AmerisourceBergen Corporation (NYSE:ABC)
Q1 2017 Results Earnings Conference Call
January 31, 2017, 08:30 AM ET
Keri Mattox - VP, Corporate & IR
Steven Collis - Chairman, President & CEO
Tim Guttman - CFO & EVP
Robert Jones - Goldman Sachs
Steven Valiquette - Bank of America Merrill Lynch
Ricky Goldwasser - Morgan Stanley
Robert Willoughby - Credit Suisse
Garen Sarafian - Citi Resources
Eric Percher - Barclays
Lisa Gill - JPMorgan
Eric Coldwell - Baird
Michael Cherny - UBS
David Larsen - Leerink
Ladies and gentlemen, thank you for standing by, and welcome to the ABC Earnings Conference Call. [Operator Instructions] As a reminder this conference is being recorded.
I'd now like to turn the conference over to Ms. Keri Mattox. Please go ahead.
Thank you. Good morning. And thank you all for joining us for this conference call to discuss AmerisourceBergen's fiscal 2017 first quarter financial results. I am Keri Mattox, Vice President, Corporate and Investor Relations for AmerisourceBergen. And joining me today are Steve Collis, Chairman, President and CEO and Tim Guttman, Executive Vice President and CFO.
On today's call we also will be discussing non-GAAP financial measures, which we use to assess the underlying performance of our business. The GAAP to non-GAAP reconciliations are provided in today's press release as well as on our website.
During this conference call, we'll also make forward-looking statements about our business and financial expectations on an adjusted non-GAAP basis including but not limited to EPS, operating margin and taxes. Forward-looking statements are based on management's current expectations, and are subject to uncertainty and change.
AmerisourceBergen assumes no obligation to update any forward-looking statements or information and this call cannot be rebroadcast without the express permission of the company. We remind you there are uncertainties and risks that could cause our actual results to differ materially from our current expectations. For a discussion of key risk factors and other cautionary statements and assumptions, we refer you to our SEC filings, including our most recent Form 10-K and to today's press release.
You will have an opportunity to ask questions after today’s remarks by management. We do ask that you limit your questions to one per participant in order for us to get to as many participants and increase as we can within the hour.
With that, I’ll turn the call over to Steve. Steve?
Thank you, Keri, and good morning, everyone.
I am pleased to discuss our first quarter results and the improved outlook and financial guidance we are providing for fiscal year 2017. Our broad portfolio of businesses performed in line or above our expectations for the quarter. Revenues were up 4% to $38.2 billion and adjusted diluted EPS grew more than 7% compared to the previous fiscal year positioning us to meet our fiscal 2017 objectives.
While they have been challenges and headwinds, we continue to see U.S. Pharmaceutical sector growth and resilience driven by patient demographics, a strengthening U.S. economy, a robust pipeline of new brand drug launches, and an increasing focus on value and outcomes.
Brand pricing actions taken earlier this month reinforce the stability of that market but also underscore the careful consideration that manufacturers are putting into their pricing strategies in the current environment. Today I think that all of us in the industry have the opportunity and the responsibility to enhance patient access, drive efficiency and ultimately reduce overall healthcare costs while creating value.
At AmerisourceBergen we take this responsibility seriously and all we believe uniquely positioned to realize the opportunity. Our customer base, leadership position in specialty products, innovative approach to services and solutions, and strong history of financial stewardship all position us to outpace the market's projected growth in coming years.
Now I'd like to discuss our key differentiators and how they helped AmerisourceBergen and our Associates deliver a strong first quarter. First, we believe we have the best customer base in the business. Our broad and diversified portfolio of growing customers across all of our businesses performed well in the first quarter. We enjoyed long-standing collaborative relationships with our anchor customers and they continue to outperform.
Walgreens Boots Alliance remains strong and aligned partner and we look forward to continuing to expand our opportunities to deliver value. Additionally we continue to make progress in our efforts to strengthen our customer relationships, expand within our existing customer base and evolve our contracts and pricing strategies for brand and specialty products to better reflect changing market conditions.
Customers understand this and are open to finding mutually beneficial solutions. We are working with them to do so. Ultimately we believe that we the strongest customer base in the industry and our objective is to create customers for life. The strength of our business is reinforced about a high quality of our customers, and our ability to develop long-term collaborative partnerships with them. We are here to support the innovation and together to advance and enhance patient care.
Second, our leadership position in specialty products puts AmerisourceBergen at the full front of a rapidly growing market segment. When we refer to outstanding specialty products, it's important to note our market-leading position in both full-line distribution, as well as specialty distribution. This quarter we are pleased to see continued growth of specialty products available through full-line distribution affirming the value and efficiency of the prime vendor model for our customers including hospitals, health systems and community pharmacies.
We once again had a great quarter across our specialty business with very strong results. Our specialty distribution business revenue grew double digits year-over-year with strong contribution primarily from oncology and community oncology solutions. Our market-leading patient services Biopharma consulting business and clinical trial logistics business also continue to make important contributions in supporting existing and newly launched specialty products.
In the quarter AmerisourceBergen continue to be selected as the pharmaceutical services partner for a wide range of new specialty products with access to both full-line distribution and specialty distribution further establishing our leadership in this area. We've also expanded patient access to new biosimilar products recently completing negotiations with key pharmaceutical manufacturers for this differentiated new product category.
One example of how leadership in this specialty arena is helping drive patient access is our assessment of the risk to community oncology care and patient access inherent in the part B demonstration project and our ability to mobilize and support of our customers and patients.
As I believe you all know proposed Part D payment model was not finalized by CMS late last year, and will likely not be reintroduced by the new administration. There were many concerns about what the proposed model would mean for physicians, patient access to critical medications and overall medical care. AmerisourceBergen was a vocal opponent of the proposed model and I’m very proud of the work we did in Washington to voice the industry concerns and educate key agencies and law makers.
With our market-leading franchises and ability to provide an integrated commercialization service offering AmerisourceBergen is the global leader in the distribution and support of specialty drugs across a wide spectrum of channels. We are proud of our trusted partner status in close collaboration with manufacturers and providers to ensure patient access to all types of specialty products.
Third, AmerisourceBergen's innovative approach to services and solutions is driving our customers' growth. We continue to execute and succeed within a challenging healthcare landscape by offering our customers the most innovative and business-critical solutions needed to drive the growth. The customer responses to our services and enhanced offerings has been extremely positive. We believe our strategic services and solutions are enabling us to grow within our existing customer base. We do this while carefully controlling costs and always taking a thoughtful and measured approach to capital expenditures.
For example, we're making smart significant investments in and improvements to our ERP systems and customer solutions. Offerings and initiatives like Good Neighbor Pharmacy and our Elevate Provider Network continue to add value and build on the integrated suite of services of resources available to independent pharmacies ultimately helping them grow. Elevate's core capabilities enable Independents to better engage with payors and patients to drive improved adherence and easily accessed data to support faster, more accurate reimbursements, two, critical needs for these community pharmacy customers.
We are also about to fully rollout our ABC order program as state-of-the-art e-commerce system designed by pharmacies for pharmacists that provide the intuitive tools to order effortlessly, manage inventory, access data and information and resolve any issues quickly. Additionally our improved First to Shelf program for new generics products has helped us service community pharmacies and ensure competitiveness in the local markets. We executed flawlessly and expanded patient access with several new generic launches in the first quarter.
We've also seen continued growth and market leading service levels of PRO Generics, our proprietary generics formulary. We will continue to look for ways to protect and enhance the role of community pharmacies so that they can continue to service the healthcare needs of millions of patients.
We're making great progress on our capital enhancements and enhance systems. To better positions our sales for the future and engage with our customers, we are building new state-of-the-art distribution centers which are expected to be fully online by the end of fiscal year 2017. These distribution centers incorporate best-in-class technology and our continuous improvement processes to help us deliver on our commitment to provide an exceptional customer experience.
We are also building out systems to better support our Lash Group Commercialization Services, World Courier Logistic business and our overall IT infrastructure. You can expect that we will continue to invest in data solutions analytics and internal and customer facing our key capabilities. We believe that AmerisourceBergen is the trusted data company in our industry and we want to continue to build on our information technology security and innovation to accelerate customer and growth in today's marketplace.
And fourth, our strong history of financial stewardship and proven ability to integrate acquired business gives AmerisourceBergen an advantage in driving growth. AmerisourceBergen takes a strategic approach to capital deployments. Over the past five fiscal years, we have returned about $8 billion to shareholders through our dividends and share repurchases programs and we have invested more than $7 billion through acquisitions and capital expenditures.
We are proud about our ability to seamlessly integrate our acquired businesses and they continue to exceed our expectations. A driver of that outperformance in our December quarter was a contribution from our recent strategic acquisitions, MWI Animal Health and PharMEDium. In fact MWI operating income and operating margin hit record high levels in the December quarter fueled by organic growth, new product innovations and achievement of sales goals with key manufacturers especially on the companion side of the business.
We believe that MWI is the largest distributor of animal health products as measured by revenues. As we come into 2017, MWI is committed to both providing value to its manufacture partners, as well as providing customers with the most comprehensive product offering in it's history. Just last week I had the pleasure of joining MWI for its national sales meeting which was attended by all MWI's sales associates and manufacturers. I continue to be impressed by MWI's demand creation salesforce and by the businesses ability to successfully grow penetration rates among existing customer which clearly underscores the value of the level of service it provides.
Finally, we continue to approach capital deployment strategically and opportunistically. We think broadly about the future of healthcare and are always evaluating innovative ways we could further diversify and grow AmerisourceBergen through the addition of new best-in-class and market leading businesses.
In summary, our differentiated industry position and continued strategic execution result in a strong quarter and we have an improved outlook for fiscal year 2017. I'll let Tim provide more details here but I'm very pleased with and inspired by the stellar contributions of our 19,000 associates. Their talent and continued commitment to the success of AmerisourceBergen is the key driver of our growth and I'm proud of our collective ability to achieve our quarterly goals and objectives despite a challenging marketplace and segment headwinds.
So thank you to AmerisourceBergen team. As we move further into 2017, we have great confidence in our unique portfolio of integrated services and the significant value we bring to pharmaceutical manufacturers and provided customers. Our consisting execution enables people to access the healthcare products ultimately improving the lives of patients and delivering the long-term value to all of our stakeholders.
Now let me turn the call over to Tim for more in depth look at our quarterly financial results and our updated financial guidance. Tim?
Thanks Steve, and good morning everyone.
We're excited to start fiscal 2017 in a positive way. Our results and business fundamentals were better than we expected. Several of our businesses made key contributions to our results this quarter and I will cover these highlights in my prepared remarks. I have two main topics this morning, I will recap our Q1 adjusted results and our revised fiscal '17 outlook. Please note that all financial comparisons are for the first quarter of fiscal '17 compared to the same period of the prior fiscal year unless otherwise noted. With let's move to our results.
Revenues were $38.2 billion up 4%, our pharmaceutical distribution segment accounted for the majority of our revenue growth due to our diverse customer mix and the strength of our ABSG specialty business. Let me highlight that we had one less business day in the current quarter versus the previous year. We also had less of a revenue tailwind this quarter given the slowdown in branded drug inflation from July through December, while still having a meaningful revenue headwind from brand and generic drug conversions.
Our ABC consolidated revenue growth would have been nearly 6% on a comparable basis which means adjusting for the one-day difference in business days. The quarter's adjusted gross profit increased by 1% to $1.1 billion and was entirely due to the growth in our other segment. Our pharmaceutical distribution segment was down this quarter with a difficult comparison as we're still cycling through the repricing of two strategic long-term contract renewals which we have discussed in detail the past few quarters and in the current quarter we began to anniversary the acquisition of PharMEDium.
Operating expenses we are very pleased with our progress in managing operating expenses which were virtually flat compared to last year. Our businesses continue to make meaningful progress focusing on their cost structures, ensuring they spend in the right areas and leveraging existing scale and capabilities where we can.
Operating income, our adjusted operating income was $486 million up about $9 million or 2%. Our adjusted operating margin was 1.27% down three basis points from the prior year driven mostly by the pharmaceutical distribution segment bringing down six basis points this quarter.
Moving below the operating income line. Interest expense net was about $35 million up some from last year. The increase is due to a combination of slightly higher average borrowings outstanding and also higher interest associated with the build to suit leases we had to capitalize last quarter.
Income taxes, our adjusted income tax rate was 33.1% down some from the prior year as a result of changes in mix of U.S. versus international income. For the quarter our adjusted diluted EPS increased a solid 7% to $1.36 to 7% growth was driven by the outstanding performance in our other segment. The benefit from an improving tax rate and a lower diluted share count.
I will highlight that we did have a couple of pennies of EPS benefit in the current quarter from the favorable timing on manufacturer rebates that we previously expected to earn in our March '17 quarter. This finishes our review of ABC consolidated results. Let's move forward and discuss our segment results starting with pharmaceutical distribution.
Total segment revenues were $36.6 billion up 4% with our drug company growing just under this level. Our core drug business saw a solid growth better than we expected in its retail, customer segment which includes Independent, Walgreens and other chains. Consistent with the past few quarters I should point out that the business continue to have a revenue headwind of about 1.5% due to lower hepatitis C drug sales primarily in our non-retail customer segment. After this current December quarter, the hepatitis C comparables get better and shouldn't be a meaningful revenue headwind going forward.
ABSG which is our specialty business and an overall revenue increase of 10% driven primarily by volume growth. This is the 12th consecutive quarter that ABSG has had top line growth at 10% or more. We continue to see excellent revenue growth in oncology and to a lesser degree in nephrology. Overall the business continues to capitalize on positive pharmaceutical industry trends and we remain a clear leader in this space.
Segment operating income was $374 million and was down 2%. Our ABSG business continued their high level of performance producing strong operating income growth through a disciplined expense management combined with a revenue growth. Our drug company was down year-over-year as anticipated primarily due to the two key customer contract renewals, slightly lower contributions from price appreciation and the impact from generic deflation.
Last year ended December '16 quarter generic deflation wasn't that meaningful. These headwinds were partially offset by a higher contribution from PharMEDium. I'd like to point out that our drug company's performance was better than we expected and the business is building positive momentum from both top line revenue growth and an improving contribution from generics. We are committed to continuous improvement, the drug company has sharpened it's focus on maintaining high customer service levels and implementing leading customer solutions.
As a result we are seeing generic compliance rates gradually improve with customers which translates the higher volumes. We can now move to our other segment which includes Consulting Services, World Courier and MWI Animal Health.
In the December quarter segment revenues were nearly $1.7 billion up just over 5% both consulting and World Courier at growth rate in the high single-digits while MWI's growth was slightly impacted by foreign exchange associated with their U.K. business. MWI continues to see high growth rate in the U.S. companion animal business, that's a percentage in the high single-digits and we are now encouraged as we're starting to see improving growth rate in the production animal side of the business.
From an operating income standpoint this segment had an outstanding quarter with operating income of $112 million and the growth rate of 17%. This marks the first time that the segment has surpassed $100 million in operating income.
As Steve highlighted MWI achieved records in operating income and operating margin. The business has a relentless focus on the customer, a drive to constantly improved capability and terrific expense management.
Wrapping up our consulting business was also a strong contributor to the segments growth this quarter due to a solid revenue growth. They delivered these results while continuing to focus on implementing a business process redesign which includes a new ERP system. This completes our segment review.
I'd like to now cover key working capital and cash flow items. In the December quarter as expected we had a negative free cash flow of $570 million. As we have discussed in the past, we continue to make a working capital investment with our largest customer Walgreens. This investment will continue to be a cash flow headwind into our Q2 '17 when the investment is complete.
When comparing to last year's free cash flow, we also had a sizable positive day of the week cash impact to our Q1 '16 free cash flow. This day of the week impact did not repeat in the current quarter and was a headwind. We ended the quarter with roughly $1.8 billion in cash with $645 million of this amount offshore.
The next area I'd like to cover is share buybacks. We purchased $230 million of shares during the quarter and we finished the quarter with $890 million left on our November 2016 share authorization. We're pleased that from late September 2016 through December 2016 we are able to buy back roughly 8 million shares returning over $600 million to our shareholders.
Now let's turn to our updated fiscal '17 expectations. As I mentioned before we are very pleased with our strong Q1 results and we are now raising our adjusted EPS guidance to a new range of $5.72 to $5.92 which reflect growth of 2% to 5% versus last fiscal year.
I will provide guidance comments in four key areas. First, revenues, our previous guidance was 6.5% to 8% revenue growth even with our Q1 '17 ABC consolidated revenue growth of 4%. We believe we will now be at the high end of this range due to two factors that will enable us to ramp our revenues during the course of the fiscal year. One, our drug company's largest customer Walgreens had added new commercial business which will benefit us and two, brand inflation realized in January will be a better revenue tailwind going forward.
The secondary operating expenses given the continued focus by our businesses on managing costs, we are revising our full-year OpEx growth rate to 4.5% to 6%. We expect that our expenses will increase over the course of the fiscal year to support the revenue ramp. Additionally we start to occur incremental costs related to several of our IT and infrastructure investments.
The third area, operating income, we are revising and moving to low end of our guidance up. Our operating income dollar growth will now be flat to up 4% versus fiscal '16. And the last area our adjusted share account. We'd expect our share account to creep up somewhat given that we front-end loaded our share repurchases. We expect modest share repurchase activity in the near-term. Our first priority now is to ensure our free cash flow track as planned in a repaid $600 million debt obligation that matures in May 2017.
As in the past however, we will remain flexible and opportunistic in terms of capital deployment. Let me point out that the rest of our previously communicated fiscal '17 financial guidance for ABC consolidated is unchanged and reaffirmed at this time.
Before I wrap up I'd like to comment on our working assumptions for the pharmaceutical drug pricing environment. I will cover generic drug pricing first. We are not changing our negative 7% to negative 9% generic deflation range for fiscal '17 at this time. After one quarter based on our drug company's generic drug portfolio we are tracking in line with this assumption. As we progress through the year, we'll hopefully have more clarity on generic pricing trends and if needed we will revise our assumption.
Moving to brand drug pricing, we are comfortable with our 7% to 9% brand inflation rate assumption based on the WAC price increases we realized in January. Both the number of brand pricing announcements, and the overall percentage increases were right in line with what we had assumed.
As a reminder we also anticipate that we will have a certain level of brand price increases in the June, July time period. This is clearly an open item given the unpredictability of pricing actions in the high level of scrutiny. This is part of the reason we continue to have a somewhat wider adjusted EPS range.
So in closing a better than expected quarter and a solid start to our fiscal year, as always we continue to deliver outstanding service, solutions and value to our customers each and every day. And at the same time we look to drive operating efficiencies. This is a winning combination that enables AmerisourceBergen to grow and create long-term shareholder value.
Now here's Keri to start our Q&A.
Thank you, Tim. As a reminder please limit your questions to one per participants so that we can get through as many of your questions as possible. Samantha, we are ready to begin with the Q&A.
[Operator Instructions] And our first question comes from the line of Robert Jones with Goldman Sachs. Please go ahead.
Good morning. Thanks for the question. Tim I wanted to make sure I got the message right on the branded pricing and the gross profit in the pharma segment. So it sounds like branded pricing in the December quarter came in a little bit later than you had expected and I'll wait a little bit on the gross margin but it sounds like January you've seen price increases more in line with your expectation.
So, as we think about the full-year, are you in fact changing the underlying assumptions for gross profit in the pharma segment given the way pricing has played out? And then just on the back of that based on the comments you just made, if you don't see price increases over the summer, are you able to stay within the full year guidance range.
Thanks Bob for the question and I'll take them in order. So the first one we did see brand pricing trail off a bit in our first quarter to December quarter. So that was a little bit of a headwind for our core drug business that we were able to cover. So that's true but then we got the January, we saw the price increases relatively in-line with last year in terms of the number of announcements. The percentages were probably a little bit less overall on a kind of weighted average basis but clearly the January price increases were in line with our 7% to 9% assumptions.
So no change there. We're keeping that assumption for the full-year. I think our point in my script was really to say that there is another time period coming June, July. Our guidance still has a certain level of pricing activity in our assumptions and that's an open item but I think with our $0.20 range, I think Steve and I and the management team we're comfortable that if that trailed off a bit in June or July, we would still fall within the range okay but again that's just one item but I would say we feel good that if the brand inflation - again I'll repeat myself as it trails off a bit we can still stay in the range but on probably the lower end.
Okay. Got it. Thank you.
Our next question comes from the line of Steven Valiquette with Bank of America Merrill Lynch. Please go ahead.
Thanks. Good morning. Hi guys, congrats on your results. On this topic we're getting some inbound queries regarding your largest customer and just given that you have this long term 10-year contract with your largest customer and the fact that you went through a bit of a repricing with that customer last year. Is there any reason if there that would be another near term renegotiation of those contract terms or should one need opportunity just to see that ABC should be all set with the price hike on that contract for a while now just given the renegotiation last year? Thanks.
Hi Steve, thanks for your comments. Yes, the latter is our understanding. So yes, it’s a fluid market, things change but there is nothing in our trends and I think if we go back to the deal we did in 2013 essentially we came up with a very good basis for our long-term contract which took into account some of the anticipated changes that we saw coming you know with the faster growth in specialty products but much more effort generic deflation that we may have expected for 2013-2014. But I think the teams were very thoughtful, we spent a lot of time thinking about the way to cross that model and then we have guided the contract just less than a year ago.
So we feel that it's very big but we are in close touch with our colleagues in Chicago and their businesses had a good quarter and we expecting some good organic growth in the back half of the year which is a driver on our revenue for us. And honesty the relationship the actual not only at my level, but at the levels below the daily interactions are strong and consistent and we have one of our most senior sales people that's fulltime on the account that I think he has done terrific job for us.
Okay, that's great. Thanks.
Our next question comes from line of Ricky Goldwasser with Morgan Stanley. Please go ahead.
Yes, hi good morning, and congratulations on the performance in the quarter. I have a couple of follow-up questions here, first of all given the moving parts in guidance. I know you talked about operating expenses being up for the remainder of the year. So when we think about different segments for the other segment obviously very impressive increase in margins, is this new margin levels sustainable going forward that’s question one, then I have a follow-up on that?
So I’ll start off and then Tim can follow-up. No there may be some seasonality in the other sector in MWI in particular there were some, we called out some forward items some hitting some thresholds on some rebates and that's definitely as we learn more and more about the business so it is our second December quarter that we had MWI's as part of the ABC family. So we become more experiment. There is some seasonality in our Lash business in World Korea so many think you’d add particular on the overall margin.
Yes, and I think Steve you hit it, I mean certainly we benefited – December is always one of the better quarters from MWI as they come down to year end contracts with manufacturers but going forward the consulting business I commented in my script that they will be implementing the new ERP system and they’ll be having some expenses in that area will ramp up a bit in quarters two, three and four.
But it’s a great margin, it’s the margin have been fairly high. But I would say that - this probably isn’t the run rate but probably not that far off I mean it should be a good margin business and all those businesses leverage well.
Okay. So given that if you think about that the performance for distribution segment going forward and in light of your comments around some of the assumptions you're factoring for that second price increase. So first you said that if it trials off a bit, it's still would be comfortable with the loan and this guidance just to clarify that because I think that’s an area we just been getting a lot of questions on is whether - if manufacturers decide to hold off on that second price increase. Even if that happens do you feel comfortable with the difference number in the business at the low end of your guidance range that’s one.
And second of all on generic pricing, I think you said you’re comfortable with the negative 9% so just to clarify is that generic price deflation range includes both the price deflation for the products and any dynamics on the sell side, so is that kind of like in - deflationary number?
Let me go back, I mean I think the brand - your brand question is a good one and I think I should clarify. I think I said when I answered Bob's question first, I said it trailed of a bit we would stay in our range and again I think that's important to me. I'm not going to comment if we had zero price increases for the rest of the year and we didn’t see any pricing activities. I mean we’d had to go back and think about that and understand the impact but certainly it trails off a bit we feel comfortable staying in our range on the brand side.
Generic deflation, I mean we've been very consistent on the minus 7% to minus 9%. We've always pegged that off of our acquisition cost of the acquisition cost in our inventory to let people know that that's what we’re seeing in terms of how that price - so how our acquisition cost is changing over period time. We're probably up towards the higher end of that range and so I think I answered your question but again that's how we calculate it’s on our portfolio, our mix of business based on our fiscal year but we still feel good about that minus 7% to minus 9% and as we go through the year we'll update the range.
Thanks Ricky. Samantha can we have the next question please.
Our next question comes from the line of Robert Willoughby with Credit Suisse. Please go ahead.
Tim, there was no reference to cash flow in the press release can you just remind us what your targets are for the year there and what maybe the capital expenditure number will be that still taking a little bit higher than where we were. And then just for Steve, just what's the likelihood of deals this year you've been quiet here for a bid are you back out there looking and could that influence your plans to retire the debt that's coming due this year?
Thanks Bob I’ll start. Certainly we reaffirmed our guidance and so I mean the guidance for free cash flow was at adjusted net income we're just slightly above, so we’re still on that. I know we had a negative free cash flow in Q1, but the cadence seasonality in our business we should see a nice positive free cash flow in our March quarter somewhat neutral to up a little bit the June quarter and then traditionally our fourth quarter is pretty high in terms of free cash flow.
So that's how we get back to where we need to be for the year. And CapEx I think we said $500 million roughly - that’s reaffirmed and we should be right about that in that range and most of that is the DC work and the ERP system. So both were consistent and both we still feel good about.
Yes thanks Robin, and then on the M&A front, one of the things about having our portfolios at this difference cadence with all the businesses. So some of our businesses are not particularly M&A oriented I would point you for medium which is such a strong CGMP business and I think that - such strong organic growth trends its really no point to do M&A and such good market share momentum.
MWI I think we’ve done a few small tuck-ins. We’re very active we’ve done some work in the U.K. I think there is some technology there on the production side which is very compelling, very sticky and very innovative as the world moves towards more of a lot feeding top of products animal business and then, some of the practice management technology we have on the companion animal side I think is transferable. So that’s a business for example where we would have a lot of interest.
Specialty we don’t really see that institutional presence in the rest of the world so not that much interest but definitely all of our individual portfolio companies remain active as they close to the market. We Tim and myself and our group with some park are very active, so if we can find other companies that have strong growth dynamics, our leaders in their respective markets, strong management team that's interested in being part of our knowledge reach and partnership culture, you could see us active on that because we do have the flexibility and we do believe that M&A has become a good competence of ABC that we've demonstrated a lot of effectiveness at. Thank you.
Thanks Bob. Samantha, can we move on to the next caller please
Our next question comes from the line of Garen Sarafian with Citi Resources. Please go ahead.
Good morning Steve and Tim. Not sure if we’re doing only one question or one plus one follow-up so I’m going to ask two in one and go from there. One is on just a follow-up on generic price deflation maintaining the 7% to 9% range and Tim you made some commentary also on the maybe towards higher end but given what happened - perhaps the volatility of it a year goes in time period from the December and into the March end quarter. Could you just elaborate on any changes in the forecast and methodology that you're using let it be the inputs you use or any changes in methodology or perhaps you're just applying a more conservative take on the same process. But just wanted to see how you're approaching if that gives you confidence this year.
And secondly really comment on taxes. I know it's a very fluid environment in terms of tax reform but if you could specifically comment on border taxes and if - how that would impact a company such as yourself. And should the net tax reform benefit be favorable if the incremental dollars if it's positive would that have a different capital deployment priority or would it be treated equally?
I’ll start Garen on the first one back to the generic deflation. We have not changed our methodology or approach. We've been very, very consistent. It's always based on our drug company's portfolio of what they have in inventory, weighted average. It's based on our fiscal year. We do exclude generic items that have not been on the market for longer than one year. So we take the ones that too have higher variability in that first year.
So we've been very consistent and we track it. We look at the methodology and were still coming up in that range of minus 7 to minus 9 and again I said little on the high end right now at the minus 9. That's why we still feel comfortable at this point.
Tax reform, I'm looking at…
I was in D.C. last week and I think we have a lot of important partners kind of just waiting to see all over the border but I mean it's - that is a lot of basic medical products that take our causes and syringes and bandages that are almost all manufactured overseas. So it could be a very significant increase in them. I was in the board of Medtech Company when we had the medical device tax and it was very significant. It does affect consumer demand. I think we've seen some models outside the U.S. where prescription medication and medical products are excluded from that.
So we really don't know. I mean as far as ABC goes, I think you can see we are proud of our operating margin performance but it was 127 basis points. So there is not much room there to absorb additional taxes. We will be very, very mindful of that and we are very - only really in BluePoint I was the importer of record and it's a couple of dozen products that we do in BluePoint that we would have to think through the ramifications.
But we think our supply partners would be supportive. There was BluePoint for certain reason and we don’t see it as a big risk at all but there is certainly an environmental risk and I’ve heard this described as a most complex area of anticipated legislation that there is.
So something will be very active and I think ABC will participate with trade associations. We'll be very much looking what the manufacturers are thinking. With the couple of manufacturers last week there were big importers of insulin so very significant ramifications for them. You know a lot of the insulin manufacturers are brought back
I think we have to really wait and see with a lot of what's proposed. I would be hopeful about corporate tax reform but again we don’t know any further details and really not worth spending too much time on conjecture.
Thank you, guys.
Our next question comes from the line of Eric Percher with Barclays. Please go ahead.
Thank you. Steve, you mentioned in your prepared comments that you're seeing in the biosimilar space the ability to differentiate and I think you used the words new product category. So have you seen the ability to create a new class of trade here and what is the case for SD or traditional distribution versus specialty pharmacy and maybe the last point on that question would be have you begun to work with physician network and been able to drive share and adoption.
Thanks Eric. I think we've got three products in the market, all of them are very different, even the legislative pathway that one of them have taken is very different. I do believe we've made progress towards saying to our existing brand manufacturers if you launch us - there goes our train - if you launch these products then speak to us, it's a different channel with different services that we can provide be that at Xcenda, be that at Lash, be that at ION and be that at U.S. bio specialty pharmacy, there are lots of different ways that we can help you approach the marketplace.
And lot of the products so far have really been in the health systems arena, so that's a area that we believe we have a lot of strength. But I think the dialogue between the manufacturers is interactive. We have our point of view. I think we've had to change some hearts and minds on what the distributor's role could be in these products. And I think when it comes more into physician marketplace, you'll see manufacturers have a more developed pathway that they really have worked with organizations like ABSG and ION.
So we state that our role would be to enhance there. So definitely a different between a patient administered and practice administered or physician administered products for the way that AmerisourceBergen works as you would know. So thanks, anything else I can get on Eric?
The idea that in health system marketplace that they are looking for it, they would much rather see it go through the mid through standard distribution but in the physician market you have a lot of value to add and more likely to see it in specialty distribution?
Yes absolutely. And then in specialty pharmacy that again will be a different market which we will have a different run. Of course we have some many of the specialty pharmacy customers are AmerisourceBergen portfolio customers and we will endeavor to work with them and have a differentiated value.
I think we said for some time that we are hopeful and sort of expressive of the view that the economics for biosimilar should start of somewhere between a brand, fee-for-service and a generic fee-for-service with a high ASP top generic product.
And you could look at that 180 days sort of exclusivity period on generics where that might only be one product. So we've always said that GP dollars are good there because we've got a high average selling price still but because it's not that competitive element yet, you won't quite see the GP percentages that we've ultimately like when there's a competitive offering here. So, thank you.
Thanks Eric. Samantha, can we move on to the next question please.
Our next question comes from the line of Lisa Gill with JPMorgan. Please go ahead.
Thanks so much. Good morning. Steve, when we had the opportunity to spend time together in San Francisco we talked about the competitive market on the Independent side and talked a lot about CPA. I think that maybe one of your comments were misconstrued, you had said that time you were informed that a very large buying group has informed you they are going to move somewhere else. My understanding is that was back in the time frame of 2015 not for the most recent period. I just wanted to confirm that to start with?
Yes, that was the contract last year we had a year ago. So that was - you know one way we've been able to retain about half of the customer base. But it certainly in the recent past history it's nothing that’s current at all. So I apologize if I wasn’t clear now is that all in the past.
We had - and thank you for the question because - so we’re doing what we can and it’s been a very good quarter with them. We are creating our market share with them with the wallets and I think we’re using big data. We honestly have much better tools and ability to monitor compliance and one point maybe to explain compliance since why it's bilaterally important.
So I think that our sales reps at op-ed, we have the change healthcare relationships, so I think we have some new tools that really enable that communication and data of that communication. So we will continue to grow our commitment to the independent customer base and the services and I think in return our customers are understanding that we expect maximum share of wallet and if there are issues on crossing, talked us about it because it’s a complex portfolio and if any one time we could be setting them a couple of thousand products, so talk to us if you’re seeing things in marketplace and I think that’s been very well accepted as the markets gets more challenging for the Independents, hopefully the objective is that they draw even closer to AmerisourceBergen.
That’s helpful. Thank you for that clarification. And then just my one follow-up would just be for Tim. Tim you talked about the gross margins and the other segment and I think if I heard you correctly you said there were few pennies from manufacture rebates, does that pertain to the other segment specifically or I'm just saying about the sustainability of what we saw on the gross margin side and that side of the business as we move towards the next several quarters?
Yes, thanks Lisa. Let me clarify no, there’re couple pennies we called out a little bit of timing and that would be in pharmaceutical distribution so more on the drug company side.
And I think that we hit some rebates.
We had some great performance on achievements of sales goals which would - you never quite show you’ve hit until the same literally so.
Right, yes the couple pennies to clarify - the couple pennies really we thought we would come as we earned in the March quarter they have pulled forward. We hit some triggers early but Steve point is right in terms of the MWI that our calendar year there are contracts of manufacturers around our calendar year and you always come down to proving that up based on final volumes and you have two different tiers and that helped us in the December quarter with MWI but that happens every December nothing unusual.
Okay great. Thank you.
Our next question comes from the line of Eric Coldwell with Baird. Please go ahead.
Thanks very much. Well my luck this morning my four questions have been asked and answered but I'm going to just do a very simple one. You mentioned Steve and I think Tim as well that you have done some tuck-in M&A probably a little more weighted to the other segment. The last deal I can track I think dates back about a year ago. So I don't think you've done much by looking or at the cash flow statement but could you give a sense how many deals have you done may be revenue or earnings magnitude over the last 12 months maybe some nature of what you've done in tuck-ins.
We bought like Agri feed business up in one of the small provinces in Canada that was couple of million dollars that's the first deal that I wasn't present at that day in the office and the executive committee by the way would asked me so how small it was to approve the deal. But the point is we have tremendous faith and Jim and the team really know the regional competitors extremely well and part of their goals was in to make MWI the preferred distribution partner in case they are considering selling - so there is our train again.
So that's really what we would see but no Eric you're right essentially we've been investing a lot in our own business. So we’ve done six new Greenfield distribution centers, we’ve got tremendous investment going on in Lash our fusion project in those DCs, new systems for World Courier and a lot of new services for Good Neighbor Pharmacy and Elevate.
So we’ve got – there was a lot of great projects to keep us busy and we have a challenging but we think loyal customer segment. So always a lot for us to invest in a lot of work going on PharMEDium making sure that we are ahead of the curve there, Jim Adams and the teams made very, very interested in continuing to raise the bar there.
So there just a lot we can do internally and I think you’re seeing a record capital investment here at AmerisourceBergen definitely since SIP, but probably in absolute dollars and maybe not comparative dollars but in absolute dollars and absolute record investment here this year.
That’s great. I’ll leave it at that thanks so much Steve.
Samantha, I think we have time for may just one or two more questions to wrap up the hour.
Our next question comes from the line of Michael Cherny with UBS. Please go ahead.
Good morning guys, and thanks for taking the question. So just to touch quickly there has been a lot of commentary around obviously the brand price trajectory. And obviously commentary in the market around how brand manufacturers are handling those price increases or lower price increases versus historical what they’re doing to change their negotiating strategy. As you think about the conversations you had with your key brand manufacturers over the last three, six months was the tender been in terms of offsetting service versus value, how you go to pitch your business to them and your value proposition in an environment where they may be a little more reluctant to take the pricing increases they had historically?
Yes, and thanks again this is a wonderful question because we get to clarify, you know it’s not that 10% of our fees get earned from inflation that’s in 10% of the contract the dollar volume of the contracts we have a component that’s earned from inflation. So that’s an important clarification and we’ve been trying to make that over the last few investor meetings.
I was actually in one of those meetings with one of our top five or six suppliers and I think our team was able to talk through that very professionally, very objectively it has been part of the value that we've traditionally earned and I think that’s - there is a meritorious argument to move towards a very transparent model, but those conversations I think are ongoing and as those contracts renew with the manufacturers and new fee-for-service, we’ll get - I believe that I'm very positive we’ll get them done, we’ll get that component that's graft inflation and move from the fee-for-service. Anything to add Tim?
I think the manufacturers realize we provide extremely valuable service in terms of the quantities we keep an inventory, the credit, the collections that we provide so I mean I think they realize it, it’s a very good value and very economical. And we had discussions, we had fee-for-service agreements over 10 plus years and we see those continuing and we don’t see those changing going forward though it seems to be very acceptable based on WAC pricing and that's how the industry is compensated.
Samantha I think we have time for just one last question.
Our last question comes from the line of David Larsen with Leerink. Please go ahead.
Congratulations on a good quarter. Can you talk about what you're seeing on the sell side like obviously there has been a bit of pressure on the independent space. Are we largely through that did those prices come in line with your expectations in the quarter and has that really been contained to the independent segment or have you seen any impact like the larger change or original change? Thanks.
We didn’t have a very active quarter in terms of renewals I mean that sort of a timing with how things go, we haven’t had a very active quarter but when preparing for this call and we do of course every month our reviews, Tim and I meet with all the keys sales people in the drug company. Everything is pretty much as normal and our customers are hunkering down, looking at issues like the, our fees and other things that are challenging to them, looking at network composition staying in the network’s performance network star ratings.
So nothing really it's a - I think our volume of generic compliance is certainly improving so some of the programs that we have introduced are showing they’re approved today they’re being productive. So nothing particular to report we’re being consistent about this for a couple of quarters there. We don’t see any fundamental changes in the way we market with independent pharmacies.
Okay, that’s great. And then just one last quick one if President Trump gets more aggressive about putting pressure on drug company CEOs to control price and cost price to pull in. Are you taking steps now with regards to your contract to basically protect your margins going forward maybe if you could just give any incremental color around what you're doing or what you could do in the future if level of ground heats up even more that will be very helpful? Thanks.
It’s important to note that we really buy the wholesale acquisition cost and there is a lot of - once we ship and go and receive payment for those products which you can see we manage our DSO pretty well. There is a lot that goes on after that and it's by enlarge you know really past us. One of the strong attributes of AmerisourceBergen in terms of our existing model is, we don’t build a lot of - we almost exclusively - 99% of our revenues we don’t go third-party pass we’re either building the manufacturer or the provider.
So a lot of that will really go past us. If there was a huge change with the growth rates and our industry were impacted, it would be a negative for us there is no doubt it would be a very, very strong headwind because we start off with the industry growing in the high single-digits. U.S. industry growing in the high single-digit so if that were to really alter, if we were to go to a flat industry I think we have flexible in our contracts, we would have to look at it on both the provider, the sell side and the buy side contract.
So that stands to reason and - but a lot of work to do that Congress would have to be involved and I think again that this is a remarkable industry with a lot of innovation. And I think we’ll come up with the right solutions for the industry. And not necessary AmerisourceBergen I think our industry will come up with the right approach and we are proud to be part of that. So thank you. Keri, we’ll wrap up now.
Yes Samantha, I think that was it for questions. Steve if you want to make any closing comments I think we all set with the hour.
Yes, thank you. This was our first quarter with Keri, and I think she did a great job. So hopefully you all enjoying the interaction you have with AmerisourceBergen. We are really pleased with our strong start to the fiscal year. Pleased that we could raise the guidance for the balance of the year and we’ll look forward to updating you at the end of next quarter and again we're excited about the progress we've made towards achieving our fiscal 2017 goals. Many thanks.
Ladies and gentlemen, it does conclude your conference for today. Thank you for your participating and for using AT&T Executive Teleconference Service. You may now disconnect.
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