SEC Filing | Covetrus

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cvet-20200930

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)


☒			Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2020


☐			Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from ____________ to _____________

Commission File Number: 001-38794

COVETRUS, INC.

(Exact Name of Registrant as Specified in its Charter)


Delaware						83-1448706
(State or other jurisdiction of incorporation)						(I.R.S. Employer Identification No.)

7 Custom House Street

Portland, ME 04101

Tel: (888) 280-2221

(Address, including Zip Code, and Telephone Number, including Area Code, of Registrant’s Principal Executive Offices)

Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class

Trading Symbol(s)

Name of Each Exchange on Which Registered

Common Stock, par value $0.01 per share

CVET

Nasdaq Global Select Market

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes

☒

☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

Yes

☒

☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated Filer

☐

Accelerated Filer

☐

Non-accelerated Filer

☒

Smaller reporting company

☐

Emerging growth company

☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes

☐

☒

The registrant had 127,516,179 shares of common stock outstanding as of November 6, 2020.

TABLE OF CONTENTS


			Page
PART I - FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements (Unaudited)
Balance Sheets			3
Statements of Operations			4
Statements of Comprehensive Income (Loss)			5
Statements of Shareholders' Equity			6
Statements of Cash Flows			8
Notes to Condensed Consolidated Financial Statements			10
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations			27
Item 3. Quantitative and Qualitative Disclosures About Market Risk			39
Item 4. Controls and Procedures			41
PART II - OTHER INFORMATION
Item 1. Legal Proceedings			43
Item 1A. Risk Factors			43
Item 2. Unregistered Sales of Securities and Use of Proceeds			45

Item 6. Exhibits			46
Signatures			47

Table of Contents

PART I

Item 1. Condensed Consolidated Financial Statements

COVETRUS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In millions, except share amounts)


	September 30, 2020		December 31, 2019
	(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	355	$	130
Accounts receivable, net of allowance of $6 and $8	498		426
Inventories, net	521		636
Other receivables	81		67
Prepaid expenses and other	45		30
Assets held for sale	—		51
Total current assets	1,500		1,340
Non-current assets:
Property and equipment, net of accumulated depreciation of $101 and $84	108		93
Operating lease right-of-use assets, net (Note 5)	118		84
Goodwill	1,154		1,154
Other intangibles, net (Note 6)	541		643
Investments and other (Note 3)	89		47
Total assets	$	3,510	$	3,361
LIABILITIES, MEZZANINE EQUITY, AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable	$	416	$	520
Current maturities of long-term debt and other borrowings (Note 7)	46		62
Accrued payroll and related liabilities	73		44
Accrued taxes	41		18
Other current liabilities	155		164
Liabilities held for sale	—		21
Total current liabilities	731		829
Non-current liabilities:
Long-term debt and other borrowings, net (Note 7)	1,082		1,125
Deferred taxes	39		47
Other liabilities	139		94
Total liabilities	1,991		2,095
Commitments and contingencies (Note 10)
Mezzanine equity:
Redeemable non-controlling interests (Note 11)	15		10
Redeemable Series A convertible preferred stock, $0.01 par value per share, $1,000 per share liquidation preference, 250,000 shares authorized, and 90,632 outstanding as of September 30, 2020 (Note 12)	88		—
Shareholders' equity:
Common stock, $0.01 par value per share, 675,000,000 shares authorized; 127,363,432 shares issued and outstanding as of September 30, 2020; 111,620,507 shares issued and outstanding as of December 31, 2019	1		1
Accumulated other comprehensive loss (Note 13)	(91)		(86)
Additional paid-in capital	2,567		2,381
Accumulated deficit	(1,061)		(1,040)
Total shareholders’ equity	1,416		1,256
Total liabilities, mezzanine equity, and shareholders’ equity	$	3,510	$	3,361

See notes to condensed consolidated financial statements.

Table of Contents

COVETRUS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In millions, except per share amounts) (Unaudited)


	Three Months Ended September 30,				Nine Months Ended September 30,
	2020		2019		2020		2019
Net sales (Note 4)	$	1,126	$	1,018	$	3,217	$	2,968
Cost of sales	929		827		2,625		2,407
Gross profit	197		191		592		561
Operating expenses:
Selling, general and administrative	224		210		642		594

Goodwill impairment	—		939		—		939
Operating loss	(27)		(958)		(50)		(972)
Other income (expense):
Interest income	—		1		1		4
Interest expense	(10)		(16)		(38)		(42)
Other, net (Note 3)	5		4		79		18
Income (loss) before taxes and equity in earnings of affiliates	(32)		(969)		(8)		(992)
Income tax benefit (expense) (Note 14)	(3)		7		(6)		7

Net income (loss)	(35)		(962)		(14)		(985)
Net (income) loss attributable to redeemable non-controlling interests	—		3		(1)		3
Net income (loss) attributable to Covetrus	$	(35)	$	(959)	$	(15)	$	(982)

Earnings (loss) per share attributable to Covetrus: (Note 15)
Basic	$	(0.33)	$	(8.56)	$	(0.18)	$	(9.26)
Diluted	$	(0.33)	$	(8.56)	$	(0.18)	$	(9.26)
Weighted-average common shares outstanding:
Basic	116		112		113		106
Diluted	116		112		113		106

See notes to condensed consolidated financial statements.

Table of Contents

COVETRUS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(In millions) (Unaudited)


	Three Months Ended September 30,				Nine Months Ended September 30,
	2020		2019		2020		2019
Net income (loss)	$	(35)	$	(962)	$	(14)	$	(985)
Other comprehensive income (loss), net of tax:
Foreign currency translation gain (loss)	14		(22)		(2)		(17)

Unrealized gain (loss) on derivative instruments	(1)		(2)		(8)		(2)

Total other comprehensive income (loss)	13		(24)		(10)		(19)
Comprehensive income (loss)	(22)		(986)		(24)		(1,004)

Comprehensive (income) loss attributable to redeemable non-controlling interests:
Net (income) loss	—		3		(1)		3
Foreign currency translation (gain) loss	—		—		(2)		(1)
Comprehensive (income) loss attributable to redeemable non-controlling interests	—		3		(3)		2
Comprehensive income (loss) attributable to Covetrus	$	(22)	$	(983)	$	(27)	$	(1,002)

See notes to condensed consolidated financial statements.

Table of Contents

COVETRUS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

(In millions, except share amounts) (Unaudited)


	Three Months Ended September 30, 2020
	Common Stock			Additional Paid-in Capital		Accumulated Deficit		Accumulated Other Comprehensive Loss		Total Shareholders' Equity
	Shares	Amount
Balance at June 30, 2020	112,674,657	$	1	$	2,404	$	(1,022)	$	(107)	$	1,276
Net income (loss) attributable to Covetrus	—	—		—		(35)		—		(35)




Change in fair value of redeemable securities	—	—		(6)		—		—		(6)
Issuance of shares in connection with share-based compensation plans	331,297	—		2		—		—		2
Share-based compensation	—	—		11		—		—		11
Series A preferred stock dividend	—	—		—		(4)		—		(4)
Conversion of Series A preferred stock	14,357,478	—		156		—		—		156

Other comprehensive income (loss)	—	—		—		—		16		16
Balance at September 30, 2020	127,363,432	$	1	$	2,567	$	(1,061)	$	(91)	$	1,416

	Nine Months Ended September 30, 2020
	Common Stock			Additional Paid-in Capital		Accumulated Deficit		Accumulated Other Comprehensive Loss		Total Shareholders' Equity
	Shares	Amount
Balance at December 31, 2019	111,620,507	$	1	$	2,381	$	(1,040)	$	(86)	$	1,256
Net income (loss) attributable to Covetrus	—	—		—		(15)		—		(15)




Change in fair value of redeemable securities	—	—		(6)		—		—		(6)
Issuance of shares in connection with share-based compensation plans	1,385,447	—		6		—		—		6
Share-based compensation	—	—		30		—		—		30
Series A preferred stock dividend	—	—		—		(6)		—		(6)
Conversion of Series A preferred stock	14,357,478	—		156		—		—		156

Other comprehensive income (loss)	—	—		—		—		(5)		(5)
Balance at September 30, 2020	127,363,432	$	1	$	2,567	$	(1,061)	$	(91)	$	1,416

Table of Contents

COVETRUS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

(In millions, except share amounts) (Unaudited) (Continued)


	Three Months Ended September 30, 2019
	Common Stock			Additional Paid-in Capital		Accumulated Deficit		Accumulated Other Comprehensive Loss		Net Former Parent Investment		Total Shareholders' Equity
	Shares	Amount
Balance at June 30, 2019	111,932,491	$	1	$	2,357	$	(33)	$	(77)	$	—	$	2,248
Net income (loss) attributable to Covetrus	—	—		—		(959)		—		—		(959)





Issuance of shares in connection with share-based compensation plans	121,782	—		1		—		—		—		1
Share-based compensation	—	—		10		—		—		—		10


Other comprehensive income (loss)	—	—		—		—		(24)		—		(24)
Balance at September 30, 2019	112,054,273	$	1	$	2,368	$	(992)	$	(101)	$	—	$	1,276

	Nine Months Ended September 30, 2019
	Common Stock			Additional Paid-in Capital		Accumulated Deficit		Accumulated Other Comprehensive Loss		Net Former Parent Investment		Total Shareholders' Equity
	Shares	Amount
Balance at December 29, 2018	—	$	—	$	—	$	—	$	(82)	$	1,576	$	1,494
Net income (loss) attributable to Covetrus (a)	—	—		—		(992)		—		10		(982)
Dividend to Former Parent	—	—		(21)		—		—		(1,153)		(1,174)
Issuance of shares at Separation (including Share Sale investors)	71,693,426	1		609		—		—		(609)		1
Issuance of shares in connection with the Acquisition	39,742,089	—		1,772		—		—		—		1,772
Shares held in escrow expected to be canceled	—	—		(30)		—		—		—		(30)
Net increase in Former Parent investment	—	—		—		—		—		176		176
Issuance of shares in connection with share-based compensation plans	618,758	—		3		—		—		—		3
Share-based compensation	—	—		35		—		—		—		35


Other comprehensive income (loss)	—	—		—		—		(19)		—		(19)
Balance at September 30, 2019	112,054,273	$	1	$	2,368	$	(992)	$	(101)	$	—	$	1,276

(a) Net income earned from January 1, 2019 through February 7, 2019 is attributed to the Former Parent as it was the sole shareholder prior to February 7, 2019.

See notes to condensed consolidated financial statements.

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COVETRUS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In millions) (Unaudited)


	Nine Months Ended September 30,
	2020		2019
Cash flows from operating activities:
Net income (loss)	$	(14)	$	(985)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization	124		113
Amortization of right-of-use assets	18		16
Goodwill impairment	—		939
Operating lease right-of-use asset impairment	8		—

Gain on divestiture of a business	(72)		—
Share-based compensation expense	30		35

Benefit for deferred income taxes	(7)		(19)



Amortization of debt issuance costs	4		—
Loss on managed exit of a business	8		—
Other	1		(2)
Changes in operating assets and liabilities, net of acquisitions:
Accounts receivable, net	(77)		(25)
Inventories, net	99		(23)
Other assets and liabilities	(42)		(36)
Accounts payable and accrued expenses	(69)		21
Net cash provided by operating activities	11		34
Cash flows from investing activities:
Purchases of property and equipment	(40)		(30)
Payments related to equity investments and business acquisitions, net of cash acquired	(13)		(26)
Proceeds from divestiture of a business, net	104		—
Proceeds from sale of property and equipment	4		—
Net cash provided by (used for) investing activities	55		(56)
Cash flows from financing activities:
Proceeds from revolving credit facility	190		—
Repayment of revolving credit facility	(190)		—
Proceeds from issuance of debt	—		1,220
Principal payments of debt	(62)		(43)
Debt issuance and amendment costs	(5)		(24)


Issuance of common shares in connection with share-based compensation plans	6		3
Dividend paid to Former Parent	—		(1,174)
Net transfers from Former Parent	—		165
Proceeds from issuance of Series A preferred stock	250		—
Series A preferred stock issuance costs	(6)		—
Series A preferred stock dividend	(6)		—

Acquisition payment	(17)		(9)
Acquisitions of non-controlling interests in subsidiaries	—		(74)
Net cash provided by financing activities	160		64
Effect of exchange rate changes on cash and cash equivalents	(1)		3
Net change in cash and cash equivalents	225		45
Cash and cash equivalents, beginning of period	130		23
Cash and cash equivalents, end of period	$	355	$	68

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COVETRUS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (In millions) (Unaudited) (Continued)
	Nine Months Ended September 30,
	2020		2019
Supplemental disclosure of cash paid for:
Interest	$	32	$	35
Income taxes	$	17	$	16
Amounts included in the measurement of operating lease liabilities	$	20	$	18
Supplemental disclosures of non-cash investing and financing activities:
Conversion of Series A preferred stock	$	156	$	—
Right-of-use assets obtained in exchange for new operating lease liabilities	$	60	$	91
Deconsolidation of a subsidiary	$	15	$	—

See notes to condensed consolidated financial statements.

Table of Contents

COVETRUS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In millions) (Unaudited)

1. Business Overview and Significant Accounting Policies

Business

Covetrus, Inc. (“Covetrus,” “Company,” “we,” “our,” “us,” or “ourselves”) is a global animal-health technology and services company dedicated to supporting the companion, equine, and large-animal veterinary markets. On February 7, 2019, Covetrus became an independent company through the consummation of the spin-off by Henry Schein (“Former Parent”) of its animal-health business (“Animal Health Business”) and the completion of its acquisition of Direct Vet Marketing, Inc. (d/b/a Vets First Choice) (“Vets First Choice”). On February 8, 2019, Covetrus began trading on the Nasdaq Stock Market. Accordingly, results provided in accordance with generally accepted accounting principles in the United States of America (“GAAP”) reflect the operations of the Animal Health Business from January 1, 2019 to September 30, 2019 and Vets First Choice for the period from February 8, 2019 to September 30, 2019.

Basis of Presentation and Principles of Consolidation

The accompanying balance sheet as of December 31, 2019, which was derived from audited financial statements, and the unaudited condensed consolidated financial statements as of and for the three and nine months ended September 30, 2020, have been prepared in accordance with applicable rules and regulations of the Securities and Exchange Commission (the “SEC”) for interim financial reporting. Pursuant to those rules and regulations, we omitted certain information and disclosures normally included in annual financial statements prepared in accordance with GAAP.

In our opinion, the accompanying condensed consolidated financial statements reflect all recurring adjustments and transactions necessary for a fair statement of our financial position, results of operations, and cash flows for the interim periods presented. Such operating results are not necessarily indicative of annual or future results. These condensed consolidated financial statements and notes should be read in conjunction with the audited consolidated financial statements and notes included in our Annual Report on Form 10-K for the year ended December 31, 2019 (“Form 10-K”) filed with the SEC on March 3, 2020.

The accompanying unaudited condensed consolidated financial statements include the operations of the Company, as well as those of our wholly-owned and majority-owned subsidiaries from their respective dates of inception or acquisition. All significant intercompany transactions and balances were eliminated in consolidation. Investments in unconsolidated affiliates, which are 20% to 50.01% owned, or investments of less than 20% in which we could influence the operating or financial decisions, are accounted for under the equity method.

During the three months ended December 31, 2019, we recorded a revision to our deferred tax assets due to a reassessment of our judgment on the realizability of deferred tax assets as of the third quarter ended September 30, 2019. In the aggregate, the revisions to our tax valuation allowance, including a revision for a deferred tax calculation error that predates the Separation, Distribution and Acquisition, were $53 million. We have concluded that this adjustment was not material to any previously issued financial statements or to our full fiscal year 2019 results. See Note 14 - Income Taxes.

Certain other immaterial prior period amounts were reclassified or rounded to conform to the presentation of the current period.

Accounting Pronouncements

Adopted

•As of January 1, 2020, we adopted Accounting Standards Codification Topic 326, Credit Losses (“Topic 326”) which requires the measurement and recognition of expected credit losses for financial assets held at amortized cost, including accounts receivable. Topic 326 is effective for interim and annual reporting periods beginning after December 15, 2019 and is required to be adopted using the modified retrospective basis, with a cumulative-effect adjustment to Retained earnings (Accumulated deficit) as of the beginning of the first reporting period in which the guidance of Topic 326 is effective. The adoption of Topic 326 did not have a material impact on the results of our condensed consolidated financial statements.

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COVETRUS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In millions) (Unaudited)

To be Adopted

•Accounting Standards Update ("ASU") 2019-12, “Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes,” removes specific technical exceptions to general principles found in Topic 740, items that often produce information that investors have difficulty understanding and simplifies the accounting for income taxes. The standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020, with early adoption permitted. We are evaluating the anticipated impact of this standard on our condensed consolidated financial statements as well as timing of adoption.

•ASU 2020-04, “Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting,” provides optional guidance for a limited period of time to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform on financial reporting for contracts, hedging relationships, and other transactions that reference the London Interbank Offered Rate (“LIBOR”). The standard is currently effective and upon adoption may be applied prospectively to contract modifications made on or before December 31, 2022. We are evaluating the impact of the LIBOR transition and this optional relief guidance on our condensed consolidated financial statements.

•ASU 2020-06, "Debt—Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging—Contracts in Entity's Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity's Own Equity," simplifies the accounting for certain convertible instruments, amends guidance on derivative scope exceptions for contracts in an entity's own equity, and modifies the guidance on diluted earnings per share calculations as a result of these changes. The standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2021, with early adoption permitted. The adoption of this standard will have no impact on our diluted earnings per share. We are evaluating the impact of the remaining provisions on our condensed consolidated financial statements, which will largely depend on the composition and terms of the financial instruments at the time of adoption.

2. Novel Coronavirus Disease 2019 (“COVID-19”)

The COVID-19 pandemic developed throughout 2020 and in response to the pandemic, measures were and continue to be instituted, including phased temporary closures of non-essential businesses throughout many of the regions in which we conduct operations. The temporary closures, on a local, state, or country level, may be extended or more widespread in response to a rising number of reported cases. However, veterinary care has been deemed an essential business in most of these regions and we continue to deliver products and services to our customers and their animal-owner clients. In addition, most of our customers are generally able to continue their operations by following new social distancing guidelines which, depending on local regulations, can include telehealth and animal curbside check-in and drop-off at clinics. To date, we continue to experience limited disruption to our results of operations from the COVID-19 pandemic. However, the COVID-19 pandemic continues to create volatility and unpredictability to our business, including shifts in timing and channel mix, inventory replenishment, reduced travel and entertainment expenses due to travel restrictions, expected extension of our workforce working from home based on the local regulations in areas where we operate, as well as other changes.

We believe our allowance for credit losses related to our accounts receivable is adequate as of September 30, 2020, due to the essential nature of our customers' businesses, as noted above, as well as the historic behavior of our large customer base. As the COVID-19 pandemic continues, there could be an increase in the aging of our accounts receivable, however, we do not anticipate a significant increase in defaults for such accounts receivable.

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 review of our goodwill as of March 31, 2020. We tested for goodwill impairment 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. We did not experience triggering events during the second quarter ended June 30, 2020 or third quarter ended September 30, 2020.

We have taken the following actions to help ensure that our business has flexibility to mitigate potential effects from continued global economic pressure:

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COVETRUS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In millions) (Unaudited)

•During the quarter ended March 31, 2020, we borrowed funds under our revolving line of credit to increase our cash position and provide flexibility. In May 2020, we issued 7.50% Series A Convertible Preferred Stock (“Series A Preferred Stock”), and we used a portion of the $244 million aggregate net proceeds to repay borrowings under our revolving line of credit. See Note 7 - Long-term Debt and Other Borrowings, Net and Note 12 - Redeemable Series A Convertible Preferred Stock

•We reduced our non-critical, near-term planned capital expenditures

•We negotiated for extended payment terms on certain contracts

•We managed our inventory levels in line with expected demand

•We instituted cost containment measures including temporary executive, 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

During the third quarter of 2020, we returned to pre-COVID-19 compensation levels and reinstated our 401(k)-employer match. We continue to monitor our business performance and intend to take a cautious yet balanced approach in managing our expenses in light of uncertainty created by the COVID-19 pandemic. Some of the measures we implement from an expense management perspective may continue as we transform our business; for example, we have recently reinstituted restrictions on hiring non -essential roles.

Risk and Uncertainties

The duration and severity of COVID-19-related potential disruptions and the actions we have taken, and may take in the future, in response thereto, involve risks and uncertainties, and it is not possible at this time to estimate the impact that COVID-19 could have on our business. The impact of COVID-19 on various business activities in affected countries could adversely affect our estimates, results of operations, and financial condition.

3. Divestiture and Equity Method Investment

Divestitures

On April 1, 2020, we completed the divestiture of our scil animal-care business (“scil”) to Heska Corporation for $110 million pursuant to an amended purchase agreement. For the nine months ended September 30, 2020, we recorded a pre-tax gain of $72 million, which reflects a $1 million foreign exchange adjustment for the finalization of the purchase price during the three months ended September 30, 2020.

During the three months ended September 30, 2020, we announced a managed exit of the operations of our French distribution business specializing in medicines, pet food, equipment and services for veterinary clinics. We accrued $7 million in severance costs based on French statutory requirements, and $1 million of other costs associated with this decision. We anticipate operations will predominantly be shut down by the end of the year.

Equity Method Investment

On April 30, 2020, we completed the previously announced combination of our subsidiary, Spain Animal Health Solutions S.L.U. (“SAHS”), with Distrivet, S.A. to form a leading animal-health provider on the Iberian Peninsula. We contributed SAHS by means of a contribution in kind of all the shares of SAHS in exchange for the transfer of shares from shareholders of Distrivet, S.A. (“Distrivet Shareholders”). In addition, at closing, we made a payment of $11 million, and we are obligated to make an additional payment of $11 million on the one-year anniversary of the closing of the combination. As a result of these transactions, we now own 50.01% of the new company, called Distrivet, a Covetrus company (“Distrivet”).

Based on Distrivet's governance structure, we do not have power over key financial and operating decisions that are made in the ordinary course of business. Accordingly, our investment in Distrivet is accounted for under the equity method and Distrivet is considered a related party. See Note 16 - Related Party Transactions.

The Investment and Shareholders Agreement of Distrivet, S.A. (“Agreement”) executed on January 13, 2020, contains put and call options on the shares owned by the Distrivet Shareholders, representing up to 49.99%, that are exercisable at fair market

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COVETRUS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In millions) (Unaudited)

value based on floor and ceiling prices tied to Earnings Before Interest, Taxes, Depreciation, and Amortization (“EBITDA”) multiples as specified in the Agreement. See Note 9 - Fair Value.

During the three months ended June 30, 2020, we deconsolidated SAHS, remeasured our retained investment initially at a fair value of $45 million, which was included in Investments and other in our condensed consolidated balance sheets, and recognized a gain of $1 million, which was included in Other, net in our condensed consolidated statements of operations. The fair value was measured using third-party valuation models and was determined using both the market approach and income approach, which includes discounted expected cash flows. As of September 30, 2020, the carrying amount of our investment in Distrivet was $49 million.

4. Revenue from Contracts with Customers

Disaggregation of Revenue

The tables below present our revenue disaggregated by major product category and reportable segment.


	Three Months Ended September 30, 2020
	Supply Chain Services		Software Solutions		Prescription Management		Eliminations		Total
North America	$	512	$	20	$	104	$	(18)	$	618
Europe	404		2		—		(3)		403
APAC & Emerging Markets	106		2		—		—		108
Eliminations	(3)		—		—		—		(3)
Total Net sales	$	1,019	$	24	$	104	$	(21)	$	1,126

	Three Months Ended September 30, 2019
	Supply Chain Services		Software Solutions		Prescription Management		Eliminations		Total
North America	$	464	$	20	$	72	$	(13)	$	543
Europe	385		2		—		(3)		384
APAC & Emerging Markets	92		2		—		—		94
Eliminations	(3)		—		—		—		(3)
Total Net sales	$	938	$	24	$	72	$	(16)	$	1,018

	Nine Months Ended September 30, 2020
	Supply Chain Services		Software Solutions		Prescription Management		Eliminations		Total
North America	$	1,469	$	60	$	298	$	(56)	$	1,771
Europe	1,169		6		—		(9)		1,166
APAC & Emerging Markets	282		6		—		—		288
Eliminations	(8)		—		—		—		(8)
Total Net sales	$	2,912	$	72	$	298	$	(65)	$	3,217

	Nine Months Ended September 30, 2019
	Supply Chain Services		Software Solutions		Prescription Management		Eliminations		Total
North America	$	1,379	$	62	$	172	$	(21)	$	1,592
Europe	1,117		7		—		(10)		1,114
APAC & Emerging Markets	264		6		—		—		270
Eliminations	(8)		—		—		—		(8)
Total Net sales	$	2,752	$	75	$	172	$	(31)	$	2,968

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COVETRUS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In millions) (Unaudited)

Contract Balances

Contract balances represent amounts presented in the condensed consolidated balance sheets when we have either transferred goods or services to the customer or the customer has paid consideration to us under the contract. These contract balances include accounts receivable, contract assets, and contract liabilities.

Accounts Receivable

Accounts receivable are recognized at the amount invoiced and the carrying amount is reduced in part by an allowance for credit losses. Our estimation of current expected credit losses, with respect to receivables and recognition of allowances that, when deducted from the balance of the receivables, represent the net amounts expected to be collected. We do not consider there to be significant concentrations of credit risk with trade receivables due to the short-term nature of our accounts, our large customer base, and strong historical experience collecting receivables. The allowance for credit losses is based on several factors which include reviewing delinquent accounts receivable, historical data, experience, customer types, creditworthiness, and economic trends. From time to time, we adjust our assumptions for anticipated changes in any of these or other factors that may affect collectability, and the allowance for credit losses is reviewed quarterly for any required adjustments. Accounts receivable are written off when it is probable that all contractual payments due will not be collected.

Contract Assets

Contract assets include amounts related to any conditional right to monetary consideration for work completed as of the reporting date and generally represent amounts owed to us by customers, but not yet billed. Contract assets are transferred to Accounts receivable when the right becomes unconditional. Current contract assets are included in Prepaid expenses and other and non-current contract assets are included in Investments and other within the condensed consolidated balance sheets. The contract assets primarily relate to the bundled arrangements for the sale of equipment and consumables and sales of term software licenses. Current and non-current contract asset balances as of September 30, 2020 and December 31, 2019 were not material.

Contract Liabilities

Contract liabilities are comprised of advance payments received and deferred revenue amounts. Contract liabilities are transferred to revenue once our performance obligation has been satisfied. Current contract liabilities are included in Other current liabilities and non-current contract liabilities are included in Other liabilities within the condensed consolidated balance sheets. The contract liabilities primarily relate to advance payments from customers and upfront payments for service arrangements provided over time. The current portion of contract liabilities of $15 million at September 30, 2020 and $37 million at December 31, 2019 were reported in Other current liabilities. Amounts related to non-current contract liabilities were not material.

Performance Obligations

Estimated future revenues expected to be generated from our long-term contracts with unsatisfied performance obligations as of September 30, 2020 were not material.

5. Leases

The lease for our compounding facility and office space in Arizona commenced on January 1, 2020, which increased our operating lease right-of-use assets and liabilities by $19 million. This facility has a lease term of 14 years. We also commenced or extended various other facility and equipment operating leases which, individually, were not material.

As of September 30, 2020, we determined that an operating lease right-of-use asset, a standalone asset group, within our North America segment was impaired. See Note 9 - Fair Value.

6. Other Intangibles, Net

Other intangibles, net includes customer relationships, trademarks, patents, product development, and non-compete arrangements.

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COVETRUS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In millions) (Unaudited)

The following table presents the balances within the condensed consolidated balance sheets as of:


	September 30, 2020		December 31, 2019
Gross definite-lived intangible assets	$	997	$	1,001
Accumulated amortization	(456)		(358)
Total Other intangibles, net	$	541	$	643

The following table presents our amortization expense:


	Three Months Ended September 30,				Nine Months Ended September 30,
Location	2020		2019		2020		2019
Cost of sales	$	1	$	1	$	3	$	3
Selling, general and administrative	33		33		98		90
Total amortization expense	$	34	$	34	$	101	$	93

7. Long-term Debt and Other Borrowings, Net

As of September 30, 2020 Long-term debt and other borrowings, net consisted of the following:


	Commencement Date	Maturity Date	September 30, 2020		December 31, 2019
Revolving line of credit	February 2019	February 2024	$	—	$	—
Term loan payable; quarterly installments of $15 million began March 31, 2020 with remaining principal due at maturity	February 2019	February 2024	1,140		1,200
Loan payable with principal due at maturity	February 2019	March 2023	6		6
Finance lease obligations			1		1
Total debt and other borrowings			1,147		1,207
Less: current maturities			(46)		(62)
Total Long-term debt and other borrowings			1,101		1,145
Less: unamortized debt discount			(19)		(20)
Total Long-term debt and other borrowings, net			$	1,082	$	1,125

The amount available for borrowing under the revolving line of credit as of September 30, 2020 was $299 million, subject to covenant restrictions.

In February 2020, our credit facility was amended primarily to delay the step down of our leverage covenant from 5.50x to 5.00x until June 30, 2021.

On April 10, 2020, we used $45 million in proceeds from the sale of scil (see Note 3 - Divestiture and Equity Method Investment) to prepay our remaining quarterly principal amortization term loan payments for 2020. Following this prepayment, the next quarterly principal amortization term loan payment of $15 million is due on March 31, 2021.

8. Derivatives and Financial Instruments

We are exposed to the impact of changes in interest rates in the normal course of business. Our financial risk management program is designed to manage the exposure arising from this cash flow risk and uses derivative financial instruments to minimize this risk. We do not enter into derivative financial instruments for trading or speculative purposes.

In 2019, we executed interest rate swap contracts with notional amounts aggregating $500 million that are designated as cash flow hedges to manage interest rate risk on our floating rate debt. These interest rate swap contracts effectively fix the borrowing rates on a portion of our floating rate debt discussed in Note 7 - Long-term Debt and Other Borrowings, Net.

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COVETRUS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In millions) (Unaudited)

Our interest rate swap agreements exchange payment streams based on the notional principal amount. These agreements fix our future interest rates ranging from 1.63% to 1.70% plus the applicable margin as provided in our debt agreement on an amount of our debt principal equal to the then-outstanding swap notional amount. The base notional amounts mature on July 31, 2021. On the interest rate swap inception dates, we designated the swaps as a hedge of the variability in cash flows we pay on our variable rate borrowings.

The following table discloses the fair value and balance sheet location of our derivative instruments:

Liability Derivatives

Cash Flow Hedging Instruments

Balance Sheet Location

September 30, 2020

December 31, 2019

Interest rate swap contracts

Other liabilities

At inception of the hedging contract, we used statistical regression to assess the effectiveness of the interest rate hedges. The hedging contracts were deemed highly effective and are expected to be highly effective throughout the hedge period. Therefore, we perform a qualitative assessment of the hedge effectiveness at each subsequent quarterly reporting date. As of September 30, 2020, derivative gains and losses were reported as a component of Other comprehensive income (loss) and will subsequently be recorded in the condensed consolidated statements of operations when the hedged transaction is recognized in earnings.

The effect of cash flow hedges on Other comprehensive income (loss) were as follows:



		Three Months Ended September 30,				Nine Months Ended September 30,
Cash Flow Hedging Instruments	Location	2020		2019		2020		2019

Interest rate swap contracts	Interest (income) expense	$	3	$	—	$	3	$	—

The net amount of deferred losses on cash flow hedges that are expected to be reclassified from Accumulated other comprehensive income (loss) into Interest expense within the next 12 months is $6 million.

9. Fair Value

GAAP defines fair value as the price that would be received from the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

We have certain financial assets and liabilities that are measured at fair value on a recurring basis, certain nonfinancial assets and liabilities that may be measured at fair value on a non-recurring basis, and certain financial assets and liabilities that are not measured at fair value in our condensed consolidated balance sheets, but the fair value is disclosed. The fair value disclosures of these assets and liabilities are based on a three-level hierarchy, which is defined as follows:

•Level 1 - Unadjusted quoted prices in active markets for identical assets or liabilities

•Level 2 - Unadjusted quoted prices in active markets for similar assets or liabilities, or unadjusted quoted prices for identical or similar assets or liabilities in markets that are not active, or inputs other than quoted prices that are observable for the asset or liability

•Level 3 - Unobservable inputs for the asset or liability

There were no changes in valuation approaches or techniques during the three and nine months ended September 30, 2020. See Note 9 - Fair Value in our Form 10-K for a description of our valuation techniques.

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COVETRUS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In millions) (Unaudited)

Assets and Liabilities Measured at Fair Value on a Recurring Basis

The following table presents our financial instruments measured at fair value on a recurring basis and indicates the level within the fair value hierarchy:

Liabilities

Level

September 30, 2020

December 31, 2019