| ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES | NOTE 1—ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Nature of Business PharMerica Corporation together with its subsidiaries, (the "Corporation"), is a pharmacy services company that services healthcare facilities, provides pharmacy management services to hospitals, provides specialty infusion services to patients outside a hospital setting, and offers the only national oncology pharmacy in the United States. The Corporation is the second largest institutional pharmacy services company in the United States based on revenues and customer licensed beds under contract, operating 99 institutional pharmacies, 19 specialty infusion pharmacies, and 4 specialty oncology pharmacies in 45 states. The Corporation's customers are typically institutional healthcare providers, such as skilled nursing facilities, nursing centers, assisted living facilities, hospitals, individuals receiving in-home care and other long-term alternative care providers. The Corporation is generally the primary source of supply of pharmaceuticals to its customers. Operating Segments The Corporation consists of three operating segments: institutional pharmacy, specialty infusion services and specialty oncology pharmacy. Management believes the nature of the products and services are similar, the payers for the products and services are common among the segments and all segments operate in the healthcare regulatory environment. In addition, the segments are economically similar. Accordingly, management has aggregated the three operating segments into one reporting segment. Principles of Consolidation All intercompany transactions have been eliminated. Use of Estimates The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States ("U.S. GAAP") which requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities and disclosure of contingent liabilities as of the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Significant estimates are involved in collectability of accounts receivable, revenue recognition, inventory valuation, supplier rebates and the valuation of long-lived assets and goodwill. Actual amounts may differ from these estimates. Potential risks and uncertainties, many of which are beyond the control of the Corporation, include, but are not necessarily limited to, such factors as overall economic, financial and business conditions; the overall condition of the Corporation's customers and suppliers; the intense competition in the Corporation's industry; the loss of one or more key pharmaceutical manufacturers; changes in manufacturers' rebate programs; the risk of loss of revenues due to the loss of certain customers or a customer or owner of a skilled nursing facility entering the institutional pharmacy business; the effects of the loss of a large customer and the Corporation's ability to adequately restructure its operations to offset the loss; the home infusion joint ventures formed with hospitals could adversely affect the Corporation's financial results; the decline in operating revenues and profitability with an increase in the Corporation's generic dispensing rate; the loss of prescription volumes and revenue from pharmaceutical products that develop unexpected safety or efficacy concerns; reduction in reimbursement rates for the Corporation's products and/or medical treatments or services may reduce profitability; modifications to the Medicare Part D program which may reduce revenue or impose additional costs; changes in Medicaid reimbursement which may reduce revenue; the payments of significant penalties and damages for failure to comply with complex and rapidly evolving laws and regulations, as well as licensure requirements; the adverse results from material litigation or governmental inquires including the possible insufficiency of any accruals established by the Corporation could have a material impact on the Corporation's business; failure to comply with Medicare and Medicaid regulations could result in loss of eligibility to participate in these programs; efforts by payers to control costs; healthcare reform adversely impacting the liquidity of the Corporation's customers thus affecting their ability to make timely payments to the Corporation; increasing enforcement in the U.S. healthcare industry negatively impacting the Corporation's business; further consolidation of managed care organizations and other third-party payers adversely affecting the Corporation's profits; federal and state medical privacy regulations increasing costs of operations and exposing the Corporation to civil and criminal sanctions; interruption or damage to the Corporation's sophisticated information systems; purchasing a significant portion of the Corporation's pharmaceutical products from one supplier; attracting and retaining key executives, pharmacists, and other healthcare personnel; revenues and volumes adversely affected by certain factors in markets in which the Corporation operates, including weather; the provisions in the Corporation's certificate of incorporation and bylaws could delay or prevent a change of control that stockholders favor; changes in volatility of the Corporation's stock price; successfully pursuing development and acquisition activities; indebtedness that restricts the Corporation's ability to pay cash dividends and has a negative impact on the Corporation's financing options; exposure to changes in interest rates; the potential impact of the litigation proceedings with AmerisourceBergen Drug Corporation ("ABDC") regarding the Previous Prime Vendor Agreement ("Previous PVA") and collection of the $72.3 million receivable included in other long-term assets on the accompanying consolidated balance sheets; the Corporation's ability to collect outstanding receivables, changes in tax laws and regulations, changes to critical accounting estimates and changes in and interpretations of accounting rules and standards. Cash and Cash Equivalents Cash and cash equivalents consist of cash on hand and cash equivalents with original maturities of three months or less. The Corporation places its cash in financial institutions that are federally insured. As of December 31, 2015 and 2016, the Corporation did not hold a material amount of funds in cash equivalent money market accounts. PHARMERICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) NOTE 1—ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Fair Value of Financial Instruments Fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based upon assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, the Corporation follows a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows: Level 1: Observable inputs such as quoted prices in active markets; Level 2: Inputs, other than quoted prices in active markets, that are observable either directly or indirectly; and Level 3: Unobservable inputs for which there is little or no market data, which require the Corporation to develop its own assumptions. Assets and liabilities measured at fair value are based on one or more of the following three valuation techniques: A. Market approach: B. Cost approach: C. Income approach: Financial liabilities and non-financial assets recorded at fair value at December 31, 2015 and 2016, are set forth in the tables below (dollars in millions): As of December 31, 2015 Asset/(Liability) Level 1 Level 2 Level 3 Valuation Technique Financial Liability Deferred Compensation Plan $ (8.2 ) $ - $ (8.2 ) $ - A Contingent Consideration $ (11.5 ) $ - $ - $ (11.5 ) C Mandatorily Redeemable Interest $ (5.8 ) $ - $ - $ (5.8 ) C As of December 31, 2016 Asset/(Liability) Level 1 Level 2 Level 3 Valuation Technique Financial Liability Deferred Compensation Plan $ (8.8 ) $ - $ (8.8 ) $ - A Contingent Consideration $ (8.1 ) $ - $ - $ (8.1 ) C Mandatorily Redeemable Interest $ (4.0 ) $ - $ - $ (4.0 ) C The deferred compensation plan liability represents an unfunded obligation associated with the deferred compensation plan offered to eligible employees and members of the Board of Directors of the Corporation. The fair value of the liability associated with the deferred compensation plan is derived using pricing and other relevant information for investments in phantom shares of certain available investment options, primarily mutual funds. This liability is classified as other long-term liabilities in the accompanying consolidated balance sheets. The contingent consideration represents future earn-outs associated with the Corporation's acquisition of an infusion business and a hospital services business both purchased in 2015. The fair values of the liabilities associated with the contingent consideration were derived using the income approach with unobservable inputs, which included future gross profit forecasts and present value assumptions, and there was little or no market data. The Corporation assessed the fair values of the liabilities as of the acquisition date and will re-assess the fair value quarterly thereafter until settlement. These liabilities are classified as other current and other long-term liabilities in the accompanying consolidated balance sheets. The mandatorily redeemable interest represents a future obligation associated with the Corporation's acquisition of a specialty pharmacy business, OncoMed Specialty, LLC ("Onco") which the Corporation made its initial purchase of interests in Onco on December 6, 2013 and made a purchase of additional interests in Onco in December 2016. The mandatorily redeemable interest is classified as a long-term liability and measured at fair value. The fair value was derived using the income approach with unobservable inputs, which included a future gross profit forecast and present value assumptions, and there was little or no market data. The Corporation assessed and adjusted the mandatorily redeemable interest liability to estimated fair value as of December 31, 2016 which resulted in a reduction in the liability of $3.2 million resulting in a decrease in interest expense in the accompanying consolidated income statements. PHARMERICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) NOTE 1—ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) For the years ended December 31, 2015 and December 31, 2016, there were no transfers between the valuation hierarchy Levels 1, 2 and 3. The following table summarizes the change in fair value of the Corporation's contingent consideration and mandatorily redeemable interest identified as Level 3 for the years ended December 31, 2015 and December 31, 2016 (in millions): Contingent Consideration Mandatorily Redeemable Interest Beginning balance, December 31, 2014 $ 1.1 $ 8.3 Additions from business acquisitions 11.9 - Contingent consideration payments (1.1 ) - Change in fair value (0.4 ) (2.5 ) Balance, December 31, 2015 11.5 5.8 Additions from business acquisitions 1.4 - Contingent consideration payments (3.9 ) - Change in fair value (0.9 ) (1.8 ) Balance, December 31, 2016 $ 8.1 $ 4.0 The carrying amounts reported in the accompanying consolidated balance sheets for cash and cash equivalents, accounts receivable, inventory and accounts payable approximate fair value because of the short-term maturity of these instruments. The Corporation's debt approximates fair value due to the terms of the interest being set at variable market interest rates (Level 2). Accounts Receivable and Allowance for Doubtful Accounts Accounts receivable primarily consist of amounts due from Prescription Drug Plans ("PDPs") under Medicare Part D, institutional healthcare providers, the respective state Medicaid programs, third party insurance companies, and private payers. The Corporation's ability to collect outstanding receivables is critical to its results of operations and cash flows. To provide for accounts receivable that could become uncollectible in the future, the Corporation establishes an allowance for doubtful accounts to reduce the carrying value of such receivables to the extent it is probable that a portion or all of a particular account will not be collected. The Corporation has an established process to determine the adequacy of the allowance for doubtful accounts, which relies on analytical tools, specific identification, and benchmarks to arrive at a reasonable allowance. No single statistic or measurement determines the adequacy of the allowance for doubtful accounts. The Corporation monitors and reviews trends by payer classification along with the composition of the Corporation's accounts receivable aging. This review is focused primarily on trends in private and other payers, PDPs, dual eligible co-payments, historic payment patterns of long-term care institutions, and monitoring respective credit risks. In addition, the Corporation analyzes other factors such as revenue days in accounts receivables, denial trends by payer types, payment patterns by payer types, subsequent cash collections, and current events that may impact payment patterns of the Corporation's long-term care institution customers. Accounts receivable are written off after collection efforts have been completed in accordance with the Corporation's policies. The Corporation's accounts receivable and summarized aging categories are as follows (dollars in millions): December 31, December 31, 2015 2016 Institutional healthcare providers $ 145.9 $ 138.2 Medicare Part D 30.2 42.5 Private payer and other 26.8 28.1 Insured 31.1 38.7 Medicaid 12.6 15.6 Medicare 3.2 3.4 Allowance for doubtful accounts (49.3 ) (31.1 )* $ 200.5 $ 235.4 0 to 60 days 63.0 % 62.9 % 61 to 120 days 15.3 % 15.7 % Over 120 days 21.8 % 21.4 % 100.0 % 100.0 % * The Corporation reclassified $2.5 million of the allowance to other long-term assets on the consolidated balance sheet as certain related receivables were reclassified as of December 31, 2016. PHARMERICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) NOTE 1—ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) The following is a summary of activity in the Corporation's allowance for doubtful accounts (dollars in millions): Beginning Balance Charges Included in Selling, General & Administrative Expenses Write-offs Ending Balance Allowance for doubtful accounts: Year Ended December 31, 2014 $ 56.7 $ 23.2 $ (21.8 ) $ 58.1 Year Ended December 31, 2015 $ 58.1 $ 7.9 $ (16.7 ) $ 49.3 Year Ended December 31, 2016 $ 49.3 $ 6.3 $ (24.5 ) $ 31.1 In the fourth quarter of 2015, the Corporation reversed an allowance of $4.6 million related to a customer's outstanding receivable for which a settlement payment was received which significantly exceeded the existing net receivable. This reversal is reflected in the "Charges Included in Selling, General & Administrative Expenses" column above. Bad debt expense for the year ended December 31, 2016 was favorably impacted by approximately $5.6 million related to collections of certain previously reserved receivables under note agreements and the settlement of a customer's trade receivable of $3.2 million. Deferred Financing Fees The Corporation capitalizes financing fees related to acquiring or issuing new debt instruments. These expenditures include bank fees and premiums, legal costs, and filing fees. The Corporation amortizes these deferred financing fees using the effective interest method. Inventory Inventory is primarily located at the Corporation's pharmacy locations. Inventory consists solely of finished products (primarily prescription drugs) and is valued at the lower of first-in, first-out ("FIFO") cost or market. Physical inventories are performed at a minimum on a quarterly basis at the end of the quarter at all pharmacy sites. Cost of goods sold is adjusted based upon the results of the physical inventory counts. Equipment and Leasehold Improvements Equipment and leasehold improvements are recorded at cost on the acquisition date and are depreciated using the straight-line method over their estimated useful lives or lease term, if shorter, as follows (in years): Estimated Useful Lives Leasehold improvements 1-7 Equipment and software 3-10 Expenditures for maintenance, repairs and renewals of minor items are expensed as incurred. Major rebuilds and improvements are capitalized. For the years ended December 31, 2014, 2015 and 2016, maintenance and repairs were $11.1 million, $12.5 million and $12.6 million, respectively. Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable. Recoverability of long-lived assets is assessed by a comparison of the carrying amount of the asset or asset group to the estimated future undiscounted net cash flows expected to be generated by the asset or group of assets. If estimated future undiscounted net cash flows are less than the carrying amount of the asset or group of assets, the asset is considered impaired and an expense is recorded in an amount required to reduce the carrying amount of the asset or asset group to its then fair value. The Corporation incurred no fixed asset impairment charges for the years ended December 31, 2015 and 2016. Capitalization of Internal Software Costs The Corporation capitalizes the costs incurred during the application development stage, which includes costs to design the software configuration and interfaces, coding, installation, and testing. Costs incurred during the preliminary project stage along with post-implementation stages of internal use computer software are expensed as incurred. Capitalized development costs are amortized generally over five years and are subject to impairment evaluations. Costs incurred to maintain existing software development are expensed as incurred. The capitalization and ongoing assessment of recoverability of development costs requires judgment by management with respect to certain external factors, including, but not limited to, technological and economic feasibility and estimated economic life. For the years ended December 31, 2015 and 2016, the Corporation capitalized internally developed software costs of $14.3 million and $22.2 million, respectively. As of December 31, 2015 and 2016, net capitalized software costs, including acquired assets and amounts for projects which have not been completed, totaled $32.6 million and $42.4 million, respectively. PHARMERICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) NOTE 1—ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Goodwill and Other Intangibles The Corporation's policy is to perform a qualitative assessment of its reporting units to determine whether it is more likely than not (defined as having a likelihood of more than 50 percent) that the fair value of a reporting unit is less than its carrying amount, unless events or circumstances warrant the need to perform a quantitative assessment. The Corporation performed the qualitative assessment of its institutional pharmacy and specialty oncology reporting units at December 31, 2016 and did not find it necessary to perform the quantitative analysis. The Corporation performed the quantitative assessment as of December 31, 2016 for its specialty infusion reporting unit. The specialty infusion reporting unit's fair values as calculated were approximately 13.0% greater than current book value. The Corporation's finite-lived intangible assets are comprised primarily of trade names, customer relationship assets, limited distributor relationships, doctor and insurer relationships and non-compete agreements. Finite-lived intangible assets are amortized on a straight-line basis over the course of their lives ranging from 5 to 20 years. Upon an impairment review resulting from a triggering event, intangible assets are reviewed on a specific pharmacy basis or as a group of pharmacies depending on the intangible assets under review. Self-Insured Employee Health Benefits The Corporation is self-insured for the majority of its employee health benefits. The Corporation's self-insurance for employee health benefits includes a stop-loss policy to limit the maximum potential liability of the Corporation for both individual and aggregate claims per year. The Corporation records a monthly expense for self-insurance based on historical claims data and inputs from third-party administrators. For the years ended December 31, 2014, 2015 and 2016, the expense for employee health benefits was $15.5 million, $15.7 million and $15.2 million, respectively, the majority of which was related to its self-insured plans. As of December 31, 2015 and 2016, the Corporation had $1.8 million and $1.9 million, respectively, recorded as a liability for self-insured employee health benefits. Supplier Rebates The Corporation receives rebates on purchases from select vendors and suppliers for achieving market share or purchase volumes. Rebates for brand name products are generally based upon achieving a defined market share tier within a therapeutic class and can be based on either purchasing volumes or actual prescriptions dispensed. Rebates for generic products are primarily based on achieving purchasing volume requirements, or in the case of the Prime Vendor Agreement with Cardinal Health ("Cardinal Health PVA"), contractually based requirements. The Corporation generally accounts for these rebates and other incentives received from its vendors and suppliers, relating to the purchase or distribution of inventory, on an accrual basis as an estimated reduction of cost of goods sold and inventory. The estimated accrual is adjusted, if necessary, after the third party validates the appropriate data and notifies the Corporation of its agreement under the terms of the contract. The Corporation considers these rebates to represent product discounts, and as a result, the rebates are allocated as a reduction of product cost and relieved through cost of goods sold upon the sale of the related inventory or as a reduction of inventory for drugs which have not yet been sold. Delivery Expenses The Corporation incurred delivery expenses of $60.8 million, $56.6 million and $55.4 million for the years ended December 31, 2014, 2015 and 2016, respectively, to deliver products sold to its customers. Delivery expenses are reported as a component of cost of goods sold in the accompanying consolidated income statements. Stock Option Accounting The measurement and recognition of compensation cost for all share-based payment awards made to employees and non-employee directors is based on the grant date fair value of the award. The Corporation recognizes share-based compensation costs for only those shares expected to vest on a straight-line basis over the requisite service period of the award. Restructuring and Impairment Charges Restructuring and impairment charges in the consolidated financial statements represent amounts expensed for purposes of realigning corporate and pharmacy locations. Income Taxes Deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The Corporation accrues for tax obligations, as appropriate, based on facts and circumstances in the various tax jurisdictions. Mandatorily Redeemable Interest On December 6, 2013, the Corporation acquired 37.5% of the membership interests of OncoMed Specialty, LLC (the "Onco Acquisition") while also obtaining control of the business. Following the Corporation's exercise of its rights to purchase additional interests of Onco in December 2016, the Corporation now owns an aggregate of 81.5% of the membership interests of Onco as of December 31, 2016. The subsidiary is consolidated in the Corporation's consolidated financial statements and the mandatorily redeemable interest is classified as debt within other long-term liabilities in the consolidated balance sheets. PHARMERICA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) NOTE 1—ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Recently Issued Accounting Pronouncements In March 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2016-09 (ASU 2016-09) "Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting" intended to simplify the accounting for employee share-based payments. Under this guidance all excess tax benefits ("windfalls") and deficiencies ("shortfalls") related to employee stock compensation will be recognized within income tax expense. Under prior guidance windfalls were recognized to additional paid-in capital ("APIC") and shortfalls were only recognized to the extent they exceed the pool of windfall tax benefits. The Corporation adopted ASU 2016-09 on January 1, 2016 and as a result recorded a decrease to the tax provision for excess tax benefits of $0.9 million for the year ended December 31, 2016. In February 2016, the FASB issued ASU No. 2016-02, "Leases", which generally requires companies to recognize operating and financing lease liabilities and corresponding right-of-use assets on the balance sheet. This guidance will be effective in the first quarter of 2019 on a modified retrospective basis and early adoption is permitted. The Corporation is still evaluating the effect that this guidance will have on its consolidated financial statements and related disclosures. In April 2015, the FASB issued ASU 2015-03 "Simplifying the Presentation of Debt Issuance Costs". The update requires debt issuance costs related to a recognized debt liability to be presented in the balance sheet as a direct deduction from the carrying amount of the related debt liability instead of being presented as an asset. Debt disclosures will include the face amount of the debt liability and the effective interest rate. The update is effective for fiscal years beginning after December 15, 2015. Effective January 1, 2016, the Corporation adopted the provisions of ASU 2015-03. In February 2015, the FASB issued ASU 2015-02 "Amendments to the Consolidation Analysis" . In November 2015, the FASB issued ASU 2015-17, "Balance Sheet Classification of Deferred Taxes" related to accounting for income taxes which changes the balance sheet classification of deferred taxes, requiring deferred tax liabilities and assets be classified as noncurrent in a classified statement of financial position. The new guidance is effective for the Corporation beginning with annual and interim periods in 2017, with early adoption permitted. The Corporation elected not to early adopt the guidance. The Corporation will adopt this ASU beginning January 1, 2017. The Corporation will no longer present a current deferred tax asset and a noncurrent deferred tax liability, instead those amounts will be combined to a net noncurrent deferred tax asset on its consolidated balance sheet. In May 2014, the FASB issued Accounting Standards Update No. 2014-09, "Revenue from Contracts with Customers", which amends the existing accounting standards for revenue recognition. In August 2015, the FASB issued ASU No. 2015-14, which delayed the effective date of ASU 2014-09 by one year. In March 2016, the FASB issued Accounting Standards Update No. 2016-08, "Revenue from Contracts with Customers: Principal versus Agent Considerations" which clarifies the implementation guidance on principal versus agent considerations. |
