Perrigo Co. Plc (NASDAQ:PRGO)
Q4 2016 Earnings Conference Call
February 27, 2017 16:30 ET
Bradley Joseph - VP, Global IR
John Hendrickson - CEO
Ron Winowiecki - Acting CFO
Marc Goodman - UBS Securities
David Risinger - Morgan Stanley
Gregg Gilbert - Deutsche Bank Securities
Randall Stanicky - RBC Capital Markets LLC
Jami Rubin - Goldman Sachs
Louise Chen - Guggenheim
David Maris - Wells Fargo Securities
Dewey Steadman - Canaccord
Christopher Schott - JP Morgan
Douglas Tsao - Barclays
Elliot Wilbur - Raymond James
Good afternoon. My name is Frederica, and I will be your conference operator today. At this time, I would like to welcome everyone to the 2016 Year-End Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session.
[Operator Instructions] Thank you. Mr. Bradley Joseph, Vice President of Global Investor Relations. Sir, you may begin your conference.
Thank you very much. Good afternoon and welcome to Perrigo's calendar year 2016 preliminary unaudited earnings conference call. I hope you all have had a chance to review the press releases we issued early this morning. Copies of the releases are available on our website, as is the slide presentation for this call. Leading today's call are John Hendrickson, Perrigo's Chief Executive Officer, and Ron Winowiecki, Perrigo's acting Chief Financial Officer.
I would like to remind everyone that during this call, participants will make certain forward-looking statements. Please refer to the important information for investors and shareholders and Safe Harbor language regarding these statements in our press releases issued this afternoon. In addition, in the appendix for today's presentation, we have provided reconciliations for all non-GAAP financial measures presented.
Please note that today we'll be discussing certain preliminary unaudited calendar year 2016 financial results and initial calendar year 2017 guidance. However, we cannot assure you that our audited 2016 results or initial 2017 guidance will not be materially different.
Now, I'd like to turn the call over to John Hendrickson.
Thank you, Brad and welcome everyone to Perrigo's calendar year 2016 preliminary earnings call. Before discussing our performance, I want to comment on the internal transition we announced in our press releases earlier today. Effective immediately, Ron Winowiecki Senior Vice President of Business Finance will assume the role of Acting Chief Financial Officer following the departure of Judy Brown, Executive Vice President of Business Operations and Chief Financial Officer. Judy is leaving Perrigo to take a position with another company in the pharmaceutical industry beginning on April 1, 2017. We thank her for her contributions, and wish her best in her future endeavors.
As our acting CFO, Ron brings almost three decades of financial and accounting experience to his position. He has the industry knowledge and technical expertise to successfully lead our finance team. I worked closely with Ron during much of his tenure at Perrigo, and I can test to his leadership skills, financial expertise, and strategic acumen. I believe that he is the right person to take on this role, as we conduct a thorough search for a permanent CFO, which will include Ron as a key candidate. I have full confidence in Ron, and look forward to working with him as our CFO.
As you've likely seen in our press release earlier today, we filed the Form 10b–25 notification of late filing with the SEC regarding our Annual Report on Form 10K for the period ended December 31, 2016. We currently expect to file our Form 10-K on or before March 16, 2017. Ron will provide you more detail regarding this matter shortly, but I would like to comment upfront that while this delay is unfortunate, we remain committed to providing timely, accurate and transparent communication to all of our stakeholders.
Now I want to talk about our business. I will begin by providing an update on the progress we have made against our strategic and operational action plan and I laid out in my initial 30 days. Next, I will provide perspective on our preliminary calendar year 2016 results, as well as my top priorities for 2017. Ron will then provide the detail regarding our delayed 10-K filing, the preliminary calendar year financial results and provide our initial 2017 guidance. I will then conclude with final comments before taking your questions.
Turning to slide six; you can see that we continue to make progress on our action plan to create value which is underpinned by our strategic portfolio review. I have a number of updates that I would like to share with you today. First, corporate governance continues to be a priority for the Perrigo Board of Directors. On February 7, we announced the appointment of three highly qualified and experienced professionals to the Board. I will discuss these individuals in more detail on next slide as we look forward to leveraging their industry expertise.
Second, as you likely saw in a separate press release we issued this afternoon, Perrigo has announced an arrangement to sell the rights to Tysabri Royalty Stream to an affiliate of Royalty Pharma, which I will discuss in greater detail in a moment. Further after extensive review, Perrigo's Board of Directors has approved a review of strategic alternatives for our active pharmaceutical ingredient business based in Israel. We believe a potential divestiture of this business allows Perrigo to give greater focus to our consumer facing OTC and Rx businesses.
Third, we previously stated that we are conducting a review to optimize our cost structure in order to better align expenses with our current and future market dynamics. Today, we are announcing a restructuring program that is expected to yield greater than $130 million in savings per annum by mid-2018. This is in addition to the strong contribution that our supply chain organization continues to generate for both our North America and International segments. Again, I'll provide details in just a few minutes.
Fourth, our Consumer Healthcare International profitability improvement program, which I will discuss in a moment includes three components; exiting unprofitable businesses, structural enhancement, and launching new products all of which remain core to our value proposition. And lastly, we continue to make progress on several other initiatives including the enhanced review of our Rx business.
Turning to slide seven; Perrigo has recently added five new highly qualified and experienced directors to our Board reinforcing our commitment to bringing fresh perspectives and new energy to the Board and Leadership. I would like to formally welcome Jeff Smith, CEO and CIO Starboard Value LP; Brad Alford, former Chairman and CEO of Nestle USA and Jeff Kindler the CEO of Centrexion and former Chairman and CEO of Pfizer to our Board. These appointments along with our recent additions of Geoff Parker and Ted Samuels will be beneficial for Perrigo and its shareholders as these individuals bring a strong mix of healthcare, consumer, and investor experience that align with Perrigo's unique business model.
Further, we will continue to seek out fresh perspectives that will contribute to Perrigo's mission of providing quality affordable healthcare products and expect to appoint two additional Board members, who will be recommended by Starboard and ultimately approved by the Board. Within the past few weeks, our new directors have been working diligently to master the company's business objectives, and curb market dynamics. It's clear from our recent discussions, that all of our board members understand the strength of our unique business model including Perrigo's highly valuable portfolio businesses. The Board continues its strategic portfolio review including an enhanced review the Rx business; as always, I promise to keep you updated as we make progress.
Turning to slide eight; I'll now discuss the agreement to sell the Tysabri Royalty Stream to Royalty Pharma for up to $2.85 billion, which consists of $2.2 billion in cash and up to $650 million in royalties earned if net sales of Tysabri meet specific threshold in 2018 and 2020. This sale enabled Perrigo to continue to focus on our other businesses while de-levering the balance sheet creating more flexibility for growth. We are committed to be a good steward of capital and maintain investment-grade status as one of our long-term status objectives.
Turning to slide nine; quality continues to be the cornerstone of our organization and our customers rely on Perrigo to manufacture safe and effective products that provide real value to consumers. We remain focused on maintaining our high standard amid increasing volume demands for our products. At this time, while I believe Perrigo has maintained a lean cost base there are always ways to be more efficient. In order to help offset significant industry price challenges, we have initiated a cost optimization strategy across the company. The core thesis of this initiative is to ensure that the needs of the individual business units are balanced against the benefits of scale, empowering our businesses unit leaders, and better positioning us to deliver on our mission.
As a result, it became clear to us that there were more opportunities to streamline and focus processes, people and organizational priorities on business-critical activities. Specifically, our global cost optimization program includes the following; one, manufacturing cost infrastructure improvements; two, integrating corporate services in the business unit function; and three, improving our go-to-market sales strategy in our Rx and Consumer Healthcare International segments that totally impacted these global changes some of which have already occurred is expected to generate an annual savings of more than $130 million by mid-2018. This will impact approximately 750 employees globally, or 14% of our nonproduction workforce. This is on top of previously announced initiatives which my team continues to execute again. These decisive actions while difficult decisions for our board and management are critical to our ability to drive our business forward.
Turning to slide 10; we are making significant progress in our CHC International business, and I believe we are on a path to capture substantial value by growing our OTC portfolio while enhancing margins over time. With these goals in mind, I would like to highlight some important developments. First, and we continue to enhance leadership across this business, I'm excited to announce the appointment of Svend Anderson to the position of Executive Vice President and President Consumer Healthcare International to enhance this business.
Over the last 10 years, Svend has been working with consumer and Pharma businesses running their European division. He has done this for LEO-Pharma, Hospira, and Actavis. As we continue to build and innovate our branded consumer healthcare OTC portfolio, Svend will play a critical role along with our strong international leadership team in driving profitability across Europe. I am confident that he has the skills and expertise to assist in our endeavors and look forward to working closely with Svend to grow this business during the next phase of our transformation.
The executive committee and I appreciate Sharon on providing leadership to the branded healthcare team during our critical period. His efforts to enhance the segment's leadership team, instill process discipline and drive execution have prepared the team to thrive under the new leaders - under a new leader such as Svend who has deep experience in growing branded products and driving a pan-European platform. As Svend transitions into his role, Sharon will continue to be a key executive for our company and businesses in Australia and Israel.
Second, during the fourth quarter of 2016 we announced a restructuring program in Belgium. Today we're announcing that we have proactively canceled additional unprofitable distribution contracts in the CHC International segment in order to focus exclusively on the development, marketing, and sales of our own brand OTC product portfolio. The exit of these unprofitable distribution contracts in the segment is now expected to have a year-over-year negative impact to our net sales line of approximately $220 million in calendar year 2017 with no impact on profits.
Third, in addition to these organizational changes, we continue to optimize our supply chain and infrastructure. The team is making great progress on enforcing and optimization of our overall supply chain. And forth, the new Head of our Branded Innovation and his team are hard at work driving the new product development process in this business. We're focused on expanding our product offerings, launching new line extensions under our well-known brand names and leveraging our products within our OTC categories. We believe this strategy will further enhance our brand equity and customer loyalty. Furthermore this long-term strategy is supported by a substantial increase in R&D for the CHC International segment in 2017 versus 2016.
Now I would like to discuss our preliminary 2016 highlights in more detail on slide 11. 2016 was a transitional year for the organization, our employees and our shareholders. Before I move on, I would like to thank Perrigo's thousands of employees around the world who work diligently to ensure our strong fourth-quarter finish. Today we announced preliminary unaudited calendar year 2016 record net sales of $5.5 billion and more than $1 billion as expected operating cash flow. Within CHC Americas we achieved record performance in the infant nutrition category, which we expect to be a key long-term driver, in addition to solid performance in the smoking cessation category.
We will launch a number of important new products, such as store brand versions of Flonase and certain products within the Mucinex family. We continue to deliver strong operating margins in this segment enhanced by strong supply chain performance. Within Rx while pricing erosion for the year was greater than expected, it was in line with our updated forecast in the second half of the year. We continue to manage the business for long-term profitability with strong R&D investments, and our recently announced partnership for our branded women health business.
I now want to talk about my perspectives on 2017. Our primary objective as an organization in 2017 is to continue to simplify, focus, and execute on the fundamentals of our business. First, focus on operational execution, including investing and innovating for growth. Second, align our businesses and structures to better meet the demand of our customers. And third, complete our strategic portfolio review to ensure that we have the right model in place to drive both top and bottom line growth. Balance against these priorities are two main headwinds we anticipate in 2017 for our Rx segment.
First, calendar 2015 performance benefited from $80 million in operating income from Entocort. This one time in fact is not expected to repeat at this level in 2017. In the past that was purchased in December 2015, the company did not anticipate all the increased market competition the product now faces resulting in significantly less operating income contribution from Entocort going forward. Second, in addition to the impact from Entocort, we expect 2017 price erosion in the rest of our Rx segment to be approximately 9% to 11%.
We have a strong private label business that leads the industry and we expect to continue to develop this market. As you can see on this slide, over the last 13 weeks market dynamics are favorable and retail brands as a whole are continuing to grow. Looking at the category components of the data, you can see that store brand Infant Formula category continues to outpace National Brand growth wherein a leading store brand player and on the yields of a record 2016, we expect this category to drive long-term growth. This year's January, this year's cold season was more severe than last year's particularly in January although the season has slowed recently.
In addition, store brand growth in this category outpaced national brand growth. We have long [indiscernible] Perrigo's unique business model and the data exemplifies the fact that consumers and the healthcare system in general continue to search for more affordable alternatives for their healthcare needs. Moving to slide 14, we've outlined a framework to continue to drive growth in CHC Americas, which we expect to grow at or above current market OTC growth rates. To be more specific, we believe this business can durably grow 2% to 4% organically over the long-term.
Despite pricing headwinds, OTC and store brand growth remained strong. Consumer dynamics are favorable and national brands are driving new product innovation. All of these factors give a confident in this framework.
Moving on to slide 15; the Rx segment continues to be one of our premier top - one of the premier topical businesses in the industry. We currently have 24 ANDAs pending FDA approval, six of which are first to file representing approximately $3.1 billion in branded sales. Further we expect to launch more than five products issue with branded sales of greater than $800 million.
Now I want to take a minute to discuss our expectations for ProAir. We are not including contribution from the product in our 2017 guidance. We continue to respond the FDA's questions on this product. Currently we are working with our partner on a rigorous set of tests to ensure that our product performance matches that of the references for drug. We plan to be in a position to fully respond to the FDA's remaining questions in the second quarter of 2017 and will work closely with the agency towards approving this first-in-class generic product.
With that, I'd like to turn it over to Ron. Ron, welcome to call. I appreciate your support.
You bet, thanks John, good afternoon everybody, I look forward to meeting you in the near future. I also look forward to continuing working with John, the rest of the Perrigo leadership team in the coming months as we continue to focus our previously stated action plan. I'd also like to take a moment and think Judy Brown for her support, guidance and leadership during our time together at Perrigo, as a friend and a colleague I certainly wish Judy the best in her new position.
Moving now onto our results. I first want to discuss the notification that we filed with the STC to delay our 10-K filing. The scope of work that is still required the finalize Perrigo financial statements, included the final payment calculations related to the announced sales of Tysabri, and deferred tax assets and other related effects Omega Pharma NV.
Let me provide some detail. As you saw on recent press release prepared a business development team finalized an agreement to announce the sale of the Tysabri royalty today. The accounting team taken this development and updated facts and circumstances that led to this announcement and is running a process to calculate the final impaired of value of the milestones associated with the Tysabri asset. Well, it may sound easy, the calculations are complicated and we need to have our calculations and procedures reviewed by our auditors.
We provided our current estimated calculation in unaudited GAAP preliminary financial results reported today. In addition, certain deferred tax assets were identified that existed at the time of the acquisition of Omega, we are quantifying the result of these assets, which will be a non-cash re classification between goodwill and deferred taxes.
Completing our procedures also require us to evaluate the related effects of this re classification. Further, in preparing the accounting treatment for today's announced sales of Tysabri and in completing the 10-K this quarter language associated with the new revenue recognition standard AFC-606, which goes into effect in 2018, late Wednesday, February 22, Ernst & Young, our independent auditors notified us that they are evaluating the historical revenue recognition practices associated with Tysabri.
So let's go back and provide some color on this disclosure. For those of you who have followed the company since 2013, you will recall that the Tysabri royalty stream was a part of the Elan pharmaceutical acquisition which closed on December 18, 2013. The business operation of Elan including many assets in addition to the Tysabri Royalty Stream such as several equity joint ventures, a number pipeline products, as well as R&D, regulatory affairs and administrative functions. The Tysabri royalty was recognized as revenue in the non-financial statements filed with the SEC.
I will review the accounting application at the time of the acquisition parable also independently concluded that the royalty stream from Biogen will be recognized as revenue in the financial statement at Perrigo. This accounting treatment was review with the NY, and agreed to under their audit opinions for fiscal year 2014, fiscal year 2015 and sub year 2015 as well. The reform 10-ks was unqualified audit opinion.
In addition, as you know we have reported the Tysabri royalty stream and related results as a separate segment in our financial statements. As the timing of this review is unfortunately overlapping our earnings release today, we felt it important to provide you with a status update as well. There's one critical point I have to underscore for everyone. The final determination irrespective of how our independent auditors conclude that expected to have no impact on a historical or future expected net cash flows generated by the company, cash is always still cash.
As John stated, we currently expect to file our form 10-K on or before March 16, 2017 within the 15 calendar dates extension period. We'll keep you updated in the event these expectations change.
Now I will turn to Slide 18. You can see the preliminary unaudited 2026 performances results we provided in our press release. Net sales for the accountable year was $5.6 billion, with adjusted net sales of $5.5 billion. As a result the adjusted net sales exclude contributions some assets held for sale.
Preliminary calendar year 2016 reporting operating loss, within a range of $4.65 billion to $4.68 billion with an adjusted operating income of $1.42 billion to $1.44 billion. I like to discuss the two main fourth quarter adjustments that impacted our calendar year reported operating income. First, we realized a tangible asset payment of $2.6 billion in a goodwill impairment charge of approximately $201 million in especially science segment associated with the announced sales of Tysabri.
Second, we identified impairment indicators for the Entocort intangible asset due to new entrance of new competition for this product, and that's reported an impairment charge of $336 million in the quarter. These non-cash effects combine with our other non-GAAP adjustments record in the fourth quarter and for the first nine months of the year resulted in a calendar year 2016 preliminary adjusted earnings per diluted share in the range of $7.10 to $7.25.
Now I would like to turn to our 2017 guidance on Slide 19. There are a number of key assumptions I would like to take a moment to highlight. Within the CHC America segment we expect 2017 net sales of approximately $2.4 billion with an adjusted rating operating margin percentage in the low 20s. We assume a mid-year launch of the store brand version of NAXM [ph] and a number of smaller store brand OTC launches during the year. Also included in our guidance, are the recent cough/cold season dynamic John mentioned, which saw an increase in the incidence of cough/cold harbor since last year, as well to assumptions for average allergy and fluticasone seasons.
In CHC international segment, or CACI, we expect the price of $1.4 billion in 2017 net sales. Segment net sales are impacted by two fundamental shifts in 2017. First; topline sales in the segment are unfavorably impacted by approximately $90 million due to the translation of foreign currencies. Second as John stated earlier, 2017 net sales to exclude $220 million due to the exit of certain distribution agreement in the segment.
To help in your modeling, the quarter net sales effects of excluding these distribution agreements is included in Table 1 of this presentation. I'd also like to note that with announced cost savings in the removal of the profitable distribution businesses, we expect operating margin percentage in the segment in the low teens. And I would like to note that this includes increased investments in new products, supported by advertising and promotion spending, which is more heavily weighted toward the first half of 2017.
Additionally, the timely cost improvement program, will be phased in over the course of the year. We expect that these combined effects will generate approximately 60% of segment operating income results in the second half of the year.
Now let me take a minute to discuss the Rx net sales guidance of approximately $925 million in 2017. First, as previously discussed, we expect the negative year-over-year headwind to the topline of approximately $70 million, related to the increased competition in the Entocort market. In addition, our 2017 modeling assumptions, year-over-year price erosion on like-for-like products are approximately 9% to 11%. Netted against these challenges is the positive contribution from our expected launch of more than five products with brand sales of greater than $800 million.
Let me reiterate again, John's earlier comment that Proera [ph] is not included in our guidance, there's no contribution from this product in our model. As you may recall at the JPMorgan conference earlier this year, we announce a partnership for our brand named Women's Health Business, which significantly reduces excelling costs in the Rx segment. This action combined with the Morgan contribution from new product launches, and the effective of our costs improvement program, enabled us to maintain adjusted operating margins of approximately - approaching 40% in 2017 for this segment.
As the management team, we are committed to long-term growth of our generic prescription business as we continue to make R&D - continue to invest R&D investments for new product that fit our growth strategy. Slide 20, aggregate effect of my segment comments, and illustrate the key year-over-year drivers.
Let me first start with the head winds we are facing. First, Entocort alone is expected to have a 42% unfavorable impact to year-over-year adjusted EPS. Second, the impact of FX headwinds related to Brexit, and a strong dollar in an addition to jurisdictional composition included in our tax expense produced an additional head wind.
On the operating flipside, we expect positive net sales and profit contribution, from our CHC Americas and CHC International businesses, approximately $200 million from new product launches in 2017, and a favorable impact from a cost improvement program as John outlined earlier. These combined factors, are expected offset the price erosion in 2017, and support our guidance range for adjusted EPS between $6.30 to $6.65 per diluted share. To be clear, without the pricing dynamics in the Rx business, and effective Entocort, our consumer facing businesses are forecast to achieve higher year-over-year profitability.
The guides in our press released this afternoon, includes the Tysabri and our API business. Staying with the company's historical practices, we do not change guidance until a transaction closes.
I would like to provide some modeling information to help you understand the effect of the Tysabri sale, on calendar 2017 guidance. As allied in the release, we expect the sales to close in 20 days. Assuming then, that if Tysabri were to be excluded for the entire year, and that we're to complete our debt paid on strategy by mid-year, the expected impact would be to lower calendar 2017 adjusted earnings in the range of $2.12 to $2.18 per diluted share. Again to avoid confusion, Tysabri is currently in our guidance, we will update you the transaction closes and we complete our capital structure action plans.
Now will turn to Slide 21. I would like to provide a brief update on our balance sheet and share our views for Q4 2017. As of December 31, 2016 total cash in the balance sheet was $622 million and total of that was approximately $20 billion. Expected cash from operating activities for calendar year 2016, is anticipated to be over $1 billion exceeding our previously revised guidance. On the right hand of the slide, you can see our cash flow and balance sheet priorities for 2017.
First, we expect operating cash flow 2017 of greater than $850 million which includes the cash flow headwind impact of approximately $60 billion of payments related to our cost reduction program and higher tax payment on a year-over-year basis. They $850 million, the healthy cash flow generation will enable us to drive our capital allocation strategy. Our current operating plans to use this cash flow to pay down debt maturities which are coming due in 2017.
When I was corporate treasure Perrigo, I had the pleasure launching our first investor grand bond offering in 2013, and the philosophies and principal outlined at that time remain today. We remain committed to investing rating, upon the closing of the average transaction we expect to move forward with the debt paid out strategy, consistent with our financial policies.
I should also like to mention, we have good support from aboard for our investment rates and great financial policy.
I'd like to now turn the call back to, John.
Thanks Ron, appreciate that. In Closing on Slide 23; I would like to reiterate the strength of our unique business model. Pharmaceutical company coupled with a fast moving consumer goods organization, layered on a world class complex supply chain. We made significant headway in the finding a path to enhance the value, and strength our business going forward.
Our 2016 review of transition, I anticipate 2017 will be the year of execution. There we build upon that foundation and strive toward consolidating growth in 2018. We have the right team and the action plan in place to able us to capitalize on our business model and focus on payroll strength and providing quality affordable healthcare products to consumers and patients around the globe.
Thank you. Brad?
Thanks, John. As I said on the out sit of this call covered certain preliminary unaudited calendar year 2016 financial results. Given that these are preliminary unaudited results, we limit your questions today to 2017 financial guidance, leadership changes and our business and strategies. Specifically we are not going to take questions regarding the 2016 preliminary unaudited financial results.
Operator we now like to open the call for questions and I ask everyone please limit yourself to one question only, thank you.
[Operator Instructions] Your first question comes from the line of Marc Goodman from UBS.
Okay one question maybe you can focus on the U.S consumer business. And talk about the pricing pressure that you were talking about that was 2% to 4%, what - what categories are you seeing in that pricing pressure and just give us a sense of what that pricing was in 2016, thanks.
In the consumer Healthcare business, Marc, we have always seen certain pricing pressure in all launched new products, a number of competitors. I would say across the categories we compete in we have competitive pricing. We've done a good job of having costs, I mean cost savings, lying driving over these cost of goods, or operating strategies. So when we look at the growth of the business we expect the 2% to 4% to be after price - after pricing for solid growth. After the pricing challenges we expect off set a number of those with our cost initiative. Will say cough/cold, allergy some of those categories tend to be more hit by some of these pricing things, there are a lot of players within those categories.
But is it safe to say the cough/cold, allergy pricing. You're expecting to be a little worse in 2017 than 2016 or is it just a continuation of what we've seen.
I would say we continue to experience some price challenges it not a new phenomenon, we continue to always have pricing in the consumer space, we expected to continue in different segments of pricing we have seen. Again, given the growth in the new products and everything we expect to be able to overcome that pricing challenge.
But like in infant [ph] formula and smoking cessation, are we seeing pricing pressure there or is it really just in those other spaces you mentioned.
I would say we see it in all different segments comes differently across the board, but it certainly had so there's not just price compression from competitors, but making sure we are maximizing our promotion in those kinds in the market too. Retailers want to drive these brands and so we continue to help them try and drive profitability across the portfolio, which can impact some price compression and things that we get to drive that business.
I'm sorry just.
And your next question comes from the line of David Risinger.
Hi, good evening. My question relates to CHC Americas. I guess could you just tell us within your EPS guidance for 2017, are you forecasting CHC America's operating income flat or down the rising in 2017, thank you.
David, this is Ron, thanks for the question. In my prepared remarks I commented on CHC America's, we do expect topline growth in the segment as we talked about we did expect operating margins in the low 20s. Again because we have not published 2016 information it's difficult for me to give you a relative compared year-over-year margin number but again the modeling we're using for the segment in 3017 is in low 20s, low 20% margin.
And your next question comes from the line of Gregg Gilbert.
Yes, thanks. John can you comment on where the Rx review is what you know and what you don't know, when you my complete that and mature overall philosophy, will that you and the boards willingness to take an offer versus the right offer, thanks.
Yes, thanks Gregg, appreciate the question. So first of all the new board assembled a good robust discussion and I would say all the business segments understanding whether add profitability to strategy with them, as you can imagine all the board getting engaged, given the new many members and so not trying to make any ultimate decision, and try and understand how they all fit together and what they do. So they continued on the path we have not clearly sit a ultimate date of decision must be made by X. and looking at that, I will say the directed to meet the board to keep driving this business, we would like to profitability, we'd be investments in R&D, deliver good operating margin, keep driving up the long term growth and profitability. So we are operating the business for the long term, not for just short term profitability. So I like their direction and I think as a board they will continue to evaluate it and see what it may sounds.
And your next question comes from the line of Randall Stanicky from RBC capital.
Great, thanks. I just had - I want to follow-up on the last question. John, can you talk about the hurdles, the specific hurdles in separating the Rx business out, both from a tax and cost perspective. And then the - attached from that question would be would you consider alternative ways of divesting this business, if you cannot find a buyer would you look at spinning it out or other creative structure to pursue that breakup? Thanks.
Yes, you got it Randall. So first of all, I just got to step back and - I've said this every time I know and everyone is probably getting tired of it. But this is a good, it's a good return business, high margin even with the pricing we were talking about, as Ron said still at a 40% kind of margin level. It's still a very good profitable business, good pipeline that we feel good about. All of those dynamics very favorable and I think the board themselves were liked what that looked like. When you think of all the potential possibilities from running it, keeping drive the profitability in [indiscernible] to separating. We are certainly not locked into any one option as far as what to do and how to do it. And again, keeping running it, keeping it integrated, keeping it as the core part of the business.
There are as we look at cost of separation, there are tax issues related to separation. There are operating issues related to separation, that all come in the play in that strategy, but I would say everyone is in a fact gathering, understanding mode, at the board level to look at all the potential options.
And there is no timeline in terms of how long should you - to go into I know there are some new board members that came on who I assume are going to take an active role in that process?
Yes, correct. All the board members are taking up very active roles in all the segments, but certainly in this. There is no timeline set, that we've said that we must have a decision by here or else. Again the Board has directed to me as to keep running the business to grow it and drive the profitability of it and that's where we are taking it right now.
Okay. Thanks very much.
And your next question comes from the line of Jami Rubin from Goldman Sachs.
Thank you. I have to say I'm still very confused by this 2017 guidance related to Tysabri. So when you're saying that when you close the Tysabri deal in 20 days, we have to take out $2.12 to $2.18. So that really assumes no offset? So I guess a couple questions. Number one, what are you going to do with that $2.2 billion in cash? Is that already incorporated in your debt pay-down guidance for the year and maybe if you could just be more specific, how much debt do you plan to pay down this year?
Hi Jami, this is Ron. Thanks again for the question. So again our earnings guidance is $6.30 to $6.65 for the year. So you made a comment that our Tysabri affected $2.12 per share to $2.18 is not a clear offset. That's actually not true. Again, we have to take a look at what is the Tysabri Royalty Stream and again you have to work with your models and I certainly…
But we have a number that's higher than the $2.12 to $2.18 so maybe that's part of it. Can you - how did you get to $2.12 to $2.18?
So again, let me just walk you through this. So you got to take the effect of Tysabri. We are not, we cannot provide our guidance for Tysabri. So you got to take your model, look at what you have allotted for the Royalty Stream. You have to take that on an after effect basis. So as you know this is an Irish held asset, it's in an efficient tax jurisdiction. Then you have to say okay, let's step back look at the debt pay down. Again we're reflecting $2.2 million and again we have [indiscernible] from our Board to continue our investment-grade financial policy. You can assume we're pointed at paying down debt. So you have to go through now, okay here's a various range the debt, the senior notes, what is the average interest rate on those senior notes over the curb, we're going to be smart from a P&L and from a future liquidity standpoint. And then you calculate that effect after-tax, because then you'll have again tax has as a deductibility in various jurisdiction and that results in the $2.12 and $2.18. You probably have a higher number.
My explanation is, one; I can't guess your model for Tysabri. Number two, again this is a mid-year debt pay down so is assuming midyear. So you may have some other assumption for the debt pay down. I can't interpolate that and…
You can't tell me how much debt you are going to pay down this year?
Well so, for this item. Again you say pay down as a share. So let's take that in two parts. So the one part is I communicated with our operating cash flow, we do expect to pay down debt maturities this year. Let's keep it [indiscernible] decide that's our guidance model. Now let's talk about that $2.12 and $2.18. We received $2.2 million in cash, you can assume that that cash is focused on debt pay down.
Okay. So at the end of the year, how much cash will you have at the end of 2017, after you paid down debt, how much cash will you have?
So we are not providing guidance on cash on balance sheet. So I am not going to provide that number right now Jami, if that's fair.
I am sorry. Can I just ask one more question? Did you guidance include - you did say OTC next, I think you said middle of the year. Is that right?
Right. Thank you.
And your next question comes from the line of Louise Chen from Guggenheim.
Hi. Thanks for taking my question. So just curious if you strategic review ever considered divestiture of Omega and why not? And then just any update on this Amazon opportunity, is it still something you are interested to pursue? Thanks.
Yes, thanks. Yes, I would say the strategic review included everything. So the good thing again is we kind of looked at every business and say why do we love, what don't we like about it, what things we change, where we not executing as well as can so it was a broad and is a broad strategic review. We certainly looked at the performance we've had in the Consumer Healthcare International. But when we looked at the market dynamics, when we looked at the home are executional plans and what we thought we could drive or continuing to try and drive that platform for growth both top and bottom. And we believe that being in Europe with the consumer business that includes brands, value brand, store brand as well as some specialty products is a great platform to have.
We've got to execute with it and deliver that value. So we continue to look at all those segments and not just pick on Rx, but continue look at all and make sure they're good, fir for us. I'd like to go back to Ron, I believe he said in his comments which is when we look at next year we've got a lot of Rx headwinds and certainly Tysabri moving on from it. So when you look at our consumer facing businesses they have some good strength year-over-year.
And Amazon, sorry about the Amazon. We continue to think Amazon is a good opportunity, certainly the products especially as they get more and more efficient and real-time delivery. When you have a headache and you want your product now, not necessarily tomorrow. So we'll get much more efficient, I think it starts taking off. We are working with them, working with other players or the retailers have online aspect to most of their businesses, we work with those in marketing and driving our online business as well as Amazon. And we think, going forwards over the next 2, 3, 4, 5 years I will continue to be a growth vehicle for us. Thank you.
And your next question comes from the line of David Maris with Wells Fargo Securities.
Hi. One question and one definition. So first on the question. When the teacher says that students are energetic, they usually mean that the students are troublemaker. So when you said that the Board Meeting, the first meeting was I forgot that are invigorating or something…
Yes, engaging. So that everyone knows that's code for people have differences and we're debating it and they are new members. Can you just describe where there is agreement and where there may be differences of opinion of the direction of the company? And separately just as a definition you had mentioned that you're improving your go to market sales strategy. I just wanted to know what that means.
Sure. So first of all, I would not take anything I have said with the Board to in that way. We have had great board interactions, the Board members have worked well with each other trying to challenge management, think with each other, I would say very, again when I say invigorating, I mean very good breadths and depths of discussions. The new Board members bring different angles at things which has been very good for the whole Board. So I think it's been a good interaction clearly with Jeff Parker and Ted, who joined a little bit earlier. But then went with Jeff and Jeff Kindler as well as Brad just brings good angles to helping us think about things, helping us think about strategies. So it's been a very good productive engagement with the new board member so far and their cooperation with the existing board member. So very positive from my standpoint, can't speak highly enough for those interactions.
On the second part of the question…
Go to market sales strategy.
Go to market sales strategy, and I believe we're talking about the Rx side of the business is one of those. We basically had a branded portfolio of products that we [indiscernible] with someone. So we had a whole detailed salesforce that were driving those brands. They were good brands, we own them. We like the products but we did not have the scale nor did we want to invest in a number of new branded product in the Rx space. We partnered with another company to be our go to market arm where we fill on the product manufacture them actually take the orders et cetera. But they do the detailing and selling and it was a good way to still leverage the product portfolio and not have the broader complexities, expenses et cetera with a sales force. They have a sales force and even more products in their basket. So it was a very good collaboration to drive, its showing good results so far.
Thank you very much.
Your next question come from the line of Dewey Steadman from Canaccord.
Hi guys, thanks for taking the question. Just a really quick one on CHCI. Following the strategy changes and sort of the return of revenues there and new good leadership for that division other opportunities to synergize between CHCA and CHCI going forward? Thanks.
Great question. So we do have a fair amount of synergies on quality, cost of goods and operating side. So I'll start there, we put a team in place early on. And then we got to figure out what we can do, they had a lot of outsourced products and number of plants as we do. And our team there, we put people on the ground headed under Ron Winowiecki whole Irish operating supply team and they have been delivering great synergies between the businesses. Doing in forcing across our plants, making sure we deliver a high value across the products that part has been going well and we continue to try and expand what we can do there to help their cost of goods as well as their operating costs.
The other side is we have a platform in Ireland and we continue to combine our Irish platform there with the platform of the operations in Nazareth, Belgium and continue to get the benefit out of doing that. On the sales side, there are some synergies not as much or as quick as we had originally expected. We originally expected to be able to launch more products. We are launching some products that tie into their value chain there. We are launching products here eventually that we think we can launch as good brands or control brand. But it's not as much early on as we expected, we continue to want to drive more value there.
One of our good wins has been we had developed in the States with our partner in Denmark a nicotine gum, that was sort of best in class and with the purchase of the nicotine products that we did in our international CHC business, we're able to bring that innovation to them and actually launch that product here over the last month and a half or two months and are seeing good results. So we feel that franchise as smoking cessation and those kind of things continue to grow in Europe that can be a good franchise force there. As a global player we have a good supply chain to back that up.
So that's a good example where working together has proven to be a beneficial thing.
Your next question comes from the line of Chris Schott with JP Morgan.
Great. Thanks very much. Can you just come back to the US CHC business, I think you used to talk about that as a mid to high single-digit growth business. Obviously different environment now, but when we compare the 2% to 4% versus the prior guidance is this all price or is there an assumption you're making about new launches in there as well that might have changed? I'd just like a little bit more color on bridging between the old and the new.
And then just a very quick follow-up on this issue of just debt pay down from here. Just might be helpful is there a target leverage ratio you need to get to post the Tysabri divestiture in order to keep investment grade rating? I think this might help us a little bit better under capital allocation priorities we just knew and where do you need to go on leverage at least in the near term? Thanks very much.
No, thank you. So I'll take the first part, and then Ron I think I'll pass the second part over to you if that's fair.
So the first part. On the business side, I would say when we look at the markets today the switch products the categories all of that we feel are very optimistic on our CHC business and feel good about that. But when we look at all the components that we try to lay out with store brand growing favorable consumer dynamics, new products. You can see pretty strong volume growth across the segment and that's close to 5% to 6%. So good volume growth. The plants are running well and those kind of things, we do expect when we put in year pricing headwinds and so we build into our model we expect pricing and make sure that we have the costs and other initiatives to do that for net growth 2% to 4%. So rather than bridging back there were certainly switching and that was also an old models in the past from big switches, as well as general growth dynamic depending on the time period that we were in, but as we look forward for the next few years we are looking to be able to grow, which I think in general will be out above the pace of the normal U.S consumer business within the pharmaceutical and healthcare we know that we operate.
Yes, I think I will take the question. I think you phrase that as the target kind a leverage metric, so you look - 2016 information but if you look at the LTM metrics as the you know 9-30 you can see the company's running somewhere called the high tree support range relative to debt-to-EBITDA. So you can sit back and say what are the companies policies, priorities, we talked about those, so again if you look at next year, we are looking at $560 million, I think the exact number is 557 million of maturity, again we talk about how we're using operating cash flow is our intense to pay that debt down, so to your question is to take up the balance sheet. So we're looking at close Tysabri by $2.2 billion in 20 days that we mentioned at our remarks.
Now again, at the [indiscernible] this in structure as we always look at the tax effect of the of the sale, look at what is the cost to pay debt down, you can run the models based on what debt is trading on today, do your own estimates but assume again for sake of discussion they're somewhere in the $2 billion to $2.1 billion there right, just to you kind of range. So what does that mean again I don't want to say every nickel and dime, goes the debt paid unless they were continuing to commit investment grade, we're continuing to work with agencies on our credit profile to ensure we continue marching down that path. If you take those numbers we are talking some more in the range of $2.6 billion to $2.7 billion of debt that would be paid out over the course of the year, you can run the leverage metrics, I don't think I need to do the math for you, so you can take the guidance, run off an EBITDA model, and then start saying what that metric come out to.
And your next question comes from a line of Douglas with Barclays.
Hi, good morning - good afternoon, thanks for taking my question. It feels like morning maybe, but I'm - just you know maybe going back to Chris's question then again you know I think in that sort of megatrends waymarked [ph] you used to put out he's got sort of highlights of the like population demographics, as well as the store brand penetration growth of 2% to 3%, which now seems to be you know 1%. You know again to sort of curious in terms of expectations in terms of store brand conversion, what it's sort of like to that change - I mean it is sort of new product introduction or it is just simply a reflection of where we are and cycle in terms of the economy and that perhaps consumers are feeling better there perhaps looking for to more or sort of more biased toward purchasing national brands.
Yes, I think again I'm trying to not down hold - downplay 2% to 4%, I realize we're going on the 5%, but 2% to 4% means with all of that volume going 5% to 6%, Store brand gaining certainly volume share, profitability being offset somewhere, just pricing go on what happened there but still good volume growth could share growth when you look overall at what we're doing. There are some consumer dynamic, we believe continue to go that way, those mega trends you talk about in my mind are still very much at work. You know we're all getting older healthcare costs are doing nothing but go up no matter what we want to talk about, having a value proposition for consumers when they go to get it, is a great thing, we believe all those work in our favor. At this point when we look at all of those balance together and say organically again organically with a portfolio of the R&D that we're doing, what we see we believe a thing that realm, that does not mean that there are other inorganic opportunities there to rise additional growth but we're talking about here just base organic growth would be portfolio and R&D, more cost per segment that we're operating in.
Okay. I guess John, in particularly focused on just why the OTC Store brand growth can be a little bit slower than what you had spoken about in the past, the company spoken about in the past.
Yes, so I think you know it all going back a couple years ago and saying here's what those dynamic were, I do good in laying out here is the dynamics today and got a lot organic growth I see and again there's still a fair amount of volume share, I do think be all the dynamics of growth, products switches all of those things lead us with this guidance, which again I feel is a very strong growing faster than segment, driving shares, doing those things performance. You can add on that [indiscernible], had some very good strong business.
Okay, great. Thank you.
Thanks, Doug. Last question, please.
And your final question comes from the line of Elliot Wilbur from Raymond James.
Thanks, good afternoon, appreciate your squeezing me in. Just want to come back to the Tysabri announcement, specifically question for Ron, is there anything you can say about the additional sales levels that would trigger the - The incremental step up in sales value there in terms of you know what those levels are. And then just a follow up to that in thinking about or try to model the company on a go forward basis new co obviously without the savage could have much higher effective tax rate, and looking at so the metrics you provided today coming up with an adjusted effective tax rate, excluding Tysabri royalty stream somewhere around 19% to 20% and just kind of a rough ballpark number one throughout out there and get some feedback on that, thanks.
Yes, you sure, you bet. So first the service - the effective tax rate; Elliot, you're in a stalling throw, I'm not going to say it right or wrong but take you in the window of acceptability, a relative to tax rate, we are not providing guidance on that today, we will certainly update our models to get that more details once we do close the transactions. So again within a stone's throw, listen we work with a partner were not disclosed in those terms and conditions, and we are not obligated to until we close, we like with all that that count until we get to that point, I think we will find is that a natural curve relative to Tysabri sales, it is always a bit outspread as you always know relative to any organic street model, so I don't want to predispose what's street numbers verses another, so it doesn't provide guidance so for me to go out there and start providing estimated revenues for the milestone now I don't this it is appropriate. So again we look at those, we understand what the metrics are, we worked our partner kind of what is the appropriate milestone for those sales thresholds, and again once that agreement becomes public we will provide more discussion at that point.
And again that's $250 million 2018, and $400 million in 2020, so as we discussed, so when they're due it's just the terms we will get once closed. Thank you everyone, I really appreciate your time and consideration, I appreciate it, thank you.
This concludes this conference call, you may now disconnect.
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