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Business Overview and Significant Accounting Policies (Policies)

12 Months Ended

Dec. 31, 2021

Basis of Presentation and Principles of ConsolidationThe accompanying consolidated financial statements are prepared in accordance with GAAP.

Principles of Consolidation

The accompanying 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. Intercompany transactions and balances are eliminated in consolidation. Investments in unconsolidated affiliates, which are 20% to 50% owned, or investments of less than 20% in which we could influence the operating or financial decisions, are accounted for under the equity method.

Use of Estimates

Preparing financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the amounts reported and disclosed in the financial statements and accompanying notes. Changes in circumstances could cause actual results to differ materially from these estimates. The most significant estimates include our evaluation of goodwill impairment, deferred taxes, contingencies, intangible assets acquired, fair value measurements, share-based compensation, and supplier rebates.

Cash and Cash Equivalents

We classify all highly liquid short-term instruments with an original maturity of three months or less as cash equivalents. We maintain cash depository accounts with high-quality banks throughout the world. Our cash on deposit in the U.S. generally exceeds federally insured limits. We have not incurred any related losses for the years ended December 31, 2021, 2020, and 2019.

Customer Contract Balances and Revenue Recognition

Customer Contract Balances

Contract balances represent amounts presented in the 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

The carrying amount of accounts receivable is reduced by an allowance that reflects our best estimate of the amounts that are not expected to be collected. We estimate and reserve for our expected credit loss exposure based on our experience with past due accounts, write-off history, the aging of accounts receivable, our analysis of customer data, current economic conditions, and reasonable and supportable future forecasts. From time to time, we adjust our assumptions for anticipated changes in any of these or other factors expected to affect collectability. Accounts receivable balances 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 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 within the 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.

Contract Liabilities

The contract liabilities primarily relate to advance payments from customers and upfront payments for service arrangements provided over time. Contract liabilities are transferred to revenue once the 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 consolidated balance sheets.

Revenue Recognition

We recognize revenue when a customer obtains control of promised goods or services in an amount that reflects the consideration that we expect to receive for those goods or services. To recognize revenue, we do the following:

•Identify the contract(s) with a customer

•Identify the performance obligations in the contract

•Determine the transaction price

•Allocate the transaction price to the performance obligations in the contract

•Recognize revenue when, or as, we satisfy a performance obligation

Our revenue is generated from the following major product categories:

•Supply Chain Services - primarily includes the sale of animal-health consumable products, including our own proprietary and Covetrus-branded products, small equipment, laboratory products, large equipment, equipment repair services, branded and generic pharmaceuticals, vaccines, surgical products, diagnostic tests, infection-control products, parasiticides, and vitamins and supplements to wholesale and retail customers. Our value-added practice solutions include equipment repair, inventory management, e-commerce, as well as continuing education services for practitioners.

•Software Services - includes practice management software systems for veterinary practitioners and animal-health clinics, client communication services, reminders, data backup services, and hardware sales and support.

•Prescription Management - includes the distribution of finished goods pharmacy products, specialty pharmaceutical compounding, e-commerce, shipping, manufacturer incentives, service fees, and data integration and support services.

We estimate the transaction price at contract inception, including any variable consideration, and update the estimate each reporting period for any changes in circumstances. Variable consideration, including provisions for discounts, rebates to customers, customer returns, and other contra revenue adjustments is included in the transaction price at contract inception by estimating the most likely amount based upon historical data and estimates and is recorded in the period in which the related sales are recognized.

Many of our contracts with customers require us to take possession of the inventory, provide the goods or services, and establish the price for the goods or services. Revenue and cost of sales from this type of contract are recognized on a gross basis. From time to time, certain contracts require us to arrange for the procurement of goods or services on behalf of our customer, but we do not purchase or take title of the product from the supplier before they are transferred to our customer. In this type of contract, we are acting as an agent, and revenue is recognized on a net basis (revenue less cost of sales is included in net sales) (“Net Agency Revenue”), as the supplier is the primary obligor, bears the inventory and credit risk, establishes the price, determines the product specifications, and the amount is fixed. For the years ended December 31, 2021 and 2020, Net Agency Revenue was not material. Payment terms differ by customer and jurisdiction and generally range from 30 to 60 days.

Supply Chain Services

Revenue derived from the sale of consumable products is recognized at a point in time when control transfers to the customer. Such sales typically entail high-volume, low-dollar orders shipped using third-party common carriers. We believe that the shipment date is the most appropriate point in time indicating control has transferred to the customer, because we have no post-shipment obligations, and this is when legal title and risks and rewards of ownership transfer to the customer, and we have an enforceable right to payment.

Revenue derived from the sale of equipment is recognized when control transfers to the customer. This generally occurs when the equipment is delivered. Such sales typically entail scheduled deliveries of large equipment primarily by equipment service technicians. Some equipment sales require minimal installation which is typically completed at the time of delivery. Our products generally carry standard warranty terms provided by the manufacturer, however, in instances where we provide warranty labor services, the warranty costs are accrued in the period the related revenue is recognized.

Software Services

Revenue derived from the sale of software products is recognized when products are shipped to customers or made available electronically. Such software is generally installed by customers and does not require extensive training due to the nature of its design. Revenue derived from post-contract customer support for software, including annual support, is generally recognized over the life of the support period while revenue from training services is recognized over the period the services are provided.

Prescription Management

Revenue under this category is primarily generated from prescription management and pharmacy services (including the distribution of finished goods products, specialty pharmaceutical compounding, shipping, manufacturer incentives, and service fees), which is recognized when control transfers to the customer, typically upon shipment or delivery.

Other Revenue

Revenue derived from other sources, including freight charges and equipment repairs, is recognized when the related product revenue is recognized or when the services are provided. We applied the practical expedient to treat shipping and handling activities performed after the customer obtains control as fulfillment activities, rather than a separate performance obligation in the contract.

Certain of our revenue is derived from bundled arrangements that include multiple distinct performance obligations that are accounted for separately. When we sell software products together with related services (e.g., training and technical support), we allocate revenue to software using the residual method, utilizing an estimate of our standalone selling price to estimate the fair value of the undelivered elements. Bundled arrangements that include elements that are not considered software consist primarily of equipment and the related installation service. We allocate revenue for such arrangements based on the relative selling prices of the goods or services. If an observable selling price is not available because we do not sell the goods or services separately, we use one of the following techniques to estimate the standalone selling price: (i) adjusted market approach, (ii) cost-plus approach, or (iii) the residual method. There is no specific hierarchy for the use of these methods, but the relative selling price reflects our best estimate of what the selling prices of each deliverable would be if it were sold regularly on a standalone basis, taking into consideration the cost structure of the business, technical skill required, customer location, and other market conditions.

Sales, value-add, and other taxes we collect concurrently with revenue-producing activities are excluded from revenue, and are recorded as liabilities and included in accrued taxes. See Note 3 - Revenue from Contracts with Customers and Note 2 - Segment Data for additional disclosures.

Inventories

Inventories consist primarily of finished goods and are valued at the lower of cost or net realizable value. When inventory is adjusted to net realizable value, the corresponding adjustment is included in cost of sales. Cost is determined by the first-in, first-out method for merchandise or actual cost for large equipment and high-tech equipment. In accordance with our policy for inventory valuation, we consider many factors, including the condition and salability of the inventory, historical sales, forecasted sales, and market and economic trends. From time to time, we adjust our assumptions for anticipated changes in any of these or other factors expected to affect the value of inventory.

We record a liability for unconditional purchase commitments with contract suppliers for quantities greater than future demand forecasts consistent with excess and obsolete inventory valuations. As of December 31, 2021 and 2020, we did not record any liability related to excess unconditional purchase commitments.

Concentration Risks

Concentration RisksWe are subject to a concentration of risk with our suppliers, as five suppliers accounted for approximately 48% and 50% of our purchases for the years ended December 31, 2021 and 2020, respectively

Property and Equipment

Property and equipment are stated at cost, net of accumulated depreciation and amortization. Depreciation is computed primarily under the straight-line method. Amortization of leasehold improvements is computed using the straight-line method over the lesser of the useful life of the assets or the lease terms. See Note 11 - Property and Equipment, Net.

Capitalized software costs consist of costs to purchase and develop software for internal use. Costs incurred during the application development stage for software bought and further customized by outside suppliers, software developed by a supplier for proprietary use, and costs incurred for our own personnel who are directly associated with software development are capitalized.

Leases

We evaluate whether an arrangement is or contains a lease at contract inception. For all our leases, we determine the classification as either operating or financing. Leases with an initial term of 12 months or less are not recognized on the consolidated balance sheets. We have lease agreements with both lease and non-lease components, which are generally accounted for together as a single lease component. We recognize lease expense for these leases on a straight-line basis over the lease term. For purposes of calculating operating lease liabilities, lease terms may be deemed to include options to extend or terminate the lease when it is reasonably certain that we will exercise that option.

Operating lease right-of-use assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. As most of our leases do not provide an implicit rate, we use a rate that is based on similarly secured borrowings available to us at commencement date in determining the present value of future lease payments. We use the implicit rate when readily determinable. See Note 10 - Leases.

Goodwill

The net assets of businesses acquired are recorded at their fair value at the acquisition date and the consolidated financial statements include their results of operations from that date. Any excess of acquisition consideration over the fair value of identifiable net assets acquired is recorded as goodwill. Goodwill is not amortized, but the potential impairment of goodwill is assessed at least annually (on October 1st) and on an interim basis whenever events or changes in circumstances indicate that the carrying value of a reporting unit exceeds its fair value. Impairment analysis for goodwill requires a comparison of the fair value to the carrying value of a reporting unit.

Some important factors that could trigger an interim impairment review include:

•Significant underperformance relative to expected historical or projected future operating results,

•Significant changes in the manner of the use of acquired assets or our overall business strategy (e.g., decision to divest a business),

•Sustained decline in our share price and a resulting decrease in our market capitalization, or

•Significant negative industry or economic trends.

See Note 6 - Goodwill and Other Intangibles, Net.

Long-lived Assets

The estimated fair value of identifiable intangible assets is based on critical estimates, judgments, and assumptions derived from analysis of market conditions, discount rate, discounted cash flows, customer retention rates, and estimated useful lives.

Definite-lived intangible assets consist primarily of non-compete agreements, trademarks, patents, customer relationships, and product development. Long-lived assets, other than goodwill, are evaluated for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable through the estimated undiscounted future cash flows derived from such assets. The carrying amount of long-lived assets is not recoverable if it exceeds the sum of undiscounted cash flows expected as a result from use and eventual disposition of the asset. For long-lived assets used in operations, impairment losses are only recorded if the asset’s carrying amount is not recoverable through its undiscounted, probability-weighted future cash flows. We measure the impairment loss based on the difference between the carrying amount and the estimated fair value. When impairment exists, the related assets are written down to fair value. See Note 6 - Goodwill and Other Intangibles, Net.

Equity Method Investments

Equity investments are accounted for using the equity method of accounting if the investment gives us the ability to exercise significant influence, but not control, over an investee. Equity method investments are included within Investments on our consolidated balance sheets. Our share of the earnings or losses as reported by equity method investees, amortization of basis differences, related gains or losses, and impairments, if any, are recognized in equity in earnings of affiliates on our consolidated statements of operations. Each reporting period, we evaluate whether declines in fair value below carrying value are other-than-temporary and if so, we write down the investment to its estimated fair value. See Note 5 - Divestitures and Equity Method Investments.

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

See Note 14 - Fair Value.

Assets and Liabilities that are Measured at Fair Value on a Nonrecurring Basis

Certain assets and liabilities may be required to be measured at fair value on a nonrecurring basis. We do not periodically adjust carrying value to fair value for these assets or liabilities; rather, the carrying value of the asset is reduced to its fair value when there is evidence of impairment.

Assets and Liabilities that are not Measured at Fair Value

Financial Assets and Liabilities

The carrying amounts reported on the consolidated balance sheets for cash and cash equivalents, accounts receivables, other receivables, accounts payable, and accrued expenses approximate their fair value due to the short maturity of those instruments.

Long-Term Debt

Our Long-term debt is classified as a Level 2 instrument. The carrying amount of the term loan facility approximates fair value given the underlying interest rate applied to such amounts outstanding is currently reset to the prevailing monthly market rate. See Note 7 - Long-Term Debt and Other Borrowings, Net.

Income Taxes

We account for income taxes under an asset and liability approach that requires the recognition of deferred income tax assets and liabilities for the expected future tax consequences of events that have been recognized in the financial statements or tax returns. In estimating future tax consequences, we generally consider all expected future events other than proposed changes in tax laws or rates. The effect on deferred income tax assets and liabilities of a change in tax rates is recognized as income or expense in the period of the enactment date. We recognize interest accrued and penalties on uncertain income tax positions as components of income tax (benefit) expense in the consolidated statement of operations. See Note 13 - Income Taxes.

Loss Contingencies

We are subject to loss contingencies, including claims with customers and vendors, pending and potential legal actions for damages, investigations relating to governmental laws and regulations, and other matters arising out of the normal course of our business. We record a liability when we believe that it is probable that a loss has been incurred and the amount can be reasonably estimated. If we determine that a loss is reasonably possible and the loss or range of loss can be estimated, we disclose the possible loss in the notes to our financial statements. Legal fees are expensed as incurred. See Note 8 - Commitments and Contingencies.

Redeemable Non-controlling Interest

Redeemable Non-Controlling Interests

Some minority equity owners in certain of our subsidiaries have the right, at certain times, to require us to acquire their ownership interest in those entities. As a result of these redemption features, we record the non-controlling interests as redeemable and classify them as mezzanine equity on our consolidated balance sheets initially at their acquisition-date fair value. The non-controlling interests are adjusted each reporting period for income (or loss) attributable to the non-controlling interests. A measurement period adjustment, if any, is then made to adjust the non-controlling interests to the higher of redemption value or carrying value each reporting period. These adjustments are recognized through retained earnings and are not reflected in net income or net income attributable to Covetrus. See Note 19 - Redeemable Non-controlling Interests.

Foreign Currency Translation and Transactions

Foreign Currency Translation and TransactionsThe financial position and results of operations of our foreign subsidiaries are determined using local currency as the functional currency with the exception of certain foreign holding companies, whose functional currency is USD. Assets and liabilities of our foreign subsidiaries are translated at the exchange rate in effect at each month of the year. Statement of operations accounts are translated at the average rate of exchange prevailing during the year. Translation adjustments arising from the use of differing exchange rates from period to period are included in accumulated other comprehensive loss in equity. Gains and losses resulting from foreign currency transactions are in other, net in our consolidated statements of operations.

Derivatives

Our global business exposes us to risks related to changes in foreign currency exchange rates and interest rates. Our financial risk management program is designed to manage the exposure arising from cash flow variability and uses derivative financial instruments to minimize this risk. We do not enter into derivative financial instruments for trading or speculative purposes.

Our derivative instruments consisted of interest rate swap contracts, which matured in July 2021, and foreign currency forward exchange contracts. We entered into the foreign currency forward exchange contracts in December 2021. The forward exchange contracts are not designated for hedge accounting. Derivative instruments are recorded in the consolidated balance sheets either as other current assets/liabilities or other assets/liabilities. The changes in the fair values of these foreign currency forward exchange contracts and of the underlying hedged exposures are generally offsetting and are recorded immediately in other, net on the consolidated statement of operations.

For the matured interest rate swap contracts, which were cash flow hedges, the changes in the fair value of the derivative were recorded as a component of accumulated other comprehensive income (loss) and subsequently reclassified into earnings in the period(s) during which the hedged transaction affected earnings. We classified the cash flows related to hedging activities in the same category on the consolidated statements of cash flows as the cash flows related to the hedged item. See Note 15 - Derivatives.

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 throughout the hedge period. Therefore, we performed a qualitative assessment of the hedge effectiveness at each subsequent quarterly reporting date. Derivative gains and losses were initially reported as a component of other comprehensive (loss) income and subsequently recorded in the consolidated statement of operations when the hedged transaction was recognized in earnings.

Cost of Sales

The primary components of cost of sales include the cost of the product (net of purchase discounts, supplier chargebacks, and rebates) and inbound and outbound freight charges. Cost of sales also includes costs directly related to the design and production of software, distribution of licenses, hardware and costs related to services provided, and amortization of the capitalized costs for internally generated software for resale.

Our distribution network costs, such as purchasing, receiving, inspections, warehousing, internal inventory transfers, and other related costs are included in selling, general and administrative along with other operating costs.

We classify the following activities into either cost of sales or SG&A:

Amortization of intangibles

Cost of Sales

Costs and expenses related to specific class of intangible assets that are directly linked with revenue-generating activities.

We include the amortization of our product formulas within cost of sales as these formulas are directly tied to the production of compounded products as alternatives to back-ordered solutions, patient-specific customized medications, and in-clinic use medications.

SG&A

Amortization expense for intangible assets that are not directly related to sales-generating activities

Shipping and handling

Cost of Sales

Freight and other direct shipping costs including payroll and related benefit costs of employees performing these activities

SG&A

Direct handling costs, which represent primarily direct payroll costs of employees who pick, pack, and otherwise prepare, if necessary, merchandise for shipment to customers

Advertising

Cost of Sales

Net amount of reimbursements received from vendors that are more than the cost of advertising

SG&A

Advertising costs are charged to operations when incurred as part of Selling, general and administrative. Advertising expense was $19 million in 2021, $17 million in 2020, and $17 million in 2019.

We receive reimbursements from certain vendors for advertising costs. Reimbursements for advertising costs are reported on a net basis within Selling, general and administrative.

Additionally, advertising and promotional costs incurred in connection with direct marketing, including product catalogs and printed
materials, are deferred and amortized on a straight-line basis over the period that is benefited, typically one year. Deferred direct marketing
expenses are included in prepaid expenses and other on the consolidated balance sheets.

Supplier Rebates

Cost of Sales

We receive quarterly and annual performance rebates from suppliers based upon attainment of certain purchase or sales goals. Supplier rebates are included as a reduction of Cost of sales and are recognized over the period they are earned.
The factors considered in estimating supplier rebate accruals include forecasted inventory purchases and sales in conjunction with supplier rebate contract terms, which generally provide for increasing rebates based on either increased purchase or sales volume.

SG&A

not applicable

Share based compensation

Cost of Sales

not applicable

SG&A

Share-based compensation represents the cost related to share-based awards granted to employees and non-employee directors, which are measured at the grant date fair value.

We recognize share-based compensation expense, net of estimated expected forfeitures, on a straight-line basis over the requisite service period of the award.

Earnings (loss) per Share

Basic EPS is computed by dividing net income (loss) available to common shareholders by the weighted-average number of shares of common stock outstanding during the period. In addition, the shares of common stock issuable pursuant to restricted stock awards, restricted stock units, performance stock units, and stock options outstanding under our 2019 Omnibus Incentive Compensation Plan, and shares issuable under our Employee Stock Purchase Plan are included in the diluted EPS calculation to the extent they are dilutive. See Note 17 - Earnings (Loss) Per Share.

Accounting Standards Update

•As of January 1, 2021, we adopted ASU 2019-12, “Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes,” which 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 adoption of this ASU did not have a material impact on the results of our consolidated financial statements.

•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 LIBOR. The standard is currently effective and upon adoption may be applied prospectively to contract modifications made on or before December 31, 2022. Our debt agreements that utilize LIBOR have not yet discontinued the use of LIBOR and, therefore, this ASU is not yet effective for us. The banking syndicate associated with our Credit Facilities ceased using the 1-week and 2-month USD LIBOR at the end of 2021. The other USD Tenors to cease June 30, 2023. We will continue to monitor, and, to the extent our Credit Facilities require amendment to reflect a replacement rate prior to December 31, 2022, we will evaluate the benefits of adopting this ASU.