美源伯根 (ABC) 2016 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the ABC earnings call.

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

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

Please go ahead.

Thank you, Roxanne.

Good morning, everyone, and thank you for joining us on this conference call to discuss AmerisourceBergen's June 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 speak as of their respective dates.

And this call cannot be rebroadcast without the express permission of the Company.

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

We have a lot of material to cover this morning, so we will get started.

And we will leave ample time for questions, but we'll try to keep the call to an hour.

Now here is Steve Collis.

Thanks, Barbara, and good morning, everyone.

We appreciate you joining us on this very busy day.

I am pleased to report solid performance in our June quarter and good progress on the objectives for fiscal 2016 that we laid out in early May.

Revenues were up nearly 8% and adjusted EPS was up 14%.

Certain areas of our business continue to perform very well, including our most recent acquisitions: MWI Veterinary Supply and PharMEDium.

Our Specialty Group also continued its strong performance in the June quarter.

At AmerisourceBergen Drug Corporation we renewed our distribution relationship with Kaiser Permanente for five years and achieved the benefit of some expense reduction earlier than expected.

With many of our large customer renewals now behind us, we feel really good about our market position in all of our key portfolio segments.

While there is still work to be done, I'm thrilled to commend our associates for their successful work and dedication in ensuring that we are well positioned as we approach the end of the fiscal year and look ahead towards next year.

As I have said many times, we are fortunate to play a key role in a vibrant industry and to have a stronghold in the US market, which is still the best market in the world.

US organic sales growth continues to be strong, and the pharmaceutical distribution industry dynamics remain competitive but stable.

In addition, we take great pride in our ability to increasingly meet the needs of our pharmaceutical manufacturing partners on a global scale and to use our extensive knowledge, reach, and partnership philosophy to help our healthcare provider customers better serve their patients.

Turning now to our performance in the quarter, Tim will provide the details, but I want to highlight some key items.

I've just returned from ThoughtSpot, our annual retail tradeshow in Las Vegas, where we hosted a record number of independent community pharmacy attendees.

I was excited to see firsthand the enthusiasm with which our independent customers are embracing our new offerings.

In Las Vegas, we renewed our long-standing commitment to community pharmacy, and we highlighted several resources we have been investing in to ensure our GMP stores remain successful.

Our government advocacy resources include a new Internet site called OurIndependentVoice.com, which provides pharmacists with a centralized place to access tools to join advocacy movements and stay abreast of community and legislative developments.

Our front-end retail excellence programs helps our members optimize front-end sales, take advantage of manufacturer promotions, and make better use of point-of-sale data and reporting tools.

We have also introduced ABC Order, our next-generation ordering platform that is specifically engineered to fit within pharmacy workflow and will be available in 2017.

While community providers certainly face challenges in the rapidly evolving healthcare landscape, I truly believe that this is a time of tremendous opportunity for independent pharmacy.

The future is in value-based and patient-centered care, which is exactly the type of care that our independent pharmacy customers excel at providing.

The future will also demand a seamless integration of technology and personalized service, and our latest offerings in these areas will enable our independent customers to be on the forefront of this evolution in pharmacy care.

We have deployed new offerings that streamline pharmacy operations and reimbursement activities.

In addition, we are providing innovative tools that simultaneously enrich the patient's experience while improving the pharmacy's efficiency.

Finally, we stand beside all our customers and the patients they serve as we advocate or (inaudible) with state and federal legislators and regulators.

Our primary work in Washington is to ensure that our customers receive a fair share of the healthcare dollar, amidst increasing pressure on costs from all payer segments and an increasingly transparent and demanding environment.

In a tumultuous political environment, it is very important to remain engaged to ensure adequate reimbursement and to preserve patient access to care.

Before I move on, I want to take a moment to recognize a great colleague and to thank Dave Neu as he retires from AmerisourceBergen after 34 years of extraordinary service to the Company and our retail pharmacy customers.

Dave started his career as a truck driver and rose through the ranks to become the head of our drug Company before ending his career as the President of Good Neighbor Pharmacy.

Dave's vision and customer-centric philosophy helped make ABC a true leader, and his dedication to excellence and to mentoring the next generation of leaders will be sorely missed.

We are excited that Brian Nightengale has ably stepped into the leading role in our retail sales operations and Good Neighbor Pharmacy program.

Brian is a pharmacist and came to ABC as the cofounder of Xcenda, one of our market-leading consulting businesses.

Like so many of our leaders, Brian elected to stay with the Company after the acquisition of Xcenda because he believed in the vision and the people of ABC.

As a business founder, he brings an entrepreneurial spirit to GMP as well as deep experience in specialty, manufactured services, and value-based care.

I am very excited about Brian's unique fit for this role, and it was awesome to see him already deeply engaged with customers last week at our tradeshow.

As I mentioned earlier, we renewed our long-standing relationship with Kaiser Permanente for an additional five years.

We're very pleased that this premier healthcare system has chosen to remain our partner, and we look forward to continuing our history of innovation focused on the Kaiser Permanente members.

During the quarter we made steady progress in our efforts to evolve our customers' pricing strategies on brand and specialty products to better reflect changing market conditions.

Every conversation we are having with our customers regarding contracts and renewals addresses this challenge, and we are pleased that our customers are not only receptive to the dialogue about the changing mix towards lower-margin and higher-priced brand and specialty products, but are open to finding workable solutions.

ABDC will continue to face occasional headwinds as we renew customers in the ordinary course of time, but we are pleased that so many key customers are signed on to long-term contracts.

PharMEDium, which, of course, is now part of ABDC, had a great quarter.

Integration of PharMEDium has been seamless, and their performance has exceeded our expectations.

Our hospital customers have proven to be receptive to the products and services that PharMEDium provides, and the scale and quality of their compounded sterile preparations is a primary driver in the ability to earn new business.

Bob Mauch and I visited PharMEDium a few weeks ago, and I'm really pleased about the quality-based innovative approach they are taking to ensure ever-higher standards of efficiency and safety, while working in a demanding regulatory environment.

PharMEDium has been an excellent addition to AmerisourceBergen, and I am very excited about the future potential of this business.

As I conclude my comments on our drug company, I want to say a few words about drug pricing.

Drug pricing trends in the quarter on both branded and generic products were in line with our expectations, though some of the brand increases came earlier than expected.

Generic deflation in the quarter was also in line with our expectations.

The intense focus on the cost of both traditional and specialty pharmaceutical care will persist for some time and will come from different venues.

But in the efforts to manage the expense of healthcare, we must not sacrifice patient access to care.

AmerisourceBergen is increasingly the partner of choice for manufacturers and healthcare providers alike who are working to demonstrate the immense value inherent in medication therapies and the life-changing impacts they have on patients and their healthcare accounts.

Our ability to work collaboratively across the entire healthcare spectrum to preserve patient access enables us to be an attractive partner in a rapidly changing marketplace.

AmerisourceBergen Specialty Group, which has long championed patient access to specialty products, once again had a strong quarter with excellent performance across the board.

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

As I explained last quarter, 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 benefits, 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 a 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.

As we have discussed before, our unique position in specialty sets us up well to be a future leader in biosimilars.

While we haven't seen many launches yet, we are pleased to see some promising developments around FDA panel approvals for biosimilars.

The unique portfolio of services we offer makes us a valuable partner in nearly every aspect of bringing the product to market.

From supporting clinical trial logistics to consulting on commercialization strategies, we are participating in the early lifecycle activities in the development of the market for biosimilars.

Taken individually, our Specialty Group is comprised of market leaders, whether it is our oncology franchise, our plasma, vaccine and physician office distribution businesses, or our third-party logistics business.

Taken together, the Specialty Group is the undisputed leader enabling specialty product success and is the essential partner for manufacturers, for providers, and ultimately for the patients they serve.

This portfolio of offerings we have both will only become more important as biosimilars come to market and personalized medicine becomes more prevalent, because all of these innovations will take place in an environment that is laser focused on value and cost efficiency.

In addition, just as we are advocates for our community pharmacy customers, we remain committed to our community oncologists and other specialty physicians who are caring for some of the sickest patients.

I've been working with community physicians for more than 20 years, and I've always been inspired by the way they care for their patients.

The costs to administer the products and to care for these patients are significant, and the risk associated with disruptions in care can be life-threatening.

We are hopeful that CMS and others will be extremely thoughtful in considering proposals to change reimbursement rates and mechanisms on Part B drugs and will do so in a way that keeps patient welfare paramount.

Our manufactured services businesses also had a solid June quarter.

Our expertise in developing patient access and adherence programs and the experience we bring to bear in the regulatory, compliance, and policy areas are clear differentiators for ABC.

The increasingly global reach we have established in this area also further expands our value propositions to manufacturers, especially in Canada, Western Europe, and Brazil.

Our best-in-class consulting services within Lash Group performed well in the quarter.

As we mentioned previously, our Consulting group is undergoing an ERP implementation which is progressing well.

The new platform will unlock new possibilities for growth by driving internal efficiencies and expanding our capability to provide custom tailored programs and services to our manufacturer customers.

Of course, the most significant global footprint we have today is in our World Courier business, which continues to grow.

World Courier has been a very consistent performer for ABC, and its team continues to strengthen its position as the undisputed leader in niche premium logistics, particularly in support of clinical trials.

World Courier recently launched Cocoon, a new transport service that utilizes innovative packaging for temperature-sensitive materials.

Cocoon offers a powerful combination of lower waste and proven higher performance that eliminates the need to sacrifice quality for cost.

World Courier's ERP and logistics platform implementation is also going well and will help ensure they remain the market leader for many years to come.

Turning now to MWI, I'm especially pleased with the strong results they continue to deliver.

Their performance is being driven by the companion side of the business where organic growth, new innovative product introductions, and market share gains all contributed.

In addition, penetration rates with existing customers are improving.

MWI's private-label generics program, VetOne, is also growing above market as it adds additional products to its portfolio and is achieving increased penetration.

We continue to discover ways in which MWI enhances ABC.

The addition of MWI has added a new perspective and dimension to our pharmaceutical manufacturer relationships.

We have learned a lot from one another, especially in sourcing and supply chain activities, where the best practices on both the human and animal health side of the business are even more complementary than we first envisioned.

The MWI team has also been working closely with ABDC's warehouse management experts to identify areas where we can drive scale efficiencies and implement best practices.

These collaborative efforts have been very successful, and I applaud our teams for being open to innovation on both sides.

MWI has been a superb addition to ABC.

It is an area which we will continue to invest in, as we have only just begun to realize the full span of opportunities that lie ahead for this business.

Looking ahead, as we noted in the press release we now expect our adjusted EPS for the full year to be in the range of $5.52 to $5.57, an increase of 11% to 12% over fiscal-year 2015.

We expect free cash flow to be in the range of $1.9 billion to $2.1 billion for the full year, and to have completed $350 million in share repurchases by fiscal year-end.

We have also reiterated the preliminary expectations for fiscal 2017 that we gave last quarter, which includes adjusted EPS growth in the range of 4% to 6% on revenue growth in line with the market.

Tim will provide additional details on our working assumptions, but keep in mind that we are still in our planning process and will provide our full guidance in early November.

Over the longer term, we would expect to be able to grow revenues slightly above the market, grow gross profit slightly slower than revenues, drive some operating leverage, generate free cash flow at approximately 125% of net income, and benefit from the balanced redeployment of capital, including both strategic and synergistic M&A and share repurchases.

Ultimately, our aspirational goal is to achieve adjusted EPS growth in the midteens.

In summary and in conclusion, I continue to have great confidence in AmerisourceBergen's future.

The strength of our long-term customer relationships and unique portfolio of integrated assets is a compelling value proposition for pharmaceutical manufacturers.

Our seasoned management team shares my passion and drive for producing excellent results while also delivering outstanding customer service.

Our dedication to continuous improvement in the quality of our offerings, our associates' track record of seamless execution, our financial performance, and our thoughtful capital management all 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 Tim.

Thanks, Steve, and good morning, everyone.

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

I would ask that you refer to our press release for a complete discussion of our GAAP results and reconciliation to our adjusted results.

Please note that all financial comparisons I make this morning are for the third quarter ended June 30, 2016, compared to the same quarter of the prior fiscal year unless otherwise noted.

I have three primary areas to cover this morning.

First, I will recap our fiscal Q3 consolidated and segment performance; second, I will cover our revised fiscal 2016 expectations; and third, I will provide updated commentary on fiscal 2017.

With that, we can begin our third-quarter review.

Revenues were $36.9 billion, up 8%.

Our Pharmaceutical Distribution segment accounted for almost all of our revenue growth.

As a reminder, included in the segment is our PharMEDium acquisition.

They accounted for a relatively small part of our overall ABC revenue increase.

The quarter's adjusted gross profit increased 6% to $1.1 billion.

Our Pharmaceutical Distribution segment accounted for roughly 80% of our gross profit dollar growth, with PharMEDium being a key contributor to this growth.

Operating expenses.

Our total adjusted OpEx increased 4% to $574 million.

Last quarter, we mentioned on our call that we are focused on expenses and ensuring we spend in the right areas.

We believe we've made good progress in this area in the June quarter.

Looking forward to our fourth quarter, please keep in mind that we typically have a seasonal increase in our operating expenses, primarily around payroll and compensation.

Operating income.

Our adjusted operating income was $493 million, up $38 million or 8%.

Our adjusted operating margin was 1.34%, a 1 basis point improvement.

Income taxes.

Our adjusted income tax rate was 32.8% for the current quarter, down from the prior year.

As highlighted on last quarter's call, we anticipated a lower tax rate due to the growth in our international businesses.

We continue to expect that our full-year tax rate will be roughly 33%.

As a reminder, this tax rate is durable as long as our mix of US-to-international business stays at its current level.

For the quarter, our adjusted diluted EPS increased 14% to $1.37, driven mostly by the performance in our Pharmaceutical Distribution segment and to a lesser degree from our lower effective tax rate.

Our adjusted diluted share count was just under 229 million shares, down about 1% from last year.

Let me highlight that in this quarter we did have a positive EPS contribution of a few pennies from two items.

The first item: We had two earlier than expected brand manufacturer price increases coming in June versus July.

And the second item: We had some expense savings that came faster than anticipated and exceeded our expectations.

Turning now to our third-quarter segment results, starting with Pharmaceutical Distribution.

Total segment revenues were $35.4 billion, up a very solid 8%.

Our drug company had a growth rate of 6.5%.

This growth was after a revenue headwind of roughly 1.5% due to lower hepatitis C sales.

The drug company had solid growth across several customer segments including Walgreens, which grew at approximately 7%.

Additionally, PharMEDium had another quarter of excellent unit volume growth, which drove a very good top-line revenue increase for their business.

ABSG, which is our Specialty business, had their highest revenue growth rate this year with revenue increasing by 20%, driven mostly by volume.

ICS, our third-party logistics business, accounted for 5% of Specialty's 20% revenue growth, due primarily to a new manufacturer relationship that started late last fiscal year.

We also continued to realize meaningful revenue growth from the sale of oncology drugs across a few of our businesses and, to a lesser degree, from the sale of ophthalmology drugs in our Besse Medical business.

Moving to gross profit, the segment's gross profit was $794 million, up $49 million or 7%.

The increase in gross profit dollars was split somewhat evenly between the drug company and ABSG.

Our drug company's increase was mostly from PharMEDium, which performed better than expected.

Segment operating income was $411 million and was up 9%.

The growth was the direct result of higher revenues and the corresponding income contribution, combined with tight expense management.

Overall, we are pleased with the progress we are making in this segment, and we are especially pleased with the performance of our ABSG Specialty business.

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

In the June quarter, segment revenues were $1.6 billion, up about 3%.

The segment had a revenue headwind of a few percentage points from a piece of business that moved from our TheraCom distribution business back to the manufacturer.

Growth rates in our core Consulting Services, World Courier, and MWI businesses were all in line with what we expected.

MWI continued to perform exceptionally well, with percentage of revenue growth in the companion animal segment in the high single digits.

On the production animal side of the business, revenue growth was still a little low, but we are very encouraged based on cattle market trends that growth rates will pick up as we move into late summer and fall.

From an operating income standpoint, the segment had operating income of $83 million, up 7%, driven primarily from MWI and our World Courier businesses.

Turning next to working capital and cash flow items.

In the June quarter, we had modest free cash flow generation when compared to our two previous quarters this fiscal year.

The lower cash generation was due to a sizable impact from timing: unfavorable working capital in the June quarter that reversed during the first week of July.

Additionally, free cash flow was also impacted from the extra working capital investment we made with Walgreens.

I should remind everyone that this working capital investment will continue to be phased in over the next few quarters.

At June 30, we had $1.9 billion in cash on our balance sheet.

This includes $470 million offshore, related primarily to our Switzerland and World Courier businesses.

And during the quarter, we purchased 1.4 million shares of our stock for about $100 million under our regular share repurchase authorization.

Moving to our revised fiscal 2016 expectations.

Before I cover our specific guidance measures, let me just make a few brief comments on the drug pricing environment in addition to what Steve discussed earlier.

Starting with generics, our generic portfolio or basket of generic drugs through July, as expected, deflated in the high single-digit range.

Let me highlight that our deflation rate is calculated using our specific sales mix and inventory levels for our fiscal year.

Others in the supply chain may calculate their indexes differently, or likely will have a slightly different deflation rate because of their unique mix of business.

While there are several market factors that can impact our forward-looking assumptions, based on what we know today we expect that our generic deflation rate will remain where it is currently through the end of our fiscal year September 30.

Switching to brand drugs.

The month of July has historically been a period where we tend to see a number of brand drug price increases.

This current July was not an exception.

The number of increases and the rate of increase were mostly in line with what we expected, except for the two manufacturers that announced their price increases earlier than expected, in June.

We can now move to our updated fiscal 2016 P&L guidance.

Adjusted EPS: As we enter our fourth quarter, as a reminder, new pricing for the Kaiser renewal took effect on July 1. Our EPS guidance range is now $5.52 to $5.57, which is growth of 11% to 12% versus last fiscal year.

Free cash flow we still expect to be in the range of $1.9 billion to $2.1 billion.

And for share repurchases, we now expect to repurchase about $350 million for the full year.

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

Even though we are in the middle of our planning process, we are still comfortable with the preliminary guidance we gave last quarter.

Starting with adjusted EPS, we expect growth in the range of 4% to 6% from the midpoint of our updated fiscal 2016 guidance range.

In our press release that we issued this morning, we listed our key assumptions related to our preliminary fiscal 2017 guidance, but there are three specific guidance assumptions I would like to highlight on our call.

Number one, generic pricing.

As mentioned earlier, the trends haven't changed from what we previously expected.

Our working assumption for fiscal 2017 is that generic deflation remains in the high single-digit range.

Number two, the Medicare Part B demonstration project and the impact to our Specialty business, with a lack of clarity on what, if anything, gets implemented and, importantly, the timing, it's just too early to estimate the impact to our business.

And number three, the new accounting rules regarding share-based compensation.

While it's likely we will early-adopt the new accounting rule in our fiscal 2017, our guidance range does not contemplate the impact from an implementation.

Most of our share-based compensation is weighted toward stock options.

This makes forecasting the tax benefit more challenging, because it's difficult to predict when the employee will exercise and, importantly, the ABC share price at the time of exercise.

Our current thinking is that the EPS impact will likely be modest.

As I wrap up my comments, overall we are pleased with our results this quarter.

As we move into our fourth fiscal quarter, we believe we are gaining traction in our core drug business.

Our ABSG Specialty business continues to have good momentum.

And MWI and PharMEDium, our most recent acquisitions, are performing very well.

As always, we thank you for your interest in ABC.

Let me now turn it over to Barbara to start the Q&A.

Thank you, Tim.

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 within the hour.

Okay, Roxanne.

Please go ahead.

(Operator Instructions) Robert Jones, Goldman Sachs.

Great.

Thanks for the questions, guys.

It sounds like you're saying, Tim, if I heard you and Steve in your prepared remarks correctly, the generic pricing was in line with your assumptions, which was for high single digits.

I think that would imply that you actually did, in fact, see things get sequentially worse from last quarter to this quarter.

I just wanted to make sure that that is, in fact, the case.

And then maybe if you could dig into that a little bit on maybe where you saw deterioration in pricing, just because I think that observation probably does run a little counter to what we were hearing from both manufacturers and others in the supply chain, at least relative to last quarter.

Yes.

Hey, Bob, good morning.

It's Tim, and I'll start; and Steve can jump in.

But, yes.

No, we're definitely saying that it's consistent with what we expected.

When we talked to investors and did our call last quarter, we communicated that we were in the mid single-digit range, probably at the top of that range.

And certainly sequentially as we moved into this quarter we bumped up a bit.

We're now in that high single-digit range, so we did move up sequentially.

But, again, I want to stress that that's what we expected across our portfolio.

And our portfolio is unique to ABC.

I still think that -- and Steve can jump in -- that we can navigate through that deflation.

We feel like it's still -- that's just one aspect of how we make money on generics.

Yes, our deflation trends are -- I think we all measure it a bit differently, but we do it mainly based on purchasing information.

And of course, we always do try to retain the GMP dollars, but we have long-term relationships with the manufacturers and we are always mindful of that.

And of course, we work a lot in concert with WBAD, and we have a very long-term approach to the business.

And we are confident, Bob, that whatever the environment we will continue to do very well in generics.

We think our sourcing is excellent.

The volume, the trend towards so many of the prescriptions are generic, so that's just a great trend for us.

There are still going to be significant generic launches next year.

And then, there is small instances of price inflation in unique circumstances based on usually some manufacturer-based events.

Yes, Bob, I would just make one more comment, if I can.

We did -- I commented that it went up sequentially.

But, again, I think it's important that it didn't change our outlook for 2017, and we didn't revise our growth expectations.

Ricky Goldwasser, Morgan Stanley.

Yes, hi.

Good morning, guys.

My question is really regarding the status of the negotiation with specialty manufacturers.

Steve, you talked about that in last quarter.

I think you touched upon it a little bit earlier today.

But can you give us some more color on where you stand?

And really, what do you think the longer-term implications are for the profitability of the Specialty business?

Yes, it's -- one thing that may not have been immediately evident is we're just getting so much more granular about the business.

And when we talked about our oncology business, I don't know if you noticed in my script, I said in all different sites of care even within Specialty.

So we've got an increasing oral oncology business; we've got an increasing hospital business, which often gets done through ASD; as well as our traditional oncology supply and ION businesses.

So there is just a lot of granularity, and this is the first time we really started measuring what we do in oncology, not just owning our Specialty business.

And we do a lot of oncology, by the way, of course, in our health system business within drug, which is a really strong franchise for us also.

But on the manufacturers' side, the manufacturers are increasingly looking at specialty as a different business.

They are looking at what components of the fee-for-service agreement do they want to see in a more specialty-oriented product.

Those are traditional, established manufacturers -- the Lillys and Pfizers and Mercks of the world -- as well as the more traditional specialty manufacturers that you associate with biotech products and specialty products.

These fee-for-service agreements we have with manufacturers are becoming more nuanced, and we expect that to continue.

That's why I'm pleased under Peyton Howell's leadership we've got a really strong customer-focused and manufacturer-focused team that focuses on access and sites of delivery as well as the economics of these products.

I think we are managing through this very well.

Almost every customer that we speak to understands these trends.

And really, on the contracting side the comments last quarter were probably more on the provider changing pricing environment as opposed to the manufacturer changes, where these trends have been well understood.

We're more in constant fee-for-service negotiation discussions with manufacturers, the next generation, as opposed to, say, Kaiser, which is a five- or seven-year contract.

Seven years last time, five years this time, and it's a very intermittent contracting opportunity.

So those are really -- I hope that's all clear, because it is very fluid and nuanced.

Garen Sarafian, Citi Research.

Good morning, guys.

I guess I just wanted to touch on the Good Neighbor Pharmacy program.

Steve, you mentioned it a little bit in your prepared remarks.

Could you just elaborate on what your expectations are that you're building in for next year?

I don't have the numbers in front of me, but I thought you hadn't grown this program as quickly as you might have wanted to recently.

So curious what you've done thus far, if you could quantify the enthusiasm at the conference last month, and how you'll judge success in GMP for next fiscal year.

Yes, there are several ways we look at the number of pharmacies in our GMP.

But most importantly, and I think this is what I feel especially good at after last week, and just getting to meet with all those key buying group customers in key regions, and like we've done in the rest of our business, we've signed the anchor tenants to long-term contracts.

I met with all of them.

Candid discussions.

They are not shy to voice their opinions.

But overall, I think ABC has really taken -- and you may be surprised at this, it's not the impression you generally have -- a very technology-enabled approach.

I think when you look at the apps that we had, we had this technology and innovation center at our tradeshow last week.

I was there right when it opened because I was getting a preview of all the different offerings we had.

So we had this virtual reality experience type encounter, where we showed the history but also what the future of pharmacy could be like.

There were just lines to see that.

Some of the apps that we have, the ABC Order, we had 200 pharmacists that were involved in the development of that new interface, which is probably the way that our customers will be interfacing more and more with us.

So I think we're getting into a more digitally enabled Good Neighbor Pharmacy-type environment.

Bob Mauch talks a lot -- when I was with him we met with customers -- really about there's no reason that experience shouldn't be as rich as when you work with Amazon or one of these other primary e-commerce sites.

And that's really what our goal is.

There was a lot of discussion on Passport in the past, the generation of ordering interface that we're replacing, about the search feature.

Now the search feature is going to be just better.

I don't want to get into too much granularity, but we're really proud of, under the leadership of our CIO and this strong IT presence throughout the business, where we're moving the technology for our customers.

We all measure success through PRO gen sales, through Good Neighbor Pharmacy membership, the Elevate participation which is going extremely well.

And I'm just pleased that we've got these key anchor tenants locked down and we can work on helping them grow.

So it's not only the quantity, it's also the quality.

And we feel good and we think there is upside there.

I think we've maybe fallen back a percent or two, and I think we hope to regain that, but really through growth of the services and investing in the customers that we have.

George Hill, Deutsche Bank.

Hey.

Good morning, guys, and thanks for taking the question.

I guess, Steve or Tim, I would -- I thought the comments that you made about the long-term EPS growth guidance was interesting.

I guess if we think about when we get through the fiscal 2017 guide, can you provide a framework around what gets the Company back to the midteens EPS growth?

I guess, how much of it comes from core operating earnings growth versus capital deployment?

Yes.

Hey, George.

Good morning.

Yes, I'll start again and Steve can jump in.

But I think I would probably just recap some of the comments Steve made in his script.

We believe having the right customers that are going to grow faster than market, you've got to grow that top line.

You've got to have good specialty.

I would say, roughly speaking, that probably if 15% is the aspirational long-term goal, then probably two-thirds of that has to come from organic growth.

Roughly speaking, two-thirds organic, one-third capital deployment.

That's roughly been a model of the past and that's probably what we would shoot for in the -- looking forward.

Yes.

The free cash flow at 125% of net income will give us lots of opportunities.

And we do -- we are very bullish about our customer mix and manufacturer relationships.

Of course, we are probably the most leveraged to the specialty pipeline, which is going to create a lot of dividends for us.

I want to remain tremendously optimistic about biosimilars, and I think it's going to be a great driver for our Part D business, particularly, which you are starting to see panels get approvals on some key products.

So I think that will be important with patient choice and provider choice and also provider profitability, which is important for us.

So, I'm really very optimistic about our future.

That 15% we talked about as being aspirational, but there's no reason in some of the years that we couldn't hit that.

I remain optimistic we can do that, but it is aspirational to get a 15% growth rate in any one year.

Yes, and just to finish up, we've always been a terrific cash flow generator and we don't see that changing once we cycle past 2017.

And we've been very prudent.

I think we've demonstrated that we know how to reinvest that for long-term shareholder value, and we'll keep doing that.

Robert Willoughby, Credit Suisse.

Thanks.

Tim, can you reiterate what the impact of the extended Walgreens relationship was on the income statement and balance sheet?

I think you said something there.

But are there any -- what incremental hits would you expect to see in the coming quarter?

And if you had a quick soundbite on pricing for the animal health business, that would be great.

Yes.

Hey, Bob, let me just comment.

In terms of the P&L, I think we've said before that there is not a P&L impact.

We talked about last quarter extending the contract for the additional three years, but there is a cash flow impact that started this quarter.

I talked about two cash flow impacts.

I'm not going to size it, but clearly the timing was bigger than the Walgreens, to put that in perspective.

But yes, going forward, each quarter we'll have an investment into working capital and a little bit on inventory and, as we mentioned last time, on terms.

Hopefully, that answers your question.

Your second part was on pricing on --

Animal health.

-- on animal health.

I think they remain.

Part of their growth, especially on companion, which is in high single digits -- part of that is new introductions, which have been terrific for them.

Part of it is new account penetration.

And to a lower part is probably pricing.

It is a part of that growth, but clearly new account penetration and new drug introductions are a bigger part of that growth.

Steven Valiquette, Bank of America Merrill Lynch.

Thanks.

Good morning.

Congrats on these results.

So, historically, it does seem that these distribution profits do tend to go up sequentially in the September quarter versus the June quarter.

But obviously for this year, that guidance implies a little bit different trend.

Just to make sure I got the factors there, you mentioned the manufacturers that had brand price increases in June instead of July; and I think there is maybe the Kaiser renewal.

But I forgot.

What were the other key factors again to consider when thinking about that sequential comparison?

Yes.

Hey, Steve; it's Tim.

Yes, clearly, one of the bigger ones -- as you look sequentially between 3 and 4, one of the bigger ones would be the Kaiser repricing.

It's a key account; it got repriced; we'll have the one-quarter impact this year, three quarters next year in 2017.

There were a couple of brand manufacturers that -- again, you can never -- you never know for sure.

You forecast; a couple came earlier; that's a slight impact.

We do tend to have a little bit of seasonality in our MWI business.

June quarter tends to be stronger.

I would say that those are the items.

And traditionally, we always have a slight ramp in expenses in the fourth quarter, just around how we hire and in terms of compensation true-ups in that area.

So that is the reconciliation sequentially between 3 and 4.

Eric Percher, Barclays.

Thank you.

I wanted to return to the earlier question on negotiations with manufacturers and I think you called it providers or dispensers.

The tone seems quite different from last quarter.

Is that because last quarter there was a message of getting us in the mindset of the pressures that exist from the dispenser clients and high growth that may be low-margin clients?

And this quarter you're coming back and talking about some of the recourse you have with manufacturers?

Am I reading that right?

Eric, not sure if we didn't have a tone that would denote anything except real confidence in our future, then I apologize.

But no real tone.

No, we weren't happy, I guess, Tim and I -- and all the team -- we're very proud of our performance, proud of our results.

So it was hard for us to take guidance down.

But that's really all you saw.

I think this quarter just affirms our confidence in our positioning and the long-term opportunities for the business.

Does that get your question?

Was that everything?

Eric, is that good?

We may have lost Eric, but, I think --

Next question?

Yes, operator, next question.

Ross Muken, Evercore.

Good morning, guys.

Just on capital allocation, you talked about, obviously, on a long-term basis an important part of the growth algorithm.

More recently, the bias has been growth diversification.

But given where the stock is and where valuation is, how are you thinking about the relative trade-offs of buying your own shares versus the continued moves in new legs of the stool and the like?

Well, thanks for getting me ready, because we have our Board meeting tomorrow and Thursday.

So it's a good -- you know, it's the eternal question.

In the short term, we almost always do best from buying our stock.

But we really like doing a mixture between dividends, between capital investments.

In fact, overall, the best returns we've had have been capital investments.

But I've been -- this is actually my 21st quarter and I'm really proud of the three big acquisitions we've made.

They've worked out so well strategically, operationally, financially, including help drive that overall portfolio effect.

But, you know, we've done a terrific amount of share buybacks.

And I'm also really proud that we've completely hedged the warrant.

So we've done a lot in all these different areas.

We do always evaluate any acquisition against our share buyback.

But in the long run, they tend to add some intangibles and some long-term benefits to the portfolio and the value that we bring to manufacturers, to providers, to patients that, if they're thoughtfully done, it really is an excellent use of capital, along with some great internal projects -- like we talked about the ABC Order, the national replenishment center, many investments that we made in our oncology, our protocol analyzer, products like that that are just terrific benefit to the customers and, really, essentially make us much more relevant and sticky with the customers.

So it's really a part of what our overall offering is.

Anything to add, Tim?

No, Steve.

I would just say we always like to be opportunistic, but you have to balance that against other demands for cash and having flexibility.

That's what we do.

We're very thoughtful about that, and we will consistently demonstrate that as we go forward.

So it's a balance, and we're always looking at how best to deploy capital long term.

Lisa Gill, JPMorgan.

Thanks very much.

Outside of the renewal pricing on Kaiser, can you maybe just talk about the current pricing environment?

And do you have anything sizable up for renewal in 2017?

Then, secondly, Steve, I just want to understand your comments when you talked about moving more contracts to fee-for-service.

Can you remind us of the percentage of your contracts that are on fee-for-service type of relationships today and where you think that could go over time?

Yes, we said last quarter that's -- on the branded side that's about 90%-plus, and we think it's just increasing with consolidations and just generally a very transparent environment and very bilateral discussions.

Peyton's team is in constant discussions with manufacturers, and I think it's just part of the evolution to mutually respectful, mutually beneficial, and mutually valuable relationships.

So that's really what I was referring to on the branded side.

And I think you have some of those trends with generic manufacturers, with the consolidation that you're seeing there.

But what's -- there's definitely room for some entrepreneurial startups, for some startups that can quickly -- with some good execution and high quality, can become pretty significant players in the generic market.

And ABC has been proud to support some of those partners.

So, that was the second part of your question.

Sorry, the first part of your question was on --?

Well, the share of brands -- brand in fee-for-service?

Okay.

So I think we got that all, Lisa?

She's not on the line.

I think we're coming up on the noon hour, so maybe we'll take one more question.

Charles Rhyee, Cowen and Company.

Yes, thanks for squeezing me in here.

I wanted to touch on biosimilars a little bit here.

Steve, you talked a lot about it, and one of your competitors, when they referred to it, they talked about their ability to do well in some categories and maybe not -- it won't be as beneficial in others.

Obviously, you guys have a lot of experience in specialty.

Can you talk about how you see that also shaping up?

Is that the right way to think about it, that we have to look at biosimilars class by class?

And which ones in your mind are better suited for you guys to benefit from than others?

Sorry, I'm just -- I knew it was coming; I didn't get to it with Lisa.

We don't have any large renewals in 2017 except for Express Scripts, which is in June of 2017, which is really a market-based contract in which we --

September of 2017.

-- September of 2017, yes.

So that's one.

Really, on biosimilars, we're just a little bit reluctant to get into predicting when they're going to have an impact on us.

Because you have the FDA process and then you have the [core] process and those are just more difficult to predict.

Having said that, I think there is an inevitable trend that we will have biosimilars in the marketplace.

The panel reviews are showing equivalency and effectiveness that are coming, and, again, we are very confident in the manufacturers that are producing and are really seeding the development of these products, investing in them.

I know that our customers are very interested and open to trying them.

So we just remain very optimistic.

It's not just the distribution capabilities we have.

It's companies like Xcenda, it's the patient work, the access work that we do at Lash.

It's the work that we'll do in complex products, whatever they -- however they need to be delivered, in whatever format they are, I'm really confident that our Specialty Group will and our drug company will develop the solutions to be the manufacturer partners and help through reimbursement challenges, access challenges.

So I think that's really all we have time for.

Barb, is that our last question?

Yes.

It's one minute to noon.

So maybe just any closing comments you have, Steve?

Yes, I'm really pleased about the quality of this quarter's earnings.

I think we made a lot of progress in all of our businesses, but particularly pleased with the progress we made in our drug company.

I think the Specialty Group with a 20% revenue growth really deserves a strong recognition from our shareholders and all of us.

It's another excellent performance on top of many years of excellent performance.

So again, Tim and I are pleased that our optimistic tone was acknowledged and recognized.

And we thank you for your attention today.

Thanks, Steve, and thanks, everyone, for joining us this morning.

As always, we'll be around this afternoon to take any follow-up calls and questions anyone has.

With that, I will turn it back to the operator.

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