麥卡遜 (MCK) 2016 Q4 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.

(Operator Instructions)

I would now like to introduce Ms. Erin Lampert, Senior Vice President, Investor Relations. Please go ahead, ma'am.

Thank you, Vicki.

Good afternoon, and welcome to the McKesson fiscal 2016 fourth-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 then James will review the financial results for the quarter and the full year. After James' comments we will open the call for your questions. We plan to end the call promptly after one hour at 6:00 PM 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 periodic, current 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 addition, I would call your attention to supplemental slides, which we will reference on today's call and can be found on the Investors page of our website.

We believe the supplemental slides, which include non-GAAP measures, will provide useful information for investors with regard to the Company's core operating performance and comparability of financial results period-over-period. Please refer to our press release announcing fourth-quarter fiscal 2016 results and the supplemental slides for further information and a reconciliation of the non-GAAP performance measures to the GAAP financial results.

Thanks, and here is John Hammergren.

Thanks Erin, and thanks everyone for joining us on our call.

I'm pleased with our fourth-quarter results, which were driven by solid execution across both our distribution solutions and our technology solutions segments.

Fiscal 2016 was a year of growth and expansion across McKesson, despite the headwinds resulting from generic pharmaceutical pricing trends and industry consolidation. I want to highlight a few important accomplishments across our Company over the last year. In our US pharmaceutical business, we continue to expand our relationships with our customers and drive strong growth across all channels including national retailers, independent pharmacies and health systems.

Our global sourcing and procurement office based in London delivered tremendous results in fiscal 2016, and I'm proud of our team's performance and the value they are delivering on a global basis for our Company and for our manufacturing partners. In fiscal 2017, we expect to achieve the full run rate of procurement-related synergies as articulated in the original Celesio acquisition more than one year ahead of the original business case. Our specialty health business delivered strong mid-teens revenue growth for the fiscal year, while announcing two strategic acquisitions to further complement our core business.

We saw solid expansion of our leading independent pharmacy banner programs across the United States, Canada and Europe. We also saw strong growth across the Lloyd's brand pharmacies in Europe, and we're also very pleased to announce our proposed acquisition of Rexall Health in Canada.

The operating margin rate in our technology solutions segment expanded nicely as a result of our efforts over the last several years at reshaping our portfolio and focusing our investments. And as we discussed in January, the Company undertook a review of its cost structure across the enterprise and implemented a set of actions designed to ensure McKesson remains at the forefront of operational excellence, efficiency, value and innovation.

I also want to highlight McKesson's strong operating cash flow results for fiscal 2016, which exceeded our expectations. For the fiscal year we generated $3.7 billion in operating cash flow, up 18% year-over-year. There's one more item I'd like to call to your attention. Many of you joined us in January when we made an unscheduled announcement to highlight some industry trends and Company-specific events that impacted our fiscal 2016 results and our preliminary outlook for fiscal 2017.

One of the topics we discussed in January and that continues to receive attention is the subject of generic pharmaceutical pricing. We believe some of you may be seeking clarification as to how it affects various industry constituents, so let me take a moment and talk about how it works here at McKesson.

Over a very long period, our generic pharmaceutical portfolio has experienced a deflation and continues to do so today. I also would remind you that our agreements with our manufacturing partners contemplate and protect us from a decrease in the value of our inventory. However, on a small group of generic drugs, as we have in the past, we expect we will continue to experience price increases.

When we talk about generic inflation at McKesson, we are specifically referring only to the small subset of generics that experience a price increase. As we think about fiscal 2017 we expect a nominal contribution from those generic pharmaceuticals that will increase in price. We saw this trend early in our guidance today as consistent with the information we shared with you in January, and further, the fiscal 2017 guidance of $13.30 to $13.80 that we've provided you today is in line with what we communicated with you back in January.

I'm proud of this management team and their constant focus on growth and innovation to create value for the long-term. I'm pleased with our accomplishments in fiscal 2016 and I would like to take this opportunity to thank our employees for their leadership, consistent focus on putting our customers' success at the forefront of everything that we do.

Turning for a moment to the broader industry environment, across all of the markets we serve the themes of cost, quality, and access remain central to the opportunities and challenges facing healthcare, and as I've seen with relative consistency over my own career, these same themes continue to take a prominent place in the national platform of the current presidential election process in the United States.

I think it is important to remember that the issues of cost, quality, and access are not new. And demographics will continue to drive strong demand for pharmaceuticals, and the use of pharmaceuticals will continue to play an important role in the healthcare systems across the world and remain the most effective and cost-efficient way to treat patients across a variety of disease states and chronic conditions. And the pace of innovation continues to advance our industry in exciting ways, from the discovery of new pharmaceutical therapies to fight and cure disease, to new technology-enabled ways in which consumers are engaging and managing their own health, to real progress we see in the pay for value care delivery models that are emerging.

Against this backdrop of change I see great opportunity for McKesson. Change inevitably opens the door to new conversations with customers about how we can bring the strength of McKesson to help address the opportunities they see and the challenges that they face. Our customer first culture demonstrates a commitment and an awareness that McKesson's long-term success is linked to our customers' success. And while change can bring its own set of challenges, I'm very excited about what the future holds for our Company.

Now moving on to our business results. Distribution solutions concluded another solid year with good performance across the segment. North America pharmaceutical distribution and services delivered 11% revenue growth on a constant currency basis compared to the prior year. The US pharmaceutical business delivered solid results for the year, despite pricing trends on generic pharmaceuticals that were below our original plan and a few notable customer transitions related to consolidation within our healthcare supply chain.

Despite the impact of these two events, the business saw growth and expansion across a number of important areas. In fiscal 2016 we continued to see excellent growth with existing customers who expanded their business with McKesson, as well as new customers choosing McKesson as their pharmaceutical sourcing and distribution partner.

At the beginning of April, we began to service the pharmaceutical sourcing and distribution for Albertsons and Safeway and I'm very pleased with the way our team is prepared to hit the ground running on day one. Our one-stop proprietary generics program continued its strong performance and grew 21% year-over-year. And Health Mart extended its tremendous track record of growth during fiscal 2016, ending the year with more than 4,600 stores or approximately 19% growth over the prior year.

I know that customer consolidation, which impacted us in fiscal 2016, has caused some to question the scale and competitiveness of McKesson's generic pharmaceutical sourcing. To me there is no better proof point than some of the examples I just walked you through, while we continue to expand our customer relationships, win new customers, deliver strong growth in our one-stop proprietary generics program, and rapidly expand the number of independent pharmacies who see real value to their bottom line by joining Health Mart.

I'm incredibly confident in the strength of our relationships with our manufacturing partners and in McKesson's ability to be a great partner to them through our global procurement scale and operational footprint. In summary, I believe in the core strength and competitive position of our US pharmaceutical business, and while we recently faced challenges related to a shift in generic pharmaceutical pricing trends and customer consolidation, I'm confident this Business remains extremely well positioned for continued success.

Our Canadian distribution business delivered solid results in fiscal 2016. In addition to the strong performance of our leading pharmaceutical distribution and services business, we also had strong performance across our extensive retail banner business. Several weeks ago we announced our proposed acquisition of Rexall Health, which we expect to close later this calendar year. This acquisition supports McKesson's commitment to drive value in the industry by improving healthcare solutions delivered in the retail pharmacy setting. And it enhances our ability to provide best-in-class pharmacy care for patients through an expanded retail footprint across Canada. Our team in Canada has an outstanding track record of delivering great value to our customers and to patients, and I'm very excited about the opportunities we see for this business in fiscal 2017 and beyond.

Turning now to our specialty health business, fiscal 2016 was another year of exceptional growth in our oncology and multi-specialty businesses. We recently brought together several assets under a new manufacturers' services organization within McKesson Specialty Health. By integrating these capabilities, we'll offer improved coordination of our best-in-class solutions to manufacturers and ultimately improve patient access and adherence to essential life-saving therapies.

Additionally, we closed on our Biologics and Vantage Oncology acquisitions on April 1. Biologics is the largest independent oncology-focused specialty pharmacy in the United States, and Vantage Oncology is a leading national provider of radiation oncology, medical oncology and integrated cancer care, and in combination with our US oncology network, this now includes over 120 integrated cancer centers across 29 states.

These two important acquisitions will increase McKesson's specialty pharmaceutical distribution scale, expand our oncology-focused pharmacy offerings, enhance our solutions for manufacturers and payers, and broaden the scope of practice management services available to providers and patients. These investments demonstrate McKesson's commitment to the success of our community oncology partners and our customers, and we believe the acquisitions of Biologics and Vantage Oncology complement our holistic approach to exceptional care for cancer patients.

Our teams are hard at work with our new colleagues from both Biologics and Vantage Oncology as they put in place detailed integration plans. And we are incredibly excited about welcoming the talent and expertise that exists across these two terrific organizations to the McKesson team.

Turning now to international pharmaceutical distribution and services, I am pleased with the results for fiscal 2016. We are making strong progress on some important investments to strengthen the information technology environment across Celesio while we continue to invest in the European retail pharmacy business. Additionally in fiscal 2016, we announced a number of acquisitions across several of our markets where we see strong opportunities to enhance our services and capabilities. Looking ahead, Celesio is well-positioned to execute on its operating plan which includes a focus on the integration of acquisitions during fiscal 2017.

In our medical surgical business we saw strong results in our physician office business, including outstanding growth with large accounts and customer wins with integrated delivery networks. Our surgery center and laboratory focused businesses also delivered strong growth in fiscal 2016. And I'm pleased to report that we have successfully concluded our integration plan of PSS World Medical, which delivered synergies as expected.

Overall I'm proud of our full-year operating performance in distribution solutions. We have an exciting year ahead of us in fiscal 2017 that will require us to do what we do best: focus on our customers' success, leverage our culture of operational excellence and innovation to deliver the best value in the industry and execute, integrate and deliver value trough the acquisitions we have announced. As we look ahead to fiscal 2017, we expect that distribution solutions revenues will increase by high single digits compared to the prior year, driven by market growth and acquisitions.

Turning now to technology solutions, I'm pleased by the strong results we delivered in fiscal 2016. We experienced outstanding growth in our payer solutions, medical imaging and relay connectivity businesses. And while revenue growth in technology solutions has been impacted over the last several years, primarily by important actions we have taken to focus our investments and shape our portfolio, our enhanced focus has resulted in meaningful improvements in our adjusted operating margin rate for the segment, which we expect will lead to further margin expansion in fiscal 2017.

To wrap up my comments, I believe we have a solid plan for fiscal 2017. Growth across our businesses and growth from capital deployment is balanced against the negative impact of generic pharmaceutical pricing trends in the United States and customer consolidation. We're in a business that continues to generate strong cash flow from operations, and while the business of healthcare continues to transform across the markets we serve around the world, we are well positioned to capitalize on the tremendous opportunities for our Company.

At McKesson we have the best management team in the business, and I'm confident in this team's ability to continue to deliver value to our customers and strong financial returns to our shareholders. I'm proud of our performance in fiscal 2016, and look forward to the many exciting opportunities ahead of us in fiscal 2017.

With that, I'll turn the call over to James for a detailed review of our financial results. James?

Thank you, John, and good afternoon, everyone.

As John discussed earlier, our fiscal 2016 results reflect solid execution and core operational growth from both segments. In addition we delivered operating cash flow which exceeded our expectations while applying our portfolio approach to capital deployment to create shareholder value.

Today I will cover both the fourth-quarter and full-year results. I will also present annual guidance for fiscal 2017. Now before I review our fiscal 2016 results, I would like to address the cost alignment plan which John mentioned in his remarks. This plan primarily includes work force reductions and business process initiatives. As outlined in January, our fiscal 2016 adjusted earnings guidance did not include restructuring charges related to this cost alignment plan, given that this plan was initiated late in the fourth quarter.

Our earnings press release outlines the pretax charges related to the cost alignment plan, totaling $229 million, were recorded during the quarter, representing an adjusted earnings impact of $0.73 for fiscal 2016. Overall, cost alignment charges reduced adjusted gross profit by $26 million and increased adjusted operating expenses by $203 million for the fourth-quarter and full-year.

The tables accompanying our press release outline our reported results, inclusive of these cost alignment charges. However, in order to review our core operating performance for the quarter and the fiscal year, my remarks will provide our constant currency results, excluding the impact of both the cost alignment charges and the gains realized earlier in FY16 on the sale of the Nurse Triage and ZEE Medical businesses.

These gains totaled $0.29 per diluted share. Therefore in addition to our earnings press release and customary tables, we have published a supplemental presentation on our website. This presentation includes additional information about our cost alignment plan, including actual fiscal 2016 charges and the charges anticipated during fiscal 2017.

This presentation also provides more of a core operational or baseline view of our fiscal 2016 earnings in constant currency, excluding the cost alignment charges and business sale gains that I just mentioned. During my remarks, I will refer to this supplemental slide presentation to review our fiscal 2016 baseline consolidated earnings and fiscal 2017 earnings outlook.

I also plan to reference the fiscal 2016 baseline consolidated and segment gross profit, operating expense and operating margin values provided within this presentation. For the balance of our fourth-quarter and fiscal 2016 results, including consolidated revenues, I will review the customary tables, which accompany our earnings press release.

Now let's move to our consolidated results, which can be found on schedules 3A and 3B of the tables accompanying our press release. Consolidated revenues for the fourth quarter increased 5% in constant currency. For the full year, revenues were $195.3 billion in constant currency, an increase of 9% over the prior year, led by growth in our distribution solutions segment.

I'll now refer you to slides 3 and 4 of the supplemental presentation. Fourth-quarter baseline gross profit was relatively flat and full-year baseline gross profit increased 3% in constant currency year-over-year. Fiscal 2016 baseline gross profit was driven by the performance of distribution solutions, primarily reflecting market growth, our mix of business and our global procurement benefits, offset by the weaker year-over-year profit contribution from generic pricing trends, primarily in the second half of the fiscal year, which were in line with our previous expectations.

Fourth-quarter baseline operating expenses declined 4%, and full-year baseline operating expenses were flat in constant currency. For the full year total baseline operating expenses benefited from lower expenses recorded related to the Nurse Triage and ZEE Medical businesses sold earlier in the fiscal year.

Now turning back to schedules 3A and 3B of the tables accompanying our press release, adjusted other income was $17 million for the quarter and $68 million for the full year. In fiscal 2017 other income is expected to increase by approximately 40% from the fiscal 2016 level, primarily related to the anticipated profit contribution from Celesio's equity investment in Brocacef, which previously announced its acquisition of the Netherlands subsidiary of Mediq.

Interest expense of $86 million decreased 4% in constant currency for the quarter. Full-year interest expense of $359 million decreased 4% in constant currency, primarily driven by the retirement of debt obligations during the fiscal year. For fiscal 2017 we expect our year-over-year interest expense to be relatively flat to fiscal 2016, driven primarily by scheduled debt maturities and the incremental financing related to acquisitions we expect to close in fiscal 2017.

Now moving to Taxes, for the full-year, our adjusted tax rate was 28.9% excluding cost alignment charges, reflecting our mix of income and a number of favorable discrete tax items. For fiscal 2017 we expect an adjusted tax rate of approximately 31%, which is primarily based on our expected mix of US versus international income.

However, this rate may fluctuate from quarter to quarter. For fiscal 2016 McKesson's constant currency net income from continuing operations totaled $3 billion, excluding after-tax cost alignment charges of $169 million and after-tax gains on the sale of the two businesses that I mentioned earlier, totaling $67 million.

I'll now refer you to slide 5 of the supplemental presentation. Our full-year baseline fiscal 2016 earnings per share of $12.52 increased 14% in constant currency versus the prior year.

Overall this year's baseline earnings per share reflects market growth across the distribution solutions segment, margin expansion in the technology solutions segment, global procurement synergies, the cumulative benefit of share repurchases in the fiscal year, and a lower adjusted tax rate versus the prior year. Wrapping up our consolidated results, diluted weighted average shares outstanding decreased by 1% year-over-year to 233 million.

During the fourth quarter we completed a $650 million accelerated share repurchase program, bringing the value of total shares repurchased during fiscal 2016 to $1.5 billion. At the end of fiscal 2016 approximately $1 billion remained on the current share repurchase authorization granted by the Board. Our diluted weighted average shares outstanding assumption for fiscal 2017 is 228 million.

Let's now turn to the segment results, which can be found on schedules 3A and 3B of the tables accompanying our press release. Distribution solutions segment revenues were up 5% in constant currency during the quarter to $46.4 billion. For the full year distribution solutions constant currency segment revenues were $192.4 billion, up 9%, primarily driven by market growth in our North America pharmaceutical distribution and services business.

In fiscal 2017, distribution solutions revenue growth is expected to increase by a high-single-digit percentage compared to fiscal 2016. As previously outlined, we continue to assume we retain the existing sourcing and distribution relationship with Rite Aid, which would contribute approximately $13 billion in revenue in fiscal 2017.

For the quarter, North America pharmaceutical distribution and services revenues increased 6% in constant currency. For the full year, North American distribution revenues increased 11% on a constant currency basis, driven primarily by market growth in our US pharmaceutical, specialty and Canadian businesses, offset primarily by the expiration of our contract with Optum at the start of our third quarter.

For fiscal 2017 we expect our North American distribution business to deliver high single digit percentage revenue growth compared to fiscal 2016. International pharmaceutical distribution and services revenues were nearly $6 billion for the quarter, up 2% in constant currency. For the full year, international revenues of $23.5 billion were impacted by approximately $3 billion in unfavorable currency rate movements, primarily attributable to a weaker euro relative to the US dollar when compared to the prior year.

For the full year, revenues were $26.5 billion in constant currency, up 1%, driven by growth in our UK business, partially offset by the loss of a hospital contract in Norway during fiscal 2015. In fiscal 2017 we expect Celesio's revenues to grow by a low double-digit percentage on a constant currency basis, driven primarily by the acquisitions we announced in fiscal 2016.

Moving now to the medical surgical business, revenues were up 1% for the quarter and 2% for the full year, driven by strong growth in our primary care business, offset by the sale of ZEE Medical in the second quarter and weaker market conditions affecting our long-term care business. Looking ahead to fiscal 2017 we expect to drive mid-single-digit percentage revenue growth year-over-year.

I'll now refer you to slide 6 of the supplemental presentation. Distribution solutions baseline gross profit decreased 1% in constant currency for the quarter and increased 3% in constant currency for the full year. Full-year segment baseline gross profit reflected market growth and our mix of business including a growing proportion of specialty pharmaceuticals, weaker profit contribution from generic pricing trends when compared to the prior year and lower profit contribution from our medical surgical business primarily driven by the sale of our ZEE Medical business in the second quarter.

Full-year distribution solutions baseline gross profit also included our global procurement synergies and $76 million in antitrust settlement proceeds. Let's now move to slide 7 of the supplemental presentation. Full-year segment baseline operating expenses increased 1% in constant currency from the prior year.

Segment baseline operating expenses benefited from lower operating expenses following the sale of the ZEE Medical business. Now I'll refer you to slide 8 in the supplemental presentation. Distribution solutions full-year baseline operating profit increased 7% in constant currency to $4.5 billion and we ended the year with a baseline operating profit margin of 234 basis points, 4 basis points below the adjusted operating margin we reported in the prior year.

Looking ahead to fiscal 2017 we expect the segment baseline operating margin to approximate the fiscal 2016 baseline operating margin. Underpinning this outlook in fiscal 2017 is planned growth in segment baseline operating profit driven by the contribution from our generics business including both our global sourcing efforts and expanded one-stop sales, strong growth from our specialty, Canadian, international and medical surgical businesses and the contribution from the previously announced acquisitions we expect to close in the fiscal year.

Offsetting this anticipated profit expansion we expect lower profit contribution from the customer contracts we previously discussed during fiscal 2016 that were impacted by market consolidation. In the US market, we also expect branded drug pricing trends to be modestly below those experience in fiscal 2016, and we anticipate a nominal contribution from generic pharmaceuticals that increase in price during fiscal 2017.

We also expect the contribution from the launch of new oral generic drugs in the US market to decline from the prior year. And finally we expect a higher mix of more complex and expensive therapies, which will impact our margin rate.

Now turning back to schedules 3A and 3B of the tables accompanying our press release, technology solutions revenues were down 5% for the quarter and down 6% for the full year to $2.9 billion. This full-year decline was driven by the anticipated revenue softness in our hospital software business, the sale of the Nurse Triage business, and the wind down and transition of our UK workforce business, partially offset by growth in our other technology businesses. Looking ahead to fiscal 2017 we expect technology solutions revenues to decline slightly year-over-year as growth in our connectivity, payer solutions, medical imaging and provider revenue cycle businesses will be more than offset by an anticipated revenue decline in our hospital software business.

Now I'll refer you to slides 9 and 10 of the supplemental presentation. Full-year baseline segment gross profit was flat year-over-year in constant currency. Full-year baseline operating expenses in the segment declined 5% in constant currency from the prior year. Full-year baseline operating expenses benefited from various ongoing cost management initiatives, including the fiscal 2015 work force reductions and lower expenses following the sale of the Nurse Triage business in the first quarter.

Let's now move to slide 11 in the supplemental presentation. Baseline segment operating profit increased 12% in constant currency, driving a full-year baseline operating margin of 18.72%, up 288 basis points over the prior year. During fiscal 2017 we expect the baseline operating margin for the segment to be in the low 20% range.

I'll now review our balance sheet metrics. For receivables, our days sales outstanding increased two days from the prior year to 28 days. Our days sales in inventories increased one day from the prior year to 32 days, and our days sales in payables increased five days from the prior year to 59 days.

As a result of our profit growth and disciplined approach to working capital management, we reported $3.7 billion in cash flow from operations during fiscal 2016, and we ended the year with a cash balance of $4 billion with $2.2 billion held offshore. In fiscal 2017 we expect cash flow from operations to grow by approximately 15%, excluding $270 million in expected cash payments related to the combination of the cost alignment plan and a settlement agreement with the US Drug Enforcement Administration and the US Department of Justice, as previously disclosed in April of 2015.

Internal capital spending totaled $677 million for fiscal 2016. For fiscal 2017 internal capital spending is projected to be between $700 million and $800 million. Our dividend obligation to Celesio's non-controlling shareholders is included within a line titled Net Income Attributable to Non-Controlling Interests on Schedule I of the tables accompanying our press release. We expect this obligation to drive a fiscal 2017 expense of $46 million, or approximately $12 million per quarter, assuming a 76% ownership stake.

During fiscal 2017 we also expect to record income for non-controlling interests related to our joint venture position partners operating within Vantage Oncology, the previously announced and now completed acquisition within our US specialty business. As a result, in fiscal 2017 we expect income attributable to non-controlling interests to increase by approximately 50% from fiscal 2016.

And finally we also anticipate a foreign currency rate headwind of approximately $0.03 during fiscal 2017. In today's earnings press release, we detail many key assumptions underpinning our fiscal 2017 outlook of $13.30 to $13.80 per diluted share, which excludes anticipated FY17 cost alignment plan charges of $40 million to $50 million, equating to approximately $0.12 to $0.15 per diluted share.

I'll now refer you to slide 12 in the supplemental presentation, which outlines our anticipated year-over-year baseline earnings growth. Our fiscal 2017 guidance of $13.30 to $13.80 provides baseline earnings growth of 6% to 10% year-over-year, which is in line with the fiscal 2017 preliminary outlook we provided back in January.

Thank you, and with that I will turn the call over to the operator for your questions. In the interest of time, I ask that you limit yourself to just one question and a brief follow-up to allow others an opportunity to participate. Vicki?

(Operator Instructions)

Ricky Goldwasser, Morgan Stanley.

Hi, good evening, and thank you very much for all the details in the supplemental slides, it's very, very helpful. So two questions here. So first of all, when we think about all the headwinds and tailwinds, what do you guys think of the normalized EBIT growth going forward in absence of benefit from generic inflation, excluding M&A? Is the baseline EBIT growth of about 5% that you delivered in the quarter for distribution segment, is that kind of like a good way for us to think of what normalized EBIT growth rate should look like?

Thanks, Ricky, for the question. I think the best way for us to think about this is really related to post the challenges we faced this year from the lapping of the generic price phenomenons we experienced last year as well as the customer consolidations and the negative mix change associated with those customers.

We think once we lap those changes and we get through this fiscal year, you should begin to see us perform at a level that's very similar to the level we performed at in the past, so we don't really see anything structural in our business or in our business model that would cause us to be concerned about our ability to grow organically in a way that's very similar to the way we have grown in the past.

Now clearly in FY18, we also have the transition with Rite Aid, and obviously you see us making lots of moves now to prepare to grow through those challenges, but we'll talk about that more as the time approaches. But other than that additional headwind that we'll face in that fiscal year, I think the business continues to perform as it has in the past.

Okay, and then one follow-up question that we're getting is really about how you think about branded inflation and how you factored that into your guidance. Obviously, we've heard a lot and talked a lot about the generic pricing impact, but it happens to be that in the summer manufacturers don't take the same level of price increases that they have in the past. Is that somewhat factored within your guidance range?

Well, as we've thought about branded price increases, we've assumed that they would be modestly below the levels that occurred in fiscal 2016, so we feel as though we've made a prudent assumption in that regard as well.

Okay great, thank you very much.

Lisa Gill, JPMorgan.

Thank you. John, I just want to follow up to a comment that you just made. You said fiscal 2018 you plan to grow through the Rite Aid challenge. As we think about the acquisitions that you have made and you think about the cost cuts that you are doing, et cetera, is it fair to say -- and I know you're going to say it's really early to think about 2018 -- but is it fair to say that you think you've set this up so that even with the challenge of Rite Aid you will be able to grow in 2018?

Well, it is early to talk about 2018. I would say that we've talked a lot about the cost reduction programs we have put in place and the quick action we have taken to streamline the organization and to make sure we maintain our efficiencies. We don't really see any structural changes in our business that cause us great concern, and obviously the one unusual event is the sale of -- pending sale of Rite Aid, and it's our objective certainly to find a way to grow through that.

I hesitate to provide any forward guidance into FY18, but I can tell you that certainly is our intent and we are working hard to make sure that that happens.

That's very helpful. And then I guess my follow-up would just be around the incremental cash flow you saw towards the end up this fiscal year. Can the cash flow going into next year, is there something unusual in the business or anything that's changing that's really providing this nice tailwind around cash flow?

Well, I will let James jump in here in just a minute, but we clearly have the Organization focused on doing what's right and balancing our objective to grow our earnings but also to manage our cash and to grow our cash flow along the way. So I think the team is very focused, and you are seeing some results from that focus. And James you might want to talk to that.

Yes, I was obviously pleased with the cash flow growth in fiscal 2016, very much driven both by the profit growth, as well as, this ongoing focus that we've had right across our businesses, both distribution and technology around working capital management. And we think there's more opportunity to continue to build this level in fiscal 2017 as we indicated in our guide.

It is important to remember though that the guide that I was referring to excluded that $270 million of cash outflows that we would expect to incur in fiscal 2017 driven by two things: the cost alignment plan and then the DEA payment.

Great, thank you for the comments.

Charles Rhyee, Cowen.

Thanks for taking the questions. John, if we can go back to the earlier question around actually the brand inflation, and I think you made the comment that you take some assumptions for it. But can you talk about it actually in relation to your fee-for-service contracts, in terms of what's embedded -- on how much changes in inflation can affect how your fee-for-service contracts may work? Or actually, how you get paid for it in terms of fee-for-service? Thanks.

Well, thanks for the question, Charles. We have a long-standing tradition of building value with our manufacturing partners, both on the generic as well as on the branded and specialty sides of our business. Our relationship with the branded manufacturers has remained pretty consistent for a long time now, and I would say that our proportion of earnings that comes through price change in the branded portfolio has remained relatively constant as well, and it is a small portion of our overall branded profit arrangement.

Most of our profits are covered under a more fixed arrangement that is pretty reliable, sort of regardless of what happens with price inflation, and there's small portion we talked about in that 20 plus or minus percent range that has some price inflation effect on it.

And just to follow up, when you talk about -- when you imbed in your assumptions around it, do you guys also take into the political climate? Obviously, we are in an election year. Do you try to factor some of that into your assumptions as well as we think about the coming year?

Sure, we're not oblivious to the conversations that is going on in the media and with the current political activity, and we're certainly not oblivious to the investigations and conversations that have been going on from a congressional perspective into these areas. I think our assumptions are reasonable and they are based on our historical work with the manufacturers and certainly buffered by what we see as the current climate. So I would say as we stated today, we believe the assumptions are realistic and are likely to occur in the way we have laid them out in our fiscal 2017 guidance.

Great thank you.

Eric Percher, Barclays.

Thank you, I'd like to return to cash flow. So given the increase in cash flow that we see, maybe a little bit of focus on what your plans are for that cash. James, I would love to hear your view of leverage and where you will be post financing, maybe some of the maturities that come up this year -- minimal cash balance in the EU and US, and how you are looking to put cash to work this year.

Well, Eric, certainly we remain committed to our portfolio approach to capital deployment. I think you know that well. That's the four elements of internal capital spending, M&A, dividends, and share buybacks. And one of the themes of this past fiscal year was that we deployed all four levers of that portfolio approach.

Now that said, we have also indicated in the past and maintain a preference for value-creating M&A if we can find good alternatives versus share buybacks. So clearly, we've made some nice progress on that recently. Yet in terms of overall leverage, we've made significant progress in the last 12 months with debt maturities bringing down the gross debt level that we entered into to finance the Celesio acquisition a couple of years ago.

So we have brought ourselves an additional level of financial flexibility as a result of doing that, and I think that has been very important. But I also indicated in my script, that as we think about closing on some of the acquisitions in the coming several months or so, that I would expect us to be raising some additional debt in order to be able to accomplish those closings as well.

So, you will see us, I think, using our debt capacity in a way very much consistent with our investment-grade credit rating and sticking with our portfolio approach to capital deployment, with an emphasis on looking for strong acquisitions as we have done in recent months that we think can continue to grow our cash flow and earnings over time.

And at this point we had talked about 3% to 4% earnings growth from capital deployment. It appears that's perhaps been achieved already. Is that a fair statement?

It's a fair statement. I'd say we are modestly above the top end of that range that we indicated preliminarily back in January.

Thank you.

Robert Jones, Goldman Sachs.

Great, thanks for the questions. Feels a little unnatural to be asking so many around branded, on the branded side over the generic side, but here goes. It seems like you guys are assuming, like you had mentioned, less inflation on the branded side in 2017 than you saw in 2016. Just to be clear, is that because you are already seeing less price increases in the market to date or is this just more conservatism that you are baking into fiscal 2017? And I guess just within that, anything specifically you are seeing around specialty pricing trends to date and what you are assuming within specialty would be helpful.

On the branded side I would just want to emphasize that our assumption is a prudent one. It's not based on anything that we have seen. Obviously we're very early in the year, but as John was indicating in his last answer, we're obviously watchful of the political environment and so forth. So that would be how I would address the branded price. The other part of the question was --

Specialty.

In terms of pricing there?

In terms of pricing, yes.

I would say that has a relatively modest effect on our business plan, and so that's mostly a fixed like fee for service type of set of agreements on that side of the business. So I wouldn't draw particular attention to the pricing there.

Got it. And just a follow-up, it sounds like you guys now expect to realize the procurement run rate in fiscal 2017. So John, like you had mentioned, a year ahead of schedule. I guess, within that, do you think there's more upside beyond that original range as you move through 2017 and into 2018? And then if you could help us level set what the run rate was, leaving fiscal 2016 around that procurement savings, that would be very helpful.

Well obviously, we made significant progress since the acquisition of Celesio to accomplish the objective that we had laid out when we made the acquisition to begin with. And you might recall that the synergy between 275 and 325 was quite additive to the existing run rate of margin and profit coming out of the Celesio business on its own without these additional global synergies.

So I am very pleased with the progress the team has made, and as you might imagine in all of our McKesson businesses, last year's result is not good enough for next year. So we're certainly pushing our organizations to continue to make progress on all the dimensions within our businesses to improve. But clearly, the magnitude of improvement left available to us in global procurement is larger than realized and now it will be more incremental improvement on that baseline.

Okay, great. Thanks.

George Hill, Deutsche Bank.

Good afternoon, guys, and two quick questions. First, an easy one for James. Any chance you would quantify the EPS impact or the step down from the -- the step down of generic introductions in fiscal 2017 versus fiscal 2016?

We're assuming it would be a relatively modest figure. Again, I wouldn't want to overdo that point.

Okay, and then one for John. John, I'm just interested how you think about the specialty business as it relates to oncology [evolves]. You guys have made quite a big bet on oncology, especially with the two most recent acquisitions. And you've got them at the demonstration project that's out there that seems to have everybody upset. Do you guys feel like that you are protected around the business investments that you have made in specialty? And I would just love your thoughts on how you think the oncology business evolves both from a benefit perspective and from a business perspective?

Well, I think clearly there are two parts to that question. The evolution of the oncology business and how we feel about our position in oncology; and the second part of the question was really related to the demonstration project that have some people concerned. As to the demonstration project, it really has no material effect on our business as a demonstration. And frankly, even if it's rolled out in its current form, which we don't think necessarily is in the best interest of patients or oncologists in this country, it would still be relatively immaterial to our Corporation.

Clearly, we are very focused on helping our oncology practice partners, whether they are in our network or they are customers of ours, become more efficient and improve the profitability of their practices. But the fundamental strategy for us is to be well-positioned as a Corporation for what we believe is a continued significant launch cycle for new oncology treatments, including drugs and other protocols. The increase in the rate of cancer patients in this country and to be positioned to help our community oncology practices thrive in an environment where they can demonstrate already a lower-cost equal or better outcomes and clearly better flexibility for the patients that they serve. So when you see us combine our efforts in not only our existing businesses but with these new acquisitions, we're really focused on making sure that we have a wide variety of offerings for the clinician to use when they are making decisions about the appropriate patient care.

And I might also mention that CMS has other programs underway, and McKesson participates very heavily in those pilot programs to make sure we're helping to demonstrate new ways to treat patients, new ways to develop value-based cost, and quality oriented outcomes. And we're excited to be working with all the payers in those areas, because we think we can do a great job in the community, and frankly, we're in a better position to deliver better cost and better value and better outcomes than many other constituents.

Okay. Thank you.

Garen Sarafian, Citigroup.

Thanks for taking the questions. First was a follow-up to the prior question. So a bit different way of asking it, so in terms of the generic launches for your upcoming year, you made a similar statement a year ago, so I was more interested in the relative difference from the step down last year versus the step down this year. So on a relative basis, does it turn from a tailwind to a headwind type of a question?

I'm not sure that there's very much I can add at this point. One observation I would make is, that the launches that we see in fiscal 2017 have more of a profile that will drive a lesser profit contribution for us, and that's because we see the likelihood that there would be more exclusive type launches than has been the case in some other years. So that's really the driver of the 2017 over 2016 effect.

Got it. Okay, and then the second question is one of your peers mentioned reimbursement pressures have climbed. Could you maybe discuss what you are seeing from your various customer segments within distribution? Any recent trends, and if so what does guidance assume for the upcoming 12 months?

Well in terms of our guide I wouldn't point to anything material in terms of our logic or in changes in reimbursement. We feel comfortable with overall sets of puts and takes that go around any guided range, and we feel as though we've got the ability to be able to execute against that range, based on a variety of different types of business conditions that may or may not arise.

Fair enough. Thank you.

Ross Muken, Evercore ISI.

Good morning -- good afternoon, sorry -- so I guess as we think about your strategy on the pharmacy side, obviously you've made again some acquisitions there internationally; and I guess as we think about your experience so far with Lloyd's and what you've learned and how you think about that as a long-term vehicle of driving value at McKesson as one of the key pillars, what are the key things you have learned that are maybe different than your perception, even though obviously you service them in the US, about how the international pharmacy markets differ? And then, how do you view that business model relative to your overall mix?

Well we're excited about the performance we have achieved with Lloyd's and the evolution of the pharmacy business in Europe in particular, given that it's extremely well positioned to be a big part of the healthcare system in many of those countries, and in particular in the UK, where healthcare demand outstrips supply and where governments and other payers are looking for lower-cost alternatives and vehicles to serve their populations. And certainly ways to reduce the queuing that goes on in the larger health systems by using pharmacists as another expert as a provider in the healthcare system.

So we are excited about Lloyd's being positioned as a destination for healthcare services. We are trying to carve a position with our pharmacy strategy, frankly, around the world that is more focused on being in the care process as opposed to some of the other avenues that some of these retail stores can take. So I think we are pleased with where we are positioned in Europe and we're also pleased with where we're headed in Canada, and we're excited to bring many of these benefits to our independent pharmacy customers either through our banner programs or just through close partnerships.

Great, thanks John.

David Larsen, Leerink Partners.

Hi, expanding on that last question a bit, could you talk about some of the organic growth opportunities that you see for Celesio over in Europe, potentially becoming an intermediary between, let's say, hospitals and manufacturers or anything along those lines? Thanks.

Well clearly, I just talked about Lloyd's and how we think Lloyd's, both in our owned stores and also in our banner stores, in many different markets is well-positioned to participate in the care process in a broader way, a more comprehensive way. Clearly, the hospital business and the specialty business in many markets in Europe is managed directly between the manufacturers and the large health systems.

We believe that both the manufacturers and the governments and others that operate these enterprises would be much better off if McKesson was in the middle, through Celesio, trying to provide the streamlined supply chain and information stream that we do here in the United States. And we continue to make acquisitions in Europe that better position us in adjacencies outside of retail pharmacy. So we think that there are opportunities for us to grow our footprint, and you see us continue to invest in our infrastructure as Celesio so that we're prepared to do that. I think we have time for one last question.

Dave Francis, RBC Capital Markets.

John, thanks for squeezing me in. Real quick on the strategic front, can you talk a little bit about how the Rexall transaction reflects any change in your acquisition or business development philosophy as it relates to the retail footprint for McKesson in North America? Thanks.

Well, we try to be leaders in the businesses that we are participating in, and that's our objective. And so when we see an opportunity for us to lead in a market with a business that becomes attractive to us. We believe both in Canada as well as in parts of Europe, we have an opportunity to be number one or number two in the retail market. And we have the ability to bring that expertise to the rest of our customers where we partner closely with them, sometimes through ownership and sometimes not, in a way that builds value.

As it relates to the US, which is where some of these questions sometimes go, we don't see a real vertical opportunity in the US that would allow us to create that leadership position of being number one or number two in the US marketplace. So clearly, our strategy here in retail is to align very closely with people that we believe are great business partners that are also winning in their sections of the market, and stand clearly with independent pharmacies and other chains that are focused on having us help them in a more material way; so I think that that captures our strategy as it relates to retail.

Thank you for the question, Dave, and I want to thank you, Vicki, for your help with the call, and I want to thank also, all of you for your time today. I do think we've presented a very solid operating plan for fiscal 2017. I'm excited about the growth opportunities that I see across all of McKesson, and I'm certainly proud of our track record of delivering value to our customers and our strong financial returns for our shareholders. And once again, I want to thank all of our employees for a very strong fiscal 2016 and a very positive plan for fiscal 2017. And thank you all for your time again. Erin?

Thanks, John. We will participate in the Bank of America Merrill Lynch healthcare conference in Las Vegas on May 11. We look forward to seeing you in the new fiscal year. Thank you and goodbye.

Thank you for joining today's conference call. You may now disconnect. Have a good day.