AmerisourceBergen (ABC) Q2 2017 Results - Earnings Call Transcript

AmerisourceBergen Corp. (NYSE:ABC)

Q2 2017 Earnings Call

May 04, 2017 8:30 am ET


Keri P. Mattox - AmerisourceBergen Corp.

Steven H. Collis - AmerisourceBergen Corp.

Tim G. Guttman - AmerisourceBergen Corp.


Eric Percher - Barclays Capital, Inc.

Robert Patrick Jones - Goldman Sachs & Co.

Steven J. Valiquette - Bank of America Merrill Lynch

Ricky R. Goldwasser - Morgan Stanley & Co. LLC

Eric W. Coldwell - Robert W. Baird & Co., Inc.

Garen Sarafian - Citigroup Global Markets, Inc.

Robert Willoughby - Credit Suisse Securities (NYSE:USA) LLC

Ross Muken - Evercore Group LLC

Charles Rhyee - Cowen & Co. LLC

Lisa Gill - JPMorgan Chase & Co.

David M. Larsen - Leerink Partners LLC


Ladies and gentlemen, thank you for standing and welcome to the ABC Earnings Conference Call. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. As a reminder, this conference is being recorded.

And I would now like to turn the conference over to our first speaker, Ms. Keri Mattox. Please go ahead.

Keri P. Mattox - AmerisourceBergen Corp.

Thank you, operator. Good morning and thank you all for joining us for this conference call to discuss the AmerisourceBergen fiscal 2017 second quarter financial results. I'm 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 will 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 expressed permission of the company.

We remind you that there are uncertainties and risks that could cause our future actual results to differ materially from our current expectation. 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. I would also like to remind you that we have posted a slide presentation to accompany this morning's press release. You can find it at the Investors page of website,

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 inquiries as we can within the hour.

With that, I'll turn the call over to Steve. Steve?

Steven H. Collis - AmerisourceBergen Corp.

Thank you, Keri, and good morning, everyone. I'm pleased to discuss our solid second quarter results and AmerisourceBergen's continued execution within a challenging market. Revenues were up 4% to $37.1 billion and adjusted diluted EPS grew 5% compared to previous fiscal year period. There were three key drivers to note for our results this quarter: strong performance across our specialty businesses, good generics volumes growth, and strategic and disciplined management of operating expenses.

As a result of this solid performance, we are pleased to be updating aspects of our fiscal year 2017 financial guidance, including tightening our adjusted diluted EPS range as we feel well-positioned moving into the second half of the fiscal year.

I continue to be very proud of how AmerisourceBergen is successfully navigating and executing in today's healthcare environment. That execution is driven by the daily contributions of our more than 19,000 associates, so I do want to take a moment to thank them for their dedication and diligence on behalf of our company and our customers. These associates are the foundation of our compelling corporate culture and our success in making AmerisourceBergen a rewarding place to work.

Multiple news organizations have again named AmerisourceBergen or one of our business units on their list of best places to work. And DiversityInc recently named us as a 2017 Noteworthy Company, selecting us from a field of more than 1,000 firms evaluated. I believe and studies show that companies with diverse rewarding workplaces deliver better long-term results, so this is an important driver of company growth on many levels. Again, thank you to the AmerisourceBergen team for all that you do.

Next, let me take a minute to talk about the U.S. pharmaceutical industry, where AmerisourceBergen has strategically focused its business. While there are challenges, the U.S. pharmaceutical market remains well-positioned for the long term. Key drivers for growth include an aging patient population, an improving U.S. economy, a robust pipeline of new anticipated brand drug launches, and an increasing focus on the relationship between value and outcomes.

We see both resilience and continuing growth opportunities in pharmaceuticals and, importantly, we see a vital role for manufacturer and provider services to support the market expansion over time. So, against the backdrop of these market conditions and long-term opportunities, how do we view AmerisourceBergen's role within the broader healthcare landscape. We define that role with our company's new purpose statement, which I think is particularly important in today's environment.

At AmerisourceBergen, we are united in our responsibility to create healthier futures. Everything we do as a company ties back to this purpose. When we provide services and solutions that improve product access, increase efficiency across the healthcare system, and enhance patient care, all that is done to fulfill our purpose. The value we bring to manufacturers, providers and, most importantly, to patients helps fulfill that responsibility to create healthier futures.

Let's talk about how are we delivering on this responsibility and supporting the growth of our customers, while also creating value for our shareholders. We believe there are four key differentiators that set AmerisourceBergen apart and have positioned us for growth.

First, we believe we have the best customer base in the business. Our broad and diversified portfolio of growing customers across all our businesses performed well in the second quarter. We enjoy long-standing collaborative relationships with our anchor customers and they continue to be among the best positioned companies in the industry for long-term growth.

Walgreens Boots Alliance remains a strong and aligned partner, and we look forward to continuing to expand our relationships to deliver value. We expect to add the AllianceRx Walgreens Prime business in June of this year. Although, the profit contribution will be immaterial this fiscal year and we continue to be optimistic about the future addition of Rite Aid, we are also seeing impressive growth across all other key customers, several large community oncology practices and MWI's largest customers.

Additionally, as recently announced, we entered into a five-year strategic contract with Express Scripts for their brand business through 2022. This is a key win for AmerisourceBergen and an illustration of the strong relationships we're able to build with our customers.

For the past five years, we worked hard to be the best possible partner and provide the highest levels of service and value to the Express Scripts team. We are proud that those efforts resulted in a new long-term contract agreement and we are excited to continue to collaborate with Express as a distribution service partner of choice.

In the last year, our Drug Corporation has also discussed two important customer initiatives and we are making progress on both. First, our efforts to improve compliance and expand our share of wallet within our existing customer base are yielding results and helping us to grow our generics volumes. We've sharpened our focus on reducing leakage and on providing our customers with the tools they need to realize the greatest business benefit of buying within their Prime Vendor Agreement.

For example, our investments in Good Neighbor Pharmacy member services are helping to optimize front-end sales. We are providing access to business coaching, manufacturer promotions and new reporting tools that incorporate point of sales data. GNP also entered into a five-year partnership with the National Community Pharmacists Association to produce a series of educational seminars for members. Early response to those services has been extremely positive. We've had 50% growth in the past 12 months across our GNP premier level membership.

Second, we are making progress with our Drug Corporation customers on our effort to rebalance our contracts and specialty pricing strategies to better reflect changing market trends and shifts in product mix. This rebalancing effort is one we've embarked on over a year ago and we have made significant progress. Our customers understand the value this restructuring brings in and we continue to establish mutually beneficial adjustments.

Throughout AmerisourceBergen, we have the strongest customer base in the industry. We bring the philosophy to be innovative, integrated and indispensable to our customers. We are proud to offer the most advanced and business critical services and solutions to help our customers most efficiently navigate the reimbursement landscape and actively support their growth, especially in a tough healthcare environment. The strength of our business is reinforced by the high quality of our customers and our ability to develop these long-term collaborative partnerships. Working together to advance and enhance patient care, it is always our goal to create customers for life.

Our second differentiator is our leadership position in specialty, which puts AmerisourceBergen at the forefront of a rapidly growing market segment. We are very proud of our long-standing leadership in specialty. I should note that when we refer to our leadership here, it includes our market leading position in full-line distribution within our drug company, specialty distribution through our ABSG business and our service offerings to specialty manufacturers ranging from pre to post commercialization support.

AmerisourceBergen has a history of strategic investment and leadership in specialty. And in the second quarter, we continued to grow our footprint and capabilities. 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 with many products for customers across multiple sites of care including hospital, health system and community pharmacies. For example, we are seeing strong growth in hospital and health systems use of biosimilar that recently became available in full-line distribution.

In the second quarter, our ABSG specialty distribution businesses delivered very strong results with revenue growing double-digits year-over-year. This is the 13th consecutive quarter with that level of growth for this business. Our strong operating income growth was driven by overall volume increases, new drug introductions, expanded indications for existing products and good expense leverage.

Our market-leading patient support services, biopharma consulting businesses, and clinical trial logistics businesses provided by Lash Group, Xcenda and World Courier also continue to make important contributions in supporting existing and newly launched specialty products. With our market-leading franchises, AmerisourceBergen is a clear leader in the commercialization, market access and patient support of specialty drugs. We are proud of our trusted partner status and 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 helping to drive our customers' growth. We at AmerisourceBergen know that we are a healthcare services company. Our value lies in offering our manufacturer and provider customers the most innovative and business critical services and solutions they need to advance their business and drive their growth.

Customer adoption of our innovative offerings has been strong, and we believe that is enabling us to grow within our existing customer base now and in the future. For example, our Consulting Services continues to lead the market and demonstrated very strong growth in the fiscal second quarter. We now have more than 5,000 employees in Consulting, working with all top 20 pharmaceutical companies and more than 150 manufacturers in total.

Manufacturer services are key to our differentiated upstream value proposition and we continue to grow the breadth and scale of our offerings. The value we provide through our product commercialization services and our consultant strategic approach was just reaffirmed to our senior management team at the National Association of Chain Drug Stores industry meeting when manufacturers called out to us the unique strength of AmerisourceBergen.

Another area where we are investing is our design of state-of-the-art distribution centers and our implementation of innovative IT solutions. To improve the customer experience and enhance capacity and operational efficiency, we are strategically building our new state-of-the-art distribution centers for our Drug Corporation business. In the second quarter, we brought our Olive Branch, Mississippi center fully online, both on time and on budget. Olive Branch employs the most leading-edge technology in our industry and is now the largest distribution center in our network. We're excited by the improved capabilities these investments provide and how they position AmerisourceBergen for the future.

On the IT front, we are currently building out a new robust technology platform to better support our Lash Group patient services. We're also continuing the phased rollout of our ABC Order platform; a state-of-the-art customer experience and e-commerce system designed by pharmacists for pharmacists that provide the intuitive tools to order effortlessly, manage inventory, access data and information, and resolve any issues quickly. Both of these business critical system investments remain on budget and on track for full implantation.

In addition, in January we rolled out a new order analytics module through our Swiss analytics platform, Certio, with generics manufacturers as the initial target. This module offers manufacturers unprecedented insight into the order fulfillment cycle. Order shipment and receiving align for more proactive daily managing of service and inventory levels. The module is an industry-first innovation and demonstrates our commitment to providing increased transparency and incremental value to our manufacture partner through analytics.

There are several other information system projects and programs underway across our business, all aimed at increasing efficiency and effectiveness while improving our customer engagement. All of these IT initiatives are examples of why AmerisourceBergen is the trusted data company in our industry. We plan to continue to invest in data solutions, analytics and internal and customer-facing IT capabilities to maintain and grow that position.

And finally, our fourth differentiator is our strong history of financial stewardship and proven ability to integrate acquired businesses, which together gives AmerisourceBergen an advantage in driving growth. AmerisourceBergen always takes the strategic approach to capital deployment. We are focusing on investing in the business, strong expense management, building long-term durable growth, and creating significant value for shareholders.

We are proud of our ability to integrate our acquisitions smoothly and enhance growth across those businesses. For example, a growth driver in our March quarter was the contribution from our strategic acquisition of MWI Animal Health. MWI delivered another record revenue quarter led by excellent customer retention, strong growth in the U.S. companion pet market, and its doubling of the number of corporate accounts in the past year.

Additionally, we are strategically increasing our investment in PharMEDium to support its continued growth. We are committed to the highest levels of product quality and patient safety and, therefore, are enhancing PharMEDium's QA and QC systems. This supports batch level finished product testing prior to product release.

The initiative will enable us to deliver the highest levels of product quality and patient safety, while also creating a compelling competitive advantage. These efforts do mean that we will ship fewer units and incur incremental costs as we focus on optimizing the QA systems, resulting in slight bottom line headwind for the business in fiscal year 2017, but we are excited about the progress being made here.

Turning to our capital deployment priorities, in the near term, as we've previously communicated, we are planning to pay down our $600 million in debt due this month. Over the longer term, we continue to approach capital deployment strategically and opportunistically and our priorities are as follows.

One: invest in the business. As I mentioned earlier, we are continuing to invest in infrastructure and quality assurance processes and to enhance our services and solutions product offerings all to better serve our customers and drive organic growth.

Two: strategic M&A. We are always evaluating ways we could further add to our value proposition and grow AmerisourceBergen through the addition of best-in-class and market-leading businesses. We are interested in enhancing our broad range of core capabilities to better upstream and downstream customers and build on our proven track records on M&A and success.

Three: share repurchases. We are open to and have board authorization for continued buyback of AmerisourceBergen shares, and we will repurchase when we believe it is the optimal way to build shareholder value.

And finally, four: dividends. We remain committed to providing shareholders with a reasonable dividend.

In summary, we believe AmerisourceBergen is clearly differentiated, strategically focused and delivering undeniable value to our customers and the overall healthcare industry. We remain resilient and have continued to execute in the fiscal second quarter despite market challenges. We remain committed to enabling the growth of our customers, serving patients and delivering value to our shareholders, and we are moving forward with a clear and defined purpose, unified and united in our responsibility to create healthier futures.

Now, let me turn the call over to Tim for a more in-depth look at our quarterly financial results and our updated financial guidance. Tim?

Tim G. Guttman - AmerisourceBergen Corp.

Thanks, Steve, and good morning, everyone. We have now reached the halfway point of our fiscal 2017 and we are pleased with our results to date. We're off to a solid start despite the challenging healthcare environment. This morning, I will provide a detailed review of our second quarter financial results and then provide an update on our full year outlook.

We finished slightly better than we expected in the second quarter with adjusted diluted EPS at $1.77, an increase of 5%. Our growth was the result of the continued strong performance of our ABSG specialty business as well as the portfolio of businesses we have in our Other segment. We also benefited from having a lower tax rate and a lower diluted share count.

I will review the segments a little later, but let's start with our consolidated results. ABC consolidated revenues were $37.1 billion, up 4%. Our Pharmaceutical Distribution Services segment accounted for more than 90% of our revenue growth due to our customer mix, volume growth and the strength of our ABSG specialty business.

I should point out we previously expected the headwind from declining hepatitis C revenues to subside this quarter. However, this wasn't the case, and we continued to experience a sizable negative revenue impact. As a reference point, excluding hepatitis C, our revenue growth would've been roughly 5.5%.

The quarter's adjusted gross profit was essentially flat at $1.2 billion. Our Other segment, which includes our manufacturer and other services businesses, had strong growth, but this segment couldn't offset the gross profit decline in our Pharmaceutical Distribution segment, which continues to cycle through the re-pricing of two previously discussed strategic long-term contract renewals.

Operating expenses. We continue to leverage our infrastructure and manage our expenses tightly. Overall, our OpEx was up just over 1%. At the halfway point in our fiscal year, all of our five primary business groups are beating their operating expense business plans. So we remain disciplined, driving efficiencies without sacrificing customer service or investment.

Operating income. Our adjusted operating income was $588 million, down about 1% due to our Pharmaceutical Distribution segment being down. Our adjusted operating margin was 1.58%, down 8 basis points from the prior year, again, driven mostly by Pharmaceutical Distribution segment being down 10 basis points.

Moving below the operating income line, other income, net: this quarter, we recognized about $5 million of income primarily from the January gain on sale of the U.S. ground business of World Courier, which we decided was a non-strategic asset. Interest expense, net, was about $35 million, up just slightly from last year.

Income taxes. Our adjusted income tax rate was 30%, down from the prior year. Importantly, the tax rate was lower than what we expected for this quarter by roughly 2% because of two items. The first tax item: due to the new accounting rules regarding share-based compensation, we recognized a fairly large benefit or credit to income taxes related to employee stock option exercises during the quarter.

When we prepared our operating plan and provided guidance for the fiscal year, we assumed that any corresponding tax benefit would be recognized ratably or equally each quarter due to the difficulty in forecasting the timing and number of option exercises. It's likely that we will realize a significantly lower tax benefit from stock compensation in the second half of our fiscal year.

The second tax item: we recorded a few discrete state income tax expenses that totaled about $4 million this quarter. So, in summary, the favorable 2% net reduction in our quarterly tax rate provided a benefit to our adjusted EPS of approximately $0.05.

Our adjusted net income was up roughly 1% to $391 million, solid results in spite of the contract renewal headwinds and a challenging healthcare market. Our second quarter diluted weighted average shares outstanding decreased 8 million shares or 4% year-over-year to 221 million shares. We did not repurchase shares during the March quarter as we position ourselves to repay our $600 million note coming up in the middle of May.

We have $889 million remaining on our board authorized share repurchase program, and as we have said in the past, we will continue to consider opportunistic share repurchases in the context of our overall capital allocation strategy.

Wrapping up our consolidated results, in the March quarter, we had positive free cash flow of $673 million as a result of cycling through the normal inventory build from calendar year-end. Let me highlight that, during the quarter, we did complete the final working capital investment with our largest customer, Walgreens.

Our year-to-date fiscal 2017 free cash flow was $106 million. Looking forward, we expect free cash flow to be nominal in our third fiscal quarter due to seasonality and holiday timing, and then to increase significantly in our fourth fiscal quarter. We ended the quarter with roughly $2.4 billion in cash, with $715 million of this amount offshore. This finishes our review of ABC consolidated results.

Now, let's turn to our segment results, starting with Pharmaceutical Distribution. Total segment revenues were $35.5 billion, up a solid 4%, with our drug company growing just under this level. Our drug company business experienced solid revenue growth in its retail customer segment, which includes independents, Walgreens and other chains.

Specifically for independents, a key customer group, our drug company continues to focus on capturing the appropriate share of wallet, which means improving compliance rates and reducing leakage. Because of these efforts, the business had another quarter of solid generic volume growth. And wrapping up, as I mentioned earlier, the drug company was noticeably impacted by the headwind from lower hepatitis C revenues.

ABSG, our specialty distribution business, had another double-digit revenue increase quarter with growth of 11%, driven mostly by volume. We continue to see excellent revenue growth primarily in oncology, but also in nephrology, MS, and specialty drugs for orphan diseases. Segment operating income was $482 million and was down just under 4%.

ABSG continued their high level of performance, growing revenues and gross profit while reducing operating expenses, a perfect formula for operating income growth. However, as we anticipated, our drug company was down year-over-year due primarily to the headwinds in gross profit from the two customer contract renewals we announced last year.

Additionally, as Steve mentioned, drug company also had a lower income contribution from PharMEDium as we begun to implement enhanced QC processes, including batch level finished product testing.

In the March quarter, PharMEDium shipped fewer units and incurred incremental costs as testing increased and wasn't yet fully optimized. There were several positives for the drug company in the quarter, including a better-than-expected contribution from higher generic volumes and lower operating expenses versus last year. Unfortunately, these positive contributions weren't enough to offset the largely expected headwinds this quarter.

We can now move to our Other segment, which includes World Courier, AmerisourceBergen Consulting, and MWI Animal Health. Businesses in Other primarily focus on value add, higher margin manufacturer services. In the March quarter, revenues were $1.7 billion, up 6%. Let me highlight that last year's results included the World Courier U.S. ground business that was subsequently sold in January 2017. So excluding the ground business, on a comparable basis, all three of our businesses had revenue growth rates in the high-single digit percentage range.

Our MWI business had another fantastic quarter with U.S. companion animal comparable revenue growth at about 9%, primarily from the sales of new innovative drugs, growth within the current customer base and also market share gains.

From an operating income standpoint, this segment had an excellent quarter with operating income of $106 million and a growth rate of 13%. All three businesses contributed meaningfully to the dollar growth this quarter. This completes our segment review.

Now, let's turn to our updated fiscal 2017 expectations. Revenues: we are revising our full year guidance to 5.5% to 6.5% revenue growth. This means we expect to end the fiscal year with revenues in the range of $155 billion. We are still forecasting stronger second half revenue growth, which includes sales to the new AllianceRx Prime Walgreens business. We will begin servicing this business late in our June quarter.

Our overall revenue guidance is lower than we previously expected. The drivers of the change are primarily, one, a continued headwind from the slowdown in hepatitis C revenues, and two, brand drug that have been holding onto market share post generic launch are now converting to the lower price generics at a higher rate than we previously forecasted, dampening our top line. Let me highlight importantly that the majority of our forecasted revenue change is from lower brand drug sales, which have a lower gross profit impact to ABC and the lower revenue forecast is not the result of any significant customer losses.

Moving to operating expenses, we are revising our guidance to a 2% to 3% increase in full year operating expenses. Our businesses have been successful in leveraging efficiencies and managing cost appropriately. I should note that we have been successful also in reducing the expected ramp of expenses as sales growth has slowed a bit and we decelerated the opening of several of the new distribution centers due to the updated timeline for the Walgreens acquisition of Rite Aid.

Next: operating income. We now expect operating income dollar growth to be flat to up 2% versus fiscal 2016. This is due to the change in our revenue and operating expense guidance ranges, as well as a change in our expected contribution from PharMEDium.

As I mentioned earlier, the business is investing in enhanced QC testing. As a result, we will experience a slight headwind primarily in our third quarter, because we won't be at full production levels, while optimizing the new quality procedures. This investment positions PharMEDium to be the trusted high quality partner for our customers and creates an even stronger competitive advantage.

Income taxes. We now expect that our full year tax rate will be approximately 32% due to our improving mix of US versus international income that benefit from the account rule change relating to stock compensation and the anticipated benefits we expect to receive from completing our R&D tax credit project.

Adjusted EPS. As I mentioned before, we are pleased with our solid second quarter results and we are now revising our adjusted EPS guidance to a new range of $5.77 to $5.92, which reflects growth of 3% to 5% versus last fiscal year.

As we think about the next two quarters and our adjusted EPS cadence, since we had a large tax benefit from stock compensation in Q2, this means we will most likely have a lower tax benefit in Q3 and Q4 versus how we originally guided. Additionally, the temporary slowdown in PharMEDium's growth will also be a slight EPS headwind. Because of these two items, we expect adjusted EPS in our third quarter to be now relatively flat to last year and our fourth quarter to have solid growth compared to last year.

Let me point out that the rest of our previously communicated fiscal 2017 financial guidance for ABC consolidated is unchanged and reaffirmed at this time. As we have done in the past, we are also providing our working assumptions for the pharmaceutical drug pricing environment. I will cover generic drug pricing first.

We are still comfortable with our minus 7% to minus 9% generic deflation range for fiscal 2017 at this time. Through April 30, based on our specific generic drug portfolio and mix and our fiscal year, we remain at the high-end of our deflation range. This is a key assumption, so we will continue to closely monitor generic deflation and provide update each quarter.

Moving to brand drug pricing, we remain comfortable with our 7% to 9% brand inflation rate assumption based on the data through the seven months ended April 30. Compared to the same period last year, we have seen a shift to lower percentage price increases, especially to increases under 5%. Because of this and historical trends, we continue to anticipate that we'll have a modest level of brand price increases in the June-July time period. Given the unpredictability of brand pricing and generic pricing actions, we continue to have a somewhat wider adjusted EPS range at the halfway point of our fiscal year.

In closing, we're pleased with our second quarter performance. We continue to focus on consistent execution and our core objectives, taking care of our great customers by delivering everything they need every day, providing value-add solutions to enable our customers to run their businesses successfully, investing in the right areas of our business with a focus on efficiency, remaining disciplined with expenses, and driving long-term growth.

As we move into the second half of our fiscal year, we look forward to updating you on our progress.

Thank you, and here's Keri to start our Q&A.

Keri P. Mattox - AmerisourceBergen Corp.

Thank you, Tim. Operator, we're ready to begin the Q&A portion of the call. Can we have the first question, please?

Question-and-Answer Session


And we do have a question from the line of Eric Percher with Barclays. Please go ahead.

Eric Percher - Barclays Capital, Inc.

Thank you for all the detailed guidance today. I have a question with respect to revenue and maybe gross margin as well. If I look back to last quarter when we showed 4%, you still felt pretty confident about the high end of the range and it sounds like hep C was the major item that you called out. As I consider the other items, the conversion of products, how significant was that in the reduction of revenue? And then, how did these run through to your expectation of gross margin, at least qualitatively, relative to where we sat last quarter?

Tim G. Guttman - AmerisourceBergen Corp.

Hi, Eric. Good morning. It's Tim. Yeah, the revenue, we did call out last quarter. I think the difference this quarter, I would say, just market factors. I want to repeat that it's not related to customer losses, it's market factors. Hep C – in the script, in the beginning call, we called out that impacted us about 1.5%. That continues. I think we had a disproportionate share of the business. We benefited on the way up and now we're seeing the headwind on the way down.

But the other item that we called out that's meaningful also, probably a little bit less than the hep C from a percentage standpoint, is the branded generic conversions. We just had a number of brand drugs that hung onto share, and we saw the change in this quarter. And again, I'm talking about brand drugs like a NEXIUM, CRESTOR, GLEEVEC, and again, those converted. That's not in our control. We don't manage when they convert and when that decision is made to convert. That's a market factor.

And I would say, in terms of how they impact the margin, I would say that, in all cases, we don't keep that generic. In some cases, we keep the generic and, in other cases, we don't. We don't keep that sale. And then, because these are older generics also that have been on the market for a while, they're past the exclusivity period and we don't benefit from the higher margins. So, again, a generic is always good for us, but it doesn't mean it's at a high margin or that we even retain the generic revenue.

Keri P. Mattox - AmerisourceBergen Corp.

Operator, can we move on to the next call, please?


And we do have a question from the line of Robert Jones with Goldman Sachs. Please go ahead.

Robert Patrick Jones - Goldman Sachs & Co.

Great. Thanks for taking the question. I guess around generic pricing, and I wanted to focus more on the sell side part of the equation, one of your competitors lowered their outlook recently, citing a still very challenging competitive pricing environment, particularly in the retail independent segment. So, I was curious if you could just maybe give us an update on what you're seeing in that channel currently and just if you think about the outlooks that have been significantly reduced over the last couple of quarters. Just wondering if you think we're kind of at an equilibrium within that customer cohort.

Steven H. Collis - AmerisourceBergen Corp.

Yeah. I'll start off, Bob. Thanks for the question. Again, our competitors – I think, in many ways, of course, we live in the same environment, but we have lots of differences in our businesses, including capital deployment and generic profile. We're not big, for example, on the spot market, telemarketing, tough (38:51) businesses. I think there also may be some differences in the way that we measure that index now as well, at least we heard on the call recently. So our forecasting method has remained constant.

Tim said we are at the top-end of the range and we most certainly are, and we'll have to see how – it's a very fluid market, the generic market, you know as well as I do. And the key determinants are the higher price, the drugs are – the higher priced generic drugs are subject to more competition. Currently, that's an area where I think manufacturers are seeing opportunity, and we could see some more pressure, but right now, we're holding onto that high-end of the 7% to 9% range.

Tim, you want to add...?

Tim G. Guttman - AmerisourceBergen Corp.

Yeah, and I would just say, to remind everybody, that our minus 7% to minus 9% is based on our acquisition cost and how we track it. It's specific to our generic mix, our customer mix, our fiscal year. I think that's important. But also, on the sell side, Bob, we haven't seen a meaningful change. It's always competitive, but we're certainly just focusing on what we can control, which is growing our share of wallet with our existing customers.

Keri P. Mattox - AmerisourceBergen Corp.

Thanks, Bob. Brad, can we move on to the next question, please?


And we do have a question from the line of Steven Valiquette with Bank of America Merrill Lynch. Please go ahead.

Steven J. Valiquette - Bank of America Merrill Lynch

Thanks. Good morning, Steve and Tim. So, just a quick question around the SG&A. I guess it's pretty impressive that you found ways to further tighten the operating expenses despite simultaneously spending to potentially ramp for, let's say, additional Rx volume, mainly Rite Aid, some time in your fiscal 2018.

I guess my question is, I'm just curious to hear more about what some of the sources are of the lower operating expense savings that you're incorporating into the remainder of fiscal 2017. Is it mainly personnel costs or are there other sources of savings that you've found within the overall company? Thanks.

Steven H. Collis - AmerisourceBergen Corp.

It started last year when we go through our planning process. We start that around May every year with it being a September year-end, and recognizing that we weren't going to have the robust industry trends that we had experienced in the past couple of years. And Tim and I spoke to our business heads, and we really instituted some strict expense policies.

And ABC had had a pretty good couple of years and I think there were opportunities. We felt there were some opportunities to take some expenses down. Our team is fantastic. Our culture is very receptive to providing good returns to investors. So I think we were very cautious, and it's worked out probably even better than we expected. The expense control has been impressive. Hopefully – certainly to ourselves and, hopefully, to all of you as well.

Anything to add, Tim?

Tim G. Guttman - AmerisourceBergen Corp.

No, I think we're focused on it and we're looking at – we're certainly not eliminating positions that are customer facing and/or create significant value, but there are always opportunities to be more efficient, and that's what we're looking at. We're in a tough healthcare environment, challenging, and our businesses know they need to respond to that.

Steven H. Collis - AmerisourceBergen Corp.

Yeah. It's also the first quarter we hadn't lapped. We didn't have any new acquisitions that we hadn't lapped. It's the first quarter where everything had been lapped, so. Thanks, next question, please.


And we do have a question from the line of Ricky Goldwasser with Morgan Stanley. Please go ahead.

Ricky R. Goldwasser - Morgan Stanley & Co. LLC

Yeah. Hi. Good morning and congrats on a good quarter. I just kind of had one follow-up and one question for you, Steve. So, on the M&A priorities, can you just talk about what areas you see as an opportunity? I know that, historically, you always talk about increasing the touch points with manufacturers, but can you help us, kind of like frame it? Are you looking for assets that you can leverage on top of existing relationship of manufacturers or expand beyond kind of like that base capabilities that you have?

Steven H. Collis - AmerisourceBergen Corp.

It's actually, in a couple of months' time, I saw Mick Besse, and it's almost 20 years since we bought Besse Medical, and Lash Group was also 20 years ago. And so, we've had a history, and I think a lot of our management team comes from the specialty group. We've had a history of adding in businesses that expand our services, but are very tied to pharmaceutical care. We absolutely regard businesses like Lash and Xcenda as core businesses.

We've talked a lot on this call about our investments in Lash. It's our biggest people business and we detailed the number programs we're doing. So we do regard that as an area of strong capability and strong interest. Again, those markets, those businesses, are not as well developed outside the U.S. In the U.S., we have very high market share and very strong customer relationships and a lot of opportunities to deploy capital to be more efficient. So that's often how we think about it.

So areas of focus for us are international specialty, which is an emerging area. We look at a lot of companies. We start with – FCPA is critical to us and the type of partners. We've learned a lot from our pro forma experience, so I think that's very illustrative to us. And one thing we believe we've done very well there is choose our partners. We've done really well with the specialty JV. Innomar in Canada is another good example of success that we've had where we are leading the specialty market there. So those are the sort of characteristics of a market we like.

MWI is – certainly, one of the reasons they joined ABC, is for international development, and we've done some in the U.K. Jim and his team are very active. I think we'd be disappointed if, in the next few years, we didn't get something done there. We think there's opportunities and we have technology to deploy particularly on the lot feeding production side, where the customers seem to be very sticky and we think, as land becomes more scarce, there will be a trend towards lot feedings. So that's something.

Those are some of the key themes. Tim has one thing he wants to say, no?

Tim G. Guttman - AmerisourceBergen Corp.

No, I just – no, that was well said and I just – we've always been consistent, Steve, and we've always been pharmaceutical centric and that's the primary focus where we can add value to a provider or to a manufacturer. That's always going to be first and foremost how we view M&A.

Keri P. Mattox - AmerisourceBergen Corp.

Ricky, thanks so much for the question. Brad, can we have the next question in queue, please?


And our next question comes from the line of Eric Coldwell with Baird. Please go ahead.

Eric W. Coldwell - Robert W. Baird & Co., Inc.

Hey, thanks very much. I might have two quick ones here. First off, on PharMEDium, frankly, I'm a little surprised that it would get this much attention on the call for some QA and QC investments, but is it a stretch to think that what's really happening here is maybe you're buying some equipment from a company like Charles River and you're implementing new systems in the facilities like a microbials testing machine? Is that what's going on here and it's just causing some disruptions as you get those implementations done?

Steven H. Collis - AmerisourceBergen Corp.

First of all, the business is ahead of what our acquisition model is. I would say we had an exceptional first year there. And I think this year, we're strengthening the team. We're happy with Jenn Adams, who's leading that business for us and was the Head of Sales and she's had a long history of the business, what she's doing. We called it out because we've had some reduction in the quantities that they are producing and it's because of some very, really, ahead of the market, ahead of legislation procedures that we've decided to adopt around testing.

But we're doing all that internally. It's certainly nothing – I haven't heard of a connection with Charles River or anything. It's just really making sure we stay ahead of the quality curve, making sure we stay ahead of regulators. We are several times the size of any other competitors in that space and, of course, the regulators look to us to set the standard. So that's absolutely what we're doing and we feel good about the quality and the competitive edge that AmerisourceBergen and PharMEDium have, and we think our customers have also been very, very supportive. So we like the business and we continue invest in it.

So, I think that covered all your questions. Tim?

Tim G. Guttman - AmerisourceBergen Corp.

No, I think, Steve, PharMEDium has been great. We think they're operating really well. We just felt it was really important to say that we're going to continue. We're going to continue to make an investment in the company and it's – certainly, our customers care about product quality and we care about product safety, and we're telling people that we had maybe a little bit of disruption, and we will in the second half, but this is going to make us even better going forward.

Keri P. Mattox - AmerisourceBergen Corp.

Thanks so much, Eric. Brad, do we have the next question in queue, please?


We do have a question from the line of Garen Sarafian from Citigroup. Please go ahead. Mr. Serafian, your line is open. Please go ahead with your question.

Garen Sarafian - Citigroup Global Markets, Inc.

Good morning, Steve and Tim. On generic deflation, it's a key metric, so to give us a better sense with half a year left in guidance, if you were to assume low-double digit deflation on generics, what would it do to your guidance?

Steven H. Collis - AmerisourceBergen Corp.

Yeah, Garen, that's tough, right? Anytime you look at one key – it is a key assumption and we track it, but it's hard to look at anything in isolation. In any business you're going to have puts and takes, you're going to have things go in different ways. But we have a $0.15 range. We felt that was important in the second half of the year because of brand pricing and generic pricing. So I really – certainly, that would be a headwind, but we'd have to see how it fits in with other puts and takes.

Tim G. Guttman - AmerisourceBergen Corp.

Yeah, but it would change our – Garen, we certainly don't think – we feel good about the $5.77 and, again, that's the low-end of our range even if generic deflation changed a few percent. We are into May, so we feel good about our assumptions.

Keri P. Mattox - AmerisourceBergen Corp.

Brad, can we have the next caller in the queue, please?


We do have a question from the line of Robert Willoughby with Credit Suisse. Please go ahead.

Robert Willoughby - Credit Suisse Securities (USA) LLC

Hey, Tim, somewhere in your guidance, I'm sure you gave cash flow guidance. Can you give us specifically what the expectation is for this year? And I know with the Walgreens deal you had some new working capital requirements associated with that. Are there any changes with the Express Scripts relationship? Have they changed your working capital terms at all?

Tim G. Guttman - AmerisourceBergen Corp.

No, but I'll hit the second part of your question. With the new agreement, same terms, no change, no impact on working capital. And just to remind everybody, our full year free cash flow guidance was to be approximately adjusted net income or just slightly above. And again, there is some seasonality in the business, we see it because of the holidays; pretty kind of modest in Q3 and then up in Q4, which is kind of similar to what we saw last year.

Keri P. Mattox - AmerisourceBergen Corp.

Thanks so much, Bob.

Steven H. Collis - AmerisourceBergen Corp.

Yeah, we knew a cash flow question was coming, Bob.

Keri P. Mattox - AmerisourceBergen Corp.

Brad, can we the next caller in the queue, please?


We do have a question from the line of Ross Muken with Evercore ISI. Please go ahead.

Ross Muken - Evercore Group LLC

Good morning, guys. I just wanted to dig back on Express. Seems like a nice timing for you in terms of getting that five-year renewal done. Can you just talk a little bit about, given all of what they have going on, kind of the scope, potentially, of expanding that partnership in places where you may be able to provide them incremental value, particularly on the sourcing side as they'll obviously, potentially, go through a pretty meaningful transition during the timing of the contracts? I just want to understand how many incremental things you can do more for them versus what you're currently doing today.

Steven H. Collis - AmerisourceBergen Corp.

Well, we are very proud. You'll recall that when this contract was signed first time five years ago, we really came from well behind to become the combined Express Scripts and Medco distributor. That was – we were very proud of that at the time and we're proud to continue. I think we were disappointed that we didn't get called wickedly good again on the press release. We thought that was a really neat adjective. But I think that we had some other great descriptions, future derisked, or.... So we struggle to keep up with the eloquence of our CEO colleague, my CEO colleague at Express Scripts.

But the agreement is largely as it was before, no big changes on terms. We were very mindful, of course, of changes in mixes which you'd expect us to do and is a theme with all of our customers from big to small, how the mix would change and what sort of contemplation of newer therapies like biosimilars, maybe cell-based therapies, but this framework gives us an opportunity to partner in really any category, and that's what we're excited about and there's also lots of good business reasons for us to work with Express on, say, networks, et cetera. We continue to do that. And we're really proud that they selected us and also for a five-year term, which we think is very significant with a company that is so scaled in our industry.

So that's about all I'd say. Tim? No? Next question, please.

Keri P. Mattox - AmerisourceBergen Corp.

Yeah, thanks so much. Brad, we can move to the next caller in the queue.


And our next question comes from Charles Rhyee with Cowen. Please go ahead.

Charles Rhyee - Cowen & Co. LLC

Yes, hey, thanks for taking the question. Steve, I want to just go back to some of your earlier comments when you talked about the Good Neighbor Pharmacy partnership with the Community Pharmacists Association, and you made some comments about the increase in the Premier Jim team member growth.

I couldn't recall what you said, was it a 15% increase or 50% increase? And I guess the question is how does that then translate into the, I guess, the margin profile of those customers as they move into that upper level? And how does that affect Amerisource's business, particularly in generics? Thanks.

Steven H. Collis - AmerisourceBergen Corp.

You know what? Thanks for the question. We talked a lot about how robust the generic sales were. In fact, we now have over 4,500 GNP and Elevate customers. And that's, I think, one of the key things that Tim and I judge our management team on is, we're making these investments, what's it doing in the marketplace? And we are really pleased with how Elevate and GNP Premier are progressing. Part of the CPA renewal was to bring all their members onto Premier level membership.

Our view is certainly one that may be it could be a little bit biased, but we believe it that GNP Premier members are more successful. We have data to show that. They're more integrated with us and we have peer-to-peer information that could show they're the most successful pharmacy. And we believe they're the most reliant customers. They're customers we don't have to worry about on compliance, et cetera.

So we had a very good quarter with independents and we expect it to continue. But growing within our customer base and increasing that market share, so we've had very nice pickup on compliance and part of that is tools and part of it is emphasis. In my experience, if you point sales people in the right way and tell them what you want to accomplish, and we've been very clear that we expect to get compliance out of the contracts that we have, that we've signed and we think are very fair to our customers. So probably that's all to say there. Next question, please?

Keri P. Mattox - AmerisourceBergen Corp.

Thanks, Charles.


And we do have a question from the line of Lisa Gill with JPMorgan. Please go ahead.

Steven H. Collis - AmerisourceBergen Corp.

Hi, Lisa.

Lisa Gill - JPMorgan Chase & Co.

Hi, good morning. I just wanted to go back and just follow-up on your thoughts on the overall competitive market on the independents side. It's just – Steve, it just really sticks with me right now that what you're saying just seems to be very different than what we've heard from some of the other competitors. So can you at least just help me to understand two things?

The first would be you've been talking about compliance rates. Do you feel that your contracts, perhaps, are different than some others in the market and you have higher compliance, so therefore, there's not as much spot market or other competitive factors that are driving that? And then, secondly, when you think about that independent market, do you think of, beyond compliance, is there something else that's making your customer that much more sticky?

I just want to understand, is what you're seeing only what's going on with Amerisource or are we starting to see stabilization and perhaps somebody like a Cardinal's catching up? I just want to understand that side of what's happening in the business right now.

Steven H. Collis - AmerisourceBergen Corp.

Yeah, I think two years ago, one buying group switched, and we've talked about that a lot. And again, the buying groups, it's tough for them to switch because it is a shared relationship and most of us have had those customers for a long time. So we've been talking about this for a long time. It's competitive. It's always been competitive.

I think we face competition amongst our peers. We also face competition with reimbursement rates and making sure that our customers can stay in networks. And I always talk about this that we have three key missions at AmerisourceBergen in terms of smaller customers, and that's community veterinarians, community oncologists and retail pharmacies, and our goal there is to help them be successful as independent businesses and looking at all the forces that they have to contend with.

So, think about a standalone business and how do we help them? So that's why we do GNP and Elevate, that's why we do business coaching, and we do these type of things, clinical programs, we do these type of things across all three businesses. And one of the things that brings me great interest and satisfaction is when we can look at combined programs that benefit each of those groups, and we're seeing that a lot. Obviously, there's enormous differences between, say, an oncologist and a veterinarian, but there's a lot of things that they have in common, and we work on that, and we have a lot of shared experience.

But I would also say we've got a lot of good mobile tools now, so those reps that go out on the field, they do have key data points that they can share with customers about how compliance benefits them. We've worked very hard with our buying group customers, the management of those buying group customers to say we've been transparent, we're giving you the great price, this is how compliance benefits both of us. This is what we expect to get. This is what best in class looks like, and I think that that's been very productive.

And then I go back to those suite of services and solutions, the customers are realizing value, and I think that that becomes a self-fulfilling prophecy. As they realize the value, they become more adherent and we do better through that.

So it's always been competitive. We haven't picked up any new buying group customers. Some of our buying groups are growing, but nothing exceptional. We are really pleased with the pickup in compliance rate, but we're not complacent. We think there's more. We want to see that compliance rate be in the 90%s, so that's our long term goal.

Tim G. Guttman - AmerisourceBergen Corp.

Yeah. I think just to add one thing, Steve. Again, to give kudos to our drug company, they've really – we've talked a lot about Elevate and we've invested there, so we've really made key investments. I think it comes down to focus by the drug company and investment by the drug company on Elevate and we're just big believers that it's service, solutions and the price in the market is the price, but you compete and win on service and solutions.

Keri P. Mattox - AmerisourceBergen Corp.

Yeah. Great point. Brad, I think we have time for one final question.


And that final question comes from the line of David Larsen with Leerink. Please go ahead.

David M. Larsen - Leerink Partners LLC

Thanks for squeezing me in. Can you talk a bit about the Prime contract? What led to the win there? When does it roll on to your platform? Can you sort of roughly size how much revenue that will add to your book? Is it mainly mail? And then, also I think Prime has a preferred retail relationship with Walgreens, I would think that you'd be picking up a lot of the retail volumes as well. Any more color there would be very helpful.

And then, also the $3 billion in specialty business that Prime recently won from CVS, when does that roll on? Thanks a lot.

Steven H. Collis - AmerisourceBergen Corp.

Yeah. So, we'll start servicing Prime next month, so it's really more of a fourth quarter event. A lot of it is specialty. The Alliance JV, Prime Alliance JV is mainly specialty products, and we were expecting it. And I think the relationship we have with WBA is enormously successful, and we have incredibly close interaction with them, and we expect that business that comes into their orbit becomes ABC business, and that's why we did the 10-year agreement, we did WBAD, the warrants, et cetera.

All of these were planned out four years ago, and we're proud as to how it's working out in the real world, and it is over four years now into that relationship. And we've been proud to help WBA grow, and make sure that anybody they bring into their sphere significantly becomes an ABC customer as well. So that's really been the goal, and that's what we're seeing with Prime.

Tim, do you want to just – anything on the top line volume that we've come to expect (61:35)?

Tim G. Guttman - AmerisourceBergen Corp.

No, we're not going to size it. Again, it starts in June, and we'll have it, like Steve said, for most of fourth quarter. And just Steve mentioned, it's primarily specialty, specialty brands, so it won't be a big impact on the year this year, but certainly will be a better benefit going forward in 2018.

Keri P. Mattox - AmerisourceBergen Corp.

Brad, thank you so much. I think, at this point, we're through the call queue, and I'd like to turn it back over to Steve Collis to make some closing remarks for the call this morning.

Steven H. Collis - AmerisourceBergen Corp.

Yeah. Thank you, everybody. Thank you for the questions. Our prepared remarks are a bit long, so we appreciate your attention, but we're just very proud of the quarter. I think we are achieving so many of our goals, say, in generic compliance and the technology deployments, and we also are very proud on the softer side of the recognition we're getting in areas like diversity. Internally, the purpose, united in our responsibility to create healthier futures has been very well received, very uplifting, and again, AmerisourceBergen proves to be a great place to work, a great place to partner with and a great place to invest in.

So many thanks for your time today.


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That does conclude your conference for today. Thank you for your participation and for using the AT&T executive teleconference service. You may now disconnect.

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