May 5, 2016
Executives
Barbara A. Brungess - Vice President-Corporate & Investor Relations Steven H.
Collis - President, Chief Executive Officer & Director Tim G. Guttman - Chief Financial Officer & Executive Vice President
Analysts
Robert Patrick Jones - Goldman Sachs & Co. Ricky Goldwasser - Morgan Stanley & Co.
LLC Lisa Christine Gill - JPMorgan Securities LLC Robert Willoughby - Credit Suisse Securities (USA) LLC (Broker) Ross Muken - Evercore Group LLC Eric Percher - Barclays Capital, Inc. Garen Sarafian - Citigroup Global Markets, Inc.
(Broker) Eric W. Coldwell - Robert W.
Baird & Co., Inc. (Broker) Dave Francis - RBC Capital Markets LLC Charles Rhyee - Cowen & Co.
LLC David M. Larsen - Leerink Partners LLC Greg Bolan - Avondale Partners LLC
Operator
Ladies and gentlemen, thank you for standing by. Welcome to the ABC Earnings Call.
At this time, all participants are in a listen-only mode and then later, we'll conduct a question-and-answer session. Instructions will be given at that time.
As a reminder, the conference is being recorded. I'll now turn the conference over to our host Barbara Brungess.
Please go ahead.
Barbara A. Brungess - Vice President-Corporate & Investor Relations
Thank you. Good morning, everyone, and thank you for joining us on this conference call to discuss AmerisourceBergen's March quarter fiscal year 2016 results.
I am Barbara Brungess, Vice President, Corporate and Investor Relations for AmerisourceBergen and joining me today are Steve Collis, Chairman, President and CEO of AmerisourceBergen; and Tim Gutman, Executive Vice President and CFO of AmerisourceBergen. During the conference call today, we will make some forward-looking statements about our business prospects and financial expectations including, without limitation, revenue, operating margin and taxes.
Forward-looking statements are based on management's current expectations and are subject to uncertainty and change in circumstances. We remind you that there were very many uncertainties and risks that could cause our actual results to differ materially from our current expectations.
For a discussion of some key risk factors and other cautionary statements, we refer you to our SEC filings including our Form 10-K for fiscal 2015 as well as our quarterly and other filings with the SEC. We will also be discussing non-GAAP financial measures which we use to assess the underlying performance of our business.
The GAAP to non-GAAP reconciliations are provided in today's press release as well as on our website. AmerisourceBergen assumes no obligation to update any forward-looking statements or information which 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. We have a lot of material to cover this morning; so our comments will be slightly longer than normal, but we will leave ample time for questions.
Now here is Steve Collis.
Steven H. Collis - President, Chief Executive Officer & Director
Thanks, Barbara, and good morning, everyone. Let me start by saying that while we delivered solid performance in our March quarter, we are disappointed that the forecasts we have presented for the second half of our fiscal 2016 and our preliminary expectations for fiscal 2017 fall below our historical rates of performance.
Nevertheless, I remain optimistic about the long-term prospects for our industry and our company and we are well positioned with the right customers and the right portfolio of services for both pharmaceutical manufacturers and healthcare providers to drive long-term value creation for our shareholders and other stakeholders. Certain areas of our business are performing very well, including both of our recent acquisitions, MWI Veterinary Supply and PharMEDium.
Our specialty group, including the distribution businesses that serve physicians and our consulting businesses, had a very strong March quarter. In addition, we recently achieved two key customer renewals or extensions in AmerisourceBergen Drug Corporation, including a three-year extension with our strategic long-term partner, Walgreens Boots Alliance, and a one-year extension with Express Scripts, our second largest customer.
ABDC has, however, been adversely impacted by several factors, including accelerating deflation on generic drugs and a lower contribution from generic launches. These unanticipated trends have exasperated the expected impact from a shift in product mix towards lower-margin and higher-priced specialty and branded drugs, as well as the lack of generic inflation we discussed in our Q1 call.
As we work through these challenges, our overall earnings growth rate will slow somewhat. Tim will discuss the March quarter results and walk through our detailed guidance for the second half of fiscal 2016 and our preliminary expectations for fiscal 2017.
Then I will outline the ways we intend to take advantage of the long-term opportunities that are in front of us before we open the call to Q&A. Now here is Tim.
Tim G. Guttman - Chief Financial Officer & Executive Vice President
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 second quarter ended March 31, 2016 compared to the same quarter of the prior fiscal year, unless otherwise noted. Also, let me point out that after this quarter, we fully anniversary the impact of adding MWI to our consolidated financial results.
My comments will be a little lengthier this morning, as I have a fair amount to cover in three primary areas. First, I will recap our fiscal Q2 consolidated and segment performance.
Second, I will cover our revised fiscal 2016 expectations. And third, I will provide some brief commentary on how we are thinking about fiscal 2017.
Even though it's early, we will provide initial thoughts in a few key areas. With that, we can begin our fiscal Q2 review.
Revenues were $35.7 billion, up 9.3%. Our Pharmaceutical Distribution segment continues to account for the majority of our revenue growth due to our diverse customer mix; our two acquisitions, MWI and PharMEDium combined, accounted for roughly 2% of our consolidated revenue growth.
The quarter's adjusted gross profit increased 12% to $1.2 billion. The dollar growth was due to our two acquisitions, MWI and PharMEDium.
Our Pharmaceutical Distribution segment, specifically the drug company, was challenged this quarter with a difficult comparison. They continued to experience headwinds from contract renewals and lower generic inflation.
Operating expenses. Our total adjusted OpEx increased 18% to $575 million.
Roughly 80% of the increase was related to our two acquisitions. Excluding the incremental OpEx impact from these two companies, our comparable OpEx growth rate would have been about 4%.
As you have come to expect from ABC, we are prudent with expense spending. This has always been one of ABC's core operating practices and it will remain so going forward.
Operating income. Our adjusted operating income was $592 million, up about $40 million or 7%.
Our adjusted operating margin was 1.66%, down three basis points from the prior year, driven mostly by the Pharmaceutical Distribution segment being down eight basis points this quarter. Moving below the operating income line, interest expense net was about $31 million, up significantly from last year, due entirely to the financing costs of the MWI and PharMEDium acquisitions.
Income taxes. Our adjusted income tax rate was 31.3% for the current quarter, down from the prior year.
This quarter's rate includes a one-time rate benefit of 1.4% from adjusting our estimated year-to-date tax rate, specifically related to an expansion of our international operations which are taxed at a lower rate. We now expect our full-year tax rate to be approximately 33%.
For the quarter, our adjusted diluted EPS increased 16% to $1.68, driven mostly by the income from our two recent acquisitions, and to a lesser degree, from our lower consolidated tax rate. Our adjusted diluted share count was about 229 million shares, down some from 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 $34.2 billion, up nearly 8%. Our drug company had a growth rate of about 6%.
This growth was net of a revenue headwind of about 2% due to lower Hepatitis C sales in the market and also a transfer of certain oncology sales to our specialty business. Drug company had solid growth across its chain customers, including Walgreens and also in our Hospital segment.
Our Specialty Business Group had another outstanding quarter with revenue increasing about 18%, driven mostly by volume growth. Similar to last quarter, we continue to have meaningful revenue growth from the sale of oncology drugs across a few of our businesses and also from the sale of ophthalmology drugs in our Specialty Medical business.
ICS, our third-party logistics business, accounted for roughly 20% of specialty revenue growth, primarily due to a new manufacturer relationship they added late last year. This is our eighth straight quarter of double-digit revenue growth for our Specialty Group.
We continue to be very pleased with their performance. They clearly help to differentiate ABC from the rest of the market.
Moving to gross profit. The segment's gross profit was $882 million, up about $33 million or about 4%.
The majority of the growth in gross profit dollars was in our drug company, specifically the benefit from PharMEDium. Excluding the acquisition benefit, drug company was behind last year's gross profit due to the headwinds I called out previously, the tough comparison on drug price inflation and contract renewals.
Segment operating income was $498 million and was up 2%. Our Specialty business continued with our high level of performance, offset by the lower performance of our drug company.
Before I finish on the segment, let me comment this was our first full quarter of reporting PharMEDium. Financially, they are contributing better than we expected as a result of strong operational performance.
For the quarter, volume growth, as a percentage, was in the mid-teens. The business has integrated especially well into the drug company.
We are off to a great start with PharMEDium. We can now move to our other segment which includes MWI Consulting Services and World Courier.
In the March quarter, segment revenues were about $1.6 billion, up significantly due to adding MWI. As a reminder, our March 2015 quarterly results included about five weeks of MWI's operating results.
Growth in just Consulting and World Courier combined was about 13%. These businesses continue to grow their top-line revenue, primarily as a result of providing additional services and growing volumes with existing customers, which is a clear indicator of customer satisfaction and value.
MWI continued to perform especially well. Percentage revenue growth in the Companion Animal segment in the low teens and we saw a nice recovery in the Production Animal segment with percentage revenue growth in the high single digits.
From an operating income standpoint, this segment had operating income of $94 million. MWI contributed a significant amount of the dollar increase.
Our Consulting business also had excellent income growth in the quarter. The segment's operating margin was down about 60 basis points.
This is the result of MWI becoming a much larger percentage of the results and having a lower margin in comparison to the two other businesses within the Other segment. During the March quarter, we celebrated the one-year anniversary of acquiring MWI.
We want to thank Jim Cleary and the entire MWI team for an outstanding first year. We continue to be impressed with the passion and knowledge that our associates demonstrate every day, partnering with our customers and the manufacturers.
And importantly, the MWI's business has outperformed our first-year financial expectations. They are on strong footing and on track to deliver the long-term returns we anticipated.
I'd like to switch over now and cover a few key working capital and cash flow items. In the March quarter, we had solid free cash flow of $790 million.
This quarter historically has been our strongest cash quarter of the year as we cycle through the seasonal inventory builds from calendar year-end. At March 31, we had roughly $2.5 billion in cash on our balance sheet.
This includes roughly $400 million offshore related primarily to our World Courier and Switzerland businesses. During the quarter, we purchased 1.1 million shares of our stock for about $100 million under our regular share repurchase authorization.
As noted in this morning's press release, we announced that our board authorized a new, regular share repurchase program that, together with the availability under the existing share program, permits us to purchase up to $750 million of our shares. Also back in mid-March, we filed an 8-K announcing that Walgreens exercised their 2016 stock warrants through our hedging program as we committed.
We successfully offset the EPS dilutive impact from the 23 million shares issued to Walgreens. In conjunction with its hedging program, the company, through an Investment Bank, executed call options to purchase ABC shares.
The funding of the call option transaction was not entirely completed in the March quarter. We paid $218 million to the Investment Bank in the March quarter.
And the remaining amount, $483 million, was paid to the bank in April. Moving to our revised fiscal 2016 expectations.
I must acknowledge that revising our adjusted EPS guidance downward a second time is very disappointing to us. Adverse market trends centered around generic pricing have become more acute than we anticipated.
And our strategic initiative to offset some of these pressures has not yet yielded the results we expected. While generic inflation has been nominal, the rate of generic drug deflation is slowly increasing and is higher than the level we previously expected in fiscal 2016 and expected to get slightly worse by year-end.
This is driven in part by the increased supply of generic product in the channel. While we are protected from inventory losses on deflationary products, it's difficult to continue to earn the same gross profit dollars on decreasing prices.
We have had some success in being made whole through new incentives or rebates or by increasing generic sales volumes, but we are not always 100% successful in achieving this. Combined with this, our gross profit contributions from new generic launches are decreasing as brand manufacturers increasingly find ways to protect and retain market share.
Additionally, after several years of a favorable branded generic revenue mix in our drug company business, this trend is starting to reverse. As more lower margin branded specialty drugs shift primarily to hospitals and specialty pharmacies through full-line distribution in our drug company, these revenues do not currently provide enough gross profit dollars to overcome the decline in generic drug gross profit.
With regard to our strategic initiative, our drug company about a year ago set forth on a strategic initiative to grow its independent retail business, and in conjunction with this, grow pro-generics revenues. The business added new management and additional resources, made investments in innovative programs and aligned internal incentives.
We expect to see meaningful progress in our June and September 2016 quarters from these investments and efforts. While we are making progress, the financial contribution is ramping slower than anticipated.
Based on the two headwinds that I've covered and the negative impact from previously disclosed contract renewals, the drug company's fiscal 2016 operating income will be lower on a year-over-year basis, even with PharMEDium included. Our revised fiscal 2016 P&L guidance is as follows: Revenues, we are now guiding to ABC consolidated revenue growth of approximately 8% for the full fiscal year.
Operating income, we expect growth in consolidated operating income to be in the range of 5% to 6% as a result of the lower second-half expectations and lower-than-expected performance of our drug company. Included in this growth is the benefit from measures we plan to take to reduce our expense structure going forward.
Adjusted EPS, we now expect our fiscal 2016 adjusted EPS to be in a range of $5.44 to $5.54, which is growth of 10% to 12%. As I just highlighted, our EPS range includes the benefit of several cents from expense reductions we will be implementing in the second half of this fiscal year.
I'd like to now cover our revised guidance on free cash flow and also share repurchases. This morning, we issued a separate press release announcing our contract amendment with our largest customer, Walgreens.
As we disclosed, we've entered into a three-year contract extension with our anchor partner for both the distribution agreement and the generic sourcing agreement. In the past, we have disclosed that this customer accounted for about 30% of our consolidated revenues.
In our view, there are a few customers that have both the scale and growth profile like Walgreens. The relationship, now in its fourth year, has exceeded our initial financial projections and has provided an excellent return to our shareholders.
In exchange for the extensions, we agreed to make additional working capital and infrastructure investments during the next several months and also into fiscal 2017. Some of these investments, including carrying extra inventory to maximize service levels, have recently started.
Because of these working capital investments, we are now revising our free cash flow guidance to $1.9 billion to $2.1 billion for the full year; and this now includes the tax benefit from the 2016 warrant exercise. For share repurchases, using a portion of the cash from the warrant exercise, we expect to increase our repurchases which will now total between $350 million and $450 million.
As always, share repurchases are subject to change depending on market conditions, our second half of the year cash position and other competing capital needs. The third and final topic I want to cover this morning is commentary on our fiscal 2017 outlook.
Since we changed our assumptions around the second half of fiscal 2015, we thought it was important to provide a preliminary look at next year fiscal 2017. Revenues, we expect our consolidated revenue growth to be slightly better than market, operating income, the headwinds that I called out related to the second half of fiscal 2016 will continue well into fiscal 2017.
Also, we do expect to have headwinds from both the Kaiser and TPA contract renewals for half of the fiscal year. Consequently, our drug company's operating income is expected to be up just slightly and this includes solid growth from PharMEDium.
Adjusted EPS growth, we expect growth in the range of 4% to 6% from the midpoint of our revised fiscal 2016 guidance range. I should highlight that the 4% to 6% adjusted EPS growth is net of a 3% headwind for the incremental expenses to support key business investments in IT systems and infrastructure.
These investments support our growth, drive customer satisfaction and further increase our operating efficiency. We expect to realize meaningful expense savings from these incremental investments of at least $30 million annually beginning in fiscal 2019.
The preliminary view of our fiscal 2017 outlook includes several key assumptions as follows: One, we are expecting generic drug deflation to be in the high single digits by fiscal year end 2016 and more importantly, we are forecasting that generic drug deflation will stay in this range for the entire fiscal 2017. Two, our tax rate will be slightly lower in fiscal 2017.
Three, we have limited capital deployments in our adjusted EPS range. We plan to complete enough share repurchases to offset stock option exercises.
Four that we retain Kaiser, an important customer of the drug company. Five, we are not including any new business, resulting from our relationship with our largest customer; Six, we've not included any impacts from the proposed TMS Medicare Part D reimbursement proposal as it's too early to ascertain the likelihood that this will be successfully implemented; and Seven, we are not assuming a meaningful contribution from biosimilars.
Moving to free cash flow, preliminary guidance and cash availability. As I mentioned earlier, we have agreed to make working capital investments as a result of the Walgreens contract amendment.
The working capital impact is greater in fiscal 2017 than fiscal 2016. Also, the impact primarily affects the first half of our fiscal 2017.
We anticipate that our capital spend will increase as we invest in our drug distribution network due to age of the network and also to increase capacity. Additionally, we are making key IT platform investments in our Consulting and World Courier businesses, both have older systems that are inefficient and costly.
As a result of these investments, we expect that our free cash flow in fiscal 2017 will be approximately equal to or just slightly below our adjusted net income. An important point: once we cycle through the impacts from the Walgreens working capital investments and the higher CapEx in fiscal 2017, our aspirational goal in fiscal 2018 and beyond would be to have free cash flow of at least 125% of net income each year, assuming over time we maintain our current terms with customers and suppliers.
From a cash availability standpoint, I should mention that we expect our offshore cash to continue to increase in fiscal 2017 as a result of our international businesses. The final item I will cover is the future exercise of the 2017 warrants.
Because of our hedging strategy, we are fully covered from any potential adjusted EPS dilutions when our share price is $88 or lower. We will certainly monitor this as we progress towards the exercise window, which is March 2017 to September 2017.
As a reminder, roughly 60% of the warrant proceeds will be used to exercise our Capped Call Options with the Investment Bank and purchase shares needed to successfully complete the hedge. The remaining proceeds are expected to be used to repay the 2017 bond that we originally issued in connection with the hedging program.
As I close my comments, we are on a different trajectory for the remainder of fiscal 2016 and also for fiscal 2017 than we had originally anticipated. However, we are well positioned to navigate through a challenging environment, drive efficiencies and thoughtfully deploy capital in a manner that drives long-term shareholder value.
Now, I will turn it back to Steve.
Steven H. Collis - President, Chief Executive Officer & Director
Thanks, Tim. As we look ahead to the second half of our fiscal year and into next year, there is no doubt that we have some challenging work ahead as we navigate the headwinds that Tim outlined.
But I am certain that we have the right team in place, not only to meet this near-term challenge, but also to ensure that we do not lose sight of the many long-term opportunities that are ahead of us. Let's look at each of the foundational pieces of our business more closely.
We are very fortunate to be heavily weighted to the U.S. pharmaceutical industry where the organic market growth rate is expected to be 7% to 8% over the next several years.
This is an extremely significant benefit that our industry enjoys and all U.S. wholesalers are beneficiaries of this market growth, especially to the extent that it is being driven by demographics and improving access to care.
Market growth in the U.S. is also driven by new brand product introductions, both in more traditional therapies and in innovative specialty products and to a lesser extent by branded drug inflation.
Of course going forward, there will be less erosion at the top line from new generic launches. The large U.S.
wholesalers together comprise the most efficient distribution network in the world and provide tremendous value to the pharmaceutical supply channel. AmerisourceBergen has distinguished itself within this accomplished group with its portfolio of services for specialty and biotech manufacturers and for the healthcare providers that administer these innovative products.
We are the global leader in the distribution of specialty drugs and these products are vital to all of our customers. The economics of specialty products vary depending on the channel in which the product is administered or dispensed, whether the product is covered by the medical or pharmacy benefits and the extent to which we can add value for the manufacturer and the provider.
In most cases, the best economic opportunity for ABC is with the products that are administered by a physician that is treating a patient in a community setting because that is where we can provide the most value to both the manufacturer and the provider. While the prices of some of these specialty drugs get a lot of attention, we should not lose sight of the fact that these products treat extremely serious illnesses.
In many cases, there are life-saving products or life-changing drugs that make a previously intractable disease manageable. While we certainly understand the need to manage the cost of care, the physicians and other healthcare providers who treat the sickest patients should not themselves be economically harmed simply by choosing the best available therapy for their patient.
As someone who's been working around community physicians, including oncologists for over 20 years, I want to comment specifically on CMS's proposed demonstration project on Part D drugs. There is little evidence, if any, that physicians are systematically and inappropriately prescribing expensive therapy.
The proposal ignores the reimbursement challenges physician already face on many Part D medications such as those that remain in place as a result of sequestration. The cost to administer the products and to care for these patients are significant and the unintended consequences of further reductions should be carefully studied because it is the patient that will bear the ultimate burden both in terms of the economics and in terms of the quality of their lives.
We are hopeful that the issues with the proposal will be addressed and that it will not be implemented in its current form. Turning back to our business, the portfolio of services we offer applies broadly to potentially all pharmaceuticals.
And going forward, we will move to a pricing model that is more balanced between generics and brand products. Today, the basic logistics of warehousing and distributing the products is the bedrock of what we do and the additional services we provide have greatly differentiated our place in the market.
We can meet the needs of pharmaceutical manufacturers and healthcare providers at virtually every point in its lifecycle, from the clinical trial phase through commercialization as a brand and into patient and product support for mature therapies and eventually through the launch of generic or biosimilar versions of products. The portfolio of offerings we have built over the last decade will be even more important in a market that is laser-focused on value and cost efficiencies.
Solid organic market growth and the right portfolio of services are critical components of increasing revenues. But to take full advantage of those cornerstones, we need to be aligned with the right customers and this is another area where I believe we excel.
AmerisourceBergen has an unparalleled group of marquee customers with whom we've established long-term relationships. As both Tim and I mentioned earlier, we are thrilled to extend our innovative and highly successful partnership with Walgreens Boots Alliance and we look forward to continuing to reap the mutual benefits of this unique and collaborative relationship well beyond the original 10-year term.
This relationship has greatly benefited both parties and has financially exceeded our expectations. I'm also pleased that Express Scripts has decided to exercise their option to extend their current contract for an additional year.
We've been working with this market-leading pharmacy benefit manager for the last four years and we continue to look for new ways we can partner together to drive value for the long term. We now have several of our largest customers in each of our key segments under long-term contract and we hope that we will soon be able to say the same about Kaiser Permanente.
Over many years, we have deliberately chosen specific customers whom we believe would be on the cutting edge of pharmaceutical care and therefore grow faster than the market over the long run. In addition to the three customers already mentioned, we renewed our largest independent GPO customer CPA during the quarter.
And of course we have our largest government contract, the Department of Defense also on a long-term contract. This strategy has already paid dividends and will continue to do so for many years to come.
Our focus on high-quality customers is not limited to just the very largest in the marketplace. We have extensive relationships with food and drug retailers, institutions and other types of healthcare providers of various shapes and sizes and have long been champions of both independent community pharmacy and have specialty physicians in community practice, for example.
We will continue to make investments to ensure that we meet specific site of care needs as well as to serve providers who integrate offerings across different channels. And I think that AmerisourceBergen is the best positioned in the market to deliver meaningful innovation in these areas.
Another key customer group is of course our pharmaceutical manufacturer partners. Our extensive array of manufacturer services businesses are another meaningful differentiator for ABC and these businesses are and will continue to be among the fastest growing in our company.
Whether we are working on clinical trial logistics in World Courier, working on reimbursement and commercialization strategies within our Consulting business or supporting patient assistance programs built around some of the more complex therapies, I believe the suite of services will only become more valuable in the future. As manufacturers must demonstrate value and comparative effectiveness and patient adherence becomes more essential and less exceptional and complex biosimilars are launched into the marketplace, AmerisourceBergen will be the partner of choice.
Serving customers well is absolutely required in today's market and we must continue to do so in the most efficient manner possible. While our expenses have increased in recent years and will continue to rise somewhat as we integrate our recent acquisitions and make some additional investments in our information technology systems and other infrastructure, I want to assure you that we remain focused on being the most efficient operator in the industry.
As cost pressures increase across the board in healthcare, it is even more important that we manage our own with an increasingly higher degree of precision than we've done historically. We have always skillfully run lean operations.
This is an area where we need to apply even greater creativity and sensitivity to what needs to be done to meet the needs of customers in a way we can strip out unproductive expenses. This is a process that never ends and it is important to remember that the investments we are making today will ultimately lower our cost of doing business in the future.
As we grow our revenues, efficiently run our operations and cycle through the working capital investments that Tim discussed, we expect to be able to generate strong cash flow over the long term. This has long been a hallmark of our business and is one of the key ways in which we have driven shareholder value.
We remain committed to being excellent stewards of capital. And as I mentioned earlier, we expect to continue to have a balanced approach to deploying our cash going forward.
Our track record in this area is very strong. We have had successful internal products like BluePoint, the NDC, National Distribution Center, and more recently, Certio.
In addition, we have made very successful strategic investments in three market leaders: World Courier, MWI Animal Health, formerly Veterinary Supply, and PharMEDium. These three large acquisitions have strengthened our business in key areas and all of them have exceeded our expectations in terms of their operational and financial performance and have yielded important strategic benefits.
Looking ahead, we will continue to look for high-quality assets in the pharmaceutical channel that have great potential to deliver long-term value. In addition, of course, we will continue to return funds to shareholders through dividends and share repurchase.
In the near term, we remain committed to offsetting the potential dilution from the exercise of the 2017 warrant and over the longer term, we will be as thoughtful and resourceful with our capital deployment as we have always been since inception of AmerisourceBergen. In summary, while we are disappointed in our near-term forecasts, I hope all of our stakeholders share my great conviction and confidence in our AmerisourceBergen franchise.
Our management team, our portfolio offerings and our collaborative and entrepreneurial spirit has never been stronger. As I've said on many occasions, while we focus on delivering short-term results, we are obsessed with delivering long-term performance that reflects ABC's excellent position, thought leadership and customer focus.
Ultimately, it is our dedication to continuous improvement in the quality of our offerings, our seamless execution, our financial performance and our thoughtful capital management that would help us ensure we will generate long-term value for all of our stakeholders for many years to come. Now we'll turn it over to Barbara to begin Q&A.
Barbara A. Brungess - Vice President-Corporate & Investor Relations
Thank you, Steve. We will now open the call to questions.
This morning, we will ask that you please limit yourself to one question so we can accommodate as many callers as possible. Please go ahead, Lori.
Operator
Thank you. We'll go to Bob Jones with Goldman Sachs.
Please go ahead.
Robert Patrick Jones - Goldman Sachs & Co.
Great. Thanks, Steve and Tim.
So it sounds like you're calling for high single-digit deflation as we leave your fiscal 2016 and enter your fiscal 2017. I guess two-parter.
How does that compare to what you're seeing currently in the marketplace from a generic deflation standpoint? And then, Tim, I think it would be really helpful if you could give us some sense, even order of magnitude of what kind of impact to the P&L should we be thinking about if you're talking about mid-single-digit deflation moving to high-single-digit deflation?
Tim G. Guttman - Chief Financial Officer & Executive Vice President
Yeah. Thanks, Bob, for the question.
I'll start with the first part of your question. I mean I would say that to give a perspective on us, where we're at today, at the end of March quarter, we were probably mid-single-digit deflation.
That changed – that definitely changed on us from where we communicated to the Street and to our investors and stakeholders back on Q1. It was probably very low single digit; so that moved against us by the time we got to March.
And as we forecast out for the balance of the year, we expect that to increase some. And that's – again we think that's related to just more supply in the channel.
And certainly, we factor that into thinking that's going to remain so into 2017. And it's a headwind and I'm not going to comment on dollars.
But we sell a lot of generics through our Pro program. And again when you do the math, a 1% change in deflation and having lower GP dollars is certainly a headwind that we have to work through.
Barbara A. Brungess - Vice President-Corporate & Investor Relations
Okay. Next question, please.
Operator
We'll go to Ricky Goldwasser with Morgan Stanley. Please go ahead.
Ricky Goldwasser - Morgan Stanley & Co. LLC
Yeah, hi. Good morning.
So, I just want to go back to one of the comments you made in the prepared remarks. I think you talked about kind of like changing the pricing model in contract (40:27) of your internal model.
Now you seem to have inflation. So can you maybe elaborate a little bit more on this?
Are you also seeing changes in pricing model in your interaction with your customers, your pharmacies and also any kind of buyers? What does it really mean?
Steven H. Collis - President, Chief Executive Officer & Director
So we've had a real long-term, for several years now, tailwind from the generic patent expirations and that's been a great benefit. We're talking now specifically about the drug company; it's obviously a bit different in our specialty business and very different in, say, our Veterinary or PharMEDium business.
But what we try and accomplish in the long term is a better balancing contribution between brand, generic and specialty therapies which would include biosimilars and precision medicine products and cell-based therapies. So all of these new innovative products we expect to get a fair return on.
And that's a discussion we're having with our customers and definitely a discussion we're having with manufacturers as well. Now the reality is that the sell side takes time to catch up with the buy side.
And by sell side, we mean the contracts that we have with providers. So we've seen some very rapid changes in the marketplace with – probably, we believe growth in the industry will be driven more by innovation than by inflation on established products even if they're not subject to generic competition.
So, it's very important that we have all these product categories be profitable for us and that's what we really are talking about. And I think AmerisourceBergen, with Bob Mauch's leadership and the very strong strategic approach to customers, we've taken a lead in this and you'll see that reflected in our contracts over the long term.
Operator
And our next question, Lisa Gill with JPMorgan. Please go ahead.
Lisa Christine Gill - JPMorgan Securities LLC
Thanks very much. Steve, thanks so much from you and Tim in giving us some thoughts around 2017.
But what I really want to understand is your more broad-based thoughts. As we think about core revenue in your distribution business, you just talked about the changing model.
You've talked about the changes around new product innovation versus increasing prices on existing products. But could we see a period of time where perhaps your revenue growth is greater than your EBIT growth because of some of these factors that are impacting the model?
And how do you think about EBIT just given your customer base, given some of the things that you're talking about over the next couple of years?
Steven H. Collis - President, Chief Executive Officer & Director
Yeah, Lisa, thank you for the question. It's a mix of customer base that we have including being with some of the fastest growers like WBA.
And our target is specialty market including we do a lot of specialty pharmacy business in our core drug wholesale business. We do expect to grow our revenue slightly above the market.
And then because we have a strong association or weighting towards those larger customers and because of the mixes that we see, we don't expect to be able to keep our gross profit growth up with that revenue growth. But we do expect that we're going to have operating leverage because of the different investments that we're making.
So there will be scale coming from that and we are moving ahead rapidly with integrating MWI and PharMEDium, which has really severely impacted our expense rate. Another good benefit that we have is our improving tax rate and then I think ABC is accelerating capital deployment not only on acquisitions, but on buying shares back at the right time.
And this is my 20th quarter. And I think when I did my first quarter, we were in the mid to high 30%s and so we've done very, very well with that.
Something that I'm very proud of and we talked on the call about (44:31) and our National Replenishment Center. These projects – BluePoint, these projects have really been outstanding.
And then you know it's – again depending on what happens in the market and how cash flow progresses and we are forecasting in the long run 125%; that's quite implicit in Tim's comments. So we would have the opportunities and certainly at lower spot prices as share repo becomes a lot more compelling to us.
So those will be the drivers for our long-term growth model.
Barbara A. Brungess - Vice President-Corporate & Investor Relations
Next caller, please.
Operator
We'll go to Robert Willoughby with Credit Suisse. Please go ahead.
Robert Willoughby - Credit Suisse Securities (USA) LLC (Broker)
Hi. Steve or Tim, you're able to sign a three-year extension with Walgreens which had six or seven years left on the deal, but only a one-year extension with Express Scripts.
I guess they exercised the option there. But what's the barrier to negotiating a long-term deal there?
Is the nature of the negotiations changing? And then secondarily, you comment on the working capital requirements that's inventory.
Have any of the payment terms changed? That's where you've made more of your recent progress?
Is Walgreens demanding different terms now?
Steven H. Collis - President, Chief Executive Officer & Director
I'll start off. Bob, first of all, it's a pity you couldn't have your daughter on the phone with us.
And second of all, it's very strange welcome to Credit Suisse folks so good to hear from you. So at Express Scripts, again, the first time I met George, he came to me, I didn't really know AmerisourceBergen.
So I think we've made tremendous progress with Express Scripts. The relationship is into its fifth year.
The teams meet regularly. We have dedicated representation therein.
We're going to work very hard to sign a new contract with them over the next 12 months. And I think this is – I think anybody would agree with me that this is a very active market with a lot going on.
And so – but I do think that the companies are strategically aligned and I expect we'll be able to renew the contract. As far as WBA, I'll let Tim comment further.
But clearly, a lot of the people that are not in our industry on a daily basis, I'm getting all these emails and texts this morning, wow, you did a $400 billion deal with WBA; and we should not take that for granted. I mean, these are the people who like saying, well, everything else that we announced today.
But there's just not any other customer probably in the world like this. And we did a historic agreement.
This is the first time we've significantly renegotiated any of the other elements of the contract and they did a lot of things that both parties wanted to find out, including the opportunity to enjoy new business with WBA. So we did make some amendments and I'll let Tim comment further.
But that's really the gist of what we have to say. Tim, anything you'd add?
Tim G. Guttman - Chief Financial Officer & Executive Vice President
Yeah, thanks Steve. Bob, now your question, we have agreed to invest in working capital.
A fair amount is extra inventory; we want to make sure we maximize our service levels, which again, as you think about it, there is also an impact to all of our customers to make sure we always have appropriate inventory. We're never out and it also helps buffer against any kind of disruption in the supply chain or shortages.
But we are also making some incremental changes in terms of – on the accounts being phased in, their payment terms to us.
Barbara A. Brungess - Vice President-Corporate & Investor Relations
Next question, please.
Operator
And we'll go to Ross Muken with Evercore ISI Group. Please go ahead.
Ross Muken - Evercore Group LLC
Hi. Good morning, guys.
So can you give a little bit more color on the 180-day exclusivity commentary. It's sort of an interesting dynamic change and we haven't heard this in general from all of your peers.
So I'm trying to get a sense of how much of it is sort of a change at the branded manufacturer that you think is sustainable? How much of it is the current environment and how you foresee that sort of evolving because clearly that's been a big profit driver at times for the wholesalers?
Tim G. Guttman - Chief Financial Officer & Executive Vice President
Yeah, Ross, I'll jump in and start and Steve can also help. But I would say in my commentary, I talked about maybe a different trend in the market that has started and seem to be progressing and that's brand manufacturers are retaining market share through co-pay cards and maybe some rebates.
And I would say in the past when we converted to a generic, we saw pretty high immediate penetration rates in the market, upwards of maybe 90%. Now when we convert on a generic, we see penetration rates that are more 50% or 60% and that puts some pressure on generic profitability on launches.
So that is definitely what we see. And that's just, I think, an evolution of the market and just something we have to work through.
Generics are still profitable. But again, I would say as we stand here today, looking out this year for some launches and even into next year, we're signaling that they just might not contribute to the level we expected.
Ross Muken - Evercore Group LLC
Yeah. Thanks, Tim.
Barbara A. Brungess - Vice President-Corporate & Investor Relations
Our next question, please.
Operator
We'll go to Eric Percher with Barclays. Please go ahead.
Eric Percher - Barclays Capital, Inc.
Thank you. I have a question on the pricing discussion and pricing model discussion.
If we go back historically, specialty was treated as brand and maybe years ago, it should've been a separate class like generics. As we get to today, I expect that it's the larger customers, the Walgreens, the Expresses where you're serving specialty through the traditional distribution channel that they're really driving pressure on margins.
So, my question is how will you go about trying to change this and where do you get leverage, maybe not just with those two customers, but across the channel to change specialty pricing and margin and in the traditional wholesale business, where there's been a move toward net-net pricing?
Steven H. Collis - President, Chief Executive Officer & Director
Yeah, Eric, that is an excellent question. And actually if I was a revisionist, I agree with you that the specialty should've been a step Expresses way (51:01).
But I think in a way, because we had the patent expiration opportunity for several years, that sort of covered for the weighting of specialty drugs. So the way we're going to get through this is through communication and trust.
We have a very well demonstrated strain that we are, I think, are doing an outstanding job as an industry of explaining this strain. I think people understand it as well.
It's well understood as to how the industry is changing and it just makes sense because the price of these products and the value that they represent is very different than traditional oral solid brand medications and also they apply to smaller patient populations and there's complex standing requirements, complex reimbursements. So AmerisourceBergen has been in this for a long time.
So recently, at a strategic review for our Specialty Group, they made a very interesting observation that I think is pertinent. And it's really that the brand – the Specialty business has become the brand business and the future specialty businesses will be orphan drugs, biosimilars, precision medicine, cell-based therapies.
I think actually AmerisourceBergen will excel and differentiate ourselves. But Bob Mauch and his team, as I've said earlier, and also Peyton Howell on our GSMR side, our global supply chain side, are really focused on talking to manufacturers about this strain, making sure we get fair reimbursement.
And we need to talk to – we are talking not only to the Walgreens and the Express Scripts, but we have a big specialty pharmacy customer base. We have a big alternate care customer base.
We have a big health system and hospital GPO customer base and all of these customers need to really move along. And as we get through the contracting phase, it is our strong intention that we will make a profit on specialty drugs and innovative therapies, whatever the site of care is.
Barbara A. Brungess - Vice President-Corporate & Investor Relations
Thanks. Next caller, please.
Operator
We'll go to Garen Sarafian with Citi Research. Please go ahead.
Garen Sarafian - Citigroup Global Markets, Inc. (Broker)
Thanks for taking the questions. One is just a follow-up on the prior question, I think it was to Ross's where – on the generic launches, expecting lower contribution, is there any way you can quantify it so that we can get a better appreciation for the new level of conservatism because I think that that will be useful?
But my question, if you allow that to not account for my one is that on the pro-generics commentary, I wouldn't have thought that a slow ramp in pro-generics and increasing independent retail sales would've made a big enough dent into EPS guidance to call it out? So could you maybe give us a little bit more on how much of the change in EPS is attributable to this phenomenon?
And I guess what exactly didn't go to plan and what are you assuming for fiscal 2017?
Steven H. Collis - President, Chief Executive Officer & Director
Yeah, I mean, just – Garen, thanks for the question. So at the beginning of February, we really dealt with the lack of generic price inflation.
And what we're calling out now – and that's probably and we lowered our range. What we're talking – Tim can give you more color, but approximately two-thirds of the lower forecast, we would say, is really environmental and then approximately one-third is from not getting to the growth target that we expected in pro-gen.
Now it's interesting because as you can imagine, we've dug very deep into this and our unit sales are not off that much. It really is the generic deflation and the lower average selling prices on a lot of the generics that are not causing our generic sales and the weighting that that implies to be as high as we anticipated, honestly even in February.
And that's about a third of the miss along with what we've seen in the last quarter and the next few quarters, which is that generic efficiency rate that we're experiencing as a wholesaler. It doesn't mean that the market's not being as efficient.
It just means that we are only seeing about that 50% conversion. So we've definitely lost a couple of percent of anticipated earnings from generic launches.
And also even in our specialty group there was a big launch we were expecting that we did not perceive as well. So it's nice being a year that we receive the benefits from generic launches that we expected.
But, Tim, anything to add to these?
Tim G. Guttman - Chief Financial Officer & Executive Vice President
Yeah, Steve. I would just say, Garen, I don't think we'd want to give any more color on the impact from the launches and what that means to us.
I think it's just fair to say that they're less than what we expected. And when we only have a handful in a year and they're less than expected, that's a challenge for you.
And as Steve mentioned, we thought we'd make up some ground on the pro-independent side. And as everybody knows, generics are profitable for us, P&L and cash flow.
And that was a headwind for us in the second half of the year. 2017, I think one part of your question is on 2017.
What does 2017 include? We expect to see some progress and some growth in 2017, a reasonable amount.
Barbara A. Brungess - Vice President-Corporate & Investor Relations
Thank you, Tim. Next question, please.
Operator
Yes. We go to Eric Coldwell with Robert W.
Baird and Company. Please go ahead.
Eric W. Coldwell - Robert W. Baird & Co., Inc. (Broker)
Thanks. I'm going to ask two.
I guess the first one is just kind of a bullet point. I doubt you'll answer, but it would be very helpful.
Could you tell us what percent of your total revenue is generics today? Get us up to speed on how that's changed with the Walgreens relationships and other client moves.
Steven H. Collis - President, Chief Executive Officer & Director
I actually don't have that number at the time. But I think you're right we would give it.
What is important to us with Walgreens and we've said this many times is that we do all the prescription medications for them. And that includes both brand and generics, and that really was a big sea change in the industry and has led to discussions around generic distribution and generic sourcing with all of our customers.
So that's what's been extremely important. In brand, the wholesale industry has well over the 90% coverage.
And in generics, it's a lot less because there still are opportunities and this is an opportunity for us to do more generic distribution with self-warehousing customers. So that is definitely something we think of as an opportunity.
And since the Walgreens transaction was announced, almost anyone's at least open to that discussion. So that's been a positive in our whole industry, not just for us, but for our peers as well.
Barbara A. Brungess - Vice President-Corporate & Investor Relations
Eric, are you still on the line?
Operator
We'll open the line. Just a moment.
Eric, your line is open. Please go ahead.
Eric W. Coldwell - Robert W. Baird & Co., Inc. (Broker)
Good, great. Thanks.
Steve's comment, it kind of led into my second question which is, you mentioned a couple of times with these working capital step-ups and investments you're making on behalf of Walgreens, that you're hoping to do more business with them. But I guess my confusion is I thought you already had all of the business with them.
So I'm not sure exactly what the incremental opportunity is other than them bringing on acquisitions. And you did state earlier that you're not factoring in an acquisition-driven revenue increase.
So I'm kind of confused. Are you talking about doing front-end?
Or what exactly are you doing since you're doing all the brands, all the specialty and all of the generics?
Steven H. Collis - President, Chief Executive Officer & Director
Well, I think what we said is that it's a historic relationship and that we revisited the contract that we entered into in 2013. And it's been a very active market.
And since then, we've had not only the various changes that we've talked about in the industry, but WBA really coming to existence as a complete company. And we have with that Alex a strong leader in the U.S.
retail that has a vision for what can be accomplished between AmerisourceBergen and WBA as partners. So we are optimistic about the strong growth for WBA.
And we're optimistic about the partnership. And I think I've said everything that there is to say about this.
And we know that WBA is a 50% shareholder and we expect that we'll carry on looking for ways to grow the marketplace together. And these are discussions that are literally ongoing every day or every week.
Barbara A. Brungess - Vice President-Corporate & Investor Relations
Next question, please.
Operator
Yes. We go to David Francis with RBC Capital Markets.
Please go ahead.
Dave Francis - RBC Capital Markets LLC
Hi, Steve and Tim. Good morning.
Moving over to Kaiser, you clearly expect to keep those guys in the family here. Can you remind us to what degree, if any, the terms of that contract have been renegotiated since you originally got into the most recent term of that so we can get a sense as to what kind of terms might be renegotiated here as you get that contract recut?
And also looking at Humana, given their transaction situation, if there's any update on that contract situation as well. Thanks.
Tim G. Guttman - Chief Financial Officer & Executive Vice President
Hey, Dave. It's Tim.
So your question about Kaiser, I mean, I think we've communicated in the past, we have that business through June 30. So we will have one quarter impact this year, 2016, and also into 2017.
We've put a reasonable assumption into our numbers this year and next year in terms of what it's going to take to renew that and that's been fairly consistent. We're heavily engaged with them.
We're in discussions with them and we're optimistic that we'll get to the finish line with that important customer. Humana, I mean they're involved in a transaction right now; so we have that business for a while.
I think I would say that our assumption for 2017 is that what we factored in is that we have that.
Barbara A. Brungess - Vice President-Corporate & Investor Relations
All right. Thank you.
Next question, please.
Operator
Yes. We go to Charles Rhyee with Cowen and Company.
Please go ahead.
Charles Rhyee - Cowen & Co. LLC
Yeah, thanks for squeezing me in here. Just wanted to go back and just clarify.
I think you were talking about – so we're looking for our free cash flow to come back once you get out to fiscal 2018 with the new extension here in the investments with the Walgreens relationship. So if we're carrying high inventories, does that mean our payable terms are changing as well out in the future so that our working capital benefits that we've experienced historically are preserved?
Or are those kind of permanently changed? I just wanted to clarify that point.
Thanks.
Tim G. Guttman - Chief Financial Officer & Executive Vice President
Yeah. Hey, Charles.
It's Tim. I think I understand your question.
I mean we talked about making working capital investments in both years and talked about inventory and other working capital being phased in 2016 and 2017, more of an impact in 2017. And there are no contemplated term changes to our manufacturers.
We're always monitoring those and negotiating with the manufacturers, but those are the only changes that we've called out and we expect our free cash flow to be back much better, as Steve mentioned, over – 125% or better of our adjusted net income in 2018 and beyond, which is still pretty healthy.
Barbara A. Brungess - Vice President-Corporate & Investor Relations
Thank you. Next question, please.
Operator
We'll go to David Larsen with Leerink Partners. Please go ahead.
David M. Larsen - Leerink Partners LLC
Hi. For the reset expectations for 2H of fiscal 2016, how much of that is coming from generic deflation?
And how much of that is coming from renewals? Is it really 50-50?
And those are the two pieces that have caused the reset and expectations?
Tim G. Guttman - Chief Financial Officer & Executive Vice President
Yeah, Dave, I'll jump in. I'm looking at Steve; so I'll jump in.
Our reset for the second half of 2016 we called out the two items, one clearly was the contribution from generics being lower, the higher deflation rate than we anticipated and also the launches not contributing as much. I would say that's a big part of the reset.
And then we also called out our plan to grow our independent generics. Those are the two reasons for the reset.
We put them in that order. The environmental first, carrying more weight; so I would say it's easily two-thirds, one-third.
Barbara A. Brungess - Vice President-Corporate & Investor Relations
Lori, we'll take one more question, please.
Operator
All right. That will be from Greg Bolan with Avondale Partners.
Please go ahead.
Greg Bolan - Avondale Partners LLC
Hey. Thanks for squeezing me in.
So going back to Garen's question and I think you answered it, Steve, but on the pro-gen side, you had mentioned that kind of being one-third of the reason for the revised guidance. And I think you'd mentioned that volumes kind of seem okay.
It's more about pricing, but there's not any evidence that you guys have lost some share in the independent pharmacy side, right?
Steven H. Collis - President, Chief Executive Officer & Director
Well, thanks for the question. Now we did lose a buying group customer last year and that's really what we made some changes and we asked Dave Neu to come in and take over our GNP program which he's done a great job of and we recently announced a new leader there.
Dave has really put in a new level of services around especially network and network contracting which is a lot like the membership base that GNP was looking for. So we feel good about where we are.
It's just that so much of the independent business is with buying groups now. And it just doesn't – you can't quite get as much progress as quickly as we would have anticipated.
So that's really what we're talking about. We have wonderful confidence in our Good Neighbor Pharmacy offering.
And we think it's a really important offering and with pro-gen for the independent base and we'll help them be successful in the future. And I think that the company's – the GNP base really appreciates it.
So we have our trade show in Vegas in July and we already have record registrations and tremendous interest. So we feel good about what AmerisourceBergen is doing for independent pharmacy and certainly will intend to carry on investing in that area.
So thanks for your time and Barbara, that will be the last question.
Barbara A. Brungess - Vice President-Corporate & Investor Relations
Yes. Did you have some closing comments?
Steven H. Collis - President, Chief Executive Officer & Director
Yeah. So I just wanted to close by thanking you for your attention.
We've actually gone to almost 70 minutes here. And I hope that you understand that we are severely disappointed about talking about taking our guidance down for 2016 and for 2017.
But we do take the responsibility we have to all of you to provide you with timely, fair and balanced information very seriously. And it was with this intention that we planned for and delivered this conference call today.
I just hope you all take heart from this call that we have tremendous confidence in the services and the offering of AmerisourceBergen and the people of AmerisourceBergen and we remain resolute that AmerisourceBergen will be the company where knowledge, reach and partnership would shape healthcare delivery in the short and medium, but especially in the long term. Thank you.
Barbara A. Brungess - Vice President-Corporate & Investor Relations
Thanks, Steve, and thank you, everyone, for joining us this morning. As always, we will be in our office this afternoon and tomorrow to address any follow-up questions.
We've also listed in our press release this morning the conferences we will be attending in the next two months. So with that, I will turn it back to the operator.
Thanks.
Operator
Thank you. Ladies and gentlemen, this will conclude our teleconference for today.
Thank you for your participation and for using AT&T Executive Teleconference Service. You may now disconnect.