Perrigo Company PLC

NYSE:PRGO

Earnings Call Transcript 2017-Q4

[Operator]

Good morning. My name is Justin, and I will be your conference operator today. At this time, I would like to welcome everyone to the Perrigo Fourth Quarter and Calendar Year 2017 Results Conference Call. [Operator Instructions]

It is now my pleasure to turn the call over to our host, Mr. Brad Joseph, VP of Global Investor Relations and Internal Communications. You may begin your conference.

[Bradley Joseph, executive]

Thank you. Good morning, and welcome, everyone, to Perrigo's Fourth Quarter and Calendar Year 2017 Earnings Conference Call. I hope you all had a chance to review the press release we issued last night. A copy of the release is available on our website, as is the slide presentation for this call.

Joining today's call are Perrigo Chairman, Laurie Brlas; Perrigo President and CEO, Uwe Röhrhoff; and Perrigo CFO, Ron Winowiecki.

I'd 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 last night.

In addition, in the appendix for today's presentation, we have provided reconciliations for all non-GAAP financial measures presented.

Turning to the agenda on Slide 3. First, Laurie will discuss the CEO search process conducted by the Board of Directors and then introduce Uwe. Uwe will then build on this introduction with insights into his leadership philosophy and how Perrigo is well-positioned in the health care and consumer industries. Ron will then discuss our calendar year 2017 performance metrics before diving into the fourth quarter results. He will then highlight the strength of our balance sheet and discuss our 2018 guidance. Finally, Uwe will close out the call with his 2018 priorities, after which we will open the line for questions.

Before I turn the call over to Laurie, I'd like to personally congratulate Uwe and Ron on their appointments. I look forward to working alongside both of you in your new and merited capacities.

Now I'd like to turn the call over to Laurie.

[Laurie Brlas, executive]

Thank you, Brad. Good morning, everyone, and thanks so much for joining us today. I'd like to take a few moments before we get started to discuss the board's CEO search, selection of Uwe and the CEO transition process that is well underway. When John Hendrickson announced his decision to step down as CEO last June, the board launched a thorough search process that included the engagement of leading executive search firms to identify the most appropriate and qualified CEO candidates. As part of our search criteria, the board was looking for a very strategic leader with a proven track record of operational excellence, experience in managing a complex global supply chain and a focus on customer service. In addition, the board was searching for a leader who would fit well within Perrigo culture and who would build on the open and transparent leadership approach established by John.

I am pleased to say that Uwe checked all of these boxes. The board was particularly drawn to his ability to drive growth and operational excellence, which resulted in a total shareholder return of approximately 225% during his tenure as CEO at Gerresheimer. Uwe is an experienced, customer-centric executive focused on value creation. During his 25 years at Gerresheimer and especially the 7 years he was CEO, he demonstrated his ability to manage a large, complex global manufacturing and supply chain operation. Uwe was instrumental in driving the company's strategic focus, transforming and reshaping its corporate portfolio and delivering on operational objectives. This strategic focus was critical to his selection. In addition, he managed global relationships with hundreds of customers, including the top 10 global pharmaceutical companies. Appointing Uwe emphasizes the board's confidence in the Perrigo management team and business unit leaders. The depth and breadth of their business acumen allowed the board to focus on selecting a strategically-minded CEO, who brings experience complementary to our health care and consumer focus. Uwe is a great addition to the team and he has the board's full support as he designs his strategic vision for the company. Uwe has already hit the ground running and we are quite excited for the next chapter at Perrigo.

Finally, on behalf of the entire board, management team and employees, I want to once again thank John Hendrickson for his nearly 30 years of commitment to Perrigo. John was appointed CEO during a challenging period in our history and his leadership, operational focus and strategic actions have set the stage for Uwe to lead the company into its next evolution.

And now I'll turn the call over to Uwe.

[Uwe Röhrhoff, executive]

Thank you, Laurie, for those very kind words. Good morning, everyone.

Before discussing my excitement about Perrigo, I would like to first address the decision to reschedule our full 2017 earnings release and conference call. Let me first apologize for the delay. We made this decision due to certain tax review procedures that were not fully completed. We simply underestimated the amount of work and time needed to complete these procedures, and we are committed to doing all we need to do to improve and correct our processes.

Now please turn your attention to Slide 7, where I want to discuss my excitement for the opportunity to serve as CEO of such a great company with a legacy of providing affordable health care solutions. Perrigo is well-positioned in the health care and consumer industry. I look forward to working with the experienced management team and the Board of Directors to leverage the company's unique asset base to deliver value for shareholders.

As a trusted partner for 130 years, Perrigo has built an impressive reputation within the industry to deliver affordable health care solutions for patients, consumers and families. Perrigo's mission to provide Quality Affordable Healthcare Products provides a true benefit to society in an environment with an increasing focus on rising health care cost.

After approximately 6 weeks as CEO, I want to share with you my first impressions and why I am excited about our business.

First, delivering results. Perrigo has a market-leading business unit -- market-leading businesses that deliver results in dynamic end markets. Given our strong performance in 2017, we are entering 2018 from a position of strength across our businesses. The CHC Americas business model is unique. We provide turnkey solutions to grow store brand market share. We are driving new product investments and are focused on channel expansion opportunities, including e-commerce and customer service excellence, all of which make Perrigo the store brand partner of choice.

In CHC International, we meet the health care needs of consumers by levering our regional branded OTC growth strategies and over 200,000 pharmacy relationships. The Rx business invests in its diversified extended topical strategy and leverages its differentiated product development process. This business focuses on the categories that are best suited to deliver value for patients and health care systems.

Second, supply chain excellence. Perrigo is a leader in operating an efficient and complex global supply chain that is challenging to replicate.

Third, commitment to quality and customer service. Delivering on customers' high expectations is one of my top priorities and I am encouraged by the Perrigo organization's commitment to quality and customer service.

Fourth, dedication to compliance and business integrity. Perrigo has an outstanding reputation and demonstrates a high level of integrity in all of its business practices.

And fifth, passionate employees. I have been energized by the dedication of the Perrigo team. This is an organization with passionate employees and a positive culture that strives to meet the high demand of customers. My management philosophy is a one-team approach, which is crucial in driving meaningful and timely solutions, and I am impressed with -- by the high caliber of talent across the entire team, including John Hendrickson.

I would like to thank John for his guidance and steady leadership during this ongoing transition period. His focus on the company's core businesses and operational excellence has provided us a greater foundation to drive value for customers and to many stakeholders that rely on us to deliver Quality Affordable Healthcare Products.

Finally, I would like to congratulate the Perrigo team on an excellent finish to 2017 and Ron on his appointment as CFO. Congratulations.

I will now turn the call over to Ron.

[Ronald Winowiecki, executive]

Thanks, Uwe. For covering our results for 2017, I'd like to take a minute to discuss our rescheduled earnings call. One area of focus this past year has been to remediate our tax material weakness that was identified in 2016. We have made progress towards this goal, including: one, strengthening our tax capabilities to a combination of key new hires and additional resources; two, enhancing the overall design in our tax process; and three, improving the precision of our new -- our review controls.

Despite this progress, we underestimated the time needed to implement tax reform in the U.S. and Belgium and to complete our year-end procedures. We continue to improve our processes, as meeting deadlines is a top priority.

Now let me take a moment to welcome Uwe to Perrigo. Uwe's track record speaks for itself. And as a leadership team, we are excited to work with him in writing the next chapter of the Perrigo story. On behalf of the Perrigo leadership team and employees, welcome to Perrigo.

Turning now to Slide 9, you can see the highlights for 2017. Our consolidated 2017 performance illustrates the experience of our leadership teams and their abilities to drive their businesses to fully leverage Perrigo's unique platforms.

This team finished the year strong, delivering adjusted net sales of $4.9 billion and adjusted earnings per share of $4.93.

In CHC Americas, adjusted net sales grew 1.4% in a challenging consumer environment. The durability of this business is illustrated by an adjusted operating margin of 21.9%, which the team now has achieved for 2 consecutive years.

In CHC International, net sales grew 2.6% on a constant currency basis, excluding the exited distribution businesses. The team has rebased the run rate adjusted operating margin level of this business with 2017 adjusted operating margin of 15% compared to 11.4% in the prior year. As previously discussed, the objective in the CHC International segment is to achieve adjusted operating margin in the upper teens. I am pleased with the progress that this leadership is making as we continue to drive towards this target.

In Rx, net sales were roughly in line with the prior year, excluding the year-over-year impact of Entocort. The team launched more than 10 new products in 2017, offsetting high single-digit price erosion, which was in line with our expectations. Our diversified extended topical strategy once again delivered a durable adjusted operating margin above 40% for the seventh consecutive year, highlighting the quality of this uniquely differentiated asset.

Underpinning these positive results is the strong operating cash flow achieved in 2017. Excluding a total of $134 million in cash restructuring payments and an unusual tax payment, adjusted operating cash flow was $833 million, which equates to a strong 120% to adjusted net income. Our strong and steady cash flow conversion highlights the consistency of our business and the ability to generate significant capital for future deployment.

Overall, calendar 2017 was a year to simplify, focus and execute in our core businesses. The actions and achievements in each of our segments places us in solid position to execute our 2018 business plan.

Now turning to Slide 10. You can see our reported results for the fourth quarter. Reported net sales were $1.3 billion and reported net income was $73 million. The primary adjustments to GAAP results are driven by the exclusion of $90 million of non-cash amortization expense and $6 million of restructuring charges related to our cost improvement program. Partially offsetting these expenses were the exclusion of $10 million related to product milestone payment. GAAP tax expense as a percentage of pretax income was 44.5% in the quarter compared to a GAAP -- non-GAAP tax rate of 16.9%. The difference is due to the tax effect of the pretax adjustments and deferred assets and liabilities consistent with non-GAAP pretax income.

Turning to the CHC Americas results on Slide 11. Net sales in the quarter were $644 million compared to net sales of $627 million in the prior year or growth of 2.5% on a constant currency basis. This increase was primarily driven by higher net sales in the gastrointestinal and analgesics categories compared to the prior year.

New product sales in the quarter were $17 million, driven by the store brand version of Nexium and certain smoking cessation products. Partially offsetting these positives were lower net sales of nutritional drink products in the infant nutrition category, in addition to pricing pressures in concerning OTC categories and discontinued products of $3 million.

Adjusted gross margin was 36%, an increase of 50 basis points compared to the prior year. Sell-through of higher-margin products and positive contributions from supply chain efficiencies offset pricing pressure in certain OTC categories versus last year.

The segment delivered a record fourth quarter adjusted operating margin of 23.1%, which was above 20% for the eighth consecutive quarter. This performance was driven by gross margin flow-through and lower selling and administrative cost due to previously announced restructuring actions.

Turning to Slide 12. Net sales in the CHC International segment grew by 3.3%, excluding $82 million from the exited unprofitable distribution businesses and favorable foreign currency movements of $26 million. This increase was primarily driven by higher net sales in the personal care category and in the U.K. store brand business, along with new product sales of $14 million. These increases were partially offset by lower net sales in the anti-parasite category in addition to discontinued products of $2 million. The improvement actions we took in this segment increased the adjusted gross margin from 41.9% in the prior year to 52% in the fourth quarter of 2017.

Adjusted operating income increased $21 million over the previous year, while adjusted operating margin expanded 660 basis points to 15.3%, driven primarily by gross margin flow-through and lower operating expenses.

Turning to Rx on Slide 13. Net sales in this segment were $261 million for the quarter, relatively in line with the prior year, excluding the $5 million year-over-year unfavorable impact of Entocort. New product sales in the quarter were $23 million, offset by lower net sales of existing products of $21 million, due primarily to price erosion, which was in line with our expectations.

Adjusted gross margin was 53.2% due to a variation of product mix experienced in the quarter and price erosion. As discussed in previous calls, adjusted gross margin in this segment may vary in any quarter plus or minus an estimated 150 to 200 basis points from the midpoint of approximately 55%. As reference, adjusted gross margin for the full year 2017 was 55.3%.

Adjusted operating margin for this segment was 38.1%, which included an increase in R&D investments to 7% of net sales in support of our strong pipeline, partially offset by lower selling expenses as a result of previously announced restructuring actions.

Turning to the balance sheet on Slide 14. As of December 31, 2017, total cash on the balance sheet was $679 million and total outstanding debt was approximately $3.3 billion. In 2017, we repaid $2.6 billion of debt or nearly 45% of the total debt outstanding at the end of 2016.

Our focus to proactively improve our capital structure, combined with our strong operating cash flow conversion, has greatly improved our financial flexibility. As a reminder, the combined total debt maturities for years 2018, 2019 and 2020 are approximately $564 million, enabling the majority of future free cash flow to be available for enhancing investment opportunities. We believe this flexibility differentiates Perrigo.

Our capital allocation decisions are focused on total shareholder returns within the context of our long-standing commitment to an investment-grade financial policy. As part of our disciplined and balanced capital allocation strategy, we completed approximately $192 million of share repurchases and paid $91 million in dividends during 2017.

On February 15, we announced our quarterly dividend, which represented an increase of 19% from the prior year. This increase in dividends per share equates to a 3-year compounded annual growth rate of 15%, which reflects management's and the board's confidence in our durable business model, cash flow generation and earnings growth.

Next, let's discuss our key operating actions for 2018 on Slide 15.

First, drive new product launches. We are investing approximately $75 million in working capital to support the launches of our strong new product pipeline, which is expected to deliver net sales of more than $300 million in 2018.

Second, invest for long-term growth. Building on the strong foundation established by the team in 2017, a core theme for 2018 is investing for organic growth. Consistent with this theme, we expect 2018 growth investment in R&D and advertising and promotion to increase approximately 12% to 15% compared to the prior year.

Third, invest in operations. As previously discussed, we're investing in our infrastructure, including integrated sales and operating systems, global supply chain capabilities, cybersecurity and global data privacy.

And fourth, achieve productivity gains. The investments I just discussed are being made on the top of a successful completion of our cost optimization program and ongoing productivity improvements in supply chain, offsetting the estimated effects of price erosion in the year.

Turning to the segment guidance on Slide 16. In CHC Americas, our guidance includes growth versus last year in our market-leading OTC and infant formula categories, as our unique position drives growth in these markets. Partially offsetting this expected growth is a loss of a partnered product in our animal health business, as the partner will now take over marketing and distribution of the product. We expect segment net sales to be approximately $2.44 billion or growth of approximately 1% on a constant currency basis of what remains a challenging consumer market.

The durability of this business is once again evident, as the adjusted operating margin in 2018 is expected to be approximately in line with the prior year, remaining at record levels. Included in this margin assumption are increased growth investments versus the prior year.

In CHC International, we expect approximately $1.56 billion in net sales. This guidance includes a year-over-year reduction in net sales of approximately $33 million as a result of actions taken in 2017. To be clear, these actions were completed in the prior year, included the mid-year restructuring of our Russia business and the exited unprofitable distribution businesses. Excluding this $33 million impact, our 2018 growth is expected to be approximately 2% on an organic constant currency basis.

The adjusted operating margin guidance for this segment is expected to be approximately in line with last year. Included in this margin assumption are the investments in growth and infrastructure I just discussed.

As I previously mentioned, we continue to target adjusted operating margin in the upper teens for CHC International and are making the investments required to achieve this goal.

In Rx, we expect 2018 net sales of approximately $1.06 billion or greater than 9% growth compared to 2017, driven by the launch of new products from our strong pipeline. This guidance includes on average for the year, a high single-digit price erosion assumption. We expect meaningful contributions from new products in the fourth quarter of the year, as we prepare for launches of: one, a significant product that we are not committed to disclose; and two, the anticipated launch of the generic version of ProAir.

Our 2018 Rx adjusted operating margin is forecasted to be approximately in line with the prior year, driven by our diversified and durable extended topical strategy and strong new product launches. Included in this margin assumption are increased R&D investments to approximately 7% of net sales.

As I have mentioned before, we continue to be extremely excited about the pipeline opportunities in our Rx business and believe that the increased investment in R&D can generate extremely attractive returns for shareholders.

On Slide 17, you can see the bridge that walks our 2017 adjusted EPS to the 2018 adjusted EPS guidance provided today. Let me highlight 3 factors to consider in the context of our 2018 adjusted EPS guidance.

First, is the approximate $0.25 per share impact from U.S. tax reform. As you will see in the next chart, our effective tax rate guidance for 2018 is approximately 20.5% to pretax income, which compares to approximately 16.8% in 2017.

A very important distinction is that our operating cash tax payments are expected to be approximately flat with 2017. In other words, U.S. tax reform has relatively no impact on our cash tax rate.

Second, is a year-over-year impact from the divested API business. The API business was included in our results for the first half of 2017, contributing approximately $0.06 per share.

Third, is an approximate $0.07 benefit in 2018 from the favorable currency movements versus the prior year.

Taking these items into account, you can see that our pro forma 2017 adjusted EPS sums to $4.69 per share. Building from this base, you can see the positive drivers of our 2018 adjusted EPS guidance, which include: First, continued operational execution across all of our segments and strong performance of our new product pipeline, representing an increase of approximately $0.29 per share as compared to 2017. Included in this increase is the expected fourth quarter launch of generic ProAir, with an estimated EPS contribution of approximately $0.09 per share; second, the completion of our 2017 capital structure actions result in a benefit of approximately $0.27 per share to our 2018 guidance. These combined factors equate to a 2018 adjusted EPS range of $5.05 to $5.45 or growth of approximately 12% from our 2017 pro forma adjusted EPS results at the midpoint.

Now let's pull this all together in Slide 18. We expect consolidated net sales of $5 billion to $5.1 billion or approximately 2.5% to 3% at the midpoint on an organic constant currency basis. Included in this net sales guidance are expected new product launches of greater than $300 million, which are heavily weighted to the fourth quarter due to the 2 Rx -- new product launches I discussed earlier.

Adjusted operating income is expected to be in the range of $1.03 billion to $1.09 billion. This growth in adjusted operating income represents greater than 2x operating leverage to net sales growth on an organic constant currency basis.

Regarding growth investments, consolidated R&D investments as a percent of net sales are expected to be approximately 4%.

Taking the 2 fourth quarter Rx new product launches into account, we are expecting approximately 30% of our adjusted operating income to be realized in the fourth quarter of 2018. Operating income is expected to be moderately improved on a sequential basis from Q1 to Q3 due to new product launches.

Our guidance for operational cash flow is to achieve approximately $770 million in 2018. Included in this guidance is the working capital to support our new product launch forecast, notably, the expected fourth quarter launch of generic ProAir.

Before I wrap up, I would like to point out that as part of our commitment to transparency, based on feedback from the investment community, we are now including in the appendix of our quarterly earnings presentation, a breakout of segment operating expenses, including advertising and promotional investments in our CHC International business and consolidated depreciation to more easily calculate EBITDA.

You will also see in our appendix a net sales bridge similar to the EPS bridge we discussed earlier. These 2 charts should provide a framework for modeling 2018 growth versus 2017.

In summary, as a testament to the leadership and culture at Perrigo, we executed on our business plan, as illustrated by our 2017 results. I would like to congratulate the team on a great year, in which we took a number of actions to set the foundation for delivering on our 2018 operating plan.

I will now turn the call back to Uwe.

[Uwe Röhrhoff, executive]

Thanks, Ron. In closing, on Slide 20, I would like to outline our top priorities for the year ahead.

Number one, deliver on our plan. We are well-positioned to capitalize on our durable platform and the health care trends to deliver on our commitments across all of our businesses in challenging end markets.

Two, maintain focus on operational execution. Continue to sharpen operational execution across our businesses, with the focus on quality and customer service, supply chain productivity, our e-commerce strategy and new product launches.

Three, drive growth. Our commitment to future growth is evidenced by the fact that our 2018 guidance assumes an approximate 12% to 15% increase in growth investments to drive long-term organic growth across our businesses.

And four, develop a value-creation road map. Over the next 6 months, I will continue to work with management and the board to develop our long-term strategic vision and capital allocation strategy. After which, we will discuss the outcome with the investment community.

In closing, Perrigo occupies unique space within the health care and consumer industry. We provide savings to consumers and families at a critical time, as health care costs continue to rise. Perrigo's business model meets the needs of consumers and families that want health care options that are high quality, effective and yet affordable. I am energized by my colleagues and the entire board and management team. I'm excited by Perrigo's progress over the past year and our opportunities ahead. I look forward to getting to know all of you in the coming weeks and months.

I will now turn the call back over to Brad.

[Bradley Joseph, executive]

Thanks, Uwe. Operator, we'd now like to open the call for questions, with Uwe, Ron and me, and ask that everyone please limit yourself to one question so we can get everybody -- get every question answered.

[Operator]

[Operator Instructions] Your first question comes from the line of Louise Chen from Cantor.

[Louise Chen, analyst]

So your cash flow is going to be improving meaningfully this year. Could you give us more color on your capital allocation strategy? And then how much of your expected free cash flow is assumed to be deployed in your 2018 guidance?

[Ronald Winowiecki, executive]

Yes, so let me start, Louise. First of all, thanks for the question. So from an operating cash flow standpoint, listen, we saw a very strong operating cash flow in '17, on a reported basis, just sort of $700 million, a 100% conversion to net income; $833 million when you take out some of the unusual items, and to your point, $775 million guidance in 2018. If you look at our capital allocation policy and process, it's based on 2 fundamental tenets, right? It's total shareholder returns and it's also an investment-grade framework. And you saw it act that way in 2017. And you look into 2018, we don't have any debt payments materially due in -- for the next 3 years. We talked about that. So debt paydown is not a priority for the company given, particularly, the low interest profile that we have at this point, and a nice maturity curve. Listen, if the market continues disruption relative to the equity, there's a lot of volatility at this time. We'll look from time to time, but it's not a core part of our policy at this point. But it'll be something we look at it, if there is something in the market that makes sense to us. And you saw our dividends increase. We're excited to continue providing a return to shareholders relative to dividends, compounding 15% growth rate. We know the yield is low, we understand that. But having said that, having a compounded growth rate of 15% shows our confidence in how we're moving forward with our business model. I'll let Uwe speak. Uwe is engaged with a process on strategic review and we can talk a little bit about that and how that ultimately plays out going forward, so...

[Uwe Röhrhoff, executive]

Thanks, Ron. I think decisions regarding our capital allocation, as Ron said, will be focused on shareholder value creation within the context of our commitment to an investment-grade profile. Over the next 6 months, as I said, we will work all together, management and the board, to develop our long-term strategy and our capital allocation strategy for Perrigo. And then we will discuss the outcome with all of you.

[Operator]

Your next question comes from the line of Patrick Trucchio from Berenberg Capital Markets.

[Patrick Trucchio, analyst]

My questions are on the CHCA business. At the CAGNY conference last week, several of the branded OTC players noted a disconnect right now between sell-in and sell-through is dampening organic growth. And then when we look at Slide 22 in your presentation, we see store brand growth of 3%, yet your guidance for 2018 at the midpoint calls for about 1% growth. So I'm wondering if this is because of the mismatch between sell-in and sell-through now. And then what inventory levels look like at retail? And related to this, to get to that high-end scenario, the plus 3% or so scenario, would this dynamic in sell-in and sell-through have to improve? And what might lead to that scenario? And then if you could tell us what might lead to the low-end scenario in your guidance as well?

[Ronald Winowiecki, executive]

That's a very good 5-part one question. I like how you phased it, that was outstanding, by the way. So well done. So listen, if you look at Consumer Healthcare Americas, the segment grew 1.4% last year. I think the key part of that chart you referenced, by the way, is please note store brand is gaining share. So if you look at what's taking place relative to the brand category, store brand gained share last year. And again, as you always know, that chart is based on MULO data. There is our factory shipments in that 52-week data. You're always going to have some variation, we know that and we've explained that before. When you think about, I call it the corridor, I think that's the way you've asked the question. It's a fair way to think about it. As you think about the corridor, how our asset is positioned as we continue to grow above market. On the low end of the corridor, inventories are abating. We're not seeing it as a material item. Obviously, when you have an effect, like there were some store closings of one of the core customers, listen, you've got some normalization of inventories. That's just a natural part of the model, as industries play through that rationalization process. So yes, you have some of that effect. I'm not going to call it a material effect at this point. I do want to remind you, you talked about the 1% growth into next year. And again, that's factually true. If we look at OTC in nutrition, the formula business is growing much faster than that. And we are being offset by this loss in the pet health business. I mean, that, if you take a look at the core, we have market-leading positions. The growth in those market-leading positions, it is higher than 1%. And the reason that it has diluted back to that level is because of the loss of the supplier arrangement with the pet health business. So I'll say, within the core space, we're sitting in the middle of that corridor and that's the way I'd like to answer that question. I don't want to worry too much about the lower or upper end. If you look at the core part of our segments, where we have market-leading positions, we're seeing healthy growth going into '18 in a tough consumer market.

[Operator]

Your next question comes from the line of Randall Stanicky from RBC Capital Markets.

[Randall Stanicky, analyst]

I just wanted to follow up. Is 2% to 4% the right way to think about the U.S. consumer business over time? Or should we be thinking about it as something on top of the overall OTC market? And then the real question I had was, as we think about the shift to online or to Amazon, does that shift help or hurt that CHCA growth rate over time?

[Ronald Winowiecki, executive]

Again, Randall, you got a 3-part question in one, which is good, by the way, I appreciate the question. So first of all, listen, we talk about relative to market. So 2% to 4% is a good threshold relative to a normalized market. Now we're not in a normalized market. I mean, you could dispatch that -- we see is that the market is like 0.5% to 1% growth and we're growing 1.4%. So we are indexed above market, Randall, and we think our business is very well-positioned to continue moving forward with that market structure. So I can't guide you at 2%, 3% or 4%, it's in that corridor, but what I can say is our business is positioned. If you look at store brand, it's gaining share. You look at -- we are the partner of choice within that space, that we continue to grow above market. So think of it relative to market, to be directly to your question. So e-commerce is an interesting one. Listen, when you look at our business model, we provide end-to-end solutions, right? We talk a lot about that. We provide -- the broadest scale of products in the U.S. marketplace, bar none, number one. Number two, we provide turnkey solutions and it's a core competency a lot of persons don't understand relative to our merchandising capabilities, our regulatory capabilities. We provide those turnkey solutions to our customers. In addition, we manage within a supply chain, a complex supply chain environment. So what I'd say is, we are the partner of choice. So as the channel is developed, e-commerce being a channel, we're excited at helping our business partners, our retail partners develop both the retail competencies and e-commerce competencies to be successful. In the intermediate period, short term, listen, it's probably an arbitrage. I mean, that's kind of, you think it through and you see the stats, we all see them, e-commerce is what, 1% to 2%, I think, of the space today. You're probably getting an arbitration, where a consumer probably would've gone to the store or maybe they are buying on Walmart's Jet site at this point. That's an arbitrage. Over time, where we're excited is that you provide the merchandising to the customer. So now the consumer has to walk up to the shelf, look at the branded product, look at Perrigo's product, and make the consumer choice on their own kind of -- own diligence. In the future with e-commerce, you get digital marketing, you can put it in their hands. You can tell them the value of store brand, the efficacy of the product, the quality of the product. And over time, we do see this creating share. But understand, that's over time. That's not an immediate effect. So hopefully, I answered your 3-part question, Randall.

[Operator]

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

[Jami Rubin, analyst]

Just staying along the lines of e-commerce, can you today describe your Amazon partnership? I know that is about to expand, but what -- is e-commerce, as you said, Ron, is a very small proportion of the overall business, you said 1% to 2%. But where do you expect that to go over the next 5 years? And I think more importantly, what implications will that have for your margins? It's hard to imagine that e-commerce, as that grows, is going to be good for your margins, but maybe you can help to describe that. And then also, you talked about pricing pressure in certain OTC categories. Can you describe what that pricing pressure is? And is this something that we should just model as a going-forward headwind? Or is this more temporary?

[Ronald Winowiecki, executive]

So listen, again, a couple-part question. Thank you, Jami. I'll let Uwe start on maybe the Amazon component. When it gets down to, I think you asked about kind of margin profile and pricing pressures, I can give some color, if that's fair.

[Uwe Röhrhoff, executive]

Yes, thank you, Ron. Let me start with -- that Perrigo has a long-standing history of meeting consumers at the health care point of purchase. And e-commerce is just one element of that. And we, obviously, work with all of our retail partners to maximize the value of their store brand offerings, online and in the store. So this makes us the partner of choice on the OTC health care space for both in-store and e-commerce solutions. And from a margin profile, it is fair to say that this is relatively consistent across all of our customers.

[Ronald Winowiecki, executive]

Yes, just to add to what Uwe just said, right, if you walk into the pricing pressures, listen, the pressures are predominantly in, I'll call, legacy categories. So you're after the long technologies, particularly in some of the tablet liquid space, Jami, is the way to think about it. That's where you have margin pressure. If you look at some of the great categories that Perrigo has been building out over time, gastrointestinal and nutrition, you have less pressure. But there is pressure in every category. To be clear, this is a multi-source competitive marketplace. But if you say where do you start seeing, I'll call it bid activity, it will be in some of the longer commodity type of things, some of the tablets and some of the liquids technologies.

[Jami Rubin, analyst]

So just to be clear, as e-commerce becomes a bigger component of your overall revenues, you would not expect that to have a depressive effect on your margins, presumably because of increased volume, is that the right way to look at it?

[Ronald Winowiecki, executive]

Yes, listen, we don't think winners and losers, Jami, is the way to think about it. So we look at margin profile, cost to all of our customers. Their pricing strategies are their strategies. That's how they position products in their space, whomever it may be. But our margin profiles are consistent across our customer base. So at this point, we're not seeing any degradation in margins relative to channel changes.

[Operator]

Your next question comes from the line of David Maris.

[Katie Kerfoot, analyst]

This is Katie Kerfoot on for David. I'm just wondering, because when we heard earlier about your priorities for capital allocation going forward, expanding the business inorganically wasn't a priority. And so is it fair for us to -- that you mentioned at least -- and so is it fair for us to think that while you're doing that review with the board, that you might be quiet on the M&A side, for at least the first half of this year or throughout this year, as you kind of level those priorities?

[Uwe Röhrhoff, executive]

Yes, thanks for the question. I think number one is the -- if it came across that organic growth is not a priority, then I need to correct that. That is obviously a top priority.

[Katie Kerfoot, analyst]

No, sorry, I meant inorganic. I meant acquisitions.

[Uwe Röhrhoff, executive]

Yes, yes. Obviously, when you -- and we will go through our value-creation road map exercise and that will include a holistic approach, looking at everything, looking at opportunities to optimize the business, looking at opportunities to drive growth. We'll also look at opportunities for inorganic subjects in our portfolio and from that perspective, it is fair to say that over the next 6 months, we need to conclude that exercise and then we will announce what we are going to do on all of those fronts.

[Operator]

Your next question comes from the line of Marc Goodman.

[Marc Goodman, analyst]

Yes, first, can you give us a sense of flu season and how much it impacted sales in the quarter and how we should expect the first quarter of this year to have an impact? And then you mentioned in animal health, there was a product that you're giving back. Can you just give us a sense of how big the sales were for that product?

[Ronald Winowiecki, executive]

Yes, thanks for the questions, Marc. I'll take those to start. The flu season is -- the way I like to step back and think about it is, first, what is the relative effect of cough/cold kind of products within the portfolio. CHC Americas, as you know, has done a fantastic job of building out, I'll call it, categories that aren't dependent upon "the weather." So gastrointestinal products, smoking cessation categories, infant nutrition is an example. You really kind of zero in on cough/cold at this point, you're talking 20%-ish of the segment revenues are in that category. And frankly, if I call it just a strip of pure cough/cold, you're talking like 10%. I mean, to be clear, it's relatively small on that category. Now having said that, the next thing you look at is shipping patterns. In Q4, not a meaningful effect. Really in Q4, our shipping patterns are selling into the season, you get a little tick, but not much. We had a small uptick, but it was very small, so we didn't mention it on the call. Look into Q1, we are seeing an uptick, we are seeing some pull-through of sales given the season. However, having said that, it's built in our guidance, to be very clear, so that's built in our model at this point. And then when we think about the animal health business, I don't want to disclose the exact sales number. I don't think it's appropriate to go after any particular product or category, but suffice it to say, it is a disappointment. You think, pet health, it's interesting. Our PetArmor brand is the #1 brand in the MULO space. So it's disappointing. We had a partnership, it was going well. We were notified late December that they chose a different strategy, fine. They made a choice. But suffice it to say, again, if our -- if we did not have the effect of this pet health change, our growth would have been, let's call it, consistent with last year within the core categories, at a minimum. So you can start kind of modeling out the construction of what the relative effect would have been.

[Operator]

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

[Christopher Neyor, analyst]

This is Chris on for Chris. In the past, you've had discussions on the potential for an Rx divestiture and to turn Perrigo into a pure consumer business. Is this an area of opportunity? Or do you feel good about the current mix of the portfolio?

[Uwe Röhrhoff, executive]

Well, first of all, I think I can say that we enter into 2018 from a position of strength, in all of our 3 businesses. And the next step we are going to take is to go through our value-creation exercise. And within this, we obviously will also challenge the positioning of each business segment and its growth opportunities. And we will come back to you, again, once we have concluded this and share our views on how we take the company forward for all of this year.

[Operator]

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

[Gregory Gilbert, analyst]

Bigger picture question on the industry. As large buyer consortia have formed in recent years to more efficiently buy generic drugs, have you noticed any changes in how those customers or others have approached buying OTC products? It was once thought that the buyers were very separate and that there was no synergy to a large generic company and a large OTC company coming together, but curious if that's still the case? Or if there is potential synergy between OTC and generic purchasing with these increasingly important customers?

[Ronald Winowiecki, executive]

Yes, Gregg, thanks for the question. I'll take that to start. So first of all, you think about the business model, right? The business model is really delivering store brand solutions to our end customers. So when you think about the consortiums and how they play out, remember, what will have to play is, is all of a sudden, Walmart would want to give up their brand or Target their brand or Costco their brand. So to really say that these consortiums are going to have a big effect in the OTC space, in our situation, in a store brand situation, that would mean the business of the turnkey solutions, the merchandising their brands themselves, they want to hand it to somebody else who's going to be a better buyer. So listen, I don't want to say never. You can never say that. It's an industry structure and condition. We monitor all emerging trends, to be very clear. Jeff Needham and his team are very proactively looking at any types of dynamics in the marketplace, who are very proactive and addressing any structural things that take place. But at this time, we're not anticipating or seeing effects from those consortiums. Again, remember the business model, it's about the brands of the customers that we service. We're not seeing any immediate effect at this point, Gregg, to your question.

[Operator]

Your next question comes from the line of Ami Fadia from Leerink.

[Ami Fadia, analyst]

Could you give me a sense of where you are with respect to some of the initiatives that are ongoing in Consumer International with respect to winning products in-house? We saw good expansion in the margins this year, but it doesn't look like you're expecting similar expansion or at least some expansion next year. So wanted some color on where you were with that. And then, how should we think about margins or gross margins in the Rx business, as you launch some of the larger products, like ProAir, at the end of the year? And lastly, just tax rate, how should we think about that into next year?

[Ronald Winowiecki, executive]

All right, very good. I'll try to remember every question asked. So thank you for the questions, by the way. So let's start with CH International (sic) [ CHC International ]. Listen, we're very pleased with the progress in this business. If you remember, we've had a multi-part strategy relative to building out the improved business model. Number one, is we did some portfolio rationalization. We sold the unprofitable European distribution businesses. Most importantly is we put in a focused brand strategy. So at this point, Svend and his team have a very clear strategic lens relative to their brands and how they are positioning those in the marketplace. And that's been a big shift for us over the last -- over the course of last year. Number two, is we've done, with that focused brand strategy, a number of sales force rationalization, restructurings as well as certain markets. We've consolidated teams to make sure we're most effective in the marketplace. Could there be more of that? Svend's always looking at efficiency and effectiveness, so you could see more of those changes. But again, that has gone very well for the actions completed at this point. Married to that, the trifecta of that kind of triangle of improvement is really disciplined A&P. So we're really now matching the A&P architecture for how we promote and drive brands in the markets, relative to, again, the focused brand strategy and the commercial activities that we have. Underpinning that, an action that has gone very well is the insourcing activities, we talked about that. We acquired CHC International, the branded business, back in 2015. They were about 80% outsourced. Our goal is to get down in that 50-ish percent kind of range, and I would call it, we are kind of halfway there. Ron Janish and his team have done a fantastic job, working through the portfolio of where is the best to insource, and we're about halfway through that journey. So it is going very well from that standpoint. And again, you talked about margin expansion this year. We've been pretty clear that we want to reinvest back in this business, that our goal that we're very focused and targeted on is upper teens, upper teens adjusted operating margin. So that is the directive that we've been playing towards. We always knew, you think about when you go through a margin expansion process, you usually want to fund it with improvements and then fund the next frontier. And that's what we've done. We've made improvements this last year. So now we're funding the next phase of this by improving our management infrastructure, putting in things like integrated sales and operating planning systems, putting in some R&D systems and architectures to help the team from an innovation standpoint. Now that helps build out the growth profile going forward. So yes, a pause. So you're seeing us give guidance in that 15%-ish kind of range on a year-over-year basis. But if you model out the business, you're seeing margin expansion at the gross margin level, investing back from an infrastructure standpoint. Margins in '18 in that 15% range. And then, again, growing back to those higher teens on a later point. I think you asked about Rx. Listen, Rx margins, all I'm going to say is we feel very good about this business. We feel very good about the pipeline. We had a 42% margin last year, consistent going in the next year. It's a business that continues to create great value for shareholders and we're excited about the launch opportunities going into the next year.

[Bradley Joseph, executive]

And then lastly, it was tax rate going into '18.

[Ronald Winowiecki, executive]

Tax rate, my apology. I missed that one. Tax rate in '18. So listen, our guidance is 20.5%. You saw that in the -- saw that in our discussion. It's tax reform, it drives a lot of different elements under the different parts of the -- under the parts of the accounting system for tax. Again, from a cash standpoint, we're not seeing any effect. And that's the important part. If you were discounted cash flow or you do perpetuity value in the company, there is no change in the cash tax rate. From a 20.5% versus the 17%, it really relates to some of the accounting mechanisms that we have to work with relative to how the balance sheet thinks and operates. So therefore, you get some non-cash effects in the deferred tax accounting. And that's what's driving the difference. On a long basis, I'm not giving any long guidance on tax rate. Our guidance at this point is 20.5% in '18.

[Operator]

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

[Douglas Tsao, analyst]

Just a couple, first in terms of e-commerce. I mean, how -- it seems to be a relatively small part of the business today, how -- any perspective on the time lines that you think it will become a much more material part of the business? And then just in terms of generic ProAir, just curious if you have an FDA action date? And just any commentary on sort of the engagement level with the agency in terms of the review of your application. Have you been getting information requests, sort of the status there?

[Ronald Winowiecki, executive]

Yes, so first, on your first piece of e-commerce, a small part of the business, but -- it's a small part of the market. So again, it's -- yes, it is small at Perrigo. But again, when I gave the 1% to 2%, that's not Perrigo, that's market numbers relative to our space, right? So listen, growth over time, it is going to grow. I don't want to give any guidance to that effect, but we do know it's going to be a growing market. Our teams are very focused on it from a capability standpoint. And again, we're looking to empower our customers to continue store brand growth. I really don't want to give any kind of longer-term guidance. And again, in the short term, it's probably an arbitrage. I mean, that's probably the important way to think about it, is you're probably going to have a consumer buy in one channel versus the other. Over time, as expansion takes place, that's where the channel will grow -- grow more. On ProAir, listen, so we've been pretty open that the FDA did issue a CRL late in the year in 2017. We responded to that CRL to the FDA. So we have given that response back to them. And everything we're working on at this point is consistent with our goal to launch in Q4. And you saw the $0.09 a share that we included in our numbers. So we're continuing to drive to that objective.

[Operator]

Next question comes from the line of Annabel Samimy from Stifel.

[Annabel Samimy, analyst]

So I want to go back to the 2% to 4% long-term growth rate so you expect for the business. Obviously, underpinning that was always some tailwind such as further store brand market penetration or new product categories going from Rx-to-OTC. We already know the price erosion component of it. So can you talk about some of those broader tailwinds within that 2% to 4% growth rate? And if those still stand going forward? Because we haven't really heard much about new product categories the way we used to.

[Ronald Winowiecki, executive]

Yes, so another way to ask the question. So I appreciate the dialogue. So if you take a look at, again, store brand penetration, store brand market share, this business, has, I'll call it, 3 legs on the stool for growth, right? So you have product line extension; so you have channel innovation development; and the third is the Rx-to-OTC -- Rx-to-OTC component that you talked about. So think about like product line innovation. Yes, we follow national brand in many instances, but we also do our own innovation. We have colors and dosage forms and oral dosing -- dosing technology is an example of that, that extend the product line, that the national brands may not have. So that's an area of growth that we don't talk a lot about, but why you see us grow above market. If you take the Rx-to-OTC, there are -- we don't have any, what I'll call, home runs. There is no omeprazoles or Cetirizines built in the model, but we do have a series of singles and doubles built into our longer-range thinking. So that, we continue to see Rx-to-OTC switches. In addition, what we're pleased by is the current tone of the FDA regarding, looking at having more OTC products in the marketplace is an exciting tone. A small example, albeit it gives a tangible example of developments is the monograph Modernization Act. It's under development. CHPA, Consumer Healthcare Products Association, which is currently, Jeff Needham is the President, is very active and continuing to drive and support regulatory change in the industry. Are there other categories that can switch? Listen, we've talked about those. We're continuing to monitor them. We don't want to get over our skis and say they're in the model on day x. That's not fair to do that, but listen, products like Xyzal within the allergy area, you're looking at Cialis potentially in erectile dysfunction, there's things where we see being worked on in those categories. But again, we're never going to give, at this point, this product, this category, at this time. That's not appropriate at this point.

[Operator]

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

[Elliot Wilbur, analyst]

Ron, just a follow-up to your commentary around the -- in the Consumer Healthcare business. You've alluded a couple of times to challenges in that business. But maybe you could elaborate in a little bit more detail in terms of what you guys see is the key challenges? Whether or not you think they are transitory or structural? And [indiscernible] just be very different from what we're hearing from some of the branded companies. So I just want to get a little more color on that.

[Ronald Winowiecki, executive]

Yes, so I think the question, to rephrase it back, it was a little broken up at first, so I'm going to try to rephrase it back is, in the health care OTC space, consumer space, there are some challenges on growth. Are they structural? Or they -- are they items that are just transitory in nature? I think is the way you phrased the overall question. Listen, a key part of it is always about innovation, right? So a key part of -- I would see from a branded standpoint is their focus on innovation, bringing new products to the pipeline. Whether that's structural or transitory, I don't want to represent that. I think that the brands themselves would have to respond to that nature of what's taking place in the marketplace. Relative to the channel itself, there are some dynamics. Again, when you see retail stores closing, that's transitory in our eyes. In other words, the consumers are going to pull through the product. The demand for the product is still there in our eyes. We're seeing nothing changing from that standpoint. But when you get some of the structural changes that take place in an industry, you do see some dynamics that take place relative to sell-through, right? You just have the inventory normalizations that takes place and although an event may not be material, you get those kind of layering effects that drives some of those changes. So I don't want to represent structural or transitory, but again, we're not seeing anything in our business model, which I think is the core important takeaway, that we continue -- that we will still continue to grow above market. We are still confident in that structural -- now, the benefits of our business model is the key way we think about it.

[Operator]

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

[David Steinberg, analyst]

On capital allocation, I know you said you may take a hiatus to develop your external strategy. But last year, you bought almost 3 million shares. I'm just curious, at the current valuation, do you feel like that will be essentially your capital allocation at this point in time, given the valuation? And secondly, if for some reason ProAir is delayed this year, do you still think you can grow your generics business in 2018?

[Ronald Winowiecki, executive]

Yes, you bet. Great question. Let me start with the latter. Yes. So I'll just answer that with an affirmative. We've been saying for some time, our pipeline support gives us a growth in '18 without ProAir. So the answer is yes. On the capital allocation, listen, I'm never going to represent on a call with you guys, good buy, bad buy. I'm going to -- I will certainly say, and I think Uwe would support, that we'll continue to look at market disruption, and we'll make sense of that at any point in time. And again, I don't want to represent any particular price as good or bad, that's not the way we think. We think long-term relative value. We want to make sure everything we do is on a long-term basis, not on a short-term thought process.

[Bradley Joseph, executive]

And just also to add on to the Rx -- on the Rx piece of ProAir, we were talking top and bottom line ex ProAir.

[Ronald Winowiecki, executive]

Correct. Yes, Brad, agreed. Good call.

[Operator]

Our next question comes from the line of Tim Chiang from BTIG.

[Timothy Chiang, analyst]

Ron, could you just comment a little bit more on just the Rx pharma business? It looks like this is going to be your fastest-growing segment in '18 and yet -- yet you're still experiencing price erosion on the base products. You commented about ProAir, but are there other products that you do expect to get approval across the year? And is that what's driving the growth for 2018 in that segment?

[Ronald Winowiecki, executive]

Yes, so thanks for the question. The -- yes, it is a strong segment. Performance going into next year, we're very pleased with the performance guidance we have out there. Now again, at the end of the day, it's about new products. We don't want to predisclose any new products. We'll certainly, we'll give you information updates as the year continues. Remember, there's 2 new products in Q4. So there is one product, again, we're, based on an agreement, we cannot disclose and discuss, but there is another strong product that we'll launch in Q4. So in your modeling, please take that into effect in that architecture of how you model it out. So again, great business, great pipeline. And the other thing to indicate, I'll call it a long-term basis, because that's probably how we like to think and talk about the business, we are increasing R&D next year as 7% of net sales. And that just shows you our confidence in that pipeline in the business. So with that increase in R&D percent, we're still circling roughly approximately 42% adjusted operating margin. So we feel very good about the business next year.

[Timothy Chiang, analyst]

Great. Ron, maybe just one last follow-up. I mean, would you say that your generic business from a pricing or a price erosion perspective, has sort of bottomed on the base business? Or is that sort of a term that's not the right term for 2018?

[Ronald Winowiecki, executive]

Yes, I don't want to guide bottom, middle or top, right? Our guidance is consistent. Listen, the way we think about this, and we've been very consistent in our approach is what we're seeing in the market, we guide forward. So we're not going to get ahead of our skis. We're looking at high-single digits experienced last year in '17. We're modeling out that same kind of expectation in '18. We'll keep you updated quarter-by-quarter as we see performance dynamics. But I don't want to represent, again, bottom or top. That's -- we don't want to represent that at this point.

[Bradley Joseph, executive]

Thanks, everybody. We appreciate your time. And look forward to having more discussions here shortly. So thanks, everyone. Have a good day.

[Operator]

This concludes today's conference call. Thank you for participating. You may now disconnect.