麥卡遜 (MCK) 2017 Q1 法說會逐字稿

Welcome to McKesson Corporation quarterly earnings call.

(Operator Instructions)

This call has been recorded. I would now like to introduce Mr. Craig Mercer, Senior Vice President, Investor Relations.

Thank you, Justin. Good afternoon and welcome to the McKesson FY17 first 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. After James's 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'll remind listeners that during the course of this call, we will make forward looking statements within the meaning of the 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 particular, John and James will reference items, excluding cost alignment plan charges and foreign currency exchange impacts.

In addition, I would call to your attention the 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 operating performance and comparability of financial results period over period.

Please refer to our press release announcing first quarter FY17 results and the supplemental slides for further information and a reconciliation of the non-GAAP performance measures to the GAAP financial results. Thank you and here is John Hammergren.

Thanks Craig. And thanks everyone for joining us on our call. Today, we reported a solid start to FY17. In the first quarter, we achieved total Company revenues of $49.9 billion, up 5% and earnings per diluted share of $3.53, up 18%, both on a constant currency basis versus the prior year. We are maintaining our full-year guidance range of $13.43 to $13.93 for FY17.

Before I dive into the operating results for the quarter, I'd like to take a moment to highlight some recent events that continue to demonstrate our commitment to long-term shareholder value creation. First, we continue to proactively develop our portfolio of businesses. In the past quarter alone, we closed seven acquisitions, including Biologics, Vantage Oncology, and UDG Healthcare. We started the important work to expeditiously integrate and achieve each acquisition's underlying business case. And we divested our Brazilian pharmaceutical distribution business.

Second, we jointly announced with Change Healthcare, the creation of a new company to deliver a broad portfolio of solutions that will help lower healthcare costs, improve patient access and outcomes and make it simpler for payers, providers and consumers to manage their transition to value-based care.

This [good] healthcare information technology company will offer complementary capabilities and will help enhance opportunities to benefit customers, employees and shareholders. This is a significant undertaking for both McKesson and Change Healthcare during the past few quarters and I'm pleased with our progress in driving this transaction forward.

Last, in May, we announced a strategic sourcing partnership with Walmart. Walmart is a very sophisticated company. Not just on the logistics side but around our sourcing and procurement operations. The selection of McKesson as a clear endorsement of not only long-term partnership but also McKesson's world-class pharmaceutical sourcing and procurement capabilities.

Building a long-term relationship makes sense for Walmart and we were the right partner. Our advantage relative to others in the industry is our ability to combine our exceptional operational excellence with our global scale and sourcing expertise.

First, it takes quality people that are trained and experienced to make this happen. Second, it takes great partners on the manufacturing side to make the supply chain work effectively. And last, it takes a continuous source of knowledge and analytics around what's possible to make great procurement decisions. All of these things positioned McKesson as the best partner in the industry.

We've had a very busy first quarter and are encouraged by the work of our employees to successfully execute against so many important initiatives.

Turning now to our business results for the quarter. Distribution Solutions revenues were $49.2 billion, up 5% on a constant currency basis. And Distribution Solutions' adjusted operating profit was $1.1 billion, flat to the prior year on a constant currency basis, and in line with our original expectations.

Our North America Pharmaceutical Distribution and Services business, which includes US Pharmaceutical, McKesson Specialty Health and McKesson Canada, drove revenue growth in the first quarter of 5% on a constant currency basis, despite the lapping effect of our customer consolidations that occurred late in FY16. Revenue in our US Pharmaceutical business met our expectations in the first quarter, driven by strong growth in customers across the retail, institutional and independent channels.

Note that effective April 1, we started servicing the combined Albertsons and Safeway network of nearly 1,700 pharmacies in the US under our new five-year distribution agreement. And I am pleased with our team's execution to onboard this important customer, which includes the sourcing and distribution of both branded and generic pharmaceuticals.

I would like to take a moment to highlight our strong and growing community of independent pharmacy customers. Last month, we hosted our annual ideaShare Conference for our independent retail pharmacy customers, including significant participation from our Health Mart partners. With approximately 4,700 stores nationwide, Health Mart has grown by 50% over the past three years.

This growth is attributed largely to, first, our focus on helping our independent retail pharmacy customers deliver and be recognized for top clinical performance; and second, our delivery of innovative solutions and implementation support that helps members compete and grow their business.

Some important tools available to our independent retail pharmacy customers include Health Mart's Pathway To Better Pharmacy performance and profit a step-by-step approach to help members navigate the changes in today's retail pharmacy market and stay ahead of the curve. And My Health Mart, a proprietary online portal that enables pharmacies to proactively manage their business.

Additionally, as a market leader in managed care solutions, McKesson's access help provides the education, expertise and tools pharmacies need to gain access to and compete in preferred networks. In summary, I'm proud of the value we deliver to our independent pharmacy customers and the innovative services and solutions that set us apart from the competition.

Turning now to McKesson Specialty Health. We again delivered impressive growth in our Specialty business, driven by the performance in oncology and other multi-Specialty categories. I would like to spend a minute to highlight an example of our progress and commitment towards the transition to value-based care.

It started from Medicare and Medicaid innovation is developing a new payment and delivery models designed to improve the effectiveness and efficiency of specialty care. Among those specialty models is the oncology care model, or OCM, which aims to provide higher-quality, or highly coordinated oncology care at the same or lower cost to Medicare.

Under the OCM, [physician] practices enter into a payment arrangement that include financial and performance accountability for care related to chemotherapy. The practices participating in OCM have committed to providing enhanced services to Medicare beneficiaries such as care coordination, navigation, and national treatment guidelines for care.

Earlier this month, we announced that 12 practices affiliated with the US Oncology Network, representinig approximately 800 physicians who will participate in the OCM. In total, approximately 3,200 physicians were chosen to participate in the OCM, which means our network-affiliated physicians represented one-fourth of all participating physicians.

And if we consider customer supported through our Onmark GPO and Vantage Oncology affiliated practices, McKesson Specialty Health supports nearly 50 practices that have been selected and unparalleled commitment to value-based oncology. The OCM marks a major milestone, a shift to value-based cancer care and we congratulate all of our affiliated practices selected to participate in this innovative program.

We remain committed to new care delivery models that will better position our affiliated practices to more effectively operate from a clinical and financial perspective and build further upon our strength in this transformation to value-based care.

Moving to our Canadian business, we had nice growth in the quarter with the results that were in line with our expectations. Our Canadian operations represent a diverse collection of businesses, similar to those in the US, with a particular emphasis on specialty and retail.

We expect to close the previously announced Rexall transaction later this calendar year, which will further enhance McKesson's retail pharmacy capabilities, procurement scale and best-in-class pharmacy care for patients across Canada.

Turning now to our results for International Pharmaceutical Distribution and Services. Revenues for the first quarter were $6.4 billion, up 9% year over year on a constant currency basis.

Operating performance from growth was slightly below our expectations for the quarter due to recent retail pharmacy reimbursement changes in the UK. While schedule reimbursement cuts were expected, there were further unanticipated cuts made by the UK government effective in April and June this year, which impacted the first quarter and will impact the remainder of the year.

Despite the unanticipated events around the recent reimbursement changes as well as the UK's decision to exit the EU, we continue to believe that Celesio represents a strong, long-term range growth opportunity across retail, wholesale and specialty.

And finally, our Medical Surgical Business performed well in the quarter, with revenues at $1.5 billion, an increase of 2% over the prior year, driven by market growth, partially offset by the prior year sale of the ZEE Medical business in the second quarter of FY16. Excluding the prior year second quarter sale of ZEE Medical, growth in the segment was 4%.

In summary, I'm pleased with the performance of our Distribution Solutions segment in the first quarter. We continue to expect Distribution Solutions revenue growth of high single digits compared to the prior year and a full-year adjusted operating margin will remain flat relative to the prior year.

Turning now to Technology Solutions, revenues were down 1% for the first quarter to $725 million on a constant currency basis. Driven primarily by an anticipated revenue decline in our Hospital Software business and the prior year sale of our Nurse Triage business, largely offset by growth in our other technology businesses.

Technology Solutions operating margin was up significantly relative to the prior year. Our first quarter results benefited from growth in our payer solutions and connectivity businesses, including favorable timing and lower operating expenses. We continue to make steady progress across Technology Solutions.

Our continued efforts to deliver customer success and improved profitability positions our technology business well for the future with Change Healthcare. I remain confident in our Technology Solutions outlook for the full year, which includes an expectation for achieving adjusted operating margin in the low 20% range for the segment.

Now to wrap up my comments. McKesson's fiscal first-quarter results represent solid execution across both segments and we are maintaining our full-year outlook for FY17 at a range of $13.43 to $13.93.

We're extremely well-positioned to execute our portfolio approach to capital deployment and deliver a value for our shareholders through a mixture of internal capital investments, acquisitions, share repurchases and dividends. With that, I will turn the call over to James and I will return to address your questions when he finishes. James?

Thank you, John, and good afternoon, everyone. As John mentioned today, we reported results which reflect a solid start to FY17. Before I get to our results, I want to note that in addition to our earnings press release, and customary tables, we have published a supplemental presentation on our website.

This presentation provides an operational or baseline view of our FY17 earnings in constant currency. This baseline view excludes the impacts of cost alignment charges from our adjusted earnings as well as a gain on the sale of a business in the first quarter of the prior year. During my remarks, I will refer to this supplemental slide presentation to review our FY17 first quarter baseline consolidated earnings and FY17 earnings outlook.

I also plan to reference the first quarter baseline consolidated and statement gross profit, operating expense, and operating margin values provided within this presentation.

Now let's move to our results for the first quarter. Our adjusted EPS was $3.50 per diluted share, which excludes four items: amortization of acquisition-related intangibles, acquisition expenses and related adjustments, claim and litigation reserve adjustments, and LIFO-related adjustments.

Baseline EPS was $3.53 per diluted share on a constant currency basis. As a reminder, our FY16 adjusted EPS of $3.14 per diluted share included a gain on the sale of the Nurse Triage business totaling $0.16 per diluted share.

Our consolidated results can be found on Schedules 2 and 3 of the tables accompanying our press release. Consolidated revenues for the first quarter increased 5% in constant currency.

I will now refer you to slides 3 and 4 of the supplemental presentation. First quarter baseline gross profit was up 1% in constant currency year over year, driven by global procurement benefits, recent business acquisitions, and an incremental pre-tax gain related to antitrust settlement proceeds, largely offset by the expected weaker profit contribution from generic pricing trends and the impact of previously disclosed customer consolidation activity.

First quarter baseline operating expenses decreased 2% in constant currency, reflecting actions taken in the fourth quarter of FY16 related to our cost alignment plan. Adjusted other income was $23 million for the quarter, an increase of 53% in constant currency, consistent with our FY17 guidance. Interest expense of $79 million decreased 11% in constant currency fourth quarter.

Now moving to taxes, our adjusted tax rate was 27.1%, which includes the discrete tax benefit of $37 million, or $0.16 per diluted share driven by an amended accounting standard related to share-based compensation that I mentioned at our Investor Day in the late June. I would note that while the impact of this standard may fluctuate from quarter to quarter, in general, the largest effect will likely continue to occur in our first quarter due to the timing of the expiration and vesting of our share-based compensation awards.

For FY17, we continue to expect a total impact of approximately $0.20 due to this amended accounting standard. As a result of this accounting change, we now expect an adjusted tax rate of approximately 30% in FY17. However, as a reminder, this rate may fluctuate from quarter to quarter. McKesson's baseline net income from continuing operations totaled $805 million in constant currency, excluding after-tax cost alignment charges of $5 million.

I will now refer you to slide 5 of the supplemental presentation. Our first quarter baseline earnings per share of $3.53 increased 18% in constant currency versus the prior year. Year-over-year currency headwind equated to $0.01 per diluted share. Wrapping up our consolidated results, diluted weighted average shares outstanding decreased by 3% year over year to 228 million. We continue to expect a full-year share count of 228 million.

Let's now turn to the segment results, which can be found on Schedule 3 of the tables accompanying our press release. Distribution Solutions segment revenues of $49.2 billion were up 5% in constant currency during the quarter.

North America Pharmaceutical Distribution and Services revenues increased 5% in constant currency in the quarter, primarily reflecting growth in our US Pharmaceutical Specialty and Canadian businesses as well as the contribution from our recent acquisitions. International Pharmaceutical Distribution and Services revenues were $6.4 billion for the quarter, up 9% in constant currency driven by market growth and acquisitions. Revenues were modestly impacted by approximately $35 million in unfavorable currency rate movements.

Moving now to the Medical Surgical business, revenues were up 2% for the quarter, driven by growth in our primary care business, partially offset by the prior year sale of the ZEE Medical business.

I will now refer you to slide 6 of the supplemental presentation. Distribution Solutions baseline gross profit was flat on a constant currency basis for the quarter.

Baseline gross profit reflected the anticipated weaker profit contribution from generic pricing trends, customer consolidation headwinds and lower compensation from our branded pharmaceutical manufacturer when compared to the prior year.

As we've discussed previously, the year-over-year impact from weaker generic pricing trends were more heavily impacted the first half of our FY17. For the full year, we continue to expect a nominal contribution from generic pharmaceuticals that increased in price. Benefiting our first quarter baseline gross profit was the incremental impact of a pre-tax gain related to an antitrust settlement recorded in the quarter which was contemplated in our original FY17 guidance.

As a reminder, in Q1 of FY16, we recorded a pre-tax gain of $59 million related to antitrust settlement proceeds so the year over year impact in the most recent quarter from these settlements totaled $83 million. We continue to expect that branded pharmaceutical pricing trends will be modestly below those experienced in FY16.

Let's now move to slide 7 of the supplemental presentation. First quarter Distribution Solutions segment baseline operating expenses were flat on a constant currency basis. The segment operating expenses benefited from the cost alignment plan actions taken in late FY16 and lower operating expenses due to the sale of ZEE Medical in the second quarter of FY16.

I will now refer you to slide 8 in the supplemental presentation. Distribution Solutions first quarter segment baseline operating profit was flat in constant currency at $1.1 billion.

The segment adjusted operating margin rate for the quarter was 231 basis points, a decrease of 11 basis points on a constant currency basis, driven by the expected weaker generic pricing trends, recent customer consolidation and lower compensation from our branded pharmaceutical manufacturer, offset by the anticipated antitrust settlement recorded in the quarter, global procurement benefits and lower operating expenses. We continue to expect the segment baseline operating margin to approximate the FY16 baseline operating margin.

Now turning back to Schedule 3 of the tables accompanying our press release. Technology Solutions revenues were down 1% for the quarter to $725 million on a constant currency basis, driven by the anticipated decline in our Hospital Software business and the prior-year sale of the Nurse Triage business, partially offset by growth in our other technology businesses.

I will now refer you to slides 9 and 10 of the supplemental presentation. First quarter baseline segment gross profit was up 11% on a constant currency basis. Driven primarily by the timing of a few items that were originally expected later in FY17. First quarter baseline operating expenses in the segment decreased 10% in constant currency from the prior year, driven by actions related to the cost alignment plan.

Let's now move to slide 11 in the supplemental presentation. Baseline segment operating profit increased 53% in constant currency, resulting in an operating margin of 24.55%, up 879 basis points over the prior year. This improvement was driven by our continued focus on higher margin businesses, lower operating expenses and certain timing benefits. We continue to expect the full-year segment baseline operating margin to be in the low 20% range.

I will now review our balance sheet metrics. As you've heard me discuss before, each of our working capital metrics can be significantly impacted by timing, including which day of the week marks the close of a given quarter.

For receivables, our days sales outstanding increased one day from the prior year to 27 days. Our days sales in inventory were flat from the prior year at 30 days. And our days sales in payables increased six days from the prior year to 59 days.

We generated $1.9 billion in cash flow from operations during the first quarter. We continue to 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 with the US Government, which we had previously disclosed in April 2015.

We ended the quarter with a cash balance of $4.7 billion, with $2.5 billion held offshore. Internal capital spending totaled $114 million for the first quarter.

We continue to deploy capital in line with our portfolio approach. In particular, we have been active on the M&A front, announcing the creation of a new company with Change Healthcare as well as closing seven acquisitions during the quarter. And yesterday, the Board of Directors approved the quarterly dividend of $0.28 per share.

I will now turn to our FY17 outlook and refer you to slide 12 in the supplemental presentation, which outlines our anticipated year-over-year baseline earnings growth. As John discussed earlier, we are reiterating our FY17 outlook of $13.43 to $13.93, which excludes approximately $0.12 to $0.15 and expected charges related to the cost alignment plan announced in March of 2016.

This range provides baseline earnings growth of 7% to 11% year over year. Our outlook anticipates a foreign currency rate headwind of approximately $0.10 during FY17, consistent with our recently updated guidance announcement on June 29.

And as a reminder, on May 4, we guided that our FY17 results would be weighted to the second half of the fiscal year. We continue to expect to generate approximately 48% of our earnings in the first half of the year. As a reminder, given the expected timing of the close of the transaction with Change Healthcare, we are not currently assuming that the creation and operation of the new company will impact our FY17 adjusted earnings per diluted share.

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. Justin?

(Operator Instructions)

Eric Coldwell, Baird.

Thanks and good afternoon. In the 10-Q tonight, I noticed that there is a comment on Distribution Solutions gross margin being impacted by lower compensation from a branded pharmaceutical manufacturer. I'm sure that's a fairly obvious item. I can guess at what manufacturer that might be but I'd love any commentary you have on that and just want to make sure it's not more of a sector theme as opposed to a one-off situation?

Thanks for the question. I think your perspective is probably correct and I would like to just further by saying our relationship with the branded manufacturers remains pretty consistent across the board. Our contracts renew on a regular basis with very minor modifications to the terms and typically what you see here is basically a difference in the yield year on year from an existing agreement with an existing supplier.

And again, John, do you think that's clearly a one-time item with this one manufacturer?

Well, certainly the magnitude of it is. If you think about the year-on-year change in pricing behavior, that's really what's the driver behind it.

Got it. Thanks very much.

Garen Sarafian, Citi Research.

Good afternoon. First, I guess I'll take care of obligatory international generic inflation moderation question. In your prepared remarks, you reiterated your expectation of expected nominal contribution to earnings but could you just elaborate a little bit further as to what you've seen since last quarter, just to give us more insight?

Yes. Really, it's been a very similar theme in recent months. So I wouldn't, frankly, point to any particularly notable change quarter over quarter.

Okay, and then on implementing Walmart, congratulations on that deal. But could you discuss the timeline of when this will occur? You mentioned that being operational by end of FY17 but I'm wondering what are the critical steps that are preventing some of the benefits from occurring earlier? For example, wouldn't that leave some of your current contracts be tiered for additional volume so that you could benefit from incremental scale sooner?

Our agreements, as you point out, are in place today and one of the things we will be doing as we go to market with the Walmart relationship will be modifying those agreements to reflect not only the incremental volume delivered by Walmart but a, really, a combination of the terms and other features of these contracts that exist with both organizations.

I do think there clearly is some nominal value that may be delivered in FY17. We really think that the preponderance of the value will be delivered in FY18 and I think it's consistent with what we said before and that's still what we think, Garen.

Okay, fair enough. (multiple speakers)/

Garen, just to add to that, that it does take some months to impact the physical side of these relationships, and that was very much the case when we implemented the broader relationship with Rite Aid, for example.

Right. Got it. Thanks again.

Charles Rhyee, Cowen.

Thanks for taking the question. John, obviously, you're closing with the -- you have the Rexall business in Canada. You are running retail operations in the UK, and with Health Mart, obviously, a franchise business, any reason at some point in the future with the way the retail market is consolidating in the US. Does it ever create an option for you to branch that into the domestic side on the US side of the business into a retail pharmacy?

Well, I think we've been asked the question before obviously and our chosen path in the US is to partner with our customers and as you mentioned independents, in particular, have been great partners and a growing base of our business, particularly, the transition of our customer base from just buying wholesale services from us to being partners in the Health Mart business.

And that really is a much more intimate relationship than one where the customer benefit significant way from our involvement and clearly, we do as well because they buy more and more of their products and service requirements from us. And we have lots of other customers that are very successful in competing in this market.

And frankly, we just don't see it an alternative for us to enter the market directly, both it would benefit us but also at the same time, allow us to provide additional benefit to our customers. So I just don't see us entering the retail space directly in the US and we'll continue to support our customers as we have in the past.

I appreciate it. And then as a follow-up, if we look at the regional chains, outsiders of the big major retail chains, can you talk about your share in the more regional chains across the US and what that landscape looks like? And do those tend to be Health Mart customers or when we think about Health Mart, we're thinking about even smaller numbers -- owned stores? Thank you.

You're welcome. Most of the regional chains have their own very strong brands and they -- particularly, if they are part of a combination where they are selling groceries or warehousing kind of marketing tools. There probably is little interest for them to use the Health Mart brand.

But obviously, we would be open to them participating with Health Mart in any way that we can. I would say the preponderance of our Health Mart stores are independent stores, and maybe aggregated in regional chain-like setups, but they would still be small in terms of total numbers of stores per aggregator, if that's the way to explain it.

Okay. Thank you.

Ricky Goldwasser, Morgan Stanley.

Hi. Good evening. A couple of questions here. First of all, John, can you comment on the discussions, the ongoing discussions with manufacturers on specialty pricing models?

Well, we're very excited about the growth in our specialty business overall. We've made significant strides in building out our value proposition for the customers. You heard us talk about oncology in particular, but -- and several of the specialties I think we are very well-positioned and the business continues to grow at rates that will be at or above market level so we are well-positioned. We are pleased with the array of services that we provide.

Clearly, the manufacturer and the customer are both important aspects of driving profitability in that business. And we are continuing to expand the relationships in both directions and we do believe that the manufacturers benefit significantly by using our services and are willing to pay for those services because it certainly reduces a lot of the financial and logistics workloads that they had on their laps.

So I hesitate to speak universally about our classic customers, but I think our relationships with the manufacturers are very sound and those relationships continue to build.

Okay. And then a follow-up question on the numbers. Just because of the moving parts here, so first of all, James, was the $0.38 in litigation benefit that you talked about in the (inaudible), did you assume that it will be all captured in the June quarter?

Yes. That was our assumption going into the year. I mentioned back on the January earnings call that it was a single case and that it was quite far along. So that was very much a part of our initial full-year guide to you.

And then the other thing really just to emphasize is the fact that we also have an antitrust settlement of substantial scale in Q1 of last fiscal year, and so the year-over-year impact from these antitrust settlements is $83 million versus the much larger figure that we recorded specifically in this Q1.

Okay and when we think about the margin because obviously, for us, would we model those operating margin assumptions are important and the last year, you've given us some guidance there. You haven't this year so when we think about the quarter, right, in Schedule 2, it's 2.29% in distribution solutions. If we back out the benefit from that settlement, we get to around I think 2.03%, what should we be using as a base for the remainder of the year? Is the --

Well, I -- just reemphasize that for the full year, we are expecting the distribution solutions operating margin to be in line with that of the prior year. And so, yes, we're obviously off to a stronger start in Q1 because of this antitrust settlement very much benefiting us in the back quarter.

But really, the overall story for the year is flat. The other thing I just further emphasize again, as you think about the first-half/second-half split is that we expect about 48% of the earnings for McKesson to come in the first half versus the second half.

We can go back and check our guidance at the beginning of the year but I believe we did give you a margin guidance. It was in line with what we just said, flat (multiple speakers) for four years.

That's right. We haven't changed that guide since we initially laid out guidance.

And to make sure that we are all using the same base for 2016, should we use the 2.29% for the year?

It's 2.34%; the same [piece]. (multiple speakers)

Okay. So excluding the restructure. Okay.

Right. That's the way you should think about it.

Okay, thank you.

Steven Valiquette, Bank of America Merrill Lynch.

Thanks. Good afternoon, John and James. I guess for us, there's been obviously some discussion in the pharma supply channel this year about lower penetration rates as some of the more recent individual first-time generic launches relative to the brand. Can you just remind us again your observations on that subject and really, just specifically, it seems to us that maybe some of those key generics that were in question have now actually achieve a much higher penetration rates with the passage of some additional time this year. Just curious to get your latest thoughts on that subject? Thanks.

Well, in terms of brand-to-generic conversions, we went into the year believing that we would see a lower overall profit contribution than have been the case in the prior fiscal year. And obviously, Crestor has been a big launch early in the year, and based on what we've seen there, we don't have any change in our point of view. We would continue to believe that we will see a lower profit contribution from these brand-to-generic conversions.

There really isn't much of a change in our past experience based on what we're seeing today. I think that's the best way to sum it up, Steven.

Okay. One other quick one just on the cost alignment plan progress. I guess as you dug deeper into your operations, have you found any new or additional sources of savings or is everything about as expected with that whole program?

That's moving along as I expected it to. Again, the point where we last talked about our guide, so no, so it's very much on track as expected.

I think the charges you will see this year are charges we anticipated when we launched the program last year. They just had to be recognized when they were realized and some of them were going to be realized this year so it's not a new cost alignment plan. It's a continuation of the one that has already been completed and the financial impact of some of those charges rolled into this year.

That's right. Some of the charges have to be taken in FY17 versus the bulk that we took in FY16.

Okay, great. Okay, thanks.

Lisa Gill, JPMorgan.

Thanks very much. John, I just wanted to follow up on an earlier comment that you made up around the branded manufacturer. I'm just curious, as we think about inventory management agreements on your branded business, I think in the past you've talked about 85% to 90% are under inventory management agreements. Are you seeing any changes in that other 10% to 15% as some of those manufacturers come under pressure to have a more firm relationship with the distributor or more defined relationship like some of the larger manufacturers do?

I think we have not see much of a change in the big relationships. They remain pretty consistent, and I just remind people that even in some of the larger relationships, there is exposure that remains both positive and negative depending on how you look at it relative to their price increase activities.

And so when we talk about the year-over-year change, you can imagine that with that particular manufacturer, we benefited from their previous price increase patterns and in this quarter, have benefited to a lesser degree and that's why we call it out, but I don't -- if you step back from that specific individual company, we're not really seeing any change to the character of our relationships.

Okay, that's helpful. And then secondly, just looking at the technology side of your business, coming in better than at least our expectations in the quarter, I'm just wondering if it beat your expectations and if there is anything notable to call out within that business in the quarter?

Well, we ran through some of the drivers. Obviously, we were very pleased with the progress of the results there, very much a focus on the higher margin businesses. Very much lower expenses as a result of the cost alignment plan, and so forth, but at the same time, there were also some timing items that benefited Q1 that I would expect to reverse out in Q2. So I'd just temper those situations with that last thought.

And you heard us in our prepared remarks talk about the low-20% type of margin, which is slightly below, obviously, what we recorded in the first quarter which is reflective of us going back to a more normal run rate. But I would agree with you that we see the business performing very well and it sets us up nice as we think about the completion of our transaction with Change Healthcare and we think customers, in particular, and investors will benefit significantly from the combination.

That's helpful. Thank you.

Ross Muken, Evercore ISI.

Good afternoon, guys. So a lot of confusion I can sense from my inbox on the implied Q2 guide. And I realize you guys don't typically give a ton of sequential commentary but I think some of issue is just off of what they -- to think about the 48% in the first half. So I just, one, want to make sure we're all talking about the same numbers in terms of which of the two annual forecasts with or without the CAP we're speaking to and to make sure we've got clarity?

And then if you could just help us other than the sequential shift, obviously, in the antitrust-plus tax, how to think about the progression aside from those two factors?

So the base from which we're making that 48% first-half comment is very much from our guide of $13.43 to $13.93, which is excluding $0.12 to $0.15 of CAP charges. So that's the base from which you should start. In terms of Q1 versus Q2 items, I just mentioned to Lisa, the point that I would expect there to be some timing items around the technology solutions business.

And then, obviously, Q1 benefited substantially from the antitrust settlement that approximately $0.38 in the quarter, equivalent to a year-over-year impact of $83 million and then in terms of the change in accounting around share-based compensation, as we discussed at Analyst Day, that was going to be $0.16 benefit for Q1. And then only another incremental $0.04 over the balance of the year so just directionally, about $0.01 or so benefit in Q2. So I think those are the important drivers, if you will, of the Q1/Q2 split.

Okay. Now that was helpful. And maybe just quickly for John, was there anything in either of the two lead candidates for President, the platforms that you thought were notably relevant for the business. I mean, obviously, more recently, a lot of it was made on PARV and a few other things but I'm just curious if anything stuck out to you that was notable?

Well, I think the thing that's most notable is that in both platforms, you hear a discussion about cost and quality at some level. And clearly, we believe the healthcare industry is headed on a continued improvement front on both of those dimensions. We need to take cost out of the healthcare system and we need better visibility to quality and people are increasingly going to be paid in a way that reflects the value they deliver on those two dimensions.

So I think regardless of the candidate that wins or the party platform that gets adopted, we're trying to help our customers prepare for that environment of more cost pressure and more inspection of their ability to deliver value and part of it is also requiring them to collaborate and connect across the boundaries of their individual businesses.

So I would say that, that theme is a thing that stuck out the most, is it -- I think the issues that have been raised from the previous administration around these issues will, or I should say, the interest rates around these issues in the previous administration will continue.

Thank you.

David Larsen, Leerink.

Can you talk about your ability to move share with biosimilars please and how that may differ from some of your competitors? Thanks.

Well, we are pleased with our position in specialty, as I mentioned a few moments ago and I think that our business has continued to focus heavily on our ability to add value to our customers and to deliver through our scale and knowledge of product and an improved value. Clearly, biosimilars produce an opportunity for us to reduce costs and deliver quality to our customers and in places where we can influence the selection of the biosimilars, we believe we will benefit and our customers will benefit.

Clearly, part of the challenge biosimilars face in the market is their ability to prove the equivalent of their product compared to the originator, and we think, in particular, our US oncology network is prepared to work with manufacturers, to do the type of work that will be necessary not only to prove to us that the product produces a similar result at a lower cost, but also provide a beachhead or benchmark from which other customers can be convinced given the rigor and discipline that our network uses to evaluate these types of opportunities.

So I think in some categories, we may not have much influence, but clearly, in products that are used in clinics or in oncology practices, in particular, we are very well-positioned to create value for the manufacturers and as a result, deliver value to our customers through that relationship with the manufacturers.

Great and then regarding Omnicare, Optum and Target, we're completely through all those as of this quarter; is that correct?

No, I wouldn't put it that way. I think it's important to note that the year-over-year headwinds from both generic pricing effects and customer consolidation, the cash where you were just referring to are very much weighted to our first half for the fiscal year. So once you get into the second half, they are significantly less, but they are very relevant in the first half of FY17 year over year.

Great, thank you.

Robert Jones, Goldman Sachs.

Great, thanks for the questions. John, you mentioned the change in reimbursement in the UK. Any chance you could give us a sense or quantify the headwind that, that creates in FY17 versus your previous expectations and then within international, I know the original guidance was for low double-digit constant currency revenue growth. Does that still hold true in light of these reimbursement changes?

Well, I will let -- (technical difficulty) first question a little bit. The second question you may have to repeat so I make sure I fully understand what it was. On the first one, I think that the second change in the UK -- the first change we understood and we saw it coming and we had prepared our organization to make moves to offset it and to grow through it.

And I think the second change was almost equal in its magnitude related to the first change which was not insignificant, so the second change is going to be more problematic for us and that's I think what we're preparing to deal with as we go through this fiscal year. If you step back from those two issues, the Celesio businesses are performing quite well.

And in fact, we're making progress in almost every country to improve our market position, our operational efficiency, getting our products service levels up. And so on, if the technology is necessary to support the business, including moving into the areas, hopefully, like specialty and the hospital business, et cetera, over time. So I think we're quite pleased with the progress of the businesses, and I think that the second hit in the UK was not anticipated, and frankly, will be a little bit of a headwind for that business this year.

I guess just, John, to the follow-up on that specifically, was just previously you guys had talked about low double-digit constant-currency revenue growth in the International business. I was asking in light of the second reimbursement hit, does that expectation still hold true for the International business' revenue growth?

The significant driver of that double-digit revenue guide is really the effect of the acquisitions that we closed a number of them in Q1. We have others yet to close, including the Sainsbury's transaction, for example. So really, that will be the driver of our ability to execute against that double-digit guide.

It's probably fair to say that the cuts in the UK are not a significant impact on the revenue side of Celesio and so we would expect those earlier forecasts to hold. It's more of an issue to earnings in the business than it (multiple speakers).

Yes, that's right.

Okay, understood. Thank you.

George Hill, Deutsche Bank.

Good afternoon, guys, and thanks for taking the question. James, I think if we think about the gross margin pressure, the gross margin erosion. If you were to just bucket it by order of magnitude, if we think about the tough comps on generics, how much of it is mix kind of brand versus generic versus specialty? And how much of it is just kind of the changing of the business mix, given the M&A that's gone on? I guess how should we think of the leading drivers of generic pressure -- I'm sorry, of margin pressure?

If you think about the gross profit margin, I would really point you back to the impact of on the year-over-year basis, the impact of generic price increased activity, and the customer consolidation issue. Particularly, on the care and the Target pharmacist. That's really the most significant pairing that's driving the gross profit margin line. And then the other thing that we've spoken about this afternoon is that, that branded manufacturer, and the compensation that we happen to have driven from them in this particular quarter.

Compared to prior year.

I guess then maybe if I step back and I back all this out, if I think -- if I back out the items in Q1 of last year and the items of Q1 of this year, would gross margin actually have been up ex the generic drug pricing impact, like where margins are actually extended?

The -- no, I would say the effect of those customer consolidations have a significant impact on the gross profit line in Q1, and again, that factor and the generic pricing increase factor will be significant in the first half of our fiscal year so in Q2 as well.

Okay, and maybe just last quick follow-up. John, I know it's early in the process but any interest in EIS yet, and has a process started to get rolling yet? Thank you.

It's probably too early to talk about EIS. Clearly, we are focused on making sure we maintain that customer base and continue to develop the product and retain the people and as we have news to update you guys on, we will certainly bring it to you.

Thank you.

Greg Bolan, Avondale Partners.

Thanks, guys. So just going back to Ross's question because we're definitely getting pinged as well here. So the -- I just want to make sure we're all on the same page, as we think about -- so if we use $3.17 in 2Q of last year, just backing out the benefits of ZEE Medical and what they implied is for the second quarter, it looks like potentially down year on year, just in terms of earnings growth in 2Q.

Is that just the remainder of the residual impact from this negative comp, if you will, in generic pricing and then we start to lap that to some degree as we get into the third and the fourth quarter? Is that another way to think about it as well?

Yes. I just emphasized again the impact in both Q1 and we expect in Q2 of the twin effects of the generic pricing environment, the lack of price increases relative to the prior year, and the effect for us of the move of Omnicare and Target away from us. So those are both going to be significant drivers in both Q1 and Q2.

Okay, perfect. Thanks, James.

Well, thank you, Justin, for helping us out today and thanks to all of you on the call for your time today and McKesson is off to a good start for FY17. And I'm excited about the opportunities ahead of us. I want to recognize the outstanding performance of our employees and their contributions to driving better business health for our customers every day. I will now turn the call back to Craig for a review about upcoming events for the financial community. Craig?

Thank you, John. A preview of upcoming events for the financial community. On September 13, we will present at the Morgan Stanley Global Healthcare Conference in New York; on November 8, we will present at the Credit Suisse Healthcare Conference in Scottsdale, Arizona. We will release second-quarter earning results in late October. Thank you and good-bye.

Thank you. That does conclude today's conference call. We do thank you for your participation today and have a great day.