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MarketScreener Homepage  >  Equities  >  Nasdaq  >  Covetrus, Inc.    CVET

COVETRUS, INC.

(CVET)
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COVETRUS : Management's Discussion and Analysis of Financial Condition and Results of Operations (form 10-Q)

08/11/2020 | 05:04pm EST

Forward-looking Statements


Certain matters discussed in this Quarterly Report on Form 10-Q ("Form 10-Q" or
"Report"), and in particular, this management's discussion and analysis of
financial condition and results of operations, contain statements, estimates,
and projections that are "forward-looking statements" as defined under U.S.
federal securities laws and involve substantial risks and uncertainties. When
used in this Report, the words "anticipate," "assume," "believe," "budget,"
"continue," "could," "estimate," "expect," "intend," "may," "plan," "potential,"
"predict," "project," "should," "will," "future," and the negative of these or
similar terms and phrases are intended to identify forward-looking statements.
Such statements are subject to numerous risks and uncertainties, and actual
results could differ materially from those anticipated due to a number of
factors including but not limited to:

•the effect of the COVID-19 pandemic on our business and the success of any
measures we have taken or may take in the future in response thereto, including
our ability to continue operations at our distribution centers and pharmacies
•risks associated with our management transition
•the ability to successfully integrate operations and employees
•the ability to realize anticipated benefits and synergies of the transactions
that created Covetrus
•the potential impact of the consummation of the transactions on relationships,
including with employees, customers, and competitors
•the ability to retain key personnel
•the ability to achieve performance targets
•changes in financial markets, interest rates, and foreign currency exchange
rates
•changes in our market
•the impact of litigation
•the impact of Brexit
•the impact of accounting pronouncements, seasonality of our business, leases,
expenses, interest expense, and debt
•sufficiency of cash and access to liquidity
•cybersecurity risks
•additional risks and factors discussed, including those discussed under the
heading "Risk Factors" in this Report and in our Form 10-K filed on March 3,
2020, and in our other SEC filings

Our forward-looking statements are based on current beliefs and expectations of
our management team and, except as required by law, we undertake no obligations
to make any revisions to the forward-looking statements contained in this
Report, or to update them to reflect events or circumstances occurring after the
date of this Report, whether as a result of new information, future
developments, or otherwise.
Although we believe the expectations reflected in the forward-looking statements
are reasonable, we can give no assurance that these expectations will prove to
have been correct. These expectations may or may not be realized. Some of these
expectations may be based upon assumptions, data, or judgments that prove to be
incorrect. Actual events, results, and outcomes may differ materially from our
expectations due to a variety of known and unknown risks, uncertainties, and
other factors. Important factors that could cause actual results to differ
materially from those indicated by such forward-looking statements include those
set forth in this Form 10-Q and under the caption Risk Factors in our Form 10-K.
We operate in a very competitive and rapidly changing market. New risks emerge
from time to time, and it is not possible for our management to predict all
risks, nor can we assess the impact of all factors on our business or the extent
to which any factor, or combination of factors, may cause actual results to
differ materially from those contained in any forward-looking statements we may
make. The results of operations for the three and six months ended June 30, 2020
are not necessarily indicative of what our operating results for the full fiscal
year will be. For the foregoing reasons, you are cautioned against relying on
any forward-looking statements.

You should read the following discussion and analysis of our financial condition
and results of operations together with our unaudited condensed consolidated
financial statements and the related notes thereto appearing elsewhere in this
Form 10-Q and our consolidated financial statements and the related notes and
other financial information included in our Form 10-K.

The terms "Covetrus," "Company," "we," "our," "us," or "ourselves" included in this Report mean Covetrus, Inc. and its consolidated subsidiaries, collectively.

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Rounding adjustments applied to individual numbers and percentages shown in this
Report may result in these figures differing immaterially from their absolute
values and certain tables may not foot or cross foot.

Overview


We are a global, animal-health technology and services company dedicated to
supporting the companion, equine, and large-animal veterinary markets. Our
mission is to provide the best products, services, and technology to
veterinarians and animal-health practitioners across the globe, so they can
deliver exceptional care to their patients when and where it is needed. In
February 2019, we combined the complementary capabilities of the Animal Health
Business, previously operated by our Former Parent, and Vets First Choice,
bringing together leading practice management software and supply chain
distribution businesses with a technology-enabled prescription management
platform and related pharmacy services. We believe our approach to the market
will support the delivery of improved veterinary care and health of their
practices while driving increased demand for our products and services.

Segments


We are organized based upon geographic region and focus on delivering our
platform of products and services to our customers on a geographical basis, our
reportable segments consist of the following: (i) North America, (ii)
Europe, and (iii) APAC & Emerging Markets. We evaluate our segment profit (loss)
solely based on adjusted earnings before interest, taxes, depreciation, and
amortization ("Adjusted EBITDA").

Definition of Non-GAAP Adjusted Earnings Before Interest, Taxes, Depreciation, and Amortization


Adjusted EBITDA is a non-GAAP financial measure used to (i) aid management and
investors with year-over-year comparability, (ii) determine management
performance under our compensation plans, (iii) plan and forecast, (iv)
communicate our financial performance to our board of directors, shareholders,
and investment analysts, and (v) understand our operating performance without
regard to items we do not consider a component of our core ongoing operating
performance. Adjusted EBITDA has certain limitations in that it does not
consider the impact of certain expenses to our condensed consolidated statements
of operations. Adjusted EBITDA excludes share-based compensation, strategic
consulting, transaction costs, formation of Covetrus expenses, separation
programs and executive severance, carve-out operating expenses, IT
infrastructure, goodwill impairment charges, capital structure related fees, and
other (income) expense items, net. Currently, we do not allocate expenses
managed at the corporate level, such as corporate wages and related benefits,
corporate occupancy costs, professional services utilized at the corporate
level, and non-recurring expenses to our operating segments. Other companies may
not define or calculate Adjusted EBITDA in the same way. We provide Adjusted
EBITDA by segment as a supplemental measure to GAAP. See below for our Adjusted
EBITDA explanations on a segment basis as well as on a consolidated, non-GAAP
basis. Non-GAAP Adjusted EBITDA on a total segment basis is reconciled in Note
18 - Segment Data as required by ASC 280.

Key Factors and Trends Affecting our Results

Impact of COVID-19 on our Business


In an effort to contain COVID-19 or slow its spread, governments around the
world enacted various measures, including orders to close all businesses not
deemed "essential," isolate residents to their homes or places of residence, and
practice social distancing when engaging in essential activities. The
determination of what is an "essential" business is mandated by local
authorities. Border restrictions have been slowly easing in certain places
around the world and several countries are beginning to lift lock-down measures.
However, since various countries have begun to reopen, there has been a surge of
coronavirus cases in various locations, and some countries are experiencing a
second wave of infections. Due to the spike in cases, some regions are
re-entering lockdowns, stepping up restrictions, or delaying phased re-opening
plans. Operationally, all of our distribution centers and pharmacies have
continued to remain open as veterinary medicine has been deemed an essential
service in most geographies across the globe. Additionally, our supply chain
operations continue to work with manufacturers and suppliers across the globe to
provide access to critical supplies and quality products.

During the first quarter of 2020, net sales reflected the positive momentum the
business had entering 2020, benefiting from prescription management growth and
certain inventory stocking activity in several geographies in connection with
the COVID-19 pandemic. A resurgence of COVID-19 may result in a reduction in our
companion animal-related net sales as wellness-related veterinary practice
visits may decline; the companion-animal market represent approximately 75% of
our global supply chain net sales. From mid-March to the end of April, we
experienced a significant slowdown in net sales as some markets, such as Spain,
went into a stricter lockdown. As a result of this slowdown and the uncertainty
surrounding the COVID-19 pandemic,
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management took certain temporary cost containment measures to help better align
our cost structure near-term, including executive, board, and other senior-level
employee compensation reductions, employee furloughs in certain European
countries, certain shift eliminations, a temporary hiring freeze, and
discretionary spending deferrals. However, our end-market across most
geographies began to improve exiting April and demand further recovered in May
and June as deferred visits to veterinary practices recovered and demand trends
normalized to pre-COVID-19 levels in some of our markets.

Additionally, demand for our prescription management and online pharmacy
services increased in the second quarter as a result of a shift in demand to our
online channel as a result of the pandemic, which could be temporary. These
services address the need veterinarians have for continuity with pet owners and
their ability to provide unique home delivery services that ties into their
technological capabilities. The upward trend in telehealth technology began
after the U.S. Food and Drug Administration relaxed its governance on
telemedicine to allow more flexible veterinary examinations during the COVID-19
pandemic. To help veterinarians respond and deliver continued care during the
COVID-19 pandemic, we also created resources for veterinary practices, including
launching a series of webinars featuring practice managers and owners discussing
strategies and real-world tactics.

The animal-health industry and veterinary-care sector have proven to be more
resilient than originally anticipated. Although the COVID-19 pandemic has caused
limited disruption to our financial results as we observed demand increases
during the first half of 2020, the pandemic has been highly disruptive to
established business practices and the buying patterns of our customers, both of
which are currently fluid as the COVID-19 pandemic's effect on our macroeconomic
environment is unpredictable. For example, our travel and entertainment expenses
were significantly reduced in the second quarter of 2020 due to travel
restrictions, which while disruptive, was beneficial in managing our operating
expense. We expect that travel and entertainment expenses will return to
previous levels when the COVID-19 pandemic eventually subsides. We believe that
the actions we have taken will help us manage through the COVID-19 pandemic,
however, our results in future quarters depend on the efficacy of containment
procedures, the consequences of re-opening plans implemented globally, the lift
on travel restrictions, and the subsequent impact on economic activity.

We began to ease some of the above-mentioned cash and liquidity conservation
measures as the impact of the COVID-19 pandemic on our results of operations, to
date, has been less than anticipated. For example, in July, we returned to
pre-COVID-19 compensation levels and, in August, we expect to reinstate our
401(k)-employer match. Hiring for our business was strictly limited, especially
in response to the COVID-19 pandemic; however, we are relaxing the restrictions
we instituted as part of our temporary hiring freeze. At the same time, we
continue to closely monitor global developments unfolding during the pandemic
and may reinstate any measures that we reverse, or we may take additional
actions to ensure we have enough liquidity for our business operations. In the
absence of cost containment measures to manage our business in this dynamic
COVID-19 environment, our selling, general and administrative expenses would
likely increase throughout the remainder of 2020 as we continue our
transformation.

To protect the health and safety of our employees, we implemented workplace
regulations and recommended guidelines from government and public health
authorities related to COVID-19. This includes frequent washing of hands, daily
disinfecting of workspaces, and limiting non-essential travel. For employees who
recently traveled to affected areas, a two-week quarantine is required prior to
returning to work. In our pharmacies, it has been our standard practice to
strictly comply with United States Pharmacopeia regulations on the use and
application of personal protective equipment by all staff. In March 2020, we
transitioned a large portion of our teams to working remotely and implemented
staggered schedules in our distribution facilities. We created a COVID-19
information portal on our Covetrus intranet that provides best practices for
working at home and staying connected, communications from our leadership,
internal contacts for any COVID-19 questions, and helpful external reference
links.

We assembled three cross-functional task forces that are actively planning
return-to-work guidelines. These task forces represent North America, Europe,
and APAC & Emerging Markets, and their goal is to develop a comprehensive plan
to establish best practices for our essential facilities such as distribution
centers and pharmacies and establish protocols for field-based employees to
return to customer sites and for us to re-open Covetrus offices to safely
accommodate more office-based employees.

Our re-open plan is organized to address four main areas:
•Health & Safety - work schedules and rotations, use of personal protective
equipment, and protocols for employee health screening, sick notifications,
on-site visitors, and more
•Operations - establish best practices and guidance for employee workspace
reconfiguration required to support social distancing, cleaning protocols,
training, and compliance management
•Commercial - enable and support field-based employees in making customer visits
and establish safety guidelines and strategies for our field sales teams
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•Communications - communicate updates of employee-related policies and provide
materials, onsite signage, and employee training on updated protocols and
policies

We will continue to actively monitor how COVID-19 is impacting us and may take
further actions to alter our business operations in the best interests of our
employees, customers, partners, suppliers, and stakeholders, or as required by
federal, state, or local authorities.

Strategic Development


In 2020, we identified four priorities for our organization to drive forward our
long-term strategic objectives: (i) creating a high-performing, customer-centric
culture, (ii) maximizing effectiveness and efficiency, (iii) driving proprietary
products and solutions, and (iv) expanding capabilities and developing sourcing
excellence.

In the first half of 2020, we made progress on these objectives:


•We onboarded several leaders with experience in driving growth and
transformation who represent an important facet of investing in our corporate
culture and growing our talent globally.
•We instituted broad-based cost containment measures and spending discipline to
provide flexibility within our organization as we adapt to the changing COVID-19
economic environment.
•We experienced strong utilization of our prescription management platform as we
were well placed in the industry to provide dynamic solutions to our customers,
so they could capitalize on the growth in e-commerce amidst the COVID-19
pandemic.
•We centralized our direct and indirect sourcing initiatives to coordinate
purchasing activity and leverage our global scale.

While the global pandemic may have a continued impact on our business and could
create new obstacles tied to achieving certain of our strategic objectives, our
focus on building a shared culture of success, driving efficiencies throughout
the organization, and executing against the core drivers of our business will
remain.

Seasonality

Our quarterly sales and operating results have varied from period-to-period in
the past and will likely continue to do so in the future. In the
companion-animal market, sales of parasite protection products have historically
tended to be stronger during the spring and summer months, primarily due to an
increase in vector-borne diseases during that time, which correlates with our
second and third quarters given that most of our business is in the northern
hemisphere. Buying patterns can also be affected by manufacturers' and
distributors' marketing programs or price increase announcements, which can
cause our customers to purchase animal-health products earlier than when those
products are needed. This kind of early purchasing may reduce our sales in the
quarters these purchases would have otherwise been made. The sales of animal
products can also vary due to changes in the price of commodities used in
manufacturing the products and weather patterns, which may also
affect period-over-period financial results. We expect our historical
seasonality trends to continue in the foreseeable future.


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Results of Operations
                                                                         Three Months Ended                                                                                                             Six Months Ended
                                                                                        $ Increase              % Increase            June 30,         June 30,           $ Increase              % Increase
(In millions)                            June 30, 2020June 30, 2019            (Decrease)              (Decrease)              2020             2019             (Decrease)              (Decrease)
Net sales                               $      1,026$      1,009$        17                        1.7  %        $ 2,091$ 1,950$       141                       7.2  %
Cost of sales                                    834                   816                   18                        2.2             1,696            1,580                  116                       7.3
Gross profit                                     192                   193                   (1)                      (0.5)              395              370                   25                       6.8
Operating expenses:
Selling, general and
administrative                                   196                   198                   (2)                      (1.0)              419              384                   35                       9.1

Operating loss                          $         (4)         $         (5)         $        (1)                     (20.0) %        $   (24)$   (14)$        10                      71.4  %

Interest expense, net                   $        (13)$        (13)         $         -                          -  %        $   (27)$   (23)         $         4                      17.4  %
Other, net (a)                          $         76          $         13          $        63                      484.6  %        $    75$    15$        60                     400.0  %

Net income (loss)                       $         54          $        (10)$        64                      640.0  %        $    21$   (23)$        44                     191.3  %
Net income (loss) attributable to
Covetrus                                $         54          $        (10)$        64                      640.0  %        $    20$   (23)$        43                     187.0  %

(a) Includes a $73 million gain on the divestiture of scil and a $1 million gain on the deconsolidation of SAHS. See Note 3 - Divestiture and Equity Method Investment.




The year-over-year increase in Net sales for the three months ended June 30,
2020 compared to the three months ended June 30, 2019 was primarily due to
strong prescription management growth, improved performance across certain of
our markets supported by the end-market recovery, and acquisitions, partially
offset by COVID-19 stocking activity that occurred in the first quarter of 2020,
pulling demand out of the second quarter, divestitures, and unfavorable foreign
exchange.

The year-over-year increase in Net sales for the six months ended June 30, 2020
compared to the six months ended June 30, 2019 was primarily due to strong
prescription management growth, improved performance across certain of our
markets, and acquisitions, partially offset by unfavorable foreign exchange and
divestitures.

The year-over-year improvement in Operating loss for the three months ended June
30, 2020 compared to the three months ended June 30, 2019 was largely due to
strong prescription management growth, and cost containment measures initiated
due to the COVID-19 pandemic, largely offset by the effect of divestitures and
increased expenses to drive our transformation as an independent, global public
company.

The year-over-year increase in Operating loss for the six months ended June 30,
2020 compared to the six months ended June 30, 2019 was due to the increase from
acquisitions (primarily Vets First Choice) and increased expenses to drive our
transformation as an independent, global public company, partially offset by
strong prescription management growth and cost containment measures initiated
due to the COVID-19 pandemic.

Net income during the three and six months ended June 30, 2020 as compared to
the three and six months ended June 30, 2019 was positively impacted by the gain
on the divestiture of scil as well as the items above.

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Year-Over-Year Period Comparisons

Net Sales
                                                                  Three Months Ended                                                                                                        Six Months Ended
(In millions)                          June 30, 2020         June 30, 2019         $ Change          % Change           June 30, 2020         June 30,
2019         $ Change           % Change
North America                         $        602$        552$    50                 9.1  %       $      1,152$      1,049$    103                9.8  %
Europe                                         342                   370              (28)               (7.6)                  764                   731                33                4.5
APAC & Emerging Markets                         85                    90               (5)               (5.6)                  180                   176                 4                2.3
Eliminations                                    (3)                   (3)               -                   -                    (5)                   (6)                1              (16.7)
Total Net sales                       $      1,026$      1,009$    17                 1.7  %       $      2,091$      1,950$    141                7.2  %



Net sales for the three months ended June 30, 2020 increased compared to the
three months ended June 30, 2019 primarily due to a $43 million increase from
strong prescription management growth, improved performance across certain of
our markets as the COVID-19 impact eased, and the contribution of $17 million in
net sales from acquisitions, partially offset by COVID-19 stocking activity that
occurred in the first quarter of 2020, pulling demand out of the second quarter,
$27 million in net sales from divestitures, and $22 million in unfavorable
foreign exchange. The drivers by segment are detailed below:

•North America increased primarily due to strong growth in prescription
management, which contributed a $43 million increase in net sales. Supply chain
net sales (net of eliminations) increased 2% as strong net sales in June offset
the decline in April and May as a result of fluctuating customer and animal
owner demand due to COVID-19.

•Europe decreased primarily due to a COVID-19 related slowdown in the
large-animal market, particularly in the United Kingdom, disposition of scil and
the deconsolidation of a subsidiary in Spain that decreased net sales by $24
million, and unfavorable foreign currency exchange of $12 million. These
decreases were partially offset by organic growth in certain of our markets in
the region, and the contribution of $16 million from our acquisitions in France
(July 2019) and Romania (May 2019) being present for the full period in 2020.

•APAC & Emerging Markets decreased primarily due to unfavorable foreign exchange
of $10 million and COVID-19 stocking activity that occurred in the first quarter
of 2020, partially offset by strong underlying organic growth in the region.

Net sales for the six months ended June 30, 2020 increased compared to the six
months ended June 30, 2019 primarily due to a $71 million increase from strong
prescription management growth, improved performance across certain of our
markets, and contribution of $67 million in net sales from acquisitions,
including $24 million from the acquisition of Vets First Choice being present
for a complete half year of sales this year versus only 4.5 months in 2019
(February 8 - June 30, 2019), partially offset by $41 million due to unfavorable
foreign exchange and $27 million effect on net sales from divestitures. The
drivers by segment are detailed below:

•North America increased primarily due to an increased contribution of $71
million from strong prescription management growth and $24 million from the
acquisition of Vets First Choice being present for a complete half year of sales
this year versus only 4.5 months in 2019 (February 8 - June 30, 2019). The
increase in supply chain net sales was partially offset by the loss of a
customer in the first quarter of 2019.

•Europe increased primarily due to $41 million from our acquisitions in France
and Romania being present for the full period in 2020 and organic growth in most
of our markets in the region, partially offset by $24 million from the
disposition of scil and the deconsolidation of a subsidiary in Spain, and
unfavorable foreign currency exchange of $23 million.

•APAC & Emerging Markets increased primarily due to the contribution of $21
million in net sales from organic growth. These increases were partially offset
by unfavorable foreign exchange of $19 million.
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Gross Profit and Gross Profit Margin
                                                                                                 Three Months Ended
                                                                        Gross Margin                             Gross Margin                        Gross Profit
(In millions)                                      June 30, 2020             %              June 30, 2019             %              $ Change          % Change
North America                                     $        127               21.1  %       $        119               21.6  %       $     8                 6.7  %
Europe                                                      48               14.0                    57               15.4               (9)              (15.8)
APAC & Emerging Markets                                     17               20.0                    17               18.9                -                   -
Total Gross profit                                $        192               18.7  %       $        193               19.1  %       $    (1)               (0.5) %



During the three months ended June 30, 2020, the decrease in gross profit was
largely driven by $8 million from divestitures, unfavorable foreign exchange of
$4 million, and a COVID-19 related slowdown in the large-animal market in
Europe, particularly in the United Kingdom. These decreases were partially
offset by a $13 million increase related to strong prescription management
growth and $2 million from acquisitions. The drivers of the decrease in our
gross profit are further detailed below by segment:

•North America increased primarily due to strong prescription management growth
which contributed $13 million, partially offset by lower agency sales and rebate
timing in our supply chain business.

•Europe decreased primarily due to the disposition of scil and the
deconsolidation of a subsidiary in Spain, which decreased gross profit by $7
million, COVID-19 stocking activity that occurred in the first quarter of 2020,
pulling demand out of the second quarter, and unfavorable foreign exchange of $2
million. These decreases were partially offset by the contribution of $2 million
from our acquisitions in France and Romania being present for the full period in
2020.

•APAC & Emerging Markets remained constant, unfavorable foreign exchange effects
of $2 million were offset by improved performance in certain markets in the
region.
                                                                                                 Six Months Ended
                                                                        Gross Margin                             Gross Margin                        Gross Profit
(In millions)                                      June 30, 2020             %              June 30, 2019             %              $ Change          % Change
North America                                     $        247               21.4  %       $        224               21.4  %       $    23               10.3  %
Europe                                                     112               14.7                   112               15.3                -                  -
APAC & Emerging Markets                                     36               20.0                    34               19.3                2                5.9
Total Gross profit                                $        395               18.9  %       $        370               19.0  %       $    25                6.8  %



During the six months ended June 30, 2020, the increase in gross profit compared
to the six months ended June 30, 2019 was largely driven by a $20 million
increase from strong prescription management growth, $15 million from
acquisitions being present for the full period in 2020 versus a partial period
in 2019, as well as improved performance across certain distribution markets.
These increases were partially offset by $8 million from the disposition of scil
and the deconsolidation of a subsidiary in Spain and unfavorable foreign
exchange of $7 million. The drivers of the increase in our gross profit are
further detailed below by segment:

•North America increased primarily due to the acquisition and growth of our
prescription management business.
•Europe was flat, with the $7 million decrease from the disposition of scil and
the deconsolidation of a subsidiary in Spain, and unfavorable foreign exchange
effects, offset by acquisitions being present for the full period in 2020 versus
a partial period in 2019 and improved performance across certain distribution
markets.
•APAC & Emerging Markets increased due to the contribution of $6 million from
organic growth, partially offset by unfavorable foreign exchange of $4 million.
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Selling, General and Administrative ("SG&A")
                                                                   Three Months Ended                                                                                                       Six Months Ended
(In millions)                           June 30, 2020         June 30, 2019         $ Change           % Change           June 30, 2020         June 30, 2019         $ Change         % Change
North America                          $        114$        127$    (13)              (10.2) %       $        235$        225$    10               4.4  %
Europe                                           39                    45                (6)              (13.3)                   92                    89                3               3.4
APAC & Emerging Markets                          13                    15                (2)              (13.3)                   27                    29               (2)             (6.9)
Corporate                                        30                    11                19               172.7                    65                    41               24              58.5
Total SG&A                             $        196$        198$     (2)               (1.0) %       $        419$        384$    35               9.1  %



SG&A expenses for the three months ended June 30, 2020 decreased compared to the
same period in 2019, primarily due to the cost containment measures initiated in
response to the COVID-19 pandemic, $7 million from the disposition of scil and
the deconsolidation of a subsidiary in Spain, offset by an increase of $2
million in SG&A from acquisitions and increased expenses to drive our
transformation as an independent, global public company. The drivers by segment
and at Corporate are detailed below:

•North America decreased primarily due to lower share-based compensation expense
and COVID-19 related cost containment measures, partially offset by increased
expenses associated with strong prescription management growth.

•Europe decreased primarily due to $6 million from the disposition of scil and
the deconsolidation of a subsidiary in Spain, COVID-19 related cost containment
measures, as well as a favorable foreign exchange impact of $1 million,
partially offset by the impact from acquisitions in France and Romania of $2
million.

•APAC & Emerging Markets decreased due to favorable foreign exchange of $2 million.

•Corporate increased primarily due to increased share-based compensation expense, strategic consulting fees of $5 million, and increased costs related to various corporate functions as we continue to establish ourselves as an independent, global public company.


SG&A expenses for the six months ended June 30, 2020 increased compared to the
same period in 2019, primarily due to the increase of $25 million in SG&A from
acquisitions (primarily Vets First Choice) and increased expenses to drive our
transformation as an independent, global public company, partially offset by
decreases due to the disposition of scil, the deconsolidation of a subsidiary in
Spain, COVID-19 cost containment measures, and favorable foreign exchange of $5
million. The drivers by segment and at Corporate are detailed below:

•North America increased primarily due to the acquisition of Vets First Choice
which contributed $19 million from a complete half-year of SG&A expenses for the
six months ended June 30, 2020 versus a 4.5 months last year, partially offset
by lower share-based compensation expenses.

•Europe increased primarily due to the impact of $6 million from acquisitions in
France and Romania being present for the full period in 2020, transaction costs
of $2 million, as well as increased IT and facility costs associated with the
formation of Covetrus as we exit our Transition Service Agreements. These
increases were partially offset by $6 million from the disposition of scil and
the deconsolidation of a subsidiary in Spain.

•APAC & Emerging Markets decreased primarily due to favorable foreign exchange of $3 million.

•Corporate grew primarily due to increased costs of $9 million related to various corporate functions as we continue to establish ourselves as an independent, global public company, strategic consulting fees of $9 million, and transaction costs of $4 million.

See section Impact of COVID-19 on our Business above for more information on our COVID-19 cost containment measures.

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Other, net

Other, net during the three and six months ended June 30, 2020 as compared to
the three and six months ended June 30, 2019 was positively impacted by the gain
on the divestiture of scil, as well as a gain on our deconsolidation of our
subsidiary, SAHS, in Spain.

Income taxes


Income tax expense for the three months ended June 30, 2020 was $6 million on a
loss before income taxes and equity earnings in affiliates of $59 million for a
consolidated effective tax rate of 10.6%. The difference between our effective
tax rate and the statutory tax rates for the jurisdictions in which we operate
for the three months ended June 30, 2020, primarily related to valuation
allowances due to uncertainty regarding the realization of future tax benefits
from deferred tax assets and the sale of scil business units.

Income tax expense for the six months ended June 30, 2020 was $4 million on
income before taxes and equity in earnings of affiliates of $24 million for a
consolidated effective tax rate of 17.7%. The difference between our
consolidated effective tax rate and the federal statutory tax rates for the
jurisdictions in which we operate for the six months ended June 30, 2020,
primarily related to non-deductible share-based compensation expense, the sale
of scil business units, valuation allowances due to uncertainty regarding the
realization of future tax benefits from deferred tax assets, and the federal tax
impact of international operations included as GILTI.

Income tax expense for the three months ended June 30, 2019 was $5 million on a
loss before income taxes and equity earnings in affiliates of $5 million for a
consolidated effective tax rate of (94.8)%. The difference between our effective
tax rate and the statutory tax rates for the jurisdictions in which we operate
for the three months ended June 30, 2019, primarily related to the change from
using the actual effective tax rate methodology for the three months ended March
31, 2019 to an annualized effective tax rate methodology for the three and six
months ended June 30, 2019.

Income tax expense for the six months ended June 30, 2019 was $1 million on a
loss before taxes and equity in earnings of affiliates of $22 million for a
consolidated effective tax rate of (2.4)% The difference between our effective
tax rate and the federal statutory tax rates for the jurisdictions in which we
operate for the six months ended June 30, 2019, primarily related to the federal
tax impact of international operations included as GILTI and non-deductible
share-based compensation expense.

Adjusted EBITDA
                                                                    Three Months Ended                                                                                                       Six Months Ended
(In millions)                            June 30, 2020         June 30, 2019          $ Change          % Change           June 30, 2020         June 30, 2019         $ Change         % Change
North America                           $         55          $        43$    12                27.9  %       $         96          $         78          $    18              23.1  %
Europe                                            16                   19                 (3)              (15.8)                   34                    35               (1)             (2.9)
APAC & Emerging Markets                            5                    4                  1                25.0                    12                     8                4              50.0
Corporate                                        (13)                 (13)                 -               NA                      (31)                  (16)             (15)             NA
Total Adjusted EBITDA                   $         63          $        53$    10                18.9  %       $        111$        105$     6               5.7  %



Total non-GAAP Adjusted EBITDA for the three months ended June 30, 2020
increased compared to the same period in 2019, largely due to strong
prescription management growth and cost containment measures, partially offset
by increasing costs incurred as we transform into an independent, global public
company. The changes by segment and at Corporate are detailed below:

•North America increased primarily due to strong prescription management growth and cost containment measures.

•Europe decreased primarily due to the disposition of scil and the deconsolidation of a subsidiary in Spain, partially offset by acquisitions and cost containment measures.

•APAC & Emerging Markets increased primarily due organic growth and cost containment measures, partially offset by unfavorable foreign exchange.

•Corporate adjusted EBITDA remained constant as our cost containment measures were offset by increased costs as we continue to establish ourselves as an independent, global public company.

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Total non-GAAP Adjusted EBITDA for the six months ended June 30, 2020 increased
compared to the same period in 2019, largely due to strong prescription
management growth, partially offset by increasing costs incurred as we transform
into an independent, global, public company. The changes by segment and at
Corporate are detailed below:

•North America increased primarily due to the acquisition and strong growth of our prescription management business.

•Europe decreased primarily due to the disposition of scil and the deconsolidation of a subsidiary in Spain and unfavorable foreign exchange, partially offset by acquisitions and cost containment measures.

•APAC & Emerging Markets increased primarily due to organic growth, partially offset by unfavorable foreign exchange.


•Corporate contributed a $15 million decrease in adjusted EBITDA primarily due
to SG&A expenses as we continue to establish ourselves as an independent, global
public company.

Liquidity and Capital Resources

Impact of COVID-19 on Liquidity and Capital Resources


During the short period of time that COVID-19 took to become a global pandemic,
it had a rapid, negative impact on global capital markets. Many equity prices
tumbled and the investment funds flowing into certain debt markets paused or
became more expensive to borrowers, and the recovery of these capital markets
has been mixed with still uncertain forecasts. In response, some governments
offered deferred tax schemes, guarantees, and loan programs to individuals,
small businesses, and larger companies as methods to boost liquidity, maintain
workforces, to help soften the impact of COVID-19 on capital structures and
financial results of businesses. We are not immune to the impact of COVID-19 and
have taken and continue to take steps to improve our liquidity position as a
result.

In April 2020, we completed the sale of our scil animal-care business under
challenging business conditions, which provided cash proceeds of approximately
$104 million, which represents gross proceeds of $110 million, net of cash
included in the sale. We used $45 million of these proceeds to prepay our
remaining quarterly term loan principal amortization payments for 2020. On May
19, 2020, we sold our Series A Preferred Stock in a private placement
transaction for $244 million in net proceeds to further enhance our liquidity
position. A portion of the Series A Preferred Stock proceeds, coupled with cash
flow generated from better than anticipated sales during COVID-19, was used to
repay our revolver borrowings earlier than expected, with the remainder used to
support general corporate purposes (see Note 12 - Redeemable Series A
Convertible Preferred Stock). Our operational plans to manage our liquidity
continue to include reducing non-critical capital expenditures, sharpening our
focus on collecting amounts owed to us by customers and for supplier rebates,
managing opportunistic inventory purchases as we carefully monitor sales
forecasts, quickly reducing our other costs, considering additional borrowings
if needed based on availability under our revolving credit facility from
time-to-time, and maximizing our payment terms wherever possible.

Our interest expense was slightly higher during the six months ended June 30,
2020 due to the revolver borrowings that were outstanding at the beginning of
the quarter. However, that increase was mitigated by fully paying the required
$60 million 2020 amortization payments to reduce our term loan outstanding and
lower monthly floating interest rates applicable to the term loan. The February
2020 amendment to our credit agreement modified the leverage-based grid that
determines the applicable margin to be added to our borrowings, which applicable
margin increases as credit agreement-defined leverage increases or decreases as
credit agreement-defined leverage decreases. In addition, this amendment will
permit us to maintain revolving credit facility borrowings near term, if needed,
and help alleviate some potential COVID-19 impact to our earnings, while
remaining compliant with our debt covenants as the step down of our leverage
covenant from 5.50x to 5.00x was delayed until June 30, 2021. We were in
compliance with the covenants in our credit agreement as of June 30, 2020. Based
on our expected credit agreement-defined leverage as of the three months ended
June 30, 2020, once the quarterly credit agreement compliance filing is made,
the applicable margin on our credit agreement borrowings outstanding will
decrease which will result in lower interest expense at least until the next
compliance filing is made for the three months ending September 30, 2020.

The duration of the COVID-19 pandemic is unknown. Should the pandemic extend
throughout the rest of 2020 and beyond, we may experience a negative impact on
our liquidity position. Therefore, we continuously assess steps we can take to
improve working capital and increase cash on our balance sheet, research
government-backed loan programs that may be available to us or to our customers,
and monitor the capital markets for additional opportunities to improve our
liquidity position.

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Overview

Our primary sources of liquidity are cash and cash equivalents, cash flows from
the operations of our business, available borrowing capacity under our credit
facility, and cash proceeds received from divestitures. Longer term, if we
desire to access alternative sources of funding through the capital and credit
markets, challenging global economic conditions, such as a long-lasting COVID-19
pandemic or economic downturn, could adversely impact our ability to do so. Our
principal uses of cash include working capital-related items, capital
expenditures, debt service, and strategic investments.

Working capital requirements, which can be substantial and susceptible to
fluctuations during the year due to seasonal demands, generally result from
sales growth, inventory purchase patterns driven by sales activity and buy-in
opportunities, our desired level of inventory, and payment terms for receivables
and payables.

Under normal historical operating conditions, we would expect to incur additional disbursements in connection with the following:


•expansion of global sales and marketing efforts
•increase of our pharmaceutical operations capacity
•international development
•equity investment and business acquisitions that we may fund from time to time
•term loan facility amortization payments (prepaid for 2020, but beginning again
in March 2021)
•capital investments in current and future facilities
•pursuit and maintenance of appropriate regulatory clearances, approvals for
existing products, and any new products that may be developed

Depending on how our results from operations continue for the remainder of 2020,
we may decide to pursue some of the opportunities noted above. Regardless, we
anticipate that we will continue to incur significant interest expense related
to debt service on the credit facility.

We regularly monitor and assess our ability to meet funding requirements. We
expect to meet our foreseeable liquidity requirements through cash and cash
equivalents, cash flow from operations, access to available funds by borrowing
against our credit facility, and net cash proceeds received from divestitures of
non-core business operations. Our decisions to use available liquidity will be
based upon the duration of the COVID-19 pandemic and our continuing review of
the funding needs for our business, optimizing the allocation of cash resources
for investments, capital structure changes or business combinations, and the
timing of cash flow generation.

Cash and Cash Equivalents


As of June 30, 2020, we had Cash and cash equivalents of $414 million. We
consider all highly liquid short-term investments with an original maturity of
three months or less to be cash equivalents. Due to the short-term maturity of
such investments, the carrying amounts are a reasonable estimate of fair value.

Cash Flows


The following table summarizes our cash flows from operating, investing, and
financing activities:
                                                                                   Six Months Ended
(In millions)                                                   June 30, 2020         June 30, 2019          $ Change
Net cash provided by operating activities                      $         54          $         3            $     51
Net cash provided by (used for) investing activities                     71                  (45)                116
Net cash provided by financing activities                               162                   73                  89
Total net cash flows                                           $        287$        31$    256

Cash inflows and outflows from changes in operating activities

For the six months ended June 30, 2020, net cash provided by operating activities increased over the six months ended June 30, 2019, primarily due to improved inventory management and disciplined expense management.

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Cash inflows and outflows from changes in investing activities


For the six months ended June 30, 2020, net cash provided by investing
activities increased compared to net cash used for investing activities the six
months ended June 30, 2019, primarily due to $104 million in net proceeds from
the divestiture of scil.

Cash inflows and outflows from changes in financing activities


For the six months ended June 30, 2020, net cash provided by financing
activities increased over the six months ended June 30, 2019, primarily due to
$250 million in gross proceeds from the issuance of Series A Preferred Stock,
partially offset by principal payments, debt issuance costs, preferred stock
issuance costs, and acquisition payments totaling $90 million. During the six
months ended June 30, 2019, we had inflows from bank debt of $1.2 billion and
our Former Parent of $165 million offset by a dividend payment to Former Parent,
principal payments, debt issuance costs, and acquisition of non-controlling
interests in subsidiaries totaling $1.3 billion.

Contractual Obligations

We did not have any material changes in our contractual obligations since the end of fiscal year 2019 outside of activities in the ordinary course of business.


Off-balance Sheet Arrangements
In April 2020, we made a final payment of $9 million for a 2019 acquisition, and
as a result, the associated $9 million letter of credit expired, which increases
the amount available to be borrowed under our revolving line of credit. As of
June 30, 2020, we had $1 million outstanding in standby letters of credit that
primarily support our obligations related to our insurance programs and $4
million in surety bonds outstanding in support of various U.S. state
registrations for pharmaceutical operations and distributions.

Critical Accounting Estimates

Business Acquisitions, Acquired Goodwill, and Intangible Assets


The COVID-19 pandemic has brought great uncertainty and volatility to markets
across the world, the effects of which have forced us to consider whether the
pandemic was a triggering event for goodwill impairment purposes and, further,
if goodwill was impaired as of March 31, 2020. Testing goodwill for impairment
is required at least annually, however, any triggering event occurring between
annual tests that would more likely than not reduce the fair value of a
reporting unit below its carrying amount requires goodwill to be tested.

During the first quarter ended March 31, 2020, we experienced a sustained
decline in our share price and a resulting decrease in our market capitalization
due to the overall macroeconomic effects of the COVID-19 pandemic. Due to this
overall market decline and the uncertainty surrounding COVID-19, we concluded
that a triggering event occurred and conducted an interim impairment test of
goodwill as of March 31, 2020 by quantitatively compared the fair value of our
North America reporting unit (the only reporting unit currently bearing
goodwill) to its carrying amount. Using the income-based approach, fair value
exceeded the carrying amount as of March 31, 2020.The income-based approach
resulted in a fair value that exceeded the carrying amount by $2 million and
$156 million at discount rates of 9.0% and 8.5%, respectively.

We did not conduct an impairment test as of June 30, 2020, as no triggering
events occurred. We continued to experience strong demand for our prescription
management and online pharmacy services during the second quarter 2020, the
COVID-19 pandemic has not had a material negative impact on our results of
operations or financial condition, and our market capitalization at June 30,
2020 increased 120% over our market capitalization at March 31, 2020.
Nevertheless, we consider our North America reporting unit's goodwill to be at
risk and changes in our forecast of future operating or financial results, cash
flows, share price, market capitalization, or discount rate used when conducting
future goodwill impairment tests could affect the estimated fair value of our
goodwill-bearing reporting unit and may result in a goodwill impairment charge
in the future.

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Income Taxes

On March 27, 2020, the CARES Act, a substantial tax-and-spending package, was
signed by the President of the United States to provide additional economic
stimulus to address the impact of the COVID-19 pandemic. For the six months
ended June 30, 2020, there were no material tax impacts to our condensed
consolidated financial statements as it relates to the CARES Act. The ultimate
impact may differ from this estimate due to changes in interpretations and
assumptions, guidance that may be issued, and actions we may take in response to
the COVID-19 pandemic and the CARES Act.

Other than the items noted above, there have been no other material changes in
our critical accounting estimates from those disclosed in Item 7 - Management's
Discussion and Analysis of Financial Condition and Results of Operations of our
Form 10-K. For a discussion of critical accounting policies and estimates as
well as accounting policies adopted, see Note 1 - Business Overview and
Significant Accounting Policies.

Recent Accounting Pronouncements

For information on recent accounting pronouncements, see Note 1 - Business Overview and Significant Accounting Policies.

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