Perrigo Company PLC (PRGO) 2017 Q2 法說會逐字稿

Good morning, my name is Hope and I'll be your conference operator today. At this time, I would like to welcome everyone to the Perrigo Second Quarter 2017 Financial Results. (Operator Instructions) Thank you. Mr. Brad Joseph, Vice President of Investor Relations and Corporate Communications, you may begin your conference.

Thank you. Good morning, everyone, and welcome to Perrigo's Second Quarter 2017 Earnings Conference Call. Hope you all had a chance to review the press release we issued earlier this morning. A copy of the release is available on our website, as is the slide presentation for this call. Leading today's call are John Hendrickson, Perrigo's Chief Executive Officer; and Ron Winowiecki, Perrigo's acting Chief Financial Officer.

I would like to remind everyone that during this call, participants will make certain forward-looking statements. Please refer to the important information for investors and shareholders and safe harbor language regarding these statements in our press release issued this morning. In addition, in the appendix for today's presentation, we have provided reconciliations for all non-GAAP financial measures presented. Now I would like to turn the call over to John Hendrickson.

Thank you, Brad, and welcome, everyone, to Perrigo's Second Quarter 2017 Earnings Call. On Slide 4, you can see the agenda that I will be covering today. I'm pleased to share with you Perrigo's strong second quarter performance and results driven by sound execution of our differentiated business model and the reasons why we have raised our guidance today.

Turning to Slide 5. You can see the margin trends in our businesses for the last 12 months. This is a direct result of our continued focus on operational excellence and being action-oriented. These principles have driven our business results and fostered sustainable margin performance and consistent operating cash flow. Slide 5 shows the durability of our business model which includes our consumer-facing businesses that comprise approximately 80% of our net sales. CHC Americas' adjusted operating margins remain strong, at over 20% for 6 quarters in a row. Consumer acceptance of store brand products continues to increase and our new product pipeline continues to deliver additional growth. In CFC International our operating margin profile has increased to the low to mid-teens as evidenced by this quarter's adjusted operating margin of approximately 15%. The team's concentration on our OTC portfolio, continued execution of [product insourcing] and disciplined ROI-based approach to advertising and promotion have resulted in the second consecutive quarter of meaningful year-over-year operating margin improvement. I remain excited about the prospects of this business. In Rx, the adjusted operating margin has consistently remained above 40% as a result of our differentiated extended topical strategy and the dynamic pricing environment. The Rx team's focused execution drove sell-through of higher margin product in second quarter and improved the timing of new product launches, both of which helped the business achieve an adjusted operating margin of approximately 47%. Overall, our business remains well positioned to benefit from the fact that consumers and health care systems around the world continue to search for more affordable alternatives for their health care needs. Health care costs continue to be a focus around the globe, and Perrigo's ability to provide quality, affordable health care Products makes us a key part of that health care cost solution.

Turning to Slide 6. New products are the growth engine for Perrigo. As is our practice, we risk-adjust all potential new product launches in our guidance. Given the earlier-than-anticipated launches, particularly within the Rx business, we're now upgrading our 2017 new product guidance to greater than $225 million, up from our previous guidance of more than $200 million. We continue to expect to launch almost 2 products per week across all of our businesses, including the anticipated store brand launch of Nexium in the second half of this year.

Turning to Slide 7. I'd like to provide some highlights on the quarter. Our focus on operational execution has produced several positive results across our businesses. As one, CHC Americas' adjusted net sales grew 3% versus the prior year and store brand again gained share versus national brands; over the last 12 months, CHC Americas' adjusted net sales also grew approximately 3%, which is in line with our long-term growth framework of 2% to 4%. Second, CHC International constant currency net sales grew a solid 4%, excluding the $39 million in the prior year from the exited unprofitable European distribution businesses. And, third, the Rx team executed extremely well and delivered solid results this quarter by leveraging our extended topical portfolio and driving our long-term strategy.

Additionally, we continue to take actions to enhance value for our owners as we largely completed the cost improvement initiative announced in February of this year and remain on track to meet our run rate goal of greater than $130 million of savings by the middle of 2018.

Second, with the completion of $2.2 billion of debt paydown in the second quarter, we have created greater optionality and flexibility to use our strengthened balance sheet as evidenced by the repurchase of $58 million of shares in the second quarter. And, three, this morning we announced the sale of our Israel API and Russia businesses. These transactions exemplify the strategy of simplifying our core offering and focusing on long-term value and profitability.

These actions, along with this quarter's strong business performance and enhanced visibility for the remainder of the year, have led us to increase and raise our 2017 guidance, which Ron will cover in more detail. Ron?

Great. Thanks, John. Before walking through my detailed comments for each of our businesses, I would like to take a minute to reflect on our performance results for the quarter. I characterize our performance for the past 3 months as converting opportunities into bottom line results. Each of our businesses with a key focus on execution, action and capitalizing on opportunities turned in strong performance results for the quarter.

Now let's turn to Slide 9 where you can see our GAAP performance results for the second quarter. Let me walk you through the primary adjustments, which are included in the appendix of this presentation that reconciles our GAAP financial statements to our adjusted performance results. Adjusted non-GAAP results exclude $135 million of debt extinguishment fees related to our debt paydown strategy that was executed in the second quarter, $89 million of noncash amortization expense, $39 million related to the fair market value adjustment of the contingent consideration payments for Tysabri, and $27 million of impairment charges related -- primarily related to certain definite-lived intangible assets in our Rx segment. GAAP tax expense as a percent of pretax income was 0.5% in the quarter compared to a non-GAAP effective tax rate of 20.9%. The difference primarily is due to the tax effect of the non-GAAP pre-tax adjustments and the effect of deferred tax assets and liabilities consistent with the adjusted pretax income.

Now, I will discuss the strong performance results for each of our segments.

Turning to CHC Americas results on Slide 10. You can see that segment net sales in the quarter were $605 million compared to adjusted net sales of $588 million in the prior year, an increase of 3% year-over-year on a constant currency basis.

This increase was primarily due to higher sales in the smoking cessation and dermatologic categories and stronger performance in our Mexico business compared to the prior year. New product sales in the quarter were $13 million primarily driven by the store brand launch of Flonase, which annualized during the quarter, in addition to the launch of new nicotine replacement gum products. Offsetting these benefits were lower sales, primarily in the animal health, analgesics and cough/cold categories compared to the prior year.

Including the 3% net sales growth this quarter, CHC Americas has now realized a 3% net sales growth over the last 12 months, which is directly within our long-term growth framework of 2% to 4%. The fundamentals in this business remain strong, led by our team's focus on new products, customer channel opportunities and increase in consumer acceptance of store brand products. For the quarter, adjusted gross margin was 35.7%. As a reminder, last year this segment realized record adjusted gross margin due to the sell-through of higher margin products. Current year adjusted gross margin includes the effect of year-over-year price erosion in certain categories partially offset by positive contributions from supply chain and manufacturing efficiencies. CHC Americas' adjusted operating margin was 20% for the 6th consecutive quarter in a row, illustrating the durability of this business.

Turning now to Slide 11. You can see that net sales in the CHC International segment were $377 million. Net sales grew approximately 4%, excluding $39 million from the exited European distribution businesses, and unfavorable foreign currency movement of $16 million. This increase was led by new product sales of $19 million and higher net sales in the allergy, analgesic, and cough/cold categories. The CHCI team delivered strong sales during the relatively higher cold, cough and allergy season compared to the prior year. Adjusted gross margin in the quarter was 51.7%, a 230 basis point improvement over the prior year, primarily due to the cancellation of the distribution businesses. This segment also benefited from our strategy to in-source more production of our branded OTC products. Offsetting these benefits were unfavorable effects from currency movements and lower margins in our U.K. store brand business.

Adjusted operating margin of 14.6% was driven primarily by gross margin flow-through combined with the benefits realized from our cost optimization program. Year-over-year adjusted operating margin improvement included higher advertising and promotional expenses as a percentage of net sales. Overall, the CHC International segment realized strong performance in the quarter as the team continued to actively integrate sales strategies with promotional programs which are yielding positive results, as evidenced by the net sales growth in the quarter and the upward shift in adjusted operating margin to the low to mid-teens.

Turning now to Rx on Slide 12. Excluding the $26 million year-over-year impact of Entocort, net sales in this segment were lower by approximately 4%. Sales volume growth in the quarter of 4% and new product sales of $6 million, driven by the launch of 3 new products late in the quarter, were offset by price erosion, which was in line with our expectations. Adjusted gross margin was 58.8% or 200 basis points higher than the prior year, as the favorable product mix and reduced level of floor stock adjustments compared to the prior year offset the effect of Entocort competition and year-over-year price erosion. Adjusted operating margin for the segment was 46.5%, 370 basis points higher than the same quarter last year, primarily driven -- due to the strong gross margin performance in the quarter, the restructuring of the Specialty Pharma sales force and timing of R&D investments. Perhaps most impressive, adjusted operating income grew by 21% or $19 million excluding the effect of Entocort. The benefits of our diversified extended topicals portfolio were realized this quarter with the sell-through of higher margin products, yet again another example of converting opportunities to bottom line results. This was a great quarter for the Rx team.

Now turning to Slide 13, I'll provide an update on our balance sheet. As of July 1, 2017, total cash on the balance sheet was $761 million and total debt outstanding of approximately $3.7 billion. This reflects the actions we took to significantly strengthen our balance sheet during the quarter by successfully executing on our debt paydown strategy, utilizing the proceeds from the sale of Tysabri. In total, year-to-date, we have reduced debt by approximately $2.2 million or nearly 40% of our total debt outstanding at the beginning of the year. Further, as discussed on previous calls, we intend to repay approximately $370 million of our remaining 2017 maturities from operating cash flow or cash on our balance sheet. These combined actions result in an estimated total debt paydown of $2.6 billion by the end of the year. In addition, actions taken during 2017 have reduced our debt maturities over the next several years. The total remaining debt maturities for 2018, 2019 and 2020 are approximately $500 million. Our debt paydown actions have increased our financial flexibility, enabling the majority of free cash -- of future free cash flows to be available for strategic purposes and/or returning capital to shareholders. Our financial policy of operating within an investment-grade credit profile remains steadfast. Within this framework, we will deploy a disciplined balanced capital allocation strategy to drive total shareholder returns. In the second quarter, we completed $58 million of share repurchases and we'll continue to evaluate market dynamics against the fundamental value of Perrigo, relative to other investment choices. In short, our capital allocation decisions are always focused on total shareholder returns within the context of our investment-grade financial policy. Turning now to operating cash flow. In the first 6 months of the year, we generated $285 million of cash from operations. As a reminder, the $285 million includes 2 unique items totaling $105 million, an unusual tax payment for $74 million and cash restructuring payments of approximately $31 million. Our team continues to focus on cash flow generation and we expect the strength of our business model to convert 100% of adjusted net income to cash. Operating cash flow conversion as a percentage to adjusted net income for the first half of the year was 120% excluding these 2 unique items.

Shifting now to discuss the remainder of 2017. On Slide 14, you can see the bridge that walks our adjusted EPS guidance provided on May 23 to the increase in adjusted EPS guidance provided this morning.

There are 3 primary drivers of this raise in guidance that I would like to discuss. First, given our strong execution across our segments in the second quarter, we are raising our 2017 adjusted EPS guidance by approximately $0.20 per share. Specifically within Rx, performance of new product launches are expected to exceed our previous forecast and as John previously mentioned, we have updated our new product guidance by approximately $25 million. Within CHCI, due to the strong execution in the second quarter and favorable currency movements compared to the forecast provided May 23, we are increasing our sales forecast in this segment by $50 million. Second, we are already benefiting from our strategy of strengthening our balance sheet. Our forecasted 2017 interest expense is approximately 25% below the prior year. And we used our strong cash flow position to repurchase $58 million or approximately 812,000 shares in the quarter which represents a benefit of approximately $0.03 per share in 2017. These completed share repurchases are reflected in our 2017 share count guidance of 143 million shares. And third, this morning, we announced the sale of Israeli API and CHCI Russia businesses. Our portfolio review process led us to the conclusion that these businesses will better thrive under new management that will dedicate the resources needed to grow their platforms. We expect to close the API transaction in the second half of 2017. Consistent with our historical practices, we are removing forecasted second half adjusted operating income of $10 million or $0.05 per share from our guidance. As a result of these combined factors, we are raising our 2017 adjusted EPS guidance to $4.45 to $4.70 per share, a $0.25 midpoint improvement from the previous range. Our continued emphasis on operational excellence, actions to focus and simplify our business model, building balance sheet flexibility and driving our new product pipeline continue to strengthen our performance outlook.

On Slide 15, you can see our 2017 segment guidance, which has been updated to reflect our stronger-than-expected first half performance across all of our segments. Walking down the slide, you can see that in CHC Americas, we continue to expect approximately $2.4 billion in net sales and adjusted operating margin in the low 20% range. In CHC International, we have increased our expected net sales guidance by approximately $50 million to approximately $1.45 billion due to the execution of our forecast and sales strategies combined with favorable currency movements compared to our previous guidance. We continue to expect an adjusted operating margin in the low to mid-teens for this segment. In Rx, we have increased our expected net sales guidance to approximately $950 million due to earlier-than-expected launch of new products.

Strong second quarter performance has led us to increase our adjusted operating margin expectations from the high 30% range to slightly greater than 40% for the year. I would like to provide a few modeling assumptions for the second half of the year. As a reminder, in CHC Americas, we are including the store brand launch of Nexium in the second half of 2017. Our CHC International segment delivered stronger-than-expected net sales in the first half of 2017, primarily due to relatively stronger cough/cold/allergy season. Other than the effects of foreign currency movement, our second half sales forecast for this segment is unchanged from our previous guidance. In the Rx segment, as previously mentioned, second quarter R&D investments were lower due to the timing of clinical trial spending. In the first half of 2017, R&D in this segment as a percent of net sales averaged approximately 5%. In the second half of 2017, we expect R&D in this segment to increase to approximately 7% of net sales.

Finally in the Rx segment, our year-over-year price erosion assumption remains at 9% to 11%.

On Slide 16, you can see our consolidated 2017 guidance metrics, updated to reflect the factors I just discussed. We've increased our full year net sales guidance range to approximately $4.7 billion to $4.85 billion which reflects improved visibility within our business and mathematically a midpoint upgrade of approximately $75 million. Adjusted operating income guidance has been upgraded to $960 million to $1 billion to reflect the flow-through of new product launches and operational improvements. As I stated earlier, our guidance now excludes approximately $10 million of adjusted operating income contribution from the Israel API business in the second half of 2017. Our interest expense guidance has been updated to reflect the added savings driven by the favorable execution of our recently completed tender. You can also see that our expected tax rate for the year has been updated to reflect an improvement of approximately 100 basis points. Regarding operational cash flow, as you likely recall, our original 2017 guidance back in February was to achieve greater than $550 million. On April 25th, we've increased this guidance to greater than $575 million. Consistent with our guidance -- earnings guidance upgrade today, we have also increased our operating cash flow guidance to approximately $600 million. As a reminder, this number includes $74 million tax payment and total estimated cash restructuring payments of $60 million for the year. And accounting for these 2 items, our 2017 operating cash flow conversion is forecasted to be over 100% to adjusted net income.

Before turning the call back to John, I would like to congratulate the Perrigo team for the strong performance result. It's exciting to see the CHC Americas team deliver 3% LTM growth with sustained 20% adjusted operating margin. Our CHC International team has shifted the baseline in this business to low to mid-teens adjusted operating margin. And as mentioned, the Rx team had a great quarter and continues to deliver our focused extended topical strategy which led to results above our expectations. These fundamentals, combined with a strength balance sheet, build a foundation for Perrigo to drive our strategic growth initiatives in quality, affordable health care. I will now turn the call back to John.

Thank you, Ron. As you can see on Slide 18, store brand drove continued healthy International brand growth in almost every major category. This was really driven by continued consumer acceptance of store brand products and launch of store brand products in categories where national brands previously held exclusive share. Over the past 3 months, the growth of store brand is particularly prominent in the cough/cold/allergy and sinus category, which was driven by store brand fluticasone, among other products. In addition, new products are continuing to drive growth in the smoking cessation category.

Let me touch briefly on e-commerce. The strength of our business model, the diversity of our product portfolio and the ability to provide an end-to-end solution make us a natural partner in this important and growing channel. As an example of this, our investments in digital marketing and promotions create a more efficient medium to educate consumers on the benefit of store brand products. And I believe we are well positioned to take advantage of this channel, partnering with all of our customers.

Turning to Slide 19. I remain excited about our CHC International businesses as I have been over the last couple of years. We have now produced meaningful margin improvement over the past 2 quarters as we continue to focus on our OTC branded portfolio. The team is continuing to invest in innovative new products and line extensions that will leverage our well-known brands and remain dedicated to ROI-based advertising and promotion investments to drive our unique product portfolio. This segment is on a path to long-term margin expansion led by new growth initiatives -- growth initiatives, combined with our focus on operational improvement.

On Slide 20, you can see our updated Rx pipeline metrics. We are continuing to execute and manage this business for the long term. To date in 2017, we have launched 5 new products and we expect our product pipeline to drive growth in this segment in 2018. Also on this slide, you can see the market size of additional opportunities that remain for this business. The Rx team is continuing to develop and bring to market difficult-to-manufacture extended topical products across these categories.

In closing, on Slide 21, we did perform well against our first half in 2017 with all segments outperforming our expectations. And the team remains focused on achieving our updated full year 2017 plan. We have set the foundation for a strong future. Our product pipeline, channel and customer opportunities position us well for growth, our cost savings initiatives have created a more efficient organization, allowing us to capture a greater contribution from every product that we launch and our enhanced balance sheet flexibility creates optionality for driving total shareholder returns.

Before turning the call over for Q&A, I would like to briefly comment on my pending retirement. I want to reiterate my confidence in the strength of Perrigo's unique business model and our leadership team. We have executed against the key initiatives and are better positioned for long-term success. The board is working diligently in its search process to identify the next CEO and I am excited by the level of interest received from many high-quality candidates.

Given the ongoing search process, we will not plan to hold the Analyst Day until a new CEO is onboard. In the meantime, Ron and I will remain fully committed and excited to continue our open dialogue with all of our investors.

I'm very proud of all we've done to focus our business over the last 5 quarters. We've made many tough decisions during this time. But I believe the actions we've taken will enhance our long-term shareholder value for our investors, while providing quality affordable health care options for customers, consumers and families across the globe.

Thank you very much. Brad?

Thanks, John. Operator, we'd now like to open the call for questions. (Operator Instructions)

(Operator Instructions) Your first question comes from the line of Annabel Samimy with Stifel.

Given that things seem somewhat stable and you have -- with the sales have every -- you have some good balance sheet flexibility, are you starting to consider some new strategic initiatives, some bolt-on acquisitions to bolster sustainability of growth in some of these franchises? And I guess, that was my one question.

Appreciate it. So I would say, yes. We feel like we've got -- are in a good position with all of our businesses, operating on a good platform and our balance sheet does give us that optionality. I think we are very open to enhancing those business platforms through bolt-on acquisitions and other products that would enhance those businesses, as well as using our balance sheet for other ways of returning capital potentially to shareholders.

I guess to that point, what areas do you think would be most suitable for that bolt-on? And what areas do you think still require some expansion, let's just say?

Yes. So I think I feel very good about all of our business segments and the actions that we've taken, I would say, over the last year or so to make sure that we have a foundational solid structure under them. I think our CHC Americas business, our CHC International and even specific products that might fit within our Rx business are clearly fair game for bolt-on acquisitions.

Your next question comes from the line of Marc Goodman with UBS Investment.

I was hoping you could come back to the overseas consumer business which seems to just be turning much quicker than we would have thought. If you could just give us -- talk about the top line a little bit and where -- I mean was there a lot of strength in any particular geographies? Were there new launches that did really well and that gives you the confidence that those new products are going to continue to do well throughout the year? Just give us a sense of what's going on there, because really it's turning quicker than we thought.

Yes. I'd say -- if I step back from -- we're still on what I consider to be a broader strategy of enhancing that business. So if I can step back a minute on you, it was sort of making sure that we have the right business structure. So we got out of some things that didn't make sense. We've spent a fair amount of time sort of massaging our portfolio, make sure it was the right value add. We started back when doing a number of things to enhance our margin profiles, insourcing product into our sites from a global perspective. We still have a ways to go on those things. We have taken good action. We can see the results. And as I said on previous calls, this isn't a next 3 months thing. This will continue to evolve over the next couple of years as we continue to enhance the margin. I think the growth if you look at the quarter was a strong cough/cold execution, within those regions, there were a fair number of regions that did execute well against the products and provided strong growth. When we look forward, if I look into what continues to drive it, we continue to put the right advertising and promotion against those core categories and businesses for us and drive those as opposed to peanut butter spreading our A&P. So the team is doing a good job of things, our key items to drive, how we make sure that we're dedicating our investment dollars against those key return areas and that has paid dividends. Ron, do you have anything else to add?

No, it's very, very well said. I don't have much to add. If you look at the models and guidance we've given to you, we had the 4% growth in Q2. You will see growth in the second half of the year. I think you've seen those models that are out there. Hopefully you've seen that. So we are expecting the growth trend and momentum to continue against the base from last year. So we're pretty excited about the future of this business.

Your next question comes from the line of David Risinger with Morgan Stanley.

I just wanted to ask a high level question about the sustainability of operating margins in the U.S. Consumer Healthcare and the Rx business. It seems like you are guiding for margins to expand in 2018, because of cost efficiency initiatives that will continue to benefit the margins. But since the 2 segments are close to all-time highs, how should we think about the sustainability of those margins longer term as more competitors compete in those areas? And then I know that you asked for only one question. But could you just comment on the second half guidance, when we subtract the beat, the second half guidance is in line with consensus, if you could just comment on that?

Great. Thanks, David. And like all good people, you kind of carved those questions together. So I thought they were good. Let me kind of take them separately. So first of all, on the sort of how do we think about sustainability of margins and those kind of things. I would say it is driven by a few different things. In both the consumer side as well as the Rx side, within the U.S., one is, you have got to keep launching product. You got to keep the pipeline [fruition], and you got to keep adding, especially with the consumer side, new line extensions. This is a business that needs you to continue to feed it, so you continue to grow that. And that is part of the margin sustainability of platform. The costs do play in there. We need to continue to be one of the best, most cost-efficient players out there so that we can make sure that those all flow to the bottom and drive that. In both businesses even in the model we laid out for our consumer side as well as Rx, we have planned in price erosion. So if you said, if you look at the back half of the year, will continue for the whole year in Rx, to talk about 9% to 11% core business erosion, we still have price erosion in the consumer side, as we laid out in our 2% to 4% normal guidance, that means our volume's growing faster than that in consumer, but some of it does get offset by this. We've included in what we think is a competitive environment and a competitive pricing environment. At the same time between new products, between share gains, between launching our cost efficiencies, we feel we can continue to grow over and above what we are seeing from a pricing competitive standpoint. Ron, do you want to take the second half question?

Yes, it was a tough question, John. So when we started the year, if you go all the way back to [sudbury now], one of the things we communicated in the back end plan, if you look at the modeling, construction and kind of guidance, we didn't give quarterly guidance, but said clearly it's going to be a lower first half versus second half. So with the theme that's now we've kind of moved forward, we've taken advantage with the strategies we put in place. Again, John talked through those very well. The Rx diversified portfolio pulled through great margin products in Q2. We capitalized on that. John talked about aligning sales strategy with promotion activities in CHCI. The reason we capitalized on things like a strong cough/cold season in Q2 and even in Q1 is because of those foundations that were set. So if you look at the model now to your point, we're more balanced. That's great. So we've derisked our -- call it, the year. We've upgraded guidance but we're sitting now about, call it, 49% H1, at an EPS level, if you use the midpoint, it's kind of the -- balance your framework, 51% in H2. So we're excited. We are also pragmatic. We want to make sure we're prudent in our approach going forward. If you look at the business segments, think about what you are seeing in the lens of the H2 kind of model. So first of all, CHC Americas you're seeing clear growth, clear operating leverage. Why? Nexium. So we have a great new product, launches coming through in H2. In Rx, we've tried to make sure we are very open in -- about what is happening in Rx. We have again pricing, we're still modeling at 9% to 11%. So pragmatic. We kind of call out the unknown unknowns, we're trying to make sure we take a risk-based approach. That seems to have worked, right? For the last 4 quarters we kind of met our expectations on pricing. Our R&D has shifted a little bit. We have some clinical trials, so as you model out, you are going to see again around 5% of R&D percent to net sales in Rx in first half, 7% in the second half. So you got some margin. Obviously lower margin because that needs to. But when you look at the Rx volume in H2, it's strong. So take a look at that as you model out your performance. And H1 -- or CHC, listen. Again as I commented earlier, that 4% growth that you saw in Q2, look at the models, we may not have changed guidance but you will still see that 4% growth in H2. So that carries -- that momentum carries into the year. But we're not changing the modeling guidance because we're sticking on that 4% OTC growth, excluding things like currency and the distribution businesses. So through that lens, again we're excited about H2, but also pragmatic in how we're trying to look at the business in the second half of the year.

Your next question comes from the line of Jami Rubin with Goldman Sachs.

This is Candace Richardson on, on behalf of Jami Rubin. Given data points across the industry call for further worsening of generic margins and competitors with similar dermatology portfolios are seeing worsening results, can you just speak to how confident you are that you can sustain operating margins in the 40% range? And then related to that, many of your peers are also expecting accelerating price erosion going forward. Can you speak to why you are confident that you still see stable erosion for the rest of the year? What differentiates your portfolio?

Yes. Thank you. I will give my perspective, I'll then ask Ron to jump in on this also. I think we had to look very hard at our process, if I go back 6 quarters ago, 5 quarters ago, very hard at our process, of what we were looking at from a pricing standpoint, how we went through our process. You need to remember those calls where we talked about deep dives into what we know, what we think we know and then what we don't know and how we balance all those things. And I will say that over that period, we gained confidence in our process as far as how we work through those and what we know. And so we feel like the last 4 quarters or so, we've been able to be in the ballpark of predicting what we thought we would see and our models have proved out. It doesn't mean we know every piece, because we do plug in some unknown variability. But using that process, using our broader looks -- look at our portfolio, seems to be playing out and giving us some decent visibility into what's there. So look, I don't -- 9% to 11% is still a big price erosion on the base. So we're not forecasting that it's going to get any easier at this point. We're saying there is still a big number in there. We feel good about our process of doing it. And we feel good about our new product pipeline, getting those launched now and what we see going forward to offset that. Ron, you have anything to add to that?

Yes. The only thing I would add is, just to put it -- is our diversified portfolio. We talked about this a great deal and we want to keep that. Where we really think we're different is we don't have any product greater than 5% of any of the sales distribution within Rx. And you go -- let's talk case studies. I think that's the best way to think about it. We have a products family that requires 9 clinicals to attack that product. And each of those clinicals are topicals, each of those clinicals are expensive, and each of the manufacturing value streams are complicated. So, look, not every product has that same competitive landscape, but that's an example of where we can pull those products through. And John and his team did a great job in Q2. This is an example of product that sold through in Q2 at higher margins. We benefit from that. We bring that to the bottom line. So again you can look at our portfolio against others. Listen, obviously we are subject to the same competitive environment as anybody else. But that diversification is something that we think we benefit from. It's a good part of our extended topicals strategy and why we can hold those margins within a tight zone as we look at it at this point.

Your next question comes from the line of Louise Chen with Cantor Fitzgerald.

So the question I had here is how should we think about sales growth and margins for your store brand business over the longer term? Is there still meaningfully growth left here for this business? And then also, in terms of the pipeline, are there any Rx OTC switches or larger products that you would highlight?

Yes thanks, Louise. So I would stay with the same framework that I tried to give over the last couple of quarters of how I think about it. And it hasn't changed. And frankly it has come to reinforce I think, of what we've been saying, which is look, I believe our U.S. business, our U.S. Consumer Healthcare business can grow through a number of avenues. One is, we have the acceptance of store brands. While we thought we had -- you may have thought we hit a cliff, continues to grow. So if you look at, we continue to gain share in categories, store brand. Consumers want a good value. They understand the difference now. I believe that kind of growth can continue. I believe bringing new product to market that we haven't been able to be in, the line extensions, all of those things that we do, add growth to that. And frankly the overall market had some growth. And so when I think of CHC Americas, we laid out a framework of in that 2% to 4%, it's higher than that from a volume standpoint, but we did add in some pricing to make sure we get to that 2% to 4%. In my mind that's 1.5x to 2x market growth in the U.S. and I think that's the -- what we should be held accountable for frankly, that we should be able to grow this business at those kind of rates over the long run. Consumer Healthcare International, we have a couple of things going on. One was making sure that our infrastructure was right to support the growth of the business, that we have the right portfolio, that we have the right, I'll call it, cost of goods as well as operating expenses. We are still on that path but making progress. And then I said the businesses, the brands we have, our ability to leverage those, should have growth in our minds, even in that segment given the challenge we have, we should be able to grow that at 1.5x of the market growth in those Europe countries. So without giving an exact number, I believe with the portfolio and the actions we're taking, we should be a faster grower within those segments than the markets that we compete in.

And I guess on Nexium, can you comment whether or not you have included an additional competitor in your guidance for this year for that product?

Yes. So I would say we've got in the back half the year for that. We do in our kind of guidance, don't have us being alone in that. You know what we think about the guidance in there, so it's risk-adjusted as we always do with new products. But we're not planning on being alone in that Nexium market.

Your next question comes from the line of Chris Schott with JPMorgan.

Just a 2-part question on the Rx business. Firstly, just on these Q2 margins. I know you touched on some of these issues. But just to help us understand a little bit more about the strong margin performance, if we look at about a 500 basis point bump from 1Q to 2Q. It sounds like there wasn't a huge amount of new product flow necessarily in this quarter because the launches were late, I know R&D timing was late. I'm just trying to understand a little bit more how we saw this type of sequential jump in margins. And then the second question was on the same Rx theme, I know you're still looking for down 9% to 11% in the second half of this year. Any just preliminary looks as we think about 2018, is that 9% to 11% a decent range to think about going forward or do you see the level of erosion starting to ease a bit as we start to think out to next year?

Ron, why don't you cover the first part. And I will give my perspective on the broad picture.

I know it sounds like a too simplified answer. But it's actually, to your point, sequentially what happened to the business. It is strong margin pull-through. And again you'll have different distribution in margins based on cluster mix within a product group. And John and his team did a great job kind of looking where -- where can product be positioned with customer A versus customer B, or channel A versus channel B. And really that's the story. There's not much more than really the business from the portfolio, had opportunities with the strong margins. And certainly again, certain products had less competition, that pull-through came through in Q2. You will see the modeling, we're not modeling 4% to 6% in Q3. So you will see that we've normalized the portfolio from a margin standpoint going forward in the second half of the year. And again, it sounds simple, but it is that simple, given the diversified portfolio, the stratification of products that sold through, where -- with a higher margin products in the second quarter versus the sequential Q1.

Great. And I would say, if you think about it and we said this year as we looked at it, 9% to 11% and again we are continuing to stay with that. And think that it falls within the sort of guidance we gave and what we're expecting. As I look forward I do eventually expect the market to, I'll call it more normalize. When I say normalize, there still is a decline of kind of core, but in the 3% to 5% range if you look out a ways. Getting back to more normalized base from what we've been experiencing. At the same token, when I look at '18, and we don't -- I'm not giving you guidance or anything because we don't have any of those out there, I don't see a softening quite yet. I don't see it tailing away where you want to see it, it was going to drop to 3% to 5% soon. So I think we are going to continue to experience a tough pricing environment at least going forward here for a little while. I think ultimately it has the balance to back down to a more normalized number because the whole industry won't sustain at these kind of levels.

Your next question comes from the line of Elliot Wilbur with Raymond James.

It becomes a little bit more difficult to let go of the Rx business if you keep performing like this. Going back to some of your earlier commentary and some of the specifics around price deflation, I guess those expectations aside, I mean clearly I think you probably experienced heightened deflation, earlier in the cycle than others, so maybe not so surprising that you continue to sort of maintain your expectation. But I guess we're -- a lot of other companies have been surprised or at least claimed to have been surprised, it just relates to the evolution of these consortium purchasing dynamics. And while perhaps that may have not played out in price, certainly seems to have played out in fairly significant negative volume impact for a lot of the players in this space. So just kind of want to ask you little bit more -- in a little bit more detail sort of how the evolution of these consortium dynamics has played out. Recently particularly the Claris one, not really sure frankly how important that combination is to your business historically. But just wondering if that's still something that is evolving and where you see potentially risk or you think we're sort of largely past that process with respect to your business?

Yes thanks, Elliot. I think what you said at the beginning of your question, I think is frankly apropos of -- we took a relatively big and strong look at this about a year ago. And we had to adjust our guidance way back then. We had to say, look we're not at the same level, here's where we're at based on what we see. And then going forward from there had a different process of saying where we're at. And so, I do think we took a big adjustment, we just took it a year ago, if you will, when we said hey, this business isn't where we think, here's where it's at. And then here is what we see going forward. And I think we were prudent at that time in doing that. And the data has played out at least so far to what we expected and thought. When I talk about the 9% to 11%, without into any agreement or anything specifically, as we look at it, that 9% to 11% in our minds includes those broader buying consortiums and new entrants into those, et cetera, include that in that number.

Your next question comes from the line of Douglas Tsao with Barclays.

If you could maybe help us in terms of the consumer business. I think you noted some of the weak -- softer results from the cough/cold category. Can you maybe provide some update on the competitive dynamics? I know over the last couple of years you have been affected by the reentry of a large national brand. Is that still playing through and a little bit of a headwind?

Yes, thanks. Good question. I would say when it comes to those kind of things where they had some other quality issues and things that kind of came back to the market, that is 95%, 98% through. I mean there is still some items out there that aren't in stock. I'm not sure if they are ever going to be stocked again, if that were ones they discontinued. But it's mostly back out there and they are operating on a more normalized plane from a national brand standpoint. There were other products that were launched from an ANDA switch standpoint or those kind of things that were not in the market. We've gone after fluticasone. Nexium is probably the other one where when you look at the PPI category, it's been 3 years without having a store brand equivalent to Nexium. We have the other PPI in our portfolio, but not that. So that's one. It's a decent sized category that once we get out there at least we'll be sort of more wholly represented on the shelves. So on the national brands coming back, I'd say they are towards the end of that reentrance.

And then just also in terms of the price erosion factor, is that -- in CHCA, is that pretty much across the board or there are particular categories where competition's been a little bit -- a little greater?

Yes. I would say it just shifts around the -- we have competitors across all the portfolio. I mean there is -- again, we've got great share, as you know. Our broad portfolio, the way we attack it's kind of a full solution that we bring to grow share for retailers, all good things. We do have competitors kind of -- in a broad array of the products and they will come and grow across those products. So again when we look at the framework, we said we expect volume growth, share growth, all those things to be higher, we built in some amount of just price competition on base things and still get to that 3%, 4% kind of a growth number given that. So there is competition out there, there always has been. We pick the right -- there good competitors. So they're not -- they're good competitors, we just have a broad solution that brings to it. So kind of included in that [goalpost] plan we have.

And one of the things that -- if I can add to that comment. If you look at the margins of this business, it's staying at 20%. If you think about it -- you call it price erosion, so as a multisource business, we want our customers to participate in our value we create in our supply chain. We have one of the best supply chains in the world. Our productivity is very strong. So we're going to partner with our programs on those improvements and therefore that's a win-win and a moat to keep competition out. So I don't want to take a -- you shouldn't think of pricing as though it's a bad thing. Price is a trade-off with those partners to ensure we are participating in the productivity gains throughout our supply chain. That's a good thing, because it helps us keep competition out as well.

Your next question comes from the line of David Maris with Wells Fargo.

This is Patrick Trucchio on for David Maris. My question is on the CHCI business. Has the margin turnaround been driven primarily by the culling of unprofitable SKUs and mix benefit from new products? Are you also realizing some benefits from the restructuring? And can you update us on the progress of the restructuring and how we should be thinking about savings driven from it in the second half and in 2018?

Yes. So thanks, Patrick. Appreciate you joining us. I would say, in general, when you think about the margins broadly as opposed to what happened in a month or what happened there, it really does come from the 3 kind of things that we talk about. There were unprofitable items, slow growth, looked good on the sales line but did nothing. So that we've been moved out of that helped. It kind of got rid of some of the deadwood. Frankly, what that also does, if you think about my mantra has been, once you simplify, it creates a focus and creates better execution. And so by doing that, you didn't have the noise out there and people were able to execute better, be more cost-efficient to drive those. All of those are in there. The A&P dollars get more focused on driving that core, those kind of things. The third one is the insourcing. We have restructured -- we've certainly restructured sales forces in some countries where we thought it was right. We also have some insourcing of products. And so all of those were part of that continuing margin improvement. As we go forward, there is still insourcing to go. So we're on a path but I think it's a while. You have got contracts, you got approvals, you got all those things. When we laid it out, that was originally from acquisition time, a 3- or 4-year process. We are a couple years in but it's still a couple more years to get that full -- to fruition. And then we also have work to do still on our operating structure. So our operating expense structure, sales force, finance, IT, those kind of things. That operating structure that enables the business. We are making progress there. But we still have a fair amount of a ways to go on that part of the cost and efficiency and focus initiatives. And again, I think by creating that simplified operating structure, simplified focus, it does deliver efficiencies over and above what just the math would say because you're doing that. So on the cost side, we're still progressing down that path. I won't say we're early on, but we still have a ways to go on those parts to make sure that we have the right cost structure that continues to drop more to the bottom line. And that's why I talk about this isn't a next month, you're going to be through the roof. It is a couple more years from now to get to those mid to upper teens where we expect to operate.

Your next question comes from the line of Gregg Gilbert with Deutsche Bank.

This is (inaudible) on for Gregg Gilbert. I wanted to ask you if you can maybe talk about your priorities among the various shareholder return levers: dividends, repurchases versus BB?

Yes. So I'm not going to give you that one goes from the other because as we think about strategic alternatives and different decisions at a board level, all of those are certainly on the table. I do think the add-on, bolt-on acquisitions, when we find those good value products, we can quickly turn those into good returns. So we continue to look for those kind of opportunities. In this last quarter, I was very excited and happy to buy our stock at the price we did. I think it was a great value. So was happy to do that and use some of our cash that we generated off our balance sheet on some of these business positions to do that. I think it was a great time to do it. But I can't -- we will continue to look at dividend policies, stock buyback, other ways of returning it in addition to those. And I don't want to prioritize on the side and say, as we find inorganic things, we want to make sure we jump on those especially that bolt into what I think is a very solid infrastructure.

Your next question comes from the line of Timothy Chiang with BTIG.

John, I wanted to sort of ask you one question is just the timing of your retirement certainly seems like a lot of the labor and time and energy that you put into sort of stabilizing the business is starting to pay off. Is there any way the board could convince you to stay at the company or is this really -- this is it for you?

Yes, thanks for the question. I do appreciate the comment. First of all, I would like to say, I think if you go back the last 4 quarters and this isn't me, this is the business leaders of the company, we have said what we're going to do, we did it. We delivered on the results. We kind of have that mantra of hey, we're going to not overpromise, we're going to say what we're going to do, we're going to do that and move on. I think the team has done a great job over that, given all the noise, to make sure that we deliver. So I'm very proud of them for that. From my standpoint, there is a personal part of this that I've had some family situations to deal with. It's just time for me to step away for a while to be a little bit more present with my family, given some of the personal circumstances that we've gone through over the last 6 months to 8 months here.

Your next question comes from the line of David Steinberg of Jefferies.

Wanted to ask about Nexium. I was wondering if you could more size up that opportunity for us, and more specifically when you launched Prilosec a couple of years ago, it became one of your biggest products, and do you think Nexium will reach similar size to Prilosec? And then just looking at your product categories from a broader perspective, historically, the company has done a great job in extracting multiple opportunities from the therapeutic class of allergies, sort of a played-out Zyrtec and Allegra and Claritin and now with Nexium I believe it's your last PPI that you can launch from that class. You've recently launched some of the nasal corticosteroids. But as we look out medium term, for big opportunities, what are the therapeutic classes that you think will go Rx to OTC and be able hit your P&L in the next 2 years to make a meaningfully impact?

I appreciate the questions. So can't give you an exact opportunity for Nexium, because it's the last of the PPIs, really if you want to think about it, that out there, and doing it. The way I typically think about the store brand market with a product like this is national brand and [to grab a price] $350 million or so is the national brand at the stage, somewhere in that ballpark. That usually means a store brand at our self-price kind of opportunity in some ways is $70 billion. Now that's for one player. You get a couple of players in there, you get 2 or 3, it carves up at some percent. But that's sort of the size of the opportunity, in our minds. I'll say from Perrigos' standpoint, we do a solid job because we have such a broad portfolio of cross-merchandising driving -- driving retailer share, doing a fair amount to make sure that we capitalize on those sales, that we let the retailers capitalize and the consumers benefit. So that's one of the broader offerings we bring. So it's that kind of a size and opportunity, if you will, when you think about the Nexium store brand version. OTC, switches, there is, in my mind, the talk that's going on, on the Rx pricing, you think about that. You think about -- talk that's going around government about, boy, we are paying too much here, all those things, has created this stir on the Rx side, which we deal with and we talk about. It also creates an impetus to say how do we manage that cost? You bring products over-the-counter. And it really gets the FDA starting to think, not just about getting product approved for an Rx market, but also which categories make sense to switch, how we could see the consumer choice versus government or private pay. What do we need to do? And I think that sentiment does play into -- if there are product that are safe and effective, we should help drive those. I can't tell you exactly what the next one would be. But I do know if you think about first of all, our derm category, many of those are natural products to switch. They are not $1 billion categories, but they are natural products that are safe, effective, could be self-prescribed, could be over-the-counter. The probably one that won't be immediate but there's certainly some partnerships out there looking at Cialis, from the erectile dysfunction category and doing those, will those come over by themselves, will there have to be have a pharmacist saying, "do you have a heart condition, okay, you can take this." Who knows what intervention there will be. But I believe that those kind of categories that are pretty expensive categories on the Rx side will continue to switch. Migraine among other ones. We've certain migraine products over the counter now. But certainly switching some of those are also kind of key ones. Probably the biggest bet -- I go a little bit back and forth on to be honest, is the patch. I think they belong over-the-counter, I think some kind of pharmacy intervention could make them out over-the-counter, almost like a third class to do that to help. But that certainly has been tried, not quite there yet. But I think even those will evolve that way if you look over the next 3 years or 4 years at big categories that could have an impact at a consumer choice level.

We have reached the allotted time for questions. I would now like to turn the floor back over to management for any closing remarks.

I really appreciate everyone joining us this morning. Again, I'm proud of the team, what they delivered, how they focused on, not only results for the quarter but driving each of our business segments to good profitability, good levels. I'm excited to be able to raise our guidance and share some of that good results with the rest of you. So thank you for your time.

Thank you. This does conclude today's conference call. You may now disconnect.