麥卡遜 (MCK) 2014 Q3 法說會逐字稿

Good afternoon and welcome to the McKesson Corporation quarterly earnings call.

(Operator Instructions)

Today's call is being recorded. If you have any objections, you may disconnect at this time. I would now like to introduce Ms. Erin Lampert, Senior Vice President, Investor Relations.

Thank you, Lisa. Good afternoon and welcome to the McKesson Fiscal 2014 third-quarter earnings call.

I'm joined today by John Hammergren, McKesson's Chairman and CEO; and James Beer, McKesson's Executive Vice President and Chief Financial Officer. John will first provide a business update and will then introduce James, who will review the financial results for the quarter.

After James' comments, we will open the call for your questions. We plan to end the call promptly after one hour at 6pm Eastern Time.

Before we begin, I remind listeners that during the course of this call, we will make forward-looking statements within the meaning of Federal Securities laws. These forward-looking statements involve risks and uncertainties regarding the operations and future results of McKesson. In addition to the Company's current, periodic, and annual reports filed with the Securities and Exchange Commission, please refer to the text of our press release for a discussion of the risks associated with such forward-looking statements.

Finally, please note that on today's call, we will refer to certain non-GAAP financial measures, in which we exclude from our GAAP financial results, acquisition expenses and related adjustments, the amortization of acquisition-related intangible assets, certain litigation reserve adjustments, and LIFO-related adjustment. We believe these non-GAAP measures will provide useful information for investors. Please refer to our press release, announcing third-quarter Fiscal 2014 results available on our website, for a reconciliation of the non-GAAP performance measures to the GAAP financial results.

Thanks, and here's John Hammergren.

Thank you, Erin, and thanks everyone for joining us on our call. As you have seen in the press release we issued this afternoon announcing our third-quarter financial results, we incurred charges related to two items, which had a negative impact on our reported results for the quarter. I'll come back to these items in just a moment.

I'd like to begin with two big headlines for the quarter. First, we had exceptional growth in our Distribution Solutions business, where operating profits grew by 37% over the prior year. We are also very excited to have secured the acquisition of Celesio through the agreements we announced last week.

First, I begin with a few comments about Celesio. Last week, we announced that we reached an agreement with the Haniel Group to purchase their entire holding of Celesio common shares. In a separate and subsequent transaction, we also reached an agreement with an affiliate of Elliott Management to purchase Celesio convertible bonds.

The agreements of the Haniel Group and Elliott will result in McKesson achieving over 75% ownership of Celesio on a fully diluted basis. We expect to close these transactions on February 6, 2014.

We are extremely pleased to move forward with the acquisition of Celesio, and we look forward to bring together the strengths of the McKesson and Celesio Organizations to provide our customers with even more efficient delivery of healthcare products and services around the world. While the path to securing this acquisition was certainly not what we had originally expected, it would seem that the interested parties to this transaction continue to see the compelling strategic benefit of McKesson and Celesio uniting to form a global leader in healthcare services.

I never lost sight of the value this transaction will bring to our customers, our supply chain partners, the employees at both Organizations, and our shareholders. That being said, we made it clear from the time we originally announced the transaction on our second-quarter earnings call, that we would need to achieve the 75% ownership threshold in order to fully realize the value and synergies we had outlined.

We also made it clear that we would be disciplined stewards of our shareholders' capital, and I'm pleased we were able to accomplish both of these important objectives. James will update the key financial elements of the transaction and provide additional information on the immediate next steps, but let me take a moment here to make a few things clear.

First, our strategic rationale and key financial assumptions remain intact. Second, the combination of McKesson and Celesio would become the world's largest pharmaceutical supply chain Company and will be well-positioned to meet the increasing global nature of our industry.

I'm extremely proud of the global sourcing capability McKesson has built over many years. We have been able to deliver tremendous value through our strong manufacturer relationships and our knowledge of the healthcare supply chain. This acquisition keeps McKesson's expertise at the center of our strategy and deepens our relationships directly with our manufacturing partners.

Finally, McKesson has a great track record of deploying capital wisely, and the acquisition of Celesio continues this trend, creating a strong platform for growth, driving benefits for our customers, our manufacturing partners, our employees, and our shareholders.

Turning now to our results for the quarter. As I mentioned, Distribution Solutions continues to deliver exceptional results, and our view of the full-year operating performance of the business has improved from our previous expectations. In our Technology Solutions segment, we continue to take actions to align our development efforts and resources to our customers' most important priorities and the realities of our marketplace.

Our third-quarter results include charges resulting from the restructuring actions related to the timing of our Horizon Clinical software platform requirement to meet Meaningful Use 3. Our third-quarter results are also impacted by a significant increase in our tax reserves.

As disclosed in our recent quarterly and annual SEC filings, we have been engaged in a tax dispute in Canada regarding the transfer pricing matter for the years 2003 through 2008. McKesson has been in litigation regarding the assessments received for the tax year 2003.

In late December, the Canadian tax court ruled against McKesson, and in January, we filed an appeal of this decision. While we believe the structure of our transfer pricing agreements were appropriate, we think it is prudent to record an increase in our current reserves for all Canadian open tax periods.

So overall, for the full year, our outlook for Distribution Solutions has improved. However, we have updated our guidance for the fiscal year and now expect to achieve adjusted earnings per diluted share of a $8.05 to $8.20 for our Fiscal 2014, which includes the restructuring charges in our Technology business and an increase in our tax reserves, which combined total $0.70.

Before I turn the call over to James for a detailed review of our financial results, I will provide some highlights from both segments of our business. As I mentioned, Distribution Solutions continues to deliver strong operating performance. In the third quarter, revenue grew 10%, and adjusted operating profit grew 37%.

Within our Distribution Solutions segment, our US Pharmaceutical business had another quarter of outstanding results. Direct distribution and services revenues increased 11% for the quarter.

In the third quarter, we continued to experience price inflation in a relatively small subset of our generics portfolio. Consistent with the expectations we outlined in the second quarter, inflation in our fiscal third-quarter moderated from what we had experienced in the second quarter.

In addition, we continue to benefit from more of our customers choosing to buy more of their genetics from McKesson and strong compliance to our generics programs and services, including strong growth in our One Stop Generics program. In summary, we had another quarter of great performance in our US Pharmaceutical business.

Revenues in Canada increased 12% on a constant currency basis, driven by continued growth in our core business and growth from new customers. Our Specialty business had another solid quarter of performance, and I'm pleased with the collaboration and innovation that's being driven between our physician partners and our specialty team.

Our Medical-Surgical business had solid results for the third quarter. As we approach the one-year anniversary of the acquisition of PSS World Medical, I'd like to take this opportunity to thank all of the employees at the combined McKesson Medical-Surgical and PSS teams for the outstanding progress they have made in the integration of these two great businesses. While we still have significant work ahead of us in the coming years to optimize our distribution network, I am proud of the way our teams have come together to implement our strategy, all while remaining focused on taking care of our customers.

In summary, I am pleased with the exceptional performance in our Distribution Solutions segment for the third quarter. We have leadership positions across all of our North American distribution businesses, including US Pharmaceutical distribution, Canadian Pharmaceutical distribution, Community Oncology distribution and services, and Medical-Surgical distribution, including physician office, home care, and long-term care. We are pleased to add a great new platform for growth on a more global scale through our acquisition of Celesio.

Turning now to our Technology Solutions segment. In the third quarter, revenues grew by 6% to $784 million, and adjusted operating margins were 8.55%.

While we are disappointed in the reported results in our Technology Solutions segment for the quarter, it is important that we take action in response to the changes in the anticipated timeline for Meaningful Use 3 and to size our Organization in Horizon Clinicals appropriately. I would point as the timelines for Meaningful Use 3 are delayed, we must maintain a certain level of resources to support our customers as they prepare for this important implementation.

Another item which had an impact on our third-quarter results and our outlook for the full year is that we had expected a recovery in demand, in particular, in our medical imaging business. This recovery in demand has not yet materialized.

You should expect to see us continue to take actions to align our Organization and development efforts to our customers' most important priorities. Our customers are going through a significant change in the way they think about their business models going forward. McKesson will continue to focus on delivering solutions that help our customers drive better decisions through analytics and business intelligence, enable connectivity, and provide tools and services to support new risk-based and value-based reimbursement business models.

In summary, it's an exciting time to be at McKesson. The performance in our Distribution Solutions businesses is strong, and our outlook for the full-year operating performance has improved from our previous expectations.

Our acquisition of Celesio positions us for leadership on a global scale. The combination of McKesson and Celesio is expected to have revenues in excess of $150 billion, approximately 81,000 employees worldwide, and operations in more than 20 countries. We will deliver to approximately 120,000 pharmacy and hospital locations on a daily basis in the US, Canada, Europe, and Brazil, including more than 11,000 pharmacies that are either owned or part of a strategic banner or franchise network of community pharmacies.

With that, I will turn the call over to James and will return to address your questions when he finishes. James?

Thank you, John, and good afternoon, everyone. As you've just heard, we are pleased by the continued strength in our operating results.

We are also very pleased to be moving forward with Celesio and expect that this acquisition will build upon the value we bring to our customers, manufacturing partners, and shareholders. Today, I will walk you through our third-quarter consolidated financial results, provide an update on our Fiscal 2014 outlook, and outline the key financial aspects of our acquisition of Celesio.

As I review the third quarter, there are three aspects of our financial results that I would like to particularly bring to your attention. First, and perhaps most important, in thinking about our Business going forward, is the continued performance and strength within our Distribution Solutions segment.

Second is a $122 million charge we recorded relating to a dispute with the Canada Revenue Agency, which we have described in our previous SEC filings. I will come back to this later in my remarks.

Third, our $42 million in restructuring charges taken in our Technology Solutions segment, primarily related to our Horizon Clinicals software platform. My remarks today will focus on our third-quarter adjusted earnings per diluted share from continuing operations of $1.45, which exclude four items -- the amortization of acquisition-related intangibles, acquisition expenses and related adjustments, certain litigation reserve adjustments, and LIFO-related adjustments.

Turning now to our consolidated results, which can be found on Schedule 2A, consolidated revenues increased 10% for the quarter to $34.3 billion. Adjusted gross profit for the quarter increased 21% to $2 billion, primarily driven by the continued strength in our Distribution business.

Total adjusted operating expenses of $1.2 billion were up 13% for the quarter, driven primarily by the impact of acquisitions closed in Fiscal 2013. For the full year, excluding the impact of these acquisitions, we expect total Company adjusted operating expenses to increase approximately 3%.

Other income year-over-year was slightly lower for the quarter at $5 million. Interest expense was approximately in line with the prior year at $59 million.

Now moving to taxes. As outlined in our recent filings, we have been engaged in a legal dispute with the Canada Revenue Agency regarding a transfer pricing matter that impacts the tax years 2003 through 2008. The Tax Court released its decision on this matter late in our third quarter, and earlier this month, we filed an appeal of that decision to the Federal Court of Appeal in Canada.

During our review of the court's decision, we reevaluated our existing tax reserves for all open tax years and recorded adjustments increasing these reserves by $122 million. We now expect our full-year adjusted tax rate to be 36.5%, an increase from our previous estimate of 31%, driven by the current quarter Canadian Tax Reserve adjustment and a change in our mix of foreign and domestic income. Excluding the current quarter tax reserve adjustment, the adjusted full-year tax rate would be 32.5%.

Adjusted earnings for the quarter were $339 million, and our adjusted earnings per diluted share from continuing operations totaled $1.45. Our adjusted earnings per diluted share this quarter were negatively impacted by $0.52 from the reserve adjustments related to the Canadian tax matter, and by an additional $0.18 from the restructuring charges recorded at our Technology Solutions segment.

Wrapping up our consolidated results, diluted weighted average shares outstanding decreased by 3% year-over-year to 234 million. This year's earnings per share number was also aided by the cumulative impact of our share repurchases. We expect our full-year diluted weighted average shares outstanding for Fiscal 2014 to be 234 million.

Moving now to our segment results, which can be found on Schedule 3A, Distribution Solutions total revenues increased 10% for the quarter to $33.5 billion, primarily driven by market growth and more business from our existing customer base. Looking at the components, direct distribution and services revenues were up 11% for the quarter to $24.9 billion.

Warehouse revenues decreased 1% for the quarter, primarily driven by a shift to direct store delivery. Canadian revenues on a constant currency basis increased 12% this quarter from the prior year, mainly driven by market growth and recent customer wins.

Turning now to our Medical-Surgical business, revenues were up 67% for the quarter to $1.5 billion, driven by the PSS acquisition and market growth. The combined business continues to perform very well as we make progress on important integration activities.

Distribution Solutions adjusted gross profit increased 27% for the quarter on 10% revenue growth, resulting in a 65 basis point improvement in our adjusted gross profit margin. In addition to the PSS acquisition, our third-quarter gross profit in Distribution Solutions benefited from continued favorable performance within our generics pharmaceutical business.

Adjusted operating expense for the segment increased 19% for the quarter, primarily driven by the acquisitions we made in Fiscal 2013. Adjusted operating margin for the quarter was 234 basis points, an improvement of 46 basis points versus the prior year. Based on our performance fiscal year-to-date, we now expect the adjusted operating margin for Distribution Solutions to be at the high end of our long-term adjusted operating margin goal of 200 to 250 basis points.

Turning now to Technology Solutions, revenues were up 6% for the quarter to $784 million, primarily driven by our acquisitions. As I mentioned earlier, the third-quarter results in Technology Solutions reflect certain business realignment and restructuring charges.

Our businesses are continuously reviewing their outlook and strategic plans and allocating their resources to drive the best outcomes for our customers and our Business. However, we do on occasion make decisions that have a more meaningful impact on our results and, therefore, we bring these to your attention.

This quarter, our results in Technology Solutions were impacted by $42 million in business realignment and restructuring charges driven by delays in the Meaningful Use 3 timeline and the realignment of our development efforts, primarily related to the Horizon Clinicals software program. $31 million of these charges reduced segment adjusted gross profit, while a further $11 million increased the segment's operating this quarter. As a result, Technology Solutions' adjusted gross profit decreased 4%, representing a 453 basis point decline in our adjusted gross profit margin.

Adjusted operating expenses in the segment increased 12%, driven primarily by the acquisitions we made in the prior year, but also as a result of the impact of the current quarter restructuring charges. Technology Solutions gross R&D spending for the quarter was $127 million, up 12% versus the prior year. Of this amount, we capitalized 6% versus 10% a year ago.

Overall, third-quarter adjusted operating profit for the segment was down 39% to $67 million. The third-quarter adjusted operating margin rate was 8.55%, a decrease of 636 basis points versus the prior year, driven largely by the charges I discussed earlier. Based on the current quarter restructuring charges and the rationale for these charges that John reviewed earlier, we now expect to be at the lower end of our long-term adjusted operating margin goal of the mid-teens.

Moving now to the balance sheet and working capital metrics, at the end of the third quarter, our days sales outstanding was 24 days versus 25 days a year ago. Our days sales in inventories of 32 days was flat year-over-year, and our days sales in payables remained at 46 days.

We generated cash flow from operations of $472 million. Overall, for the full year, we continue to expect that cash flow from operations will total approximately $2 billion. We ended the quarter with a cash balance of $2.4 billion, with $1.5 billion held offshore.

Internal capital spending totaled $296 million for the first nine months of Fiscal 2014. We now expect full-year internal capital spending to be approximately $400 million.

Now I will turn to our outlook. Let me once again remind you that our earnings this quarter were specifically impacted by three items that also affect our full-year outlook.

First, the dispute with Canada Revenue Agency had a negative impact of approximately $0.52 per diluted share for the quarter and the full year. Second, the current quarter adjustments to our tax reserves and our change in income mix also drove an increase in our updated full-year adjusted tax rate to 36.5% from our prior estimate of 31%. Third, the Technology Solutions charges lowered our adjusted earnings by approximately $0.18 per diluted share this quarter.

As a result of these three items, we are updating our adjusted earnings guidance to a range of between $8.05 and $8.20. Also, to be clear, we have not included any earnings from Celesio in our updated Fiscal 2014 outlook. We expect that the results from our acquisition of Celesio will not have a meaningful impact on our Q4 results.

In addition, we expect to exclude from GAAP earnings $0.76 in amortization of acquisition-related intangible assets and $0.55 of acquisition expenses and related adjustments. We also expect to exclude $0.23 for litigation reserve adjustments and LIFO-related adjustments of $0.71 to $0.77.

Now let me take a few moments to talk about the acquisition of Celesio. McKesson expects to fund a portion of the transaction with offshore cash and has a bridge financing facility in place to fund the balance of the purchase price. As we consider our permanent financing plans, we remain committed to maintaining our status as an investment-grade rated Company.

We will begin to consolidate the financial results of Celesio during our fourth quarter, ending March 31, 2014, and our earnings will reflect [technical difficulty] of Celesio's earnings, although as I mentioned, we do not expect the acquisition will have a meaningful impact on our Q4 results. After the expected close of our agreements with the Haniel family and Elliott on February 6, 2014, we will exceed 75% ownership of Celesio's shares on a fully-diluted basis.

We plan to launch a tender offer for the remaining outstanding common shares of Celesio in our fiscal fourth quarter, and we continue to expect that we will have operational control of Celesio late in the first half of our Fiscal 2015. Just to remind you, getting to operating control of Celesio, also known as a domination in Germany, is the point in time when we expect to begin executing on our synergy business case.

By the fourth year, following the completion of the required steps to obtain operating control, we expect to realize annual synergies between $275 million and $325 million. We estimate this transaction to be $1 to $1.20 accretive on an adjusted earnings basis in the first 12 months following the completion of the transactions with the Haniel family and Elliott.

This range, however, assumes 100% ownership of the outstanding common shares of Celesio, and thus will have to be adjusted in line with our actual ownership at different stake in Celesio at different points in time over the coming months. Overall, our assumptions for accretion and synergies from this acquisition remain unchanged.

In summary, we have recorded three very strong quarters this year and we are excited to move forward with our acquisition of Celesio and expect the transaction to deliver tremendous value to our customers, manufacturing partners, and shareholders in the years ahead. Thank you, and with that I will turn the call over to the operator for your questions.

(Caller Instructions)

Operator?

Thank you, sir.

(Operator Instructions)

Our first question comes from Glen Santangelo with Credit Suisse.

Good evening. John, I just want to follow-up on some of the comments you made in your prepared remarks. It seems you suggested that maybe the generic inflation moderated a little bit in fiscal 3Q versus 2Q, but yet the magnitude of the beats out of the Pharmaceutical segment continue to get bigger, and so I'm wondering if you could elaborate a little more, give us a little more color, about maybe what in the business maybe did much better than you would've thought, given that moderating inflation -- generic inflation?

We were really pleased with the performance of the Distribution Solutions segment in the quarter, and we continue to have strength really across the board. You saw nice revenue growth in the business. Clearly, the PSS integration is going well for us, which has been additive to the performance in that business.

But the real strength is really coming still out of our generics business. Our One Stop revenues were up nicely. The share of wallet we are getting from our customers who are relying more and more on our generic capabilities and now depending on us to source the right products at the right price for them, has been very helpful.

And clearly, the position we have with those manufacturers continues improve. We have really built very positive trusting relationships.

And inflation continues to be an important part. It's too early to call a trend change in generic inflation, but clearly some moderation has occurred and it has been helpful. It's still positive relative to our original expectations.

And maybe just one quick follow-up. If I look at what you are implying now for the fourth quarter based on your updated guidance, it looks like about $2.26 to $2.41 in the fiscal fourth quarter, which is lower than consensus.

The reason I bring it up is because on one of your competitors conference calls, they seemed to suggest there was some price inflation that was maybe moved from the March quarter into the December quarter. So I'm wondering, was there anything that might have -- that you might've recognized a little bit earlier than you otherwise would have. Is there any difference in the typical seasonality of these two quarters?

I don't think a lot of changes in the way the branded manufacturers behaved in our portfolio, the way we have established our agreements. Having said that, there may have been some slight move into our third quarter and out of our fourth-quarter. We clearly believe that the inflation moderation is going to continue as we look into our fourth quarter and we also have some follow-on expense in our MTS segment, as I talked about in my prepared comments.

This Meaningful Use 3 thing for us was a real critical change. It pushed out our customers' implementation. We were able to, through the charge, reduce a significant amount of the investment we had sitting there, waiting to do these service implementations with our customers, but there is still a remaining investment both in services and R&D as we try to prepare ourselves for whenever the MU3 things gets put in place for us.

So it's a combination of that moderation on the generic side, to some degree in the fourth quarter, as well as the MTS business. We will have this follow-on expense associated with MU3 and some of the other things we've got going on there.

Okay. Thanks very much.

The other thing I would just add to that is, of course, the tax rate that I mentioned for the full year. We are looking at that 36.5% tax rate, so you have to bear that in mind as well.

Okay. Thank you very much.

And we will take our next question from Ricky Goldwasser with Morgan Stanley. Please go ahead.

Can you share with us what is deemed the feedback from your customers on the acquisition of Celesio? I know, John, you talk about increase in generic wallet of customers, but are you seeing increased appetite from customers that historically sourced the bulk of their generics directly from manufacturers to strategically do more with McKesson?

We have been actively working for almost a decade helping our customers realize the value, both from our sourcing, as well as our logistics efforts. We believe that we are sourcing as well now as almost anyone, and Celesio is going to help us improve even more as we add that volume, and in particular, the retail footprint that, that brings along with it.

The dynamic with our customers is also a focus on how to get supply chain efficiency and [purchasing generics independent of the] wholesale channel is not -- has not proven to be the most logistically favorable way to do it. There's added costs in not only the buying and procurement side, but you could also certainly envision the increment of cost when it goes into our customers warehouses and then they have to handle the product and get it back out, when we are already in those stores every day anyway with the delivery of the other product that we have been selling them.

So there is an increased appreciation at the executive level within our customers to look at those costs and to look also at the changing global world of generic sourcing and increased interest in focusing on McKesson. What is great about the relationship that we've created here with the acquisition of Celesio is that it allows is continuing to have tremendous transparency into the supply chain, it gives us really total control of our own destiny, and it allows us to maintain those close partnerships with our manufacturing partners so that we can continue to have the visibility to the opportunity, bring those opportunities to our customers, and present them in a way that is compelling relative to them moving their internal sourcing of generics over to McKesson.

Okay and then the one follow-up is regarding the Ranbaxy planned import ban. How do you view the ban -- how does that impact your view of generic price inflation? I know that you talk about some moderation, but could that change the trends?

Ricky, I would remind you that McKesson has a very large generics portfolio consisting of thousands of products. To put this inflation thing into context, the inflation is really coming from a very small subset of our total portfolio products, and a small subset of the manufacturers.

With regards to Ranbaxy, I believe the industry is well aware of the work the FDA has been doing. They have increased their funding and their staffing to do critical inspections.

Although I certainly feel bad for the Ranbaxy folks relative to this, McKesson is aware of this increased scrutiny and trying to make sure that we are availing ourselves of a wide enough supply chain so that we have access to the products. I do not expect any of the recent situations with one of the Ranbaxy plants in India to have an impact on our delivery to our customers, nor an impact on our view of inflation going forward.

Thank you.

Our next question comes from Tom Gallucci with FBR. Please go ahead, sir.

The morning -- good afternoon, at this point. Thanks for the details, John.

Just curious, we get a lot of questions on the generics and the price inflation and the impact and how it flows through. Can you help us understand a little bit the extent to which you are seeing benefits from more buy-and-hold type pricing, or is it that the same percentage spread on a big dollar amount gives you some more earnings? Where I am going with it is, to what extent when price inflation moderates, is it just lack of upside, or do you actually have a negative that you have to overcome year-over-year because the earnings actually get lower in dollars?

Well we have seen a trend over time with generic pricing. It used to be a deflationary headwind we had to deal with year-on-year, and as that began to moderate, it clearly made the year-on-year effect easier.

With an inflation environment, like we've experienced this year, clearly, it was a surprise to us that this would occur to the magnitude that it has. As you think about our thinking going forward, it could provide a headwind for us, depending on what your view of ongoing generic inflation might be.

Clearly, the offsets to that would be to get more and more folks buying off of our generic portfolio. Additional offsets would be the power of what we are doing with Northstar and our sourcing there and clearly our global sourcing initiatives are going to get additional fuel or accelerant as we put the Celesio teams together with McKesson teams to approach the market on a global basis.

Also, as you think about FY13, we have a brand-to-generic trend that moves in our favor again. This was really the low year for generic conversions, and as you think about next year, we will see that pick back up again.

Right, and as a follow-up to that, you started to mention that you've said for a few quarters now that you are seeing more generics business from your existing customers. Can you [drain] the potential in terms of what's left on the table there in any way for us to get an understanding of where you been and maybe how much more there is to go if more and more customers were, in fact, to move more of their business to you?

We have a great book of business. We have been able, over the years, to take a great deal of the responsibility for delivering generics to our independents -- [on] is one of our key requirements.

As you know, Tom, you have been following us for some time, we've been moving up the food chain with bigger and bigger customers testing us from a generic perspective and coming to the conclusion that we do, in fact, do the best job for them relative to generic pricing and generic service and generic availability. That movement is continuing.

Our very largest customers still purchase generics on their own. Clearly, that would be a very large opportunity for us as we continue to build a compelling vision for what that might mean for them.

Thanks a lot, John.

You're welcome.

Our next question comes from Ross Muken with ISI Group. Please go ahead, sir.

I was curious just in terms of the cash flow and where we are. It seems like it's pretty back half -- 4Q-weighted for the year. How does that impact how you are thinking about the financing mix for Celesio?

Obviously, we saw you raise the bridge. But I'm just curious in terms of in the new or old guidance assumption, what is the backbone behind that, just in terms of percent, from new debt versus cash on hand. Obviously, you have a portion in Europe.

Yes, certainly, the fourth quarter is traditionally a strong operating cash flow quarter for us, in part as a result of the timing of a lot of the brand price increases that we traditionally see. So in terms of the financing for Celesio, we have the view that we would have at least $1 billion or so of cash available offshore, and then we would, obviously, draw on the bridge for the balance of our needs.

Those needs, of course, are dependent upon the timing of the remaining 25% or so of the Celesio shares that we acquire. So we will see how we play out in terms of that remaining 25% or so of the shares that will help us define the eventual amount of permanent debt that we would put in place once we pay off the bridge.

Great and maybe, John, you touched upon, obviously, over time as these generic relationships develop, the potential to touch more of your large customers. But I'm curious, with all of the new relationships in the industry, what are you seeing from the independents, which has obviously been a core strength of yours for years, and how are they reacting to all of these new arrangement and the potential for them to possibly participate in new services -- and this is now going to be true for you both here and in Europe?

The independents in both Europe and here in the United States has been very positive about the announced Celesio acquisition, and now they are even more positive on the view that it's going to close here in a few weeks. They believe that not only will they be able to enjoy continued great service and price on generics, but there are obviously tremendous retail experience that comes with Celesio through the management of the Lloyd's pharmacies, as well as the many banner stores that they support throughout Europe, to continue to find ways to bundle our capabilities effectively for our independent customers.

I would also point out that none of our customers in Europe or here see the merger of McKesson and Celesio as a conflict of interest on their side. They don't feel threatened by it; they don't see it as something against their ultimate goals; and they don't see it as a competitive action in any way. So from a discussion perspective, we don't have any conflict of interest relative to what our motives are, and they continue to look at this in a favorable way, Ross.

Great, John. Thanks and congrats again.

Our next question comes from Lisa Gill with JPMorgan.

Thanks very much. Good morning -- or good afternoon, John.

A lot of talk today about generic inflation. Can you maybe just give us any color as far as brand price inflation you saw in the quarter and expectations for the March quarter. We've heard some talk about the fact that some things may have been pulled into the December quarter. Did you see something similar, and how should we think about it in the March quarter?

I would say that our view in the quarter was pretty consistent with our going in thoughts as we developed our plans for the year. Given that it hasn't been brought to my attention and that when I asked the question to our team, there might have been some nominal changes in behavior, but as a portfolio, the price really came in close to what our expectations were.

Okay. Great.

Then secondly, in Canada, obviously, you called it out that it was up 12%. You talked about customer as well as market growth.

Can you maybe just talk about how much of that came from market growth? Are using substantially more market growth there than we are seeing in the US? If so, what are the key drivers to that?

Clearly, we have picked up a bunch of new customers in Canada. We have been very selective on those new relationships.

One of our competitors exited Canada through the sale of their business to another competitor in Canada and some of the customers that were serviced by that competitor were open to a conversation with McKesson. As a result, we have been able to grow our business.

I might also say that our Specialty business in Canada, which we believe is market-leading, continues to grow very nicely. We have been encouraged by that continued penetration in that part of our book.

Is there a way to look at the 12%, how much came from the new customers versus the overall market in Canada?

It's probably difficult to parse out, Lisa. There are public numbers on market growth rates in Canada, but clearly we believe that we have had a significant increase in revenue as a result of our customer wins in the Canadian marketplace.

Okay, great. Thank you.

Our next question comes from Steven Valiquette with UBS.

Thanks, good afternoon. I have quick question on the March quarter as well.

If I'm doing the math right, the implied fourth-quarter guidance is $2.26 to $2.41 and TheStreet is at $2.46 right now. But again, with all the details in the press release and the commentary on the call, is there anything that is one-time-ish in nature that you are including in the upcoming March quarter that is baked within that quarterly guidance in particular, or is that more of a clean range, the way things stand right now, just in relation to taxes or IT charges or even charges tied to Celesio as well? Thanks.

No, there is nothing that we are implying as to the fourth quarter or a one-time nature or anything like that. Really, the three drivers I would ask you to really focus on -- obviously, the Canada tax, $0.52; the technology charges of $0.18; and then the impact of the tax run rate, which is both partly driven by that Canada tax item, but also as a result of a change in our income mix with our Distribution business representing a greater proportion of the total profitability of McKesson.

Okay, got it. Okay. Thanks.

Our next question comes from Charles Rhyee with Cowen and Company.

Thanks for taking the question here. John, obviously, you have talked a bit about your generics program here, and when you look at the other partnerships that have formed, yours is obviously a little different because you are basically owning Celesio. But as you think in the future, [and specifically] your large customers, do you envision it more that they will just join your -- they'll just become a customer of your One Stop program, or could it end up being where you are partnering more in a JV format. How do you vision -- what would be your preferred route, and how would you see it or do you even see the need to do that? Thanks.

Charles, that's a good question. The way I think about it is that the -- first of all, you see through these combinations that scale really matters and that wholesalers really matter. We are an integral part even in the largest customer set of the value proposition and the service offering that's brought to the marketplace. So the industry overall and wholesaling has done a very good job of continuing to add significant value and changing our model over time so we remain vibrant and viable and in the middle of a very important industry and earn our position every day.

I would say relative to structures, we have not had great success at McKesson creating joint ventures that are sustainable -- that -- where interests are always combined and unified. Usually we end up with a situation where they collapse under their own complexity or they have some problem with one venture partner trying to optimize against another. So we are not really inclined to enter joint ventures, although I would say that with the caveat of clearly, we will listen to the opportunity and make a decision.

I would say that with respect to our largest customers, we hope to continue to evolve our value proposition so that the economics that are afforded to them through our One Stop program or through custom develop programs, that they will buy off of our portfolio, and that, that transaction will make sense for us and for them without the complexity of some type of a venture structure, which could be difficult to manage.

Thanks and if I can just follow up, your largest customers that do buy direct, we generally assume that they buy all their generics direct. Is that really the case or is it they are buying the high-value generics directly and maybe low-value generics through you?

I can only speak for McKesson's customers. I would say that, without exception, they all buy some generics from us. Given the frequency with which we deliver to the stores, our position has always been to help our customers from the service perspective.

Clearly, many of them have their own warehouses and do their own buying as well for certain sets of products and how they've reached the decision as to which they buy from themselves and which they buy through us may not be totally transparent to us. I would assume it would usually be from an economic perspective, they would make that decision.

Our job is to wrap the value proposition of our complete relationship with the customer, which should include the brand, generic, our service offering, our automation systems, our warehousing capabilities, to make it compelling for them to discontinue their own purchasing. We have been effective at doing that all the way up to our largest customers. It is our responsibility to continue to evolve our program so we that can earn the privilege of serving their needs from a generic perspective in a more holistic way.

Great. Thank you.

Our next question comes from George Hill with Deutsche Bank.

Good afternoon, John and James. Thanks for taking the question.

John, first one for you is can you detail for us, with the generic inflation that's been going on, how is Northstar leveraged to that? Has that been an excess margin opportunity for Northstar? And maybe the opportunities for Northstar in Europe?

Thanks, George, for the question. Northstar, clearly, is around the globe looking at opportunities to bring product into our supply chain.

The visibility we get through Northstar enhances our view of the opportunities that exist globally for us as well as some of the challenges that may exist, whether it's plant closures, limited supply of raw materials, or other issues that may come along. That Northstar experience helps inform all of McKesson from a sourcing perspective in a very positive way.

We have launched a variant of Northstar into Canada with success, and that product continues to build its position in Canada, that product line. I believe, and so do our new partners at Celesio, that there are opportunities to explore with our generic portfolio in Europe. Clearly, Northstar will be part of that.

James, maybe just two quick housekeeping questions. I want to make sure I heard things right. With the 36.5% tax rate you mentioned, was that for the fourth quarter or was that what we expected the full year rate to be?

That's the rate for the full year, and that includes the impact of the Canadian tax matter that I talked about.

Okay and then just as you guys launch the tender process for the remainder of Celesio, how long does that tender process go on for? And then maybe just a very simple explanation of next steps? Thank you and I will hop off.

The tender process that we are doing -- envisage taking about four weeks and then you would have an additional two week period, very similar to actually the structure of the original tender, whereby additional people could tender their shares during that extra two week period. Then we have already issued our intent to go through a domination hearing. That will take some time; there are a few steps that we have to go through to be able to get to that hearing.

First of all, we have to go through a valuation process, and then we also have to give six weeks notice to call an annual general meeting, at which the domination process would be heard. So that will take a few months, but we would still expect to be on track to reach domination towards the end of the first half of our Fiscal 2015.

Of course, it is at that point in time where we can really start work on the synergy case. That's the point at time in which we have operating control of Celesio.

Very helpful. Thank you.

Our next question comes from David Larsen with Leerink Swann

Hello, guys. Congratulations on a great quarter.

John, can you touch on how simple or perhaps complex it might be for the combined buying power of both McKesson and Celesio to operate across borders? Will that be a fairly simple process? And then can you also touch on the pricing environment in Germany? Thanks.

Thank you, David, for the questions. It's probably difficult to characterize the 14 countries in Celesio's book in one way. I would say it really matters which country you are thinking about relative to the way generics are purchased today, how they are contracted for, whether the payers are involved or the government is involved.

I would say that we have carefully mapped out the positions by country, by manufacturers. We understand where we think these synergies might fall for us, and clearly our guidance to synergies and how we talked about it when we first announced the deal, all of those factors remain in place. So we believe there are places where we can go across the borders with a more unified approach.

I'm sorry, David, I forgot the second question you asked.

And then just in Germany, the pricing environment in Germany. Any challenge there, any headwinds? Thanks.

That's another good question. Our German operation -- or the German operation under Celesio in that market, there has been public discussion about the wholesaling pricing in that market, just to be clear about what pricing at least I think I'm talking about. The wholesalers in that market have been in a competitive battle with each other for some time.

The Celesio people, on their last public conference call, characterize it as stabilizing but not improving. I don't think I want to make any additional comment other than that, but clearly that is what their view was the last time they spoke publicly about it.

Great. Thanks very much.

And then, I saw you had a press release on a relationship with RedBrick. Can you maybe just comment on what that will provide to McKesson's clients?

Well, it's in our Technology business. I have to say it's a relatively small part of our portfolio.

We do think it's important. We have been impressed with what the RedBrick have to provide, but it won't really be anything material for McKesson at our scale.

We will take our next question from Robert Jones with Goldman Sachs.

Thanks, guys. Just understanding that we will get formal guidance next quarter, I was wondering, John, maybe if you could share a little bit how you're thinking about the operating margin range. Considering this year sounds like it will be towards the upper end of the 200 to 250 basis point range, just trying to get a sense of how much of the drivers of the performance or outperformance this year, do you think directionally are sustainable as we think about next fiscal year, and this is ex Celesio, of course?

Sure, Robert. Thank you for the question.

We have not contemplated our guidance for next year yet. As you know, we will do that when we report our fourth-quarter results in April.

I believe that our view, however, as a Company is that margin expansion is a priority. Clearly, as you see the P&L flow this quarter, we like to grow revenues in line with the market or maybe faster if we can get a bigger share of our customers' spend, which is what we have been focused on with our generics. We like to get very positive drop to our gross product lines by managing our pricing carefully in the marketplace, so we are not giving it all away, and then, clearly, want to manage our expenses very carefully, as well, so that we can drop it to the bottom line.

That is what delivers a great business and a great business model. I see no reason to believe that we can't continue to focus on gross margins as a top priority. I don't see any negative mix change occurring in our Business, and generics continue to be a propellant across the board if you think about our sourcing.

If you think about next year, we have another brand to conversion cycle, which will be helpful to us from a margin expansion perspective. It remains a priority, and as we --hopefully, as I keep telling Paul Julian, when you get past the 250, we will come up with a new goal for you, which he is always excited to discuss.

That's fair. Just if I could skip one in a Medical. Not to be [lost], obviously good results there as well this quarter.

Understanding PSS has been a big part of the contribution of growth this fiscal year, we start to lap that next quarter. I was wondering if you could just give us a sense of what you are seeing on underlying growth within the Medical business and what your expectations might be in that segment going forward?

I'm glad you brought up PSS. We have just a terrific franchise -- or I should say Med-Surg -- we just have a terrific franchise in completing the PSS acquisition. It was an important step to market leadership in almost all -- in fact, all of the segments that we serve now in Medical.

That integration is going very well. You saw the strengthen in the revenue. But I believe that those businesses' underlying growth, setting aside the acquisition, are all growing at or above the marketplace.

Those are places where our value proposition really stands unique. We have the ability to continue to grow share in home care, long-term care, and our physician office business.

Thanks so much.

You're welcome.

Our next question comes from Bob Willoughby with Bank of America Merrill Lynch.

John, how quickly can you proceed with an acquisition strategy for Celesio to really expand that platform? Do you have to wait a couple of years or is it something instantaneously you can put in place?

An acquisition on top of Celesio? Was that what you were asking?

Yes, building out the European or Latin America markets, wherever you might choose to go?

It's probably a little premature for me to speculate on it, given that we need to do a close diagnostic on what position we are in, in each one of these markets and how well we are positioned to take on additional work in those markets. Celesio is a composite of a 14 countries that are all managed in a very discrete way, and I would think each one of these countries would provide additional opportunities.

So we have both an execution, a challenge we would have to understand, if we were to bring on additional acquisitions and, clearly, we have a balance sheet constraint that we've put in place that says we are not going to lose our investment grade and we're going to manage our cash flow very carefully. With those two caveats, we are open to acquisitions and to doing things, but we are not going do it in a way that disturbs our integration plans with Celesio and we are not going to do it in a way that would integrate -- or risk our investment-grade rating.

And that concludes today's question-and-answer session. I would like to turn the conference back over to our speakers for any additional or closing remarks.

Great. Thank you, Lisa. And thanks to all of you for being on the call today.

I'm really pleased with the operating performance of our Business and excited about the future and our acquisition of Celesio. We are bringing on a great Management team, a great group of employees, and a great asset that will help us really build our Company as we go forward.

I look forward to welcoming those teams as I travel throughout Europe in the next several months. This platform is important to us and it's important to our customers.

I'm now going to hand the call off to Erin for her upcoming review of upcoming events.

Thank you, John. I have a preview of the upcoming event for the financial community. On February 25, we will present at the Citi Global Healthcare Conference in New York.

We will release our fourth-quarter earnings results in early May. Thank you and goodbye.

And that concludes today's teleconference. Thank you for your participation.