Mckesson Corporation (MCK) — Q4 2016 Earnings Call Transcript

Thank you, Vicki. Good afternoon and welcome to the McKesson fiscal 2016 fourth quarter earnings call. I'm joined today by John Hammergren, McKesson's Chairman and CEO, and James Beer, McKesson's Executive Vice President and Chief Financial Officer. John will first provide a business update, and then James will review the financial results for the quarter and the full year. After James's comments, we will open the call for your questions. We plan to end the call promptly after one hour at 6 PM Eastern Time. Before we begin, I remind listeners that during the course of this call we will make forward-looking statements within the meaning of federal securities laws. These forward-looking statements involve risks and uncertainties regarding the operations and future results of McKesson. In addition to the company's periodic current and annual reports filed with the Securities and Exchange Commission, please refer to the text of our press release for a discussion of the risks associated with such forward-looking statements. Finally, please note that on today's call we will refer to certain non-GAAP financial measures. In addition, I would call your attention to supplemental slides which we will reference on today's call and can be found on the Investors page of our website. We believe the supplemental slides, which include non-GAAP measures, will provide useful information for investors with regard to the company's core operating performance and comparability of financial results period over period. Please refer to our press release announcing fourth quarter fiscal 2016 results and the supplemental slides for further information and a reconciliation of the non-GAAP performance measures to the GAAP financial results. Thanks and here's John Hammergren.

Thanks, Erin, and thanks, everyone, for joining us on our call. I am pleased with our fourth quarter results, which were driven by solid execution across both our Distribution Solutions and Technology Solutions segments. Fiscal 2016 was a year of growth and expansion across McKesson despite the headwinds resulting from generic pharmaceutical pricing trends and industry consolidation. I want to highlight a few important accomplishments across our company over the last year. In our U.S. Pharmaceutical business, we continue to expand our relationships with our customers and drive strong growth across all channels, including national retailers, independent pharmacies, and health systems. Our global sourcing and procurement office, based in London, delivered tremendous results in fiscal 2016. I am proud of our team's performance and the value they are delivering on a global basis for our company and for our manufacturing partners. In fiscal 2017, we expect to achieve the full run rate of procurement-related synergies as articulated in the original Celesio acquisition, more than one year ahead of the original business case. Our Specialty Health business delivered strong mid-teens revenue growth for the fiscal year while announcing two strategic acquisitions to further complement our core business. We saw solid expansion of our leading independent pharmacy banner programs across the United States, Canada, and Europe. We also saw strong growth across the Lloyds brand pharmacies in Europe. We were also very pleased to announce our proposed acquisition of Rexall Health in Canada. The operating margin rate in our Technology Solutions segment expanded nicely as a result of our efforts over the last several years at reshaping our portfolio and focusing on our investments. As we discussed in January, the company undertook a review of its cost structure across the enterprise and implemented a set of actions designed to ensure McKesson remains at the forefront of operational excellence, efficiency, value, and innovation. I also want to highlight McKesson's strong operating cash flow results for fiscal 2016, which exceeded our expectations. For the fiscal year, we generated $3.7 billion in operating cash flow, up 18% year over year. There's one more item I'd like to call to your attention. Many of you joined us in January when we made an unscheduled announcement to highlight some industry trends and company-specific events that impacted our fiscal 2016 results and our preliminary outlook for fiscal 2017. One of the topics we discussed in January and it continues to receive attention, is the subject of generic pharmaceutical pricing. We believe some of you may be seeking clarification as to how it affects various industry constituents. Let me take a moment and talk about how it works here at McKesson. Over a very long period, our generic pharmaceutical portfolio has experienced deflation and continues to do so today. I would remind you that our agreements with our manufacturing partners contemplate and protect us from a decrease in the value of our inventory. However, on a small group of generic drugs, as we have in the past, we will continue to experience price increases. When we talk about generic inflation at McKesson, we are specifically referring only to this small subset of generics that experience a price increase. As we think about fiscal 2017, we expect a nominal contribution from those generic pharmaceuticals that will increase in price. We saw this trend early, and our guidance today is consistent with the information we shared with you in January. The fiscal 2017 guidance of $13.30 to $13.80 that we provide you today is in line with what we communicated with you back in January. I'm proud of this management team and their constant focus on growth and innovation to create value for the long term. Despite the challenges faced related to generic pharmaceutical pricing trends and customer consolidation, I am confident that our business remains extremely well positioned for continued success. Turning for a moment to the broader industry environment, across all of the markets we serve, the themes of cost, quality, and access remain central to the opportunities and challenges facing healthcare. As seen with relative consistency over my own career, these same themes continue to take a prominent place in the national platform of the current Presidential election process in the United States. I think it is important to remember that the issues of cost, quality, and access are not new. Demographics will continue to drive strong demand for pharmaceuticals. The use of pharmaceuticals will continue to play an important role in healthcare systems across the world and remain the most effective and cost-efficient way to treat patients across various disease states and chronic conditions. The pace of innovation continues to advance our industry in exciting ways, from the discovery of new pharmaceutical therapies to fight disease, to new technology-enabled ways in which consumers engage in managing their health, and real progress we see in the pay-for-value care delivery models that are emerging. Against this backdrop of change, I see great opportunity for McKesson. Change inevitably opens the door to new conversations with customers about how we can bring the strength of McKesson to help address the opportunities they see and the challenges they face. Our customer-first culture demonstrates a commitment and an awareness that McKesson's long-term success is linked to our customers' success. While change can bring its own set of challenges, I am very excited about what the future holds for our company. Moving on to our business results, Distribution Solutions concluded another solid year with good performance across the segment. North American Pharmaceutical Distribution and Services delivered 11% revenue growth on a constant currency basis compared to the prior year. The U.S. Pharmaceutical business delivered solid results for the year despite pricing trends on generic pharmaceuticals that were below our original plan and a few notable customer transitions related to consolidation within our healthcare supply chain. Despite the impact of these events, the business saw growth and expansion across a number of important areas. In fiscal 2016, we continued to see excellent growth with existing customers who expanded their business with McKesson as well as new customers choosing McKesson as their pharmaceutical sourcing and distribution partner. At the beginning of April, we began to service the pharmaceutical sourcing and distribution for Albertsons and Safeway, and I'm very pleased with how our team was prepared to hit the ground running on day one. Our OneStop proprietary generics program continued its strong performance and grew 21% year over year. Health Mart extended its tremendous track record of growth during fiscal 2016, ending the year with more than 4,600 stores, or approximately 19% growth over the prior year. I know that customer consolidation has caused some to question the scale and competitiveness of McKesson's generic pharmaceutical sourcing. To me, there's no better proof point than the examples I just shared, where we continue to expand our customer relationships, win new customers, deliver strong growth in our OneStop proprietary generics program, and rapidly expand the number of independent pharmacies that see real value in their bottom line by joining Health Mart. I'm incredibly confident in the strength of our relationships with our manufacturing partners and in McKesson's ability to be a great partner to them through our global procurement scale and operational footprint. In summary, I believe in the core strength and competitive position of our U.S. Pharmaceutical business. While we faced challenges related to a shift in generic pharmaceutical pricing trends and customer consolidation, this business remains extremely well positioned for continued success. Our Canadian distribution business delivered solid results in fiscal 2016. In addition to the strong performance of our leading Pharmaceutical Distribution and Services business, we also had strong performance across our extensive retail banner business. Several weeks ago, we announced our proposed acquisition of Rexall Health, which we expect to close later this calendar year. This acquisition supports McKesson's commitment to drive value in the industry by improving healthcare solutions delivered in the retail pharmacy setting, and enhances our ability to provide best-in-class pharmacy care for patients through an expanded retail footprint across Canada. Our team in Canada has an outstanding track record of delivering great value to our customers and to patients, and I'm very excited about the opportunities we see for this business in fiscal 2017 and beyond. Turning now to our Specialty Health business, fiscal 2016 was another year of exceptional growth in our oncology and multi-specialty businesses. We recently brought together several assets under a new Manufacturer Services organization within McKesson Specialty Health. By integrating these capabilities, we will offer improved coordination of our best-in-class solutions to manufacturers and ultimately improve patient access and adherence to essential life-saving therapies. Additionally, we closed on our Biologics and Vantage Oncology acquisitions on April 1. Biologics is the largest independent, oncology-focused specialty pharmacy in the United States, and Vantage Oncology is a leading national provider of radiation oncology, medical oncology, and integrated cancer care. In combination with our U.S. Oncology Network, this now includes over 120 integrated cancer centers across 29 states. These two important acquisitions will increase McKesson's Specialty Pharmaceutical Distribution's scale, expand our oncology-focused pharmacy offerings, enhance our solutions for manufacturers and payers, and broaden the scope of practice management services available to providers and patients. These investments demonstrate McKesson's commitment to the success of our community oncology partners and customers. We believe the acquisitions of Biologics and Vantage Oncology complement our holistic approach to exceptional care for cancer patients. Our teams are hard at work with our new colleagues from both Biologics and Vantage Oncology as they implement detailed integration plans. We are excited about welcoming the talent and expertise that exists across these two organizations to the McKesson team. Now turning to international Pharmaceutical Distribution and Services, I am pleased with the results for fiscal 2016. We are making strong progress on important investments to strengthen the information technology environment across Celesio while we continue to invest in the European retail pharmacy business. Additionally, in fiscal 2016, we announced several acquisitions across our markets where we see strong opportunities to enhance our services and capabilities. Looking ahead, Celesio is well positioned to execute on its operating plan, which includes a focus on the integration of acquisitions during fiscal 2017. In our Medical-Surgical business, we saw strong results in our physician office business, including outstanding growth with large accounts and customer wins with integrated delivery networks. Our surgery center and laboratory-focused businesses also delivered strong growth in fiscal 2016. I am pleased to report we have successfully concluded our integration plan of PSS World Medical, which delivered synergies as expected. Overall, I'm proud of our full-year operating performance in Distribution Solutions, and we have an exciting year ahead of us in fiscal 2017 that will require us to do what we do best: focus on our customers' success; leverage our culture of operational excellence and innovation to deliver the best value in the industry; and execute, integrate, and deliver value through the acquisitions we have announced. As we look ahead to fiscal 2017, we expect that Distribution Solutions revenues will increase by high single digits compared to the prior year, driven by market growth and acquisitions. Turning now to Technology Solutions, I am pleased with the strong results we delivered in fiscal 2016. We experienced outstanding growth in our payer solutions, medical imaging, and relay connectivity businesses. While revenue growth in Technology Solutions has been impacted over the last several years, primarily due to important actions we've taken to focus our investments and shape our portfolio, our enhanced focus has resulted in meaningful improvements in our adjusted operating margin rate for the segment, which we expect will lead to further margin expansion in fiscal 2017. To wrap up my comments, I believe we have a solid plan for fiscal 2017. Growth across our businesses and growth from capital deployment is balanced against the negative impact of generic pharmaceutical pricing trends in the United States and customer consolidation. We are in a business that continues to generate strong cash flow from operations. While the business of healthcare continues to transform across the markets we serve, we are well positioned to capitalize on tremendous opportunities for our company. At McKesson, we have the best management team in the business, and I am confident in this team's ability to continue to deliver value to our customers and strong financial returns to our shareholders. I am proud of our performance in fiscal 2016 and look forward to the many exciting opportunities ahead of us in fiscal 2017. With that, I'll turn the call over to James for a detailed review of our financial results.

Thank you, John, and good afternoon, everyone. As John discussed earlier, our fiscal 2016 results reflect solid execution and core operational growth from both segments. Additionally, we delivered operating cash flow that exceeded our expectations while applying our portfolio approach to capital deployment to create shareholder value. Today, I will cover both the fourth quarter and full-year results, and I will also present annual guidance for fiscal 2017. Before I review our fiscal 2016 results, I would like to address the cost alignment plan, which John mentioned in his remarks. This plan primarily includes workforce reductions and business process initiatives. As outlined in January, our fiscal 2016 adjusted earnings guidance did not include restructuring charges related to this cost alignment plan, given that this plan was initiated late in the fourth quarter. Our earnings press release outlines the pre-tax charges related to the cost alignment plan, totaling $229 million, which were recorded during the quarter, representing an adjusted earnings impact of $0.73 for fiscal 2016. Overall, cost alignment charges reduced adjusted gross profit by $26 million and increased adjusted operating expenses by $203 million for the fourth quarter and full year. The tables accompanying our press release outline our reported results inclusive of these cost alignment charges. However, in order to review our core operating performance for the quarter and the fiscal year, my remarks will provide our constant currency results excluding the impact of both the cost alignment charges and the gains realized earlier in FY 2016 on the sale of the Nurse Triage and ZEE Medical businesses. These gains totaled $0.29 per diluted share. Therefore, in addition to our earnings press release and customary tables, we have published a supplemental presentation on our website. This presentation includes additional information about our cost alignment plan, including actual fiscal 2016 charges and the anticipated charges during fiscal 2017. This presentation also provides a core operational or baseline view of our fiscal 2016 earnings in constant currency excluding the cost alignment charges and business sale gains. During my remarks, I will refer to this supplemental slide presentation to review our fiscal 2016 baseline consolidated earnings and fiscal 2017 earnings outlook. Now let's move to our consolidated results, which can be found on Schedules 3A and 3B of the tables accompanying our press release. Consolidated revenues for the fourth quarter increased 5% in constant currency. For the full year, revenues were $195.3 billion in constant currency, an increase of 9% over the prior year, led by growth in our Distribution Solutions segment. I'll now refer you to slides three and four of the supplemental presentation. Fourth quarter baseline gross profit was relatively flat, and full-year baseline gross profit increased 3% in constant currency year over year. Fiscal 2016 baseline gross profit was driven by the performance of Distribution Solutions, primarily reflecting market growth, our mix of business, and our global procurement benefits, offset by the weaker year-over-year profit contribution from generic pricing trends, primarily in the second half of the fiscal year, which were in line with our previous expectations. Fourth quarter baseline operating expenses declined 4%, and full-year baseline operating expenses were flat in constant currency. For the full year, total baseline operating expenses benefited from lower expenses recorded related to the Nurse Triage and ZEE Medical businesses sold earlier in the fiscal year. Now turning back to Schedules 3A and 3B of the tables accompanying our press release, adjusted other income was $17 million for the quarter and $68 million for the full year. In fiscal 2017, other income is expected to increase by approximately 40% from the fiscal 2016 level, primarily related to the anticipated profit contribution from Celesio's equity investment in Brocacef, which previously announced its acquisition of the Netherlands subsidiary of Mediq. Interest expense of $86 million decreased 4% in constant currency for the quarter. Full-year interest expense of $359 million decreased 4% in constant currency, primarily driven by the retirement of debt obligations during the fiscal year. For fiscal 2017, we expect our year-over-year interest expense to be relatively flat to fiscal 2016, driven primarily by scheduled debt maturities and the incremental financing related to acquisitions we expect to close in fiscal 2017. Now moving to taxes, for the full year, our adjusted tax rate was 28.9% excluding cost alignment charges, reflecting our mix of income and several favorable discrete tax items. For fiscal 2017, we expect an adjusted tax rate of approximately 31%, primarily based on our expected mix of U.S. versus international income. However, this rate may fluctuate from quarter to quarter. For fiscal 2016, McKesson's constant currency net income from continuing operations totaled $3 billion, excluding after-tax cost alignment charges of $169 million and after-tax gains on the sale of the two businesses I mentioned earlier, totaling $67 million. I'll now refer you to slide five of the supplemental presentation. Our full-year baseline fiscal 2016 earnings per share of $12.52 increased 14% in constant currency versus the prior year. This year's baseline earnings per share reflects market growth across the Distribution Solutions segment, margin expansion in the Technology Solutions segment, global procurement synergies, the cumulative benefit of share repurchases in the fiscal year, and a lower adjusted tax rate versus the prior year. Wrapping up our consolidated results, diluted weighted average shares outstanding decreased by 1% year over year to 233 million. During the fourth quarter, we completed a $650 million accelerated share repurchase program, bringing the value of total shares repurchased during fiscal 2016 to $1.5 billion. At the end of fiscal 2016, approximately $1 billion remained on the current share repurchase authorization granted by the board. Our diluted weighted average shares outstanding assumption for fiscal 2017 is 228 million. Let's now turn to segment results, which can be found on Schedules 3A and 3B of the tables accompanying our press release. Distribution Solutions segment revenues were up 5% in constant currency during the quarter to $46.4 billion. For the full year, Distribution Solutions constant currency segment revenues were $192.4 billion, up 9%, primarily driven by market growth in our North America Pharmaceutical Distribution and Services business. In fiscal 2017, Distribution Solutions revenue growth is expected to increase by a high single-digit percentage compared to fiscal 2016. We continue to assume we retain the existing sourcing and distribution relationship with Rite Aid, which would contribute approximately $13 billion in revenue in fiscal 2017. For the quarter, North America Pharmaceutical Distribution and Services revenues increased 6% in constant currency. For the full year, North American distribution revenues increased 11% on a constant currency basis, driven primarily by market growth in our U.S. Pharmaceutical, Specialty, and Canadian businesses, offset primarily by the expiration of our contract with Optum at the start of our third quarter. For fiscal 2017, we expect our North American Distribution business to deliver a high single-digit percentage revenue growth compared to fiscal 2016. International Pharmaceutical Distribution and Services revenues were nearly $6 billion for the quarter, up 2% in constant currency. For the full year, international revenues of $23.5 billion were impacted by approximately $3 billion in unfavorable currency rate movements, primarily attributable to a weaker euro relative to the U.S. dollar compared to the prior year. For the full year, revenues were $26.5 billion in constant currency, up 1%, driven by growth in our UK business, partially offset by the loss of a hospital contract in Norway during fiscal 2015. In fiscal 2017, we expect Celesio's revenues to grow by a low double-digit percentage on a constant currency basis, driven primarily by the acquisitions we announced in fiscal 2016. Moving to the Medical-Surgical business, revenues were up 1% for the quarter and 2% for the full year, driven by strong growth in our primary care business, offset by the sale of ZEE Medical in the second quarter and weaker market conditions affecting our long-term care business. Looking ahead to fiscal 2017, we expect to drive mid-single-digit percentage revenue growth year over year. I'll now refer to slide six of the supplemental presentation. Distribution Solutions baseline gross profit decreased 1% in constant currency for the quarter and increased 3% in constant currency for the full year. Full-year segment baseline gross profit reflected market growth and our mix of business, including a growing proportion of specialty pharmaceuticals, weaker profit contribution from generic pricing trends compared to the prior year, and lower profit contribution from our Medical-Surgical business, primarily driven by the sale of our ZEE Medical business in the second quarter. Full-year Distribution Solutions baseline gross profit also included our global procurement synergies and $76 million in antitrust settlement proceeds. Let's now move to slide seven of the supplemental presentation. Full-year segment baseline operating expenses increased 1% in constant currency from the prior year, benefiting from lower operating expenses following the sale of the ZEE Medical business. Now I'll refer to slide eight in the supplemental presentation. Distribution Solutions full-year baseline operating profit increased 7% in constant currency to $4.5 billion. We ended the year with a baseline operating profit margin of 234 basis points, four basis points below the adjusted operating margin we reported in the prior year. Looking ahead to fiscal 2017, we expect the segment baseline operating margin to approximate the fiscal 2016 baseline operating margin. Underpinning this outlook in fiscal 2017 is planned growth in segment baseline operating profit, driven by the contributions from our generics business, including both our global sourcing efforts and expanded one-stop sales, strong growth from our specialty, Canadian, international, and Medical-Surgical businesses, and the contribution from the previously announced acquisitions we expect to close during the fiscal year. Offsetting this anticipated profit expansion, we expect a lower profit contribution from the customer contracts we previously discussed during fiscal 2016 but were impacted by market consolidation. In the U.S. market, we also expect branded drug pricing trends to be modestly below those experienced in fiscal 2016. We anticipate a nominal contribution from generic pharmaceuticals that increase in price during fiscal 2017. We also expect the contribution from the launch of new oral generic drugs in the U.S. market to decline from the prior year. Finally, we expect a higher mix of more complex and expensive therapies, which will impact our margin rate. Turning back to Schedules 3A and 3B of the tables accompanying our press release, Technology Solutions revenues were down 5% for the quarter and down 6% for the full year to $2.9 billion. This full-year decline was driven by anticipated revenue softness in our hospital software business, the sale of the Nurse Triage business, and the wind-down and transition of our UK Workforce business, partially offset by growth in our other technology businesses. Looking ahead to fiscal 2017, we expect Technology Solutions revenues to decline slightly year over year, as growth in our connectivity, payer solutions, medical imaging, and provider revenue cycle businesses will more than offset an anticipated revenue decline in our hospital software business. I'll now refer to slides nine and 10 of the supplemental presentation. Full-year baseline segment gross profit was flat year over year in constant currency. Full-year baseline operating expenses in the segment declined 5% in constant currency from the prior year. Full-year baseline operating expenses benefited from various ongoing cost management initiatives, including the fiscal 2015 workforce reductions and lower expenses following the sale of the Nurse Triage business in the first quarter. Let's now move to slide 11 in the supplemental presentation. Baseline segment operating profit increased 12% in constant currency, driving a full-year baseline operating margin of 18.72%, up 288 basis points over the prior year. During fiscal 2017, we expect the baseline operating margin for the segment to be in the low-20% range. Now I'll review our balance sheet metrics. For receivables, our days sales outstanding increased two days from the prior year to 28 days. Our days sales in inventories increased one day from the prior year to 32 days. Our days sales in payables increased five days from the prior year to 59 days. Due to our profit growth and disciplined approach to working capital management, we reported $3.7 billion in cash flow from operations during fiscal 2016. We ended the year with a cash balance of $4 billion, with $2.2 billion held offshore. In fiscal 2017, we expect cash flow from operations to grow by approximately 15%, excluding $270 million in expected cash payments related to the combination of the cost alignment plan and a settlement agreement with the U.S. Drug Enforcement Administration and the U.S. Department of Justice, as previously disclosed in April of 2015. Internal capital spending totaled $677 million for fiscal 2016. For fiscal 2017, internal capital spending is projected to be between $700 million and $800 million. Our dividend obligation to Celesio's non-controlling shareholders is included in a line titled Net Income Attributable to non-Controlling Interests on Schedule 1 of the tables accompanying our press release. We expect this obligation to drive a fiscal 2017 expense of $46 million, or approximately $12 million per quarter, assuming a 76% ownership stake. During fiscal 2017, we also expect to record income for non-controlling interests related to our joint venture physician partners operating within Vantage Oncology, the previously announced and now completed acquisition within our U.S. Specialty business. As a result, in fiscal 2017, we expect income attributable to non-controlling interests to increase by approximately 50% from fiscal 2016. Finally, we also anticipate a foreign currency rate headwind of approximately $0.03 during fiscal 2017. In today's earnings press release, we detail many key assumptions underpinning our fiscal 2017 outlook of $13.30 to $13.80 per diluted share, which excludes anticipated fiscal 2017 cost alignment plan charges of $40 million to $50 million, equating to approximately $0.12 to $0.15 per diluted share. I'll now refer you to slide 12 in the supplemental presentation, which outlines our anticipated year-over-year baseline earnings growth. Our fiscal 2017 guidance of $13.30 to $13.80 provides baseline earnings growth of 6% to 10% year over year, which is in line with the fiscal 2017 preliminary outlook we provided back in January. Thank you, and with that, I will turn the call over to the operator for your questions. In the interest of time, I ask that you limit yourself to just one question and a brief follow-up to allow others an opportunity to participate.

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

Thanks, Ricky, for the question. I think the best way for us to think about this is really related to post the challenges we faced this year from the lapping of the generic price phenomena we experienced last year as well as the customer consolidations and the negative mix change associated with those customers. We think once we lap those changes and we get through this fiscal year, you should begin to see us perform at a level that's similar to what we experienced in the past. We don't see anything structural in our business or in our business model that would cause us concern about our ability to grow organically in a way similar to the way we've grown in the past. Now clearly in fiscal 2018, we also have the transition with Rite Aid, and you'll see us making moves to prepare for that. We'll talk about that more as the time approaches. But other than that additional headwind that we'll face in that fiscal year, I think the business continues to perform as it has in the past.

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

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

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

It is early to talk about 2018. I would say that we talked a lot about the cost reduction programs we've put in place and the quick action we've taken to streamline the organization and ensure we maintain our efficiencies. We don't see any structural changes in our business that cause us great concern. The pending sale of Rite Aid is an unusual event, and it's our objective to find a way to grow through that. I hesitate to provide any forward guidance into fiscal 2018, but I can tell you that is our intent, and we're working hard to ensure that happens.

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

I'll let James jump in here in just a minute, but we clearly have the organization focused on balancing our objective to grow earnings while managing our cash flow. So I think the team is focused, and you're seeing results from that focus. James, you might want to talk about it.

I was pleased with the cash flow growth in fiscal 2016, driven both by profit growth and ongoing focus around working capital management. We think there's more opportunity to continue to build this level in fiscal 2017, as we indicated in our guide. It's important to remember, though, that the guide I referred to excluded $270 million of cash outflows that we would expect to incur in fiscal 2017, driven by two things: the cost alignment plan and then the DEA payment.

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

We have a longstanding tradition of building value with our manufacturing partners, both on the generic and branded and specialty sides of our business. Our relationship with the branded manufacturers has remained pretty consistent for a long time. Our proportion of earnings that comes through price change in the branded portfolios has remained constant, and it is a small portion of our overall branded profit arrangement. Most of our profits are covered under a more fixed arrangement that is reliable regardless of what happens with price inflation. There's a small portion that we mentioned in that 20% plus or minus range that has some price inflation effect on it.

Just to follow up, do you also factor in the political climate? We're in an election year, so do you take that into your assumptions as we think about the coming year?

We're not oblivious to the conversations going on in the media and the current political activity, and we're certainly aware of investigations and congressional conversations in these areas. Our assumptions are reasonable based on our historical work with the manufacturers and are buffered by the current climate. So I believe that as we stated today, these assumptions are realistic and likely to occur as laid out in our fiscal 2017 guidance.

Thank you. I'd like to return to cash flow. Given the increase in cash flow we see, can you discuss your plans for that cash? James, I'd love to hear your view on leverage and where you'll be post-financing, maybe some maturities that come up this year, minimal cash balance in the EU and U.S., and how you're planning to use cash this year?

We remain committed to our portfolio approach to capital deployment. That includes internal capital spending, M&A, dividends, and share buybacks. One of the themes in this past fiscal year was that we deployed all four levers of that portfolio approach. We have indicated a preference for value-creating M&A if we can find good alternatives versus share buybacks. We've made progress on that. We've made significant progress with debt maturities, bringing down the gross debt level we entered to finance the Celesio acquisition a couple of years ago. We've brought ourselves an additional level of financial flexibility as a result of that. We expect to be raising some additional debt in order to accomplish closing on some of the acquisitions in the coming months.

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

I think it's a fair statement. We're modestly above the top end of that range we indicated preliminarily back in January.

Great, thanks for the questions. It feels a little unnatural to be asking so many around branded versus generic side, but here goes. It seems you guys are assuming less inflation on the branded side in 2017 than you saw at 2016. Is that because you're already seeing less price increases in the market to date, or is this just more conservatism that you're baking into fiscal 2017? Any insight specifically on specialty pricing trends would be helpful.

On the branded side, our assumption is a prudent one. It's not based on anything we've seen. We're very early in the year. But we're watchful of the political environment and so on. That would be how I would address branded price. Regarding specialty pricing, it has a relatively modest effect on our business plan. It's mostly a fixed-like fee-for-service agreement in that area. I wouldn't draw particular attention to the pricing there.

I am pleased to have made significant progress since acquiring Celesio to accomplish the objectives we set when we made the acquisition. The synergy between $275 million and $325 million was quite additive to the existing run rate of margin and profit coming from the Celesio business without these global synergies. I'm pleased with the progress our team has made, and we're focused on continuing to push for improvement.

Hey. Good afternoon, guys, two quick questions. First, could you quantify the EPS impact or the step down of generic introductions in fiscal 2017 versus 2016?

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

John, I'm interested in how you think about the Specialty business regarding oncology. You've made a significant investment there, and the Medicare Part D demonstration project seems to upset everyone. Do you feel protected around the business investments you've made in specialty? How do you think the oncology business evolves?

The demonstration project really has no material effect on our business. Even if it's rolled out in its current form, which isn't in the best interest of patients or oncologists, it would still be relatively immaterial to us. We focus on helping our oncology practice partners become more efficient and improve their practice profitability. Our strategy is to be well positioned for significant launches of new oncology treatments, including drugs and protocols. We are also actively engaged in pilot programs to demonstrate new ways to treat patients and achieve value-based outcomes.

Thanks for taking the questions. Can you discuss the organic growth opportunities you see for Celesio potentially becoming an intermediary between hospitals or manufacturers?

Lloyds is well-positioned to participate in the care process in many countries, especially in the UK, where healthcare demand outstrips supply. We're excited about Lloyds playing a significant role in healthcare services. We aim to establish a pharmacy strategy worldwide focused on being part of the care process while investing in Celesio's infrastructure to grow our footprint.

Hi. Quick question regarding the Rexall transaction. How does it reflect any change in your acquisition or business development philosophy concerning your retail footprint for McKesson in North America?

We aim to lead in the businesses we participate in. Opportunities to lead in the market with businesses attract us. We believe we can be number one or number two in the retail market in Canada and parts of Europe. We are transitioning to focus on aligning closely with great business partners and winning independent pharmacies while supporting them with our expertise.

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