ABC
#Thanks, Steve, and good morning, everyone
We are now in the home stretch of our fiscal year 2017, and considering the healthcare environment that we operate in, we are pleased with our results after nine months
This morning, I'll provide a detailed review of our third quarter financial results, an update on our full year 2017 outlook, and then make some high-level comments around our thoughts for fiscal 2018. We finished slightly better than expected in the third quarter, with adjusted diluted EPS at $1.43, an increase of 4%
Despite some challenges in operating income in our Pharmaceutical Distribution Services segment, we are able to overcome these headwinds and still grow our adjusted EPS
I will review the segments a little later
Let's begin with our consolidated results
ABC revenues were $38.7 billion, up 5%, helped by solid unit volume growth across several of our businesses
As discussed in prior quarters, we again experienced a decline in year-over-year hepatitis C revenues of about 20%, causing a drag on our quarterly growth rate of about 120 basis points
The quarter's adjusted gross profit was down by about 1% to just under $1.1 billion
Our Other segment, which consists of global commercialization services and animal health, continued with its excellent growth
But this segment currently offsets the gross profit decline in our Pharmaceutical Distribution segment
Operating expenses, we continue to be laser-focused on spending in the right areas and leveraging our infrastructure
Overall, our OpEx was up about 2%
On a year-to-date basis, our positive expense trends have in part been related to effectively managing the opening days of several new distribution centers
As Steve mentioned, it was impractical to delay the openings any longer and we've now opened four state-of-the-art DC this year
The uptick in our third quarter operating expenses, including depreciation, is primarily the result of these openings
We will open one more DC in Q4 and the last two new DCs will open in early fiscal 2018. Operating income, our adjusted operating income was $471 million, down about 5%, with operating margins down 12 basis points due to the decrease in gross profit in our Pharmaceutical Distribution segment
Moving below the operating income line, income taxes, our adjusted income tax rate was 27%, down significantly from the prior year due to two primary drivers
The first tax item, as discussed on prior calls, we again recognize the benefit to income taxes related to the accounting rule change and share-based compensation
This benefit impacted our quarterly tax rate by roughly 2%
In the second and third quarters, our share price has been higher, which has resulted in a large number of employee exercises
Given the nature of the tax benefit, it is very difficult to forecast the timing of exercises and the ultimate impact to our tax rate and financials
The second tax item, in conjunction with our filing of our fiscal 2016 federal tax return, we finished our combined R&D credit and Section 199 tax projects with excellent first time results
We mentioned this work on our call last quarter
The tax projects contributed a tax benefit to the current quarter
However, about $10 million of the tax benefit was related to prior fiscal years, and is a discrete one-time item
Consequently, we had a non-recurring 2% tax rate benefit in the quarter or a positive $0.05 benefit to our adjusted EPS
Our adjusted net income was up roughly 2% to $318 million
We continue to find ways to grow despite headwinds and an evolving healthcare market
Our adjusted diluted share count decreased nearly 7 million shares or 3% year-over-year to 222 million shares
We did not repurchase shares during the June quarter as we repaid our $600 million of senior notes upon maturity in May
We have about $890 million remaining on our Board authorized share repurchase program
Wrapping up our consolidated results
In the June quarter, we had negative free cash flow of $354 million which was lower than anticipated due to its lower wind-down of extra inventory related to holiday timing and, to a lesser degree, the working capital impact from the new Prime JV business, which had a heavy brand drug inventory and sales mix
Our year-to-date fiscal 2017 free cash flow was a negative $248 million
Let me highlight, we continue to expect meaningful positive free cash flow in our Q4, similar to the cash flow performance we've had in Q4 of our last two fiscal years
We ended the quarter with roughly $1.3 billion in total cash, a little lower than normal due primarily to repaying the May senior notes and the inventory timing I just mentioned
Our total cash amount we held – of the total cash amount we held about $800 million offshore
This finishes our review of ABC consolidated results
Now let's turn to segment results, starting with Pharmaceutical Distribution Services
So segment revenues were $37 billion, up a solid 5%
Our independent customer segment had very good organic growth at nearly 7%
We continue to see the benefits of working with our customer buying groups to improve overall compliance rates, which has translated into reduced leakage
We have been able to demonstrate value to our pharmacy customers when they source a higher percentage of their generics from us
Because of these efforts, the business had another solid quarter of generic volume growth
Our ABSG specialty business, which primarily focuses on physician-administered drugs, had another strong revenue quarter, with growth of just over 10%, driven mostly by increased volumes
This is the 14th consecutive quarter of 10% or better revenue growth
We continue to see excellent revenue growth primarily in oncology, but also in several other therapeutic classes
Let me highlight one more time that the Distribution segment had a revenue headwind of about 120 basis points due to lower hepatitis C sales in the quarter
The good news, our hepatitis C revenues on a sequential basis, so between our March and June quarters, were flat
This is the first time in the last eight quarters that sequential hep
revenues did not decline
Segment operating income was $377 million, down about 9%
This segment benefited from the continued growth in our businesses that primarily service physician practices with specialty drugs, with income up just over 10%
The segment also benefited from overall brand and generic volume growth
However, the overall decline in the segment's operating income was caused by three meaningful headwinds
First, on the drug pricing side, the 2016 June quarter was the last quarter we had instances of impactful generic drug price increases
We had a nominal contribution in the current June 2017 quarter
To a lesser degree, we also had a headwind from lower brand inflation in the current quarter
Second, we renewed a key contract with Kaiser last year
This repricing was a gross profit headwind in the June 2017 quarter
As we enter the September quarter, this contract renewal headwind is now anniversaried
And the third item, we continued to experience lower throughput or shipments in our PharMEDium business
The business team is working diligently to complete the QC process
In addition to enhancing compliance, this will also lead to a superior quality offering and provide a further competitive advantage in the market
So, in summary, the segment continued to make progress in several key areas
But positive contributions weren't enough to offset the headwinds this quarter
We can now move to the other segment
This segment includes World Courier, AmerisourceBergen Consulting and MWI, businesses that focus on global commercialization services and animal health
In the June quarter, revenues reached a record $1.7 billion, up 11%
Our MWI and consulting businesses had revenue growth just over 10%
Our World Courier business had a record number of shipments in the quarter
And on a comparable basis, revenue growth in U.S
dollars was 7% or 10% in local currency
To provide a little more color on MWI we had a strong revenue quarter with comparable U.S
companion animal revenue growth of 11%, primarily from sales of new innovative drugs, organic growth with existing customers, and the addition of new customers
From an operating income standpoint, this segment had an excellent quarter with operating income of $95 million and a growth rate of 15%
We are especially pleased with the results this quarter of World Courier and Lash and Xcenda consulting businesses
This completes our segment review
Let's move to our full year fiscal 2017 expectations
With one quarter to go we are updating our guidance
Revenues, we are revising the full year growth rate to a range of approximately 5%
At this point in the year, we have a better understanding of market and customer dynamics, related manufactured drug pricing trends and scrip growth rates
Let me highlight it's a bit of an unusual year that we will have two less business days in fiscal 2017 versus the prior year
Moving to operating expenses, we continue to expect an overall increase of 2% to 3% in full year OpEx
Next, operating income
We now expect operating income dollar growth to be relatively flat versus fiscal 2016, primarily due to lower revenue growth, a slightly lower contribution in Q4 from brand drug price increases, and a slightly lower contribution from PharMEDium
Income taxes
Based on favorable year-to-date tax benefits and initiatives, we now expect that our full year tax rate will be approximately 31%
Adjusted EPS
We are now revising our full year guidance to a new range of $5.82 to $5.92, which reflects growth of 4% to 5% versus fiscal 2016. And we currently expect to end the year in the mid to upper half of that range
Free cash flow
We now expect to finish the year between $750 million and $1 billion in free cash flow
The $260 million litigation reserve that we highlighted in our press release and 8-K this morning is likely to be paid by September 30. Additionally, and to a lesser degree, we expect our cash flow to be negatively impacted by the investments related to onboarding the Prime JV business and lower overall revenues
That concludes our discussion on our full-year fiscal 2017 financial guidance
Looking ahead, while we have a strong handle on our business, our corporate process moving forward will be to provide comprehensive financial guidance at the end of the fiscal year
Our guidance needs to be informed by and reflective of the formal output of our completed business planning process
As Steve discussed, we are also working through our new ABC organizational structure
Consequently, we are still in the early stages of our fiscal 2018 business plan process
However, we are in a position to share some select commentary on headwinds and tailwinds
Starting with the headwinds
First, pricing
For brand inflation, based on the actual pricing activity to date, it's likely that the inflation rate we modeled for fiscal 2018 will be at the low end or slightly below our fiscal year 2017 range
For generic deflation, it's important to remember that deflation is a headwind that we have to work to offset, primarily achieved by increasing volumes
We have yet to see generic deflation ease from its current high single digits, where it's been for about three quarters now
We are still evaluating the probability of this continuing into fiscal 2018 as part of our planning process
Next, operating expenses
As mentioned previously, we decelerated the opening of our new DCs, minimizing the fiscal 2017 OpEx impact
This strategic phasing means that the fiscal 2018 related DC OpEx will be considerably higher
It's likely there will be a mismatch of new DC OpEx with any associated incremental revenues
Also, in relation to our reorganization, we are currently evaluating possible investments in IT systems
These investments may yield organizational benefits and efficiencies over time but would be a short-term headwind
Overall, we will be diligent in our strong management of OpEx, but we do anticipate a higher OpEx growth rate in fiscal 2018. The last headwind to call out at this point is taxes
We will see an increase in our overall tax rate as we expect the favorable benefit from employee option exercises to slow
Additionally, we have to lap certain one-time discrete tax benefits recognized to-date in fiscal 2017. And finally, as a reminder, the addition of any significant new U.S
business, like Walgreens' pending acquisition of the Rite Aid pharmacies, would change the mix of our pre-tax income and increase our overall tax rate
Let's close the fiscal 2018 discussion with tailwinds
First, revenues
Our customer base, which includes our strategic partner relationships, has us well-positioned to continue to grow in today's healthcare environment
This, combined with our leadership in specialty, differentiates us and will enable strong top line revenue growth
The next tailwind, compliance rates for our independent customers
We have made steady progress during the last 12 months reducing leakage and improving our market share
We expect to make further progress in fiscal 2018, but likely at a slower pace
Let me point out once compliance rates reach higher levels, it becomes increasingly difficult to capture incremental volumes especially since we aren't willing to sacrifice fair compensation
And the last tailwind, PharMEDium
As I mentioned, we anticipate that we will complete the quality initiatives this fiscal year
Customers are already seeing the value in our superior quality standards
We expect sales volumes and growth rates to ramp during fiscal 2018. Wrapping up my comments this morning, at this point, we expect the healthcare environment will be similar in fiscal 2018 to this year
We have shown our ability to execute within the current market
Therefore, we are uniquely positioned and we remain confident in our ability to grow our business in the coming year
As always, we continue to focus on achieving our core objectives: delivering outstanding service, solutions and value to our customers and also delivering long-term value to our shareholders
Thank you, and here's <UNK> to start our Q&A
Yeah, I would just add, Bob, quickly, I think it's important to remember, our deflation basket is unique to ABC
We may look at it differently than others
How we exclude launches, launches that lose exclusivity, and after a certain period, we exclude those
So again, everybody looks at us slightly differently
We have more than 15,000 SKUs broad-based
But as Steve mentioned, we're on the high end
And I think, it's important that for us, as we talk about fiscal 2018, it's still an open item
It's clearly one of the macro items that we're evaluating and is critical in terms of our plan assumption in 2018. So we are watching it and monitoring it
Yes, I'll – good morning, <UNK>, I'll start and Steve can jump in
I mean, we think it's really important to have our planning process complete and make sure that we're transparent and it's very comprehensive
We're just not in a position yet to do that
We have to finish our planning process
There are just a lot of moving parts
So at this point, we felt it was appropriate to call out headwinds, items that we think – headwinds and tailwinds, items that we think that we're monitoring, that are impactful
We're contemplating that we need to work through
That's really the best we can do at this point
But I would say also we're also working through the new organizational structure
So I think in a lot of ways, there are just several moving parts right now
And hopefully, we'll have better clarity on our top line revenue
I mean, I – just one more thing I'll say quickly is that revenue drives the P&L, it drives the cash flow
We need to spend more time looking at our top customers' revenue forecast
It could be organic or inorganic product mix
Pricing, that's critically important
So we still have a fair bit of work to do
And when we're prepared, which is at the end of the year, we'll provide full complete guidance
Just quickly so we can move along, I think, <UNK>, for 2017, one of the bigger impacts on revenues will just be in brand inflation
We do a large percentage in brand business and having that inflation move to the lower end of the range at just the sheer amount of dollars that we do is a big headwind, and that was a little bit of a moving target this year on where brand inflation would end
As we look forward to 2018, I mean I think our largest customer, strategic partner, Walgreens, I mean they're ramping up certain aspects – certain commercial business activities
And just like Prime, we'll have that commercial business for a whole year next year in 2018, so we'll have that benefit
But as we contemplate fiscal year 2018 and good solid revenue growth, we're not factoring in acquisitions or inorganic growth
It's just the full year impact of the organic growth
Yeah, I mean, I would say certainly, we're behind a little bit in terms of where we are for the year, where we thought we'd be for our third quarter, but most of that is timing and will reverse in Q4. We still expect pretty solid free cash flow for fiscal year 2017. I think it's important to really stress that
Just from a foundational standpoint, nothing's changed
We are a little bit lower in free cash flow this year in 2017 than we expected originally, but the core cash flow metrics are still all in place
So, I mean in terms of next year, I wouldn't say to call anything out
We expect we're still committed to our target
I think that's really important
We're still committed to our target of free cash flow add to about approximately 125% of adjusted net income, given the mix and how we expect to grow generics
So, I mean, I think, that's a real positive point to make to everybody
Thanks, <UNK>
Again, my comments that from earlier were definitely that we would see OpEx growth, I mean, we're going to be very mindful and do what we can, but we're going to have the full year impact of the DCs open
Some will still have the new DC and the old DC
We mentioned ABC Order, Steve mentioned Fusion, I mean, these are fairly large systems that, again, as you think about it, we bring on a new system and we still have the expense of the old system
So in many ways next year, we have some duplication and we don't have the full year benefit of gross profit or savings or revenues
So, there is – I call that a little bit of a mismatch
I don't think we're ready to tell you specifically, but we just know that we've done a terrific job this year and we're going to be up 2% to 3%, which is just outstanding for the company
We're just telling our investors in the sell side, as you think about 2018 in your model, just make sure you contemplate that it's going up because of these items
Yeah, let me just jump in here
The change in our cash flow guidance, free cash flow guidance for 2017 is strictly due to, one, the litigation reserve which we highlighted this morning, $260 million that we fully expect to pay and fund by the end of the year
And then almost equally is really the investment in the Prime business, which is heavy brand, and the cash conversion cycle just isn't as optimized as generics
So that's really the change of why we had to drop the free cash flow guidance for full year fiscal 2017.
Steve, I'll jump in and take the last one just about OpEx
Again, Ricky, I just can't be real specific at this point
We're still working through all that
But, I mean, year-to date, we were – through March, through six months, we were relatively flat on OpEx
This quarter, we were up 2%
In Q4, it's certainly going to be higher in order to glide into the 2% to 3% that we said for the year
So I mean – and again, a lot of the duplication from 2017 is coming in the second half or even late in the year
So, I just – the point is, you need to – as we communicate out externally and you model, you just – you need to just be thoughtful like we're being, in terms of next year it's going to be a little bit higher, certainly, as you think about our OpEx trend
Yeah, I'll jump in and say, <UNK>, I mean, Steve mentioned it, that capital deployment is critically important to us
It's certainly part of the equation to get back to that aspirational mid-teens
We – our balance sheet, we're in terrific position with our balance sheet
We've worked hard to do that, and we talked about earlier on the call, we expect to get back to a very solid free cash flow in 2018 and beyond
So we're going to be positioned very well to deploy capital to grow our business long term
Yeah, I don't – <UNK>, thanks
I mean we listed out the headwinds
We didn't necessarily put them in any type of rank order
There are items that we're looking at and evaluating, so I'd prefer probably not to evaluate them
But again, we're being transparent, we let you know what we're thinking about
In terms of generic deflation, certainly, there's a top 10 list that has higher deflation
The deflation that we see in our basket is maybe a little bit more broad-based
So, again, I think, we – in our comments I think we expected not to ease, at least where we're at right now, we don't think anything will change
We're still saying it's going to be in that 7% to 9% and not easing and not getting worse
So that's positive, it's stable, but still in that 7% to 9%
Oh, no, I – Steve, I just thought it's important to – I think, <UNK>, maybe you're asking just about a headwind or impacts, and we wouldn't expect – as we convert those over, we wouldn't expect to have a headwind and convert those – convert the economic or the fee-for-service
We provide substantial value to manufacturers and we believe we should be fairly compensated for that
And that's what we're always working to do
