Feb 5, 2016
Executives
Barbara Brungess - VP, Corporate & IR Steve Collis - President and CEO Tim Guttman - EVP and CFO
Analysts
Robert Jones - Goldman Sachs Steven Valiquette - UBS Garen Sarafian - Citigroup Ricky Goldwasser - Morgan Stanley Lisa Gill - JPMorgan Charles Rhyee - Cowen and Company George Hill - Deutsche Bank Eric Coldwell - Robert W. Baird
Operator
Ladies and gentlemen, thank you for standing by and welcome to the AmerisourceBergen Earnings Call. At this time all participants are in a listen-only mode.
Later we will conduct a question-and-answer session. Instructions will be given at that time.
[Operator Instructions]. And as a reminder, this conference is being recorded.
I would now like to turn the call over to our host, Barbara Brungess. Please go ahead.
Barbara Brungess
Thank you, Lisa. Good morning, everyone, and thank you for joining us on this conference call to discuss AmerisourceBergen's December quarter and fiscal year 2016 results.
I am Barbara Brungess, Vice President, Corporate & Investor Relations for AmerisourceBergen. And joining me today are Steve Collis, President and CEO of AmerisourceBergen; and Tim Guttman, Executive Vice President and CFO of AmerisourceBergen.
During the conference call today, we will make some forward-looking statements about our business prospects and financial expectations, including, without limitations, revenue, operating margin and taxes. Forward-looking statements are based on management's current expectations and are subject to uncertainty and change in circumstances.
We remind you that there are many uncertainties and risks that could cause our actual results to differ materially from our current expectations. For a discussion of some key risk factors and other cautionary statements, we refer you to our SEC filings, including our Form 10-K for fiscal 2015 as well as our quarterly and other filings with the SEC.
We will also be discussing non-GAAP financial measures, which we use to assess the underlying performance of our business. The GAAP to non-GAAP reconciliations are provided in today's press release as well as on our website.
AmerisourceBergen assumes no obligations to update any forward-looking statements or information which speaks as of their respective dates, and this call cannot be rebroadcast without the express permission of the company. Those connected by phone will have an opportunity to ask questions after our opening remarks.
Now here is Steve Collis to begin our conference.
Steve Collis
Thanks, Barbara, and good morning, everyone. I am pleased with our results in the first quarter of fiscal 2016 and I commend our associates for the tremendous value they provide to the pharmaceutical supply channel.
Day in and day out they are focused on creating value for all of our stakeholders and ultimately for the patients we all serve. We play a vital role in the provision of healthcare which is grounded in our dedication to operational excellence, a continuous improvement in the efficiency, and our bold embrace of innovation.
Everything we do is ultimately driven by one objective, enabling high quality pharmaceutical care for patients. The unique knowledge and expertise we have developed in our partnership philosophy and our increasingly global reach enable us to influence and shape healthcare delivery by providing creative solutions to the challenges inherent in today’s healthcare market place.
The proficiency with which we run our business creates value for all of our stakeholders and enables us to strategically position ourselves to take advantage of the opportunities that are unfolding in a rapidly changing landscape. Tim will provide the details on our financial performance in the quarter, but I want to highlight a few items.
Revenues were up 9% in the December quarter to $36.7 billion. Adjusted earnings per share grew 12% to $1.27, an impressive result considering the strong performance in the prior year.
We are making good progress on our free cash flow objectives for the year, generating $661 million in our first quarter of fiscal 2016. In addition, we have continued to make strategic investments in our business in order to position ourselves well to meet the changing needs of our customers and take advantage of future growth opportunities.
In November, we closed acquisition of PharMEDium, the premiere national provider of outsourced compounded sterile preparations to acute care hospitals in the US. Health systems are playing an increasingly important role in patient care and this acquisition represents a significant investment in our ability to provide market leading services and/or solutions to this key customer segment.
PharMEDium’s proven ability to consistently deliver high quality CSPs in select therapeutic areas combined with the impressive track record of growth, makes them a compelling addition to ABDC. We are very pleased that PharMEDium new state-of-the-art facility in Dayton, New Jersey is now open and providing high quality sterile IV products to their customers.
This new facility further enhances their capabilities and capacity and will be critical to supporting the future growth we expect in this business. The integration work with ABDC is going very well and PharMEDium is on track to make a significant contribution to our fiscal 2016 and to our health systems customers for many years to come.
As we have previously discussed, in addition to making investments in our business, we have also kept our commitment to our shareholders and have virtually completely offset the expected impact of exercises of the warrants held by Walgreens Boots Alliance we anticipate in fiscal 2016 and 2017. While the only share repurchases in the December quarter were under the special program and related to warrant hedging, we did repurchase a $100 million under our normal share repurchases program in January.
I’m very proud of the financial stewardship we have demonstrated over the years and we remain disciplined in the deployment of capital. We are fortunate to be part of a unique and very successful industry that is excelled by constantly working to take cost out of the healthcare system, while helping to ensure that patients have the widest possible access to the medications their physicians prescribe for them.
The industry is competitive but stable in large parts, because we enjoy a solid level of organic market growth, but also because of participants in this industry are sophisticated enterprises that have made important investments in infrastructure and technology in order to continuously improve the most efficient and secure pharmaceutical supply chain in the world. Today our expertise extends well beyond demand aggregation and logistics.
We help enable pharmaceutical care, serving manufacturers as they strive to develop new products and get them to market, and healthcare providers as they focused on expertly improving patient outcomes while managing the cost of care. AmerisourceBergen is uniquely positioned within this industry to help support the entire life cycle of growth and to cheer patients who have access to both traditional and complex new therapies across all sides of care.
We work with thousands of manufacturers and make daily deliveries to tens of thousands of customers efficiently turning inventory to maintain an order full rate of more than 99%. We work effectively in highly regulated environment, maintain the flexibility to respond to emergencies on demand, and we do sell at an exceptionally low cost.
In many cases, patients’ lives are at stake and our associates never hesitate to credibly solve problems and meet whatever challenges might be in front of them. Let’s turn now to the performance of AmerisourceBergen in the September quarter.
AmerisourceBergen Drug Corporation had a solid quarter with revenues up 5% driven in large part by solid organic volume growth offset by some previously announced lost business. Our retail chain, mail order and hospital customers all had strong revenue growth in the quarter.
ABDC is however working with some top comparisons this year and generic inflation in particular is declining more than we had originally anticipated. As always we continue to remain focused on driving efficiency in operations without sacrificing the service we are able to provide our customers.
We also are committed to making investments in our business that will position us well to take advantage of future opportunities. These activities are critical to securing future growth.
Just this week we began servicing over 900 public stores with a grand specialty product and some of the generic that they dispense in their food and drug combination stores. This is a great example of how we continue to support access to specialty products across all sides of care.
One of the unique aspects of this distribution agreement is that Publix will utilize our RFID enabled Cubixx specialty drug inventory cabinets as they further deliver to develop their specialty pharmacy offerings. In addition, Publix will have access to the full breadth of our knowledge and expertise in this area, and we look forward to a long term collaborative relationship with this key growing food and drug retailer.
In January, we signed an early renewal and a 9-year contract extension with our largest independent pharmacy group purchasing organization customer, Compliant Pharmacy Alliance or CPA. CPA is one of the most innovative groups of independent pharmacy owners and has become an important anchor of customer in our independent retail segment with 1225 member stores.
Since we first began our relationship back in 2009, they’ve nearly doubled the number of member stores. Their impressive growth, the high quality dealership they provide in independent pharmacy and the value they place upon our good neighbor pharmacy programs make them an exceptional long term partner.
Both at CPA contract and the public contract further strengthen our high quality retail customer base and provide opportunity for future growth. We also are pleased with the performance in our health systems customers this quarter.
Our acute care customers increasingly provide some of the most important touch points for patient care. These customers now represent one of the fastest growing segments we serve in ABDC and the investments we’ve made in targeted programs and services for this channel is paying off.
For example, both our progenerics programs and our private label generic programs BluePoint today itself has hospitals as well as retailers, and of course as I mentioned earlier, we closed the PharMEDium acquisition during the quarter and we have made excellent progress on the integration of this business. I am very excited about what our health systems customers bring to ABC and we continue to explore ways to bring innovative new solutions to help it raise the challenges they face in a rapidly changing market.
AmerisourceBergen specialty group again had impressive results in the quarter with a number of different factors driving revenues up 15%. Our community oncology business in particular had a strong quarter and our physician distribution businesses also had a good quarter.
Our market leadership in specialties rooted in intimate knowledge of our customers and long and deep experience in the market place. The expertise we have in this area and the portfolio of services we have developed over many years extends well beyond specialty logistics.
We help manufacturers and healthcare providers manage the distinct requirement for specific disease stage and unique classes of products. Our collaborative approach in this area has been the foundation upon which we have established ourselves as the preferred partner for specialty products and services and gives us a firm footing in this most vibrant and dynamic area of the market place.
In a market that is increasingly focused on the cost of care, the best way to discover and deliver value in the long run is to work in concert with our business partners. One of the ways we accomplish this is through our global supply and manufacture relations business units based in Bern, Switzerland also known as AmerisourceBergen Switzerland.
We have made important progress in the brand specialty generic and consumer areas to establish an even greater level of sophistication and coordination between manufacturers and our customers. In October, the Switzerland teams launched Certio a new portal that provides business insights and customized reporting for our generic manufacturer partners.
Certio offers real time access to AmericasourceBergen sales data as well as inventory management and sales forecasting tools. The Swiss based platform also offers a flexibility to schedule and receive customized reports based on the manufacturers business needs.
Certio’s value is evidenced by its rapid adoption and usage, with virtually all of our generic manufacture partners accessing the system. Looking ahead we continue to review the possibility to expand a better report and data for manufacturers, helping them make more informed decisions and supporting their efforts to improve supply chain efficiency for their products.
Lets’ turn now to the other segment, this segment continues to benefit from the inclusion of MWI in our results and we are very pleased with their performance. We have made excellent progress on the integration and a few investments to help them continue to meet their long term objectives.
The companion animal business was especially strong in the December quarter as MWI benefitted from strong organic growth, new product introductions and healthy pricing environment and some new business wins. We are very confident that MWI will continue to deliver excellent performance in fiscal 2016 and will make important differentiated contributions to the value we provide to pharmaceutical supply channels, as we continue to grow our presence in the complex animal health segment.
Just this week I attended the MWI National Sales Conference in Orlando, and I was reminded again of the strong culture at MWI, the excellent fit with ABC, and a significant industry presence that MWI has in animal health which is exemplified by their demand generating sales force. Our manufacture services businesses also had a solid December quarter with Lash Group in particular performing very well as they grew their business for key manufacture customers.
Our expertise in developing patient access and adherence programs and the experience we bring to bear in the regulatory compliance and policy areas are clear differentiators for ABC. Our increasingly global reach in this area further expands our value proposition to manufacturers.
We continuously seek out ways to expand our ability to offer complex solutions for high value pharmaceutical products whether through World Courier in the clinical trial base or through our consulting business in the commercialization phases. When we compound these unique capabilities with the other programs and services ABC offers, we are increasingly able to effectively support product launch in most of the developed world.
As I’ve said many times before, it is the great time to be in the pharmaceutical services industry in both the human and animal health segments. We are well positioned in all of our customer segments and we are proud to service flagship customers like Walgreens Boots Alliance with a pharmaceutical they need to meet the needs of their patients on a daily basis.
While we face headwinds and tailwinds in any given year, we are well positioned to deliver 15% to 18% adjusted earnings per share growth in the year following two consecutive years in which delivered growth over 20%. Tim will provide the details on our revised guidance, and while I’m disappointed that we no longer believe we can achieve the high-end of our regional EPS guidance range for fiscal 2016, we remain on track to deliver strong revenue growth and substantial free cash flow over the course of the year.
We would of course remain laser focused on being as efficient as we can possibly be, while providing the level of services our customers expect. Before I turn it over to Tim, I want to reiterate that our value creation is a result of flawless execution, creative thinking and the courage to implement bold new ideas, and our associates are the firm foundation upon on which our performance is built.
While fiscal 2016 has been somewhat more challenging than we first expected. I have confidence because our associate share my conviction that doing thing efficiently and being a dynamic channel partner with a view to the future is what sets ABC apart.
Our dedication to continuous improvement in the quality of our offerings, our seamless execution, and our thoughtful capital management, all help us grow our business in ways that will help ensure we generate long term value for all of our stakeholders for many years to come. Now here’s Tim
Tim Guttman
Thanks Steve and good morning everyone. Consistent with past quarters my remarks this morning will focus on our adjusted results.
Please note that all financial comparisons are for the first quarter ended December 2015 compared to the same period of the prior fiscal year unless otherwise noted. As a reminder, Steve highlighted that we closed PharMEDium in early November and the results are now included in our pharmaceutical distribution segment.
I have two main topics to cover this morning. First I’ll recap our fiscal Q1 consolidated and segment performance and second I will cover our revised fiscal ’16 expectations.
With that we can begin our Q1 review; revenues were 36.7 billion up just over 9%, our pharmaceutical distribution segment continued to account for the majority of our revenue growth due to our diverse customer mix. On a comparable basis, the last year which means excluding MWI which is in our other segment, our ABC consolidate revenue growth would have been just under 7%.
The quarters adjusted gross profit increased 18% to 1.54 billion, the majority of the dollar growth was due to the two acquisitions that we’ve made most notably MWI. Our pharmaceutical distribution segment was challenged this quarter with a difficult comparison.
Last year in the December 2014 quarter, we had especially strong contributions from generic price appreciation and we are still cycling through the repricing of the Department of Defense contract renewal. We anticipated these headwinds and we previously called them out.
Operating expenses, our total adjusted OPEX increased 26% to 579 million, roughly 75% of the increase is related to our two acquisitions, MWI and PharMEDium. Excluding the incremental OPEX impact from these two companies our comparable OPEX growth rate would have been in the mid-single digits.
Operating income; our adjusted operating income was 475 million, up about 40 million or 9%. Our adjusted operating margin was 1.29%, down one basis points from the prior year, driven mostly by the pharmaceutical distribution segment being down 10 basis points this quarter.
Moving below the operating income line, interest expense net was about 29 million, up significantly from last year due entirely to the financing cost for MWI and PharMEDium. Income taxes, our adjusted income tax rate was 34.6% for the current quarter, down from the prior year.
We continue to realize a higher percentage of our income from our international businesses which includes World Courier, our Ireland BluePoint private label company and our ABC Switzerland company., As Steve mentioned, we continue to expand our service offerings to manufacturers from Switzerland including the very successful launch of Certio, a market leading data portal. Looking ahead, as we continue to expand our international service offering and formally implement an ongoing R&D tax credit program, we now expect our full year tax rate to be approximately 33.5%.
For the quarter, our adjusted diluted EPS increased 12% to $1.27, driven mostly from the contributions of our acquisitions, our adjusted diluted share count was about 230 million shares roughly flat to last year. This finishes our review of ABC consolidated results.
Let’s move forward and discuss our segment results starting with pharmaceutical distribution. Total segment revenues were 35.2 billion, up nearly 7%, and as mentioned earlier by Steve our Drug Company had a growth rate of over 5%, a solid growth across key customer segments including independent, chain and alternate site.
Contributor to this growth includes overall market growth, the launch of new innovative drugs like the Hepatitis C drugs and a continued good brand pricing environment. I should point out that the Drug Company did have a slight revenue headwind this quarter of about 1.5% due to two previously announced customer losses.
Our Specialty Business Group had an overall revenue increase of 15%, driven primarily by unit volume growth. This is the 7th consecutive quarter that our Specialty Group has grown top line revenues at 10% or above.
Looking at it from a disease state standpoint, we had meaningful revenue growth in oncology across a few of our specialty businesses and also ophthalmology. Overall we are very pleased with the continued performance of this key business group that helps to differentiate ABC.
Moving to gross profit, the segments gross profit was 772 million, up about 20 million or about 3%. The growth in gross profit dollars was about evenly split between our two businesses, Drug Company and the Specialty Group.
Drug Company excluding the benefit from PharMEDium was behind last year’s gross profit due to the two large headwinds I called out previously, the tough comparison engineered price inflation and the Department of Defense contract repricing. Segment operating income was 380 million and was down 3%, our Specialty Business continued with a high level of performance offset by lower performance by our Drug Company, due to the gross profit items I just called out.
Wrapping up, even though it was a partial quarter for PharMEDium, this business is growing revenues and contributing operating income right in line with what we’d expected, so a very positive start. We can now move to our other segment, which includes Consulting Services, World Courier and MWI.
In the December quarter, segment revenues were about 1.6 billion, up significantly due to adding MWI. On a comparable basis, so excluding MWI revenue growth would have been as a percentage in the high-single digits.
Let me cover our last consulting business first, they had a very good quarter as a result of new and expanded support services, two existing manufacture customers. MWI continues to perform exceptionally well.
This is our third full quarter of owning MWI, and we are extremely pleased with the integration and progress made to date. The management team is laser focused on servicing their customers and growing the business.
On a comparable basis, MWI grew as companion revenues as a percentage in the mid-teens, we continue to see an expanding US animal health market, driven by organic growth, new innovative products, and a healthy drug pricing environment. From an operating income standpoint, this segment had operating income of nearly 96 million.
MWI contributed the majority of the increase, since we haven’t anniversaried the acquisition yet for consulting also help to drive the exceptional result in this segment. Let me point out that the operating margin is down some in this segment as MWI has a lower overall margin compared to our two other businesses, so overall mix of causing compression in the margin percentage.
This completes our segment review and let me switch and quickly cover our two large GAAP items, warrant and LIFO. Warrants have highlighted in the 8-K that we filed on November 23, we received a favorable IRS private letter ruling on the deductibility of the fair market value of the warrant upon exercise.
Our GAAP tax rate in this quarters’ financial results, now reflect the applicable tax accounting as a result of the ruling. Switching to our tax deduction, our deduction will be at a fair market value or the intrinsic value of the respective warrants at the time of exercise.
Our cash tax benefit is essentially our effective tax rate multiplied by the tax deduction amount. It may take several quarters to actually monetize the deduction, because we’ll have to change our quarterly estimated tax payments and also potentially file for refunds.
LIFO, this quarter we recorded an expense of just over 100 million which represent about 25% of our full year estimate. Our full year fiscal ’16 expense is expected to be less than the prior year due primarily to a slightly lower projected brand inflation rate.
This wraps up our P&L review, I’d like to cover key working capital and cash flow items. In the December quarter we had solid free cash flow of 661 million.
We continue to manage our working capital metrics closely. DSO and a number of days in inventory both remain relatively unchanged even with our large top line growth.
We ended the quarter with about $1 billion in cash on our balance sheet, with a relatively small percentage of this amount offshore. The next area I’d like to cover is share buyback and also our warrant hedging coverage.
In October we purchased 1.3 million shares for 119 million under special share authorization to complete our previously announced March 2015 call option hedging strategy. These were the only shares purchased in the quarter.
We highlighted on our year-end call that we limit our regular share repurchases as a result of the additional borrowings to partially fund the PharMEDium acquisitions. As noted in our press release table and as we’ve said in the past, we are 100% hedged against the 2016 warrant exercise based on the ABC closing share price at December 31, 2015.
This means we will not have an increase to our adjusted diluted share count when the warrant is exercised by Walgreens mostly likely in March 2016. Now lets’ turn to our revised fiscal ’16 expectations, I will provide guidance comments in a few key areas.
Revenues we continue to guide the ABC consolidated revenue growth in the 8% to10% range for the full year which included the new publics account, operating income. Let me cover three items that are now impacting our full year operating income and margin.
First generic inflation trends, previously our fiscal ’16 guidance factored in moderating generic price appreciation and consequently for ABC to translate it to a lower dollar level of contribution versus fiscal ’15. Now that we are starting our 5th month of our current fiscal year, we’d had a longer period to evaluate generic pricing trends.
We thought that we see some increased activity in January like we did last year, but it’s still been especially slow. Based on this, our assumption around generic price appreciation has been updated.
We now believe that generic inflation will be quite modest during the remaining three quarters of our fiscal year. The second item we are also forecasting our contributions from new generic drugs will be less than expected.
This includes the ALOXI an infused oncology drugs that we previously expected to convert to generic, however based on a recent court ruling, the generic launch has now been delayed a couple of years. And the third item that’s highlighted by Steve, we recently signed a new strategic long term contract with CPA, an anchor customer to our independent retail segment.
We made a proactive decision to renew roughly one year early, so that we can start enhanced programs and initiatives with them to drive incremental business over the long term. To summarize, two of the items that I covered above, our full year fiscal ’16 operating income growth has slowed as a result we now expect that our operating margins will increase 3 to 5 basis points down from the previous guidance of an increase of 8 to 12 basis points.
Adjusted EPS, we now expected fiscal ’16 adjusted EPS to be in the range of $5.73 to $5.83, which still reflects strong growth of 15% and 18% for the last years adjusted EPS. Free cash flow, our guidance that we previously provided, $2.3 billion to $2.7 billion remains unchanged since we are still early in our fiscal year.
As I wrap up I’d like to add that we did purchase approximately $100 million of stock under our regular share repurchase program in January. But a continued top priority for ABC is to reduce the portion of the debt associated with our recent acquisitions.
However as always, this is subject to reviewing our cash flow, market conditions and other competing capital needs. So in summary, a solid quarter and start to the year, however we’ll be working through the impact of two incremental headwinds this fiscal year that weren’t previously accepted along with renewing an anchored customer to a unique 9 year contract.
As always we continue to drive efficiencies in our business while delivering value to all of our customers, we remain committed to growing our adjusted EPS in a meaningful way in fiscal ’16 by focusing on what we do best, servicing our customers, deploying capital appropriately and making the right decisions to grow our business for the long run. As always, we greatly appreciate your interest in ABC.
Now here’s Barbara to start on the Q&A
Barbara Brungess
We will now open the call for questions. We ask that you please limit yourself to one question and a brief follow-up so we can accommodate as many callers as possible.
Please go ahead Lisa.
Operator
[Operator Instructions] our first question comes from the line of Robert Jones with Goldman Sachs.
Robert Jones - Goldman Sachs
Despite all of the comments and focus, I think there’s still a good amount of confusion in the marketplace related to generic pricing and the impact on wholesaler economics. Just two-part question, one would be, how comfortable are you today that what you are factoring in now contemplates a true downside scenario for generic pricing?
The second part would be, it would be helpful to just level set for everyone, why if we are in fact returning to a more normalized deflationary environment. How does that not create a more significant drag on profitability?
Steve Collis
Of course at recent conference that we’ve discussed this a lot, I would say that ABC’s approach as we’ve been saying, we always knew we didn’t have perfect information about generic cost increases and we did factor it in. Of course we like to have strived for high performance, so it was something that we had to take in to account.
But we knew always that it was somewhat unpredictable, we don’t have perfect information. So I would just say that ABC and our industry has proved to be very resilient.
It’s scrappy, we’ve gone through a change, [depleted] service, had a huge patent exploration that we’ve experienced in the past few years. We’ve had some specific events in specialty like (inaudible) Platin and we’ve cross spinning both inflationary and deflationary comps.
So our manufacture contracts will take us on the downside for deflation and the key to us is always increasing volume and to help the right scale, and that’s where I think to [weave] that Alliance is so powerful. We entered in to that before we started experiencing significant inflation because we felt like being global, we felt like really going in to partnership with the largest retailer was the right way to make sure that we always had competitive pricing on generics and profitable environment, whatever we saw in the market.
So, I think we’ve made a lot of smart moves, and I would just say that we are confident we could make in a deflation environment and we have historically as well.
Tim Guttman
And Bob let just add to Steve in terms of the first part of your question was, we are very comfortable with our range now, we’ve taken the risk out. I mentioned in my prepared comments that we put in we think generic inflation would quite modest.
So we definitely took the risk out of the range and we think it’s quite achievable. If it turns against us for the balance of the year, than we still feel confident we’ll stand erect.
Robert Jones - Goldman Sachs
Got it, and just the second question related to that but maybe taking a step back, if we look at the core growth for the Drug Company, if we back out a couple of months for PharMEDium, it looks like EBIT margins were down maybe in the 15 basis point range. If we are in a more normalized maybe deflationary generic environment, you mentioned maybe fewer generic launches, how should we think about the growth profile, the profit growth profile for that business going forward?
Steve Collis
We always thought about the Drug Company as the engine, and I would point to the fact that we’ve got a couple of outstanding customers notably WBA. I think the CPA contract renewal a really key one for us with a nine year contract, that’s a tremendous expression of confidence not only ABC but in our offering around independent pharmacy.
So we think that we’ve got a great business of the Drug Company. It definitely is mature and a lot of our customers are mature and we’ll be helped a lot by our new drug innovations.
We saw Sovaldi was a real great and all the Hep C clash was great for us. We’ve got the new (inaudible), so it’s a lot of new opportunities and we expect at some stage we’re going to start seeing our 2017 plan, we haven’t started yet but I can tell you that when Tim and I meet with Bob Mauch, the President of the Drug Company in [‘16], we’re going to be expecting good growth next year on operating margins.
So maybe that’s the best way I can answer. Tim anything to add?
Tim Guttman
I would just add that we want to pick relationships and our customers carefully. We want customers that grow faster than market.
That’s why we get these long term contracts with CPA, so it’s all about growing. It’s all about growing your generic volume base and controlling and making sure you capture the entire wallet from that customer.
I think we’ve done a good job at aligning ourselves with these types of customers and that also including in all of our segments. So we’re still very bullish on the Drug Company and it comes down to generic revenues and like I said making sure that you capture all of their purchases.
Barbara Brungess
Thanks Bob, next question please.
Operator
That comes from the line of Steven Valiquette with UBS.
Steven Valiquette - UBS
Just looking at the rest of fiscal ’16 and thinking about the magnitude of the impact of the three variables you were calling out. Obviously you have taxes as the good guy, but on the other side you have the generic pricing changes, the customer contract renewal pricing, and then you also mentioned the lowering set of profits from the new generics.
Is there anyway just to rank order the magnitude of those, just to give us a little more color for which ones are more critical versus less critical? I am sure we have a sense, but just any additional color would be helpful.
Tim Guttman
I’ll jump in Steve and I would say that we felt they are all significant to call out. Looking at each one individually along with the tax benefit, they weren’t probably significant to drop our range but collectively all three together was why we had dropped the range.
I think that’s the best way to answer the question.
Steven Valiquette - UBS
The other real quick one just on the quarterly chronology, I'm not sure how granular you want to get on this. But it does seem like the March quarter, in particular could be a pretty tough comp on the generic pricing, but then it does seem to get a little bit easier after that based on our data.
So I am curious if you guys share that view or is it may be too early to draw that conclusion at this stage?
Tim Guttman
I would say looking out for the balance of the year the next three quarters, the second half of June and September, probably June get a little bit better for us. We do have an easier comp in the second half for two reasons, one, that generic inflation is a better comp and also we start the [last] DOD.
So well these two items won’t make the drug company a better, a stronger second half, along with a good launch of one of the generics this year in the second half that we’ve talked about previously that’s still on schedule to launch.
Barbara Brungess
Next question please.
Operator
That comes from Garen Sarafian with Citigroup.
Garen Sarafian - Citigroup
On moderating generic inflation, could you give us a sense of how conservative your current assumptions are now versus before? So if things continue to deteriorate further, how much more room is there to fall before getting to zero contribution to earnings for the year or is it contemplated in the current guidance?
Steve Collis
Yeah, again I’ll go back to that comment, obviously we’re very considerate of that comment. We just don’t have perfect information.
We were surprised in a couple of quarters at the strength of generic inflation and we’ve been surprised at how quickly we didn’t see inflation in the last couple of months, and you’ve seen various comments on it. So you could make an argument that we’d be conservative for the next couple of quarters through the end of fiscal ’16.
But again we don’t have perfect information and we’re calling it like we see it right now, and if there was to be an assumption and there are a lot of industry factors for example the big acquisitions activity that’s going on. So things could change and we’ll be back, but we made a commitment that one of your competitor conference that as soon as we understood all the trends in January and we collided all of our data that we’d be a transparent as we can be, and I think we’ve looked up to that commitment very well.
Garen Sarafian - Citigroup
And then Tim I think you touched on this in your prepared remarks. But in terms of your renewal with CPA, could you elaborate a little bit more as to what drove it to be renewed early?
I think as Steve had mentioned that the competitive landscape remains still, so wondering how these types of deals get renewed.
Tim Guttman
The competitive landscape is competitive, but I think those big customers really do like to stay with us. What was important as for CPA, right as [Bob] became President of the Drug Company we took over this account.
We’ve had a relationship with them, where we’ve seen them experience tremendous growth. We’ve obviously seen a tightening of networks etcetera in independent pharmacy and we’ve seen a real desire on ABC’s account to expand the level of services that what we call the next generation of good neighbor pharmacy services.
So when you look at over 1200 independent members that CPA has and you look at our need for anchored customers which we have that theme throughout ABC. We have it for example with Florida Cancer, we have it with of course WBA.
We have it in dialysis with the DaVita and Fresenius folks. So we have a lot of these just tremendous accounts.
So we wanted to really get CPA to quote them to unpack their bags, to acclimatize for the long-term so we could work on the planning that is so vital to the strength and hard work and collaboration that we have with many key customers. So that’s what this is about and we think that we made the right long term move for our customers and you’ll find ABC unapologetically always been focused on driving the long term value for our customers and this nine year is emblematic of that.
Barbara Brungess
Next caller please.
Operator
Our next question comes from Ricky Goldwasser with Morgan Stanley.
Ricky Goldwasser - Morgan Stanley
Steve if we just think about all the different moving parts and assuming the generic inflation is just going to be more normalized longer-term and the generic product line is what it is and the mix of the product coming generics being a little bit more complex, which might mean that we are not going to see the direct correlation of patent expirations and generic launches that we've seen in the past. So when you step back and you think about the future, what do you think is the sustainable growth profile for the core drug distribution business from topline and EBIT perspective?
Steve Collis
We first always thought in our industry that’s growing and we could go off script data but we have a way to sort of aggregate IMS data. You look at a pretty good picture with brand introductions and also the customer profile that we have those anchor customers that I talked about and many other customers that are so important to overall growth.
And then you also look at our specialty credit business and especially market share. So we feel excited about the future, and we have a lot of other levels that we continue to pull around operating excellence, more analysis, better long term contracting with more information.
We have expense efficiency that we continue to be very thoughtful about, and then of course that thoughtful capital deployment which I think almost everyone would give us high marks on, whether it’s the right dividend policy or the right share repurchases, the right internal investments which we’ve made, many of which are so critical to our growth. We talked about one here in AmerisourceBergen Switzerland, but there’s lots of example of those really strategic internal investments we’ve made which are hearty among the best ROIC that we get on any investment.
So I’d say, I’m excited about the future, I think we’ve got good prospects, and I would remind you that again we’re talking about in 2016 15% to 18% growth of two years or 20% plus. So how many companies that have a revenue growth rate of approximately 150 billion aren’t doing that.
So again this is a great industry and I think the outlook for us really highlights that.
Ricky Goldwasser - Morgan Stanley
So two thoughts on this, for the top line I think distribution grew at about 7% this quarter on an organic basis. Do you think that is a reasonable growth rate for us to think about going forward?
And if so like a 7% topline growth and assuming the opportunities for further efficiencies, should we think about EBIT growth at the 9% level so that’s one thought? The second one, you highlighted capital deployment and obviously the cash flows are above industry standard and continue to be very strong.
So can you just walk us through just the sustainability of that longer-term to continue to generate these cash flows when you think about customer mix and the product dynamics?
Tim Guttman
Yeah Ricky its Tim, I’ll take the first one which is the revenue. I’ll echo what Steve said, we have a very strong portfolio of customers and I would say that our revenue should grow above market, that’s our working thesis that we selected past growers and whatever IMS is, whatever the market is showing we should be above that and when you add in specialty that’s also, I would recall an enhancer to our revenue growth.
So again high to above market growth. EBIT I think it’s too early, we are not ready to really comment on EBIT.
We’ll provide more color as we move through the year and talk about that as we go.
Steve Collis
And you know the cash flow I think ABC is always targeting to have a higher cash flow than our net earnings. And you’ll know that we’re working on some things with our changing tax rate.
So it’s still our goal. Absent any big changes in customer, a significant customer or supply terms there’s no reason why we shouldn’t bear to carry on generating that sort of capital efficiency that we’ve guided for 2016.
I wouldn’t go off 2015, I’d go more of 2016, that’s the better range for you to bake any models on, back on to 2015 which had some one-time benefits for us.
Barbara Brungess
Next question please.
Operator
That comes from Lisa Gill with JPMorgan.
Lisa Gill - JPMorgan
Just to follow up on a few things. First off, Tim, I think you talked about the IRS ruling around the warrants as impacting your tax rate going forward.
So how do we think about that? You offset or excluded all the other warrant kind of expenses, but we will see the benefit in the actual income statement that you are reporting on a GAAP basis, as well as at a reported basis?
Tim Guttman
Good question Lisa and just to clarify, so we did see a tax rate change benefit on our GAAP tax rate this quarter and our GAAP financial, but we’ve always excluded that from our adjusted. So there’s no change on the adjusted tax rate, only on a GAAP standpoint.
I think that should answer your question.
Lisa Gill - JPMorgan
Okay, that helps. But will it be accounted the same way going forward, as you talked about some of the rulings that are going to impact tax rate on a go-forward basis?
Steve Collis
Well there won’t be a difference going forward in terms of our GAAP and our adjusted rate. Now we’re synchronized because of that.
The benefit really from the ruling is we’ll get a cash tax benefit upon exercise that will take several quarters to monetize.
Lisa Gill - JPMorgan
Okay. And then, Steve, I just wanted to go back to your most recent comment that 2015 is somewhat of a difficult comparison.
But if I look at the revenue growth, for example, on this quarter 9.3%, and adjusted EBIT growing 9.1%, I think what people are trying to get at or trying to understand is the leverage to the business model. And keeping in mind that there were some unusual opportunities around generic price inflation and some other things that have gone on as you talked about in fiscal 2015.
But can you maybe just help us to think about this business model in general, and what are some of the drivers to the leverage of a model off of that revenue number? And then secondly just to understand some of the acquisitions that you have made recently for example like PharMEDium and the impact that they can have, because as we just think about their revision to the EBIT growth rate or the margin expansion.
I think we are just trying to work through the different impacts, how much that potentially is generic drug price inflation versus repricing and the benefit of some of these higher-margin businesses that you bought? So any incremental color around that I think would just be really helpful.
Steve Collis
I think PharMEDium is very new and you have a good idea if you go back to what we said at the time. It’s performing very well, as is MWI.
MWI of course is in a similar sort of industry from a competitive perspective as we are where they have some strong competitors that we compete against, but I think we are well positioned. I was at their sales meeting as I said on the call, so they are really performing on expectations, and particularly have done because of some economic circumstances, the companion animal business has actually done especially well and again we keep on adding new services there.
PharMEDium, we just really two months that we reported in May closing and early November. We’re happy we’ve made a few changes.
We haven’t had surprises, we of course are very mindful of the regulatory environment and trying to go to where the pack is going and make sure we are ahead of regulators but it’s a business that we drill to own. The response from customers has been good, but I’d say it’s going to take long for the three to be really any synergy on the business development side with PharMEDium and our health systems business.
But an edge to the overall discussion level that edged out strategic relevance. So we like the acquisition, I will tell you that the growth profile in this business especially the way that they can just do more business with the current customers or not, we are almost full penetrated, we do all the needs for our health system customers.
On the prescription side this is a whole new way for them to grow as they keep on adding new therapies to their offerings as the customers get to like their service. So we are really pleased by that.
Getting back to your questions as far as the growth rate, you will see, we’ve had a lot of investment because of WBA and the real number of SKUs that we’re distributing through our business has really increased significantly and we’ve really caught up with that investment now. We would hope to continue investing in the network, making sure it’s both updated efficient and we do expect our total customers to carry on growing.
So the [amount] is very leveragble and I think you can look at the long history we’ve had of trading efficiency, so I would say it is leveragable and we’ve just had some occurrences here with not having a strong generic launch period in this quarter and probably the march quarter, and also the inflation that we talked about as well as some tough comps on the DOD and the renewal on CPA which I could tell you we’ve done for all the right reasons. So that - Tim had something to add as well.
Tim Guttman
I’ll just say Lisa that PharMEDium probably added a few basis points to this segment this quarter because again as Steve mentioned two months and they are certainly a higher margin profile company. And second, I just want to go back to your tax questions just to confirm.
When we gave new guidance on our revised tax rate that clearly not related to the IRS private letter ruling. The change in our tax rate is related to international mix been very plentiful and thoughtful of our growing international business, seeing the tax rate come down because of that and also we’re implementing a formal R&D tax rate credit program related to technology.
So those are drivers of the adjusted tax rate not the IRS private ruling just wanted to confirm that.
Barbara Brungess
Next question please.
Operator
That comes from Charles Rhyee with Cowen.
Charles Rhyee - Cowen and Company
Just want to touch on this concept when we are talking about generic inflation and obviously that is moderating. But when we talk about deflation for generic drugs, my assumption has always been that deflation occurs either when the drug goes from brand to generics, you have a big step downs in pricing.
And then when more manufacturers come into a market, more generic manufacturers come into the market and the pricing falls further after sort of an exclusivity period. Are there situations though when let's say there are a constant number of manufacturers for a generic drug where prices would then again start falling?
Steve Collis
I don’t think you’re talking about rapid decreases I think you’re talking about contract renewal process or market conditions or as you said a new entrant in to the market. But this is something we’ve experienced for a long time.
It’s a robust market, there are new entrance from India and China they’re coming to the market. But I think again, most of the generic manufacturers that we work with are multinational companies that are holding to shareholders and have got commitments to shareholders and are going to be responsible about the long term positioning.
So we don’t see anything that’s really in a historical context irrational or truly surprising. Again we don’t have perfect information on and we did talk about especially the third and fourth quarter last year as well as the first quarter.
We had some really strong comp. So sorry we saw it moderating in the third and fourth quarter, the first two quarter last year we saw a very strong cost inflation which surprised us.
And we pointed that out on all of our calls. Tim any more details.
Tim Guttman
I would just say that the last few years if we - we always talk about our generic baskets of portfolio drug has been on the market for over a year. When we saw inflation the inflation was in the low-single digits.
Now that we’re seeing some deflation that is probably deflating in the low-single digits. So we’re not talking like extreme movement either way.
Charles Rhyee - Cowen and Company
Okay, that is helpful, and just a follow-up. Obviously we had the renewal of CP here, I think another contract you had talked about in the past with Kaiser which I think comes up at some point.
Any thoughts on where we are with this one and is that more of a fiscal ‘17 issue that we should think about or is that something that we could be renewing soon?
Steve Collis
The contract expires in our fourth quarter of this fiscal year, and we certainly had thought about early renewal but each large contract renewal and it’s a very large customer. It’s a little different and we haven’t had the opportunity to renew it early but that’s not impossible, but we still expect that our guidance would hold true even if we do renew Kaiser early or we announce a contract renewal with them, which should really be as you pointed out fiscal year ’17 event.
So of course that’s an ongoing process so we can’t comment too much about it.
Barbara Brungess
Next question please.
Operator
Our question comes from George Hill from Deutsche Bank.
George Hill - Deutsche Bank
Just a couple of quick ones, if we think about the GPL renewal, how early was it? When was it originally scheduled to be renewed?
And I'm just trying to get a sense for whether or not it was contemplated in the guidance?
Steve Collis
That was not contemplated in the guidance, we would have contemplated in fiscal year ’17. As I said we haven’t really started doing our detail planning for that.
So it was not contemplated, but we had an opportunity and I had a great meeting with their Board along with our senior drug and independent pharmacy, and I was really encouraged by their willingness to commit. Think about nine years from now to think about signing a contract for all the members, and one of their Board members was very emotional, almost have been and talked about the responsibility they have to their patients to their employees, to the different members, and it is kind of a voluntary group.
They get together for various reasons and the fact that we are willing to commit to ABC we took as a good sign. So we went ahead and there wasn’t a formal [RAP] process and that’s actually how a lot of our industry works.
Customers like staying with their current wholesaler in most cases and absent some changes in ownership with that, you know a lot of customers do stay with us even though it’s a very competitive environment. So we are so excited with the new Elevate program that Dave knew and he’s working hard on them adding different elements to that.
Our (inaudible) and the new contracting that we have with many networks to get CPA really embedded in that is very important to our whole good neighbor pharmacy offering including to the other good neighbor pharmacy members. The strength of their program is having a robust membership and for us sorry a very high level services and high level of efficiency on the purchasing side.
So that was part of that decision there.
George Hill - Deutsche Bank
That is great color, Steve. Congrats on that.
I would ask everybody is obviously focused on the generic drug price issue. Do your contracts with generic manufacturers typically allow you to retain minimum economics or earnings in the face of a deflationary environment or any color you can provide us around how those contracts work?
And how should we think about how those contracts are similar or are different to the IMAs on the brand side where you guys capture a certain amount of value? It almost looks like kind of fee for service and a certain amount of value that is tied to spread.
And I guess is that something that you guys moving back to a deflationary environment will think about as we move into the next round of negotiations?
Steve Collis
One of the things that’s really important to our customers is protection on the down side if products do decline. I think that one of the best way that I can answer is refer back to my comments on [WBAD] and the global scale and sourcing that we have and the fact that we did this is 2013 was one of the key drivers for our product agreement and the equity and the warrants and the [four] seats that we gave to WBA and at that it was two separate companies of course now they have come together.
So that was a key driver and the contracting process is really it’s not necessary that you’ve seen one and you’ve seen them all. We’ve try to have a fairly wide sourcing philosophy and that’s true both at ABC and at WBAD.
So we think we’re very well positioned and that puts our customer in a good position and it puts our relationship with the suppliers in a good position. So we feel that we can be successful in any generic environment, and the agreements with generic manufacturers are more market share based, they are more performance based as opposed to the IMAs on the branded side.
I would just characterize it as that.
Barbara Brungess
Given we’re past noon, let’s take one more question please.
Operator
Our question comes from Eric Coldwell with Baird.
Eric Coldwell - Robert W. Baird
First, two topics, both have already been briefly touched on, first one’s on the tax rate. Understand the drivers of this year, curious what your thoughts are next year and beyond?
Should we for now just be using something around 33.5 and holding that or is there a reason to expect a big delta two years out?
Tim Guttman
Hey Eric its Tim. I would say it’s kind of early to talk about next year.
We feel that the 33.5% is durable. We are committed to always looking at the tax rate and trying to do what we can, but I would model it off to 33.5 for now.
Eric Coldwell - Robert W. Baird
Second one is I think Charles hit on this one. You talked about meeting with the ABDC leadership in the near-term and that you are going to be expecting some strong operating margin improvement in fiscal ‘17 in that group.
But today we are bringing the core outlook down a little bit on the CPA renewal. And if I am not mistaken I think you have at least Humana, Kaiser and Express Scripts all renewing over the next several months.
So I guess Steve, my question is do your comments on the fiscal ‘17 operating margin expansion, does that really contemplate what could happen with somewhere the tens of billions of revenue renewing over the next six to seven months? Just curious on how that plays into your earlier comments?
Steve Collis
Humana is not in fiscal ’17 and I am not quite sure when it is, we call follow-up with you that. Certainly Kaiser and Express are renewing.
Kaiser has been a long term contract and of course we do expect that we will renew at a market rate that has changed. A lot has changed that was seven year contract I believe that is now here and so we expect that.
So my comments meeting with the Drug Company leadership team was around, what sort of growth can we expect going forward. And I will tell you that, the Drug Company is (inaudible) so it’s not specifically our margin because it’s too early, it’s really around what growth rate do we expect for the Drug Company and those gross profit dollars are very important to us as well as they are to our shareholders and of course no business is more working capital efficient than our drug company.
So that’s another key value driver that we look for from the Drug Company. My comment was really around when we do meet with Bob Mauch and his team we expect them to be generating growth next year.
Eric Coldwell - Robert W. Baird
So on Humana just hate to clarify, but in February of 2011 you announced the five-year agreement taking effect in May 1 of 2011, so would that not lead to a renewal in May of 2016?
Steve Collis
Yeah I believe there’s been subsequent negotiation so Barbara please.
Barbara Brungess
We’ve had an interim agreement with them Eric. We can’t really give the detail given that they are in a transaction mode.
So --.
Eric Coldwell - Robert W. Baird
Got it. Okay, fair enough, thanks for the clarification on that.
Appreciate the comments.
Barbara Brungess
With that Steve do you have --.
Steve Collis
Yeah thanks for the questions and we’ve had a robust discussion today which Tim and Barbara and I and everyone on our ABC team has enjoyed and we hope that you could see that we try to be as transparent and thoughtful about the information we’ve provided you. I would just end by saying that I feel really good about how AmerisourceBergen is positioned, the customer relationships we enjoy, the supply relationships we enjoy and the way that we thoughtfully deploy capital to create long term shareholder value.
So thank you for attention today.
Barbara Brungess
Thanks Steve and thank you everyone for joining us this morning. Before we go I just want to highlight that we will be attending the following conferences.
The Leerink Partners Global Healthcare Conference on February 11 in New York; The RBC Healthcare Conference on February 22 also in New York; The Raymond James Institutional and Investor Conference in Orlando on March 8; and the Barclays Healthcare Conference in Miami on March 16. In addition we will be holding our annual meeting of stockholders in Philadelphia on March 3 and proxy materials relating to that meeting are available on our website.
With that this concludes our call today and I will now turn it back to the operator.
Operator
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