美源伯根 (ABC) 2018 Q3 法說會逐字稿

Ladies and gentlemen, thank you very much for standing by, and welcome to the ABC Earnings Conference Call.

(Operator Instructions)

And as a reminder, today's call is being recorded.

I would now like to turn the call over to your first speaker, Mr. Bennett Murphy.

Please go ahead.

Thank you.

Good morning, and thank you all for joining us for this conference call to discuss the AmerisourceBergen Fiscal 2018 Third Quarter Financial Results.

I am Bennett Murphy, Vice President, Investor Relations for AmerisourceBergen, and joining me today are Steve Collis, Chairman, President and CEO; and Tim Guttman, Executive Vice President and CFO.

On today's call, we will be discussing non-GAAP financial measures, which we use to assess the underlying performance of our business.

The GAAP to non-GAAP reconciliations are provided in today's press release as well as on our website.

During the conference call, we will also make forward-looking statements about our business and financial expectations on an adjusted non-GAAP basis included, but not limited to EPS, operating income and income taxes.

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

AmerisourceBergen assumes no obligation to update any forward-looking statements or information.

And this call cannot be rebroadcast without the expressed permission of the company.

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

For a discussion of key risk factors and other cautionary statements and assumptions, we refer you to our SEC filings including our most recent Form 10-K and to today's press release.

I would like to remind you that we have posted a slide presentation to accompany this morning's press release.

You can find it at our website, investor.amerisourcebergen.com.

You'll have an opportunity to ask questions after today's remarks by management.

(Operator Instructions)

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

Steve?

Thank you, Bennett, and good morning to everyone on today's call.

Our continued focus on operational excellence helped us deliver a strong third quarter, with revenue increasing 11% to $43 billion and adjusted diluted EPS growing 8% to $1.54.

Our ability to consistently execute and maximize our opportunities for growth has helped us successfully navigate an evolving market landscape and overcome internal challenges, including the lower-than-expected contribution from PharMEDium this year, putting us in a strong position to finish fiscal 2018 on track and within our guidance range.

We believe our results demonstrate the value that our businesses are creating for our manufacturer and provider partners and reinforce our long-term prospects for growth despite any near-term uncertainty.

The importance of our work and our ability to consistently execute was on full display across our businesses during the third quarter.

Over the past several weeks and months, many people have asked about the landscape for our industry and questioned our ability to adapt if there are changes to the model.

In times like these, I believe it's important to take a step back and look at our results in the context of the value we provide and the critical work we've already done to innovate in a fast-changing market.

In our Pharmaceutical Distribution and strategic global sourcing group, we saw continued performance and execution in the core distribution business, both in increasing volumes with our existing customers and supporting their growth.

I'm excited and pleased to announce that our team has re-signed our of our key anchor customers, Humana.

We've had a long relationship with this strategic partnership -- partner, and its early renewal shows a mutual appreciation and strong desire to continue growing together.

Consistent with our customer contract rebalancing efforts, we were able to build a long-term contract that is a win-win for both partners and one that does not create a margin headwind.

AmerisourceBergen continues to benefit from our history of strategic investment and leadership in the distribution of specialty products.

We have the best franchise, key customer relationships and continued support to launch a virtually all-new specialty products.

This quarter marks the 18th consecutive quarter with 10% of greater revenue growth for this part of the business.

The connection we provide between manufacturers and our physician customers enables us to best support the commercialization of specialty products, both new innovative products and new biosimilar products and empower those physicians to best serve their patients.

As a brief update on PharMEDium, I'm proud of the execution of our associates in remediating at PharMEDium's Memphis facility.

You'll recall we voluntarily suspended operations in December.

We've been in active communications with the FDA and 2 weeks ago, we notified the FDA of our intent to resume limited production at the Memphis facility and commence commercial distribution this month.

We expect production in Memphis to increase gradually over time and to be fully operational in fiscal 2019.

While this process has certainly taken longer than we originally expected, enhancing PharMEDium's quality assurance and quality control programs to ensure patient safety was our top priority.

We feel we are best positioned in the industry to meet and grow market demand, while delivering the highest quality and safety products to our customers.

Additionally, we are encouraged by the FDA's draft guidance, explaining how compounding from bulk drug substance generally presents greater risk to patient than PharMEDium's model of compounding from FDA-approved drugs.

The guidance provides further clarity and increased oversight around its 503B standards, both positives for our business and patient safety.

On to our Global Commercialization Services & Animal Health group.

World Courier continues to be the partner of choice for global clinical trial logistics, driving demand and innovating to further enhance their differentiation in the market.

The team at World Courier is delivering excellent results and executing world-class logistics, moving innovation forward.

We're proud to be at the forefront of supporting the successful commercialization and launch of cell and gene therapies.

At Lash Group, we're continuing the rollout of the Fusion platform and successfully on-boarding new business.

However, the migration of customers to this new platform continues to take longer than we had anticipated.

We are being thoughtful in how and when we migrate programs to the new system to ensure there's zero disruption in service level.

Lash is the leader in supporting access and adherence programs to ensure patients receive the best possible care.

Additionally, we are excited by the recent launch of Lash's new electronic benefit verification solution, which utilize artificial intelligence and machine learning and will accelerate speed to therapy and improve the care delivery experience for patients and providers.

The investment and work to launch these new offerings improves patient access to life-saving medications and enhances patient engagement and outcomes.

The services provided by Lash are key to supporting manufacturer programs, and the business is positioned to meet the commercialization needs of the next generation of therapies.

Innovation continues to be vital to the important work that we do throughout AmerisourceBergen, as we continue to improve our value proposition for manufacturers and downstream provider customers.

AmerisourceBergen has invested for decades to ensure we operate at -- offer differentiated value to our manufacturer and provide our customers of all sizes.

That culture of execution and continued innovation has positioned AmerisourceBergen as a best-in-class partner with leading-edge solutions.

For example, a couple of weeks ago, we hosted ThoughtSpot, our annual trade show for independent pharmacists, where we had record customer attendance and engagement.

The energy, excitement and drive to continue to grow and support independent pharmacies and their patients was overwhelming.

Now is a great time to be an independent pharmacy owner.

We're seeing people shift their mindsets from strictly treating illness to managing their health and improving their well-being.

Because of that, the community pharmacy is positioned to provide the personalized health care experience that consumers expect.

To meet the changing independent pharmacy needs, we continue to improve the programs and services we offer to Good Neighbor Pharmacy and the Elevate Provider Network.

We are supporting the growth of independent pharmacies and continue to advocate for new value-based payment models that reflect the care pharmacists provide, not just the products they dispense but also for the services and advice they provide their patients.

As I've talked with our independent pharmacy partners, their entrepreneurial spirit is contagious and they're encouraged by the new opportunities for their pharmacies and how they can further the critical consultative role they play in their local communities.

In many parts of the country, these pharmacies are the only accessible health care destination, which means that the pharmacist plays an important role in the community, and they have the unique opportunity to help manage the inherent challenges that many patients face.

Our GMP independent pharmacies have built up significant trust in their local communities and provide the best health care through personalized and differentiated service.

Examples like these illustrate the important role AmerisourceBergen plays in the health care system and demonstrates how we create value for our partners in unique ways.

Another key customer is the manufacturer, and we continue to help these key partners successfully navigate the complexity of the U.S. health care system.

We service more than 50,000 sites throughout the United States, providing pharmaceuticals from hundreds of manufacturers each morning with an impeccable track record of order accuracy, all of this while bringing significant distribution center automation and vital security to the supply chain.

People often lose sight of the fact that if you're a manufacturer, whether you have one product or hundreds of products, you only need agreements in place with 1 to 3 partners in order to provide every patient in the United States access to your pharmaceutical at any of the tens of thousands of sites of care.

That is no small feat.

Rather than build out a complex distribution system, which requires investments to ensure security and efficiency, our key networks attract, monitor and process specific customer contract process and purchase orders and a financial arm to administer the credit and collection functions.

Manufacturers can instead allocate their resources back into the health care system and invest in research and development with the goal of developing the next class of lifesaving or life-changing drugs.

Pharmaceuticals are the most efficient care option, improving patient lives and keeping people out of their local hospital or doctor's office.

Our ability to execute day in and day out and succeed in this highly regulated and complex market enables the utilization of and access to pharmaceuticals.

We thought it was important to take this step back today and provide some additional detail and context regarding the vital role AmerisourceBergen plays in the U.S. health care supply chain.

All too often debates regarding our country's health care system occur at a headline level, with the cost of care and the price of prescription drugs grabbing the attention.

The intricacies of how everything else works never receives equal prominence.

At AmerisourceBergen, our model is built on being able to efficiently navigate a highly regulated market, while delivering value to the supply chain.

The cost savings we provide through economies of scale, efficiency, security, continuous investment, automation, IT systems and a high-quality balance sheet are tremendously valuable for providers and manufacturers.

The current fee-for-service model provides transparency for both manufacturers and distributors, and we believe this serves as an efficient and aggressive way of delivering appropriate compensation for the value we provide.

If there are changes to the model, we will be at the forefront of discussions with manufacturers and other stakeholders to ensure that our important role in the supply chain continues to be recognized.

As we think about our role beyond distribution and services, we remain steadfast in our commitment to build healthier futures by fostering a positive impact on the world.

Corporate citizenship isn't just an obligation we have, but it's a promise we keep.

We are thoughtfully improving our business practices and operations to work mindfully and measurably towards reducing our environmental impact.

In addition, we provide volunteer operations, opportunities and support like-minded organizations through the AmerisourceBergen Foundation.

We've detailed our progress in the 2017 Corporate Citizenship Report that is now available on our website.

While it's only a representative summary, this report provides visibility into our purpose, our accomplishments and our priorities moving forward, as we continue to embed corporate citizenship values into everything we do.

In summary, we continue to demonstrate the value we provide every day to both health care providers and manufacturers in navigating our complex and dynamic health care system.

Now I'll turn the call over to Tim for a more in-depth discussion of our quarterly financial results and our financial guidance updates for fiscal 2018.

Thanks, Steve, and good morning, everyone.

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

For a discussion of our GAAP results, I would ask that you please refer to our earnings release.

I also want to remind everyone that we are now in our second quarter of consolidating the adjusted financial results of Profarma Brazil and the specialty joint venture.

For a comparability to prior financial results, we continue to include a schedule in our press release, which illustrates the financial impact of consolidating these businesses.

On an operational note, we wrapped up our third fiscal quarter with solid performance in our business, albeit still challenged by results at PharMEDium.

Our ABC team continues to focus on executing our strategy, delivering the best customer experience and ensuring we are operationally efficient.

All of this translates into positive financial results.

With that, we can begin our Q3 financial review.

I will provide commentary in 2 main areas: first, I will discuss our quarterly consolidated and segment performance; and the second area, I will provide a brief update of our fiscal '18 expectations.

We finished the quarter with adjusted diluted EPS at $1.54, an increase of 8%.

This included a $0.01 benefit from consolidated Brazil.

Our consolidated revenues were $43 billion, up a strong 11%.

Gross profit also increased 11% or $116 million to about $1.2 billion.

However, when excluding the impact from Brazil, our gross profit would have increased 5% or $56 million.

Our Pharmaceutical Distribution Services segment contributed most of the increase, and they did this while covering a significant year-over-year headwind from PharMEDium.

Operating expenses increased 19% or $113 million to $697 million.

Brazil contributed nearly half of that percentage growth and dollar increase.

Excluding Brazil, consolidated OpEx grew 10% and about half of this increase is the direct result of Pharmaceutical Distribution's acquisition of HD Smith earlier this fiscal year.

Importantly, when backing out Brazil and HD Smith, we are right in line with our OpEx growth expectations from the beginning of the fiscal year.

We remain diligent in spending in the right areas, while staying focused on always leveraging our infrastructure.

Operating income.

Our adjusted operating income was $474 million, up about 1% from last year.

On a comparative basis, so excluding consolidated Brazil, our operating income was just slightly lower or down about 1% versus last year.

As I mentioned at the start, we're pleased that our volumes and margins were both slightly better than we expected, but the results weren't enough to completely offset the PharMEDium year-over-year headwind.

In terms of operating margin, we were down 12 basis points, primarily due to our Pharmaceutical Distribution Segment's lower margin.

Moving below, the operating income line.

Interest expense, net and other increased by a combined $8 million.

Excluding Brazil, the net increase was $5 million and due primarily to the new debt issued for our HD Smith acquisition.

Income taxes.

Our adjusted income tax rate was just under 21% and reflects the positive impact from tax reform and the new lower U.S. corporate income tax rate.

Excluding this tax rate benefit, we would've been comparable to last year's tax rate.

Both periods include our annual tax return to provision true-up as well as contributions from our R&D tax credit program.

Our adjusted net income after backing out the Brazil noncontrolling equity interest was $341 million, an increase of 7%, driven mostly by our lower tax rate and corresponding tax expense.

During the quarter, we made good progress on our commitment to keep our share count flat for the year, and we purchased about $265 million of shares of which a small dollar amount was settled and paid in early July.

Consequently, at quarter-end, our diluted share count decreased to 221 million shares.

We exited the quarter with roughly $465 million remaining on our current board share repurchase authorization.

Moving over to cash flow and our cash balance.

As discussed last quarter, our inventory was somewhat elevated in March as we carried extra inventory to ensure the on-boarding of new business was seamless.

This quarter, we realized a benefit from normalizing and also optimizing our inventory levels.

Consequently, our free cash flow was an impressive $744 million.

This means that on a year-to-date basis, we are now at approximately $500 million for free cash flow.

We are tracking well, and we remain confident in our adjusted full year free cash flow guidance range of $1.35 billion to $1.6 billion, which at the midpoint is just under $7 of free cash flow per share.

Finally from a cash standpoint, we ended the quarter with $2.4 billion in cash, which included about $1 billion offshore.

This finishes the review of our consolidated results.

Next, let me switch and cover our segment results.

We can begin with Pharmaceutical Distribution services.

Total segment revenues were nearly $42 billion, up 12%.

Growth would've been 11% excluding Profarma Brazil.

Consistent with the past quarter, this segment benefits from 2 key drivers of revenue growth.

First, our strategic relationships with our anchor and long-term customers provided the majority of our revenue growth.

Examples of this would be the new business with our largest customer, Walgreens.

As a reminder, this is our first full quarter servicing all of their acquired Rite Aid pharmacies.

Through Walgreens, we also continue to benefit from incremental alliance, our ex specialty business.

Additionally, I want to highlight that several of our other anchor customers, especially in health systems and independent retail grew especially well and faster than the market.

And the second key revenue driver was our industry-leading specialty distribution business, defined by us as the distribution of oncology and physician-administered drugs.

This part of our business continues to grow as a result of developing the right mix of customers, providing the right practice management tools and value to our customers and importantly, being the best positioned to support the new innovative specialty drugs entering the market.

This quarter, we finished with just under $10 billion in revenues and our year-over-year growth was 13%, our highest growth rate in several quarters.

We had solid growth in lines shipped, which drove the revenue increase, especially in oncology and to a lesser extent, in ophthalmology and other therapeutic areas.

Wrapping up the segment revenue discussion, since the 11% revenue growth ex Brazil is mostly due to new business including HD Smith, it's important to highlight that revenue growth on a more normalized basis is just a little under half of our reported growth rate.

We're pleased with this growth rate and it's clearly above market.

Moving to segment operating income.

We had an increase of about 3% to $393 million.

Growth excluding Profarma Brazil was a solid 2%.

Solid, because we successfully covered the financial headwind from PharMEDium where our units shipped were down significantly because of the Memphis facility being closed during the quarter.

As I mentioned, we're pleased that the segment ex PharMEDium has balanced acquisition across many of its businesses.

We benefited from very good revenue growth, disciplined OpEx spending and solid margins.

As Steve and I both highlighted, we're pleased that PharMEDium's Memphis facility is now operational, although with limited production.

The business has worked diligently on remediation, implementing new processes and controls and fortifying the team with new staff and leadership.

We continue to expect Memphis to be fully operational in fiscal '19, as we are being thoughtful about how we ramp production at the facility.

As we highlighted earlier, patient safety and providing the highest-quality products to our customers are the top priorities for the business.

By doing this, we continue to be the market leader and the preferred partner.

We can now move to the other segment, businesses that focus on Global Commercialization Services & Animal Health and includes World Courier, AmerisourceBergen Consulting and MWI.

As a reminder, we consolidate our Brazil specialty joint venture in this segment.

In the quarter, total segment revenues were $1.6 billion, up 9%.

When excluding the Brazil specialty JV, revenues grew 3.5% led by World Courier and NMR, our Canadian specialty business which is part of consulting.

World Courier, like they have all year, continues delivering excellent results, with records again this quarter in both the number of shipments handled and billable weight.

They continue to expand strategic relationships with key customers, while picking up incremental business from new customers.

Moving to MWI.

The revenues were relatively flat, partly due to a tough comparison with last year's revenue being unusually high.

More importantly, MWI's top line was negatively impacted by one manufacturer that switched pharmaceutical products back in January to agency from buy-sell.

Normalized for the products switched to agency from buy-sell, our companion animals segment would have grown in the mid-single-digit range, while the production animal segment was down slightly due to general market factors.

From an operating income standpoint, excluding Brazil, this segment had operating income of $81 million, down about $10 million or 11%.

For the quarter, World Courier had outstanding operating income growth due to higher revenues and continued leveraging of their best-in-class infrastructure.

The segment was significantly impacted by performance of Lash consulting.

The good news is that our Fusion implementation is progressing, and we added another key manufacturer to the platform.

We continue to receive high satisfaction scores from our partners on this new leading technology platform.

However, cost continued to be higher than we anticipated during the go-live period, as it has taken longer to migrate existing programs and large amounts of health data to the new system.

Additionally, we continue to see a slightly slower new business development pipeline in the market.

We are pleased with our contract win percentage, validating that manufacturers understand the value Lash provides in the drug commercializing process, but the sheer size of the wins are lower than we expected.

Just recently, our Lash business was selected as a partner of choice and new business will be moving over from a competitor.

Access to our Fusion system was a key factor in the switch.

This reinforces our confidence that investing in innovation will enable Lash to be the best positioned in the market.

This completes our segment review.

Let me transition and cover our full year expectations.

Most of our previous guidance metrics are not being revised.

I would like to spend a few minutes and provide additional commentary on a handful of key items and a few changes.

Let me start with PharMEDium.

Again, we are pleased that we are now operational in Memphis.

Given the extended phased ramp in Memphis, we are not changing our previous guidance.

We continue to expect only a nominal contribution from the business in Q4 and this contribution will be significantly less than that in Q4 of last year.

On the manufacturer pricing front.

We are still comfortable with our guidance assumption for brand inflation.

Given recent activity in the market, we will likely finish toward the bottom of our 6% to 7% range.

Regarding the generic deflation rate, our buy side range has been at minus 7% to minus 9%.

We are certainly encouraged by recent discussions in the market, specifically around SKU rationalization and rightsizing supply to demand.

At this point, we aren't changing our range given we're closing in on the end of our fiscal year, and we're forecasting that our cumulative deflation rate will stay within the range.

In terms of operating income, there is no change to our guidance for consolidated or pharmaceutical distribution segment operating income.

However, for our other segment with 1 quarter left and performance to date, EBIT growth for this segment is being revised to down 4% to down 7%.

Continued headwinds at our Lash consulting business and slightly lower growth than we expected at our MWI business is causing the revision.

Switching to our full year tax rate.

Due to continued tax initiatives and benefits from certain discrete tax items, we're revising our tax rate down to about 22%.

As I wrap up, adjusted EPS, our range remains at $6.45 to $6.65.

Consistent with last quarter when we said that our second half adjusted EPS would be about $3, we continue to track this way and consequently, expect to finish our fiscal '18 near the bottom of our EPS range.

We are executing well in the current environment and succeeding in offsetting the headwind from PharMEDium.

Looking ahead, we are strategically positioned in the market and look forward to resuming growth of our operating income in fiscal '19 and beyond.

As it pertains to fiscal '19 guidance, our corporate process continues to be that we will provide comprehensive financial guidance at the end of the current fiscal year.

This approach allows for our guidance to be fully informed by the output of our year-end business planning process.

In closing, our principles remain strongly in place.

We are aligned on providing the best customer experience.

We are highly focused on execution, and we are always financially disciplined.

All of this enables us to advance our business and drive long-term stakeholder value.

Thank you.

Now let me turn the call back over to Steve for some final remarks before Q&A.

Thank you, Tim.

Before we proceed with Q&A, I would like to take a moment to thank our associates.

The execution of our strategy wouldn't be possible without the 21,000 AmerisourceBergen associates who drive our value proposition and live our purpose every day.

It's their performance that reminds me that we have the strongest team, the broadest experience and the deepest expertise in the industry.

We are extremely proud of the critical role that we play in supporting our customers and ensuring patients have access to the highest quality healthcare treatments.

Our businesses are established leaders in their market with key long-term strategic relationships, both with services that support manufacturer commercialization objectives and solutions that support the growth and longevity of our provider customers.

Over the last year, our associates have propelled the transformation of our business and are collaborating to serve our manufacturer and provider customers in more efficient and integrative ways.

AmerisourceBergen is well positioned for long-term growth.

We have invested and innovated to ensure we are meeting the evolving needs of our customers, driving value for our shareholders and ultimately serving patients.

We are united in our responsibility to create healthier futures.

As always, we appreciate your interest in AmerisourceBergen.

Now here is Bennett to start our Q&A.

Thanks, Steve.

Operator, who do we have as our first question?

Our first question comes from the line of Glen Santangelo with Deutsche Bank.

Steve, I just wanted to hit on a high-level topic that seems to be on everybody's mind.

While your drug distribution business seemed to have a good quarter, there has been a lot of concerns on the path going forward with respect to some of the recent manufacture commentary on price inflation and maybe secondarily, on the administration's blueprint with respect to the potential transition from gross to net pricing.

Could you maybe talk about those 2 issues, and how you think that could potentially impact AmerisourceBergen on a go-forward basis?

Yes.

Thanks, and obviously, it's a question that's come up a lot.

And we obviously are very conversant, very familiar with negotiating with both brand manufacturers and our large customers, our small customers, and that's sort of what our role is.

I always like to tell the story that we're nobody's customer, and we're always negotiating with everybody.

And as you know, we live in a world where we have, well-healed competitors, and we compete every day, and I think we also are very familiar and -- with defending our value proposition.

So first of all, I think these changes are probably, over the long term, going to happen.

It seems like there's some opaqueness and also some elements of the current pricing systems that are difficult for patients with chronic diseases, big deductibles -- the donut hole.

So we've learnt a lot.

We have constant discussions with manufacturers.

We've learned a lot.

We're very informed, and we do think there'll have to be changes.

We also are very confident that AmerisourceBergen and our industry can defend the value that we have, and we can adjust our contracts.

I mean part of what we've been talking for a couple of years about is our rebalancing effort and that's because we will adjust sell sides if buy sides change.

But we also feel that the compensation we receive from brand manufacturers is very fair.

It's a transparent model, and we're proud of the work that AmerisourceBergen did in being one of the leaders in switching to the fee-for-service industry, and we don't think that there's a theme from anybody that our fees are too high or the services.

And we had a good quarter.

But look, at the end of the day, look at the operating profit that we report with all the different businesses we have, we are -- our value is very defensible, very fair.

And if it was -- if we were not [checked,] we did not have the service, there would be a tremendous negative pressures on the whole industry.

And we built these services up that we provide to our customers and to the manufacturers literally over 3 or 4 decades, and we think they're all relevant and up-to-date.

And we think our portfolio is ideally tweaked to help launch these products, support mature products, launch new biosimilars, manage through generic cycles, and just these services are not easily replicable, and they're highly defensible in my opinion.

Maybe if I can just ask Tim one quick follow-up.

Tim, obviously a good quarter in drug distribution, but the question we're getting this morning is what's sort of implied in the 4Q guidance because essentially, given the size of the beat and just the maintaining, it kind of suggests that 4Q may be a little bit lower.

And I just wanted to try to put that in perspective as we think about potential headwinds and tailwinds as we're about to enter fiscal '19.

Yes, Glenn.

As Steve said and you said, we're really pleased.

We -- our distribution segment had a very good quarter.

Reminding everybody that we covered that headwind from PharMEDium.

Rather than just make minor tweaks in guidance, I mean we do think the distribution segment will be down slightly in Q4.

Again, we called out the PharMEDium headwind in Q4.

Again, it's a little bit larger in Q4, and again, that's probably the main item that we're calling out.

And I would say also, year-over-year, there is -- we've taken our estimate down slightly on inflation given the current activity that we've seen out there because of July.

And our next question comes from the line of Robert Jones with Goldman Sachs.

Great, I guess actually just to pick up there, Tim, as you think about the lack of branded increases you've seen in July, and I know you're not giving guidance on next year but could you maybe just help us frame a little bit, what type of tailwind the typical branded increases would imply on any given year?

I mean, I think everyone understands, Steve, to your point, about the value proposition overall, but if we just think more tactically in an environment where there are less branded price increases, how should we think about that headwind as this -- if this continues into next fiscal year?

Yes.

Bob.

I mean, I'll start and Steve can jump in.

I mean, certainly, we saw there's activity out there and commentary.

We're seeing less brand price increases in July that will carry through most likely to the end of the fiscal year.

It's too early to really speculate on what's going to happen in January.

We had a number of price increases in January of '18.

Certainly, I think we've always said that there is -- we have a little bit of exposure on brand price increases and the contribution we get from those.

We've worked really hard to shift those agreements and not rely on those.

We've done a terrific job in shifting to fee-for-service, and we'll continue to do so.

That's our goal.

So I mean, I think, just depending on what happens in the market, we're in a little bit of a hold pattern here.

We'll see what happens.

Again, it's a little bit early to speculate on what's going to change as we get into the new year.

And always, if we see a change, we'll go back and we'll modify our approach, and as Steve mentioned, we'll negotiate and we'll make sure we get fair value on the service we provide.

Yes, I mean, just to put a bit of a finer point on it, as Tim said, we do have -- we've talked about 10% of our supply contracts where we do get compensated on inflation and that comes disproportionately in that January quarter.

But you should assume that we will have that discussion if inflation assumptions change.

And again, it's not -- the inflation rate that we experienced -- this is the point we made in the script.

This is not a headline business.

It's too complicated, the whole way the pharma pricing works, and it's not necessary the inflation rate we experience is inflation rate that consumers, patients, government agencies experience.

In fact, we know that that's quite the opposite, and there's somewhere around up to 30% of wholesale acquisition cost that still gets discounted through to the consumer.

My point earlier was that, that system is somewhat sticky.

It's really embedded in the way that large procurers, payers, employers are used to contracting, and we don't see that changing in 1 quarter or 2. It's a change that probably will happen, but we think it's going to be very gradual.

And hopefully, it's going to happen through changes in business practices that we're part of the dialogue of.

It's not going to happen probably as soon as January of 2019, that would be my best guess.

It just doesn't seem to work like that.

Yes, I guess, Steve, if I may, I mean I think there might be a little bit of, maybe, misunderstanding out there too.

People look at our results and they look at that period of the March quarter, so January, February, March and again, why do we have a higher contribution, higher operating income.

People just naturally go to it's all related to price appreciation, but there is some seasonality in the business.

And as you look at the winter months, you look at flu season, some of our business just perform better, have higher volumes, higher revenues, we ship more lines.

So again, there is seasonality in the business, and it's not related totally or -- it's not related -- it's not all -- again, I think that's a little bit of a misnomer that it's related to PA and that's exposure.

That's not the case.

Yes.

Take Lash Group, for example, Tim, we do extreme -- that's our busiest benefit verification period, because we're reverifying everyone's benefits for the programs we do, so that's another example of why it's a good quarter.

But hopefully, Bob, that's maybe a longer answer than you expected, but...

No, no.

I appreciate all that.

I'll stop there.

We feel positive around them.

And I think this is some confusion out there, so we're happy to go on the record and give you what our sincere views of how we see some of this playing out.

And our next question comes from the line of Charles Rhyee with Cowen and Company.

Steve, I appreciate the comments earlier on talking about sort of the services that you provide in distribution and the sort of the scale and the breadth that you've built over time, not just yourself but the industry overall.

And I noticed -- and also your comments on independent pharmacies, but when you think about some of the disruptions that's possibly coming right just as -- obviously, everybody's talking about Amazon and acquiring PillPack here.

I guess, the question really more is down the road, what is -- what do you think about sort of the risk profile for independent pharmacies?

Clearly, I think the pharmacies that are still around today have managed to find ways to compete in a world where you have these large team pharmacies.

Maybe, can you just speak to sort of the characteristics of these independent pharmacies?

Do you think they can face this kind of new set of challenges coming down the road?

Yes.

We just came back from our ThoughtSpot, and it's honestly always inspiring that we had 3,000 independent pharmacies there.

These guys are great entrepreneurs.

They go through -- they do so many challenges from networks to DRRPs to just frankly competing against the CVS and the Rite Aid and of course Walgreens, our largest customer.

It's daunting, but they're very confident in their service model, they're extremely confident in their relationships with their patients.

And we have heard very interesting stories about a local payer or a local employment or even the government changing the way that benefits get designed.

And them being able to use their patients to advocate and get that change because many times, they are that source of care in the community.

The relationships -- you should have seen our Good Neighbor Pharmacy of the Year winner.

I mean he lives in a county, where there's 50,000 people, about 4,000 people in the town he lives in, in Wyoming.

And he just does amazing things in his community.

Families (inaudible) community, and he knows all his patients, he knows their kids.

I think he knows their animals.

I mean, it's just -- and that's -- obviously, that's not a representative sample, that's just one story.

but I got to spend time with him and his family, and it's -- these guys provide a unique service, the counseling they provide is second to none.

I think what we're trying to do is make sure that we get recognized for that.

And that maybe on the financial counseling side that there's more room and availability, less restrictions on pharmacists doing that sort of work.

So just to comment on PillPack, it's one form of how patients can access medications.

I've a friend whose mom uses them, he really likes it.

That's just one patient.

I mean some people like to shop online, some people like to go to Nordstrom, some people like to go to fancy stores on Fifth Avenue.

That's the flavor of the overall market.

But the big markets are -- we feel, are going to be independent pharmacy, the retailers.

Mail orders reached a certain level and certain patients like that, but it's another way to access medications, and we don't see that particular customer is going to be a huge percentage of the market for the moment.

And obviously, we'll keep an eye on it.

Just maybe I can follow-up on it -- just a clarification on PharMEDium.

You said you notified the FDA that your intent to -- you're in production now, is there any other communication you need to receive from FDA at this point?

Or is that at this point, you've had your conversations and now it's just making sure you have the processes in place?

So what are -- what's our next step regulatory wise, are we waiting for?

Charles.

No, we're really pleased, Memphis is open.

We are in production.

We expect to ship, like we said, in August here commercially, so we're gearing up for that.

We were -- we've always been in active conversations -- sorry active conversations with the FDA, and we would expect in due course, like they do with others, that they would come in and at some point, do their work at Memphis.

But again, we're off and running, we're pleased, and again, this -- we were -- we're pleased that we've made the changes.

It's taken a little bit of a while, but it's all about getting product back out to our customers who want it and need it for their patients.

Our next question comes from the line of Michael Cherny.

Michael?

Our next question comes from the line of Ricky Goldwasser with Morgan Stanley.

Ricky?

Can you hear me?

Yes.

We can, Ricky.

So my first question is on generic inflation.

In the prepared remarks, you talked about the cumulative generic deflation still at a negative 7% to a negative 9%.

But can you share with us what you're seeing in the spot market?

Are you seeing some improvement in deflation trends?

And also what you're seeing on the sell side?

Yes.

Ricky, we would say that, notably, deflation is easing a bit.

I mean you're seeing it in some of the industry data.

And we probably feel like this is the level that we're going to be setting at for a while.

And unless there're any market changes, we will incorporate it into our 2019 guidance, but it's just something we feel that we now are working through, and it seems like that's the norm.

But it's stable at these levels.

We have been encouraged by as one would anticipate, because it's a logical business reaction.

And we're dealing with large public companies for the most part that some manufacturers are talking about, the rationalization of product lines.

And we do see the markets firming in certain instances a bit, which is positive for anyone.

On the sell side, we're very proud of the programs.

We have really recontacted with so much of our customer base.

I think, if I look at the release today, one of the things we're most proud of is we re-signed our -- one of our largest customers without too much fuss on a win-win basis for everybody.

And I think that's reflective of the value and the way that we're contracting with our customers.

We're putting a lot of heat not necessarily on this contract at all, but generally, we're saying, we're going to give you the best pricing, here's what our needs are, here's where we think brand price, inflation prices are, here's what we think happening with biosimilars, with generics, mature generics, new cell-based therapies, and we contract for all those different categories.

And I think, we're very transparent and -- but also very demanding of our customers.

You sign a contract with us, we expect you to adhere to those clauses.

Because they are, as we said, it's -- they're very, very precise.

And so we're dealing with sophisticated kind of bodies in most cases.

Even with independent pharmacies, we're usually dealing with buying groups.

So we're very thoughtful about it, and we expect our customers to be.

And we certainly expect that they understand we need to make a fair return on the business, so hopefully that makes sense.

So one follow-up there.

When we think about genetic deflation, to your point, kind of like stable at negative 7% to negative 9%.

In guidance, you highlight to us always, brand inflation and then generic deflation.

So as we think about these 2 factors, would be very helpful for us if you can help us just understand, which one has a greater impact on guidance?

So how would you rank branded inflation impact on your forecast versus generic inflation?

Well, generics is much more the volume, brand is slightly more the dollars.

But we -- it's hard to gauge it.

I think we have been -- and we've been very candid with you.

Over the last 3 years or so, we've been very surprised at how stubbornly persistent the downdraft on generics was, right?

And it's -- we've had it worked through, but we feel that, that's something we've incorporated into our numbers and our guidance.

And I think we're managing through it.

On brand, we're busy assessing it.

Obviously, the political climate has changed.

There's more rhetoric about it than there's ever been.

And it's one of the things that we will try -- think through as we look to fiscal year '19.

That -- maybe, Tim can give you some further color on how we think about it.

No.

I don't really have much to add.

I mean, again, genetic deflation, we're pleased it's easing.

We did -- just to go back to Steve's comments, we did give -- we talked about cumulative, because we're 9 months into the year.

Generic deflation's a headwind.

We just have to price appropriately in their market, but Steve's absolutely right.

I mean generic deflation's always a little bit more impactful to us on our P&L than brand inflation.

But clearly, we'll -- you have to look at both, and we'll look at both as we exit '18 into '19.

Our next question comes from the line of George Hill with RBC.

Steve and Tim, there's a lot of discussion in the investment community about what we call like the make-whole thesis, which is kind of through this pricing change, can you guys sustain your -- the level of value that you drive from both manufacturers and dispensers?

So I guess, can you say, as it relates to the fee-for-service model in distribution, how much of the current fee-for-service margin is based on underlying list prices?

And how much is based on a -- what I'll call, a different assessment of value provided by the wholesaler to the different constituents?

Well, we've made comments that it's about 90% of the brand purchases are covered by fee-for-service and we don't benefit from inflation.

There's still a few contracts, which cover -- 2 of them are pretty significant where we don't -- we do benefit from inflation.

You should have seen the discussions with those manufacturers and in some of the occasions, the inflation rates may not change but we're having those iterative discussions all the time.

This is not -- we don't just meet with a lot of suppliers once every 3 years and renew the fee-for-service contract.

The new products that get launched, the issues that come up from time to time, there is just contracts that expire at different rates.

So we have very large resources devoted to negotiating with both brand and generic suppliers.

And the brand team is a team where I know a lot of the people personally we've added terrific resources there.

They're some of the most talented people in the company, and I think we are very, very honed in our messaging and I think that's very understood, the value we bring.

And again, going back to the results that we report, very defensible.

When you look at everything that AmerisourceBergen does, it's a very fair return that we get a fair return on invested capital and a fair operating margin and again, these are very reimbursement-sensitive products.

Sometimes, these fees are not possible on.

I am very familiar, of course, with part b, and we prosper in this environment, and we had good growth.

Our customers are doing well, and I think that we will manage through this.

We're confident that we will manage through this.

It's somewhat disconcerting that there's so lack of confidence when this industry has developed -- has demonstrated value over 3 or 4 decades and consistent value and ability to transition.

Yes.

I mean I think, Steve, again, I mean people need to remember, we operate world-class supply chain systems.

And this year, we're on track.

We'll make less than 1% after-tax.

We provide incredible value every day, just-in-time delivery, and again, like Steve said, it will take some work, but we're very confident on the value we provide and it's defensible, and it's -- we think it's very supportable and appropriate.

And our final question comes from the line of Michael Cherny with Bank of America Merrill Lynch.

Can you hear me this time?

Yes.

Go ahead, Mike.

Okay, perfect.

Just diving back into the 4Q numbers, not necessarily to get '19 guidance but to think about the business.

In terms of the implied ramp into 4Q on the profitability for pharma, it seems like if you assume flat for the year, which is your guidance, that it's a pretty meaningful step down.

You talked about PharMEDium being a bigger headwind, you talked about that change in brand.

Are there any pieces in terms of that 4Q bridge that we should think about in terms of getting us to that flat number?

Or is flat more a round number in terms of how we should think about it given Tim's comments on it being down modestly or slightly?

Yes.

Again -- Mike, I'll jump in again and maybe just repeat a little bit.

I mean again, PharMEDium is a headwind, we don't expect that to continue.

I mean, while Q1 of '19 though, we'll have a little bit of a headwind, again lapping PharMEDium.

But Q4 tends to be a lower contribution period for us.

Again, with PharMEDium, the brand inflation, specialty's a little bit Our legacy specialty business is a little bit lower, and our OpEx tends to be a little bit higher as we exit the year.

So I don't think that necessarily Q4 is an indicator, a true indicator for what Q1 will be necessarily.

There are some unique aspects of Q4.

So hopefully that helps.

Steve?

Well, thanks, everyone.

And I hope we've had a good dialogue on the industry and the value that we provide.

I and -- Tim and myself are very proud of this quarter.

We think we showed a lot of the resilience and strength that we have.

We've executed on core initiatives.

We're incredibly pleased that -- we took our time with PharMEDium.

There's no doubt about it, but the team worked hard.

We brought in some new talent, and we will begin commercial operations this month.

That's a big step for us.

We think we've worked collaboratively with regulators, and we're excited that we can get back to doing what we do best there, which is taking care of customers and doing that in the safest possible way.

And the same could be said for all of our businesses.

AmerisourceBergen is creating value for our customers, for our suppliers and for the healthcare system as a whole.

And we'll look forward to seeing some of you in the next couple of months.

Many thanks for your time today.

Thank you.

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