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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)

11/10/2020 | 05:17pm 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, including risk associated with our dependence on third
party service providers as a large portion of our workforce is working from home
•additional risks and factors discussed, including those discussed under the
heading "Risk Factors" in this Report and in our 2019 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 2019 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 nine months ended September
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 2019 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,
operating lease right-of-use asset impairments, managed exits from businesses we
are exiting or closing, and other income and 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 17 - 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. However, since various countries started reopening in the second
half of 2020, there has been a surge of coronavirus cases in various locations
and some countries are experiencing a second wave of infections. Due to recent
spikes in cases, some regions are re-entering lockdowns, stepping up
restrictions, or delaying phased re-opening plans. The animal-health industry
and veterinary-care sector have proven to be more resilient than originally
anticipated. Operationally, all of our distribution centers and pharmacies
continue to remain open as veterinary medicine has been deemed an essential
service in most geographies across the globe. 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. From mid-March to the end of April, we experienced a
significant slowdown in net sales as some markets went into a stricter lockdown.
As a result of this slowdown and the uncertainty surrounding the COVID-19
pandemic, management took certain temporary cost containment measures to help
better align our cost structure near-term, including temporary executive,
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board, and other senior-level employee compensation reductions, employee
furloughs in certain European countries, certain shift eliminations, a temporary
hiring freeze, discretionary spending deferrals, deferred payroll taxes as
available under the Coronavirus Aid, Relief, and Economic Security Act (the
"CARES Act"), and temporarily suspended our 401(k)-employer match. However, our
end-market across most geographies began to improve exiting April and demand has
largely recovered as deferred visits to veterinary practices recovered and
demand trends normalized to pre-COVID-19 levels in most of our markets.

Additionally, demand for our prescription management and online pharmacy
services increased in the second quarter with growth rates returning to
pre-COVID-19 levels in the third quarter as the pandemic shifted customer and
animal-owner demand to our online channel; however, this demand may be
temporary. COVID-19 may result in a reduction in our companion animal-related
net sales should wellness-related veterinary practice visits decline; as the
companion-animal market represents approximately 75% of our global supply chain
net sales. Even though, to date, the COVID-19 pandemic has caused limited
disruption to our financial results as we observed demand increases, 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.
Although our supply chain and distribution network is meeting our market demand,
we are exposed to third party shipping surcharges and anticipate this trend to
continue.

Our travel and entertainment expenses were significantly reduced in the second
and third quarters of 2020 due to travel restrictions, which while disruptive,
were 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 are monitoring our business to address our adaptability
to COVID-19 in the short term as well as long-term sustainability. 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. We returned to pre-COVID-19 compensation
levels and reinstated our 401(k)-employer match. 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, as
needed, 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 to establish
ourselves as a standalone company and invest for growth.

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. In October 2020, we issued
internal guidance on the expected return to work in July 2021 for our North
America workforce that is currently operating remotely. Outside of North
America, we adhere to the regulations and guidelines instituted by local
authorities in our area of operations and make judgments with the best available
information at the time. 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 actively monitor our
return-to-work guidelines. These task forces represent North America, Europe,
and APAC & Emerging Markets, and their goal is to maintain a comprehensive plan
of 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 return to work plan addresses four main areas:
•Health & Safety - create work schedules and rotations, use of personal
protective equipment, and protocols for employee health screening, sick
notifications, on-site visitors, and more
•Operations - 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 other 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.

To date, we have taken a number of steps to support these priorities, including:


•We onboarded several leaders with experience in driving growth and
transformation to increase coordination across our business units and technology
capabilities as we phase-in our global integration efforts and tap into growth
opportunities
•As part of our commitment to creating a diverse and inclusive environment, we
created a Global Diversity & Inclusion governance and community program, which
includes a Global Advisory Board and a number of global, business unit and
regional diversity and inclusion leads dedicated to drive our commitments and
strategic focus areas as well as to ensure local support
•In August, with our focus on our team, retaining our hardworking talent, and
the knowledge of how COVID-19 may be affecting team members in their personal
lives, we launched the Covetrus Hardship Fund to help our colleagues with
COVID-19 illness-related hardship
•We instituted broad-based cost containment measures and spending discipline to
adapt to the changing COVID-19 economic environment. Many of these measures
drive organizational and spending behavior we were seeking to instill anyway
within our organization to support our growth and continued performance. For
example, on an as-needed basis, we would expect to implement hiring freezes of
non-essential positions as well as capital expenditure trimming
•We experienced strong utilization of our prescription management platform as we
were well placed in the industry to provide dynamic solutions to our customers,
although this growth may be temporary
•We centralized our direct and indirect sourcing initiatives to coordinate
purchasing activity and leverage our global scale
•In October 2020, we made a strategic investment in Veterinary Study Groups -
which we will consolidate in the fourth quarter of 2020 - that furthers our
strategy to drive increased customer alignment

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 has and
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                                                                            Nine Months Ended
                                        September 30,        September 30,           $ Increase              % Increase             September 30,           September 30,            $ Increase              % Increase
(In millions)                                2020                 2019               (Decrease)              (Decrease)                 2020                    2019                 (Decrease)              (Decrease)
Net sales                               $     1,126$     1,018          $         108                     10.6  %       $        3,217$        2,968          $         249                      8.4  %
Cost of sales                                   929                  827                    102                     12.3                   2,625                   2,407                    218                      9.1
Gross profit                                    197                  191                      6                      3.1                     592                     561                     31                      5.5
Operating expenses:
Selling, general and
administrative                                  224                  210                     14                      6.7                     642                     594                     48                      8.1

Goodwill impairment                               -                  939                   (939)                  (100.0)                      -                     939                   (939)                  (100.0)
Operating loss                          $       (27)$      (958)$        (931)                   (97.2) %       $          (50)         $         (972)         $        (922)                   (94.9) %

Interest expense, net                   $       (10)$       (15)         $          (5)                   (33.3) %       $          (37)         $          (38)         $          (1)                    (2.6) %
Other, net (a)                          $         5          $         4          $           1                     25.0  %       $           79          $           18          $          61                    338.9  %

Net income (loss)                       $       (35)$      (962)$        (927)                   (96.4) %       $          (14)         $         (985)         $        (971)                   (98.6) %
Net income (loss) attributable to
Covetrus$       (35)$      (959)$        (924)                   (96.4) %       $          (15)         $         (982)         $        (967)                   (98.5) %

(a) Includes a $72 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 September
30, 2020 compared to the three months ended September 30, 2019 was primarily due
to prescription management growth, improved performance across certain of our
markets as the end-market demand recovered, and favorable foreign exchange,
partially offset by divestitures.

The year-over-year increase in Net sales for the nine months ended September 30,
2020 compared to the nine months ended September 30, 2019 was primarily due to
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
September 30, 2020 compared to the three months ended September 30, 2019 was
largely due to the impact of the goodwill impairment charge in the comparative
period of the prior year.

The year-over-year improvement in Operating loss for the nine months ended
September 30, 2020 compared to the nine months ended September 30, 2019 was
largely due to the impact of the goodwill impairment charge in the comparative
period of the prior year, partially offset by increased SG&A expense related to
various corporate functions as we continue to invest in our corporate
infrastructure to enable our growth.

The year-over-year improvement in Net loss for the three months ended September
30, 2020 compared to the three months ended September 30, 2019 was largely due
to the impact of the goodwill impairment charge in the comparative period of the
prior year.

The year-over-year improvement in Net loss for the nine months ended September
30, 2020 compared to the nine months ended September 30, 2019 was largely due to
the impact of the goodwill impairment charge in the comparative period of the
prior year, the gain on the divestiture of scil, partially offset by increased
SG&A expense related to various corporate functions as we continue to invest in
our corporate infrastructure to enable our growth.
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Year-Over-Year Period Comparisons

Net Sales
                                                           Three Months Ended                                                                 Nine Months Ended
                               September 30,        September 30,                                                September 30,        September 30,
(In millions)                       2020                 2019              $ Change            % Change               2020                 2019              $ Change            % Change
North America                  $       618$       543$      75                 13.8  %       $     1,771$     1,592$     179                 11.2  %
Europe                                 403                  384                 19                  4.9                1,166                1,114                 52                  4.7
APAC & Emerging Markets                108                   94                 14                 14.9                  288                  270                 18                  6.7
Eliminations                            (3)                  (3)                 -                    -                   (8)                  (8)                 -                    -
Total Net sales                $     1,126$     1,018$     108                 10.6  %       $     3,217$     2,968$     249                  8.4  %



Net sales for the three months ended September 30, 2020 increased compared to
the three months ended September 30, 2019 primarily due to a $32 million
increase from prescription management growth, improved performance across
certain of our markets as the COVID-19 impact eased, and the $14 million
favorable impact of foreign exchange, partially offset by $29 million in net
sales from divestitures as the divested businesses contributed net sales for a
full period in 2019. The drivers by segment are detailed below:

•North America increased primarily due to growth in prescription management,
which contributed a $32 million increase in net sales. Supply chain net sales
(net of eliminations) increased 10% due to end-market recovery at or above
pre-COVID-19 levels.

•Europe increased primarily due to the COVID-19 end-market recovery in certain
of our European markets and favorable foreign currency exchange of $16 million,
partially offset by the disposition of scil and the deconsolidation of a
subsidiary in Spain that decreased net sales by $26 million as the divested
businesses contributed net sales for a full period in 2019. Our business in
Germany has been adversely affected by our transition to a third party logistics
provider in the fourth quarter of 2020. Also, a loss of a U.K. supplier
effective January 2021, will result in decreasing net sales in future periods.
We are taking steps to mitigate these effects and do not expect the
profitability impact to be significant.

•APAC & Emerging Markets increased primarily due to strong underlying organic
growth in the region, partially offset by unfavorable foreign exchange of $2
million.

Net sales for the nine months ended September 30, 2020 increased compared to the
nine months ended September 30, 2019 primarily due to a $102 million increase
from 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 three quarters of sales this year versus only 7.5 months in 2019
(February 8 - September 30, 2019), partially offset by $27 million due to
unfavorable foreign exchange and $55 million effect on net sales from
divestitures as the divested businesses contributed net sales for a full period
in 2019. The drivers by segment are detailed below:

•North America increased primarily due to an increased contribution of $102
million from prescription management growth and $24 million from the acquisition
of Vets First Choice being present for a complete three quarters of sales this
year versus only 7.5 months in 2019 (February 8 - September 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 organic growth in most of our markets in the
region and $41 million from our acquisitions in France and Romania being present
for the full period in 2020, partially offset by $50 million from the
disposition of scil and the deconsolidation of a subsidiary in Spain as the
divested businesses contributed net sales for a full period in 2019, and
unfavorable foreign currency exchange of $6 million.

•APAC & Emerging Markets increased primarily due to the contribution of $37
million in net sales from organic growth. These increases were partially offset
by unfavorable foreign exchange of $20 million.
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Gross Profit and Gross Profit Margin
                                                                                                    Three Months Ended
                                                                             Gross Margin         September 30,        Gross Margin                           Gross Profit
(In millions)                                     September 30, 2020               %                  2019                   %               $ Change           % Change
North America                                   $               123                19.9  %       $        116                21.4  %       $       7                 6.0  %
Europe                                                           53                13.2                    57                14.8                 (4)               (7.0)
APAC & Emerging Markets                                          21                19.4                    18                19.1                  3                16.7
Total Gross profit                              $               197                17.5  %       $        191                18.8  %       $       6                 3.1  %



During the three months ended September 30, 2020, the increase in gross profit
compared to the prior year period was due to $6 million related to prescription
management growth, improved performance across certain of our markets as the
end-market demand recovered, and $1 million in favorable foreign exchange,
partially offset by $8 million from divestitures as the divested businesses
contributed gross profit for a full period in 2019. The drivers of the increase
in our gross profit are further detailed below by segment:

•North America increased primarily due to prescription management growth which contributed $6 million and the increase in supply chain net sales related end-market recovery.


•Europe decreased primarily due to the disposition of scil and the
deconsolidation of a subsidiary in Spain as the divested businesses contributed
gross profit for a full period in 2019, which decreased gross profit by $7
million, partially offset by favorable foreign exchange of $2 million and an
increase in net sales related to the end-market recovery in many European
markets.

•APAC & Emerging Markets increased due to improved performance in certain markets in the region.

                                                                                                 Nine Months Ended
                                                 September 30,        Gross Margin         September 30,        Gross Margin                          Gross Profit
(In millions)                                        2020                   %                  2019                   %              $ Change           % Change
North America                                   $        371                20.9  %       $        340                21.4  %       $     31                 9.1  %
Europe                                                   164                14.1                   169                15.2                (5)               (3.0)
APAC & Emerging Markets                                   57                19.8                    52                19.3                 5                 9.6
Total Gross profit                              $        592                18.4  %       $        561                18.9  %       $     31                 5.5  %



During the nine months ended September 30, 2020, the increase in gross profit
compared to the nine months ended September 30, 2019 was largely driven by a $26
million increase from 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 $16 million from the disposition of
scil and the deconsolidation of a subsidiary in Spain as the divested businesses
contributed gross profit for a full period in 2019 and unfavorable foreign
exchange of $6 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 decreased primarily due to $14 million from the disposition of scil and
the deconsolidation of a subsidiary in Spain as the divested businesses
contributed gross profit for a full period in 2019, and unfavorable foreign
exchange effects, partially 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 $9 million from
organic growth, partially offset by unfavorable foreign exchange of $5 million.
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Selling, General and Administrative ("SG&A")
                                                               Three Months Ended                                                                        Nine Months Ended
                                                            September 30,                                                                             September 30,
(In millions)                   September 30, 2020              2019              $ Change            % Change            September 30, 2020              2019              $ Change            % Change
North America                  $         129               $        121$      8                  6.6  %       $               364          $        347$     17                  4.9  %
Europe                                    51                         46                 5                 10.9                          142                   135                 7                  5.2
APAC & Emerging Markets                   14                         15                (1)                (6.7)                          41                    43                (2)                (4.7)
Corporate                                 30                         28                 2                  7.1                           95                    69                26                 37.7
Total SG&A                     $         224               $        210$     14                  6.7  %       $               642          $        594$     48                  8.1  %



SG&A expenses for the three months ended September 30, 2020 increased compared
to prior year period primarily due to increased costs related to various
corporate functions as we continue to invest in our corporate infrastructure to
enable our growth, an $8 million operating lease right-of-use asset impairment
and $7 million of costs accrued in connection with the managed exit of our
French distribution business, strategic consulting fees, and an unfavorable
foreign exchange effect. This increase was partially offset by $8 million from
the disposition of scil and the deconsolidation of a subsidiary in Spain as the
divested businesses contributed expenses for a full period in 2019. The drivers
by segment and at Corporate are detailed below:

•North America increased primarily due to an $8 million operating lease right-of-use asset impairment.


•Europe increased primarily due to $7 million of costs incurred in connection
with the managed exit of our French distribution business, $2 million of
unfavorable foreign exchange, and an increase in IT and facility costs
associated with the formation of Covetrus as we exit our transition service
agreements. The increase was partially offset by $7 million from the disposition
of scil and the deconsolidation of a subsidiary in Spain as the divested
businesses contributed expenses for a full period in 2019.

•APAC & Emerging Markets decreased primarily due to favorable foreign exchange of $1 million.


•Corporate increased primarily due to increased costs related to various
corporate functions as we continue to invest in our corporate infrastructure to
enable our growth and strategic consulting fees of $3 million, partially offset
by a decrease in expenses related to the formation of Covetrus.

SG&A expenses for the nine months ended September 30, 2020 increased compared to
the same period in 2019, primarily due to the increase of $25 million from
acquisitions (primarily Vets First Choice) and increased costs related to
various corporate functions as we continue to invest in our corporate
infrastructure to enable our growth, strategic consulting fees, an $8 million
operating lease right-of-use asset impairment, and $7 million of costs accrued
in connection with the managed exit of our French distribution business. These
costs were partially offset by decreases due to the disposition of scil, the
deconsolidation of a subsidiary in Spain as the divested businesses contributed
expenses for a full period in 2019, decreased expenses related to the formation
of Covetrus, and favorable foreign exchange of $4 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 incremental expense from a complete nine months of
SG&A expense this year versus 7.5 months last year and an $8 million operating
lease right-of-use asset impairment, partially offset by lower share-based
compensation expenses and expenses related to the formation of Covetrus.

•Europe increased primarily due to $7 million of costs accrued in connection
with the managed exit of our French distribution business, $6 million from
acquisitions in France and Romania being present for the full period in 2020,
and increased IT and facility costs associated with the formation of Covetrus as
we exit our transition service agreements. These increases were partially offset
by $13 million from the disposition of scil and the deconsolidation of a
subsidiary in Spain as the divested businesses contributed expenses for a full
period in 2019.

•APAC & Emerging Markets decreased primarily due to favorable foreign exchange.


•Corporate grew primarily due to increased costs incurred as we continue to
invest in our corporate infrastructure to enable our growth and $13 million
related to strategic consulting fees, partially offset by decreased expenses
related to the formation of Covetrus.
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Other, net

Other, net during the three months ended September 30, 2020 as compared to the three months ended September 30, 2019 was relatively flat.


The nine months ended September 30, 2020 as compared to the nine months ended
September 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 September 30, 2020 was $3
million on a loss before income taxes and equity earnings in affiliates of $32
million for a consolidated effective tax rate of (8.0)%. The difference between
our effective tax rate and the federal statutory tax rates for the jurisdictions
in which we operate for the three months ended September 30, 2020, primarily
relates to the sale of our scil business and change in valuation allowance due
to uncertainty regarding the realization of future tax benefits from certain
U.S. deferred taxes.

Income tax expense for the nine months ended September 30, 2020 was $6 million
on a loss before taxes and equity in earnings of affiliates of $8 million for a
consolidated effective tax rate of (90.6)%. The difference between our effective
tax rate and the federal statutory tax rates for the jurisdictions in which we
operate for the nine months ended September 30, 2020, primarily relates to the
sale of our scil business and non-deductible stock compensation expense.

Income tax benefit for the three months ended September 30, 2019 was $7 million
on a loss before taxes and equity in earnings of affiliates of $969 million for
a consolidated effective tax rate of 0.8%. The income tax benefit for the nine
months ended September 30, 2019 was $7 million on a loss before taxes and equity
in earnings of affiliates of $992 million for a consolidated effective tax rate
of 0.7%. The difference between our effective tax rate and the federal statutory
tax rates for the jurisdictions in which we operate for the three and nine
months ended September 30, 2019, primarily related to the federal tax impact of
international operations included as GILTI and change in valuation allowance due
to uncertainty regarding the realization of future tax benefits from certain
U.S. deferred taxes.

Adjusted EBITDA
                                                           Three Months Ended                                                                     Nine Months Ended
                               September 30,         September 30,                                                                             September 30,
(In millions)                       2020                 2019              $ Change            % Change            September 30, 2020              2019              $ Change            % Change
North America                  $        45          $         39          $      6                 15.4  %       $               141          $        117$     24                 20.5  %
Europe                                  19                    15                 4                 26.7                           53                    50                 3                  6.0
APAC & Emerging Markets                  8                     5                 3                 60.0                           20                    13                 7                 53.8
Corporate                              (13)                  (10)               (3)               NA                             (44)                  (27)              (17)               NA
Total Adjusted EBITDA          $        59          $         49          $
    10                 20.4  %       $               170          $        153$     17                 11.1  %



Total non-GAAP Adjusted EBITDA for the three months ended September 30, 2020
increased compared to the same period in 2019, largely due to prescription
management growth, partially offset by increasing costs incurred as we continue
to invest in our corporate infrastructure to enable our growth. The changes by
segment and at Corporate are detailed below:

•North America increased primarily due to prescription management growth.

•Europe increased primarily due to the COVID-19 end-market recovery in certain of the European markets.

•APAC & Emerging Markets increased primarily due to organic growth.


•Corporate contributed a $3 million decrease largely due to increased costs
incurred as we continue to invest in our corporate infrastructure to enable our
growth.

Total non-GAAP Adjusted EBITDA for the nine months ended September 30, 2020
increased compared to the same period in 2019, largely due to prescription
management growth, partially offset by increasing costs incurred as we continue
to invest in our corporate infrastructure to enable our growth. The changes by
segment and at Corporate are detailed below:
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•North America increased primarily due to growth of our prescription management business.

•Europe increased primarily due to the COVID-19 end-market recovery in certain of our European markets.

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


•Corporate contributed a $17 million decrease primarily due to increased SG&A
expenses incurred as we continue to invest in our corporate infrastructure to
enable our growth.

Liquidity and Capital Resources

Impact of COVID-19 on Liquidity and Capital Resources


The spread of COVID-19 as a global pandemic in early 2020 led to rapid pricing
fluctuations and changing terms that have impacted global capital markets. Many
equity prices tumbled and the investment funds flowing into certain debt markets
paused or became more expensive to borrowers in the early stages of the
pandemic, 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 and maintain workforces to help soften
the impact of COVID-19 on capital structures and financial results of
businesses. We have not been immune to the impact of COVID-19 and have taken and
continue to take steps to improve our liquidity position.

In April 2020, under challenging conditions, we completed the sale of our scil
animal-care business for net cash proceeds of approximately $104 million,
representing 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 cash 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 outstanding at that time earlier than
expected, with the remainder used to support general corporate purposes (see
Note 12 - Redeemable Series A Convertible Preferred Stock). In September 2020,
we acted on the opportunity to convert a portion of our Series A Preferred Stock
to common stock that will result in a reduction of our cash dividend payments on
the Series A Preferred Stock by $12 million, on an annualized basis assuming
cash payments. On November 17, 2020, we are scheduled to hold a Special Meeting
of Shareholders to vote on the conversion of the remaining outstanding Series A
Preferred Stock into common stock that would allow us to further save
approximately $7 million in annual dividend payments.

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 lower during the nine months ended September
30, 2020 primarily due to fully paying the required $60 million 2020
amortization payments by April 2020, which reduced our term loan outstanding and
lowered 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 permits us to maintain revolving credit facility borrowings near term,
if needed, 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
September 30, 2020. Based on our expected credit agreement-defined leverage as
of the three months ended September 30, 2020, once the quarterly credit
agreement compliance filing is made, the applicable margin on our credit
agreement borrowings outstanding will remain unchanged at least until the next
compliance filing is made for the three months ended December 31, 2020.

The duration of the COVID-19 pandemic continues to be 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 (paid in full 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

Results from operations for the remainder of 2020 will likely influence whether
we 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 September 30, 2020, we had Cash and cash equivalents of $355 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:
                                                                                    Nine Months Ended
                                                                                           September 30,
(In millions)                                                  September 30, 2020              2019               $ Change
Net cash provided by operating activities                     $          11               $         34          $     (23)
Net cash provided by (used for) investing activities                     55                        (56)               111
Net cash provided by financing activities                               160                         64                 96
Total net cash flows                                          $         226               $         42          $     184

Cash inflows and outflows from changes in operating activities


For the nine months ended September 30, 2020, net cash provided by operating
activities decreased over the nine months ended September 30, 2019, primarily
due to growth in working capital.

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Cash inflows and outflows from changes in investing activities

For the nine months ended September 30, 2020, net cash provided by investing
activities increased compared to net cash used for investing activities the nine
months ended September 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 nine months ended September 30, 2020, net cash provided by financing
activities increased over the nine months ended September 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, preferred stock dividends, and acquisition payments
totaling $96 million. During the nine months ended September 30, 2019, we had
net cash 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.

We anticipate contractual obligations which are tied to acquisitions and investments made to grow our business will reduce our available liquidity by approximately $60 million through the rest of 2020 and the first half of 2021.


Off-balance Sheet Arrangements
In April 2020, we made a final payment of $9 million for a 2019 acquisition
which increased the amount available to be borrowed under our revolving line of
credit. As of September 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 comparing 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 or September 30, 2020,
as no triggering events occurred. We continued to experience strong demand for
our prescription management and online pharmacy services during the third
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 September 30, 2020 increased 240% 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 nine months
ended September 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
2019 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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