AmerisourceBergen Corporation
Q2 2017 Earnings Call Transcript

Published: 4 May 2017

[Operator:]

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:]

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, www.amerisourcebergen.com. 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:]

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

[Tim G. Guttman:]

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

[Keri P. Mattox:]

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

[Operator:]

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

[Eric Percher:]

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:]

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:]

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

[Operator:]

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

[Robert Patrick Jones:]

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:]

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

[Tim G. Guttman:]

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:]

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

[Operator:]

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

[Steven J. Valiquette:]

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:]

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:]

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:]

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.

[Operator:]

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

[Ricky R. Goldwasser:]

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:]

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:]

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:]

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

[Operator:]

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

[Eric W. Coldwell:]

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:]

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:]

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:]

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

[Operator:]

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:]

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:]

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:]

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:]

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

[Operator:]

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:]

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:]

Thanks so much, Bob.

[Steven H. Collis:]

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

[Keri P. Mattox:]

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

[Operator:]

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

[Ross Muken:]

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:]

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:]

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

[Operator:]

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

[Charles Rhyee:]

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:]

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:]

Thanks, Charles.

[Operator:]

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

[Steven H. Collis:]

Hi, Lisa.

[Lisa Gill:]

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:]

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:]

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:]

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

[Operator:]

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

[David M. Larsen:]

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:]

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

[Tim G. Guttman:]

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:]

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:]

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.

[Operator:]

And ladies and gentlemen, today's conference will be available for replay after 10