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McKesson Corporation (NYSE:MCK)

Q4 2014 Earnings Conference Call

May 12, 2014 5:00 PM ET

Executives

Erin Lampert – Senior Vice President-Investor Relations

John H. Hammergren – Chairman, President and Chief Executive Officer

James A. Beer – Executive Vice President and Chief Financial Officer

Analysts

Steven J. Valiquette – UBS Securities LLC

Lisa C. Gill – JPMorgan Securities LLC

Ricky Goldwasser – Morgan Stanley & Co. LLC

Glen J. Santangelo – Credit Suisse Securities LLC

George R. Hill – Deutsche Bank Securities, Inc.

Charles Rhyee – Cowen & Co. LLC

Robert P. Jones – Goldman Sachs & Co.

Greg T. Bolan – Sterne, Agee & Leach, Inc.

David M. Larsen – Leerink Partners LLC

Operator

Good afternoon, everyone, and welcome to the McKesson Corporation Quarterly Earnings Call. All participants are in a listen-only mode. (Operator Instructions) Today's call is being recorded. If you have any objections, you may disconnect at this time.

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

Erin Lampert

Thank you, Talarie. Good afternoon and welcome to the McKesson fiscal 2014 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 will then introduce James who 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 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 which we exclude from our GAAP financial results, acquisition expenses and related adjustments, amortization of acquisition-related intangible assets, certain litigation reserve adjustments and LIFO related adjustments. We believe these non-GAAP measures will provide useful information for investors. Please refer to our press release announcing fourth quarter fiscal 2014 results available on our Web site for a reconciliation of the non-GAAP performance measures to the GAAP financial results.

Thanks, and here is John Hammergren.

John H. Hammergren

Thanks, Erin, and thanks everyone for joining us on our call today. We reported results for the fourth quarter and full year that reflect strong operating results across all of our businesses. For the full year, revenues were up 13% to $137.6 billion and adjusted earnings per share increased by 31% over the prior year to $8.35.

Fiscal 2014 was a year of exceptional execution across McKesson. There are many areas to highlight, but to name just a few we saw tremendous performance in our generics business, including strong growth in our proprietary OneStop Generics program. We delivered solid results from the first full year of the PSS World Medical acquisition and met or exceeded all of our year one integration priorities.

We expanded our long-standing distribution agreement with Rite Aid to include the sourcing and distribution of all of Rite Aid's brands and generic pharmaceutical requirements. And we secured the acquisition of Celesio in a disciplined manner and established a platform for McKesson as a global leader in pharmaceutical distribution.

In addition to these terrific accomplishments, we've generated $3.1 billion in operating cash flow for the year another outstanding result. We successfully funded the acquisition of Celesio while maintaining a solid investment grade rating, and we invested $415 million in capital to support the growth of our businesses.

I'm extremely proud of our accomplishments in fiscal 2014, and would like to take this opportunity to thank the employees of McKesson for their dedication to our customers and their constant focus on delivering exceptional value in all they do.

Today, we also provided fiscal 2015 guidance of $10.40 to $10.80 per diluted share and expected year-over-year increase in adjusted earnings per share of 25% to 29%, reflecting strong growth across our broad portfolio of businesses and the expected full year results of our acquisition of Celesio.

We are at an exciting time in the 181 year history of our company. We have a solid portfolio of growing businesses that are performing very well. We have the financial strength and discipline to continue to invest in the growth that we expect across our businesses and we've positioned McKesson as a leader in the global healthcare supply chain by expanding our success of leading global sourcing capabilities and direct relationships with our manufacturing partners to deliver value to our customers.

Turning for a moment to the broader industry environment. As we entered this election year healthcare topics remained in the spotlight both at Federal and State level. The long anticipated implementation of the key provisions of the Affordable Care Act were launched in recent months and I believe we are only at the beginning of the evolution we should expect to see in healthcare in the United States for years to come. With full suite of capabilities to help our diverse customer base navigate change we are actively engaged in supporting them as they evolve their business.

Pharmacies are increasingly positioning themselves as convenient alternative sites for primary care and offering services to patients to assist them in managing their health. Payers and providers are collaborating in innovative ways to design effective value based reimbursement programs that will slowly shift our fee for service based approach to a care delivery to our payment for value approach tied to outcomes delivered by providers. And consumers are more engaged in understanding the cost and quality of healthcare than ever before.

We see more health plans and employers offering effective incentives for preventive care as well as wellness programs to help people with chronic conditions manage their own health. Our customers continue to seek solutions to help them thrive in this dynamic environment. This includes solutions for reducing their costs, navigating evolving payment models, meeting increasing regulatory requirements and improving the quality and the customer experience.

McKesson stands unique in the industry for the depth of our knowledge and the insight and the challenges and opportunities our customers face. It is our comprehensive and solution-oriented approach that sets us apart as we focus on providing value for our customers and in return creating customers for life.

Moving now to some of the business results for our fourth quarter and full year. Distribution Solutions had another excellent year driven by strong execution in all of our businesses. In fiscal 2014, Distribution Solutions' revenue increased 13% and operating margins increased by 31 basis points over the prior year to 2.39%. North American distribution and services, which includes our U.S. Pharmaceutical business, McKesson Specialty Health and McKesson Canada delivered strong results for the year led by outstanding performance in our U.S. Pharmaceutical business. U.S. Pharmaceutical delivered tremendous growth in fiscal 2014 and led the strong expansion of our generics business.

Our OneStop proprietary Generics program continues to deliver great value to our customers and we were pleased to see excellent growth during the year. More of our customers are buying more of their generics from McKesson, which also helped fuel the growth in our generic business in fiscal 2014.

And as I mentioned earlier, we are extremely pleased with the trust and confidence that Rite Aid placed in McKesson by making the decision to expand their relationship with us to include the sourcing and distribution of all generic and brand pharmaceuticals, and I'm confident this agreement will deliver excellent value to both companies as we complete the transition over the coming months.

In fiscal 2014, we've also continued to perform well for our branded pharmaceutical manufacturing partners and maintain steady levels of compensation in return.

McKesson's global sourcing team continues to drive significant value for our Company and for our customers. Our team has developed innovative programs that help expand and foster strong partnerships with the best manufacturers across the globe. We are excited about the opportunities to continue to leverage this global sourcing capability as we expand our relationships going forward.

And finally, I'd like to mention Health Mart. Health Mart continued its strong track record of growth during our fiscal 2014, ending the year with nearly 3,300 stores. Our U.S. Pharmaceutical business continues to deliver innovative programs and services to our community pharmacy customers, and we are proud of our growing and thriving Health Mart community of pharmacists.

In summary, the U.S. Pharmaceutical team had an excellent year and I believe the business remains extremely well positioned for continued success.

Our Canadian distribution business delivered solid revenue growth in fiscal 2014. We expanded our business in Canada by winning new customers and growing our business with existing customers. And even in a tough generic pricing environment, we continued to see solid contributions from our Canadian business through efficient management of our distribution network, growth and investment in our Canadian specialty business and a constant focus on our customers' success.

Finally, our specialty business delivered solid financial results through growth across our broad portfolio of specialty solutions. We made steady progress in the growth of the number of physicians who are part of the U.S. oncology network, and we also grew our core oncology distribution and services business. We experienced solid growth in services for other multispecialty areas and strong adoption of our proprietary technologies for these specialist physicians.

Last year at this time, we were talking about the impact sequestration cuts were expected to have on medical oncology reimbursement. U.S. oncology continues to grow despite this headwind. One of the great advantages of our model is our ability to work with our physician partners to drive productivity and clinical advances across our network and that makes U.S. oncology a great place for physicians and an excellent care setting for patients.

Turning now to our results for international pharmaceutical distribution and services; upon achieving over 75% ownership of Celesio in February, we've begun to consolidate the financial results of Celesio into McKesson's financial results. Today, if you've seen our new reporting format, and going forward, the revenue results for Celesio reported and represented in our international pharmaceutical distribution and services line.

I will remind you that while we've begun to consolidate the financial results of Celesio, we are still working through the domination process, which upon completion will allow us to begin to exercise operating control over the Company.

We continue to believe that we will complete the steps required to register the domination agreement by the end of the first half of fiscal 2015. Upon achieving operating control of the Company, we can begin to work collaboratively with Celesio to implement our synergy plan. In the meantime, we've established a jointly staffed coordination office to begin important planning efforts in a number of functional areas. We are very excited about the opportunities that lie ahead with Celesio and at the same time, we are mindful of the hard work that is in front of us.

In fiscal 2014, reported results include two months of revenue for Celesio and therefore our reported year-over-year growth in international pharmaceutical distribution and services will increase significantly throughout the year. That being said, for McKesson's fiscal 2015, we expect to underline full-year revenue growth of this business to be in the low single digits.

Our medical-surgical business delivered strong results with 57% growth in revenues in fiscal 2014. The acquisition of PSS World Medical growth in our markets and terrific execution all contributed to this result. As I've mentioned all year, I've been extremely impressed with our team and the results they've delivered through the first year of the integration of this great business.

Now as we look ahead, the team has begun an important phase of the integration which includes combining the distribution and IT infrastructure of the companies. We have ambitious plans that we think are very achievable for this phase of the integration and we have the best team in the business to carry it through to success. What has been most notable to me in this integration effort is our team's steadfast focus on ensuring we are providing the best value and most comprehensive set of solutions to our customers.

For fiscal 2015, we expect revenue growth in the medical-surgical business to be in the mid-single-digits now that we have fully lapped the PSS acquisition.

Overall, I'm extremely pleased with our full year operating performance in Distribution Solutions, and I'm confident this business is very well positioned for the future. As we look ahead to fiscal 2015, we expect that revenue in Distribution Solutions will increase significantly driven by the acquisition of Celesio, and we expect operating margins to expand toward the upper end of our long-term margin goal of 200 to 250 basis points.

Turning now to Technology Solutions. For the year, Technology Solutions revenues were up 5% to $3.2 billion. Full year adjusted operating profit was up 25% to $467 million. I'm pleased to report that we made progress in a number of key areas, including delivering solutions for value-based reimbursement, helping customers optimize performance and analytics and business intelligence, and we're making advances now in our connectivity and data interoperability initiatives.

During fiscal 2014 we saw a solid growth in of our connectivity and payer-facing businesses, which serve as the foundation for the investment areas I mentioned earlier. And we continue to work with our customers as they deal with delays and the expected implementation of ICD-10 and meaningful use standards.

Looking forward to fiscal 2015, we expect Technology Solutions revenue will decline modestly year-over-year, as growth in our connectivity and payer-facing businesses will be offset by an expected revenue decline in other areas. We expect that operating margins in Technology Solutions will expand in fiscal 2015 to the upper end of our long-term margin goal of mid-teens.

In summary, we remain committed to helping our customers use information technology strategically to better enable business, better care, and better connectivity.

To wrap up my comments, I believe we have a strong plan as we enter fiscal 2015 to reflex growth across our broad portfolio of businesses, and capabilities of propelled McKesson, as a global leader in healthcare services. We're in the business that continues to generate strong cash flow from operations. We expect that our cash flow from operations will be approximately $3 billion in fiscal 2015.

I'm confident in our team's ability to continue to deliver value to our customers and strong financial returns to our shareholders. We expect fiscal 2015 adjusted earnings per diluted share of $10.40 to $10.80.

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

James A. Beer

Thank you, John, and good afternoon everyone. As you've just heard, we are very pleased by the strength of our results this quarter and for the full year. We've had a great year of operating performance including strong growth in adjusted earnings per share, record operating cash flow, and the acquisition of Celesio.

Looking forward, we believe our strategic and operational execution during fiscal 2014 will set the foundation for continued adjusted EPS growth.

Today, I will cover both the fourth quarter and full year results. I will also present guidance for fiscal 2015. As a reminder, we provide our guidance on an annual basis due to the seasonality and the quarter-to-quarter variability inherent in many of our businesses. Before I begin, there are three aspects of our financial results for our fourth quarter and full year that I would like to bring to your attention.

First, our fourth quarter and full year results reflect the consolidation of Celesio’s results for the two-month period ended March 31, 2014. In the fourth quarter and for the full year, McKesson's share of Celesio’s net income for the two-months ended March 31 was offset by a charge to cost of sales associated with a reversal of a step-up to fair value of Celesio’s inventory at the date of acquisition. Therefore McKesson's share of Celesio's results had no material impact on adjusted earnings for the fourth quarter and the full year.

Second, as detailed on Schedules 3A and 3B, we have revised our revenue presentation for the Distribution Solutions segment. Celesio's revenues are presented within a new caption called international pharmaceutical distribution and services.

Additionally, the results from our Canadian and U.S. pharmaceutical distribution businesses are now both included within a broader North America pharmaceutical distribution and services caption. This line also includes the revenues of our specialty business. Medical-surgical distribution and services business continues to be reported separately.

Lastly, it is also important to note that Schedules 3A and 3B provide segment financial results for the fourth quarter and full year, but reflect 100% of the results of Celesio for the two months ended March 31 in accordance with U.S. GAAP. You'll recall that the non-controlling interest in Celesio is presented below our net income line as outlined on Schedule 1.

Now let's move to our results. My comments today will focus on our full year fiscal 2014 adjusted EPS of $8.35, which excludes four items, the amortization of acquisition-related intangibles, acquisition expenses and related adjustments, certain litigation reserve adjustments and LIFO-related adjustments.

Now turning to our consolidated results, which can be found on Schedules 2A and 2B, consolidated revenues increased 25% for the quarter and 13% for the full year to $137.6 billion. Adjusted gross profit increased 35% for the quarter and 26% for the full year to $8.6 billion, primarily driven by strong execution in our distribution businesses, market growth and our acquisitions of Celesio and PSS.

Total adjusted operating expenses of $1.8 billion were up 50% for the quarter, driven mainly by our acquisition of Celesio. For the full year, excluding the impact of our recent acquisitions, total company adjusted operating expenses increased 5%.

For fiscal 2015, we expect operating expenses will increase year-over-year driven by the acquisition of Celesio. Other income for the full year of $46 million was 35% higher than the prior year, primarily due to non-recurring gains in the fourth quarter.

Full year adjusted interest expense increased to $28 million versus the prior year to $257 million. This increase was driven primarily by our acquisition of Celesio, including interest associated with our fiscal fourth quarter bond issuance of $4.1 billion, interest on debt used to initially finance the acquisition and interest on the debt acquired from Celesio. For fiscal 2015, we expect our year-over-year interest expense to be higher based on the new level of combined McKesson and Celesio debt.

Now moving to taxes, for the full year, our adjusted tax rate was 35.2%. Excluding the impact of the Canadian revenue agency third quarter charge of $122 million, we ended the year with an adjusted tax rate of 31.2%. Our full year adjusted tax rate was lower than our expectations driven by favorable discrete tax items recognized during the fourth quarter that contributed approximately $0.11 to our adjusted EPS. Our share of Celesio's results during the quarter did not significantly impact our full year tax expense.

Looking forward our fiscal 2015 outlook assumes an adjusted tax rate of approximately 31.5%. However this rate may fluctuate from quarter-to-quarter. Adjusted net income for the full year totaled $1.9 billion and our adjusted earnings by diluted share totaled $8.35.

Overall, this year's earnings per share benefited significantly from the strong performance in our U.S. pharmaceutical business specifically the favorable performance across our entire portfolio of generic pharmaceutical offerings. In addition, we realized a full year of contribution from our acquisition of PSS within our medical-surgical business.

Wrapping up our consolidated results, diluted weighted average shares outstanding decreased by 3% year-over-year to $233 million. This reduction was predominantly driven by $800 million in share repurchases completed late in our fiscal 2013.

Our diluted weighted average shares outstanding assumption for fiscal 2015 is $236 million. We have not planned for share buybacks in our FY 2015 plan. Particular FY 2015 capital allocation priorities include acquiring additional Celesio shares that may be put to us during our domination process and reducing our current degree of leverage, including planning for fiscal 2016 debt maturities.

That being said, it is important to note that there has been no change to our historical portfolio approach to capital deployment, which includes a mixture of internal capital investments, acquisitions, share repurchases and dividends.

Let's now turn to the segment results, which can be found on Schedules 3A and 3B. Distribution Solutions total revenues increased 26% for the quarter and increased 13% for the full year. Revenue growth was driven primarily by acquisitions completed during fiscal 2013 and 2014 and from market growth.

During fiscal 2015, we anticipate Distribution Solutions revenue growth will increase significantly driven by Celesio. North America Pharmaceutical distribution and services revenue for the full year increased 7%, driven primarily by market growth and our mix of business.

For fiscal 2015, we expect North America pharmaceutical distribution and services to deliver mid-single digit revenue growth compared to fiscal 2014. During the fourth quarter and full year, we recognized $4.8 billion of Celesio revenue in our international pharmaceutical distribution and services line. This line includes 100% of Celesio's revenues for the two months ended March 31, 2014.

For fiscal 2015, on a constant currency basis, we expect low single-digit growth in the underlying annual revenues of Celesio. Medical-surgical revenues were up 28% for the quarter and up 57% for the full year, driven by the acquisition of PSS. We continue to perform well against our three-year synergy business case. During fiscal 2015, we will continue our integration efforts while delivering mid single-digit revenue growth year-over-year.

Distribution Solutions adjusted gross profit increased 30% for the full year on a 13% increase in segment revenues, resulting in a 31 basis point improvement in our adjusted gross profit margin year-over-year.

As we look ahead to fiscal 2015, we expect continued adjusted operating profit growth for the segment driven by our acquisition of Celesio, further progress on PSS synergies and the contribution from our generic drug distribution and services businesses. Specifically, our generics businesses will benefit from increased generic launches, expanded one-stop sales and the breadth and depth of our global sourcing efforts.

Adjusted operating expense for the segment increased 39% for the full year, driven mainly by our acquisitions of Celesio and PSS. Excluding the impact of acquisitions, our full-year Distribution Solutions adjusted operating expense was up approximately 6% versus the prior year. Distribution Solutions full-year adjusted operating profit increased 30% to $3.2 billion and we ended the year with an adjusted operating profit margin of 239 basis points. In fiscal year 2015, we expect high single-digit basis point growth in the Distribution Solutions operating margin.

Turning now to Technology Solutions, revenues were down 1% for the quarter and up 5% for the full year to $3.2 billion as noted on Schedules 3A and 3B. Adjusted operating profit increased 138% for the quarter, primarily due to growth in higher margin revenues and the effect of $36 million in asset impairment charges taken in the fourth quarter of fiscal 2013.

For the full year, adjusted operating profit increased 25% to $467 million. Our full-year adjusted operating margin was 14.67% increasing 227 basis points year-over-year, primarily due to a favorable shift in our mix of income.

Adjusted operating expenses in the segment decreased to 10% for the quarter, primarily driven by impairment charges incurred in the prior year and increased 3% for the full year. Looking ahead to fiscal 2015, we expect Technology Solutions revenues to decline modestly year-over-year as growth in our payor facing and connectivity businesses will be offset by a revenue decline in our Horizon hospital software business along with the impact of eliminating a low-margin product line. During the coming year, we expect to achieve a mid-teens adjusted operating margin, in line with the high-end of the range for this previously articulated long-term goal.

Moving now to the balance sheet and working capital metrics. Since only two months of Celesio’s results were included in the quarter and year, I’ll discuss our working capital metrics excluding Celesio. However, these metrics include the full year of results from our acquisition of PSS.

For receivables, our days sales outstanding remained flat at 25 days. Our days sales in inventories decreased one day from the prior year to 32 days. Our days sales in payables increased to 53 from 51 days in the prior year. Our working capital metrics, along with our continued focus on cash generation, resulted in record cash flow from operations of $3.1 billion during our fiscal year. We ended the year with a cash balance of $4.1 billion, with $2.4 billion held offshore.

Looking ahead, we expect cash flow from operations to be approximately $3 billion for fiscal 2015. Internal capital spending totaled $415 million for the full year, which includes Celesio spending of $15 million for the two months ended March 31. For fiscal 2015, internal capital spending should be between $575 million and $625 million, with the increase being primarily driven by Celesio.

Before concluding my remarks, I would like to briefly review some of the important aspects of our acquisition of Celesio. As discussed during our third quarter earnings call, we launched a tender offer for the remaining outstanding common shares of Celesio during our fiscal fourth quarter. This tender offer closed subsequent to the end of our fiscal year and consistent with our expectations only nominally increased our ownership in Celesio to approximately 76% on a fully diluted basis.

With greater than 75% ownership in Celesio, we continue to expect that we will secure operational control late in the first half of our fiscal 2015. The current fiscal 2015 adjusted EPS guidance contemplates the anticipated transaction accretion and the modest synergies that we expect to derive from Celesio in the coming year. It is important to note that in our fiscal 2015 guidance, we have assumed that we own 76% of Celesio. We have also assumed an exchange rate of $1.36 per euro.

Now, before I conclude, I would point out that in today’s earnings press release, we detailed the key assumptions for fiscal 2015 adjusted earnings per diluted share of $10.40 to $10.80. As always, our plan includes certain risks, but overall, we are very pleased with our outlook for the coming year.

Our plan provides strong adjusted EPS growth from our continued operational and strategic execution, and allows us to create significant value for our customers, manufacturing partners, and shareholders.

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. Talarie?

Question-and-Answer Session

Operator

(Operator Instructions) We will take our first question from Steven Valiquette, UBS.

Steven J. Valiquette – UBS Securities LLC

Thanks, good afternoon. Just a question on the generic price trends. You had that – there was a bullet in the slide deck or in the press release about price trends on generics outside the exclusivity periods expected to be in the high single-digits, and you’re saying that’s a decline from the trend in fiscal 2014. So I just want to make sure; firstly, you’re talking about growth there sort of declines, but also I think both of them I think are probably a lot higher than what I thought they were as far as the trend lines for fiscal 2014 and 2015. So I guess any additional color on what’s going on there would be definitely helpful? Thanks.

James A. Beer

Well, as you say, the guidance that we have there in the press release talks about growth in FY 2015. It’s between the high-single-digit realm. Yes, that is lower than the percentage growth that we saw for generics that are past that exclusivity period that we saw in fiscal 2014. So, it is a relative headwind year-over-year, but still growth for fiscal 2015 year-over-year.

John H. Hammergren

Steven, these are price trends, not the growth of the market overall. This is just the trend of price inflation on generics. So we do expect this year to be a good launch year for generics.

Steven J. Valiquette – UBS Securities LLC

Okay. For the quarter just reported though, was there pretty consistent trends in the March quarter versus what you saw back in the December quarter sequentially or was there a little bit of tapering off on some of the economics tied to that? Just curious on the sequential quarterly trend.

John H. Hammergren

Well, at the beginning of the year, we talked about the strength in the first half of the year and we expected that to moderate in the back half and that’s exactly what we saw in our third and fourth quarters.

Steven J. Valiquette – UBS Securities LLC

Okay, perfect. Thanks.

Operator

We’ll move on to Lisa Gill with JPMorgan.

Lisa C. Gill – JPMorgan Securities LLC

Thanks very much and good afternoon. John, I just want to make sure that I understood this correctly. Operational control late in the first half of 2015, but, just being conservative as far as the guidance goes on Celesio?

John H. Hammergren

Well, the operational control is a technical accomplishment that has to be reached after a shareholder meeting and a bunch of other things that we have to do from a European perspective or German perspective. So that is proceeding as we have planned. There is no change in our forecast when we expected to achieve operational control.

As you recall, we wanted to have the 75% threshold, which we thought would enable this to happen in the timeframe that we’ve outlined. We did pick up another percent in ownership from 75% to 76%, which is really also what we had expected. Our guidance that we talked about – we said in our guidance that Celesio was going to grow moderately this year including our first year modest synergies. So, I’m not quite sure what portion of our guidance you’re asking the question about. Is it the operational control, the ownership percentage or talk about the…

Lisa C. Gill – JPMorgan Securities LLC

Yes. Maybe just trying to understand that a little more clearly. So, you are talking about the operational control first half of 2015, but you are saying that ownership is at 76%. At 76%, you don’t have operational control, isn’t that correct?

John H. Hammergren

That’s correct. We have to go through a couple of more steps. We don’t believe there is any risk in us not obtaining operational control, but we don’t have it automatically just from ownership. We don’t need 100% to get operational control. So what will happen is, we’ll get this operational control, which will allow us to be more interactive with the company than we can today, because we still have a responsibility with regard to operational control to manage the business independent of McKesson and that will change when we achieve operational control.

The difference between 76% and 100% ownership is just how much of the earnings we actually consolidated in the end and that’s what James was trying to describe. So we have 100% of the revenue in, we take out the minority ownership from an earnings perspective on that full schedule.

Lisa C. Gill – JPMorgan Securities LLC

Okay, that’s very helpful.

James A. Beer

And I’d just add to that if I could, the attainment of operational control towards the end of the first half of fiscal 2015 that allows us to really get going on the synergy business case.

Lisa C. Gill – JPMorgan Securities LLC

And then just so I understand when you look at for example Celesio reported today and may talk about the German market reimbursement economics getting better. Are those trends that you are going to talk to us about John or James going forward and what are your overall thoughts on those markets right now?

John H. Hammergren

Well, it’s difficult for us to talk about their view of their markets until we get operational controls. So I think you should expect us to be more open and perhaps, discuss more freely what’s going on in the various businesses inside of Celesio and various markets inside of Celesio. Our view, I have spent a lot of time in Europe now with the country managers and I think Paul, and I both would share a point of view that business is run by professional managers we respect and admire what they are doing in many of their markets.

And in their press release this morning, they did talk about the strength in their European pharmacy network activities and the strength in particular, Lloyds out of the U.K. and we certainly have seen some of that in our travels. I think it’s probably difficult for us to speculate at this point what will happen with the German discounting in the outside our end of our fiscal year, which is really what they are referring to.

Lisa C. Gill – JPMorgan Securities LLC

Okay, great. Thank you for the clarification.

John H. Hammergren

Yes.

Operator

And next, we’ll move to Ricky Goldwasser with Morgan Stanley.

Ricky Goldwasser – Morgan Stanley & Co. LLC

Yes, hi, good afternoon. Some questions around the Rite Aid contribution, so how should we think of the ramp up for the Rite Aid distribution agreements throughout the year? Also, does guidance factor in improved economics to OneStop from your enhanced scale that comes with the Rite Aid contract?

John H. Hammergren

Thanks for the question, Ricky. The guidance we’ve provided includes our entire outlook for the year. so it does include our view of the ramp-up of our relationship with Rite Aid. What’s great about the Rite Aid relationship for both Rite Aid and McKesson is that we don’t have any structural impediments to our speed to market and we were able to move very rapidly once that agreement was complete to work with our manufacturing partners to begin building momentum against the opportunity that lies ahead for all of us.

I would say to you that I think we’re substantially complete now with the work that we need to do with manufacturers. As to the rollout of the service offering to Rite Aid related to distribution of generics, we’re very, very early in that process. We have only just begun the process of serving the Rite Aid stores or some of the Rite Aid stores with their generic requirements.

Ricky Goldwasser – Morgan Stanley & Co. LLC

Is that something that will take your full fiscal year to achieve?

John H. Hammergren

I think it will ramp up over the next half of the year. Next two to three months, we should be well into it.

Ricky Goldwasser – Morgan Stanley & Co. LLC

Thank you.

John H. Hammergren

Yes.

Operator

Next, we’ll move on to Glen Santangelo with Credit Suisse.

Glen J. Santangelo – Credit Suisse Securities LLC

Hey John, I just want to follow up on the generic question. Essentially, given that the Celesio revenues are now sort of being consolidated and you’ve pulled Rite Aid into the fold, and I guess you answered this by suggesting that substantially you’ve completed all the work with the manufacturers. I guess what I’m kind of curious is, have you been able to take that incremental volume amount to the manufactures and start to renegotiate the terms of those agreements? And if you’re not, are you starting to see some benefits today and if not, how long will that ultimately take?

John H. Hammergren

When I spoke about the Rite Aid implementation, the first step really was to bring the combined volumes of our corporations together and go to the marketplace to make sure that we are providing the best opportunity to the manufacturers to gain access to that share position. We are now in the process of implementing the generics actually into – the distribution business into Rite Aid, but the value for McKesson relative to the renegotiation should begin to be realized basically effective right now at the beginning of this fiscal year.

I might note however that none of the Celesio synergies or volumes or generic purchases, et cetera have been included in any of this upfront work with the manufacturers. It’s simply been McKesson’s business that has continued to grow and thrive, including the incremental Health Mart stores we’ve added, as well as the increment of Rite Aid generic bind that we were able to put together and complete – as I said, substantially complete the negotiations with manufacturers as we sit here today. And clearly, as we get into the late summer months, we should be reworking those relationships to include the Celesio volume as well.

Glen J. Santangelo – Credit Suisse Securities LLC

So James, and if I could just follow up on that Celesio accretion analysis. Essentially, when you guys first announced the deal, I think you suggested it’d be a $1 to $1.20 accretive and that was with very modest synergies. Now that you have76% ownership, should we think about that year one accretion being in the $0.75 to $0.80 range with only moderate synergies because based on John’s comments, it kind of sounds like the Company hasn’t been able to bring those volumes into the fold and start to really exercise some of that synergy potential at this point.

James A. Beer

Well, we stand by the $1 to $1.20 of accretion for 100% of the ownership. Of course, as you say, we’re only at 76% and that was for the first 12 months of operations, after beginning of February. So in essence, we got the first two months of that in the Q4, just finished and then the balance of the 10 months, we’d be receiving in fiscal 2015. Now, the reason that we ended up net neutral in fiscal 2014 was because we had this one-time inventory write-up consistent with the acquisition accounting and so forth.

Glen J. Santangelo – Credit Suisse Securities LLC

Okay, okay. Thank you.

Operator

Next, we’ll move to George Hill with Deutsche Bank.

George R. Hill – Deutsche Bank Securities, Inc.

Hey. Good afternoon, John and James. Thanks for taking the question, John; I don’t know if I missed – if I didn’t hear this properly. I didn’t hear NorthStar mentioned in the prepared comments. I guess, can you provide any color on how Northstar’s doing and when you’ll have the chance to provide NorthStar products to Rite Aid and Celesio?

John H. Hammergren

We continue to make great progress with NorthStar and in fact, have launched a version of NorthStar that’s called, Savant in Canada. And so both of those product lines are continuing to gain momentum. Now, clearly, we’re working closely with the manufacturing community to make sure we’ve got the best choice of product and the best choice of partners and the Rite Aid agreement does include NorthStar as one of the value offerings to both companies.

As it relates to Celesio, which is probably premature to talk about, what we might be able to do with NorthStar or with the NorthStar model as it relates to many of the markets in Europe, but we clearly will have that as part of our evaluation as we get into that next phase.

George R. Hill – Deutsche Bank Securities, Inc.

Maybe a quick follow-up. A couple of your competitors are using JV or GPO type structures for the procurement of generic drugs. Is that something that makes sense to do with the inclusion of Celesio, or is the straight integration just McKesson buying the drugs directly from manufacturers and selling through the – I guess, through the supply chain, is that the right way? I guess, I’m just trying to think about industry structure going forward? Thank you.

John H. Hammergren

No problem, George. We don’t plan to have any JVs or any type of unusual structure to get access to the synergy we believe are possible, and there was no JV structure as it relates to Rite Aid, will not be one related to Celesio. It will be McKesson’s sourcing operation that does all of the work.

George R. Hill – Deutsche Bank Securities, Inc.

Thank you.

John H. Hammergren

Yes.

Operator

We’ll move on next to Steve Halper with FBR & Company.

John H. Hammergren

Steve, are you on mute?

Operator

Mr. Halper, your line is now open.

Erin Lampert

Talarie, maybe, we’ll move to the next question.

Operator

Certainly, and we’ll move on to the next question from Charles Rhyee with Cowen & Company.

Charles Rhyee – Cowen & Co. LLC

Yes, thanks. Can you guys hear me?

John H. Hammergren

Yes.

Charles Rhyee – Cowen & Co. LLC

Okay, hey, guys. Thanks for taking the question. John, just going back to Celesio real quick. Obviously, you’re going to the core process. You talked about a jointly staffed coordination office. Can you talk about specifically what then – is this more focused on the integration itself, or is this, as other people have kind of asked, more towards how you approach manufacturers?

John H. Hammergren

Well, it’s a little bit of both. A part of that coordination activity is to make sure we’re getting after the synergies that we think exist in the primary synergies we’ve outlined in our conversations regarding Celesio is around product sourcing. so clearly, that’s a top priority and those teams are already beginning to do some work. But as I said it really can’t accelerate until we get pass this operational control phase. With the other part of the project management or coordination office role is to make sure that we understand what Celesio is working on today and what they might need our assistance with, things like IT or other kinds of projects that we might be able to lend a helping hand to. So, I would say that it’s basically a process of understanding more completely Celesio’s operations and corporate functions, so that work is under way.

Charles Rhyee – Cowen & Co. LLC

Great. And as a follow-up James. I don’t know if I saw it in the assumptions you gave on the guidance. Can you give us an estimate of, what sort of interest expense are you expecting for fiscal 2015? Thank you.

James A. Beer

Yes. We would expect interest expense to be rising year-over-year, consistent with the new debt that we took on to finance Celesio. So that is all publicly available and so I’ll just leave at there at the moment.

Charles Rhyee – Cowen & Co. LLC

Great, thank you.

Operator

We’ll move on to Robert Jones with Goldman Sachs.

Robert P. Jones – Goldman Sachs & Co.

Thanks for the question. Just wanted to go back, John, if I could to the generic inflation assumption in guidance. I know this has been a tailwind if you will for the last several years. It seems like Distribution Solutions, I was just curious, how much visibility do you have into this variable and given that your expectations are for it to moderate a bit into fiscal 2015. Just wondering what the main drivers of that in your view could be?

John H. Hammergren

Well, the inflation – just to remind the listeners, generics has been driven by a relatively small subset of the overall generic portfolio and a relative small subset of manufacturers. Like any other estimate that we have to make, whether it’s brand inflation or generic inflation or generic launches, et cetera, what we attempt to do is use the best resources we have internal to the company and whatever resources are available externally to create those views. I think we were correct on our assumption that it was going to moderate in the back half of this year, of fiscal 2014 which it did, and we believe the assumption we’ve given relative to FY 2015 is our best thinking as it stands today for what inflation will be.

It certainly could be wrong, and the manufacturers don’t typically tell us what they’re going to do. One of the reasons we state our assumptions so clearly in our press release is, so those of you on the phone can create your own view of our assumptions, and provide that input into your own models as you reflect on what we’ve done. But we still think it’s going to be an important part of our 2015 performance. We expect it to still be very solid, and it just will be slightly less than we experienced in 2014.

Robert P. Jones – Goldman Sachs & Co.

Got it. That’s helpful. And then just a quick follow-up within specialty. John, you continue to sound very pleased with the performance of U.S. oncology. I was wondering if you’ve seen a shift at all in the site of care within oncology treatment? Any pressure in the marketplace for oncology treatment to be done more in the acute care setting?

John H. Hammergren

We do see that pressure. It ebbs and flows depending on the markets and where our physicians are based. I would say that the pressure is not coming from payers and it’s not coming from patients. The pressure is usually driven by the purchase of a practice where a local hospital or hospital system decides to buy a group of oncologists that were customers of McKesson.

And many times if the hospital is a customer of McKesson, we’ll retain all of that business, clearly if it just go through standard distribution. But I think the beauty of the U.S. Oncology model is that, many times we’re able to follow those physicians into the hospital setting and begin to manage the practices on behalf of the hospital, maybe you pick up net new physicians that are part of the network as the hospital relies on our expertise to continue to work with those doctors to optimize the quality of care and the cost of that care.

So, although it continues to be something we have to pay attention to, and on occasion we’ll lose a practice if a customer that goes into a hospital and we don’t have any affiliation with the hospital afterwards and obviously, that’s a net loss for us. But I would say the team has been very good at working with our customers in these transitions and retaining our position.

Robert P. Jones – Goldman Sachs & Co.

Got it. Thanks.

John H. Hammergren

Yes.

Operator

We’ll move on next to Greg Bolan with Sterne Agee.

Greg T. Bolan – Sterne, Agee & Leach, Inc.

Thanks for taking the question. So just a few technical questions, James. Celesio, was it fair to say that it added about 700 basis points to total revenue growth in the fiscal fourth quarter?

James A. Beer

Yes. It added about $8 billion in revenue in fiscal fourth quarter.

Greg T. Bolan – Sterne, Agee & Leach, Inc.

Okay, got it.

James A. Beer

Yes.

Greg T. Bolan – Sterne, Agee & Leach, Inc.

Okay. Thank you, and then, I know obviously annual guidance is being given here and that’s historically been the case, but just as you think about how the first half of the fiscal year will gate into the second half, obviously you’ve got Celesio that will be coming on board from an earnings contribution perspective in the back half, as well as – well, I guess that was somewhat offset kind of a slight headwind from a little bit lower generic pricing increases. So, is it kind of fair to say, first half 45% of earnings and back half 55% of earnings, if we kind of think about the midpoint of guidance?

James A. Beer

Well, just one thing I misspoke on the Celesio revenue that was $4.8 billion in Q4, not $8 billion.

Greg T. Bolan – Sterne, Agee & Leach, Inc.

Got it, thank you.

James A. Beer

So in terms of the mix of earnings during the year, what I would point to is that last year, we had particularly strong earnings in the first half of the year, year-over-year and that was driven by somewhat unusually high generic price increase activity. So returning in our fiscal 2015 plan to more the profile that we saw in fiscal 2013 back through fiscal 2011 that type of picture in some quarterly seasonality.

Greg T. Bolan – Sterne, Agee & Leach, Inc.

Okay, that’s very helpful. Thank you.

Operator

We will move next to David Larsen, Leerink Partners.

David M. Larsen – Leerink Partners LLC

Hi, congratulations on a good quarter. For the $1 to $1.20 in Celesio synergies, can you just describe what the nature of that is and would that be expected to be achieved after domination is realized? Thanks.

John H. Hammergren

So that’s an accretion number, not a synergy number. The synergy number was $275 million to $325 million realized over four years, with a modest impact this fiscal year.

James A. Beer

Yes. So the $1 to $1.20 of accretion is very largely just our share of Celesio’s earnings. Now again, that always assumed 100% ownership and we only own 76% of the shares at this point. So it’s important to factor that into account.

David M. Larsen – Leerink Partners LLC

And then the driver of the synergies $275 million to $325 million, can you just talk about the nature of those please?

James A. Beer

By far the most significant driver there are the purchasing synergies that we would look to be able to attain over time. As John said, we’d look to get to $275 million to $325 million per year by year four. So, it will really be that procurement synergy effort that drives that to some modest amount of tank savings that we believe will be available as well.

David M. Larsen – Leerink Partners LLC

Great. Thanks a lot.

John H. Hammergren

So operator, I don’t think there are any other questions on the phone. So, I think that we’ll wrap this up. I want to thank all of you on the call today for your time. We certainly have a strong plan in place for fiscal 2015 and we’re excited about the tremendous growth opportunities that are available to us across McKesson. I’m certainly once again; proud of our track record in our delivery to our customers and the tremendous financial returns we’ve delivered to our shareholders this year and for many years, and I also want to thank all of our tremendous employees for their effort this last year on driving that success for us.

With that, I’ll turn it over to Erin for a view of upcoming events for the financial community.

Erin Lampert

Thank you, John. I have a preview of upcoming events. We will participate in the UBS Global Healthcare Conference in New York on May 20th and the Goldman Sachs Healthcare Conference in Rancho Palos Verdes on June 11th. We will release first quarter earnings results in late July. We look forward to seeing you at one of these upcoming events. Thank you and good-bye.

Operator

And everyone, that does conclude our conference call for today. Thank you all for your participation.

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