美源伯根 (ABC) 2016 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the ABC earnings call.

(Operator Instructions) As a reminder, the conference is being recorded.

I will now turn the conference over to our host, Barbara Brungess.

Please go ahead.

Thank you.

Good morning, everyone, and thank you for joining us on this conference call to discuss AmerisourceBergen's March quarter fiscal year 2016 results.

I am Barbara Brungess, Vice President - Corporate and Investor Relations for AmerisourceBergen.

And joining me today are Steve Collis, Chairman, President and CEO of AmerisourceBergen; and Tim Guttman, Executive Vice President and CFO of AmerisourceBergen.

During the conference call today we will make some forward-looking statements about our business prospects and financial expectations including without limitation revenue, operating margin and taxes.

Forward-looking statements are based on management's current expectations and are subject to uncertainty and change in circumstances.

We remind you that there are many uncertainties and risks that could cause our actual results to differ materially from our current expectations.

For a discussion of some key risk factors and other cautionary statements, we refer you to our SEC filings including our Form 10-K for fiscal 2015 as well as our quarterly and other filings with the SEC.

We will also 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.

AmerisourceBergen assumes no obligation to update any forward-looking statements or information which speaks as of their respective dates, and this call should not be rebroadcast without the express permission of the Company.

Those connected by phone will have an opportunity to ask questions after our opening remarks.

We have a lot of material to cover this morning, so our comments will be slightly longer than normal, but we will leave ample time for questions.

Now here is Steve Collis.

Thanks, Barbara, and good morning, everyone.

Let me start by saying that while we delivered solid performance in our March quarter, we are disappointed that the forecast we have elected for the second half of our fiscal 2016 and our preliminary expectations for fiscal 2017 fall below our historical rate of performance.

Nevertheless, I remain optimistic about the long-term prospects for our industry and our Company and we are well-positioned with the right customers and the right portfolio services for both pharmaceutical manufacturers and healthcare providers to drive long-term value creation for our shareholders and other stakeholders.

Certain areas of our business are performing very well, including both of our recent acquisitions, MWI Veterinary Supply and PharMEDium.

Our specialty group, including the distribution businesses that serve physicians and our consulting businesses, had a very strong March quarter.

In addition, we recently achieved two key customer renewals or extension in AmerisourceBergen Drug Corporation, including a three-year extension with our strategic long-term partner, Walgreens Foods Alliance, and a one-year extension with Express Scripts, our second largest customer.

[ABDC] is, however, being adversely impacted by several factors, including accelerating deflation on generic drugs and a lower contribution from generic launches.

These unanticipated trends have exacerbated the expected impact from a shift in product mix towards lower-margin and higher-priced specialty and branded drugs as well as the lack of generic inflation we discussed in our Q1 call.

As we work through these challenges, our overall earnings growth rate will slow somewhat.

Tim will discuss the March quarter results and walk through our detailed guidance for the second half of fiscal 2016 and our preliminary expectations for fiscal 2017, then I will outline the ways we intend to take advantage of the long-term opportunities that are in front of us, before we open the call to Q&A.

Now here is Tim.

Thanks, Steve.

Good morning, everyone.

Consistent with past quarters, my remarks this morning will focus on our adjusted results.

Please note that all financial comparisons are for the second quarter and at March 31, 2016, compared to the same quarter of the prior fiscal year, unless otherwise noted.

Also let me point out that after this quarter we fully anniversary the impact of adding MWI to our consolidated financial results.

My comments will be a little lengthier this morning, as I have a fair amount to cover in three primary areas.

First, I will recap our fiscal Q2 consolidated and segment performance.

Second, I will cover our revised fiscal 2016 expectations.

And third, I will provide some brief commentary on how we're thinking about fiscal 2017.

Even though it's early, we will provide initial thoughts in a few key areas.

With that, we can begin our fiscal Q2 review.

Revenues were $35.7 billion, up 9.3%.

Our pharmaceutical distribution segment continued to account for the majority of our revenue, due to our diverse customer mix.

Our two acquisitions, MWI and PharMEDium, combined accounted for roughly 2% of our consolidated revenue growth.

The quarter's adjusted gross profit increased 12% to $1.2 billion.

The dollar growth was due to our two acquisitions, MWI and PharMEDium.

Our Pharmaceutical Distribution segment, specifically the drug company, was challenged this quarter with a difficult comparison.

They continue to experience headwinds from contract renewals and lower generic inflation.

Operating expenses -- our total adjusted OpEx and 18% to $575 million.

Roughly 80% of the increase was related to our two acquisitions.

Excluding the incremental OpEx impact from these two companies, our comparable OpEx growth rate would have been about 4%.

As you have come to expect from ABC, we are prudent with expense spending.

This has always been one of ABC's core operating practices and it will remain so going forward.

Operating income -- our adjusted operating income was $592 million, up about $40 million or 7%.

Our adjusted operating margin was 1.66%, down 3 basis points from the prior year, driven mostly by the Pharmaceutical Distribution segment being down 8 basis points this quarter.

Moving below the operating income line, interest expense net was about $31 million, up significantly from last year, due entirely to the financing costs of the MWI and PharMEDium acquisitions.

Income taxes -- our adjusted income tax rate was 31.3% for the current quarter, down from the prior year.

This quarter's rate includes one-time rate benefits of 1.4% from adjusting our estimated year-to-date tax rate, specifically related to the expansion of our international operations, which are taxed at a lower rate.

We now expect our full-year tax rate to be approximately 33%.

For the quarter our adjusted diluted EPS increased 16% to $1.68, driven mostly by the income from our two recent acquisitions and, to a lesser degree, from our lower consolidated tax rate.

Our adjusted diluted share count was about 229 million shares, down some from last year.

This finishes our review of ABC consolidated results.

Let's move forward and discuss our segment results, starting with Pharmaceutical Distribution.

Total segment revenues were $34.2 billion, up nearly 8%.

Our drug company had a growth rate of about 6%.

This growth was net of a revenue headwind of about 2% due to lower hepatitis C sales in the market and also a transfer of certain oncology sales to our specialty business.

Drug company had solid growth across its chain customers including Walgreens, and also in their hospital segment.

Our specialty business group had another outstanding quarter with revenue increasing about 18%, driven mostly by volume growth.

Similar to last quarter, we continue to have meaningful revenue growth through the sale of oncology drugs across a few of our businesses and also from the sale of ophthalmology drugs in our [best C] medical business.

IGS, our third-party logistics business, accounted for roughly 20% of specialty's revenue growth, primarily due to a new manufacturer relationship they added late last year.

This is our eighth straight quarter of double-digit revenue growth for our specialty group.

We continue to be very pleased with their performance.

They clearly help to differentiate ABC from the rest of the market.

Moving to gross profit, the segment's gross profit was $882 million, up about $33 million or about 4%.

The majority of the growth in gross profit dollars was in our drug company, specifically to benefit from PharMEDium.

Excluding the acquisition benefit, drug company was behind last year's gross profit due to the headwinds I called out previously, the tough comparison on drug price inflation and contract renewals.

Segment operating income was $498 million and was up 2%.

Our specialty business continued with our high level of performance, offset by the lower performance of our drug company.

Before I finish on the segment, let me comment this was our first full quarter of reporting PharMEDium.

Financially, they are contributing better than we expected as a result of strong operational performance.

For the quarter, volume growth as a percentage was in the midteens.

The business has integrated especially well into the drug company.

We're off to a great start with PharMEDium.

We can now move to our Other segment, which includes MWI, Consulting Services and World Courier.

In the March quarter, segment revenues were about $1.6 billion, up significantly due to adding MWI.

As a reminder, our March 2015 quarterly results included about five weeks of MWI's operating results.

Growth in just consulting and World Courier combined was about 13%.

These businesses continue to grow their topline revenue, primarily as a result of providing additional services and growing volumes with existing customers, which is a clear indicator of customer satisfaction and value.

MWI continues to perform especially well, percentage revenue growth in the Companion Animals segment in the low teens, and we saw a nice recovery in the Production Animal segment with percentage revenue growth in the high single digits.

From an operating income standpoint this segment had operating income of $94 million.

MWI contributed a significant amount of the dollar increase.

Our Consulting business also had excellent income growth in the quarter.

The segment's operating margin was down about 60 basis points.

This is a result of MWI becoming a much larger percentage of the result and having a lower margin in comparison to the two other businesses within the Other segment.

During the March quarter we celebrated the one-year anniversary of acquiring MWI.

We want to thank Jim Cleary and the entire MWI team for an outstanding first year.

We continue to be impressed with the passion and knowledge their associates demonstrate every day, partnering with their customers and the manufacturers.

And, importantly, the MWI business has outperformed our first-year financial expectation.

They are on strong footing and on track to deliver the long-term returns we anticipated.

I'd like to switch over now and cover a few key working capital and cash flow items.

In the March quarter we had solid free cash flow of $790 million.

This quarter historically has been our strongest cash quarter of the year as we cycle through the seasonal inventory build from calendar year end.

At March 31 we had roughly $2.5 billion in cash on our balance sheet.

This includes roughly $400 million offshore, related primarily to our World Courier and Switzerland businesses.

During the quarter we purchased 1.1 million shares of our stock for about $100 million under our regular share repurchase authorization.

As noted in this morning's press release, we announced that our Board authorized a new regular share repurchase program that, together with the availability under the existing share program, permits us to purchase up to $750 million of our shares.

Also back in mid-March we filed an 8-K announcing that Walgreens exercised their 2016 stock warrants through our hedging program.

As we committed, we successfully offset the EPS dilutive impact from the 23 million shares issued to Walgreens.

In conjunction with its hedging program, the Company -- through an investment bank -- executed call options to purchase ABC shares.

The funding of the call option transaction was not entirely completed in the March quarter.

We paid $218 million to the investment bank in the March quarter, and the remaining amount of $483 million was paid to the bank in April.

Moving to our revised fiscal 2016 expectation, I must acknowledge that revising our adjusted EPS guidance downward a second time is very disappointing to us.

Adverse market trends centered around generic pricing have become more acute than we anticipated and a strategic initiative to offset some of these pressures has not yet yielded the results we expected.

While generic inflation has been phenomenal, the rate of generic drug deflation is slowly increasing.

And it is higher than the level we previously expected in fiscal 2016 and expected to get slightly worse by year end.

This is driven in part by the increased supply of generic product in the channel.

While we are protected from inventory losses on deflationary products, it is difficult to continue to earn the same gross profit dollars on decreasing prices.

We have had some success in being made whole through new incentives or rebates or by increasing generic sales volumes, but we're not always 100% successful in achieving this.

Combined with this, our gross profit contributions from new generic launches are decreasing as brand manufacturers increasingly find ways to protect and retain market share.

Additionally, after several years of a stable branded generic revenue mix in our drug company business, this trend is starting to reverse.

As more lower-margin brand specialty drugs ship primarily to hospitals and specialty pharmacies through full-line distribution in our drug company, these revenues do not currently provide enough gross profit dollars to overcome the decline in generic drug gross profit.

With regard to our strategic initiative, our drug company about a year ago set forth on a strategic initiative to grow its independent retail business and, in conjunction with this, grow PRO Generics's revenues.

The business and new management and additional resources, made investments and innovative programs and aligned internal incentives.

We expect to see meaningful progress in our June and September 2016 quarters from these investments and efforts.

While we are making progress, the financial contribution is ramping slower than anticipated.

Based on the two headwinds that I've covered and the negative impact from previously disclosed contract renewals, the drug company's fiscal 2016 operating income will be lower on a year-over-year basis, even with PharMEDium included.

Our revised fiscal 2016 P&L guidance is as follows.

Revenues we are now guiding to ABC consolidated revenue growth of approximately 8% for the full fiscal year.

Operating income -- we expect growth in consolidated operating income to be in the range of 5% to 6% as a result of the lower second-half expectation and lower than expected performance of our drug company.

Included in this growth is the benefit from measures we plan to take to reduce our expense structure going forward.

Adjusted EPS -- we now expect our fiscal 2016 adjusted EPS to be in the range of $5.44 to $5.54, which is growth of 10% to 12%.

As I just highlighted, our EPS range includes the benefit of several cents from expense reductions we will be implementing in the second half of this fiscal year.

I'd like to now cover our revised guidance on free cash flow and also share repurchases.

This morning, we issued a separate press release announcing our contract amendment with our largest customer, Walgreens.

As we disclosed, we have entered into a three-year contract extension with our anchor partner through both the distribution agreement and a generic sourcing agreement.

In the past we have disclosed that this customer accounted for about 30% of our consolidated revenues.

In our view, there are a few customers that have both the scale and growth profile like Walgreens.

The relationship, now in its fourth year, exceeded our initial financial projections and has provided an excellent return to our shareholders.

In exchange for the extensions, we agreed to make additional working capital and infrastructure investment during the next several months and also into fiscal 2017.

Some of these investments, including carrying extra inventory to maximize service levels, have recently started.

Because of these working capital investments we are now revising our free cash flow guidance to $1.9 billion to $2.1 billion for the full year.

And this now includes the tax benefit from the 2016 warrant exercise.

For share repurchases, using a portion of the cash from the warrant exercise, we expect to increase our repurchases, which will now total between $350 million and $450 million.

As always, share repurchases are subject to change, depending on market conditions, our second half of the year cash position and other competing capital needs.

The third and final topic I want to cover this morning is commentary on our fiscal 2017 outlook.

Since we changed our assumptions around the second half of fiscal 2016, we thought it was important to provide a preliminary look at next year, fiscal 2017.

Revenues -- we expect our consolidated revenue growth to be slightly better than the market.

Operating income -- the headwinds I called out related to the second half of fiscal 2016 will continue well into fiscal 2017.

Also we do expect to have headwinds from both the Kaiser and CTA contract renewal for half of the fiscal year.

Consequently, our drug company's operating income is expected to be up just slightly.

And this includes a solid growth from PharMEDium.

Adjusted EPS growth -- we expect growth in the range of 4% to 6% from the midpoint of our revised fiscal 2016 guidance range.

I should highlight that the 4% to 6% adjusted EPS growth is net of a 3% headwind from the incremental expenses to support key business investments in IT systems and infrastructure.

These investments support our growth, drive customer satisfaction and further increase our operating efficiency.

We expect to realize meaningful expense savings from these incremental investments of at least $30 million annually beginning in fiscal 2019.

The preliminary view of our fiscal 2017 outlook includes several key assumptions, as follows.

One, we are expecting generic drug deflation to be in the high single digits by fiscal year-end 2016.

And more importantly, we are forecasting that generic drug deflation will stay in this range for the entire fiscal 2017.

Two, our tax rate will be slightly lower in fiscal 2017.

Three, we have limited capital deployments in our adjusted EPS range.

We plan to complete enough share repurchases to offset stock option exercises.

Four, that we retain Kaiser, an important customer of the drug company.

Five, we are not including any new business resulting from our relationship with our largest customer.

Six, we have not included any impact from the proposed CMS Medicare Part D reimbursement proposal, as it is too early to ascertain the likelihood that this will be successfully implemented.

And seven, we are not assuming a meaningful contribution from biosimilars.

Moving to the free cash flow preliminary guidance and cash availability -- as I mentioned earlier, we have agreed to make working capital investments.

As a result of the Walgreens contract amendment, the working capital impact is greater in fiscal 2017 and fiscal 2016.

Also the impact primarily affects the first half of our fiscal 2017.

We anticipate that our capital spend will increase as we invest in our drug distribution network, due to age of the network and also to increase capacity.

Additionally, we are making key IT platform investments in our Consulting and World Courier businesses.

Both have older systems that are inefficient and costly.

As a result of these investments, we expect that our free cash flow in fiscal 2017 will be approximately equal to or just slightly below our adjusted net income.

And an important point -- once we cycle through the impacts from the Walgreens working capital investment and the higher CapEx in fiscal 2017, our aspirational goal in fiscal 2018 and beyond will be to have free cash flow of at least 125% of net income each year, assuming over time we maintain our current terms with customers and suppliers.

From a cash availability standpoint I should mention that we expect our offshore cash to continue to accrete in fiscal 2017 as a result of our international businesses.

The final item I will cover is the future exercise of the 2017 warrants.

Because of our hedging strategy we are fully covered from any potential adjusted EPS dilution when our share price is $88 or lower.

We will certainly monitor this as we progress towards the exercise window, which is March 2017 to September 2017.

As a reminder, roughly 60% of the warrant proceeds will be used to exercise our cap call options with the investment bank and purchase shares needed to successfully complete the hedge.

The remaining proceeds are expected to be used to repay the 2017 bond that we originally issued in connection with the hedging program.

As I close my comments, we are on a different trajectory for the remainder of fiscal 2016 and also for fiscal 2017 than we had originally anticipated.

However, we are well-positioned to navigate through a challenging environment, drive efficiencies and thoughtfully deploy capital in a matter that drives long-term shareholder value.

Now I will turn it back to Steve.

Thanks, Tim.

As we look ahead to the second half of our fiscal year and into next year, there is no doubt that we have some challenging work ahead as we navigate the headwinds that Tim outlined.

But I am certain that we have the right team in place not only to meet this near-term challenge but also to ensure that we do not lose sight of the many long-term opportunities that are ahead of us.

Let's look at each of the foundational uses of our business more closely.

We are very fortunate to be heavily weighted to the US pharmaceutical industry, where the organic market growth rate is expected to be 7% to 8% over the next several years.

This is an extremely significant benefit that our industry enjoyed.

And all US wholesalers are beneficiaries of this market growth, especially to the extent that it is being driven by demographics and improving access to care.

Market growth in the US is also driven by new brand product introductions, both in more traditional therapies and in innovative specialty products and, to a lesser extent, by branded drug inflation.

Of course, going forward there will be less erosion at the top line from new generic launches.

The large US wholesalers together comprise the most efficient distribution network in the world and provide tremendous value to the pharmaceutical supply channel.

AmerisourceBergen has distinguished itself within this accomplished group with this portfolio of services for specialty and biotech manufacturers and for the healthcare providers that administer these innovative products.

We are the global leader in the distribution of specialty drugs and these products are vital to all of our customers.

The economics of specialty products vary depending on the channel in which the product is administered or dispensed, whether the product is covered by the medical or pharmacy benefit and the extent to which we can add value for the manufacturer and the provider.

In most cases the best economic opportunity for ABC is with the products that are administered by physician that is treating a patient in a community setting, because that is where we can provide the most value to both the manufacturer and the provider.

While the prices of some of these specialty drugs get a lot of attention, we should not lose sight of the fact that these products treat extremely serious illnesses.

In many cases, they are life-saving products or life-changing drugs that make a previously intractable disease manageable.

While we certainly understand the need to manage the cost of care, the physicians and other healthcare providers who treat the sickest patients should not themselves be economically harmed, simply by choosing the best available therapy for their patient.

As someone who has been working around community physicians, including oncologists, for over 20 years, I want to comment specifically on CMS's proposed demonstration project on [part] B drugs.

There is little evidence, if any, that physicians are systematically and inappropriately prescribing expensive therapies.

The proposal ignores the reimbursement challenges physicians already face on many part B medications such as those that remain in place as a result of sequestration.

The costs to administer the products and to care for these patients are significant, and the unintended consequences of further reductions should be carefully studied because it is the patient that will bear the ultimate burden both in terms of the economics and in terms of the quality of their lives.

We are hopeful that the issues of the proposal will be addressed and that it will not be implemented in its current form.

Turning back to our business, the portfolio of services we offer applies broadly to potentially all pharmaceuticals, and going forward we will move to a price model that is more balanced between generics and brand products.

Today the basic logistics of warehousing and distributing the products is the bedrock of what we do.

And additional services we provide have greatly differentiated our place in the market.

We can meet the needs of pharmaceutical manufacturers and healthcare providers at virtually every point in a drug's lifecycle, from the clinical trial phase through commercialization of the brand and into patient and product support for mature therapies and eventually through the launch of generic or biosimilar versions of products.

The portfolio of offerings we have built over the last decade will be even more important in a market that is laser-focused on value and cost efficiency.

Solid organic market growth and the right portfolio of services are critical components of increasing revenues.

But to take full advantage of those cornerstones we need to be aligned with the right customers, and this is another area where I believe we excel.

AmerisourceBergen has an unparalleled group of marquee customers with whom we have established long-term relationships.

As both Tim and I mentioned earlier, we are thrilled to extend our innovative and highly successful partnership with Walgreens Boots Alliance, and we look forward to continuing to reap the mutual benefits of this unique and collaborative relationship well beyond the original 10-year term.

This relationship has greatly benefited both parties and has financially exceeded our expectations.

I am also pleased that Express Scripts has decided to exercise their option to extend their current contract for an additional year.

We have been working with this market-leading pharmacy benefit manager for the last four years and we continue to look for new ways we can partner together to drive value for the long term.

We now have several of our largest customers in each of our key segments under long-term contract, and we hope that we will soon be able to say the same about Kaiser Permanente.

Over many years we have deliberately chosen specific customers whom we believe would be on the cutting edge of pharmaceutical care and therefore grow faster than the market over the long run.

In addition to the three customers I already mentioned, we renewed our largest independent GPO customer, CPA, during the quarter.

And of course, have our largest government contract, the Department of Defense, also on a long-term contract.

This strategy has already paid dividends and will continue to do so for many years to come.

Our focus on high-quality customers is not limited to just the very largest in the marketplace.

We have extensive relationships with prudent drug retailers, institutions and other types of healthcare providers of various shapes and sizes and have long been champions of both independent community pharmacies and of specialty physicians in community practice, for example.

We will continue to make investments to ensure that we meet specific site-of-care needs as well as to serve providers who integrate offerings across different channels.

And I think that AmerisourceBergen is the best positioned in the market to deliver meaningful innovation in these areas.

Another key customer group is, of course, our pharmaceutical manufacturer partners.

Our extensive array of manufactured services businesses are another meaningful differentiator for ABC, and these businesses are and will continue to be among the fastest growing in our Company.

Whether we are working on clinical trial logistics in World Courier, working on reimbursement and commercialization strategies within our consulting business or supporting patient assistance programs built around some of the more complex therapies, I believe the suite of services will only become more valuable in the future.

As manufacturers must demonstrate value and comparative effectiveness and patient adherence becomes more exceptional and less exceptional and complex biosimilars are launched into the marketplace, AmerisourceBergen will be the partner of choice.

Serving customers well is absolutely required in today's market, and we must continue to do so in the most efficient manner possible.

While our expenses have increased in recent years and will continue to rise somewhat as we integrate our recent acquisitions and make some additional investments in our informational technology systems and other infrastructure, I want to assure you that we remain focused on being the most efficient operator in the industry.

As cost pressures increase across the board in healthcare, it is even more important that we manage our own with an increasingly higher degree of precision than we have done historically.

We have always skillfully run lean operations.

This is an area where we need to apply even greater creativity and sensitivity to what needs to be done to meet the needs of customers and where we can strip out unproductive expenses.

This is a process that never ends, and it is important to remember that investments we are making today will ultimately lower our cost of doing business in the future.

As we grow our revenues, efficiently run our operations and cycle through the working capital investments that Tim discussed, we expect to be able to generate strong cash flow over the long term.

This has long been a hallmark of our business and is one of the key ways in which we have driven shareholder value.

We remain committed to being excellent stewards of capital.

And as I mentioned earlier, we expect to continue to have a balanced approach to deploying our cash going forward.

Our track record in this area is very strong.

We have had successful internal projects like BluePoint, the NDC -- National Distribution Center, and more recently [Serlio].

In addition, we have made very successful strategic investments in three market leaders -- World Courier, MWI Animal Health, formerly Veterinary Supply and PharMEDium.

These three large acquisitions have strengthened our business in key areas, and all of them have exceeded our expectations in terms of operational and financial in performance and have yielded important strategic benefits.

Looking ahead, we will continue to look for high-quality assets in the pharmaceutical channel that have great potential to deliver long-term value.

In addition, of course we will continue to return funds to shareholders through dividends and share repurchases.

In the near term we remain committed to offsetting the potential dilution from the exercise of the 2017 warrants, and over the longer term we will be as thoughtful and resourceful with our capital deployment as we have always been since the inception of AmerisourceBergen.

In summary, while we are disappointed in our near-term forecast, I hope all of our stakeholders share my great conviction and confidence in our AmerisourceBergen franchise.

Our management team, our portfolio offerings and our collaborative and entrepreneurial spirit has never been stronger.

As I have said on many occasions, while we focus on delivering short-term results we are obsessed with delivering long-term performance that reflects ABC's excellent position, thought leadership and customer focus.

Ultimately, it is our dedication to continuous improvement, the quality of our offerings, our seamless execution, our financial performance and our thoughtful capital management that will help us ensure we will generate long-term value for all of our stakeholders for many years to come.

Now I will turn it over to Barbara to begin Q&A.

Thank you, Steve.

We will now open the call to questions.

This morning we will ask that you please limit yourself to one question so we can accommodate as many callers as possible.

Please go ahead, Lori.

(Operator Instructions) Bob Jones, Goldman Sachs.

So it sounds like you are calling for high single-digit deflation as we leave your fiscal 2016 and enter your fiscal 2017.

I guess, the two-parter -- how that compared to what you are seeing currently in the marketplace from a generic deflation standpoint?

And then, Tim, I think it would be really helpful if you could give us some sense, even order of magnitude, of what kind of impact to the P&L should we be thinking about if you are talking about mid-single-digit deflation moving to high single-digit deflation.

I'll start with the first part of your question.

I would say that to give a perspective honest, where we are at today -- at the end of March quarter we are probably mid-single-digit inflation.

That has definitely changed on us from where we communicated to the Street and to our investors and stakeholders back on Q1.

It was probably very low single digit.

So that moved against us by the time we got to March.

And as we forecast out for the balance of the year, we expect that to increase some.

Again, we think that's related to just more supply in the channel.

And certainly we factor that into thinking that's going to remain so into 2017.

And it's a headwind.

I'm not going to comment on dollars, but we sell a lot of generics to our PRO program.

And again, when you do the math, a 1% change in deflation and have lower GP dollars is certainly a headwind that we have to work through.

Ricky Goldwasser, Morgan Stanley.

So I just want to go back to one of the comments you made in the prepared remarks.

I think you talked about changing the pricing model and contract of your internal models and obviously in drug inflation.

So can you maybe elaborate a little bit more on this?

Are you also seeing changes in pricing model in your interaction with your customers, your pharmacies and also in [cutoff like buy sector].

What does it really mean?

So we have had a real long-term, for several years now, tailwind from the generic patent expirations.

And that has been a great benefit.

We're talking now specifically about the drug companies, it's obviously a bit different in our specialty business and very different in, say, a veterinary or PharMEDium business.

But what we try and accomplish in the long term is a better balance and contributions between brand, generic and specialty therapies, which would include biosimilars and precision medicine products and cell-based therapies.

So all of these -- there are all of these new, innovative products we expect to get a fair return on.

And that's a discussion we are having with our customers and definitely a discussion we are having with manufacturers as well.

Now, the reality is that the sell side takes time to catch up with the buyer side.

And by sell side we mean the contracts that we have with providers.

So we have seen some very rapid changes in the marketplace with probably, we believe, growth in the industry will be driven more by innovation and by inflation on established products, even if they are not subject to generic competition.

So, it's very important that we have all these product categories be profitable for us.

And that's what we really are talking about.

And I think AmerisourceBergen, with Bob Marsh's leadership and the very strong strategic approach to customers -- we have taken a lead in this and you will see that reflected in our contracts over the long term.

Lisa Gill, JPMorgan.

Steve, thanks so much from you and Tim in giving us some thoughts around 2017.

But what I really want to understand is your more broad-based thoughts.

As we think about core revenue and your distribution business, you just talked about this changing model.

You've talked about the changes around new product innovation versus increasing prices on existing products.

But could we see a period of time where perhaps your revenue growth is greater than your EBIT growth because of some of these factors that are impacting the model?

And how do you think about EBIT, just given your customer base, given some of the things that you are talking about over the next couple of years?

It's a mix of customer base that we have, including being with some of the fastest growers like WBA and our ties to the specialty market including we do a lot of specialty pharmacy business in our core drug wholesale business.

We do expect to grow revenues slightly above the market.

And then, because we have a strong association or weighting towards those larger customers and because of the mixes that we see, we don't expect to be able to keep our gross profit growth up with that revenue growth.

But we do expect that we're going to have operating leverage because of the different investments that we are making.

So there will be scale coming from that.

And we are moving ahead rapidly with integrating MWI and PharMEDium, which has really severely impacted our exchange rate.

Another good benefit that we have is our improving tax rate.

And then I think ABC has excelled in capital deployment, not only on acquisitions but on buying shares back at the right time.

This is my 20th quarter, and I think when I did my first quarter we were in the mid to high 30s.

And so we have done very, very well with that.

Something that I'm very proud of and we talked on the quarter about Serlio and our national replenishment center, these projects -- BluePoint -- these projects have really been outstanding.

And as you know, again depending on what happens in the market and how cash flow progresses, and we are forecasting in the long run 125% -- that's quite implicit in Tim's comments.

So, we would have opportunities and certainly, at lower stock prices, share repo becomes a lot more compelling to us.

Those will be the drivers for our long-term growth model.

Robert Willoughby, Credit Suisse.

Steve or Tim, you were able to sign a three-year extension with Walgreens which had six or seven years left on the deal, but only a one-year extension with Express Scripts.

I guess they exercised the option there.

But what's the barrier to negotiating a long-term deal there?

Is the nature of the negotiations changing?

And secondarily, you comment on the working capital requirements, its inventory.

Have any of the payment terms changed?

That's where you made more of your recent progress.

Is Walgreens demanding different terms now?

I'll start off, Bob.

First of all, it's a pity you couldn't have your daughter on the phone with us.

And second of all, it's very strange -- welcome to Credit Suisse.

So good to hear from you.

So Express Scripts -- again, the first time I met George he said to me -- I didn't really know AmerisourceBergen.

So I think we've made tremendous progress with Express Scripts.

The relationship is into its fifth year, the teams meet regularly, we have dedicated representation there.

And we're going to work very hard to sign a new contract with them over the next 12 months.

And I think this is -- I think anybody would agree with me that this is a very active market with a lot going on.

And so -- but I do think that the Companies are strategically aligned and I expect we will be able to renew the contract.

As far as WBA, I'll let Tim comment further.

But clearly, a lot of the people that are not in our industry on a daily basis -- I'm getting all these emails and texts this morning -- wow, you did a $400 billion deal with WBA.

And we should not take that for granted.

These are the people who are not saying, well, everything else that we announced today.

But there is just not any other customer, probably, in the world like this.

And we did a historic agreement.

This is the first time we've significantly renegotiated any of the other elements of the contract.

And there's a lot of things that both parties wanted to find out, including the opportunity to enjoy new business with WBA.

So we did make some amendments.

And I'll let Tim comment further, but that's really the gist of what we have to say.

Tim, anything you would add?

Yes, thanks, Steve.

Bob, your question -- we have agreed to invest in working capital.

A fair amount is extra inventory.

We want to make sure we maximize our service levels which, again, as you think about it, there's also an impact to all of our customers to make sure we always have appropriate inventory, we are never out, and it also helps buffer against any kind of disruption in the supply chain or shortages.

But so we are also making incremental changes in terms of -- on the accounts being phased in, their payment terms to us.

Ross Muken, Evercore ISI Group.

So can you give a little bit more color on the [analyst day] exclusivity contract?

It's an interesting dynamic change, and we haven't heard this in general from all of your peers.

So I'm trying to get a sense of how much of it is a change at the branded manufacturer that you think is sustainable, how much of it is the current environment and how you foresee that evolving?

Because clearly that has been a big profit driver at times for the wholesalers.

I'll jump in and start, and Steve can also help.

But I would say in my commentary I talked about maybe a different trend in the market that has started and seems to be progressing, in that brand manufacturers are retaining market share through co-pay cards and maybe some rebates.

And I would say in the past when we converted to a generic, we saw pretty high immediate penetration rates in the market, upwards of maybe 90%.

Now, when we convert on a generic, we see penetration rates that are more 50% or 60%.

And that puts some pressure on generic profitability on launches.

So that is definitely what we see.

And that's just, I think, an evolution of the market and just something we have to work through.

Generics are still profitable.

But again, I would say as we stand here today looking out this year for some launches and even into next year, we are signaling that they just might not contribute to the level we expected.

Eric Percher, Barclays.

I have a question on the pricing discussion or pricing model discussion.

If we go back historically, specialty was treated as brand.

And maybe years ago it should have been a separate class like generics.

But as we get to today, I expect that it's the larger customers, the Walgreens and the Expresses, where you are serving specialty through the traditional distribution channel, that are really driving pressure on margins.

So my question is, how will you go about trying to change this?

And where do you get leverage maybe not just with those two customers but across the channel to change specialty pricing and margin in the traditional wholesale business, where there has been a move toward net-net pricing?

That is an excellent question.

And actually, if I was a revisionist I would agree with you that the specialty should have been a separate class of trade.

But I think in a way, because we had the patent expiration opportunity for several years, that covered for the weighting of specialty drugs.

So the way we are going to get through this is through communication and trust.

We have a very well-demonstrated trend that we, I think, are doing an outstanding job as an industry of explaining this trend.

I think people understand this.

It's well-understood as to how the industry is changing.

And it just makes sense because the price of these products and value that they represent is very different than traditional oral solid brand medication.

And also, they apply to smaller patient populations and there is complex standing requirements, complex reimbursement.

So AmerisourceBergen has been in this for a long time.

So recently, at a strategic review for our Specialty Group, and they made a very interesting observation that I think is pertinent.

And it's really that the brand, the specialty business has become the brand business.

And the future specialty businesses will be orphan drug, biosimilars, precision medicines, cell-based therapies.

And I think that's where AmerisourceBergen will excel and differentiate ourselves.

But Bob Marsh and his team, as I said earlier, and also Payton Howell and [our GSMR] side, our global supply chain side, are really focused on talking to manufacturers about the strength, making sure we get fair reimbursement.

We need to talk to -- we are talking not only to the Walgreens and Express Scripts, but we have a big specialty pharmacy customer base.

We have a big alternate care customer base.

We have a big health system and hospital GPO customer base.

And all of these customers need to really move along.

And as we get through the contracting fees, it is our strong intention that we will make a profit on specialty drugs and innovative therapies, whatever the site of care is.

Garen Sarafian, Citi Research.

Thanks for taking the questions.

One is just to follow up on the prior question, I think it was Ross's, where on the generic launches expecting lower contribution, is there any way you can quantify it so that we can get a better appreciation for the new level of conservatism?

I think that that will be useful.

But my question, if you will allow that to not count for my one, is that on the PRO Generics commentary, I would not have thought that a slow ramp in PRO Generics and increasing independent retail sales would have made a big enough dent into EPS guidance to call it out.

So could you maybe give us a little bit more on how much of the change in EPS is attributable to this phenomenon?

And what exactly didn't go to plan, and what are you assuming for fiscal 2017?

So, at the beginning of February we really dealt with the lack of generic price inflation.

And what we are calling out now -- and that's probably -- and we lowered our range.

What we are talking -- Tim can give you more color.

But approximately two thirds of the lower forecast, we would say, is really environmental.

And then, approximately one third is from not getting to the growth targets that we expected in PRO Gen.

Now, it's interesting because, as you can imagine, we have dug very deeply into this.

And our unit sales are not all that much.

It really is the generic inflation and the lower average selling prices on a lot of the generics that are not causing our generic sales and the weighting that that implies to be as high as we anticipated, honestly, even in February.

And that's about a third of the miss, a lot of what we have seen in the last quarter and the next few quarters, which is that generic efficiency rate that we are experiencing as a wholesaler.

It doesn't mean that the market is not being as efficient; it just means that we are only seeing about that 50% conversion.

So we've definitely lost a couple of percent of anticipated earnings from generic launches.

And also even in our Specialty Group there was a big launch we were expecting that we did not receive as well.

So it has not been a year that we've received the benefits from generic launches that we expected.

But Tim, anything to add, please?

Yes, Steve.

I would just say here, I don't think we would want to give any more color on the impact from the launches and what that means to us.

I think it's just fair to say that they are less than what we expected.

And we only have a handful in a year, and they are less than expected.

So that's a challenge for you.

And as Steve mentioned, we thought we would make up some ground on the PRO independent side.

And as everybody knows, generics are profitable for us, P&L and cash flow.

And that was a headwind for us in second half of the year.

2017 -- I think part of your question is on 2017.

What does 2017 include?

We expect to see some progress and some growth in 2017, a reasonable amount.

Eric Coldwell, Robert W. Baird.

Thanks.

I'm going to ask two.

The first one is just a bullet point; I doubt you will answer, but it would be very helpful.

Could you tell us what percent of your total revenue is generics today?

Get us up to speed on how that has changed with the Walgreens relationship and other client moves?

I actually don't have that (technical difficulty).

But I think you are right; we wouldn't give it.

But what is important to us with Walgreens, and we've stated this many times, is that we do all the prescription medications for them.

And that includes both branded generics, and that really was a big sea change in the industry and has led to discussions around generic distribution and generic sourcing with all of our customers.

So that is what has been extremely important.

On brand, the wholesale industry has well over the 90% coverage.

And generics it's a lot less because there still are opportunities.

And this is an opportunity for us to do more generic distribution with self warehousing customers.

So that is something we think of as an opportunity.

And since the Walgreens transaction was announced almost anyone to leave open to that discussion.

So that has been a positive in our whole industry, not just for us but for our peers as well.

Steve's comment -- it played into my second question, which is you mentioned a couple of times that these working capital step ups send investments you are making on behalf of Walgreens, that you're hoping to do more business with them.

But I guess my confusion is I thought you already had all of the business with them.

So I'm not sure exactly what the incremental opportunity is, other than them bringing on acquisitions.

And you did state earlier that you are not factoring in an acquisition-driven revenue increase.

So I'm kind of confused.

Are you talking about doing front end, or what exactly are you doing, since you are doing all the brands, all the specialty and all of the generics?

I think what we said is that it's a historic relationship and that we revisited the contract that we entered into in 2013.

And that has been a very active market.

And since then we've had not only the various changes that we've talked about in the industry but WBA really coming into existence as a complete company.

And we have, with Alex, a strong leader in the US retail that has a vision for what can be accomplished between AmerisourceBergen and WBA as partners.

So we are optimistic about strong growth for WBA and we are optimistic about the partnership.

And Tim, I think I've said everything that there is to say about this.

And we know that WBA is a [15%] shareholder and we expect that we will carry on looking for ways to grow the marketplace together.

And these are discussions that are literally ongoing every day or every week.

David Francis, RBC Capital Markets.

Moving over to Kaiser, you clearly expect to keep those guys in the family here.

Can you remind us to what degree, if any, the terms of that contract have been renegotiated since you are originally got into the most recent turn of that, so we can get a sense as to what kind of terms might be renegotiated here as you get that contract recut?

And also looking at Humana, given their transaction situation, if there is any update on that contract situation as well?

Thanks.

To your question about Kaiser, I think we've communicated in the past we have that business through June 30.

So we will have one quarter impact this year, 2016, and also into 2017.

We've put a reasonable assumption into our numbers this year and next year in terms of what is going to take to renew that.

And that has been fairly consistent.

We are heavily engaged with them, we are in discussions with them and we are optimistic that we will get to the finish line with that important customer.

Humana -- they are involved in the transaction right now, so we have that business for a while.

I think I would say that our assumption for 2017 is that what we factored into that, we have that.

Charles Rhyee, Cowen and Company.

Just wanted to go back and just clarify.

I think you had talked about -- so we are looking for our free cash flow to come back once you get out to fiscal 2018.

With the new extension here in the investments in the -- with the Walgreens relationship, so for -- if we are not going to carry high inventories, does that mean our payable terms are changing as well out in the future so that our working capital benefits that we've experienced historically are preserved?

Or are those permanently changed?

I just wanted to clarify that point.

Thanks.

I think I understand your question.

We talked about making working capital investments in both years, talked about inventory and other working capital being paid in 2016, 2017, more of an impact in 2017.

And there are no contemplated term changes to our manufacturers; we are always monitoring those and negotiating with manufacturers.

But those are the only changes that we have called out, and we expect our free cash flow to be back much better, as Steve mentioned, over 125% or better of our adjusted net income in 2018 and beyond, which is still pretty healthy.

David Larsen, Leerink Partners.

For the reset expectations for 2H of fiscal 2016, how much of that is coming from generic deflation and how much of that is coming from renewals?

Is it really 50-50 and those are the two pieces that have caused the reset in expectations?

I'll jump in.

I'm looking at Steve, so I'll jump in.

Our reset for the second half of [2016] -- we called out the two items.

One clearly was the contribution from generics being lower, the higher deflation rate than we anticipated and also the launches not contributing as much.

I would say that's a big part of the resets.

And then we also called out our plan to grow our independent generics.

Those are the two reasons for the resets.

We put them in that order, the environmental first, carry more weight.

So I would say it's easily two thirds, one third.

Greg Bolin, Avondale Partners.

So going back to Garen's question and I think you answered it, Steve, but on the PRO Gen side, you had mentioned that being one third of the reason for the revised guidance, and I think you had mentioned that volumes seem okay; it's more about pricing.

But there's not any evidence that you guys have lost some share in the independent pharmacy side; right?

Now, we did lose a buying group customer last year.

And that is really what -- we made some changes and we asked Dave New to come in and take over our GNP program, which he has done a great job of.

And we recently announced a new leader there.

Dave has really put in a new level of services around especially network and network contracting, which is a lot of what the membership base in GNP was looking for.

So we feel good about where we are.

It's just that so much of the independent business is with buying groups now.

And it just doesn't -- you can't quite get as much progress as quickly as we would have anticipated.

So that's really what we are talking about.

We have a wonderful confidence in our good neighbor pharmacy offerings and we think it's at a really important offering, and with PRO Gen for the independent base and will help them be successful in the future.

And I think that the Company's, the GNP pace really appreciates it.

So we have our tradeshow in Vegas in July, and we already have record registrations and tremendous interest.

So we feel good about what AmerisourceBergen is doing for independent pharmacy, and certainly we intend to carry on investing in that area.

So thanks for your time.

And Barbara, that will be the last question.

Yes.

Did you have some closing comments?

Yes.

So I just wanted to close by thanking you for your attention.

We've actually gone to almost 70 minutes.

And I hope that you understand that we are severely disappointed about talking about taking our guidance down for 2016 and for 2017.

But we do take the responsibility we have to all of you to provide you with timely, fair and balanced information very seriously.

And it was with this intention that we planned for and delivered this conference call today.

I just hope you all take heart from this call that we have tremendous confidence in the services and the offering of AmerisourceBergen and the people of AmerisourceBergen, and we remain resolute that AmerisourceBergen will be the Company with knowledge, reach and partnership that will shape healthcare delivery in the short and medium but especially in the long term.

Thank you.

Thanks, Steve.

And thank everyone for joining us this morning.

As always, we will be in our office this afternoon and tomorrow to address any follow-up questions.

We have also listed in our press release this morning the conferences we will be attending in the next two months.

So with that I will turn it back to the operator.

Thank you.

Ladies and gentlemen, this will conclude our teleconference for today.

Thank you for your participation and for using AT&T Executive Teleconference Service.

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