Mckesson Corporation (MCK) — Q3 2015 Earnings Call Transcript

Thank you, Travis. Good afternoon, and welcome to the McKesson's Fiscal 2015 Third Quarter Earnings Call. I'm joined today by John Hammergren, McKesson's Chairman and CEO; and James Beer, McKesson's Executive Vice President and Chief Financial Officer. John will first provide a business update and will then introduce James, who will review the financial results for the quarter. After James' comments, we will open the call for your questions. We plan to end the call promptly after one hour at 6 p.m. Eastern Time. Before we begin, I remind listeners that during the course of this call, we will make forward-looking statements within the meaning of federal securities laws. These forward-looking statements involve risks and uncertainties regarding the operations and future results of McKesson. In addition to the company's periodic, current, and annual reports filed with the Securities and Exchange Commission, please refer to the text of our press release for a discussion of the risks associated with such forward-looking statements. Finally, please note that on today's call, we will refer to certain non-GAAP financial measures, in which we exclude from our GAAP financial results acquisition expenses and related adjustments, amortization of acquisition-related intangible assets, and LIFO-related adjustments. We believe these non-GAAP measures will provide useful information for our investors. Please refer to our press release announcing third quarter fiscal 2015 results available on our website for a reconciliation of the non-GAAP performance measures to the GAAP financial results. Thanks. And here's John Hammergren.

Thanks, Erin, and thanks, everyone, for joining us on our call. Today, we reported solid results for the third quarter, with total company revenues of $47 billion and adjusted earnings per diluted share from continuing operations of $2.89. In addition to the solid execution across our business, our third quarter results benefited from a pull-forward of certain brand price increases into the quarter, which had previously been anticipated in the fourth quarter. Our third quarter results also reflect a lower-than-expected tax rate driven by the intense enactment of recent legislation. James will address both of these items in further detail in his remarks. I'm pleased with the strong performance of our business for the first nine months of the fiscal year. We've updated our outlook and now expect adjusted earnings per diluted share from continuing operations of $10.80 to $10.95 for fiscal 2015. Before I begin my review of our business results for the quarter, I will provide a brief update on our acquisition of Celesio. During the third quarter, we achieved an important milestone with the formal registration of the domination and profit and loss transfer agreement. As I mentioned in my remarks last quarter, with this milestone now complete, McKesson and Celesio can begin our cooperative work to deliver the synergy case we have outlined, where we expect to achieve $275 million to $325 million in annual synergies by the end of fiscal 2019. We've established a new global procurement and sourcing office based in London to begin the work associated with realizing the synergy case we have outlined. The team, consisting of seasoned executives from both McKesson and Celesio, will focus on expanding our relationships with our manufacturing partners and further building upon our global sourcing capabilities. As the needs of the health care industry continue to evolve, broader global reach, channel influence, and greater purchasing scale are increasingly important. We're excited to serve our customers as one of the largest pharmaceutical wholesalers and providers of health care services in the world. Moving now to our business results. Distribution Solutions had strong results in the third quarter with revenue of $46.3 billion, up 38% as reported and up 39% on a constant-currency basis. Distribution Solutions' adjusted operating profit was $1 billion in the third quarter, up 33% as reported and up 34% on a constant-currency basis. North American distribution and services, which includes our U.S. Pharmaceutical business, McKesson Specialty Health and McKesson Canada, delivered strong results for the third quarter, with 17% revenue growth on a reported and constant-currency basis compared to the prior year. This growth was primarily driven by strong growth within our existing customer base, including further penetration of our generics programs, solid market growth, and the demand for recently launched drugs for the treatment of hepatitis C. Our U.S. Pharmaceutical business continues to deliver excellent value for our customers. During the third quarter, we were extremely pleased to have expanded our long-standing relationship with Omnicare, the nation's largest institutional pharmacy and a leading specialty pharmaceutical services provider. For over ten years, Omnicare has partnered with McKesson for the distribution of branded pharmaceuticals. As part of our expanded agreement, McKesson will now have responsibility for the sourcing and distribution of generic pharmaceuticals as part of McKesson's proprietary, OneStop Generics program. We are proud of the value we deliver as our customers choose McKesson as not only their distribution partner but also their sourcing partner. Our customers value the strength of our OneStop program, our industry-leading service levels, and the working capital efficiencies we are able to drive on their behalf. We also created outstanding value across our independent pharmacy customer base. I'm pleased to share that Health Mart was recently named Pharmacy Innovator of the Year by Chain Drug Review, a leading pharmacy industry publication. We are proud to accept this award on behalf of all of our independent pharmacies who are on the front line caring for patients every day. This recognition acknowledges Health Mart for its commitment to giving member pharmacies the tools they need to thrive in their markets, its efforts to enhance and expand the scope of pharmacy practice, and the pharmacy's consistent high-level performance in terms of patient satisfaction. We are privileged to partner with our Health Mart pharmacy customers and to provide the tools that enable them to grow their business and enhance the deep relationships they have with their customers. In summary, our U.S. Pharmaceutical business continues to deliver tremendous results as we strengthen and expand our relationships with our customer base. Turning now to our specialty business. We had another quarter of excellent results. In addition to the strength of our oncology business and the growth we are driving in other specialties, such as ophthalmology and rheumatology, McKesson's Specialty Health offers a tremendous value proposition to our pharmaceutical manufacturing partners. Our specialty manufacturing services span across the entire pharmaceutical life cycle, from R&D to post-commercialization and maturity. We are unique as a partner to manufacturers in facilitating clinical trials. US Oncology has conducted more than 1,400 clinical trials including 120 early phase studies, and more than 60,000 patients have participated in these trials conducted by US Oncology. US Oncology Research has participated in the development of more than 300 investigational products, including 51 FDA-approved cancer therapies, which represents nearly one-third of cancer therapies approved by the FDA to date. Manufacturers value our deep clinical understanding and the expertise of our provider-centered organization. We also have a leading technology set of assets customized for the needs of specialty providers and focused on driving better patient outcomes. And as the leader in community oncology, we have the benefit of tremendous scale in the market. I am pleased with the strong results of our specialty business in the quarter and believe we remain very well positioned to serve our customers and partners in this exciting market. Our Canadian business had another solid quarter with the results that were consistent with our expectations. In addition to the growth at our core distribution business, we are driving great results with our extensive base of independent pharmacies operating under one of our many banners, the expansion of our private-label generics program, Sivem, and the growth in our specialty business in Canada. Turning now to our results for international pharmaceutical distribution and services. Revenues for the third quarter were $7.3 billion, an increase of 7% on the underlying results of Celesio on a constant-currency basis. As I mentioned earlier, we are extremely pleased to have reached a key milestone on achieving operating control of Celesio during the third quarter. We're only just beginning to do the work to bring together these two great organizations, and I remain excited about the opportunities we see as we move forward together. Turning to our Medical-Surgical business. Revenues were $1.6 billion for the first quarter, an increase of 7% over the prior year. We continue to see solid growth across the alternate site markets we serve, and our third quarter results also reflect an increase in sales of flu vaccines and supplies compared to the prior year. We are entering the third and final year of our PSS integration efforts. We remain on track to deliver the synergies we had previously outlined, and I continue to be impressed with the progress made by our Medical-Surgical team. In summary, Distribution Solutions performed well in the third quarter, driving excellent service and value for our customers and delivering strong financial results. Technology Solutions' revenues were down 7% for the third quarter, driven primarily by anticipated revenue softness in our Horizon clinical software platform and the planned elimination of a product line, both contemplated in the original guidance we provided in fiscal 2015. Adjusted operating margin in the segment was 16.3% in the quarter, consistent with our expectations for this business. I am pleased with the progress we've made as we evolve our Technology Solutions portfolio. Increasingly, we are hearing about the shift toward value-based reimbursement in the delivery of health care. Just last month, the Department of Health & Human Services announced the goal of tying the vast majority of traditional Medicare payments to quality or value metrics by 2016. At McKesson, we are focused on helping our customers prepare for this shift to value-based reimbursement. And we have the unique expertise and set of solutions to position our customers for success as their businesses evolve. The important component of the shift to value-based care is enabling patients and providers to have a holistic view of the patient across different settings of care through data interoperability, which is why we are proud members of the CommonWell Health Alliance. The CommonWell Health Alliance continues to expand, with new members joining, additional studies of care added, and more provider sites going live. Through CommonWell, we are committed to leading the industry towards a vision of patient-centered interoperability that moves us well beyond the challenges of today's point-to-point exchange towards an environment where the right health information is available to the patient at the right time. We will continue to focus on our key strategic priorities for Technology Solutions, including helping our customers reduce costs and operate more efficiently, providing our customers with solutions to drive improved analytics, and supporting our customers' transformation to a world of value-based care. Now to wrap up my comments for Q3. We delivered solid results in the third quarter and I'm pleased by the great execution we have seen across our business. We've updated our outlook for the full year and now expect adjusted earnings per diluted share of $10.80 to $10.95 for fiscal 2015. In addition to the solid operating performance in the third quarter, we continue to have a strong balance sheet. For the first nine months of the fiscal year, we generated cash flows from operations of $1.2 billion, and our expectation to deliver cash flows from operations of approximately $3 billion for fiscal 2015 remains unchanged from our original guidance. With that, I'll turn the call over to James. And we'll return to address your questions when he finishes.

Thank you, John, and good afternoon, everyone. As you've just heard, we are pleased with our third quarter operating results, driven by the solid performance of our Distribution Solutions segment. Late in the third quarter and consistent with our expectations, we secured operating control of Celesio. As we look ahead, we are working to execute against our previously articulated synergy case and are beginning our integration efforts. Today, I will walk you through our third quarter consolidated financial results and I will also provide an update on our fiscal 2015 outlook. Later in my remarks, I will highlight revisions to our financial statement presentation, subsequent to achieving operating control of Celesio, alongside key transaction milestones and assumptions. Before I review our third quarter results, there are four items that I'd like to bring to your attention that I hope will give you a better perspective on our performance in the quarter. First, in addition to the solid execution across our business, our third quarter results were aided by a lower-than-expected tax rate, primarily due to the passage of recent legislation. The related reduction in our tax expense for the quarter contributed approximately $0.13 to our adjusted earnings. Second, our third quarter Distribution Solutions' adjusted operating profit reflects a timing benefit, primarily from a pull-forward of certain brand price increases from our fiscal fourth quarter into our fiscal third quarter. This benefit contributed approximately $0.09 to our adjusted earnings. Third, during our second quarter earnings call, we discussed our average exchange rate assumption of $1.31 per euro, applicable to our fiscal 2015 adjusted EPS guidance range. While currency rate movements did not have a material impact on our adjusted EPS during the first half of our fiscal year, I indicated that we expected a negative foreign currency translation impact of approximately $0.04 during the second half of fiscal 2015. The actual adjusted EPS impact from currency movements during our fiscal third quarter was approximately $0.03 per share. Given the recent strengthening of the U.S. dollar, we are now assuming an average exchange rate of $1.15 per euro in the fourth quarter. This would drive a negative foreign currency translation impact of approximately $0.04 to our adjusted EPS in the fourth quarter. In summary, the negative foreign currency translation impact on our full year adjusted EPS, as compared to our original plan, is now anticipated to be approximately $0.07 versus the previously guided $0.04. Lastly, we realized a $0.05 benefit from an update to our accounting for the noncontrolling interest in Celesio, which I'll cover later in my remarks. We now expect adjusted earnings per diluted share from continuing operations of $10.80 to $10.95 for fiscal 2015, based on a full year average exchange rate of $1.29 per euro. Now let's move to our results. My remarks today will focus on our third quarter adjusted EPS from continuing operations of $2.89, which excludes three items: Amortization of acquisition-related intangibles; acquisition expenses and related adjustments; and LIFO-related adjustments. Turning now to our consolidated results, which can be found on Schedule 2A. Consolidated revenues increased 37% for the quarter to $47 billion. On this 37% revenue growth, adjusted gross profit for the quarter increased 52% to $3 billion, driven by Celesio and the performance of our other Distribution Solutions businesses. Total adjusted operating expenses of approximately $2 billion were up 61% for the quarter. Excluding the impact of Celesio, operating expenses increased 3% for the quarter. Other income was $13 million during Q3. Interest expense increased 64% versus the prior year to $97 million, driven by debt issued and assumed related to our acquisition of Celesio. Now moving to taxes. This quarter's adjusted tax rate benefited significantly from the R&D and international tax provisions of legislation passed in December 2014, which applied retroactively to the beginning of the calendar year. The resulting benefit of approximately $20 million, in addition to other discrete items, reduced our Q3 tax rate to 28.7%. For the full year, we now expect our adjusted tax rate to be approximately 31%. Adjusted income from continuing operations for the quarter were $679 million, with our adjusted earnings per diluted share from continuing operations at $2.89, up 95% versus the prior year. Excluding Canadian tax reserve adjustments and the technology product realignment and impairment charges taken in the prior year totaling $0.70, our adjusted EPS was up 33%. As I discussed earlier, our adjusted earnings per diluted share this quarter benefited from a lower-than-expected tax rate and from a pull-forward of certain brand price increases from our fiscal fourth quarter into our third quarter. Collectively, these benefits contributed approximately $0.22 to our adjusted earnings from continuing operations per diluted share during the quarter. Wrapping up our consolidated results. Diluted weighted average shares outstanding increased by 1% year-over-year to 236 million. Now let's turn to the segment results, which can be found on Schedule 3A. Distribution Solutions' segment revenues increased for the quarter to $46 billion, up 38% on a reported basis and 39% on a constant-currency basis. North America pharmaceutical distribution and services revenues increased to $37.4 billion, up 17% on a reported and constant-currency basis. Current quarter revenue growth primarily reflects market growth and our mix of business, including strong growth from existing customers, continued demand for drugs used in the treatment of hepatitis C, and the timing of certain generic launches. Driven by these factors, we now expect that for fiscal 2015, our North America revenue will grow by a mid-teens percentage over the prior year. International pharmaceutical distribution and services revenues were $7.3 billion for the third quarter. On a constant-currency basis, revenues increased 7% on the underlying revenues of Celesio. Medical-Surgical revenues were up 7% for the quarter, driven by market growth, including the incremental benefit of a strong flu season. Distribution Solutions' adjusted gross profit increased 63% for the quarter on 38% revenue growth, resulting in an 87 basis point improvement in our adjusted gross profit margin, driven by our acquisition of Celesio and the market growth. Adjusted operating expenses for the segment increased 90% for the quarter, primarily due to our acquisition of Celesio. Excluding Celesio, operating expenses for the segment increased 6% year-over-year. The segment-adjusted operating margin rate for the quarter was 226 basis points, a decline of 8 basis points versus the prior year. This decline was driven by a higher mix of branded drug sales and an adjusted operating profit contribution from Celesio that was lower than we expected. Excluding the impact of Celesio and the hepatitis C drugs, the segment-adjusted operating margin was 248 basis points, an increase of 14 basis points over the prior year. Based on our anticipated mix of revenues, including continued strong demand for hepatitis C drugs and the lower contribution from Celesio, we now expect the full year Distribution Solutions' adjusted operating margin to be down mid-single digit basis points versus the prior year. Turning now to Technology Solutions. Revenues were down 7% for the quarter to $755 million. This decline was primarily driven by the anticipated revenue softness of the Horizon clinical software platform, the planned elimination of a product line, and the wind down of our U.K. workforce business, partially offset by growth in our other technology businesses. For the full year, we now expect revenues to decline by mid-single digits year-over-year, driven by the factors I just mentioned and the impact of some large customers delaying certain contracting decisions due to competing business and regulatory priorities. Adjusted operating expenses in the segment decreased 11%, driven by our restructuring actions. Excluding the impact of charges taken in the prior year, operating expenses declined 8% year-over-year. Third quarter adjusted operating profit for the segment increased 60% to $123 million. Adjusting for the impact of prior year charges, adjusted operating profit increased 3% year-over-year on 7% lower revenues. The segment-adjusted operating margin rate was 16.3%. Adjusting for the impact of prior year charges, the adjusted operating margin was up 167 basis points year-over-year. I'll 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. In addition, our working capital metrics also include Celesio. For receivables, our days sales outstanding increased 2 days versus the prior year to 26 days. Excluding Celesio, our days sales outstanding remained flat year-over-year. Our days sales in inventories remained flat year-over-year at 31 days. Our days sales in payables increased 5 days year-over-year to 52 days. Excluding Celesio, our days sales in payables increased 6 days to 53 days. We generated $1.2 billion in cash flow from operations during the first nine months of fiscal 2015. Overall, for the full year, we continue to expect our cash flow from operations to be approximately $3 billion. We ended the quarter with a cash balance of $4.6 billion, with $2.2 billion held offshore. Internal capital spending totaled $405 million for the first nine months of fiscal 2015. We now expect full-year internal capital spending to be approximately $525 million versus our initial guidance of $575 million to $625 million. Now I'll turn to our adjusted EPS outlook. Let me once again remind you that our earnings this quarter were specifically impacted by three items that also affect our full year outlook. First, we benefited from a lower-than-expected tax rate which allowed us to reduce our full year adjusted tax rate to 31%. Second, the negative foreign currency translation impact to our full year adjusted EPS is now anticipated to be $0.07 versus the $0.04 previously expected. And we have now updated the full year average exchange rate applicable to our adjusted EPS guidance to a rate of $1.29 per euro. Lastly, based on our anticipated mix of revenues, including continued strength and demand for hepatitis C drugs and a lower-than-expected profit contribution from Celesio, we now expect the full year Distribution Solutions' adjusted operating margin to be down mid-single-digit basis points versus the prior year. Considering these items and our year-to-date results, we are updating and narrowing our guidance for adjusted earnings from continuing operations to a range of between $10.80 and $10.95 per diluted share. With respect to GAAP earnings per share for the full year, we now expect $1.48 in amortization of acquisition-related intangible assets and $0.63 of acquisition expenses and related adjustments. We also expect to exclude between $0.97 and $1.07 per share in LIFO-related adjustments. Now let me take a few moments to talk about our updated financial statement presentation for the noncontrolling interest in Celesio. At the highest level, we continue to consolidate the financial results of Celesio and we continue to expect that our ownership of Celesio will remain at approximately 76% for the remainder of fiscal 2015. However, as a result of achieving operating control of Celesio in December 2014, some important changes were necessary to appropriately reflect McKesson's obligations to the minority shareholders of Celesio within our financial statements. When we initially gained greater than 75% of Celesio's fully diluted shares during the fourth quarter of fiscal 2014, you might recall that a line titled Net Income Attributable to Noncontrolling Interests was presented below our net income line on Schedule 1, which accompanied our press release. Through the second quarter of fiscal 2015, this line item primarily reflected the minority shareholders' claim to approximately 24% of Celesio's net income. Subsequent to achieving operating control this past December, McKesson now retains 100% of Celesio's net income. In exchange, McKesson is obligated to pay an annual dividend of EUR 0.83 per share to Celesio's minority shareholders. In today's results, this dividend drives approximately $50 million of the Schedule 1 entry for the nine months ended December 31, under the heading Net Income Attributable to Noncontrolling Interests. This $50 million amount addresses our calendar 2014 dividend commitment to Celesio's minority shareholders. Beginning in our fourth quarter and continuing through subsequent fiscal years, this EUR 0.83 dividend will drive a quarterly expense of approximately $12 million, assuming our 76% ownership stake remains unchanged and an exchange rate of $1.15 per euro. Once again, these dividends will be recorded in the line entitled Net Income Attributable to Noncontrolling Interests. This change in accounting contributed approximately $0.05 to our adjusted EPS in Q3. We do not expect any material impact to adjusted EPS from the accounting change in Q4. Distribution's segment results as outlined on Schedules 3 and 4 continued to reflect 100% of the results of Celesio. The balance sheet, as reflected on Schedule 5, includes a new caption titled Redeemable Noncontrolling Interests. Subsequent to a pending operating control of Celesio, the carrying value of the noncontrolling interests in Celesio of approximately $1.5 billion were reclassified from equity to redeemable noncontrolling interests. This reclassification was triggered when noncontrolling interests in Celesio became redeemable, allowing put rights held by the minority shareholders to be exercised. As a reminder, these put rights allow minority shareholders to sell their Celesio shares to McKesson at a price of EUR 22.99. In summary, now that we have operating control of Celesio, we recognized 100% of Celesio's net income while owning only 76% of Celesio's outstanding shares. And for this benefit, we are obligated to record annual dividend compensation of EUR 0.83 per share or approximately $12 million per quarter, payable to Celesio's minority shareholders. In addition, our assumptions related to our previously articulated transaction synergies are unchanged. As mentioned by John, by fiscal 2019, we still expect to realize annual synergies between $275 million and $325 million. In summary, we've recorded three very solid quarters this year and we are excited to have secured operating control of Celesio. We expect the transaction to deliver tremendous value to our customers, manufacturing partners, and shareholders in the years ahead. Thank you. And with that, I will turn the call over to the operator for your questions.

John, I just wanted to follow up on some of James' comments regarding the noncontrolling interest piece of Celesio. So how do you think about it from this point going forward? It seems like a pretty straightforward capital deployment situation. You could either pay up to redeem the remaining piece or you could just let it continue to sit out there and make the dividend payment on a quarterly basis and reallocate that capital elsewhere. So given that you've already guided the market that you would reaccelerate capital deployment in fiscal 2016, how do you think about that capital deployment situation from here?

Glen, thanks for the question. I think that you have the basics right. I believe the only thing that's missing in your assumption there is related to their ability to put the shares to us. So we look at it as a source of financing. We know what the put right is, we know what the dividend cost is on an annual basis, and we know how much money is tied up related to this obligation. The only difference is that we really can't call that right. We have to have it put against us. But I think just from our perspective, it's a source of financing and there is no longer any P&L or earnings upside by the consolidation of those remaining shares other than a reduction of the dividend, but replaced by whatever are the costs you have associated with the deployment of that capital.

Maybe if I could just follow up on some of the comments you made in your prepared remark regarding the global procurement office that you opened in London. Could you give us a sense for maybe what types of products we'd be purchasing out of there, or what percentage of your products? Can you do all your generics, branded, OTC? And then, James, how do we start to think about that having an impact on the company's tax rate over time?

To start, we have been concentrating on sourcing private-label products in a tax-efficient manner for some time now. The recent expansion in London primarily targets generics and branded drugs, emphasizing our relationships with manufacturers and our go-to-market strategy. James, could you elaborate on the tax aspects?

Well, I would just observe that obviously now with a broader worldwide operation, we'll be looking at optimizing our tax position on a global basis, obviously consistent with all the rules and regulations of each authority in which we're doing business. So I wouldn't want to point to anything in particular emanating out of London.

But, Glen, you did mention OTCs. And I do think that the addition of Lloyds Pharmacy through the acquisition of Celesio does give us a large footprint in OTC products and relationships that would expand beyond our typical branded and generic relationships, albeit that's probably a third leg to put into the strategy. We're going to focus on pharmaceuticals first. I do think there's a way for us to bring our other U.S. customers' and North American customers' demand for OTC products into this discussion at some later date.

John, you mentioned the significant growth from various sectors, particularly hep C. Recently, Gilead announced that they anticipate a 25% rise in treated patients due to new agreements with managed care and PBMs. I'm curious about how this will influence your business moving forward. Will you be able to capture a steady share of that market? Additionally, could you clarify how much of this quarter's growth can be attributed to hep C? Finally, it would be helpful if you could shed light on the margins related to hep C and other expensive specialty drugs that are entering the market.

Thank you, Lisa, for your question. It's quite challenging for us to provide specific details on the number of patients not receiving treatment for Hep C, as well as the potential market share shifts among different manufacturers. Our business is largely focused on government contracts and mail order. We maintain strong relationships in these areas, especially with the VA and the DoD, where we have a significant concentration of products, including those for Hep C. While these Hep C products contribute positively to our revenue growth, they do negatively impact our overall profit margins. This quarter, we saw growth influenced by Hep C, but I would also emphasize that we believe our growth outpaced market averages thanks to strengthened relationships with current customers and our success in expanding generics, particularly with Rite Aid and other clients. Overall, we are optimistic about the momentum we have in our business.

And, in fact, if I could just add, an example of that growth is in our OneStop program, where even aside from the growth that Rite Aid represented in OneStop, we still, in addition, grew OneStop 20% year-over-year. Specifically to the revenue contribution of the hepatitis C drugs, they drove about 4 points of the 17% growth that we saw in Q3 year-over-year. And as we're alluding to here, they're one of the two drivers, along with the Celesio contribution, that were driving our commentary around Distribution Solutions' margins in Q3 and for the full year.

I guess, John, I kind of noticed that absent from the commentary of this call was kind of the thoughts on generic drug price inflation and two of your peers have kind of talked about moderating generic drug price inflation. I thought you might give us an update on what McKesson is seeing.

Our view on generic price inflation is basically in line with how we viewed the year as we came into the year. We said that we felt it was going to be generally flat with last year, perhaps slightly down compared to prior year. And I think our view has remained consistent and remains consistent as we think about what we've accomplished in the first three quarters and what we have in front of us. I would say it's difficult perhaps to compare the commentary between those in the industry because all of us look at generic price inflation, we define it differently, first; and then secondly, we all have different books of business with different manufacturers and have probably different exposure to all of this. So I would say that our quarter results in Q3 and what we're talking about for the rest of the year is pretty much in line with our expectations when we started the year.

Okay. That's helpful. And maybe a quick follow-up on Celesio. I'm going to assume that there were no Celesio synergies delivered in the quarter and you guys are sticking to your guidance on the procurement synergies. I guess at what point kind of in the process of the acquisition will you be ready to talk about operating synergies as opposed to procurement synergies?

Well, you're right. There really were no synergies in our results for the quarter related to Celesio. I mean we just achieved operating control, which allows us to go as a unified body to the marketplace, which this London operation is beginning to do, has begun to do in January and is continuing throughout the rest of this quarter. So the $275 million to $325 million has yet to be executed on, particularly from a product perspective. Now some of the tax savings that we forecasted there should begin to flow more quickly than the products side of it. As it relates to operating synergies, we have a bit of a path here to get the organization to where we think it can be operationally. And clearly, one of the big things we need to do is invest in the IT infrastructure that's necessary to help Celesio realize the advantage of scale and to be more productive in the operation. We have some work underway to help them optimize certain functions in terms of distribution and transportation. We're working on those initiatives. But clearly, it's probably too early to forecast any operating synergies related to Celesio as we think about the remainder of this year.

And I would expect that those items that John was just mentioning to be one of the drivers of our capital spending each year.

And in fact, to some extent, George, the synergy from an operating perspective in the early phases may be more of a dis-synergy as we invest more heavily than we get returns on in the early phases. And so we'll probably see actually a little more expense. Now clearly, the upside from this acquisition wasn't in significant operating synergy in the near term in Celesio. It was really about accomplishing our sourcing and procurement synergies. And we have no reason to believe that we won't be successful on that objective. And I think that, that is a first priority. The second priority is what do we do to assist Celesio in its operations. In the near term, that's probably more of an investment expense slash phase than it is a synergy that we deliver to the bottom line phase. So we're focused on doing both.

John, you spent some time in the prepared remarks talking about the specialty business and the opportunities there. Can you help us quantify what percent of the 17% top line growth came from specialty? And I'm assuming that specialty segment is excluding the HCV benefit. And what are the specific areas within specialty that you're seeing most growth from? And then I have another follow-up.

Well, I mean, our specialty business, once again, it's similar to the other themes in this conversation. Probably each person participating in the industry may define specialty differently. When we talk about specialty, we're not talking about hepatitis C drugs or some of the things that have impacted our revenues in such a significant way. What we're talking about are primarily oncology products and some of the other -ologies like rheumatology and ophthalmology. From a growth perspective, we have some of those other specialty areas growing more rapidly than oncology, but it's off of a very small base. Oncology continues to be the main driver of our performance in specialty, and our bullish remarks regarding our growth in specialty is driven by our success in the oncology portfolio of our business, on a combined basis: Both the work we're doing on the network to grow the number of physicians in US Oncology; in our distribution platform out to oncology and other specialties; and clearly in some of the work that we're doing with manufacturers on the clinical services, and the data work that we're doing, really is all-encompassing. But we're pleased with the progress we're making in specialty, and it's an important part of our continued performance.

Okay. And then just one follow-up on Rite Aid, which you talked about the contribution to OneStop. I mean, obviously, Rite Aid very publicly attributed their improved outlook to their expanded relationship with McKesson. Is kind of the proof of concept that we're seeing in Rite Aid starting to resonate with some of your other large retail clients that are not buying the bulk of their generics from you?

We believe that's the case. A great example is our successful partnership with Omnicare, where we not only renewed our agreement but also got them to collaborate with us on sourcing their generic portfolio. Rite Aid has served as a strong reference point for our success. As Rite Aid and other companies recognize McKesson as the best option, along with other industry players shifting towards wholesaling instead of direct purchasing, it highlights the advantages that wholesaling offers the industry. This includes our purchasing and sourcing capabilities, our efficient capital use, and our logistics expertise. Many McKesson customers are expressing interest in expanding their relationships with us to include generics, and we are optimistic about this trend.

John, I just wanted to go back to the comments around the pull-forward you saw this quarter. And I feel like we've heard this from time to time from you and your competitors. I mean, is this just seeing pricing coming in ahead of your internal expectations? Or is it actually something more contractual?

I cannot speak for the industry or our competitors, but regarding McKesson's work with manufacturers we have contracts with, we have clear visibility into the potential income from these relationships over time. However, forecasting the methods and timing of that income can be challenging. This is why we do not provide quarterly guidance, as we are not always certain when price increases will occur. This relates to the pull-forward we mentioned. We know the total amount we will receive, but if we receive a significant portion in the third quarter, it won’t be repeated in the fourth quarter. Additionally, some of our income from branded manufacturers is earned outside these relationships. Nonetheless, a large part of what we recognized this quarter was visible to us and simply reflected a shift from one quarter to the next.

Got it. That answers the question. And then I guess, just the follow-up I have was around biosimilars. That's something the industry has been talking about for years. Now it seems like we have a feel on the near-term horizon with Remicade and Neupogen. Can you maybe just remind us how you see the economics playing out for McKesson? Is your expectation that as we see biosimilars, and these two specifically, come to the market, that the wholesalers will be able to leverage their value? Or could these maybe end up looking more similar to additional branded launches?

I believe it's challenging to make a broad industry prediction. However, McKesson's position is distinctive, especially concerning cancer drugs, due to our relationship with US Oncology and our network. While we don't employ those physicians directly, we collaborate closely with them. As I mentioned earlier, our insight into the clinical processes required to bring a branded drug to market and advance it through the different phases of clinical trials should assist in demonstrating that biosimilars provide comparable outcomes for patients compared to the products they may replace. This capability is something unique to McKesson, and I believe our ability to leverage it will enhance value for the manufacturers entering this market. It may still be too early to measure the potential impacts of this, but I wanted to highlight the unique advantages we contribute to the business.

I guess kind of looking back through time. The McKesson fiscal fourth quarter EPS results have been up sequentially versus fiscal 3Q, like every year for the past eight years or so, potentially even further back from that, except for the fact that my model doesn't go back, so I can't analyze it further on the fly. But really the question is, I guess, is the pull-forward of the brand inflation economics really that material to drive this unique cadence this fiscal year? Or again, maybe I missed it, were there one or two other big factors that might be driving the EPS down sequentially besides just that brand inflation? I know you mentioned a little bit about Celesio profits staying a little bit lower. But I just want to make sure I didn't miss any other key variables there.

Yes. I think it is a little bit more complicated this Q4 sequentially. We have this branded pull-forward item that John has just been discussing. We also have the tax rate effect between Q3, which was particularly low, and Q4. And then, of course, we also have a little bit higher FX headwind than we were expecting 90 days ago when we were on the call. And then we've also given you something of a sense around both of the DS margins and how they would be driving relative to this quite high DS revenue growth. And then we've also given you a sense of the TS revenue situation as well for the full year. So I think those are really the key drivers that will be relevant for us in Q4 and drive the sequential pattern that you're referring to.

Given that you have operational control and you're expecting $1.8 billion in cash flow in the coming quarter, James, can you clarify if there are any obstacles that might hinder your ability to reinvest cash? What are your thoughts on the minimum cash balance? Do you take the noncontrolling interest into account? Last quarter, you mentioned debt maturities, and it seems possible that you could end up with an inefficient balance sheet because the noncontrolling interest may persist for an extended period. I understand you have the capacity to refinance and grow or reduce leverage through EBITDA growth. How do you factor in those considerations?

We recognize the need to be prepared for minority Celesio shareholders to sell their shares to us. While I spoke in detail about accounting, we must also brace for an expected cash outflow of approximately $1.5 billion related to these shares. Additionally, we have significant debt maturities coming due in fiscal 2016, which will also total around $1.5 billion, more than we've experienced in recent years. Importantly, we remain committed to maintaining our investment-grade credit ratings, and our approach to capital allocation remains unchanged. This includes internal capital expenditures, mergers and acquisitions, dividends, and share buybacks. We particularly want to focus on internal CapEx and M&A as avenues for driving cash flow growth that will benefit our shareholders. During my time here, I've been impressed with McKesson's long-standing track record in M&A, which has been effective in creating value. We aim to ensure we have the capacity for M&A opportunities during this de-levering phase, should they arise.

John or James, do you expect Celesio here to grow sequentially from this point? And what actually did drive the slightly lower profits for the business this past quarter?

Celesio represents a mix of various markets. Depending on the market, whether in wholesaling or retailing, we anticipate growth in our businesses at or above market levels. However, we are somewhat uncertain about growth expectations in markets like Brazil and France, particularly in France due to reimbursement pressures. Germany has faced challenges, but there are signs of stability and revenue growth. The U.K. has been performing well in both wholesale and retail sectors. We are pleased with the revenue growth Celesio achieved this quarter and expect this business to continue to grow at or above market levels. From a market perspective, James?

Well, I was just going to add, our experience thus far in fiscal 2015 has been a stronger first half than a second half. And while we're only just really still in the middle of our FY 2016 planning exercise, directionally, I wouldn't be surprised to see that continuing into the future.

Okay. And just margin-wise, just various challenges across various markets but nothing specific?

Well, I think the margin side of Celesio will be driven by the experience of Brazil and France in particular. Again, the U.K., we're seeing strong performance and we're somewhat encouraged by the situation in Germany that seems to be seeing some stability.

Robert already covered my question, so I’ll ask a different one that's not as critical. John, you often highlight a small business within the company that's performing well. This time, you dedicated some extra time in your remarks to discuss US Oncology and the CRO services businesses. Was there something specific that prompted this additional focus, such as market conditions or areas where you're investing? Thank you.

I believe this is a good question. Our financial focus on the CRO business isn't primarily about the compensation we receive for conducting clinical trials. What's more important is our relationship with manufacturers and the influence we have within their networks, especially in terms of collaborating with them on products, particularly in the early stages of community oncology. A significant amount of clinical trial work is conducted in large university settings where they can consolidate a lot of tasks within a single enterprise. However, there isn't really another group of community oncologists that can provide a unified approach across various markets and types of doctors. Therefore, we are focused on ensuring that we continue to add substantial value to the services we provide to manufacturers across all our businesses and find ways to differentiate ourselves.

So I just wanted to quickly touch on the Tech Solutions business. It's been a sort of long winding road the last few years. And obviously, you've made a number of decisions to kind of restructure and revamp the business. As we're sort of exiting the year, I'm looking for more qualitative not quantitative, but how do you feel like the portfolio now is kind of taking shape? And I guess as you think about areas to either strengthen or whether or not there's even anything left that's small, left to sort of maybe not divest but deemphasize, how do you feel like you need to kind of continue evolve that asset to be a sort of net contributor to the business on an EBIT growth basis going forward?

Well, we're pleased with the performance of that business; it's basically in line with what we had anticipated this year, given that we had talked about that we were going to and have prepared the portfolio to focus on those businesses where we felt we had an opportunity to grow. And in particular, took out a business or two that produced no earnings. And part of what you've seen is great margin expansion as a result of that focus and attention. The businesses that are performing well there are businesses that we've had for a long time and that are continuing to modify their models so we can create a recurring revenue stream. And I would say the businesses that are flat or struggling are those that have either been replaced in the market with other priorities that people are spending on, other things that they have to buy and not buy some of our products that they'll have to come back around to later, or businesses where a transition's underway from a technology perspective. So I think we are still in middle of the game relative to the transition between Horizon and Paragon, which will be ongoing, which is a bit of a headwind as we think going forward. But we're also trying to invest in front of what we think will be a buy cycle for products that will help customers understand data better to make better decisions to take on risk and to follow the patient in a more longitudinal way. So there's a bunch of interesting places that we're placing bets, including CommonWell Health, that we think will pay off. But generally steady as she goes is the way we think about it at this point.

Could you elaborate on Ross' question, John? If we consider the business a few years from now, you've mentioned strengths like interoperability and the assets from RelayHealth in the past and today. What do you envision the business mix to look like? Additionally, as you phase out some of the legacy businesses, how much longer do you anticipate that process will take?

I think the question is challenging to address due to the varying priorities our customers have regarding certain activities. For instance, we have a significant presence in the payer space, and we aim to encourage our customers to invest in opportunities that enhance their performance rather than just dealing with regulatory or security issues. Therefore, our customers' priorities do not always align with where our product offerings are most advantageous. However, looking two to three years ahead, it's likely that the EMR space and the transition away from Horizon will be mostly completed, which we expect will yield better results in relation to the pay-for-performance focus. There is a belief among HHS and others that the market must shift more towards a value-based reimbursement model, and this will necessitate further investment.

And is that coming from sort of more through the trained-up spaces, really from your payer solutions business, as well as sort of the RelayHealth business?

Well I think we're well positioned in the connectivity spaces because those transactions are already flowing through our businesses and those transactions are well underway and we are helping our customers do things more efficiently with more knowledge as a result of connectivity and interoperability. I think it's the places where folks can delay their purchasing decisions that we experience the volatility in our base. And most of our businesses today that are ahead of plan are ahead of plan because of volumes related to transactions. And most of the businesses that are behind their plans in our technology suite are behind not because customers have chosen somebody else's solution, they're behind because the buy decision has been delayed because there's other priorities for the customer, either from a capital deployment perspective or other priorities from a workload perspective for their IT groups to focus on other things other than buying a piece of software that might have a great return but they just don't have the ability to do it given that the priorities are someplace else. So I think that that's why this business is a little bit difficult to forecast because of some of those nuances that don't frankly exist in our distribution businesses where, unless you lose a large customer, you can count on the volume being there the next year, and it's just a question of maintaining that satisfaction level of the customers to continue to grow the business.

The first question was a quick follow-up bringing it back to procurement. I know it's only been a short while since obtaining operational control. But knowing Paul and his team, I suspect they've already had a healthy dose of meetings with the manufacturer. So could you give us any specifics as to the progress you've made there and maybe some broad strokes as to how the conversations are going? And maybe even if and how you shifted your approach to the market as you're receiving early feedback?

Well, we are very early in this process. We couldn't really begin this dialogue until we had operational control. That didn't happen until middle of December. And I would say that our early conversations with manufacturers have been very positive, and we've made very nice progress. And I think most of the manufacturers in the world have an interest in having a dialogue with McKesson because of the value that we bring and the customers that have entrusted us with their business and their volumes to go to the marketplace in a unified way. So I do feel positive about where we're headed. I think it's early to try to quantify timing or value. But I think from a first-step perspective, we're on track with where we thought we would be at this point post-domination.

Well, I just wanted to add, we’ll be focused on the operational synergies as we just discussed, while we work on the procurement side of things. And just to echo John's comments, I think it's a great start.

Well. Thank you, operator, and thank you, all, for being on the call today and for your time. I'm pleased with our solid results in the third quarter, and I'm excited about the opportunities we see across our business to deliver exceptional value to our customers. I'm now going to hand the call back to Erin for her review of upcoming events for the financial community. Erin?

Thank you, John. On March 3, we will present at the Cowen Healthcare Conference in Boston, and we will release fourth quarter earnings results in May. Thank you and goodbye.