AmerisourceBergen Corporation (NYSE:ABC)
UBS Global Healthcare Conference
May 20, 2013 1:30 pm ET
Tim G. Guttman - Chief Financial Officer, Principal Accounting Officer and Senior Vice President
Steven Valiquette - UBS Investment Bank, Research Division
Steven Valiquette - UBS Investment Bank, Research Division
All right. Good afternoon. I'm Steven Valiquette, the Health Care Distribution Analyst here at UBS. Next company up is AmerisourceBergen. In case you haven't noticed, these guys have been a little bit busy lately. A few headlines, to say the least, over the past 6 months.
So with us for the presentation today is Tim Guttman, the company's CFO. And we also have Barbara Brungess here as well from Investor Relations. With that, I'll turn it over to Tim.
Tim G. Guttman
All right. Thanks, Steve. Good afternoon, everyone. Pleasure to be here. Thanks for your interest in ABC. I am -- my name's Tim Guttman. I'm CFO of the company. Short presentation this afternoon. And really, this afternoon, I'd like to cover 3 areas. I'll provide a brief background on ABC, who we are, a little bit about our company and how we performed since the merger. Then I'll switch gears. I'll talk a little bit about the 3/19 announcement that we had, March 19 announcement on the Walgreens-Alliance Boots transaction. And then I'll wrap up at the end, and I'll talk a little bit about how we've done through 6 months fiscal year '13 and also provide some guidance on full year fiscal '13.
And as I talk about guidance, here is the cautionary note on guidance. Certain risk factors may impact -- may materially impact that guidance. Please make sure you read our 10-K and our subsequent 10-Qs, where we highlight our risk factors. So with that, let's get into the presentation.
AmerisourceBergen. We are a large pharmaceutical services company. This year, fiscal '13, over $80 billion in revenues. We are a high-volume, low-margin business. And let me explain low margin. For fiscal year '13, we should be probably around 1.40% operating income margin. So again, that gives you an idea of the low margin.
Given that low margin, we have to be extremely efficient. It's all about scale and volume. So that's what we do best. And again, to talk about high volume, again, to put some perspective around that, our drug company, we typically make about 25,000 deliveries a day. Our specialty business, we have about 30,000 active customers that we'll ship to in a given month. And even our consulting business will have probably about 2 million points of contact with a patient, with a customer. And that patient can be -- is through a manufacturing program that we provide support services for manufacturers and reimbursement, insurance verification, patient assistance. Again, about 2 million points of contact with customers. So again, fairly high-volume, low-margin business. But we do have excellent cash flow characteristics. And I have a slide later in the presentation that will demonstrate that.
Primarily, U.S., we do have a specialty business up in Canada and then internationally, recently with our World Courier acquisition that we announced last year in May. We have offices with World Courier in over 50 countries.
In terms of consistent performance, that we're very proud of this, and again, I have a chart that we'll look at in a few minutes in terms of EPS. But our EPS, since the merger, when we combined AmeriSource and the former Bergen, 17% over 11 years and a very solid return on invested capital. Our return on invested capital is about 18%.
Let's talk a little bit about the industry landscape. And I think we're in a pretty good position here, not only us, but our industry. As we cycle through '13 and we look beyond into '14, '15 and '16, I think we have some really good positive dynamics happening in the industry.
First and foremost, let's look at the -- on the right-hand side, demographics. Demographics are clearly in our favor. Everyone's heard the statistic, 10,000 baby boomers turning 65 through the end of 2029. And again, by the time we get to that period, 2029, Medicare will virtually double in terms of participants. And that's a real positive for the industry and also, for AmerisourceBergen. As we get older, there -- you tend to use more prescription drugs. So a very positive dynamic. Expansion of coverage with health care reform effective in January. The numbers out there, 25 million people, uninsured, having access to drugs. Again, probably about half of those people will come through the Medicaid system, probably half through health care exchanges. Again, we think that's a real positive for the industry and also, for ABC.
New brand drug launches. Very good year in '12, pretty good year in '13. And again, on the new launches on brand, a lot of those are in the specialty oncology side of the business, where we have a leading market share.
Generic launches. I would say that fiscal '13 was a fairly average year. Generic launches for '14 and '15 tend to be better. Again, a very positive for the industry. And a couple of items that I'd like to point out, some safety concerns, especially around the supply chain. What we call a pedigree -- electronic pedigree in the supply chain to make sure that we have a safe and secure supply channel with drugs. There's some legislation out there that's being looked at in Washington. It may impact us. And of course, that bottom one, reimbursement pressure especially with our oncology drug, we have community oncologists, which is a big part of our oncology business, under a little bit of pressure with changes in Medicare reimbursement.
So mostly positives. And again, on the left-hand side of the chart, let's spend a minute here. You can definitely see that the red line is the percentage growth. And you can see that in '12 and in '13, '12, the growth is down, '13 it's negative. And what's impacting that is the large brand-to-generic conversions, when those brand drugs convert to generics, it's puts a compression on that top line revenue. When you get to '14, '15, '16, you have fewer brand-generic conversions. You have good organic growth with health care reform. So again, another reason why we're very positive on health care reform and growing organic revenues.
All right. Let's talk a little bit about the drug -- our core drug business. I always like to say that the drug business is the engine behind ABC. The engine because it's a large part of our revenue mix, about 80% of revenues, a very strong driver of our free cash flow. And the drug company, we have 26 automated DCs around the country. And a positive factor, also for the drug company, is the fact that all of our key, all of our top accounts have re-signed. So we're in a pretty good position for '13 and into fiscal '14, with top customers being re-signed. All of our top -- all of our customers, except for our large PBM, buy generics from us, which again is a very positive.
And again, I think it's the -- it's that bottom line that I think is an important one, that the drug company, again, is a consistent performer that enables us to generate the strong cash and enables us to go out and invest in our other businesses, specifically specialty and consulting.
Just to take a look at how we've done historically. And I mentioned this on the very first slide, where I talked about very consistent performance. This is an 11-year chart. Again, since the merger between AmeriSource and the former Bergen, very solid EPS growth, 17%. When you look at the last few years, and this is on a GAAP basis, we're quite proud of this, 18% on top of 15% on top of 30%. And if you look at this slide, the left-hand side of this slide is really all the synergies we got post the merger. In the middle of the slide is where we've benefited from a change in the industry as we move to a fee-for-service model. And then the right-hand part of the slide is where we benefited significantly from strong generic launches, not only in our specialty business, but especially in '12 in terms of our drug company on the oral solid sign -- side.
So overall, I guess, before we leave this slide, I'd like to make 2 points. One is, during a changing industry and also, during some challenging economic times most recently, we've had very consistent EPS growth. In terms of cash generation, cash flow, again, one of the hallmarks of ABC. I would focus right now on the 2 lines. You can see that the green line is our net income. The yellow Gold line is our free cash flow. We've done a terrific job at making sure that our free cash flow is above our net income. In fact, the last couple of years, it's accelerated. And then the bars, you can see the bars, which are the returned free cash flow to our shareholders, share repurchase and dividends, the last couple of years have exceeded the free cash flow. So we do -- I think we do a very, very good job at making sure that when we have cash on the balance sheet that we're not using for internal projects, CapEx, M&A, we do a very good job at returning the cash to shareholders in the form of share repurchases, to help accelerate our earnings per share.
Okay, let's switch gears and spend a few minutes and talk about the announcement we made on March 19. The new alliance, the new relationship with Walgreens and Alliance Boots. And I guess right at the beginning, I'd like to answer the question, why did AmerisourceBergen do this?
And really, it's that bottom line on the chart. It strengthens nearly every aspect of our business. And remember we talked about the core drug business being the engine of ABC. This transaction clearly enables us to strengthen our core drug business. We've always been very pleased with our customer mix in terms of the drug company, but the one thing that we were lacking was a national retailer, a retailer with scale, an retailer that was growing. We had to very good retailers. We lost both because of M&A activity. This enables us to have a large customer that's growing organically. And again, that enables us to realize some scale improvement, volume and efficiency. So again, a very important contributor to our core drug business.
The 3 top bullet points, I'd like to call these the economic buckets, the 3 buckets on how we're going to create value. And that first bucket, the 10-year distribution contract, that's a great contact that we have that covers both brand and generics. So again, very unusual for the industry to have a 10-year agreement. I would say it's -- hasn't been done recently and it's very innovative to have both a brand and a generic. And really, this, again, will provide a nice economic benefit to our drug company over a long sustained period.
It's that second bucket, the global sourcing opportunity, that really is an impactful one. It's the benefit that we expect to receive from being able to align with Walgreens and Alliance Boots in their procurement joint venture. They've established a joint venture over in Switzerland. The goal of that joint venture is to aggregate volume, specifically on generics, to have a very compelling value proposition, to go to generic suppliers and be able to negotiate long-term contracts in exchange for some favorable economics. And again, the second bucket is going to take a little bit of time to ramp up. It's not immediate. We're saying this is probably a 2- to 3-year time horizon by the time we join contracts and aggregate volume. But we've done a fair bit of diligence during this process in terms of the deal transaction, that we feel pretty good about there are some meaningful opportunities out there and economics to get by aggregating volume.
And that last bucket, the platform leverage, domestic and international, the third bucket is really utilizing our existing platform for specialty and also consulting, 2 businesses that are very strong growers, high growers in terms of revenues and good margins for AmerisourceBergen, and taking those platforms and potentially doing that type of business internationally. And I think that's an important one. I think it's going to be an interesting one because ultimately -- and this one has a little bit longer time period. This is probably a 3- to 5-year time horizon. But again, we'll do this with a very good international partner Alliance Boots. And again, I think this is a meaningful one where that second bucket is going to provide economic benefits and will enable us to have the cash and have the economics to go make this investment spend and to grow both specialty and consulting in certain international markets.
Finally, that last bullet point is really where we're talking about, part of the transaction that we announced was the fact that we issued warrants to Alliance Boots and also, to Walgreens. The warrants are approximately 16% in terms of shares as a company. Walgreens and Alliance Boots also have the right to go out and purchase 7% in the open market. So combined, that's 23%. And the equity position, I think, is an important point here. And part of that is because it's that second word, alignment. We really wanted to provide a financial incentive to our partners to all work together and to focus on these 3 economic buckets, and to, again, to move along in terms of timeliness and speed to go out there and to harness some of that earnings power that we have from this transaction. So again, the warrants help us to incent and motivate our partner so we're all working together in a collective goal to grow all of our businesses.
Next, let me spend a minute just on the long-term strategic relationship. This time line. There are a lot of moving parts. It's -- there's a lot to be done over the next several months. Focus on the years, please, in terms of the columns. For the second half of fiscal year '13, we have start-up costs that we talked about. We're going to be hiring people. We're going to be spending some money CapEx in our DCs in terms of automation equipment. So we do have some start-up costs. We have an inventory build in the months of July and August getting ready for a go-live in September, when we start to ship brand drug right to the 8,000 Walgreens stores. And then also there is -- we talked about offsetting some of the dilution from the warrant that will be exercised, most likely in '16 and '17. We've about offsetting that dilution through a hedge, through call options or call spreads.
So we have a lot to do. The second half of '13 and actually, into '14, you can see where that start-up costs, where that carries over. And really, it carries over into '14 because our operations, our DCs, I say, just really are not optimized yet. They're not totally efficient. We're using people in place of automation. As we get into '14, we'll make additional CapEx spend in '14. And by the time we get to the end of '14, I think that we'll have a pretty efficient operation in terms of our DC.
When you move down '14, you can see the brand product distribution. We'll have brand for the entire '14. You can see that for generic product distribution. We'll have that for probably about half the year in '14. Again, we ramp that up over time to make sure we can execute properly. And you can see that right below that global purchasing benefits, which is that JV that I talked about, really not expecting that much in fiscal '14. Again, because of that ramp-up type period. ABC, we have to sell our inventory, get out of contracts, join their contracts, that's going to take a fair bit of time.
So moving over to '15. '15 is like -- is when I say we're kind of full throttle. We're optimizing our operations in our DCs. We're very efficient, we're -- we have the brand inventory and the generic distribution the full year. Those are both working very well. And also, we're starting to realize benefits from the procurement JV. And you can see how that carries forward in '16 and '17. And then you can see how the warrants come into play in '16 and '17 as they get exercised. So that gives you a little bit of a point of reference for the time line.
And let me point out, there's a lot to be done, but the one thing that I really want to stress to everyone that, remember at the very beginning, I talked about the drug company having 25,000 customers we deliver to every day. So in conjunction with doing the heavy lifting with Walgreens, we need to make sure that our standards never fall with servicing our existing customers. We have to do a terrific job at managing existing customers because that's what they expect from us.
All right. So let's switch and talk a little bit about '13. We're at the halfway point for '13. We had our earnings release back on the 25th of April. Our GAAP diluted earnings per share, $0.87. We also had included in that number was about a penny negative impact from the warrants. So if you look at it from an adjusted standpoint, we're about $0.88. Revenue is up 4%, primarily due to our new PBM contract. And again, a little bit of a dampening on the top line from brand-to-generic conversions, that gets better the second half of the year, as we have less of an impact. Gross profit, up 5.5%, mostly from our acquisition last year of World Courier. And we had a very strong cash flow quarter, where you can see a cash flow from operations through the half of the year, almost $1 billion. A little bit of that impacted by just timing of how the March month then cut off, but very strong cash flow for the company.
Looking at full year targets, we just reconfirmed guidance back on Friday, when we had a press release, where we announced that we received regulatory approval on the transaction. So it is official. The transaction is closed. We reconfirmed guidance again, same range, $3.04, $3.14. Again, we expect that revenue to accelerate the second half of the year. We onboard Walgreens the second half of the year. Again, that brand-to-generic conversion is less the second half of the year. And also, we're going to pick up some additional business from our PBM customer Express Scripts.
Operating margin, down this year compared to last year. And we've talked about this in our earnings call, really 3 factors there: one, being our new Express Scripts contract that got repriced to a market contract; the loss of a large customer to a competitor that was a shared account; and then, finally, just a lower generic launch here in fiscal '13 for oral solid.
Free cash flow. We had a streak of 9 years in a row where our free cash flow was higher than our net income. Unfortunately, the streak is going to be over this year because of the onboarding of Walgreens. I talked about all that brand inventory we have to buy here in the summer to onboard Walgreens successfully. Our new guidance for free cash flow that we reconfirmed as of 5/17, which was the same as what we talked about back in -- on our future earnings call, $100 million to $200 million. And again, that's because of that extra brand inventory we have to buy during the summer.
The good news there is, of that $700 million impact to the free cash flow this year, about half of that comes back next year as we start to deliver generics. So kind of net-net over this year and next year. It's about an incremental $350 million net investment we have to make in working capital to support of the new Walgreens business. And then we'd expect to be on track again next year in '14 to have that free cash flow above net income.
Share repurchases, $400 million for the year. Through March, we were at about $280 million. So that leaves about $120 million for Q3 and Q4. And again, that's it for the targets. We feel pretty good about the range and kind of where we stand at this point. And we'll give some additional color when we release Q3.
And looking ahead, my final slide here. Really, we feel very good about our prospects moving forward into '14, '15, '16. Again, that better organic growth coming from health care reform. Again, it starts in '14. There's going to be a ramp-up. We may not see a big benefit in '14. But with that ramp-up, we expect that '15 will be a very good organic year in terms of top line growth. We also expect the additional generic launches that will help, especially in '14. We have the benefit of a large generic launch next year that will impact us positively in May. That's a very favorable one.
And then also, there's a very strong potential for biosimilars down the road, right? So clearly, clearly, there is a path for biosimilars coming to the market. It's a high-growth area. And we think we will do especially well in that area, between our specialty and our consulting businesses.
That second bullet point, there are unprecedented opportunities through our new long-term strategic relationship with Walgreens and Alliance Boots. As I mentioned, we feel that there's tremendous earnings power. Because of this relationship, now it's up to us to go out there and execute and harness all that. And because of that, we feel very confident we can sustain our EPS growth in the mid-teens going forward.
And significant -- that last bullet point, significant cash flow. We expect to, as we cycle through this cash crunch, for the next several months as we onboard Walgreens, we have a negative impact from that brand inventory. Again, next year, that free cash flow gets much better. And getting into '15, that free cash flow will get better and even accelerate. So again, we feel like our prospects on free cash flow are very good and even improved with this relationship.
So I think we're positioned very well to keep delivering what we always have for our shareholders: good solid consistent EPS growth in the mid-teen. So that's it. I really appreciate your time and attention today.
Steven Valiquette - UBS Investment Bank, Research Division
All right. Again, the breakout will be right across the hall in the Carnegie West room. Thanks.
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