months Ended September 30, 2014 2015 $
3.6
$
14.9
30,073,133
30,431,845
29,944,875
30,336,548
522,169 30,595,302 0.28 0.28
464,449 30,896,294 0.10 0.10
558,053 30,502,928 0.12 0.12
462,286 30,798,834 0.49 0.48
465,377
$ $
197
$ $
481,844
$ $
504
(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. 18
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS This Quarterly Report on Form 10-Q contains forward-looking statements, within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which reflect the Corporation's current estimates, expectations and projections about the Corporation's future results, performance, prospects and opportunities. Forward looking statements include, among other things, the information concerning the Corporation's possible future results of operations including revenues, costs of goods sold, and gross margin, business and growth strategies, financing plans, the Corporation's competitive position and the effects of competition, the projected growth of the industries in which we operate, and the Corporation's ability to consummate strategic acquisitions. Forward-looking statements include statements that are not historical facts and can be identified by forward-looking words such as "anticipate," "believe," "could," "estimate," "expect," "intend," "plan," "may," "should," "will," "would," "project," and similar expressions. These forward-looking statements are based upon information currently available to the Corporation and are subject to a number of risks, uncertainties and other factors that could cause the Corporation's actual results, performance, prospects or opportunities to differ materially from those expressed in, or implied by, these forward-looking statements. Important factors that could cause the Corporation's actual results to differ materially from the results referred to in the forward-looking statements the Corporation makes in this report include: • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • •
the Corporation's access to capital, credit ratings, indebtedness, and ability to raise additional financings and operate under the terms of the Corporation's debt obligations; anti-takeover provisions of the Delaware General Corporation Law, which in concert with our certificate of incorporation and our by-laws could delay or deter a change in control; the effects of adverse economic trends or intense competition in the markets in which we operate; the Corporation's risk of loss of revenues due to a customer or owner of skilled nursing facility entering the institutional pharmacy business; the effects of the loss of a large customer and the Corporation's ability to adequately restructure its operations to offset the loss; the demand for the Corporation's products and services; the risk of retaining existing customers and service contracts and the Corporation's ability to attract new customers for growth of the Corporation's business; the effects of renegotiating contract pricing relating to significant customers and suppliers, including the hospital pharmacy business which is substantially dependent on service provided to one customer; the impacts of cyber security risks and/or incidents; the effects of a failure in the security or stability of our technology infrastructure, or the infrastructure of one or more of our key vendors, or a significant failure or disruption in service; the effects of an increase in credit risk, loss or bankruptcy of or default by any significant customer, supplier, or other entity relevant to the Corporation's operations; the Corporation's ability to successfully pursue the Corporation's development and acquisition activities and successfully integrate new operations and systems, including the realization of anticipated revenues, economies of scale, cost savings, and productivity gains associated with such operations; the Corporation's ability to control costs, particularly labor and employee benefit costs, rising pharmaceutical costs, and regulatory compliance costs; the effects of healthcare reform and government regulations, including interpretation of regulations and changes in the nature and enforcement of regulations governing the healthcare and institutional pharmacy services industries including the dispensing of antipsychotic prescriptions; changes in the reimbursement rates or methods of payment from Medicare and Medicaid and other third party payers to both us and our customers; the potential impact of state government budget shortfalls and their ability to pay the Corporation and its customers for services provided; the Corporation's ability, and the ability of the Corporation's customers, to comply with Medicare or Medicaid reimbursement regulations or other applicable laws; the effects of changes in the interest rate on the Corporation's outstanding floating rate debt instrument and the increases in interest expense, including increases in interest rate terms on any new debt financing; further consolidation of managed care organizations and other third party payers; political and economic conditions nationally, regionally, and in the markets in which the Corporation operates; natural disasters, war, civil unrest, terrorism, fire, floods, tornadoes, earthquakes, hurricanes, epidemic, pandemic, catastrophic event or other matters beyond the Corporation's control; increases in energy costs, including state and federal taxes, and the impact on the costs of delivery expenses and utility expenses; elimination of, changes in, or the Corporation's failure to satisfy pharmaceutical manufacturers' rebate programs; the Corporation's ability to attract and retain key executives, pharmacists, and other healthcare personnel; the Corporation's risk of loss not covered by insurance; the outcome of litigation to which the Corporation is a party from time to time, including adverse results in material litigation or governmental inquiries including the possible insufficiency of any accruals established by the Corporation from time to time; changes in accounting rules and standards, audits, compliance with the Sarbanes-Oxley Act, and regulatory investigations; changes in market conditions that would result in the impairment of goodwill or other assets of the Corporation; changes in market conditions in which we operate that would influence the value of the Corporation's stock; the uncertainty as to the long-term value of the Corporation's common stock; the Corporation's ability to anticipate a shift in demand for generic drug equivalents and the impact on the financial results including the negative impact on brand drug rebates; the effect on prescription volumes and the Corporation's net revenues and profitability if the safety risk profiles of drugs increase or if drugs are withdrawn from the market, including as a result of manufacturing issues, or if prescription drugs transition to over-the-counter products; the effects on the Corporation's results of operations related to interpretations of accounting principles by the SEC staff that may differ from those of management; 19
• • • • • •
the potential impact of the litigation proceedings with ABDC regarding the Amended PVA; the Corporation's ability to comply with the terms of its Memorandum of Agreement with the DEA and the Corporate Integrity Agreement with the OIG; the Corporation's ability to collect outstanding receivables; changes in tax laws and regulations; the effects of changes to critical accounting estimates; and other factors, risks and uncertainties referenced in the Corporation's filings with the Commission, including the "Risk Factors" set forth in the Corporation's Annual Report on Form 10-K for the year ended December 31, 2014.
YOU ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON ANY FORWARD-LOOKING STATEMENTS, ALL OF WHICH SPEAK ONLY AS OF THE DATE OF THIS QUARTERLY REPORT. EXCEPT AS REQUIRED BY LAW, WE UNDERTAKE NO OBLIGATION TO PUBLICLY UPDATE OR RELEASE ANY REVISIONS TO THESE FORWARD-LOOKING STATEMENTS TO REFLECT ANY EVENTS OR CIRCUMSTANCES AFTER THE DATE OF THIS QUARTERLY REPORT OR TO REFLECT THE OCCURRENCE OF UNANTICIPATED EVENTS. ALL SUBSEQUENT WRITTEN AND ORAL FORWARD-LOOKING STATEMENTS ATTRIBUTABLE TO US OR ANY PERSON ACTING ON THE CORPORATION'S BEHALF ARE EXPRESSLY QUALIFIED IN THEIR ENTIRETY BY THE CAUTIONARY STATEMENTS CONTAINED OR REFERRED TO IN THIS SECTION AND IN OUR RISK FACTORS SET FORTH IN PART I, ITEM 1A OF THE CORPORATION'S ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2014 AND IN OTHER REPORTS FILED WITH THE SEC BY THE CORPORATION. 20
General The condensed consolidated financial statements and Management's Discussion and Analysis of Financial Condition and Results of Operations included in this quarterly report on Form 10-Q as of and for the three and nine months ended September 30, 2015, reflect the financial position, results of operations, and cash flows of the Corporation. Unless the context otherwise requires, all references to "we," "us," "our," and "Corporation" refer to PharMerica Corporation and its subsidiaries. Institutional Pharmacy Business Our core business provides pharmacy products and services to residents and patients in skilled nursing facilities, nursing centers, assisted living facilities, hospitals, and other long-term alternative care settings. We purchase, repackage, and dispense prescription and non-prescription pharmaceuticals in accordance with physician orders and deliver such medication to healthcare facilities for administration to individual patients and residents. Depending on the specific location, we service healthcare facilities typically within a radius of 120 miles or less of our pharmacy locations at least once each day. We provide 24-hour, seven-day per week on-call pharmacist services for emergency dispensing, delivery, and/or consultation with the facility's staff or the resident's attending physician. We also provide various supplemental healthcare services that complement our institutional pharmacy services. We offer prescription and non-prescription pharmaceuticals to our customers through unit dose or modified unit dose packaging, dispensing, and delivery systems, typically in a 14 to 30 day supply. Unit dose medications are packaged for dispensing in individual doses as compared to bulk packaging used by most retail pharmacies. The customers we serve prefer the unit dose delivery system over the bulk delivery system employed by retail pharmacies because it improves control over the storage and ordering of drugs and reduces errors in drug administration in healthcare facilities. Nursing staff in our customers' facilities administer the pharmaceuticals to individual patients and residents. The Corporation also utilizes an on-site dispensing system, with real time data transfer between the system and the Corporation, which provides timely medication administration in emergency and first dose situations. We also offer clinical pharmacy programs that encompass a wide range of drug therapy and disease management protocols, including protocols for anemia treatment, infectious diseases, wound care, nutritional support, renal dosing, and therapeutic substitution. Our computerized dispensing and delivery systems are designed to improve efficiency and control over distribution of medications to patients and residents. We provide computerized physician orders and medication administration records for patients or residents on a monthly basis as requested. Data from these records are formulated into monthly management reports on patient and resident care and quality assurance. This system improves efficiencies in nursing time, reduces drug waste, and helps to improve patient outcomes. Hospital Pharmacy Management Services We also provide hospital pharmacy management services. These services generally entail the overall management of the hospital pharmacy operations, including the ordering, receipt, storage, and dispensing of pharmaceuticals to the hospital's patients pursuant to the clinical guidelines established by the hospital. We offer the hospitals a wide range of regulatory and financial management services, including inventory control, budgetary analysis, staffing optimization, and assistance with obtaining and maintaining applicable regulatory licenses, certifications, and accreditations. We work with the hospitals to develop and implement pharmacy policies and procedures, including drug formulary development and utilization management. We also offer clinical pharmacy programs that encompass a wide range of drug therapy and disease management protocols, including protocols for anemia treatment, infectious diseases, wound care, nutritional support, renal dosing, and therapeutic substitution. The hospital pharmacy management services business is comprised of a few customers, of which, our largest service is to the majority of the Kindred Healthcare ("Kindred") hospitals. Consultant Pharmacist Services Federal and state regulations mandate that long-term care facilities, in addition to providing a source of pharmaceuticals, retain consultant pharmacist services to monitor and report on prescription drug therapy in order to maintain and improve the quality of resident care. On September 30, 2008, the United States Department of Health and Human Services Office of Inspector General ("OIG") published OIG Supplemental Compliance Program Guidance for Nursing Homes. With quality of care being the first risk area identified, the supplemental guidance is part of a series of recent government efforts focused on improving quality of care at skilled nursing and long-term care facilities. The guidance contains compliance recommendations and an expanded discussion of risk areas. The guidance stressed that facilities must provide pharmaceutical services to meet the needs of each resident and should be mindful of potential quality of care problems when implementing policies and procedures on proper medication management. It further stated that facilities can reduce risk by educating staff on medication management and improper pharmacy kickbacks for consultant pharmacists and that facilities should review the total compensation paid to consultant pharmacists to ensure it is not structured in a way that reflects the volume or value of particular drugs prescribed or administered to residents. We provide consultant pharmacist services to approximately 67% of our patients serviced. The services offered by our consultant pharmacists include: · · · · ·
Monthly reviews of each resident's drug regimen to assess the appropriateness and efficiency of drug therapies, including the review of medical records, monitoring drug interactions with other drugs or food, monitoring laboratory test results, and recommending alternative therapies; Participation on quality assurance and other committees of our customers, as required or requested by such customers; Monitoring and reporting on facility-wide drug utilization; Development and maintenance of pharmaceutical policy and procedure manuals; and Assistance with federal and state regulatory compliance pertaining to resident care.
Medical Records The Corporation provides medical records services, which includes the completion and maintenance of medical record information for patients in the Corporation's customers' facilities. The medical records services include: · · · · ·
Real-time access to medication and treatment administration records, physician order sheets and psychotropic drug monitoring sheets; Online ordering to save time and resources; A customized database with the medication profiles of each resident's medication safety, efficiency and regulatory compliance; Web-based individual patient records detailing each prescribed medicine; and Electronic medical records to improve information to make it more legible and instantaneous.
21
Specialty Infusion Services The Corporation provides specialty infusion services focused on providing complex pharmaceutical products and clinical services to patients in client facilities, hospice, and outside of hospital or nursing home settings. We offer high-touch clinical services to patients with acute or chronic conditions. The delivery of specialty infusion therapy requires comprehensive planning and monitoring which is provided through our registered nursing staff. Our nursing staff performs an initial patient assessment, provides therapy specific training and education, administers therapy and monitors for potential side effects. We also provide extensive clinical monitoring and patient follow-up to ensure patient therapy adherence and proactively manage patients' conditions. An in-network strategy facilitates easier decision-making for referral sources and provides us with the ability to pre-authorize patients, auto adjudicate, and bill electronically, enabling faster prescription turnaround. Specialty Oncology Pharmacy We provide dispensing of oncology drugs, care management and other related services to patients, oncology practices, and hospitals. These services encompass clinical coordination and review, compliance to appropriate oncology protocols, patient assistance with outside funding, and timely delivery of medication. We coordinate the administration of medications to the physician's office or directly to the patient at the appropriate point of treatment. We work directly with the payers to bill insurance companies for the medication provided, ensuring all prior authorizations and approvals are obtained. These services offer physicians an alternative to the traditional buy-and-bill distribution model, allowing them to outsource drug procurement, inventory management, and prescription administration. Suppliers/Inventory We obtain pharmaceutical and other products from Cardinal Health ("Cardinal") and other contracts negotiated directly with pharmaceutical manufacturers for discounted prices. The Corporation entered into a Prime Vendor Agreement with Cardinal effective April 1, 2015. The loss of a supplier could adversely affect our business if alternate sources of supply are unavailable. We seek to maintain an on-site inventory of pharmaceuticals and supplies to ensure prompt delivery to our customers. Cardinal maintains local distribution facilities in most major geographic markets in which we operate. In addition, beginning in the fourth quarter of 2013, we began supplying many of our pharmacies with select products from a distribution center operated by a third-party logistics company. Brand to Generic Conversions The following table summarizes the material brand-to-generic conversions expected to occur in 2015 through 2018: 2015 Patanol (Q4) Renagel (Q4) Renvela(Q4)
2016 Gleevec (Q1) Nuedexta (Q1) Combivent (Q2) Crestor (Q2) Cubicin (Q2) Tamiflu (Q3) Kaletra (Q4) Seroquel XR (Q4) Zetia (Q4)
2017 Azilect (Q1) Vytorin (Q2)
2018 Nasonex (Q2)
(Number in parentheses refers to the expected quarter of conversion)
When a branded drug shifts to a generic, initial pricing of the generic drug in the market will vary depending on the number of manufacturers launching their generic version of the drug. Historically a shift from brand-to-generic decreased our revenue and improved our gross margin from sales of these classes of drugs during the initial time period a brand drug has a generic alternative. However, recent experience has indicated that the third-party payers may reduce their reimbursements to the Corporation faster than previously experienced. In addition, the number of generic manufacturers entering the market impacts the overall cost and reimbursement of generic drugs. This acceleration in the reimbursement reduction and the number of generic manufacturers have resulted in margin compression much earlier than we have historically experienced. Due to the unique nature of the brand-to-generic conversion, management cannot estimate the future financial impact of the brand-to-generic conversions on the Corporation's results of operations. Supplier and Manufacturer Rebates We currently receive rebates from certain manufacturers and distributors of pharmaceutical products for achieving targets of market share or purchase volumes. Rebates are designed to prefer, protect, or maintain a manufacturer's products that are dispensed by the pharmacy under its formulary. Rebates for brand name products are generally based upon achieving a defined market share tier within a therapeutic class and can be based on either purchasing volumes or actual prescriptions dispensed. Rebates for generic products are more likely to be based on achieving purchasing volume requirements. 2010 Health Care Reform Legislation The Patient Protection and Affordable Care Act and the reconciliation law known as Health Care and Education Affordability Reconciliation Act (combined we refer to both Acts as the "2010 Health Care Reform Legislation") were enacted in March 2010. State participation in the expansion of Medicaid under the 2010 Health Care Reform Legislation is voluntary. Three key provisions of the 2010 Health Care Reform Legislation that are relevant to the Corporation are: (i) the gradual modification to the calculation of the Federal Upper Limit ("FUL") for drug prices and the definition of Average Manufacturer's Price ("AMP"), (ii) the closure, over time, of the Medicare Part D coverage gap, which is otherwise known as the "Donut Hole," and (iii) short cycle dispensing. Regulations under the 2010 Health Care Reform Legislation are expected to continue being drafted, released, and finalized throughout the
next several years. 22
FUL and AMP Changes The reimbursement rates for pharmacy services under Medicaid are determined on a state-by-state basis subject to review by Centers for Medicare and Medicaid Services ("CMS") and applicable federal law. Although Medicaid programs vary from state to state, they generally provide for the payment of certain pharmacy services, up to the established limits, at rates determined in accordance with each state's regulations. Federal regulations and the regulations of certain states establish "upper limits" for reimbursement of certain prescription drugs under Medicaid (these upper limits being the "FUL"). The 2010 Health Care Reform Legislation amended the Deficit Reduction Act of 2005 (the "DRA") to change the definition of the FUL by requiring the calculation of the FUL as no less than 175% of the weighted average, based on utilization, of the most recently reported monthly AMP for pharmaceutically and therapeutically equivalent multi-source drugs available through retail community pharmacies nationally. In addition, the definition of AMP changed to reflect net sales only to drug wholesalers that distribute to retail community pharmacies and to retail community pharmacies that directly purchase from drug manufacturers. Further, the 2010 Health Care Reform Legislation continues the current statutory exclusion of prompt pay discounts offered to wholesalers and adds three other exclusions to the AMP definition: (i) bona fide services fees;(ii) reimbursement for unsalable returned goods (recalled, expired, damaged, etc.); and (iii) payments from and rebates/discounts to certain entities not conducting business as a wholesaler or retail community pharmacy. In addition to reporting monthly, the manufacturers are required to report the total number of units used to calculate each monthly AMP. CMS will use this information when it establishes FULs as a result of the new volume-weighted requirements pursuant to the 2010 Health Care Reform Legislation. In September 2011, CMS issued the first draft FUL reimbursement files for multiple source drugs, including the draft methodology used to calculate the FULs in accordance with the 2010 Health Care Reform Legislation. CMS continues to release this monthly data and a three-month rolling average and is expected to do so going forward. CMS has not posted monthly AMPs for individual drugs, but only posted the weighted average of monthly AMPs in a FUL group and the calculation methodology. CMS has stated that AMP-based FULSs will be published at or about the same time that CMS publishes the Medicaid Covered Outpatient Drug final rule. On August 4, 2015, the Office of the Management and Budget (the "OMB") received the Medicaid Covered Outpatient Drug final rule for final review. The OMB website stated that it expected final action on this rule in August 2015; however, final action has not yet been taken. CMS will continue to post draft monthly FULs. The Corporation will continue to analyze the draft monthly FULs, including the relationship of those FULs to the National Average Drug Acquisition pricing. Part D Coverage Gap Starting on January 1, 2011, the Medicare Coverage Gap Discount Program (the "Program") requires drug manufacturers to provide a 50% discount on the negotiated ingredient cost to certain Medicare Part D beneficiaries for certain drugs and biologics purchased during the coverage gap (this is exclusive of the pharmacy dispensing fee). In addition, the 2010 Health Care Reform Legislation requires Medicare to close or eliminate the coverage gap entirely by fiscal year 2020 by gradually reducing the coinsurance percentage for both drugs covered and not covered by the Program for each applicable beneficiary. At this time, the Corporation is unable to fully evaluate the impact of the changes to the coverage gap to its business. Short Cycle Dispensing and Dispensing Fees Pursuant to the 2010 Health Care Reform Legislation, Prescription Drug Plans ("PDPs") are required, under Medicare Part D and Medicare Advantage prescription drug plans ("Medicare Advantage" or "MAPDs") to utilize specific, uniform dispensing techniques, such as weekly, daily, or automated dose dispensing, when dispensing covered Medicare Part D drugs to beneficiaries who reside in a long-term care facility to reduce waste associated with 30 to 90 day prescriptions for such beneficiaries. Pursuant to CMS issued regulation, beginning January 1, 2013, pharmacies dispensing to long-term care facilities must dispense no more than 14-day supplies of brand-name oral solid medications covered by Medicare Part D. The Corporation fully implemented short cycle dispensing on January 1, 2013. The impact of short cycle dispensing has not had a material adverse impact on the Corporation's results of operations. In a February 12, 2015 Final Rule entitled "Medicare Program: Contract Year 2016 Policy and Technical Changes to the Medicare Advantage and the Medicare Prescription Drug Benefit Programs", CMS finalized a regulation, effective January 1, 2016, prohibiting financial arrangements that penalize more efficient long-term care dispensing techniques (e.g., dispensing a three day supply over a 14-day supply) through pro-rated dispensing fees based on a day's supply or quantity dispensed. CMS also finalized a requirement that, effective January 1, 2016, any differences in payment methodologies among long-term care pharmacies incentivize more efficient dispensing techniques. The Corporation is unable to evaluate the full impact of these changes on its business at this time. Medicare Part D Changes In a May 23, 2014 Final Rule entitled "Medicare Program: Contract Year 2015 Policy and Technical Changes to the Medicare Advantage and the Medicare Prescription Drug Benefit Programs," CMS finalized a requirement that applicable January 1, 2016 and enforceable June 1, 2016, certain prescribers of Part D covered drugs must be enrolled as Medicare providers (or be granted a valid opt-out affidavit on file with a Part A or Part B Medicare Administrative Contractor) in order for a claim to be covered under Medicare Part D. CMS also finalized several specific requirements to reduce prescriber fraud, waste, and abuse. The Corporation is unable to evaluate the full impact of these changes on its business at this time. 23
CIA and DEA MOA In May 2015, the Corporation entered into a five-year corporate integrity agreement ("CIA") with the OIG and a Memorandum of Agreement ("MOA") with the Drug Enforcement Agency ("DEA") concurrent with the execution of settlement agreements with the OIG and the DEA settling alleged Controlled Substance Act ("CSA") violations and associated False Claims Act allegations. The CIA requires the Corporation, among other things to: (i) create procedures designed to ensure it complies with the CSA and related regulations; (ii) retain an independent review organization to review the Corporation's compliance with the terms of the CIA and report to the OIG regarding that compliance; and (iii) provide training for certain Corporation employees as to the Corporation's requirements under the CSA. If the Corporation fails to comply with the terms of the CIA, it may be required to pay certain monetary penalties. Furthermore, if the Corporation commits a material breach of the CIA, the OIG may exclude the Corporation from participating in federal healthcare programs. Any such exclusion would result in the revocation or termination of contracts and/or licenses and potentially have a material adverse effect on our financial condition, results of operations and business prospects. The MOA provides for an independent obligation for the Corporation to comply with all requirements of the CSA, specifically relating to the dispensing of Scheduled prescription drugs. If the Corporation fails to comply with the terms of the MOA, the DEA may suspend a Corporation's pharmacy's DEA Certificate of Registration and begin an administrative hearing process pursuant to 21 U.S.C. § 824. Any such suspension would prohibit the Corporation's pharmacy from dispensing Scheduled prescription drugs and would lead to the revocation or termination of contracts and/or licenses and potentially have a materially adverse effect on our financial condition, results of operation and business prospects. 24
Critical Accounting Estimates The preparation of financial statements in accordance with U.S. GAAP requires us to make estimates and assumptions that affect reported amounts and related disclosures. Management considers an accounting estimate to be critical if: • •
It requires assumptions to be made that were uncertain at the time the estimate was made; and Changes in the estimate or different estimates could have a material impact on our condensed consolidated results of operations or financial condition.
The critical accounting estimates discussed below are not intended to be a comprehensive list of all of the Corporation's accounting policies that require estimates. Management believes that of the significant accounting policies, discussed in Note 1 of the condensed consolidated financial statements included in this report, the estimates discussed below involve a higher degree of judgment and complexity. Management believes the current assumptions and other considerations used to estimate amounts reflected in the condensed consolidated financial statements are appropriate. However, if actual experience differs from the assumptions and other considerations used in estimating amounts reflected in the condensed consolidated financial statements, the resulting changes could have a material adverse effect on the condensed consolidated results of operations and financial condition of the Corporation. Allowance for doubtful accounts and provision for doubtful accounts Accounts receivable primarily consist of amounts due from PDP's under Medicaid Part D, long-term care institutions, respective state Medicaid programs, private payers and third party insurance companies. Our ability to collect outstanding receivables is critical to our results of operations and cash flows. We establish an allowance for doubtful accounts to reduce the carrying value of our receivables to their estimated net realizable value. In addition, certain drugs dispensed are subject to being returned and the responsible paying parties are due a credit for such returns. Our quarterly provision for doubtful accounts included in our condensed consolidated statements of operations is as follows (dollars in millions): 2014 Amount First Quarter Second Quarter Third Quarter Fourth Quarter
$
5.6 5.7 5.3 6.6
2015 % of Revenues 1.2% 1.3 1.1 1.3
Amount First Quarter Second Quarter Third Quarter
$
% of Revenues
5.0 3.0 1.5
1.0% 0.6 0.3
The following table shows our pharmacy revenue days outstanding reflected in our net accounts receivable as of the quarters indicated: 2014 37.7 37.0 36.7 34.9
First Quarter Second Quarter Third Quarter Fourth Quarter
2015 34.0 35.4 35.5
The following table shows our summarized aging categories by quarter:
First 56.7% 17.7 25.6
0 to 60 days 61 to 120 days Over 120 days
2014 Second Third 53.9% 57.3% 17.3 16.9 28.8 25.8
Fourth 58.8% 17.2 24.0
First 61.4% 15.8 22.8
2015 Second 60.0% 15.7 24.3
Third 58.9% 15.2 25.9
The following table shows our allowance for doubtful accounts as a percent of gross accounts receivable (dollars in millions):
Allowance First Quarter $ Second Quarter Third Quarter Fourth Quarter
2014 Gross Accounts Receivable
% of Gross Accounts Receivable
57.7 $
242.2
23.8%
60.3
246.5
57.4 58.1
Allowance
2015 Gross Accounts Receivable
% of Gross Accounts Receivable
59.7 $
259.2
23.0%
24.5
First Quarter $ Second Quarter
58.8
257.9
22.8
272.4
21.1
Third Quarter
57.7
253.5
22.8
253.5
22.9
We recognize revenues at the time services are provided or products are delivered. A significant portion of our revenues are billed to PDPs under Medicare Part D, state Medicaid programs, long-term care institutions, third party insurance companies, and private payers. Some claims are electronically adjudicated through online processing at the point the prescriptions are dispensed such that our operating system is automatically updated with the actual amounts to be reimbursed. As a result, our revenues and the associated receivables are based upon the actual reimbursements to be received. For claims that are adjudicated on-line and are rejected or otherwise denied upon submission, the Corporation provides contractual allowances based upon historical trends, contractual reimbursement terms and other factors which may impact ultimate reimbursement. Amounts are adjusted to actual reimbursed amounts based upon cash receipts.
25
A summary of revenues by payer type follows (dollars in millions):
Medicare Part D Institutional healthcare providers Medicaid Private and other Insured Medicare Hospital management fees Total
Three Months Ended September 30, 2014 2015 % of % of Amount Revenues Amount Revenues $ 214.6 45.6% $ 234.6 47.0% 110.4 23.5 114.5 23.0 39.5 8.4 34.3 6.9 19.5 4.1 19.9 4.0 64.8 13.8 74.2 14.9 5.9 1.3 5.7 1.1 15.5 3.3 15.6 3.1 $ 470.2 100.0% $ 498.8 100.0%
Medicare Part D Institutional healthcare providers Medicaid Private and other Insured Medicare Hospital management fees Total
Nine Months Ended September 30, 2014 2015 % of % of Amount Revenues Amount Revenues $ 618.2 45.1% $ 703.2 46.6% 337.3 24.6 354.1 23.5 122.9 9.0 110.8 7.4 59.0 4.3 61.6 4.0 173.1 12.6 215.0 14.3 16.3 1.2 16.3 1.1 44.2 3.2 46.8 3.1 $ 1,371.0 100.0% $ 1,507.8 100.0%
Inventory and cost of drugs dispensed We have inventory located at each of our institutional pharmacy, specialty infusion, and specialty oncology locations as well as our drug distribution center. Our inventory is valued at the lower of first-in, first-out cost or market. The inventory consists of prescription drugs, over the counter products and intravenous solutions. Our inventory relating to controlled substances is maintained on a manually prepared perpetual system to the extent required by the Drug Enforcement Agency and state board of pharmacies. All other inventory is maintained on a periodic system, through the performance of, at a minimum, quarterly physical inventory at the end of each quarter. All inventory counts are reconciled to the balance sheet account and differences are adjusted through cost of goods sold. In addition, we record an amount of potential returns of prescription drugs based on historical rates of returns and record an estimate for rebates associated with inventory remaining at the end of each period. As of December 31, 2014 and September 30, 2015, our inventories were $135.5 million and $117.5 million, respectively. The inventory days on hand were as follows for the periods presented:
First Quarter Second Quarter Third Quarter Fourth Quarter
2014 26.0 35.1 31.7 29.1
2015 26.1 29.6 25.7
Goodwill and other intangible assets Goodwill represents the excess of the purchase price over the fair value of the net assets of acquired companies. Our intangible assets are comprised primarily of trade names, customer relationship assets, and non-compete agreements. Our goodwill as of December 31, 2014 (as adjusted) and September 30, 2015 was $323.6 million and $341.8 million, respectively. The Corporation's policy is to perform a quantitative assessment of its institutional pharmacy and specialty infusion reporting units to determine whether it is more likely than not (defined as having a likelihood of more than 50 percent) that the fair value of a reporting unit is less than its carrying amount. The Corporation performed a quantitative assessment as of December 31, 2014. The institutional pharmacy and specialty infusion reporting unit's fair value as calculated for the analysis were approximately 48.2% and 13.1%, respectively, greater than book value at December 31, 2014. As a result of the excess on the specialty infusion unit not being significant, the Corporation continues to closely monitor the results of the specialty infusion reporting unit. The specialty infusion reporting unit had goodwill with a carrying value of $57.7 million at December 31, 2014. The Corporation also performed a qualitative assessment of its specialty oncology reporting unit as of December 31, 2014 and did not find it necessary to perform the first step of the two-step impairment test based on that analysis. There were no impairment triggering events during the nine months ended September 30, 2015. Accounting for income taxes We assess the likelihood that deferred tax assets will be realized from future taxable income. A valuation allowance is provided for 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. Our net deferred tax asset balances as of
December 31, 2014 and September 30, 2015 were $27.1 million and $23.0 million, respectively. Our valuation allowances for state deferred tax assets in our condensed consolidated balance sheets as of December 31, 2014 and September 30, 2015 were $4.1 million. 26
Definitions Listed below are definitions of terms used by the Corporation in managing the business. The definitions are necessary to the understanding of the Management's Discussion and Analysis section of this document. Gross profit per prescription dispensed: Represents the gross profit divided by the total prescriptions dispensed. Gross profit margin: Represents the gross profit per prescription dispensed divided by the revenue per prescription dispensed. Prescriptions dispensed: Represents a prescription filled for an individual patient. A prescription will usually be for a 14 or 30 day period and will include only one drug type. Revenue per prescription dispensed: Represents the revenue divided by the total prescriptions dispensed. 27
Results of Operations The following table presents selected consolidated comparative results of operations and statistical information for the periods presented (dollars in millions, except per prescription and per patient amounts, and prescriptions in thousands):
Revenues Cost of goods sold
Three Months Ended September 30, Nine Months Ended September 30, Increase Increase 2014 (Decrease) 2015 2014 (Decrease) 2015 % of % of % of % of Amount Revenues Amount Revenues Amount Revenues Amount Revenues $ 470.2 100.0 $ 28.6 6.1% $ 498.8 100.0 $1,371.0 100.0 $136.8 10.0% $1,507.8 100.0
Gross profit $
387.2 83.0
82.3
33.0
17.7 $ (4.4)
8.5 (5.3 )% $
420.2 78.6
Pharmacy (in whole numbers except where indicated) Financial data Prescriptions dispensed (in thousands) 8,492 (284) (3.3 ) % 8,208 Revenue per prescription dispensed $ 55.37 $ 5.40 9.8% $ 60.77 Gross profit per prescription dispensed $ 9.77 $ (0.19) (1.9 )% $ 9.58 Gross profit margin 17.7% (1.9 )% (10.7 )% 15.8% Generic dispensing rate 85.1% 1.4% 1.6% 86.5%
84.2
1,126.1
15.8 $ 244.9
82.1
133.3
17.9 $
3.5
11.8
1,259.4
83.5
1.4% $ 248.4
16.5
25,511
202
$ 53.74
$ 4.90
9.1% $ 58.64
$
$ 0.06
6.3% $
9.60 17.9% 84.9%
(1.4) 1.0%
0.8%
25,713
9.66
(7.8 )%
16.5%
1.2%
85.9%
Revenues Revenues increased $28.6 million for the three months ended September 30, 2015 compared to the three months ended September 30, 2014 which was driven by recent acquisitions, growth in the Corporation's specialty pharmacy businesses, and branded drug inflation. The increase of $28.6 million is comprised of a favorable rate variance of approximately $44.3 million or $5.40 increase per prescription dispensed, partially offset by an unfavorable volume variance of approximately $15.7 million or 284,000 fewer prescriptions dispensed. The revenue per prescription dispensed increase was due to the increased volume in the Corporation's specialty pharmacy businesses, which carries higher revenue per script and branded drug inflation. Revenues increased $136.8 million for the nine months ended September 30, 2015 compared to the nine months ended September 30, 2014 which was driven by recent acquisitions, growth in the Corporation's specialty pharmacy businesses, and branded drug inflation. The increase of $136.8 million is comprised of a favorable rate variance of approximately $126.0 million or $4.90 increase per prescription dispensed, along with a favorable volume variance of approximately $10.8 million or 202,000 more prescriptions dispensed. The revenue per prescription dispensed increase was due to the increased volume in the Corporation's specialty pharmacy businesses, which carries higher revenue per script and branded drug inflation. Gross Profit Gross profit for the three months ended September 30, 2015 was $78.6 million or $9.58 per prescription dispensed compared to $83.0 million or $9.77 per prescription dispensed for the three months ended September 30, 2014. The decrease in gross profit was primarily driven by lower volumes resulting from an improvement in the Corporation's client mix and higher drug costs under the Corporation's prime vendor agreement. Gross profit margin for the three months ended September 30, 2015 was 15.8% compared to 17.7% for the three months ended September 30, 2014. The gross profit margin was adversely impacted by the increased volume in the Corporation's specialty pharmacy businesses, which carry lower profit margins as well as volume decreases in the long-term care pharmacy business and higher drug costs under the Corporation's prime vendor agreement. Gross profit for the nine months ended September 30, 2015 was $248.4 million or $9.66 per prescription dispensed compared to $244.9 million or $9.60 per prescription dispensed for the nine months ended September 30, 2014. The increase in gross profit was driven by 2014 acquisitions, growth in the Corporation's specialty pharmacy businesses, and branded drug inflation. The increase in gross profit was partially offset by volume decreases in the longterm care pharmacy business and higher drug costs under the Corporation's prime vendor agreement. Gross profit margin for the nine months ended September 30, 2015 was 16.5% compared to 17.9% for the nine months ended September 30, 2014. The gross profit margin was adversely impacted by the increased volume in the Corporation's specialty pharmacy businesses, which carry lower profit margins as well as volume decreases in the long-term care pharmacy business and higher drug costs under the Corporation's prime vendor agreement. Selling, General and Administrative Expenses Selling, general and administrative expenses were $52.7 million, or 10.6% of revenues, for the three months ended September 30, 2015 compared to $56.0 million, or 11.9% of revenues, for the three months ended September 30, 2014. The decrease of $3.3 million was due to cost improvements and a reduction in bad debt expense as the Corporation improved its client mix.
Selling, general and administrative expenses were $167.1 million, or 11.1% of revenues, for the nine months ended September 30, 2015 compared to $171.1 million, or 12.5% of revenues, for the nine months ended September 30, 2014. The decrease of $4.0 million was due to cost improvements and a reduction in bad debt expense as the Corporation improved its client mix. 28
Depreciation and Amortization Depreciation expense was $5.7 million for the three months ended September 30, 2015 as compared to $4.9 million for the three months ended September 30, 2014 and $17.2 million for the nine months ended September 30, 2015 as compared to $14.5 million for the nine months ended September 30 2014. Depreciation expense increased $0.8 million for the three months and $2.7 million for the nine months, due to depreciation expense recognized on the assets acquired through the 2014 Acquisitions as well as additions to fixed assets. Amortization expense was $7.0 million for the three months ended September 30, 2015 compared to $4.9 million for the three months ended September 30, 2014 and $20.6 million for the nine months ended September 30, 2015 as compared to $13.6 million for the nine months ended September 30, 2014. The increase of $2.1 million for the three months and $7.0 million for the nine months, was due primarily to the amortization expense recognized on intangibles acquired through the 2014 and 2015 acquisitions. Settlement, Litigation and Other Related Charges Settlement, litigation and other related charges were $2.1 million for the three months ended September 30, 2015 compared to $1.1 million for the three months ended September 30, 2014 and were $11.3 million for the nine months ended September 30, 2015 as compared to $28.9 million for the nine months ended September 30, 2014. These costs relate to the Corporation's defense and settlement of certain governmental investigations and other litigation. Restructuring and Impairment Charges Restructuring and impairment charges were $0.2 million for the three months ended September 30, 2015 compared to $0.1 million for the three months ended September 30, 2014 and were $0.3 million for the nine months ended September 30, 2015 compared to $3.2 million for the nine months ended September 30, 2014. These costs are part of the Corporation's initiative to realign the organization in connection with the loss of two significant customers, which were primarily recognized in 2014, along with the specialty infusion restructuring and centralization initiative in 2015. Merger, Acquisition, Integration Costs and Other Charges Merger, acquisition, integration costs and other charges were $8.0 million for the three months ended September 30, 2015 compared to $3.8 million for the three months ended September 30, 2014 and were $15.2 million for the nine months ended September 30, 2015 compared to $10.3 million for the nine months ended September 30, 2014. The increase was related to costs associated with the 2014 and 2015 acquisitions. Interest Expense Interest expense was $2.1 million for the three months ended September 30, 2015 and 2014 and was $5.4 for the nine months ended September 30, 2015 compared to $6.9 million for the nine months ended September 30, 2014. The decrease was primarily due to lower interest rates as a result of the new credit agreement signed in 2014, along with lower amortization of deferred financing costs. Tax Provision The effective tax rate for the nine months ended September 30, 2015 was 47.5%, comprised of the 35.0% federal statutory rate and 2.2% for the state rate, and 10.3% for discrete events. The discrete events included a non-deductible $4.4 million legal charge and $1.2 million of other items. Excluding the impact of the discrete events, the provision for income taxes as a percentage of pre-tax income would have been 37.2%. The effective tax rate excluding discrete events for the nine months ended September 30, 2014 was 37.0%. The increase in the effective tax rate excluding the impact of the discrete events between the two periods was primarily the result of an increase in certain non-deductible employee compensation costs. 29
Liquidity and Capital Resources Cash Flows - The following table presents selected data from our condensed consolidated statements of cash flows for the periods presented (dollars in millions):
Net cash provided by (used in) operating activities Net cash used in investing activities Net cash provided by (used in) financing activities Net change in cash and cash equivalents Cash and cash equivalents at beginning of period Cash and cash equivalents at end of period
$
$
Three Months Ended September 30, 2014 2015 19.7 $ 37.5 $ (113.4) (6.8) 89.7 (12.0) (4.0) 18.7 11.1 21.3 7.1 $ 40.0 $
Nine Months Ended September 30, 2014 2015 (2.4) $ 59.6 (143.3) (38.3) 128.6 (14.6) (17.1) 6.7 24.2 33.3 7.1 $ 40.0
Operating Activities – Cash provided by operating activities aggregated $37.5 million for the three months ended September 30, 2015 and $59.6 million for the nine months ended September 30, 2015 compared to $19.7 million for the three months ended September 30, 2014 and cash used in operating activities of $2.4 million for the nine months ended September 30, 2014. The increase in cash from operating activities is due primarily to the $48.8 million in ABDC drug purchase payments withheld, the Corporation's inventory purchasing strategy and new prime vendor agreement, and an increase in net income in the nine months ended September 30, 2015, which were partially offset by an increase in ABDC rebates receivable. Investing Activities – Cash used in investing activities aggregated $6.8 million and $38.3 million for the three and nine months ended September 30, 2015, respectively, compared to $113.4 million and $143.3 million for the three and nine months ended September 30, 2014, respectively. The decrease is due to the acquisitions completed by the Corporation in the third quarter of 2014. Financing Activities – Cash used in financing activities aggregated $12.0 million for the three months ended September 30, 2015 and $14.6 million for the nine months ended September 30, 2015 compared to cash provided by financing activities of $89.7 million and $128.6 million for the three and nine months ended September 30, 2014, respectively. The decrease in cash provided by financing activities is due primarily to borrowings on the revolving credit facility to fund 2014 Acquisitions, along with term and revolving credit facility payments in the third quarter of 2015. Credit Agreement On September 17, 2014, the Corporation entered into a Credit Agreement by and among the Corporation, the lenders named therein, 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 (the "Credit Agreement"). The Credit Agreement consists of a $225.0 million term loan facility and a $310.0 million revolving credit facility. The terms and conditions of the Credit Agreement are customary to facilities of this nature. Unless terminated earlier, the Credit Agreement will mature on September 17, 2019, and the principal amount outstanding thereunder, together with all accrued unpaid interest and other amounts owed thereunder, if any, will be payable in full on such date. The Credit Agreement requires term loan principal payments by the Corporation in an amount of $2.8 million each quarter beginning September 2015 through September 2019. The final principal repayment installment of term loans shall be repaid on the term maturity date, September 17, 2019. In addition, the term loan is subject to certain prepayment obligations relating to certain asset sales, certain casualty losses and the incurrence of certain indebtedness. The Corporation had a total of $222.2 million outstanding of term debt under the Credit Agreement and $115.0 million outstanding under the revolving portion of the Credit Agreement as of September 30, 2015. The Credit Agreement provides for the issuance of letters of credit which, when issued, constitute usage and reduce availability on the revolving portion of the Credit Agreement. The amount of letters of credit outstanding as of September 30, 2015 was $3.0 million. After giving effect to the letters of credit and amounts outstanding under the revolving credit agreement, total availability under the revolving credit facility was $192.0 million as of September 30, 2015. The Corporation was compliant with all debt covenant requirements at September 30, 2015. Drug Wholesaler Agreement We obtain pharmaceutical and other products from Cardinal pursuant to a Prime Vendor Agreement with Cardinal effective April 1, 2015. The Corporation also obtains pharmaceutical and other products for discounted prices directly from pharmaceutical manufacturers. While the loss of a supplier could adversely affect our business if alternate sources of supply are unavailable, numerous sources of supply are generally available to us and we have not experienced any difficulty in obtaining pharmaceuticals or other products and supplies to conduct our business. The Corporation seeks to maintain an on-site inventory of pharmaceuticals and supplies to ensure prompt delivery to our customers. Cardinal maintains local distribution facilities in most geographic markets in which we operate. 30
Treasury Stock 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 was used. On July 2, 2012 the Board of Directors authorized an increase to the remaining portion of the existing stock 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, 2015. 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 three months ended September 30, 2015, the Corporation repurchased no shares of common stock. The Corporation may redeem shares from employees upon the vesting of the Corporation's stock awards for minimum statutory tax withholding purposes and to cover option exercise costs. The Corporation redeemed 156,963 shares from the vesting of certain awards and the exercise of certain stock options, for an aggregate price of approximately $4.3 million during the nine months ended September 30, 2015. These shares have also been designated by the Corporation as treasury stock. 31
Supplemental Quarterly Information The following tables represent the results of the Corporation's quarterly operations for the year ended December 31, 2014 and for the first, second and third quarters of 2015 (in millions, except where indicated):
Revenues Cost of goods sold Gross profit Selling, general and administrative Amortization expense Merger, acquisition, integration costs, and other charges Settlement, litigation and other related charges Restructuring and impairment charges Hurricane Sandy disaster costs Operating income (loss) Interest expense, net Loss on debt extinguishment Income (loss) before income taxes Provision (benefit) for income taxes Net income (loss)
First $ 452.2 372.2 80.0 57.2 4.4
First $ 511.6 423.0 88.6 59.0 6.6
2015 Quarters Second Third $ 497.5 $ 498.8 416.3 420.2 81.2 78.6 55.4 52.7 7.0 7.0
1.5
3.8
3.3
3.8
3.4
8.0
$
1.2 1.9 10.3 2.5 7.8 3.0 4.8
$
26.6 1.2 0.1 (9.7) 2.3 (12.0) (2.3) (9.7)
$
1.1 0.1 17.1 2.1 4.3 10.7 2.2 8.5
$
8.4 0.1 (1.8) 12.7 3.0 9.7 6.5 3.2
$
2.3 0.1 16.8 1.4 15.4 5.8 9.6
$
6.9 8.5 1.9 6.6 4.3 2.3
$
2.1 0.2 0.1 8.5 2.1 6.4 3.4 3.0
Earnings (loss) per share (1): Basic Diluted
$ $
0.16 0.16
$ $
(0.32) (0.32)
$ $
0.28 0.28
$ $
0.11 0.10
$ $
0.32 0.31
$ $
0.08 0.07
$ $
0.10 0.10
Adjusted diluted earnings per diluted share (1)(2):
$
0.37
$
0.40
$
0.45
$
0.45
$
0.48
$
0.37
$
0.39
Balance sheet data: Cash and cash equivalents Working capital (3) Goodwill (3) Intangible assets, net Total assets (3) Long-term debt Total stockholders' equity Supplemental information: Adjusted EBITDA(2) Adjusted EBITDA Margin (2) Adjusted EBITDA per prescription dispensed (2) Net cash provided by (used in) operating activities Net cash used in investing activities Net cash (used in) provided by financing activities
29.8 30.4 $ $ $ $ $ $ $
12.7 273.4 282.7 131.9 868.6 230.9 470.0
$ $ $ $ $ $ $
30.0 30.0
30.1 30.6
30.1 30.7
30.2 30.7
30.4 30.8
30.4 30.9
11.1 310.3 286.9 130.4 922.5 268.9 462.2
$ 7.1 $ 335.1 $ 319.5 $ 184.1 $ 1,045.5 $ 360.9 $ 472.7
$ 33.3 $ 319.1 $ 323.6 $ 177.6 $ 1,074.0 $ 350.7 $ 478.1
$ 25.2 $ 292.8 $ 341.9 $ 179.2 $ 1,044.9 $ 325.5 $ 487.1
$ 21.3 $ 293.5 $ 341.9 $ 172.2 $ 1,062.3 $ 349.3 $ 492.1
$ 40.0 $ 285.1 $ 341.8 $ 165.2 $ 1,060.0 $ 337.4 $ 496.9
$
29.7 $ 6.6%
30.6 $ 6.8%
33.0 $ 7.0%
37.3 $ 7.1%
37.4 $ 7.3%
33.2 $ 6.7%
33.3 6.7%
$
3.45
$
3.64
$
3.89
$
3.93
$
4.13
$
3.93
$
4.06
$ $
4.4 (16.3)
$ $
(26.5) (13.6)
$ $
19.7 (113.4)
$ $
50.8 (13.7)
$ $
44.3 (25.0)
$ $
(22.2) (6.5)
$ $
37.5 (6.8)
$
0.4
$
38.5
$
89.7
$
(10.9)
$
(27.4)
$
24.8
$
(12.0)
Statistical information (in whole numbers except where indicated) Volume information Prescriptions dispensed (in thousands) Revenue per prescription dispensed $ Gross profit per prescription dispensed $ Gross profit margin Generic drug dispensing rate Inventory days on hand Revenue days outstanding
(3)
Fourth $ 523.5 429.1 94.4 65.2 6.5
5.0
Shares used in computing earnings (loss) per share: Basic Diluted
(1) (2)
2014 Quarters Second Third $ 448.6 $ 470.2 366.7 387.2 81.9 83.0 57.9 56.0 4.3 4.9
8,608
8,411
8,492
9,491
9,053
8,452
8,208
52.53 $ 9.29 $ 17.7% 84.5% 26.0 37.7
53.33 $ 9.74 $ 18.3% 85.0% 35.1 37.0
55.37 $ 9.77 $ 17.7% 85.1% 31.7 36.7
55.16 $ 9.95 $ 18.0% 84.9% 29.1 34.9
56.51 $ 9.79 $ 17.3% 85.3% 26.1 34.0
58.86 $ 9.61 $ 16.3% 86.0% 29.6 35.4
60.77 9.58 15.8% 86.5% 25.7 35.5
The Corporation has never declared a cash dividend. Earnings (loss) per common share in actual cents. See "Use of Non-GAAP Measures for Measuring Quarterly Results" for a definition and Reconciliation of Adjusted Earnings Per Diluted Common Share to Earnings (Loss) Per Diluted Common Share, and for Reconciliation of Net Income (Loss) to Adjusted EBITDA and Adjusted EBITDA Margin. As adjusted, see Note 2—Acquisitions in the Condensed Consolidated Financial Statements.
32
Use of Non-GAAP Measures for Measuring Quarterly Results The Corporation calculates Adjusted EBITDA as provided in the reconciliation below and calculates Adjusted EBITDA Margin by taking Adjusted EBITDA and dividing it by revenues adjusted for the contractual amount associated with the California Medicaid estimated recoupment. The Corporation calculates and uses Adjusted EBITDA as an indicator of its ability to generate cash from reported operating results. The measurement is used in concert with net income (loss) and cash flows from operating activities, which measure actual cash generated in the period. In addition, the Corporation believes that Adjusted EBITDA and Adjusted EBITDA Margin are supplemental measurement tools used by analysts and investors to help evaluate overall operating performance and the ability to incur and service debt and make capital expenditures. In addition, Adjusted EBITDA, as defined in the Credit Agreement, is used in conjunction with the Corporation's debt leverage ratio and this calculation sets the applicable margin for the quarterly interest charge. Adjusted EBITDA, as defined in the Credit Agreement, is not the same calculation as this Adjusted EBITDA table. Adjusted EBITDA presented herein does not represent funds available for the Corporation's discretionary use and is not intended to represent or to be used as a substitute for net income (loss) or cash flows from (used in) operating activities data as measured under U.S. GAAP. The items excluded from Adjusted EBITDA but included in the calculation of the Corporation's reported net income (loss) and cash flows from (used in) operating activities are significant components of the accompanying condensed consolidated statements of operations and cash flows and must be considered in performing a comprehensive assessment of overall financial performance. The Corporation's calculation of Adjusted EBITDA may not be consistent with calculations of EBITDA used by other companies. The following are reconciliations of Adjusted EBITDA to the Corporation's net income (loss) and net operating cash flows for the periods presented. The Corporation calculates and uses adjusted diluted earnings per share, which is exclusive of the impact of merger, acquisition, integration costs and other charges, settlement, litigation costs and other related charges, Hurricane Sandy disaster costs, restructuring and impairment charges, stock-based compensation and deferred compensation, loss on debt extinguishment, and impact of discrete items on tax provision ("the Excluded Items") as an indicator of its core operating results. The measurement is used in concert with net income and diluted earnings per share, which measure actual earnings per share generated in the period. The Corporation believes the exclusion of these charges in expressing earnings per share provides management with a useful measure to assess period to period comparability and is useful to investors in evaluating the Corporation's operating results from period to period. Adjusted diluted earnings per share after giving effect to the Excluded Items does not represent the amount that effectively accrues directly to stockholders (i.e., such costs are a reduction in earnings and stockholders' equity) and is not intended to represent or to be used as a substitute for diluted earnings per share as measured under U.S. GAAP. The Excluded Items are significant components of the accompanying condensed consolidated statements of operations and must be considered in performing a comprehensive assessment of overall financial performance. The following is a reconciliation of adjusted diluted earnings per share to the Corporation's U.S. GAAP earnings (loss) per diluted common share for the periods presented. 33
Unaudited Reconciliation of Net Income (Loss) to Adjusted EBITDA (dollars in millions) 2014 Quarters Second Third $ (9.7) $ 8.5
First $ 4.8
Net income (loss) Add: Interest expense, net Merger, acquisition, integration costs and other charges Settlement, litigation and other related charges Restructuring and impairment charges Loss on extinguishment of debt Hurricane Sandy disaster costs Stock-based compensation and deferred compensation Provision (benefit) for income taxes Depreciation and amortization expense Adjusted EBITDA $ Adjusted EBITDA Margin
Fourth $ 3.2
First $ 9.6
2015 Quarters Second Third $ 2.3 $ 3.0
2.5
2.3
2.1
3.0
1.4
1.9
2.1
5.0
1.5
3.1
3.3
3.8
3.4
8.0
1.2
26.6
1.1
8.4
2.3
6.9
2.1
1.9 -
1.2 0.1
0.1 4.3 -
0.1 (1.8)
0.1 -
-
0.2 0.1
2.1 3.0
1.8 (2.3)
1.8 2.2
2.3 6.5
2.0 5.8
1.7 4.3
1.7 3.4
9.2 29.7 $ 6.6%
9.1 30.6 $ 6.8%
9.8 33.0 $ 7.0%
12.3 37.3 $ 7.1%
12.4 37.4 $ 7.3%
12.7 33.2 $ 6.7%
12.7 33.3 6.7%
Unaudited Reconciliation of Adjusted EBITDA to Net Operating Cash Flows (dollars in millions)
Adjusted EBITDA Interest expense, net Merger, acquisition, integration costs and other charges Provision for bad debt Amortization of deferred financing fees (Gain) loss on disposition of equipment (Gain) loss on acquisition Provision (benefit) for income taxes Deferred income taxes Changes in federal and state income tax payable (receivable) Excess tax benefit from stock-based compensation Changes in assets and liabilities Other Net Cash Flows Provided by (Used in) Operating Activities
2014 Quarters 2015 Quarters First Second Third Fourth First Second Third $ 29.7 $ 30.6 $ 33.0 $ 37.3 $ 37.4 $ 33.2 $ 33.3 (2.5) (2.3) (2.1) (3.0) (1.4) (1.9) (2.1) (5.6) 5.6 0.7 (0.1) (0.3) (3.0) 4.0
(29.4) 5.7 0.6 2.3 (3.3)
(4.3) 5.3 0.5 0.1 (2.2) (4.0)
(11.8) 6.6 0.1 (6.5) 1.0
(6.2) 5.0 0.1 0.1 (5.8) 2.3
(10.3) 3.0 0.2 (4.3) 0.2
(10.4) 1.5 0.1 (3.4) 2.1
(1.3)
(2.8)
3.7
7.6
0.1
(9.1)
(1.0)
(2.7) (20.2) 0.1
(0.5) (27.4) -
(0.2) (10.1) -
19.1 0.4
(1.9) 14.6 -
(0.2) (33.1) 0.1
(0.2) 17.6 -
(22.2) $
37.5
$
4.4
$
(26.5) $
19.7
$
50.8
$
44.3
$
Unaudited Reconciliation of Diluted Earnings (Loss) Per Share to Adjusted Diluted Earnings Per Share 2014 Quarters Second Third
First Diluted earnings (loss) per share $ Add: Diluted earnings per share impact of: Merger, acquisition, integration costs and other charges Settlement, litigation and other related charges Restructuring and impairment charges Loss on extinguishment of debt Hurricane Sandy disaster costs Stock-based compensation and deferred compensation Impact of discrete items on tax provision Adjusted diluted earnings per share
$
0.16
$
(0.32) $
Fourth
0.28
$
0.10
2015 Quarters Second
First $
0.31
$
0.07
Third $
0.10
0.10
0.03
0.06
0.08
0.08
0.07
0.17
0.03 0.04 -
0.61 0.03 -
0.02 0.09
0.11 -
0.05 -
0.13 -
0.04 0.01 -
-
-
-
-
-
-
0.04
0.04
0.04
0.04
0.04
0.04
0.37
$
0.01 0.40 34
$
(0.04) 0.45 $
(0.04) 0.05 0.15 0.45
$
0.48
$
0.06 0.37
$
0.03 0.39
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
During the reporting period, there have been no material changes in the disclosures set forth in Part II, Item 7a in our Form 10-K for the year ended December 31, 2014. Item 4.
Controls and Procedures
Evaluation of Disclosure Controls and Procedures The Corporation has carried out an evaluation under the supervision and with the participation of management, including the Corporation's Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Corporation's "disclosure controls and procedures" as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act") as of the end of the period covered by this report. The Corporation's disclosure controls and procedures are designed so that information required to be disclosed in the Corporation's reports filed under the Exchange Act, such as this Quarterly Report on Form 10-Q, is recorded, processed, summarized and reported within the time periods specified in the Commission's rules and forms. The Corporation's disclosure controls and procedures are also intended to ensure that such information is accumulated and communicated to the Corporation's management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives, and management necessarily is required to use its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. Based upon this evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of September 30, 2015, the Corporation's disclosure controls and procedures are effective to provide reasonable assurance that information required to be disclosed in the reports that the Corporation files and submits under the Exchange Act is recorded, processed, summarized and reported as and when required and such information is accumulated and communicated as appropriate to allow timely decisions regarding required disclosures. Changes in Internal Control Over Financial Reporting There have been no changes in the Corporation's internal control over financial reporting during the quarter ended September 30, 2015, that have materially affected, or are reasonably likely to materially affect, the Corporation's internal control over financial reporting. 35
PART II. OTHER INFORMATION Item 1.
Legal Proceedings
The information called for by this item is incorporated herein by reference to Note 5 included in Part I, Item 1, Financial Statements (Unaudited) Notes to Condensed Consolidated Financial Statements. Item 1A.
Risk Factors
Except as set forth below, there have been no material changes in our risk factors from those disclosed in the Corporation's Annual Report on Form 10-K for the year ended December 31, 2014. We encourage you to read these risk factors, together with the risk factor below, in their entirety. If we fail to comply with the terms of our Corporate Integrity Agreement with the OIG or Memorandum of Agreement with the DEA, it could subject us to substantial monetary penalties or suspension or termination from participation in federal healthcare programs. In May 2015, the Corporation entered into a five-year corporate integrity agreement ("CIA") with the United States Department of Health and Human Services Office of Inspector General ("OIG") and a Memorandum of Agreement ("MOA") with the Drug Enforcement Agency ("DEA") concurrent with the execution of settlement agreements with the OIG and the DEA settling alleged Controlled Substance Act ("CSA") violations and associated False Claims Act allegations. The CIA requires the Corporation, among other things to: (i) create procedures designed to ensure it complies with the CSA and related regulations; (ii) retain an independent review organization to review the Corporation's compliance with the terms of the CIA and report to the OIG regarding that compliance; and (iii) provide training for certain Corporation employees as to the Corporation's requirements under the CSA. If the Corporation fails to comply with the terms of the CIA, it may be required to pay certain monetary penalties. The imposition of monetary penalties would adversely affect our profitability. Furthermore, if the Corporation commits a material breach of the CIA, the OIG may exclude the Corporation from participating in federal healthcare programs. Any such exclusion would result in the revocation or termination of contracts and/or licenses and potentially have a material adverse effect on our financial condition, results of operations and business prospects. The MOA provides for an independent obligation for the Corporation to comply with all requirements of the CSA, specifically relating to the dispensing of scheduled prescription drugs. If the Corporation fails to comply with the terms of the MOA, the DEA may suspend a Corporation's pharmacy's DEA Certificate of Registration and begin an administrative hearing process pursuant to 21 U.S.C. § 824. Any such suspension would prohibit the Corporation's pharmacy from dispensing Scheduled prescription drugs and would lead to the revocation or termination of contracts and/or licenses and potentially have a materially adverse effect on our financial condition, results of operation and business prospects. Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
In August 2010, the Board of Directors authorized a share repurchase program of up to $25.0 million of the Corporation's common stock, of which $10.5 million was 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. The Corporation did not repurchase any common stock shares under this program during the nine months ended September 30, 2015. Additionally, the Corporation may redeem shares from employees upon vesting of the Corporation's stock awards for minimum statutory tax withholding purposes and to cover option exercise costs. The Corporation redeemed 156,963 shares from the vesting of certain awards and the exercise of certain stock options, for an aggregate price of approximately $4.3 million during the nine months ended September 30, 2015. These shares have been designated by the Corporation as treasury stock. The following table summarizes our share repurchase activity by month for the three months ended September 30, 2015:
July 1, 2015 - July 31, 2015 August 1, 2015 - August 31, 2015
277 8,456
(1) $ (1)
35.28 34.08
Approximate Dollar Value of Shares that may yet be Purchased under the Plans or Programs (in millions) - $ 19.7 19.7
September 1, 2015 - September 30, 2015
3,746
(1)
31.34
-
Period
Total Number of Shares Purchased
Weighted Average Price Paid per Share
Total Number of Shares Purchased as Part of a Publicly Announced Plans or Programs (2)
19.7
(1)
The Corporation repurchased 12,479 shares of common stock in connection with the vesting of certain stock awards to cover minimum statutory withholding taxes.
(2)
On August 24, 2010, the Board of Directors announced a share repurchase program whereby the Corporation is authorized to purchase up to $25.0 million of the Corporation's common stock, of which $10.5 million was 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. The Corporation did not repurchase any common stock shares under this program during the nine months ended September 30, 2015.
Item 4.
Mine Safety Disclosures
Not Applicable 36
Item 6.
Exhibits
Exhibit No. 10.28*
Corporate Integrity Agreement, dated May 14, 2015, by and between PharMerica Corporation and the Office of Inspector General of the United States Department of Health and Human Services.
10.29*
Memorandum of Agreement, dated May 14, 2015, by and between PharMerica Corporation and the United States Department of Justice, Drug Enforcement Administration.
31.1*
Certification of Chief Executive Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2*
Certification of Chief Financial Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1*
Certification of Chief Executive Officer, pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2*
Certification of Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS
XBRL Instance Document.
101.SCH
XBRL Taxonomy Extension Schema Document.
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document.
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document.
101.LAB
XBRL Taxonomy Extension Label Linkbase Document.
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document.
*
Furnished herewith.
37
SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. PHARMERICA CORPORATION Date: November 6, 2015
/s/ Gregory S. Weishar Gregory S. Weishar Chief Executive Officer and Director
Date: November 6, 2015
/s/ David W. Froesel, Jr. David W. Froesel, Jr. Executive Vice President, Chief Financial Officer and Treasurer /s/ Berard E. Tomassetti Berard E. Tomassetti Senior Vice President and Chief Accounting Officer
Date: November 6, 2015
38
Exhibit Index Exhibit No.
Description
10.28
Corporate Integrity Agreement, dated May 14, 2015, by and between PharMerica Corporation and the Office of Inspector General of the United States Department of Health and Human Services.
10.29
Memorandum of Agreement, dated May 14, 2015, by and between PharMerica Corporation and the United States Department of Justice, Drug Enforcement Administration.
31.1
Certification of Chief Executive Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2
Certification of Chief Financial Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1
Certification of Chief Executive Officer, pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2
Certification of Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS
XBRL Instance Document.
101.SCH
XBRL Taxonomy Extension Schema Document.
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document.
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document.
101.LAB
XBRL Taxonomy Extension Label Linkbase Document.
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document.
39
U.S. DEPARTMENT OF JUSTICE DRUG ENFORCEMENT ADMINISTRATION MEMORANDUM OF AGREEMENT
This Memorandum of Agreement ("Agreement") is entered into by and between the United States Department of Justice, Drug Enforcement Administration (hereinafter "DEA") and PHARMERICA CORPORATION (hereinafter "PMC"), each a "Party" and collectively hereinafter the "Parties". I. APPLICABILITY This Agreement shall be applicable to PHARMERICA CORPORATION and any PHARMERICA retail pharmacies, current or future, within the United States, registered with DEA to dispense, distribute, or otherwise handle controlled substances or List I chemicals. Unless specifically stated herein, nothing contained in this Agreement will lessen, supplant or expand PMC's legal obligations under any statute, regulation, or law. II. BACKGROUND Based on investigations conducted by the DEA at eleven PHARMERICA retail pharmacies, under DEA Registration Numbers BV5369740, BP5312121, BP6553677, BP9444136, BP5703788, BP5723449, FK0624571, FP0954568, BG5758113, FP0640537 and BP5704324, the United States of America, acting through the United States Attorney's Offices for the Eastern District of Wisconsin, the Eastern and Western Districts of Virginia, and the District of Rhode Island, contends that it had certain civil penalty claims against PMC. PharMerica acknowledges that its pharmacies, to include PharMerica Pharmacies specified in the above paragraph, on some occasions during the Covered Conduct period, dispensed controlled substances in a manner not consistent with its obligations under the CSA and the CSA's implementing regulations. To avoid the delay, uncertainty, inconvenience, and expense of protracted litigation of the above referenced claims, PMC, DEA, and the U.S. Attorney's Office for the Eastern District of Virginia and the Western District of Virginia, entered into Settlement Agreements on January 8, 2014 and April 15, 2014, respectively. Contemporaneous to this Agreement, PMC, DEA, and the U.S. Attorney's Offices for the Eastern District of Wisconsin and the District of Rhode Island are also entering into a Settlement Agreement.
III. TERMS AND CONDITIONS A.
Intention of Parties to Effect Settlement
Based on PMC's acceptance of responsibility as stated in the Settlement Agreements, PMC agreed to enter into a compliance agreement, also referred to as "Memorandum of Agreement", as required by the DEA. B.
Covered Conduct
For purposes of this Agreement, "Covered Conduct" shall mean the following conduct, whether it occurred at any of the PMC pharmacy locations listed above or at any other PMC Pharmacy locations throughout the United States. (1)
PMC dispensed Schedule II controlled substances and failed to obtain valid prescriptions written by a practitioner, as required per 21 U.S.C.
§ 829(a), such violations included: (a)
PMC initiated partially or fully pre-populated templates/forms, transmitted via facsimile, for a practitioner to sign. Under these circumstances, the practitioner had yet made the determination, in the usual course of practice, that there was a legitimate medical purpose for the prescription. PMC's practice failed to meet the requirements of 21 U.S.C. § 829 (a) and 21 C.F.R. § 1306.04(a);
(b)
PMC dispensed Schedule II controlled substances and failed to obtain a written prescription prior to the dispensation took place in
that a signed prescription was obtained after the fact, as required per 21 U.S.C. § 829(a) and 21 C.F.R. § 1306.11(a); (c)
PMC dispensed Schedule II controlled substances pursuant to orders from long term care facilities that failed to include required
elements, such as the patient's address, quantity prescribed, dosage form, practitioner's name, practitioner's address, practitioner's signature, and DEA registration number, in violation of 21 U.S.C. § 829 (a) and 21 C.F.R. § 1306.05(a); (2)
PMC dispensed Schedule II controlled substances "refills" to patients without obtaining a new prescription. The refilling of a Schedule II
controlled substance is prohibited. PMC failed to meet the requirements of 21 U.S.C. § 829 (a) and 21 C.F.R. § 1306.12(a).
(3)
PMC dispensed partially filled Schedule II controlled substances and failed to record on the prescription whether the patient was "terminally
ill" or a "LTCF patient", as required per 21 U.S.C. § 829 (a) an d 21 C.F.R. § 1306.13(b). In addition, for each partial filling, PMC failed to record on the back of the prescription (or on another appropriate record, uniformly maintained, and readily retrievable) the date of the partial filling, quantity dispensed, remaining quantity authorized to be dispensed, and the identification of the dispensing pharmacist. (4)
PMC dispensed partially filled Schedule II controlled substances in excess of the total quantity prescribed and for a period that exceeded 60
days from the issue date, both in violation of 21 U.S.C. § 829 (a) and 21 C.F.R. § 1306.13(b). (5)
PMC dispensed emergency Schedule II controlled substances in violation of 21 U.S.C. § 829 (a) and 21 C.F.R. § 1306.11(d), and such
violations included: (a) PMC failed to receive an oral authorization of a prescribing individual, as required by U.S.C. § 829 (a) an d 21 C.F.R. § 1306.11(d); (b) PMC dispensed emergency Schedule II controlled substances and failed to dispense the quantities limited to the amount adequate to treat the patient during the emergency period, as required per 21 U.S.C. § 829 (a) and 21 C.F.R. § 1306.11(d)(1); and (c) PMC dispensed emergency Schedule II controlled substances and failed to notify the nearest office of the Administration when the practitioner failed to deliver the written prescription to the pharmacy within 7 days after authorizing an emergency oral prescription, as required per 21 U.S.C. § 829 (a) and 21 C.F.R. § 1306.11(d)(4).
(d) PMC dispensed emergency Schedule II controlled substances based on the oral authorization by a practitioner and failed to immediately reduce the oral prescription to writing with all of the information required, as required per 21 U.S.C. § 829 (a) and 21 C.F.R. § 1306.11(d)(2). (6)
PMC dispensed Schedule II controlled substances from emergency kits placed at long-term care facilities and failed to receive an oral
authorization of a prescribing individual practitioner, as required per 21 U.S.C. § 829 (a) and 21 C.F.R. § 1306.11(d). (7)
PMC pharmacists failed to exercise their corresponding responsibility to ensure that controlled substances were dispensed pursuant to
prescriptions that were valid under 21 C.F.R. § 1306.05, and as required per 21 U.S.C. § 829 (a) and 21 C.F.R. § 1306.04(a). (8)
PMC placed Schedule II controlled substances in emergency kits at long-term care facilities and later filed a DEA form 106 acknowledging
that some controlled substances were missing. PMC failed to provide effective controls and procedures to guard against diversion or theft of controlled substances from emergency kits located at long-term care facilities as required per 21 C.F.R. § 1301.71(a). (9)
PMC dispensed Schedule III-V controlled substances in violation of 21 C.F.R. § 829(b)(c) and 21 C.F.R. § 1306.21(a), and such violations
included: (a) PMC dispensed Schedule III–V controlled substances pursuant to Physician's Orders faxed by nurses and failed to obtain a paper prescription signed by a practitioner, or a facsimile of a signed paper prescription, or an oral prescription made by an individual practitioner and promptly reduced to writing; (b)
PMC dispensed Schedule III-V controlled substances in emergency kits at long-term care facilities and failed to obtain a paper
prescription signed by a practitioner, or a facsimile of a signed paper prescription, or an oral prescription made by an individual practitioner and promptly reduced to writing, as required per 21 C.F.R. § 829(b)(c) and 21 C.F.R. § 1306.21(a); (c)
PMC dispensed Schedule III-V controlled substances pursuant to prescriptions with missing essential elements, such as the patient's
address, quantity prescribed, dosage form, number of refills, practitioner's name, practitioner's address, practitioner's signature, and DEA registration number, as required per 21 U.S.C. § 829 (b)(c) and 21 C.F.R. § 1306.05(a) (d)
PMC dispensed Schedule III-V controlled substances pursuant to orders from long term care facilities that did not include the
required elements of a prescription, such as the patient's address, quantity prescribed, dosage form, number of refills, practitioner's name, practitioner's address, practitioner's signature, and DEA registration number, as required per 21 U.S.C. § 829 (b)(c) a n d 21 C.F.R. § 1306.05(a). (10)
PMC failed to maintain, on a current basis, a complete and accurate record of each substance received, dispensed, or otherwise disposed of
by him/her, as required per 21 U.S.C. § 827(a)(3) and 21 C.F.R. § 1304.21(a). (11)
PMC failed to record on Copy 1 and 2 of DEA Forms 222 the number of commercial containers furnished and the dates on which the
containers were shipped to the purchaser, as required per 21 U.S.C. § 828 and 21 U.S.21 C.F.R. § 1305.13(b).
(12)
PMC failed to record on Copy 3 of DEA Forms 222 the number of commercial containers furnished and the dates on which the containers
were received by the purchaser, as required per 21 U.S.C. § 828 and 21 C.F.R. § 1305.13(e). (13)
PMC failed to submit to the Virginia Prescription Monitoring Program all controlled substances dispensed as required per Title 54.1-2521
of the Code of Virginia. C.
Term of Agreement
The obligations contained in this Agreement shall remain in full force and effect for a period of three (3) years from the effective date of this Agreement. D.
Obligations of PHARMERICA (1)
PMC shall dispense Schedule II controlled substances only pursuant to valid prescriptions written, signed, and dated on the day signed, by a
practitioner, as required per 21 U.S.C. § 829(a) and 21 C.F.R. § 1306.11(a). (2) (3)
PMC shall not dispense "refills" of Schedule II controlled substance prescriptions. PMC shall not dispense Schedule II controlled substances to a hospice patient pursuant to a faxed prescription that fails to indicate that it
was written for a hospice patient. (4)
In the case of an emergency situation, as defined by 21 C.F.R. § 290.10 , PMC shall only dispense a Schedule II controlled substance upon
receiving oral authorization of a prescribing individual practitioner, as per 21 U.S.C. § 829(a) and 21 C.F.R. § 1306.11, provided that: (a)
The quantity prescribed and dispensed is limited to the amount adequate to treat the patient during the emergency period
(dispensing beyond the emergency period must be pursuant to a paper or electronic prescription signed by the prescribing individual practitioner); (b)
The prescription shall be immediately reduced to writing by the pharmacist and shall contain all information required in 21 C.F.R. §
1306.05, except for the signature of the prescribing individual practitioner; (c)
If the prescribing individual practitioner is not known to the pharmacist, he must make a reasonable effort to determine that the oral
authorization came from a registered individual practitioner, which may include a callback to the prescribing individual practitioner using his phone number as listed in the telephone directory and/or other good faith efforts to insure his identity; and (d)
Within 7 days after authorizing an emergency oral prescription, the prescribing individual practitioner shall cause a written
prescription for the emergency quantity prescribed to be delivered to the dispensing pharmacist. In addition to conforming to the requirements of 21 C.F.R. §1306.05, the prescription shall have written on its face "Authorization for Emergency Dispensing," and the date of the oral order. The paper prescription may be delivered to the pharmacist in person or by mail, but if delivered by mail it must be postmarked within the 7-day period. Upon receipt, the dispensing pharmacist must attach this paper prescription to the oral emergency prescription that had earlier been reduced to writing. For electronic prescriptions, the pharmacist must annotate the record of the electronic prescription with the original authorization and date of the oral order. The pharmacist must notify the nearest office of the Drug Enforcement Administration if the prescribing individual practitioner fails to deliver a written prescription to him; failure of the pharmacist to do so shall void the authority conferred by this paragraph to dispense without a written prescription of a prescribing individual practitioner. (5)
PMC shall not partially fill Schedule II controlled substances without recording on the prescription whether the patient is "terminally ill" or
an "LTCF patient." In addition, for each partial filling dispensed, PMC shall record on the back of the paper prescription (or on another appropriate record, uniformly maintained, and readily retrievable) the date of the partial filling, quantity dispensed, remaining quantity authorized to be dispensed, and the identification of the dispensing pharmacist. Information pertaining to current Schedule II prescriptions for patients in a LTCF or for patients with a medical diagnosis documenting a terminal illness may be maintained in a computerized system if this system has the capability to permit: (a)
Output (display or printout) of the original prescription number, date of issue, identification of prescribing individual practitioner, identification of
patient, address of the LTCF or address of the hospital or residence of the patient, identification of medication authorized (to include dosage, form, strength and quantity), listing of the partial fillings that have been dispensed under each prescription and the information required in 21 C.F.R. § 1306.13(b). (b)
Immediate (real time) updating of the prescription record each time a partial filling of the prescription is conducted.
(c)
Retrieval of partially filled Schedule II prescription information is the same as required by 21 C.F.R. § 1306.22(b)(4) and (5) for Schedule III and IV
prescription refill information.
(6)
By no later than March 1, 2015, PMC shall implement systems to allow for the recording of partial fillings as a subset of the original
prescription number such as .01, .02, .03, etc. After this date, PMC shall not use a new serial number (prescription number) for each partial filling dispensed under the original prescription number. (7)
PMC shall not partially fill Schedule II controlled substances in excess of the total quantity prescribed by the practitioner or for a period that
exceeds 60 days from the issue date of the prescription. (8)
PMC shall partially fill Schedule II controlled substances that were prescribed by a practitioner in the case of an emergency, as defined by 21
C.F.R. § 290.10, in compliance with 21 C.F.R. 1306.13. (9)
PMC shall not fill a Schedule III-V controlled substance prescription that does not conform to the requirements of 21 C.F.R. § 1306.05 ,
including but not limited to obtaining a paper prescription signed by a practitioner; a facsimile of a signed paper prescription; an oral prescription made by an individual practitioner and promptly reduced to writing; or an electronic prescription which meets the requirements of 21 C.F.R. §1306.08. (10)
PMC shall not knowingly fill an invalid prescription or a prescription that it reasonably believes was issued for other than a legitimate
medical purpose or by a practitioner acting outside the usual course of professional practice. (11)
PMC shall not initiate partially or fully pre-populated templates/forms for a practitioner to sign, as PMC may not be characterized as the
prescribing practitioner's agent for purposes of preparing the prescriptions. (12)
PMC shall implement procedures to verify that the DEA registration number for the issuing prescriber of each controlled substance
prescription is a valid, DEA registration number, independent of calling local DEA offices. Such verification shall be performed periodically using the NTIS or similar-reliable third party database where DEA registration changes are recorded. PMC is not precluded from contacting any DEA office to verify the legitimacy of a DEA registration, however, it is understood that the verification of a DEA registration number alone does not fulfill all the obligations of a pharmacist's corresponding responsibility. (13)
PMC shall direct and train its pharmacists to fill prescriptions in accordance with the terms of this Agreement and that their responsibility
under federal law requires them not to fill a prescription that such pharmacist knows or has reason to know was issued for other than a legitimate medical purpose or by a practitioner acting outside the usual course of professional practice. (14)
PMC shall implement and maintain policies and procedures to ensure that Schedule II-V controlled substances are only dispensed pursuant
to valid prescriptions and proper oral authorizations by a prescribing practitioner. (15)
In connection with PMC's recordkeeping requirements pursuant to 21 C.F.R. § 1306.04, PMC agrees to implement no later than March 1,
2015 and thereafter to maintain records regarding the dispensing of controlled substances in electronic format, in addition to the regularly maintained paper files, including records relating to partial fillings of Schedule II controlled substance prescriptions and refills of Schedule III-V controlled substance prescriptions. These records shall be made available to DEA Special Agents, Task Force Officers or Diversion Investigators, upon demand, without the need for a warrant or subpoena, provided that the DEA Special Agents, Task Force Officers or Diversion Investigators present appropriate identification. PMC shall provide electronic reports of dispensing on an ad hoc basis in response to DEA requests within a reasonable time. (16)
By no later than March 1, 2015 PMC shall implement, and thereafter shall maintain, systems to allow for the maintenance on a current basis
of a complete and accurate record of each substance received, dispensed, or otherwise disposed of. (17)
PMC shall maintain a compliance program in an effort to detect and prevent diversion of controlled substances as required under the CSA
and applicable DEA regulations. This program shall include procedures to identify the common signs associated with the diversion of controlled substances. The program shall also include the routine and periodic training of all PMC pharmacy employees responsible for dispensing controlled substances on the elements of the compliance program and their responsibilities under the CSA and applicable DEA regulations. (18)
PMC shall maintain a Department of Compliance which includes employees with pharmacy-related training and managerial experience,
who shall be trained in relevant diversion-related issues to coordinate compliance efforts related to controlled substances. The director of the compliance department shall report directly to the Board of Directors and not simultaneously be an employee of PharMerica's legal department, including but not limited to the general counsel. Within one (1) month of the effective date of this Agreement, PMC will identify the director of the compliance department as a dedicated point of contact (including a name, title, address, telephone number and dedicated email address) for DEA. The point of contact will be responsible for the implementation of PMC's obligations listed in this Memorandum of Agreement and on-going monitoring of its level of compliance. (19)
PMC agrees that DEA personnel, during the term of this Memorandum of Agreement, may enter the PMC's registered locations at any time
during regular operating hours upon presentation of a Notice of Inspection to verify compliance with this memorandum. (20)
PMC shall abide by all state specific Prescription Drug Monitoring program regulations, to the extent required under applicable state law,
contain the correct valid, and active practitioners DEA Registration number.
(21)
PMC shall abide by all regulations relating to the transfer of original prescription information for controlled substances listed in Schedule
III, IV or V, as required by 21 C.F.R. § 1306.25. (22)
PMC shall abide by all regulations relating to the registration and recordkeeping for Automated Dispensing Systems maintained at Long
Term Care Facilities, as required by 21 C.F.R. § 1301.17(c), 1301.27, and 1304.04(a)(2). (23)
Upon the acquisition of a pharmacy, the newly acquired pharmacy shall adhere to the requirements of the CSA and its implementing
regulations prior to dispensing any controlled substance medications and PharMerica shall take measures otherwise to bring the acquired pharmacy into compliance with the non-CSA provisions of this MOA within a reasonable time.
E.
Release by DEA
In consideration of the fulfillment of the obligations of PMC under this Agreement, DEA hereby releases and agrees to refrain from filing any administrative actions against PMC based on the Covered Conduct or similar conduct at any other PMC pharmacy on or before the effective date of this agreement, within DEA's enforcement authority under 21 U.S.C. Sections 823 and 824. Notwithstanding the release by DEA contained in the Paragraph, DEA reserves the right to seek to admit evidence of the Covered Conduct in any other administrative proceedings. Further, nothing in this Paragraph shall prohibit any other agency within the Department of Justice, any State attorney general, or any other law enforcement, administrative, or regulatory agency of the United States or any State or political subdivision thereof ("law enforcement agency"), from initiating administrative, civil, or criminal proceedings with respect to the Covered Conduct. DEA shall, as obligated in fulfilling its statutory duties, assist and cooperate with any law enforcement agency that initiates an investigation, action, or proceeding, involving the Covered Conduct. At PMC's request DEA agrees to disclose the terms of this Agreement to any other law enforcement agency and will represent that PMC's compliance with this Agreement adequately addressed the allegations raised in the administrative proceedings by DEA as defined in the Covered Conduct. F.
Release by PMC
PMC fully and finally releases the United States of America, its agencies, employees, servants, and agents from any claims (including attorney's fees, costs, and expenses of every kind and however denominated) which PMC has asserted, could have asserted, or may assert in the future against the United States of America, its agencies, employees, servants, and agents, related to the Covered Conduct and the United States investigation and prosecution thereof. G.
Reservation of Claims
Notwithstanding any term of the Agreement, specifically reserved and excluded from the scope and terms of the Agreement as to any entity or person (including PMC) are the following:
a)
Any civil, criminal, or administrative liability arising under Title 26, U.S. Code (Internal Revenue Code);
b) Any liability to the United States (or its agencies) for any conduct other than the Covered Conduct subject to paragraph 5 of the Agreement;
c)
Any liability based upon such obligations as are created by this Agreement.
IV. MISCELLANEOUS A.
Binding on Successors This Agreement is binding on PMC, and its respective successors, heirs, transferees, and assigns.
B.
Costs
Each Party to this Agreement shall bear its own legal and other costs incurred in connection with this matter, including the preparation and performance of this Agreement. C.
No Additional Releases
This Agreement is intended to be for the benefit of the Parties and the Released Parties only and by this instrument the Parties do not release any claims against any other person or entity other than the Released Parties. D.
Effect of Agreement
This Agreement constitutes the complete agreement between the Parties. All material representations, understandings, and promises of the Parties are contained in this Agreement, and each of the Parties expressly agrees and acknowledges that, other than those statements expressly set forth in this Agreement, it is not relying on any statement, whether oral or written, of any person or entity with respect to its entry into this Agreement or to the consummation of the transactions contemplated by this Agreement. Any modifications to this Agreement shall be set forth in writing and signed by all Parties. PMC represents that this Agreement is entered into with advice of counsel and knowledge of the events described herein. PMC further represents that this Agreement is voluntarily entered into in order to avoid litigation, without any degree of duress or compulsion. By executing this Agreement, Pharmerica waives all rights to seek judicial review or to challenge or contest the validity of any terms or conditions of this Agreement.
E.
Execution of Agreement
This Agreement shall become effective on the date of signing by the last signatory (the "Effective Date") and remain in effect for a period of three (3) years from the Effective Date. DEA agrees to notify PMC immediately when the final signatory has executed this Agreement. F.
Breach of Agreement
Only material and systemic violations of the provisions of this Agreement may constitute a breach of the Agreement. Parties shall have a reasonable time to cure any such violation. G.
Effect of Breach Violation of any material term of this Agreement may result in the immediate suspension of Pharmerica's DEA Certificate of Registration and in an
administrative hearing, all pursuant to 21 U.S.C. § 824. Further, nothing in this Agreement shall be construed as a waiver on the part of the Drug Enforcement Administration of its authority to utilize any other grounds for revocation or denial of a DEA registration.
H.
Disclosure PMC and DEA may each disclose the existence of this Agreement and information about this Agreement to the public without restriction.
I.
Execution in Counterparts
This Agreement may be executed in counterparts, each of which constitutes an original, and all of which shall constitute one and the same agreement.
J.
Authorizations
The individuals signing this Agreement on behalf of PMC represent and warrant that they are authorized by PMC to execute this Agreement. The individuals signing this Agreement on behalf of DEA represent and warrant that they are signing this Agreement in their official capacity and that they are authorized by DEA to execute this Agreement.
UNITED STATES OF AMERICA
DATED:
5-14-15
/s/ Dennis A. Wichern Dennis A. Wichern Special Agent in Charge Chicago Field Division United States Drug Enforcement Administration
DATED:
___5-14-15
/s/ Karl C. Colder Karl C. Colder Special Agent in Charge Washington Field Division United States Drug Enforcement Administration
PHARMERICA CORPORATION
DATED:
5/11/15
/s/ Michael R. Manthei Michael R. Manthei Jeremy M. Sternberg HOLLAND & KNIGHT LLP
DATED:
5/11/15
/s/ Thomas Caneris Thomas Caneris Vice President and General Counsel PharMerica Corporation
Exhibit 31.1 CERTIFICATION I, Gregory S. Weishar, certify that: 1. I have reviewed this quarterly report on Form 10-Q of PharMerica Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d -15(f)) for the registrant and have: a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c. Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d. Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and 5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions): a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. DATE: November 6, 2015 /s/ Gregory S. Weishar Chief Executive Officer and Director
Exhibit 31.2 CERTIFICATION I, David W. Froesel, Jr., certify that: 1. I have reviewed this quarterly report on Form 10-Q of PharMerica Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a -15(f) and 15d -15(f)) for the registrant and have: a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c. Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d. Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and 5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions): a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. DATE: November 6, 2015 /S/ David W. Froesel, JR. Executive Vice President, Chief Financial Officer and Treasurer
Exhibit 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of PharMerica Corporation (the “Corporation”) on Form 10-Q for the quarter ended September 30, 2015 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Gregory S. Weishar, Chief Executive Officer and Director of the Corporation, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Corporation. /s/ Gregory W. Weishar Gregory S. Weishar Chief Executive Officer and Director November 6, 2015
Exhibit 32.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of PharMerica Corporation (the “Corporation”) on Form 10-Q for the quarter ended September 30, 2015 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, David W. Froesel, Jr., Executive Vice President and Chief Financial Officer of the Corporation, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Corporation. /s/ David W. Froesel, Jr. David W. Froesel, Jr. Executive Vice President, Chief Financial Officer and Treasurer November 6, 2015
UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549
FORM 10-Q (Mark One) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 ☒ For the quarterly period ended September 30, 2016 or ☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from
to
.
Commission File Number: 001-33380
PHARMERICA CORPORATION (Exact name of registrant as specified in its charter) Delaware 87-0792558 (State or Other Jurisdiction of Incorporation or Organization) (I.R.S. Employer Identification No.) 1901 Campus Place Louisville, KY (Address of Principal Executive Offices)
40299 (Zip Code)
(502) 627-7000 (Registrant's Telephone Number, Including Area Code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. ☒ Yes ☐ No Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). ☒ Yes ☐ No Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. Large accelerated filer ☒
Accelerated filer☐
Non-accelerated filer ☐ (Do not check if a smaller reporting company)
Smaller reporting company ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ☐ Yes ☒ No Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Class of Common Stock Common stock, $0.01 par value
Outstanding at November 2, 2016 30,781,867 shares
PHARMERICA CORPORATION FORM 10-Q TABLE OF CONTENTS Page PART I. FINANCIAL INFORMATION Item 1.
Financial Statements (Unaudited) Condensed Consolidated Income Statements - For the Three and Nine Months ended September 30, 2015 and 2016
3
Condensed Consolidated Balance Sheets - As of December 31, 2015 and September 30, 2016
4
Condensed Consolidated Statements of Cash Flows - For the Three and Nine Months Ended September 30, 2015 and 2016
5
Condensed Consolidated Statement of Stockholders' Equity - For the Nine Months Ended September 30, 2016
6
Notes to Condensed Consolidated Financial Statements
7
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
17
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
32
Item 4.
Controls and Procedures
32
PART II. OTHER INFORMATION
33
Item 1.
Legal Proceedings
33
Item 1A
Risk Factors
33
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
33
Item 4.
Mine Safety Disclosures
33
Item 6.
Exhibits
34
SIGNATURES
35
Exhibit Index
36 2
PHARMERICA CORPORATION CONDENSED CONSOLIDATED INCOME STATEMENTS For the Three and Nine Months Ended September 30, 2015 and 2016 (Unaudited) (In millions, except share and per share amounts)
Revenues Cost of goods sold Gross profit Selling, general and administrative expenses Amortization expense Merger, acquisition, integration costs and other charges Settlement, litigation and other related charges Restructuring and impairment charges Hurricane Sandy disaster costs Operating income Interest expense, net Income before income taxes Provision for income taxes Net income
Three Months Ended September 30, 2015 2016 $ 498.8 $ 512.6 420.2 434.1 78.6 78.5 52.7 53.1 7.0 8.3 8.0 5.3 2.1 (0.8) 0.2 0.6 0.1 8.5 12.0 2.1 3.0 6.4 9.0 3.4 1.7 $ 3.0 $ 7.3
Nine Months Ended September 30, 2015 2016 $ 1,507.8 $ 1,556.7 1,259.4 1,314.4 248.4 242.3 167.1 165.8 20.6 24.7 15.2 14.1 11.3 7.2 0.3 3.1 0.1 33.8 27.4 5.4 9.3 28.4 18.1 13.5 4.2 $ 14.9 $ 13.9
Earnings per common share: Basic Diluted
$ $
$ $
Shares used in computing earnings per common share: Basic Diluted
0.10 0.10
30,431,845 30,896,294
$ $
0.24 0.23
30,754,253 31,071,290
See accompanying Notes to Condensed Consolidated Financial Statements 3
0.49 0.48
30,336,548 30,798,834
$ $
0.45 0.44
30,670,487 31,040,849
PHARMERICA CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS As of December 31, 2015 and September 30, 2016 (Unaudited) (In millions, except share and per share amounts) December 31, 2015
September 30, 2016
ASSETS Current assets: Cash and cash equivalents Accounts receivable, net Inventory Deferred tax assets, net Income taxes receivable Prepaids and other assets
$
Equipment and leasehold improvements Accumulated depreciation
23.1 200.5 155.2 41.8 10.5 52.4 483.5
$
218.5 (144.0) 74.5
Goodwill Intangible assets, net Other long-term assets (See Note 5) $
371.0 190.2 32.4 1,151.6
6.5 215.4 118.8 26.3 8.7 54.3 430.0 245.2 (160.6) 84.6
$
388.1 171.4 83.4 1,157.5
LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable Salaries, wages and other compensation Current portion of long-term debt Other accrued liabilities
$
Long-term debt Other long-term liabilities Deferred tax liabilities Commitments and contingencies (See Note 5) Stockholders' equity: Preferred stock, $0.01 par value per share; 1,000,000 shares authorized and no shares issued, December 31, 2015 and September 30, 2016 Common stock, $0.01 par value per share; 175,000,000 shares authorized; 33,237,732 and 33,687,457 shares issued as of December 31, 2015 and September 30, 2016, respectively Capital in excess of par value Retained earnings Treasury stock at cost, 2,776,875 and 2,916,742 shares at December 31, 2015 and September 30, 2016, respectively $ See accompanying Notes to Condensed Consolidated Financial Statements 4
71.7 30.6 11.6 27.5 141.4
$
73.0 28.2 11.8 25.5 138.5
413.6 56.5 20.7
378.7 91.2 13.3
-
-
0.3 404.6 152.1 (37.6) 519.4 1,151.6
$
0.3 410.4 166.0 (40.9) 535.8 1,157.5
PHARMERICA CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS For the Three and Nine Months Ended September 30, 2015 and 2016 (Unaudited) (In millions) Three Months Ended September 30, 2015 2016 Cash flows provided by (used in) operating activities: Net income Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation Amortization Stock-based compensation and deferred compensation Amortization of deferred financing fees Deferred income taxes Loss on disposition of equipment Other Change in operating assets and liabilities: Accounts receivable, net Inventory Prepaids and other assets Accounts payable Salaries, wages and other compensation Other accrued and long-term liabilities Change in income taxes payable (receivable) Excess tax benefit from stock-based compensation Net cash provided by operating activities
$
3.0
Nine Months Ended September 30, 2015 2016
$
7.3
$
14.9
$
13.9
5.7 7.0 1.7 0.1 2.1 -
6.2 8.3 2.2 0.1 0.2 0.1 -
17.2 20.6 5.4 0.4 4.6 0.1 0.1
17.2 24.7 6.3 0.4 8.0 0.1 0.1
3.4 17.5 (7.7) 3.6 2.1 0.2 (1.0) (0.2) 37.5
(7.4) 43.9 (0.2) (24.5) 0.2 (4.1) 6.9 (0.1) 39.1
1.2 18.1 12.3 (11.9) (0.9) (10.2) (10.0) (2.3) 59.6
(14.4) 36.5 (0.7) 2.3 (2.5) (13.4) 3.1 (1.3) 80.3
Cash flows provided by (used in) investing activities: Purchase of equipment and leasehold improvements Acquisitions, net of cash acquired Cash proceeds from sale of assets Net cash used in investing activities
(6.6) (0.3) 0.1 (6.8)
(13.0) (24.4) 0.1 (37.3)
(17.6) (20.9) 0.2 (38.3)
(26.3) (31.3) 0.1 (57.5)
Cash flows provided by (used in) financing activities: Repayments of long-term debt Net activity of long-term revolving credit facility Issuance of common stock Treasury stock, for employee taxes on stock awards Excess tax benefit from stock-based compensation Repayments of capital lease obligations Net cash used in financing activities
(2.8) (9.0) (0.4) 0.2 (12.0)
(2.8) (19.5) 0.1 (0.3) (0.2) (22.7)
(2.8) (10.0) 0.7 (4.3) 2.3 (0.5) (14.6)
(8.4) (27.5) 0.2 (3.3) (0.4) (39.4)
18.7 21.3
(20.9) 27.4
6.7 33.3
(16.6) 23.1
Change in cash and cash equivalents Cash and cash equivalents at beginning of period Cash and cash equivalents at end of period
$
40.0
$
6.5
$
40.0
$
6.5
Supplemental information: Cash paid for interest Cash paid (received) for taxes
$ $
3.2 2.4
$ $
2.7 (5.0)
$ $
6.2 19.4
$ $
7.9 (4.8)
See accompanying Notes to Condensed Consolidated Financial Statements 5
PHARMERICA CORPORATION CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY For the Nine Months Ended September 30, 2016 (Unaudited) (In millions, except share amounts)
Balance at December 31, 2015 Net income Exercise of stock options and tax components of stock-based awards, net Vested restricted stock units Vested performance stock units Treasury stock, for employees taxes on stock awards Stock-based compensation - non-vested restricted stock Balance at September 30, 2016
Common Stock Shares Amount 30,460,857 $ 0.3
Capital in Excess of Par Value $ 404.6
$
Retained Earnings 152.1 13.9
95,804 190,473 163,448
-
-
-
(139,867)
-
-
-
30,770,715
$
0.3
$
5.8 410.4
$
166.0
See accompanying Notes to Condensed Consolidated Financial Statements 6
Treasury Stock $ (37.6)
Total $
-
-
(3.3)
$
(40.9)
519.4 13.9
(3.3)
$
5.8 535.8
PHARMERICA CORPORATION 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 95 institutional pharmacies, 17 specialty home infusion pharmacies, and 4 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. 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, 2015, included in the Corporation's Annual Report on Form 10-K. The balance sheet as of December 31, 2015 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. 7
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, 2015 and September 30, 2016 are set forth in the tables below (dollars in millions):
As of December 31, 2015 Financial Liability Deferred Compensation Plan Contingent Considerations Mandatorily Redeemable Interest
As of September 30, 2016 Financial Liability Deferred Compensation Plan Contingent Considerations Mandatorily Redeemable Interest
Liability $
Level 1
(8.2) (11.5) (5.8)
$
Liability $
Level 2 -
$
Level 1 (8.9) (7.3) (6.7)
$
(8.2) -
$
(11.5) (5.8)
Level 2 -
$
Valuation Technique
Level 3
A C C Valuation Technique
Level 3 (8.9) -
$
(7.3) (6.7)
A C 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 the Corporation's acquisition of an infusion business and a hospital services business both purchased in 2015. 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 longterm 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"), purchased on December 6, 2013. 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 September 30, 2016. This liability is classified as other long-term liabilities in the accompanying condensed consolidated balance sheets. For the year ended December 31, 2015 and the nine months ended September 30, 2016, 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 consideration and mandatorily redeemable interest identified as Level 3 for the year ended December 31, 2015 and the nine months ended September 30, 2016 (in millions): Mandatorily Redeemable Interest
Contingent Consideration Beginning balance, December 31, 2014 Additions from business acquisitions Subtractions from business acquisitions Change in fair value Balance, December 31, 2015 Additions from business acquisitions Contingent consideration payment Change in fair value Balance, September 30, 2016
$
$
1.1 11.9 (1.1) (0.4) 11.5 (3.9) (0.3) 7.3
$
$
8.3 (2.5) 5.8 0.9 6.7
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). 8
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, 2015 $ 145.9 30.2 26.8 31.1 12.6 3.2 (49.3) $ 200.5
Institutional healthcare providers Medicare Part D Private payer and other Insured Medicaid Medicare Allowance for doubtful accounts
0 to 60 days 61 to 120 days Over 120 days
September 30, 2016 $ 137.8 34.6 27.7 37.6 14.0 3.6 (39.9) $ 215.4
62.0% 15.0% 23.0% 100.0%
61.0% 14.4% 24.6% 100.0%
The following is a summary of activity in the Corporation's allowance for doubtful accounts (dollars in millions):
Beginning Balance Allowance for doubtful accounts: Year ended December 31, 2015 Nine months ended September 30, 2016
$ $
58.1 49.3
Charges Included in Selling, General & Administrative Expenses $ $
7.9 4.0
Write-offs $ $
(16.7) (13.4)
Ending Balance $ $
49.3 39.9
In the fourth quarter of 2015, the Corporation reversed an allowance of $4.6 million related to a customer's outstanding receivable for which a settlement payment was received which significantly exceeded the existing net receivable. This reversal is reflected in the "Charges Included in Selling, General & Administrative Expenses" column above for the year ended December 31, 2015. Restructuring Charges Restructuring charges in the condensed consolidated financial statements represent amounts expensed for purposes of realigning corporate and pharmacy locations. Mandatorily Redeemable Interest The Corporation acquired 37.5% of the membership interests of Onco while also obtaining control of the business. The subsidiary is consolidated in the Corporation's condensed consolidated financial statements and the mandatorily redeemable interest is classified as debt within other long-term liabilities in the condensed consolidated balance sheets. 9
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 March of 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update No. 2016-09 (ASU 2016-09) "CompensationStock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting" intended to simplify the accounting for employee share-based payments. Under this guidance all excess tax benefits ("windfalls") and deficiencies ("shortfalls") related to employee stock compensation will be recognized within income tax expense. Under prior guidance windfalls were recognized to additional paid-in capital ("APIC") and shortfalls were only recognized to the extent they exceed the pool of windfall tax benefits. The new standard is effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. Early adoption is permitted for any interim or annual period. The Corporation early adopted ASU 2016-09 effective January 1, 2016. As a result of the adoption a tax benefit of $0.9 million was recorded in the nine months ended September 30, 2016 reflecting the excess tax benefits. The adoption was on a prospective basis and therefore had no impact on prior years. NOTE 2—ACQUISITIONS 2016 Acquisitions During the nine months ended September 30, 2016, the Corporation completed acquisitions of two long-term care businesses and one infusion business (collectively the "2016 Acquisitions"), none of which were individually significant to the Corporation. The 2016 Acquisitions had an estimated purchase price of $24.4 million. The resulting amount of goodwill and identifiable intangibles related to these transactions in the aggregate were $15.9 million and $5.8 million, respectively. The Corporation believes the resulting amount of goodwill reflects the synergistic benefits of the acquisitions. Tax deductible goodwill associated with the acquisitions was $22.3 million as of September 30, 2016. 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. 2015 Acquisitions During the year ended December 31, 2015, the Corporation completed acquisitions of two long-term care businesses, two infusion businesses and one hospital services business (collectively the "2015 Acquisitions"), none of which were individually significant to the Corporation. The 2015 Acquisitions had an estimated purchase price of $83.7 million, comprised of a net cash payment of $76.4 million and an estimated fair value of contingent consideration of $7.3 million. The resulting amount of goodwill and identifiable intangibles related to these transactions in the aggregate were $48.5 million and $41.2 million, respectively. The Corporation believes the resulting amount of goodwill reflects the synergistic benefits of the acquisitions. Tax deductible goodwill associated with the acquisitions was $40.8 million as of September 30, 2016. The net assets and operating results of the 2015 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 2015 Acquisitions as the results are not material to the Corporation's condensed consolidated financial statements. Other For the three months ended September 30, 2015 and 2016, the Corporation incurred $7.6 million and $5.2 million, respectively, and $14.7 million and $13.9 million for the nine months ended September 30, 2015 and 2016, respectively, of acquisition-related costs, which have been classified as a component of merger, acquisition, integration costs and other charges. NOTE 3—GOODWILL AND INTANGIBLES As of December 31, 2015 and September 30, 2016 the carrying amount of goodwill was $371.0 million and $388.1 million, respectively. The following table presents the components of the Corporation's finite lived intangible assets (dollars in millions): Balance at December 31, 2015 $ 216.8 63.1 20.9 300.8 (110.6) $ 190.2
Finite Lived Intangible Assets Customer relationships Trade name Non-compete agreements Sub Total Accumulated amortization Net intangible assets
Additions $
$
5.4 0.1 0.4 5.9 (24.7) (18.8)
Balance at September 30, 2016 $ 222.2 63.2 21.3 306.7 (135.3) $ 171.4
Amortization expense relating to finite-lived intangible assets was $7.0 million and $8.3 million for the three months ended September 30, 2015 and 2016, respectively. Amortization expense relating to finite-lived intangible assets was $20.6 million and $24.7 million for the nine months ended September 30, 2015 and 2016, respectively. 10
PHARMERICA CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued (Unaudited) NOTE 4—CREDIT AGREEMENT On September 17, 2014, the Corporation entered into a credit agreement 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 (the "Credit Agreement"). The Credit Agreement consists of a $225.0 million term loan facility and a $310.0 million revolving credit facility. The terms and conditions of the Credit Agreement are customary to facilities of this nature. As of September 30, 2016, $210.9 million was outstanding under the term loan facility and $179.5 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, 2015 Term Debt - payable to lenders at LIBOR plus applicable margin (2.524% as of September 30, 2016), matures September 17, 2019 Revolving Credit Facility payable to lenders, interest at LIBOR plus applicable margin (2.453% as of September 30, 2016), matures September 17, 2019 Deferred financing costs, net * Capital lease obligations Total debt Less: Current portion of long-term debt Total long-term debt
$
219.4
$
207.0 (2.1) 0.9 425.2 11.6 413.6
September 30, 2016 $
210.9
$
179.5 (1.6) 1.7 390.5 11.8 378.7
* The Corporation adopted FASB Accounting Standards Update ("ASU") 2015-03 "Simplifying the Presentation of Debt Issuance Costs". Therefore, debt issuance costs related to the Corporation's debt liability in the condensed consolidated balance sheets are presented as a direct deduction from the carrying amount of the debt obligation. The Corporation retrospectively adjusted prior period amounts, which decreased other long-term assets and decreased long-term debt by $2.1 million in the condensed consolidated balance sheet as of December 31, 2015. The Corporation's indebtedness has the following maturities as of September 30, 2016 (dollars in millions):
Year Ending December 31, 2016 2017 2018 2019 2020
Term Debt $ 2.8 11.3 11.3 185.5 $ 210.9
Revolving Credit Facility $
$
179.5 179.5
Deferred Financing Costs $ (0.1) (0.6) (0.5) (0.4) $ (1.6)
Capital Lease Obligations $ 0.1 0.6 0.4 0.4 0.2 $ 1.7
Total Maturities $ 2.8 11.3 11.2 365.0 0.2 $ 390.5
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, 2016 was $2.8 million. After giving effect to the letters of credit, total availability under the revolving credit facility was $127.7 million as of September 30, 2016. 11
PHARMERICA CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued (Unaudited) NOTE 5—COMMITMENTS AND CONTINGENCIES 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 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. On August 29, 2016, the District Court held a status conference and ordered the relator to file his motion to supplement by December 29, 2016. The Corporation has until March 1, 2017 to respond. The Corporation intends to continue to defend the case vigorously. 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 the nursing home was at financial risk, 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. 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. The court has not yet ruled on the motions. 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. In the meantime, fact discovery continues. The Corporation intends to vigorously defend itself against the remaining allegations in the case. 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 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 accompanying 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. 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 $50.4 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. 12
PHARMERICA CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued (Unaudited) NOTE 5—COMMITMENTS AND CONTINGENCIES (Continued) On April 1, 2016, the Jefferson Circuit Court ruled that the Corporation could not set-off payment 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 $50.4 million of payments for drug purchases in the first quarter of 2015, including post-judgment interest. 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 have to post a bond, pay ABDC post-judgment interest, or appeal 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. Amounts owed to and from ABDC were previously offset resulting in a net receivable of $21.9 million from ABDC in the accompanying condensed consolidated balance sheet at September 30, 2016 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 has grossed up the receivable from ABDC to $72.3 million and the payable to $50.4 million. Accordingly, the $72.3 million receivable from ABDC is reflected in other long-term assets and the $50.4 million payable is reflected in other long-term liabilities in the accompanying condensed consolidated balance sheet as of September 30, 2016. 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 condensed consolidated financial condition, results of operations, or liquidity. The litigation with ABDC could continue for an extended period of time, likely longer than 12 months. 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, 2016, the Corporation had accrued approximately $17.9 million related to the pending or settled legal actions and investigations. NOTE 6—MERGER, ACQUISITION, INTEGRATION COSTS AND OTHER CHARGES Merger, acquisition, integration costs and other charges combined were $8.0 million and $5.3 million for the three months ended September 30, 2015 and 2016, respectively, and $15.2 million and $14.1 million for the nine months ended September 30, 2015 and 2016, 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. NOTE 7—RESTRUCTURING COSTS AND OTHER CHARGES In July 2013, the Corporation commenced the implementation of its restructuring plan as a result of the loss of two of the Corporation's significant customers, Kindred Healthcare Inc. and Golden Living. The plan was a major initiative primarily designed to optimize operational efficiency while ensuring that the Corporation remains well-positioned to serve its clients and achieve sustainable, long-term growth. The Corporation's restructuring plan included steps to right size its cost structure by adjusting its workforce and facility plans to reflect anticipated business needs. In addition, in the year ended December 31, 2015, the Corporation began a restructuring and centralization initiative related to its specialty pharmacy business. The initiative is not expected to be material to the financial statements. The Corporation recorded restructuring costs and other related charges of $0.2 million and $0.6 million during the three months ended September 30, 2015 and 2016, respectively, and $0.3 million and $3.1 million for the nine months ended September 30, 2015 and 2016, 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, 2015 $ 0.3 0.7 $ 1.0
Employee Severance and related costs Facility costs
Utilized Amounts
Accrual $ $
2.5 0.6 3.1
$ $
(2.2) (0.8) (3.0)
Balance at September 30, 2016 $ 0.6 0.5 $ 1.1
The liability at September 30, 2016 represents amounts not yet paid relating to actions taken in connection with the restructuring plan (primarily lease payments and severance costs). 13
PHARMERICA CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued (Unaudited) NOTE 8—COMMON STOCK, PREFERRED STOCK, 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, 2016. 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, 2016, 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 139,867 shares from the vesting of certain awards and exercise of certain stock options, for an aggregate price of approximately $3.3 million during the nine months ended September 30, 2016. 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, 2016. The following table summarizes option activity for the periods presented:
Number of Shares 639,145 (95,804) (97,688) (2,635) 443,018 443,018
Outstanding shares at December 31, 2015 Exercised Canceled Expired Outstanding shares at September 30, 2016 Exercisable shares at September 30, 2016
WeightedAverage Exercise Price Per Share $ 14.34 14.99 15.22 13.60 $ 14.06 $ 14.06
WeightedAverage Aggregate Remaining Intrinsic Value Term (in millions) 1.3 years $ 13.2
1.0 years $ 1.0 years $
6.2 6.2
Nonvested Shares The following table summarizes nonvested share activity for the periods presented:
Number of Shares 901,159 253,625 212,289 (31,549) (353,921) 981,603
Outstanding shares at December 31, 2015 Granted - Restricted Stock Units Granted - Performance Share Units Forfeited Vested Outstanding shares at September 30, 2016
WeightedAverage Grant Date Fair Value $ 22.26 11.26 9.11 22.67 18.74 $ 22.61
The weighted average remaining term and intrinsic value of non-vested shares as of September 30, 2016 was 1.4 years and $27.6 million, respectively. 14
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, 2015 2016 2015 2016 $ 3.4 $ 1.7 $ 13.5 $ 4.2 53.1% 19.7% 47.5% 23.4%
Provision for income taxes Total provision as a percentage of pre-tax income
The decrease in our provision for income taxes as a percentage of pre-tax income for the nine months ended September 30, 2016 compared to the comparable 2015 period was due to decreases in certain non-deductible employee compensation costs and discrete events. For the nine months ending September 30, 2016, the discrete events included the Corporation's early adoption of ASU 2016-09 for 2016 which resulted in a decrease to the tax provision for excess tax benefits of $0.9 million. In addition, during the quarter ended September 30, 2016, the Corporation deducted its legal settlement payments related to the Amgen litigation and recorded certain adjustments, resulting in a tax benefit of $1.7 million. 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 tax basis of the Corporation's tax deductible goodwill was approximately $171.1 million and $171.5 million at December 31, 2015 and September 30, 2016, 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, 2016, the Corporation had $18.0 million ($6.3 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 and 2014. 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 $4.2 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 $21.1 million and $13.0 million at December 31, 2015 and September 30, 2016, respectively, net of state valuation allowances of $3.8 million. The federal statute of limitations remains open for tax years 2013 through 2014. 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 2010. 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. 15
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):
Numerator: Numerator for basic and diluted earnings per share - net income Denominator: Denominator for basic earnings per share - weighted average shares Effect of dilutive securities (stock options, restricted stock units and performance share units) Denominator for earnings per diluted share - adjusted weighted average shares Basic earnings per share Earnings per diluted share Unexercised employee stock options and unvested restricted shares excluded from the effect of dilutive securities above (a)
Three Months Ended September 30, 2015 2016
Nine Months Ended September 30, 2015 2016
$
$
$ $
3.0
$
7.3
14.9
$
13.9
30,431,845
30,754,253
30,336,548
30,670,487
464,449 30,896,294 0.10 0.10
317,037 31,071,290 0.24 0.23
462,286 30,798,834 0.49 0.48
370,362 31,040,849 0.45 0.44
197
$ $
213
$ $
$ $
504
-
(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. 16
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS This Quarterly Report on Form 10-Q contains forward-looking statements, within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which reflect the Corporation's current estimates, expectations and projections about the Corporation's future results, performance, prospects and opportunities. Forward looking statements include, among other things, the information concerning the Corporation's possible future results of operations including revenues, costs of goods sold, and gross margin, business and growth strategies, financing plans, the Corporation's competitive position and the effects of competition, the projected growth of the industries in which we operate, and the Corporation's ability to consummate strategic acquisitions. Forward-looking statements include statements that are not historical facts and can be identified by forward-looking words such as "anticipate," "believe," "could," "estimate," "expect," "intend," "plan," "may," "should," "will," "would," "project," and similar expressions. These forwardlooking statements are based upon information currently available to the Corporation and are subject to a number of risks, uncertainties and other factors that could cause the Corporation's actual results, performance, prospects or opportunities to differ materially from those expressed in, or implied by, these forward-looking statements. Important factors that could cause the Corporation's actual results to differ materially from the results referred to in the forward-looking statements the Corporation makes in this report include: • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • •
the Corporation's access to capital, credit ratings, indebtedness, and ability to raise additional financings and operate under the terms of the Corporation's debt obligations; anti-takeover provisions of the Delaware General Corporation Law, which in concert with our certificate of incorporation and our by-laws could delay or deter a change in control; the effects of adverse economic trends or intense competition in the markets in which we operate; the Corporation's risk of loss of revenues due to a customer or owner of a skilled nursing facility entering the institutional pharmacy business; the effects of the loss of a large customer and the Corporation's ability to adequately restructure its operations to offset the loss; the demand for the Corporation's products and services; the risk of retaining existing customers and service contracts and the Corporation's ability to attract new customers for growth of the Corporation's business; the effects of renegotiating contract pricing relating to significant customers and suppliers, including the hospital pharmacy business which is substantially dependent on service provided to one customer; the impacts of cyber security risks and/or incidents; the effects of a failure in the security or stability of our technology infrastructure, or the infrastructure of one or more of our key vendors, or a significant failure or disruption in service; the effects of an increase in credit risk, loss or bankruptcy of or default by any significant customer, supplier, or other entity relevant to the Corporation's operations; the Corporation's ability to successfully pursue the Corporation's development and acquisition activities and successfully integrate new operations and systems, including the realization of anticipated revenues, economies of scale, cost savings, and productivity gains associated with such operations; the Corporation's ability to control costs, particularly labor and employee benefit costs, rising pharmaceutical costs, and regulatory compliance costs; the effects of healthcare reform and government regulations, including interpretation of regulations and changes in the nature and enforcement of regulations governing the healthcare and institutional pharmacy services industries including the dispensing of antipsychotic prescriptions; changes in the reimbursement rates or methods of payment from Medicare and Medicaid and other third party payers to both us and our customers; the potential impact of state government budget shortfalls and their ability to pay the Corporation and its customers for services provided; the Corporation's ability, and the ability of the Corporation's customers, to comply with Medicare or Medicaid reimbursement regulations or other applicable laws; the effects of changes in the interest rate on the Corporation's outstanding floating rate debt instrument and the increases in interest expense, including increases in interest rate terms on any new debt financing; further consolidation of managed care organizations and other third party payers; political and economic conditions nationally, regionally, and in the markets in which the Corporation operates; natural disasters, war, civil unrest, terrorism, fire, floods, tornadoes, earthquakes, hurricanes, epidemic, pandemic, catastrophic event or other matters beyond the Corporation's control; increases in energy costs, including state and federal taxes, and the impact on the costs of delivery expenses and utility expenses; elimination of, changes in, or the Corporation's failure to satisfy pharmaceutical manufacturers' rebate programs; the Corporation's ability to attract and retain key executives, pharmacists, and other healthcare personnel; the Corporation's risk of loss not covered by insurance; the outcome of litigation to which the Corporation is a party from time to time, including adverse results in material litigation or governmental inquiries including the possible insufficiency of any accruals established by the Corporation from time to time; changes in accounting rules and standards, audits, compliance with the Sarbanes-Oxley Act, and regulatory investigations; changes in market conditions that would result in the impairment of goodwill or other assets of the Corporation; changes in market conditions in which we operate that would influence the value of the Corporation's stock; the uncertainty as to the long-term value of the Corporation's common stock; the Corporation's ability to anticipate a shift in demand for generic drug equivalents and the impact on the financial results including the negative impact on brand drug rebates; the effect on prescription volumes and the Corporation's net revenues and profitability if the safety risk profiles of drugs increase or if drugs are withdrawn from the market, including as a result of manufacturing issues, or if prescription drugs transition to over-the-counter products; the effects on the Corporation's results of operations related to interpretations of accounting principles by the SEC staff that may differ from those of management; 17
• • • • • •
the potential impact of the litigation proceedings with ABDC regarding the Previous PVA; the Corporation's ability to comply with the terms of its Memorandum of Agreement with the DEA and the Corporate Integrity Agreement with the OIG; the Corporation's ability to collect outstanding receivables; changes in tax laws and regulations; the effects of changes to critical accounting estimates; and other factors, risks and uncertainties referenced in the Corporation's filings with the Commission, including the "Risk Factors" set forth in the Corporation's Annual Report on Form 10-K for the year ended December 31, 2015.
YOU ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON ANY FORWARD-LOOKING STATEMENTS, ALL OF WHICH SPEAK ONLY AS OF THE DATE OF THIS QUARTERLY REPORT. EXCEPT AS REQUIRED BY LAW, WE UNDERTAKE NO OBLIGATION TO PUBLICLY UPDATE OR RELEASE ANY REVISIONS TO THESE FORWARD-LOOKING STATEMENTS TO REFLECT ANY EVENTS OR CIRCUMSTANCES AFTER THE DATE OF THIS QUARTERLY REPORT OR TO REFLECT THE OCCURRENCE OF UNANTICIPATED EVENTS. ALL SUBSEQUENT WRITTEN AND ORAL FORWARDLOOKING STATEMENTS ATTRIBUTABLE TO US OR ANY PERSON ACTING ON THE CORPORATION'S BEHALF ARE EXPRESSLY QUALIFIED IN THEIR ENTIRETY BY THE CAUTIONARY STATEMENTS CONTAINED OR REFERRED TO IN THIS SECTION AND IN OUR RISK FACTORS SET FORTH IN PART I, ITEM 1A OF THE CORPORATION'S ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2015 AND IN OTHER REPORTS FILED WITH THE SEC BY THE CORPORATION. 18
General The condensed consolidated financial statements and Management's Discussion and Analysis of Financial Condition and Results of Operations included in this quarterly report on Form 10-Q as of and for the three and nine months ended September 30, 2016, reflect the financial position, results of operations, and cash flows of the Corporation. Unless the context otherwise requires, all references to "we," "us," "our," and "Corporation" refer to PharMerica Corporation and its subsidiaries. Institutional Pharmacy Business Our core business provides pharmacy products and services to residents and patients in skilled nursing facilities, nursing centers, assisted living facilities, hospitals, and other long-term alternative care settings. We purchase, repackage, and dispense prescription and non-prescription pharmaceuticals in accordance with physician orders and deliver such medication to healthcare facilities for administration to individual patients and residents. Depending on the specific location, we service healthcare facilities typically within a radius of 120 miles or less of our pharmacy locations at least once each day. We provide 24-hour, seven-day per week on-call pharmacist services for emergency dispensing, delivery, and/or consultation with the facility's staff or the resident's attending physician. We also provide various supplemental healthcare services that complement our institutional pharmacy services. We offer prescription and non-prescription pharmaceuticals to our customers through unit dose or modified unit dose packaging, dispensing, and delivery systems, typically in a 14 to 30 day supply. Unit dose medications are packaged for dispensing in individual doses as compared to bulk packaging used by most retail pharmacies. The customers we serve prefer the unit dose delivery system over the bulk delivery system employed by retail pharmacies because it improves control over the storage and ordering of drugs and reduces errors in drug administration in healthcare facilities. Nursing staff in our customers' facilities administer the pharmaceuticals to individual patients and residents. The Corporation also utilizes an on-site dispensing system, with real time data transfer between the system and the Corporation, which provides timely medication administration in emergency and first dose situations. We also offer clinical pharmacy programs that encompass a wide range of drug therapy and disease management protocols, including protocols for anemia treatment, infectious diseases, wound care, nutritional support, renal dosing, and therapeutic substitution. Our computerized dispensing and delivery systems are designed to improve efficiency and control over distribution of medications to patients and residents. We provide computerized physician orders and medication administration records for patients or residents on a monthly basis as requested. Data from these records are formulated into monthly management reports on patient and resident care and quality assurance. This system improves efficiencies in nursing time, reduces drug waste, and helps to improve patient outcomes. Hospital Pharmacy Management Services We also provide hospital pharmacy management services. These services generally entail the overall management of the hospital pharmacy operations, including the ordering, receipt, storage, and dispensing of pharmaceuticals to the hospital's patients pursuant to the clinical guidelines established by the hospital. We offer the hospitals a wide range of regulatory and financial management services, including inventory control, budgetary analysis, staffing optimization, and assistance with obtaining and maintaining applicable regulatory licenses, certifications, and accreditations. We work with the hospitals to develop and implement pharmacy policies and procedures, including drug formulary development and utilization management. We also offer clinical pharmacy programs that encompass a wide range of drug therapy and disease management protocols, including protocols for anemia treatment, infectious diseases, wound care, nutritional support, renal dosing, and therapeutic substitution. The hospital pharmacy management services business is comprised of hospital customers, of which, our largest service is to the majority of the Kindred Healthcare hospitals. Consultant Pharmacist Services Federal and state regulations mandate that long-term care facilities, in addition to providing a source of pharmaceuticals, retain consultant pharmacist services to monitor and report on prescription drug therapy in order to maintain and improve the quality of resident care. On September 30, 2008, the United States Department of Health and Human Services Office of Inspector General ("OIG") published OIG Supplemental Compliance Program Guidance for Nursing Homes. With quality of care being the first risk area identified, the supplemental guidance is part of a series of recent government efforts focused on improving quality of care at skilled nursing and long-term care facilities. The guidance contains compliance recommendations and an expanded discussion of risk areas. The guidance stressed that facilities must provide pharmaceutical services to meet the needs of each resident and should be mindful of potential quality of care problems when implementing policies and procedures on proper medication management. It further stated that facilities can reduce risk by educating staff on medication management and improper pharmacy kickbacks for consultant pharmacists and that facilities should review the total compensation paid to consultant pharmacists to ensure it is not structured in a way that reflects the volume or value of particular drugs prescribed or administered to residents. We provide consultant pharmacist services to approximately 65% of our patients serviced. The services offered by our consultant pharmacists include: · · · · ·
Monthly reviews of each resident's drug regimen to assess the appropriateness and efficiency of drug therapies, including the review of medical records, monitoring drug interactions with other drugs or food, monitoring laboratory test results, and recommending alternative therapies; Participation on quality assurance and other committees of our customers, as required or requested by such customers; Monitoring and reporting on facility-wide drug utilization; Development and maintenance of pharmaceutical policy and procedure manuals; and Assistance with federal and state regulatory compliance pertaining to resident care.
Medical Records The Corporation provides medical records services, which includes the completion and maintenance of medical record information for patients in the Corporation's customers' facilities. The medical records services include: · · · · ·
Real-time access to medication and treatment administration records, physician order sheets and psychotropic drug monitoring sheets; Online ordering to save time and resources; A customized database with the medication profiles of each resident's medication safety, efficiency and regulatory compliance; Web-based individual patient records detailing each prescribed medicine; and Electronic medical records to improve information to make it more legible and instantaneous. 19
Specialty Infusion Services The Corporation provides specialty infusion services focused on providing complex pharmaceutical products and clinical services to patients in client facilities, hospice, and outside of hospital or nursing home settings. We offer high-touch clinical services to patients with acute or chronic conditions. The delivery of specialty infusion therapy requires comprehensive planning and monitoring which is provided through our registered nursing staff. Our nursing staff performs an initial patient assessment, provides therapy specific training and education, administers therapy and monitors for potential side effects. We also provide extensive clinical monitoring and patient follow-up to ensure patient therapy adherence and proactively manage patients' conditions. An in-network strategy facilitates easier decision-making for referral sources and provides us with the ability to pre-authorize patients, auto adjudicate, and bill electronically, enabling faster prescription turnaround. Specialty Oncology Pharmacy We provide dispensing of oncology drugs, care management and other related services to patients, oncology practices, and hospitals. These services encompass clinical coordination and review, compliance with appropriate oncology protocols, patient assistance with outside funding, and timely delivery of medication. We coordinate the administration of medications to the physician's office or directly to the patient at the appropriate point of treatment. We work directly with the payers to bill insurance companies for the medication provided, ensuring all prior authorizations and approvals are obtained. These services offer physicians an alternative to the traditional buy-and-bill distribution model, allowing them to outsource drug procurement, inventory management, and prescription administration. Suppliers/Inventory We obtain pharmaceutical and other products from Cardinal Health ("Cardinal Health") and other contracts negotiated directly with pharmaceutical manufacturers for discounted prices. The Corporation entered into a Prime Vendor Agreement with Cardinal Health effective April 1, 2015 ("Cardinal Health PVA"). The initial term of the agreement is through June 30, 2018 and contains one year automatic renewal provisions. The Cardinal Health PVA requires the Corporation to purchase certain levels of brand and non-injectable generic drugs from Cardinal Health. The Cardinal Health PVA does provide flexibility for the Corporation to contract with other suppliers. Under the agreement, the Corporation is entitled to certain rebates based on drug purchases. The loss of a supplier could adversely affect our business if alternate sources of supply are unavailable or if available are significantly more expensive. We seek to maintain an on-site inventory of pharmaceuticals and supplies to ensure prompt delivery to our customers. Cardinal Health maintains local distribution facilities in most major geographic markets in which we operate. In addition, we supply many of our pharmacies with select products from a distribution center operated by a third-party logistics company. Brand to Generic Conversions The following table summarizes the material brand-to-generic conversions expected to occur in 2016 through 2019: 2016 Combivent (Q4) Seroquel XR (Q4)* Zetia (Q4)
2017
2018
Azilect (Q1) Tamiflu (Q1)* ProAir (Q2) Vytorin (Q2) Advair (Q3)* Reyataz (Q4)
Invanz (Q1)* Sensipar (Q1)*
2019 Renexa (Q1)* Lyrica (Q2)* Vesicare (Q2)*
* These represent the most significant brand-to-generic conversions (Number in parentheses refers to the expected quarter of conversion)
When a branded drug shifts to a generic, initial pricing of the generic drug in the market will vary depending on the number of manufacturers launching their generic version of the drug. Historically, a shift from brand-to-generic decreased our revenue and improved our gross margin from sales of these classes of drugs during the initial time period that a brand drug has a generic alternative. Third-party payers may reduce their reimbursements to the Corporation after the initial period. In addition, the number of generic manufacturers entering the market impacts the overall cost and reimbursement of generic drugs. This acceleration in the reimbursement reduction and the number of generic manufacturers generally result in margin compression. Due to the unique nature of the brand-to-generic conversion, management cannot estimate the future financial impact of the brand-to-generic conversions on the Corporation's results of operations. Supplier and Manufacturer Rebates We currently receive rebates from certain manufacturers and distributors of pharmaceutical products for achieving targets of market share or purchase volumes. Rebates are designed to prefer, protect, or maintain a manufacturer's products that are dispensed by the pharmacy under its formulary. Rebates for brand name products are generally based upon achieving a defined market share tier within a therapeutic class and can be based on either purchasing volumes or actual prescriptions dispensed. Rebates for generic products are more likely to be based on achieving purchasing volume requirements. 20
2010 Health Care Reform Legislation The Patient Protection and Affordable Care Act and the reconciliation law known as Health Care and Education Affordability Reconciliation Act (combined we refer to both Acts as the "2010 Health Care Reform Legislation") were enacted in March 2010. State participation in the expansion of Medicaid under the 2010 Health Care Reform Legislation is voluntary. Two key provisions of the 2010 Health Care Reform Legislation that are relevant to the Corporation are: (i) the gradual modification to the calculation of the Federal Upper Limit ("FUL") for drug prices and the definition of Average Manufacturer's Price ("AMP") and (ii) short cycle dispensing. FUL and AMP Changes The reimbursement rates for pharmacy services under Medicaid are determined on a state-by-state basis subject to review by the Centers for Medicare and Medicaid Services ("CMS") and applicable federal law. Although Medicaid programs vary from state to state, they generally provide for the payment of certain pharmacy services, up to the established limits, at rates determined in accordance with each state's regulations. Federal regulations and the regulations of certain states establish "upper limits" for reimbursement of certain prescription drugs under Medicaid (these upper limits being the "FUL"). The 2010 Health Care Reform Legislation amended the Deficit Reduction Act of 2005 (the "DRA") to change the definition of the FUL by requiring the calculation of the FUL as no less than 175% of the weighted average, based on utilization, of the most recently reported monthly AMP for pharmaceutically and therapeutically equivalent multi-source drugs available through retail community pharmacies nationally. In addition, the definition of AMP changed to reflect net sales only to drug wholesalers that distribute to retail community pharmacies and to retail community pharmacies that directly purchase from drug manufacturers. Further, the 2010 Health Care Reform Legislation continues the current statutory exclusion of prompt pay discounts offered to wholesalers and adds three other exclusions to the AMP definition: (i) bona fide services fees; (ii) reimbursement for unsalable returned goods (recalled, expired, damaged, etc.); and (iii) payments from and rebates/discounts to certain entities not conducting business as a wholesaler or retail community pharmacy. On February 1, 2016, CMS released a Final Rule titled Medicaid Program: Covered Outpatient Drugs. This Final Rule details the types of sales that are to be included and excluded in determining AMP. Moreover, consistent with the 2010 Health Care Reform Legislation, the Final Rule calculates the FULs at 175% of the weighted average, determined based on the basis of utilization, of the most recently reported monthly AMP. As an exception, however, if the AMP-based FUL is lower than the National Average Drug Acquisition Cost ("NADAC"), the FULs will be set at the drug's NADAC. This Final Rule became effective on April 1, 2016. CMS published the draft FULs in accordance with the Final Rule for two months before publishing the final FULs. The final FULs became effective April 1, 2016 to coincide with the effective date of the Final Rule. States had until May 1, 2016 to implement the FULs. CMS will update the FULs on a monthly basis after April 1, 2016 and the FULs became effective on the first date of the month following their publication. States had 30 days after the effective date of the monthly updates to implement the new FULs. The Final Rule also changed how states reimburse pharmacies. The Final Rule now requires states to pay pharmacies based on the actual acquisition cost of the drug, as opposed to the estimated acquisition cost. Moreover, the Final Rule requires states to consider the sufficiency of both the ingredient cost reimbursement and dispensing fee reimbursement when proposing changes to either of these components of reimbursement for Medicaid covered drugs. The Corporation will continue to analyze the effect of these changes on its business, results of operations, and liquidity. Short Cycle Dispensing and Dispensing Fees Pursuant to the 2010 Health Care Reform Legislation, Prescription Drug Plans ("PDPs") are required, under Medicare Part D and Medicare Advantage prescription drug plans ("Medicare Advantage" or "MAPDs") to utilize specific, uniform dispensing techniques, such as weekly, daily, or automated dose dispensing, when dispensing covered Medicare Part D drugs to beneficiaries who reside in a long-term care facility to reduce waste associated with 30 to 90 day prescriptions for such beneficiaries. Pursuant to CMS issued regulation, beginning January 1, 2013, pharmacies dispensing to long-term care facilities must dispense no more than 14-day supplies of brand-name oral solid medications covered by Medicare Part D. Medicare Part D Changes In a May 23, 2014 Final Rule titled "Medicare Program: Contract Year 2015 Policy and Technical Changes to the Medicare Advantage and the Medicare Prescription Drug Benefit Programs," CMS announced the Part D Prescriber Enrollment Requirement, which states that Medicare Part D prescription drug benefit plans may not cover drugs prescribed by providers who are not enrolled in (or validly opted out of) Medicare in an approved status, except in very limited circumstances. CMS has stated that it is delaying enforcement of the Part D Enrollment Requirements until February 1, 2017. In a February 12, 2015 Final Rule entitled "Medicare Program: Contract Year 2016 Policy and Technical Changes to the Medicare Advantage and the Medicare Prescription Drug Benefit Programs," CMS finalized a regulation, effective January 1, 2016, prohibiting financial arrangements that penalize more efficient long-term care dispensing techniques (e.g., dispensing a 3 day supply over a 14 day supply) through pro-rated dispensing fees based on a day's supply or quantity dispensed. CMS also finalized a requirement that, effective January 1, 2016, any differences in payment methodologies among long-term care pharmacies incentivize more efficient dispensing techniques. The Corporation has implemented these regulations in its operations. 21
CIA and DEA MOA In May 2015, the Corporation entered into a five-year Corporate Integrity Agreement ("CIA") with United States Department of Health and Human Services Office of the Inspector General ("OIG") and a Memorandum of Agreement ("MOA") with the Drug Enforcement Agency ("DEA") concurrent with the execution of settlement agreements with the OIG and the DEA settling alleged Controlled Substance Act ("CSA") violations and associated False Claims Act allegations. The CIA requires the Corporation, among other things to: (i) create procedures designed to ensure it complies with the CSA and related regulations, (ii) retain an independent review organization to review the Corporation's compliance with the terms of the CIA and report to the OIG regarding that compliance; and (iii) provide training for certain Corporation employees as to the Corporation's requirements under the CSA. If the Corporation fails to comply with the terms of the CIA, it may be required to pay certain monetary penalties. Furthermore, if the Corporation commits a material breach of the CIA, the OIG may exclude the Corporation from participating in federal healthcare programs. Any such exclusion would result in the revocation or termination of contracts and/or licenses and potentially have a material adverse effect on our financial condition, results of operations and business prospects. The MOA requires the Corporation to comply with all requirements of the CSA, specifically relating to the dispensing of scheduled prescription drugs. If the Corporation fails to comply with the terms of the MOA, the DEA may suspend a Corporation's pharmacy DEA Certificate of Registration and begin an administrative hearing process pursuant to 21 U.S.C. Section 824. Any such suspension would prohibit the Corporation's pharmacy from dispensing scheduled prescription drugs and would lead to the revocation or termination of contracts and/or licenses and potentially have a materially adverse effect on our financial condition, results of operations and business prospects. 22
Critical Accounting Estimates The preparation of financial statements in accordance with U.S. GAAP requires us to make estimates and assumptions that affect reported amounts and related disclosures. Management considers an accounting estimate to be critical if: • •
It requires assumptions to be made that were uncertain at the time the estimate was made; and Changes in the estimate or different estimates could have a material impact on our condensed consolidated results of operations or financial condition.
The critical accounting estimates discussed below are not intended to be a comprehensive list of all of the Corporation's accounting policies that require estimates. Management believes the estimates discussed below involve a higher degree of judgment and complexity. Management believes the current assumptions and other considerations used to estimate amounts reflected in the condensed consolidated financial statements are appropriate. However, if actual experience differs from the assumptions and other considerations used in estimating amounts reflected in the condensed consolidated financial statements, the resulting changes could have a material adverse effect on the condensed consolidated results of operations and financial condition of the Corporation. Allowance for doubtful accounts and provision for doubtful accounts Accounts receivable primarily consist of amounts due from PDPs under Medicaid Part D, long-term care institutions, respective state Medicaid programs, private payers and third party insurance companies. Our ability to collect outstanding receivables is critical to our results of operations and cash flows. We establish an allowance for doubtful accounts to reduce the carrying value of our receivables to their estimated net realizable value. In addition, certain drugs dispensed are subject to being returned and the responsible paying parties are due a credit for such returns. Our quarterly provision for doubtful accounts included in our condensed consolidated income statements is as follows (dollars in millions): 2015 % of Revenues
Amount First Quarter Second Quarter Third Quarter Fourth Quarter
$
5.0 3.0 1.5 (1.6)*
2016 % of Revenues
Amount
1.0% 0.6 0.3 (0.3)
First Quarter Second Quarter Third Quarter
$
3.2 0.7 0.1*
0.6% 0.1 -
* In the fourth quarter of 2015, the Corporation reversed an allowance of $4.6 million related to a customer's outstanding receivable for which a settlement payment was received which significantly exceeded the existing net receivable. In the third quarter of 2016, the Corporation's bad debt expense was positively impacted by approximately $1.4 million related to payments on previously reserved receivables. The following table shows our pharmacy revenue days outstanding reflected in our net accounts receivable as of the quarters indicated: 2015 First Quarter Second Quarter Third Quarter Fourth Quarter
2016 34.0 35.4 35.5 34.7
34.7 35.4 37.4
The following table shows our summarized aging categories by quarter:
2015 First 0 to 60 days 61 to 120 days Over 120 days
Second 61.4% 15.8 22.8
Third 60.0% 15.7 24.3
Fourth 58.9% 15.2 25.9
2016 Second
First 62.0% 15.0 23.0
63.5% 14.7 21.8
Third 61.9% 16.3 21.8
61.0% 14.4 24.6
The following table shows our allowance for doubtful accounts as a percent of gross accounts receivable (dollars in millions): 2015 Gross Accounts Receivable
Allowance First Quarter Second Quarter Third Quarter Fourth Quarter
$
59.7 58.8 57.7 49.3
$
259.2 257.9 253.5 249.8
% of Gross Accounts Receivable
2016 Gross Accounts Receivable
Allowance
23.0% 22.8 22.8 19.7
First Quarter Second Quarter Third Quarter
$
44.9 43.0 39.9
$
244.4 251.1 255.3
% of Gross Accounts Receivable 18.3% 17.1 15.6
We recognize revenues at the time services are provided or products are delivered. A significant portion of our revenues are billed to PDPs under Medicare Part D, state Medicaid programs, long-term care institutions, third party insurance companies, and private payers. Some claims are electronically adjudicated through online processing at the point the prescriptions are dispensed such that our operating system is automatically updated with the actual amounts to be reimbursed. As a result, our revenues and the associated receivables are based upon the actual reimbursements to be received. For claims that are adjudicated on-line and are rejected or otherwise denied upon submission, the Corporation provides contractual allowances based upon historical trends, contractual reimbursement terms and other factors which may impact ultimate reimbursement. Amounts are adjusted to actual reimbursed amounts based upon cash receipts. 23
A summary of revenues by payer type follows (dollars in millions):
Medicare Part D Institutional healthcare providers Medicaid Private and other Insured Medicare Hospital management fees Total
Three Months Ended September 30, 2015 2016 % of % of Amount Revenues Amount Revenues $ 234.6 47.0% $ 244.9 47.8% 114.5 23.0 108.6 21.2 34.3 6.9 29.5 5.8 19.9 4.0 17.0 3.3 74.2 14.9 84.4 16.4 5.7 1.1 8.6 1.7 15.6 3.1 19.6 3.8 $ 498.8 100.0% $ 512.6 100.0%
Medicare Part D Institutional healthcare providers Medicaid Private and other Insured Medicare Hospital management fees Total
Nine Months Ended September 30, 2015 2016 % of % of Amount Revenues Amount Revenues $ 703.2 46.6% $ 734.3 47.2% 354.1 23.5 340.9 21.9 110.8 7.4 99.0 6.4 61.6 4.0 54.1 3.5 215.0 14.3 243.5 15.6 16.3 1.1 26.0 1.7 46.8 3.1 58.9 3.7 $ 1,507.8 100.0% $ 1,556.7 100.0%
Inventory and cost of drugs dispensed We have inventory located at each of our institutional pharmacy, specialty infusion, specialty oncology and distribution center locations. The Corporation's inventory is valued at the lower of first-in, first-out cost or market. The inventory consists of prescription drugs, over the counter products and intravenous solutions. The Corporation's inventory balances tend to be higher at June 30 and December 31 based on purchasing strategies associated with brand name drugs. Our inventory relating to controlled substances is maintained on a manually prepared perpetual system to the extent required by the Drug Enforcement Agency and state board of pharmacies. All other inventory is maintained on a periodic system, through the performance of, at a minimum, quarterly physical inventories at the end of each quarter. All inventory counts are reconciled to the balance sheet account and differences are adjusted through cost of goods sold. In addition, we record an amount of potential returns of prescription drugs based on historical rates of returns and record an estimate for rebates associated with inventory remaining at the end of each period. As of December 31, 2015 and September 30, 2016, our inventories were $155.2 million and $118.8 million, respectively. The inventory days on hand were as follows for the periods presented: 2015 First Quarter Second Quarter Third Quarter Fourth Quarter
2016 26.1 29.6 25.7 32.9
24.4 33.5 25.2
Goodwill and other intangible assets Goodwill represents the excess of the purchase price over the fair value of the net assets of acquired companies. Our intangible assets are comprised primarily of trade names, customer relationship assets, and non-compete agreements. Our goodwill as of December 31, 2015 and September 30, 2016 was $371.0 million and $388.1 million, respectively. The Corporation's policy is to perform a qualitative assessment of its institutional pharmacy and a quantitative assessment of its specialty infusion and specialty oncology reporting units to determine whether it is more likely than not (defined as having a likelihood of more than 50 percent) that the fair value of a reporting unit is less than its carrying amount. The Corporation performed the qualitative assessment of its institutional pharmacy reporting unit at December 31, 2015 and did not find it necessary to perform the first step of the two-step impairment analysis. The Corporation also performed the quantitative assessments as of December 31, 2015 for its specialty infusion and specialty oncology reporting units. The specialty infusion and specialty oncology reporting unit's fair value as calculated were approximately 23.8% and 175.7%, respectively, greater than book value at December 31, 2015. There were no impairment triggering events during the nine months ended September 30, 2016. 24
Definitions Listed below are definitions of terms used by the Corporation in managing the business. The definitions are necessary to the understanding of the Management's Discussion and Analysis section of this document. Gross profit per prescription dispensed: Represents the gross profit divided by the total prescriptions dispensed. Gross profit margin: Represents the gross profit per prescription dispensed divided by the revenue per prescription dispensed. Prescriptions dispensed: Represents a prescription filled for an individual patient. A prescription will usually be for a 14 or 30 day period and will include only one drug type. Revenue per prescription dispensed: Represents the revenue divided by the total prescriptions dispensed. Results of Operations The following table presents selected condensed consolidated comparative results of operations and statistical information for the periods presented (dollars in millions, except per prescription amounts, and prescriptions in thousands):
Revenues Cost of goods sold Gross profit
Three Months Ended September 30, Nine Months Ended September 30, Increase Increase 2015 (Decrease) 2016 2015 (Decrease) 2016 % of % of % of % of Amount Revenues Amount Revenues Amount Revenues Amount Revenues $ 498.8 100.0 $ 13.8 2.8% $ 512.6 100.0 $ 1,507.8 100.0 $ 48.9 3.2% $ 1,556.7 100.0 420.2 84.2 13.9 3.3 434.1 84.7 1,259.4 83.5 55.0 4.4 1,314.4 84.4 $ 78.6 15.8 $ (0.1) (0.1)% $ 78.5 15.3 $ 248.4 16.5 $ (6.1) (2.5)% $ 242.3 15.6
Pharmacy (in whole numbers except where indicated) Financial data Prescriptions dispensed (in thousands) 8,208 (319) Revenue per prescription dispensed $ 60.77 $ 4.21 Gross profit per prescription dispensed $ 9.58 $ 0.37 Gross profit margin 15.8% (0.5)% Generic dispensing rate
86.5%
(0.9) %
(3.9) % 6.9%
7,889
25,713
$ 64.98
$ 58.64 $
3.9% $ (3.2)%
9.95 15.3%
(1.0) %
85.6%
9.66 16.5% 85.9%
(951)
(3.7) %
$
4.23
7.2%
$
0.13 (0.9) 0.3%
24,762 $ 62.87
1.3% $ (5.5)% 0.3%
9.79 15.6% 86.2%
Revenues Revenues increased $13.8 million for the three months ended September 30, 2016 compared to the three months ended September 30, 2015 which was driven by significant organic growth and acquisitions in the Corporation's specialty pharmacy businesses partially offset by a 4.0% reduction in prescription volumes in the institutional pharmacy business, lower Medicare Part D reimbursement and 2015 brand to generic conversions. The increase of $13.8 million is comprised of a favorable rate variance of approximately $34.6 million or $4.21 increase per prescription dispensed, partially offset by an unfavorable volume variance of approximately $20.8 million or 319,000 fewer prescriptions dispensed. The revenue per prescription dispensed increase was due to the increased volume in the Corporation's specialty pharmacy businesses, which carries higher revenue per script, and branded drug inflation. Revenues increased $48.9 million for the nine months ended September 30, 2016 compared to the nine months ended September 30, 2015 which was driven by recent acquisitions, growth in the Corporation's specialty pharmacy businesses and branded drug inflation, partially offset by a 3.8% reduction in prescription volumes in the institutional pharmacy business, lower Medicare Part D reimbursement and 2015 brand to generic conversions. The increase of $48.9 million is comprised of a favorable rate variance of approximately $108.8 million or $4.23 increase per prescription dispensed, partially offset by an unfavorable volume variance of approximately $59.9 million or 951,000 fewer prescriptions dispensed. The revenue per prescription dispensed increase was due to the increased volume in the Corporation's specialty pharmacy businesses, which carry higher revenue per script, and branded drug inflation. Gross Profit Gross profit for the three months ended September 30, 2016 was $78.5 million or $9.95 per prescription dispensed compared to $78.6 million or $9.58 per prescription dispensed for the three months ended September 30, 2015. The decrease in gross profit was due to lower prescription volumes in the Corporation's institutional pharmacy business partially offset by higher gross profit associated with the Corporation's specialty pharmacy businesses. Gross profit for the nine months ended September 30, 2016 was $242.3 million or $9.79 per prescription dispensed compared to $248.4 million or $9.66 per prescription dispensed for the nine months ended September 30, 2015. The decrease in gross profit was due to lower prescription volumes in the Corporation's institutional pharmacy business partially offset by higher gross profit associated with the Corporation's specialty pharmacy businesses. 25
Selling, General and Administrative Expenses Selling, general and administrative expenses were $53.1 million, or 10.4% of revenues, for the three months ended September 30, 2016 compared to $52.7 million, or 10.6% of revenues, for the three months ended September 30, 2015. The increase of $0.4 million was due to selling, general and administrative expenses associated with 2015 Acquisitions, partially offset by a reduction in bad debt expense as a result of 2016 collections on previously reserved receivables. Selling, general and administrative expenses were $165.8 million, or 10.7% of revenues, for the nine months ended September 30, 2016 compared to $167.1 million, or 11.1% of revenues, for the nine months ended September 30, 2015. The decrease of $1.3 million was due to a reduction in bad debt expense, as a result of 2016 collections on previously reserved receivables, partially offset by selling, general and administrative expenses associated with the 2015 Acquisitions. Depreciation and Amortization Depreciation expense was $6.2 million for the three months ended September 30, 2016 and $5.7 million for the three months ended September 30, 2015 and $17.2 million for both the nine months ended September 30, 2016 and September 30, 2015. Amortization expense was $8.3 million for the three months ended September 30, 2016 compared to $7.0 million for the three months ended September 30, 2015 and $24.7 million for the nine months ended September 30, 2016 as compared to $20.6 million for the nine months ended September 30, 2015. The increase of $1.3 million for the three months and $4.1 million for the nine months, was due primarily to the amortization expense recognized on intangibles acquired through the 2015 and 2016 Acquisitions. Settlement, Litigation and Other Related Charges Settlement, litigation and other related charges were $(0.8) million for the three months ended September 30, 2016 compared to $2.1 million for the three months ended September 30, 2015 and were $7.2 million for the nine months ended September 30, 2016 as compared to $11.3 million for the nine months ended September 30, 2015. These costs relate to the Corporation's defense and settlement of certain governmental investigations and other litigation. These costs decreased compared to the prior year due to fewer litigation settlements in the current year. In the second quarter of 2016, amounts were recorded for interest charges related to the AmerisourceBergen Drug Corporation litigation. It was determined in the third quarter of 2016 that the interest amounts would not be allowed based on the August 8, 2016 ruling by the Jefferson City Circuit Court. Accordingly, the Corporation reversed those charges at that time. (See Note 5) Restructuring and Impairment Charges Restructuring and impairment charges were $0.6 million for the three months ended September 30, 2016 compared to $0.2 million for the three months ended September 30, 2015 and were $3.1 million for the nine months ended September 30, 2016 compared to $0.3 million for the nine months ended September 30, 2015. These costs are primarily the result of the Corporation's specialty pharmacy restructuring and centralization initiative in 2015 and 2016. Merger, Acquisition, Integration Costs and Other Charges Merger, acquisition, integration costs and other charges were $5.3 million for the three months ended September 30, 2016 compared to $8.0 million for the three months ended September 30, 2015 and were $14.1 million for the nine months ended September 30, 2016 compared to $15.2 million for the nine months ended September 30, 2015. The decrease was related to higher costs incurred in 2015 associated with integrating acquisitions completed in the fourth quarter of 2014. Interest Expense Interest expense was $3.0 million for the three months ended September 30, 2016 compared to $2.1 million for the three months ended September 30, 2015 and was $9.3 million for the nine months ended September 30, 2016 compared to $5.4 million for the nine months ended September 30, 2015. The increase was primarily due to increased borrowing on the revolving credit facility, associated with the Corporation's inventory purchasing strategy and current year acquisitions, and net activity associated with the mandatorily redeemable interest liability. Tax Provision The Corporation's effective tax rate for the nine months ended September 30, 2016 was 23.4%, comprised of the 35% federal statutory rate, 2.4% for the state rate, 1.1% for permanent differences, and (15.1)% for discrete events. The favorable discrete events are the result of the Corporation's early adoption of ASU 2016-09 during the first quarter resulting in $0.9 million of excess tax benefits, and adjustments related to the deductibility of certain legal settlements, reported on the amended 2015 federal income tax return in the third quarter, resulting in $1.4 million of tax benefit. Excluding the impact of discrete events and other nonrecurring items, the provision for income taxes as a percentage of pre-tax income would have been 37.3% and 36.6% for the nine months ended September 30, 2016 and September 30, 2015 respectively. The increase in the effective tax rate excluding the impact of the discrete events and nonrecurring items between the two periods was primarily the result of a decrease in pre-tax book income. 26
Liquidity and Capital Resources Cash Flows - The following table presents selected data from our condensed consolidated statements of cash flows for the periods presented (dollars in millions): Three Months Ended September 30, 2015 2016 $ 37.5 $ 39.1 (6.8) (37.3) (12.0) (22.7) 18.7 (20.9) 21.3 27.4 $ 40.0 $ 6.5
Net cash provided by operating activities Net cash used in investing activities Net cash used in financing activities Net change in cash and cash equivalents Cash and cash equivalents at beginning of period Cash and cash equivalents at end of period
Nine Months Ended September 30, 2015 2016 $ 59.6 $ 80.3 (38.3) (57.5) (14.6) (39.4) 6.7 (16.6) 33.3 23.1 $ 40.0 $ 6.5
Operating Activities – Cash provided by operating activities aggregated $39.1 million for the three months ended September 30, 2016 compared to $37.5 million for the three months ended September 30, 2015 and $80.3 million for the nine months ended September 30, 2016 as compared to $59.6 million for the nine months ended September 30, 2015. While the three month periods were relatively consistent, the increase in cash from operating activities for the nine month period is due primarily to an increase in accounts payable and a decrease in inventory associated with the Corporation's inventory purchasing strategies partially offset by year over year reductions in cash provided by operations for accounts receivable and prepaid and other assets. Investing Activities – Cash used in investing activities aggregated $37.3 million and $57.5 million for the three and nine months ended September 30, 2016, respectively, compared to $6.8 million and $38.3 million for the three and nine months ended September 30, 2015, respectively. The increase in cash used in investing activities is a result of cash paid for acquisitions during the respective periods and an increase in fixed asset purchases. Financing Activities – Cash used in financing activities aggregated $22.7 million for the three months ended September 30, 2016 compared to $12.0 million for the three months ended September 30, 2015. Cash used in financing activities aggregated $39.4 million for the nine months ended September 30, 2016 compare to $14.6 million for the nine months ended September 30, 2015. The increase in cash used in financing activities is due primarily to the increase in revolving credit facility payments in the three and nine months ended September 30, 2016 compared to the same periods in the prior year. Credit Agreement On September 17, 2014, the Corporation entered into a $535.0 million Credit Agreement with Bank of America, N.A. as administrative agent (the "Credit Agreement"). The Credit Agreement consists of a $225.0 million term loan facility and a $310.0 million revolving credit facility. The terms and conditions of the Credit Agreement are customary to facilities of this nature. Unless terminated earlier, the Credit Agreement will mature on September 17, 2019, and the principal amount outstanding thereunder, together with all accrued unpaid interest and other amounts owed thereunder, if any, will be payable in full on such date. The Credit Agreement requires quarterly term loan principal payments in an amount of $2.8 million on each quarter beginning September 2015 through September 2019. The final principal repayment installment of term loans shall be repaid on the term maturity date, September 17, 2019. In addition, the term loan is subject to certain prepayment obligations relating to certain asset sales, certain casualty losses and the incurrence of certain indebtedness. The Corporation had a total of $210.9 million outstanding of term debt under the Credit Agreement and $179.5 million outstanding under the revolving portion of the Credit Agreement as of September 30, 2016. The Credit Agreement provides for the issuance of letters of credit which, when issued, constitute usage and reduce availability on the revolving portion of the Credit Agreement. The amount of letters of credit outstanding as of September 30, 2016 was $2.8 million. After giving effect to the letters of credit and amounts outstanding under the revolving credit agreement, total availability under the revolving credit facility was $127.7 million as of September 30, 2016. The Credit Agreement also contains financial covenants that require us to satisfy certain financial tests and maintain certain financial ratios. The Corporation was compliant with all debt covenant requirements at September 30, 2016. Drug Wholesaler Agreement We obtain pharmaceutical and other products from Cardinal Health pursuant to the Cardinal Health PVA effective April 1, 2015. The Corporation also obtains pharmaceutical and other products for discounted prices directly from pharmaceutical manufacturers. While the loss of a supplier could adversely affect our business if alternate sources of supply are unavailable or if available are significantly more expensive, numerous sources of supply are generally available to us and we have not experienced any difficulty in obtaining pharmaceuticals or other products and supplies to conduct our business. The Corporation seeks to maintain an on-site inventory of pharmaceuticals and supplies to ensure prompt delivery to our customers. Cardinal Health maintains local distribution facilities in most geographic markets in which we operate. 27
Treasury Stock 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 was used. On July 2, 2012 the Board of Directors authorized an increase to the remaining portion of the existing stock 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, 2016. 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, 2016, 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 minimum statutory tax withholding purposes and to cover option exercise costs. The Corporation redeemed 139,867 shares from the vesting of certain awards and the exercise of certain stock options, for an aggregate price of approximately $3.3 million during the nine months ended September 30, 2016. These shares have also been designated by the Corporation as treasury stock. As of September 30, 2016, the Corporation had a total of 2,916,742 shares held as treasury stock. 28
Supplemental Quarterly Information The following tables represent the results of the Corporation's quarterly operations for the year ended December 31, 2015 and for the first, second and third quarters of 2016 (in millions, except where indicated):
Revenues Cost of goods sold Gross profit Selling, general and administrative Amortization expense Merger, acquisition, integration costs, and other charges Settlement, litigation and other related charges Restructuring and impairment charges Hurricane Sandy disaster costs (recoveries) Operating income Interest expense, net Income before income taxes Provision (benefit) for income taxes Net income
First $ 511.6 423.0 88.6 59.0 6.6 3.8 2.3 0.1 16.8 1.4 15.4 5.8 $ 9.6
2015 Quarters Second Third $ 497.5 $ 498.8 416.3 420.2 81.2 78.6 55.4 52.7 7.0 7.0 3.4 8.0 6.9 2.1 0.2 0.1 8.5 8.5 1.9 2.1 6.6 6.4 4.3 3.4 $ 2.3 $ 3.0
Fourth $ 520.6 433.9 86.7 55.4 8.0 6.1 2.0 0.2 (5.0) 20.0 1.2 18.8 (1.4) $ 20.2
First $ 524.5 442.5 82.0 57.0 8.2 4.4 3.1 1.4 7.9 3.0 4.9 0.8 $ 4.1
Earnings per share (1): Basic Diluted
$ $
0.32 0.31
$ $
0.08 0.07
$ $
0.10 0.10
$ $
0.66 0.66
$ $
0.13 0.13
$ $
0.08 0.08
$ $
0.24 0.23
Adjusted diluted earnings per diluted share (1)(2):
$
0.57
$
0.48
$
0.49
$
0.56
$
0.45
$
0.47
$
0.44
Shares used in computing earnings per share: Basic Diluted Balance sheet data: Cash and cash equivalents Working capital Goodwill Intangible assets, net Total assets (4) Long-term debt (4) Total stockholders' equity Supplemental information: Adjusted EBITDA(2) Adjusted EBITDA Margin (2) Adjusted EBITDA per prescription dispensed (2) Net cash provided by (used in) operating activities Net cash used in investing activities Net cash (used in) provided by financing activities Statistical information (in whole numbers except where indicated) Volume information Prescriptions dispensed (in thousands) Revenue per prescription dispensed (3) Gross profit per prescription dispensed (3) Gross profit margin (3) Generic drug dispensing rate Inventory days on hand Revenue days outstanding (1) (2) (3) (4)
30.2 30.7
$ $ $ $ $ $ $
$ $ $ $ $
$ $
25.2 292.8 341.9 179.2 1,042.5 323.1 487.1
35.4 6.9% 3.91 44.3 (25.0) (27.4)
30.4 30.8
$ $ $ $ $ $ $
21.3 293.5 341.9 172.2 1,060.0 347.0 492.1
$
31.5 6.3% 3.73 (22.2) (6.5) 24.8
$ $ $ $
9,053 56.51 $ 9.79 $ 17.3% 85.3% 26.1 34.0
30.4 30.9
$ $ $ $ $ $ $
$ $ $ $ $
8,452 58.86 $ 9.61 $ 16.3% 86.0% 29.6 35.4
40.0 285.1 341.8 165.2 1,057.8 335.2 496.9
31.6 6.3% 3.85 37.5 (6.8) (12.0)
30.4 31.0
$ $ $ $ $ $ $
$ $ $ $
8,208 60.77 $ 9.58 $ 15.8% 86.5% 25.7 35.5
23.1 342.1 371.0 190.2 1,151.6 425.2 519.4
34.7 6.7% 4.13 (41.1) (65.8) 90.0
2016 Quarters Second Third $ 519.6 $ 512.6 437.8 434.1 81.8 78.5 55.7 53.1 8.2 8.3 4.4 5.3 4.9 (0.8) 1.1 0.6 7.5 12.0 3.3 3.0 4.2 9.0 1.7 1.7 $ 2.5 $ 7.3
30.5 30.9
$ $ $ $ $ $ $
$ $ $ $ $
8,411 61.60 $ 10.01 $ 16.3% 86.3% 32.9 34.7
25.5 303.9 372.1 182.1 1,166.6 377.6 522.4
30.3 5.8% 3.50 65.3 (12.1) (50.8)
30.7 31.0
$ $ $ $ $ $ $
$ $ $ $ $
8,647 60.66 $ 9.48 $ 15.6% 86.6% 24.4 34.7
27.4 325.8 372.2 173.9 1,201.1 411.8 526.9
31.8 6.1% 3.87 (24.1) (8.1) 34.1
30.8 31.1
$ $ $ $ $ $ $
$
6.5 291.5 388.1 171.4 1,157.5 390.5 535.8
$ $ $ $
31.5 6.1% 3.99 39.1 (37.3) (22.7)
8,226 63.17 $ 9.94 $ 15.7% 86.3% 33.5 35.4
7,889 64.98 9.95 15.3% 85.6% 25.2 37.4
The Corporation has never declared a cash dividend. Earnings per common share in actual cents. See "Use of Non-GAAP Measures for Measuring Quarterly Results" for a definition and Reconciliation of Adjusted Earnings Per Diluted Common Share to Earnings Per Diluted Common Share, and for Reconciliation of Net Income to Adjusted EBITDA and Adjusted EBITDA Margin. The fourth quarter 2015 amounts do not include the $2.5 million California Medicaid recoupment reversal. Adjusted due to an accounting change for deferred financing costs associated with long-term debt. See Footnote 4 to the condensed consolidated financial statements. 29
Use of Non-GAAP Measures for Measuring Quarterly Results The Corporation calculates Adjusted EBITDA as provided in the reconciliation below and calculates Adjusted EBITDA Margin by taking Adjusted EBITDA and dividing it by revenues adjusted for the contractual amount associated with the California Medicaid estimated recoupment. The Corporation calculates and uses Adjusted EBITDA as a performance measure. The measurement is used in concert with net income (loss) and cash flows from operating activities, which measure actual cash generated in the period. In addition, the Corporation believes that Adjusted EBITDA and Adjusted EBITDA Margin are supplemental measurement tools used by analysts and investors to help evaluate overall operating performance and the ability to incur and service debt and make capital expenditures. In addition, Adjusted EBITDA, as defined in the Credit Agreement, is used in conjunction with the Corporation's debt leverage ratio and this calculation sets the applicable margin for the quarterly interest charge. Adjusted EBITDA, as defined in the Credit Agreement, is not the same calculation as this Adjusted EBITDA table. Adjusted EBITDA presented herein does not represent funds available for the Corporation's discretionary use and is not intended to represent or to be used as a substitute for net income or cash flows from (used in) operating activities data as measured under U.S. GAAP. The items excluded from Adjusted EBITDA but included in the calculation of the Corporation's reported net income and cash flows from (used in) operating activities are significant components of the accompanying condensed consolidated income statements and condensed consolidated statements of cash flows and must be considered in performing a comprehensive assessment of overall financial performance. The Corporation's calculation of Adjusted EBITDA may not be consistent with calculations of EBITDA used by other companies. The following are reconciliations of Adjusted EBITDA to the Corporation's net income and net operating cash flows for the periods presented. The Corporation calculates and uses adjusted diluted earnings per share, which is exclusive of the impact of merger, acquisition, integration costs and other charges, settlement, litigation and other related charges, Hurricane Sandy disaster costs (recoveries), restructuring and impairment charges, California Medicaid recoupment, amortization of intangible assets, and the tax impact of the adjustments on the tax provision ("the Excluded Items") as an indicator of its core operating results. The measurement is used in concert with net income and diluted earnings per share, which measure actual earnings per share generated in the period. The Corporation believes the exclusion of these charges in expressing earnings per share provides management with a useful measure to assess period to period comparability and is useful to investors in evaluating the Corporation's operating results from period to period. Adjusted diluted earnings per share after giving effect to the Excluded Items does not represent the amount that effectively accrues directly to stockholders (i.e., such costs are a reduction in earnings and stockholders' equity) and is not intended to represent or to be used as a substitute for diluted earnings per share as measured under U.S. GAAP. The Excluded Items are significant components of the accompanying condensed consolidated income statements and must be considered in performing a comprehensive assessment of overall financial performance. The following is a reconciliation of adjusted diluted earnings per share to the Corporation's U.S. GAAP earnings per diluted common share for the periods presented. 30
Unaudited Reconciliation of Net Income to Adjusted EBITDA (dollars in millions)
First Net income $ Add: Interest expense, net Provision (benefit) for income taxes Depreciation and amortization expense EBITDA Merger, acquisition, integration costs and other charges Settlement, litigation and other related charges California Medicaid recoupment Restructuring and impairment charges Hurricane Sandy disaster costs (recoveries) Adjusted EBITDA $ Adjusted EBITDA Margin
9.6
2015 Quarters Second Third $ 2.3 $ 3.0
1.4 5.8 12.4 29.2 3.8 2.3 0.1 35.4 $ 6.9%
1.9 4.3 12.7 21.2 3.4 6.9 31.5 $ 6.3%
Fourth $ 20.2
2.1 3.4 12.7 21.2 8.0 2.1 0.2 0.1 31.6 $ 6.3%
First $
1.2 (1.4) 13.9 33.9 6.1 2.0 (2.5) 0.2 (5.0) 34.7 $ 6.7%
2016 Quarters Second Third 4.1 $ 2.5 $ 7.3
3.0 0.8 13.5 21.4 4.4 3.1 1.4 30.3 $ 5.8%
3.3 1.7 13.9 21.4 4.4 4.9 1.1 31.8 $ 6.1%
3.0 1.7 14.4 26.4 5.3 (0.8) 0.6 31.5 6.1%
Unaudited Reconciliation of Adjusted EBITDA to Net Operating Cash Flows (dollars in millions)
Adjusted EBITDA Interest expense, net Merger, acquisition, integration costs and other charges Provision for bad debt Amortization of deferred financing fees (Gain) loss on disposition of equipment Gain on acquisition (Provision) benefit for income taxes Deferred income taxes Changes in federal and state income tax payable (receivable) Stock-based compensation and deferred compensation Excess tax benefit from stock-based compensation Changes in assets and liabilities Other Net Cash Flows Provided by (Used in) Operating Activities
First $ 35.4 (1.4) (6.2) 5.0 0.1 0.1 (5.8) 2.3 0.1 2.0 (1.9) 14.6 $ 44.3
2015 Quarters Second Third $ 31.5 $ 31.6 (1.9) (2.1) (10.3) (10.4) 3.0 1.5 0.2 0.1 (4.3) (3.4) 0.2 2.1 (9.1) (1.0) 1.7 1.7 (0.2) (0.2) (33.1) 17.6 0.1 $ (22.2) $ 37.5
Fourth $ 34.7 (1.2) (0.8) (1.6) 0.2 (0.1) (0.4) 1.4 (0.6) (0.7) 2.4 (0.1) (74.2) (0.1) $ (41.1)
First $ 30.3 (3.0) (8.9) 3.2 0.1 (0.8) 3.1 (0.9) 1.4 (1.0) 41.7 0.1 $ 65.3
Fourth
First
2016 Quarters Second Third $ 31.8 $ 31.5 (3.3) (3.0) (10.4) (5.3) 0.7 0.1 0.2 0.1 0.1 (1.7) (1.7) 4.7 0.2 (2.9) 6.9 2.7 2.2 (0.2) (0.1) (45.7) 8.1 $ (24.1) $ 39.1
Unaudited Reconciliation of Diluted Earnings Per Share to Adjusted Diluted Earnings Per Share 2015 Quarters Second Third
First Diluted earnings per share $ Add: Diluted earnings per share impact of: Merger, acquisition, integration costs and other charges Settlement, litigation and other related charges California Medicaid recoupment Restructuring and impairment charges Hurricane Sandy disaster recoveries Amortization of intangible assets Tax impact of the above adjustment charges on tax provision Adjusted diluted earnings per share $
0.31
$
0.07
0.08 0.05 0.13 0.57
$
0.07 0.13 0.14 0.07 0.48
$ 31
0.10
$
0.17 0.04 0.01 0.15
$
0.02 0.49
0.66
$
0.11 0.05 (0.05) (0.10) 0.15
$
(0.26) 0.56
0.13
2016 Quarters Second $
0.09 0.06 0.03 0.17
$
(0.03) 0.45
0.08
Third $
0.09 0.10 0.02 0.17
$
0.01 0.47
0.23
0.11 (0.02) 0.01 0.17
$
(0.06) 0.44
Item 3.
Quantitative and Qualitative Disclosures about Market Risk During the reporting period, there have been no material changes in the disclosures set forth in Part II, Item 7a in our Form 10-K for the year ended December
31, 2015. Item 4.
Controls and Procedures
Evaluation of Disclosure Controls and Procedures The Corporation has carried out an evaluation under the supervision and with the participation of management, including the Corporation's Chief Executive Officer and Interim Chief Financial Officer, of the effectiveness of the design and operation of the Corporation's "disclosure controls and procedures" as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act") as of the end of the period covered by this report. The Corporation's disclosure controls and procedures are designed so that information required to be disclosed in the Corporation's reports filed under the Exchange Act, such as this Quarterly Report on Form 10-Q, is recorded, processed, summarized and reported within the time periods specified in the Commission's rules and forms. The Corporation's disclosure controls and procedures are also intended to ensure that such information is accumulated and communicated to the Corporation's management, including the Chief Executive Officer and Interim Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives, and management necessarily is required to use its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. Based upon this evaluation, the Chief Executive Officer and Interim Chief Financial Officer have concluded that, as of September 30, 2016, the Corporation's disclosure controls and procedures are effective to provide reasonable assurance that information required to be disclosed in the reports that the Corporation files and submits under the Exchange Act is recorded, processed, summarized and reported as and when required and such information is accumulated and communicated as appropriate to allow timely decisions regarding required disclosures. Changes in Internal Control Over Financial Reporting There have been no changes in the Corporation's internal control over financial reporting during the quarter ended September 30, 2016, that have materially affected, or are reasonably likely to materially affect, the Corporation's internal control over financial reporting. 32
PART II. OTHER INFORMATION Item 1.
Legal Proceedings
The information called for by this item is incorporated herein by reference to Note 5 included in Part I, Item 1, Financial Statements (Unaudited) - Notes to Condensed Consolidated Financial Statements.
Item 1A.
Risk Factors There have been no material changes in our risk factors from those disclosed in the Corporation's Annual Report on Form 10-K for the year ended December
31, 2015.
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
The Corporation may redeem shares from employees upon vesting of the Corporation's stock awards for minimum statutory tax withholding purposes and to cover option exercise costs. The Corporation redeemed 139,867 shares from the vesting of certain awards and the exercise of certain stock options, for an aggregate price of approximately $3.3 million during the nine months ended September 30, 2016. These shares have been designated by the Corporation as treasury stock. The following table summarizes our share repurchase activity by month for the three months ended September 30, 2016:
Total Number of Shares Purchased
Period July 1, 2016 - July 31, 2016 August 1, 2016 - August 31, 2016 September 1, 2016 - September 30, 2016
Weighted Average Price Paid per Share
210 9,936 262
(1) (1) (1)
$
25.97 24.25 26.79
Total Number of Shares Purchased as Part of a Publicly Announced Plans or Programs (2)
Approximate Dollar Value of Shares that may yet be Purchased under the Plans or Programs (in millions) - $ 19.7 19.7 19.7
(1)
The Corporation repurchased 10,408 shares of common stock in connection with the vesting of certain stock awards to cover minimum statutory withholding taxes.
(2)
On August 24, 2010, the Board of Directors announced a share repurchase program whereby the Corporation is authorized to purchase up to $25.0 million of the Corporation's common stock, of which $10.5 million was 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. The Corporation did not repurchase any common stock shares under this program during the nine months ended September 30, 2016.
Item 4.
Mine Safety Disclosures
Not Applicable. 33
Item 6.
Exhibits
Exhibit No. 31.1*
Certification of Chief Executive Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2*
Certification of Chief Financial Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1*
Certification of Chief Executive Officer, pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2*
Certification of Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS
XBRL Instance Document.
101.SCH
XBRL Taxonomy Extension Schema Document.
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document.
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document.
101.LAB
XBRL Taxonomy Extension Label Linkbase Document.
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document.
*
Furnished herewith. 34
SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. PHARMERICA CORPORATION Date: November 9, 2016
/s/ Gregory S. Weishar Gregory S. Weishar Chief Executive Officer and Director /s/ Berard E. Tomassetti Berard E. Tomassetti Interim Chief Financial Officer, Senior Vice President and Chief Accounting Officer
Date: November 9, 2016
35
Exhibit Index Exhibit No.
Description
31.1
Certification of Chief Executive Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2
Certification of Chief Financial Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1
Certification of Chief Executive Officer, pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2
Certification of Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS
XBRL Instance Document.
101.SCH
XBRL Taxonomy Extension Schema Document.
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document.
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document.
101.LAB
XBRL Taxonomy Extension Label Linkbase Document.
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document. 36
