Good afternoon, and welcome to the McKesson Corporation Quarterly Earnings Call. All participants are in a listen-only mode. Today's call is being recorded. If you have any objections, you may disconnect at this time. I would now like to introduce Mr. Craig Mercer, Senior Vice President of Investor Relations.

Thank you, Noah. Good afternoon, and welcome to the McKesson fiscal 2017 second quarter earnings call. I am joined today by John Hammergren, McKesson's Chairman and CEO, and James Beer, McKesson's Executive Vice President and Chief Financial Officer. John will first provide a business update, and then James will review the financial results for the quarter. After James' comments, we will open the call for your questions. We plan to end the call promptly after one hour, at 6:00 PM Eastern Time. Before we begin, I remind listeners that during the course of this call, we will make forward-looking statements within the meaning of the federal securities laws. These forward-looking statements involve risks and uncertainties regarding the operations and future results of McKesson. In addition to the company's periodic, current and annual reports filed with the Securities and Exchange Commission, please refer to the text of our press release for a discussion of the risks associated with such forward-looking statements. Please note that on today's call, we will refer to certain non-GAAP financial measures. In particular, John and James will reference adjusted earnings, which excludes four items: amortization of acquisition-related intangibles, acquisition expenses and related adjustments, claim and litigation reserve adjustments, and LIFO-related adjustments. Finally, I would call your attention to the supplemental slides, which we will reference on today's call, and those can be found on the Investors' page of our website. We believe the supplemental slides, which include non-GAAP measures, will provide useful information for investors with regard to the company's operating performance, and comparability of financial results period-over-period. Please refer to our press release announcing second quarter fiscal 2017 results and the supplemental slides for further information and a reconciliation of the non-GAAP performance measures to the GAAP financial results. Thank you. And here's John Hammergren.

Thanks, Craig, and thanks, everyone, for joining us on our call. Before I jump into our second quarter results, I'd like to take a few moments to frame our discussion today, as events impacting our second quarter results have implications for our outlook for Fiscal 2017. Let's start with our revised Fiscal 2017 outlook. In particular, we now provide an update to our expectation of a lower profit contribution, resulting from recent customer pricing activities, and lower operating profit as a result of further moderating branded pharmaceutical inflation trends, compared to previous expectations, both of which affect our U.S. pharmaceutical business within Distribution Solutions. As a result of these updates, we now expect $12.35 to $12.85 per diluted share, which excludes from adjusted earnings a goodwill impairment charge in our Enterprise Information Solutions business, which James will cover in his comments, as well as estimated charges related to our cost alignment plan that was previously announced in March of 2016. As we built our plan and entered Fiscal 2017, we assumed some moderation around drug inflation activity. In particular, we commented on our expectation for a nominal contribution from generic pharmaceuticals that increase in price. We also commented that our expectation that branded pharmaceutical price trends would be modestly below those experienced in fiscal 2016. First generic price inflation has been largely in line with our original assumption. However, customer pricing and branded inflation continue to evolve. In our first quarter, we witnessed some evidence of inflation and pricing softness in line with our original assumptions. However, this softness became much more pronounced in our second quarter, first around brand inflation and later, around customer pricing. While we generally do not provide specific assumptions around customer pricing activity, we do operate in a competitive environment. And though competitive, we've always…

Thank you, John. And good afternoon, everyone. Today I will first discuss our fiscal 2017 outlook and then review our second quarter results. In addition, I will provide more information related to the pending Change Healthcare transaction prior to John and I taking your questions. Before I get to our outlook, I want to note that in addition to our earnings press release and customary tables, we have published a supplemental presentation on our website. This presentation provides an operational view of our fiscal 2017 earnings or adjusted earnings excluding unusual items. We exclude from this view the non-cash pre-tax goodwill impairment charge taken in our EIS business within our Technology Solutions segment during the second quarter as well as charges or related reversals associated with the cost alignment plan we announced in March 2016. This view also excludes prior-year gains on the sales of two businesses. To expand on these unusual items, in the second quarter, we recorded a non-cash pre-tax goodwill impairment charge of $290 million or $1.24 per diluted share associated with our EIS business. Also, in the second quarter, we recorded pre-tax credits of $10 million or $0.02 per diluted share related to the cost alignment plan. Now I will focus on our fiscal 2017 outlook. As John discussed earlier, based on our reported earnings and expectations for the remainder of the year, we have lowered our fiscal 2017 guidance for adjusted earnings per diluted share from $13.43 to $13.93 to a new range of $12.35 to $12.85. This new range excludes approximately $1.31 to $1.33 from adjusted earnings driven by the combination of the EIS goodwill impairment charge and anticipated charges during the fiscal year for the cost alignment plan. Our revised outlook includes the impacts of competitive customer pricing and softness in brand inflation…

Thank you. Our first question comes from Ross Muken with Evercore ISI. Your line is open.

Good afternoon. So, John, having been covering this company a long time, I can't recall the last time we had a discussion on competitive pricing. And so, I guess what do you think caused that part of the environment to change over the last three or six months? And obviously, the magnitude that you've given is quite large, and so it's a fairly substantial change. Obviously, we're seeing a lot of different constituents talk about drug pricing and all sorts of other things, but this seems actually unrelated. And so help us just understand, one, what you think caused this, how you think the industry will then respond and hopefully heal. And then, secondarily, on your end, I guess how we should put this into context of what has happened historically, if there's anything that you would compare this to.

Let me start with that, Ross. I have seen this, obviously, throughout my career. But we also saw it at McKesson that where, in particular, we took a step function down with pricing. You may recall, I think in the early part of 2008, we had talked publicly about a significant price-related challenge that we are facing now. It happened that year that we were able to fill the margin hole created from that stair step through a unique opportunity to be the sole provider of the H1N1 flu vaccine back then. And that gave us a stream of profitability that allowed us to grow through that challenge. So it does happen from time to time. You'd have to really probably ask the companies involved in it as to why they would pursue price. I can tell you that McKesson doesn't believe you can build sustainable relationships with customers or value for shareholders with a price-oriented approach. And I know that at least one company in our sector has been pretty public about growing revenues above market and about regaining market share, particularly in the independent space. And so I think that certainly people have different motives perhaps to grow their business beyond the market. I would tell you that what McKesson's been focused on, as we've talked about year in and year out, is the expansion of the service we provide our customers and the value that we deliver to create those relationships and expand our margins while we do so. And margin growth comes from solid relationships that are built over time. And from time to time, those relationships can be challenged if the price differential between where the customer perceives the market price to be and what we're asking for become disconnected. So it has happened before. We covered through those periods of time. And like I said, I don't think a price-oriented approach to market share is something that's stable in the end anyway.

That was helpful. Thanks, John.

Our next question comes from George Hill with Deutsche Bank.

Yeah. Thanks for taking the question. And John, you may have just spoken to it because you called out the pricing pressure, and I wanted to see if you could comment on which market sub-segments are you seeing the pricing pressure the most. It seems like you spoke to independents, but also is it in the independents and the franchisees and the big boxes? I guess any more color on the pricing pressure would be helpful.

Well, thanks for the question, George. I think the most acute area right now is in our independent segment. And clearly, that's a place where you have lots of customers that had long-term relationships, but they also can be fluid. And I think what we've tried to say today is that we plan to maintain our share positions and to grow our business on the value we deliver. And that's really what we're after. The rest of our segments are always competitive, but this is the most material impact we've seen in some time.

Okay. And then just my only follow-up would be from a quantification perspective. You gave us the basis point impact. But is there a way to think about the magnitude of the pricing change in that segment that you're seeing? Quantify that. I'm sorry.

Yeah, I think James talked a little bit about the reduction in our expectations and how that split with a larger portion really coming from the price pressure we feel. And so that gives you a sense for the magnitude. And clearly, the independent segment for us is a very valuable and important franchise and we have a lot of business there. So I think that between those comments, you should really get a sense directionally for the size of the challenge.

Okay. Appreciate the color. Thanks.

Yeah.

Our next question comes from Lisa Gill with JPMorgan.

Thanks very much. John, just looking at the industry, my understanding was always that a bigger component of your margin actually came from the manufacturers versus the customer relationships. So can you talk about what's happening on that side of your business? And our understanding has been that inventory management agreements cover 80% or 85%. What are you seeing in that other 15% to 20%? Is that having a direct correlation on what you're seeing as far as the reduction in earnings as well?

Right. There really are two factors, and I'll have James talk a little bit about the manufacturers in a minute. Because that obviously, when we talk about brand price inflation trends and we tried to quantify once again in our prepared comments how much of this challenge we had this quarter and the forecast for year is coming from that component, we do have some variability that resides in that part of our business. Clearly, the manufacturers that play a very important role for us, and we're constantly working with the manufacturers to make sure that we've identified the value that we deliver and that we're properly reimbursed for that value and we plan to continue to do so. On the customer side, it's not unimportant I think to point out that we do have a nice and profitable relationship with customers on the generic portion of our business. And albeit we may not make much or any on the brand side, the profit stream we get from generic participation as we've talked about before when we were picking up the Rite Aid generic business or the Target generic business. That generic business is a source of profitability, and there is obviously flexibility in how we price those generics. And there's a market for generics. And we have to be responsive to how the market pricing plays for generics. James, maybe you can talk a little bit about the manufacturer side.

Yeah. In terms of when we came into the year, we were assuming that the level of brand manufacturer or pricing inflation would be modestly below what we had seen in the previous fiscal year. And today, we've updated that tight commentary to now being meaningfully below what we saw last year. To try to perhaps put a little bit more quantification around that, I would say that the delta, if you will, between the rate of inflation that we expected and the one that we have seen thus far year-to-date is greater than a third reduction versus our original expectations. The other thing I would comment on in terms of the brand income, why this inflation rate is important is that there is both a fixed component and a variable component of the income that we receive from branded manufacturers. Now, a year or more ago, we were talking about that being a roughly 80%, 20% type split in terms of the fixed component of the equation versus the variable component. In part, the contracts have evolved. But also in part as inflation rates have come down in the last few months, I peg that split more at 90%, 10%. 90% of our income is fixed, 10% is variable. But obviously, that 10 points is still being able to have a meaningful impact on the financials that we've been talking about today.

James, can you help us understand what the actual rate of inflation was last year, when you say you expected it to be down, but now it's meaningfully down? Is there a number you can put around that?

I wouldn't throw out a specific number, but that's why I articulate, the decline that we have seen in the inflation rate is greater than a third of the original expectation for the year. So it's a significant decline.

Okay. Great. Thank you.

I think, Lisa, also, when we look at what we come up with from a calculation perspective on branded inflation, it's plus or minus what you'll see from published sources of inflation. But it is also important to point out that those averages sometimes don't necessarily tell the whole story, because of the mix, or the relationship, or the individual products that are going up or going down in the portfolios can be materially different. And so I do think the economics aren't always necessarily driven with the direct correlation to the average price increases that everybody talks about.

Okay. Thanks.

Yeah.

Our next question comes from Michael Cherny with UBS.

Good afternoon, guys. I'm going to take this in a little bit of a different direction. I just want to clarify relative to the Change Healthcare deal. James, if you don't mind going back over it, so you said, I believe, $1.10 to $1.30 of dilution from the deal, offset by some other estimate. So is that $1.10 or $1.30 a net dilution deal number to the entire business, or is that offset by those benefits, in which case we're on our own to make the assumptions on that front?

Yeah. So you should think of the $1.10 to $1.30 as the combined effect of the two items that I discussed. The impact of the deferred revenue and then the impact of the higher interest expense on $6.1 billion worth of debt. So wanted to put quantification around those two items. Then, the other comment I made was getting at the reality that as we're actually operating the business and starting to drive the synergies, the EPS that will drive from the contributed assets, if you will, our share of NewCo will be greater than the ability of those assets, absent our deal with Change Healthcare, to drive EPS. So there's an accretive effect, if you will, on that element of the equation. As you would expect, when we come together and drive synergies in a deal. But there are also going to be these two large, very distinct items that will drive dilution, the interest expense and the deferred revenue, haircut you could call it, and that those two items total to this $1.10 to $1.30 range that I mentioned.

Thank you. I know this is a complicated transaction. I appreciate the color. I'll let other people ask some other questions.

Thank you.

Our next question comes from Robert Willoughby with Credit Suisse. Robert Willoughby - Credit Suisse Securities (USA) LLC (Broker): I guess to that, James, do you have any growth forecasts for each of the businesses, EIS and the others? I don't think I see them anywhere. And just maybe, can you speak to the inventory environment? I know last year you scaled up inventory meaningfully in the third quarter. This year you liquidated some. I mean, does that not account for some of the profit shortfall? I know you say you don't do it, but isn't there some opportunity associated with that practice from a profit standpoint that maybe fell out of the model?

There was nothing unusual in the third quarter. You would very normally have an inventory build as you come into the winter season. So no, I wouldn't point to anything odd around inventory management. Our cash flow was obviously a bright spot in our numbers here, and that was very much a result of ongoing working capital management initiatives, these sorts of things that have been going on at McKesson for years as well as our underlying operating profitability obviously as well. But the working capital initiatives have been important focus for us, and we'll continue to have that. The first part of your question, the technology businesses, I wouldn't get into specific growth rates around EIS or any particular segment of the business. Overall, we feel as though our technology segment is performing very nicely, they're very much where we expected them to be at this point in the year. Even though there, as John mentioned in his remarks, is plenty of work going on around setting up the new company or preparing to set up the new company, so we've been pleased that they've been able to maintain their focus. And so we feel good about the trajectory of those businesses generally. Robert Willoughby - Credit Suisse Securities (USA) LLC (Broker): And just a clarification. James, you did liquidate inventory in the September quarter of this year that did not scale up. Is it just a combined effect of all the businesses resulted in a modest reduction?

Yeah. What I was observing is, in Q3, you would normally have an inventory buildup as you go into the winter season. So yes, that's right. Robert Willoughby - Credit Suisse Securities (USA) LLC (Broker): All right. Thank you.

Okay.

Our next question comes from Robert Jones with Goldman Sachs. Robert P. Jones - Goldman Sachs & Co.: Thanks for the questions. Yeah, John, I guess like others I'm surprised to hear you highlight competitive pricing, just given how rational the industry has been for so long. And I guess if I take a step back, this year alone, we've seen the negative impact to profitability from generic pricing, moderating. Now, we're talking about a slowdown in branded inflation. Is there any thought that those dynamics themselves are what are forcing your competitors to maybe go harder after market share to make up for what seemingly would have created a shortfall in profit? And then, I guess more importantly, how sustained do you think this competitive behavior could be? Do you think this is more of a one-off, a few accounts that they went after harder, or do you think this could potentially be a more lasting changing dynamic?

I think those are all good questions. I think that the best way for me to answer them would be the way we think at McKesson. I can't speak to how our competitors make their decisions or how they make their pricing calls in the industry. I can tell you that McKesson is focused on retaining our customer base and creating additional value for our customers as I talked about before, and charging a fair price. And on that fair price idea, there is plenty of headroom in terms of the value we deliver to the industry that we don't charge for. And as I've seen in the past when – we have faced pressures like this, where there's been a reduction in product launches or other things happen, with some of the profit pools become more difficult. What typically we would attempt to do is reduce the level of incremental discounts that we pass on to our customers when we're in those discussions. But clearly, that conversation isn't successful if there are alternatives that are providing something that is even more significant. My best hope is that we demonstrate to our customers that they're going to always get a fair price from us, and in return, they're going to get superior service and tremendous focus on their success. And that's where we plan to stay. And I know at McKesson, at least, we think growing market share through a price-oriented approach ultimately will not be successful, because customers don't want a change. Our customers, when they get a better deal, come to us and say, hey, listen, can you match this deal because I'd like to stay with you. And so that customer pressure to remain with us because they like us always provides McKesson an advantage when we're in these discussions. Robert P. Jones - Goldman Sachs & Co.: Understood. I'll leave it there. Thank you.

Yeah.

Our next question comes from Charles Rhyee with Cowen & Co. Charles Rhyee - Cowen & Co. LLC: Yeah. Hey. Thanks for taking the question. Just curious, James or John, when we think about the reduction in guidance for the year, can you give us a split, maybe, between how much you think is coming from the customer side, versus how much is from the brand inflation side? Is it half and half or...?

Yeah. So a couple of points. In terms of the negative effects, I would say it's the competitive pricing having a greater impact than the brand manufacturer price inflation rate. But also, remember that we offered $1.60 to $1.90 range for those two items. We're bringing the overall company range down by less than that because we've got tailwinds in our view around our tax rate, around our share count, around our interest expense and so forth. So that's going to drive the delta between the two ranges that we're offering today. Charles Rhyee - Cowen & Co. LLC: And then to just follow up on the brand inflation side. Obviously, I think most people coming in would have thought, hey, the elections are a factor driving this. How are you guys thinking about it as we move into next year post-elections? Obviously, a lot of spotlight on Congress right now on this topic. How are you at this point thinking about – do you think it bounces back, or do you think this is maybe the new normal and we have to wait for the anniversary? Any thoughts there would be helpful. Thanks.

Well, I think the view we have is sort of a year-to-date view. We have the same information that you have and probably the same visibility. And we're just guessing as to what manufacturers are likely to do going forward like everybody else. They control their pricing decisions, and we don't have much visibility into anything, other than their historic behavior. And their historic behavior, obviously, has been rising over the last several years. And if you go back before the more recent years, there's always been a level of – at least in our data, always been a level of inflation that has occurred. And you do hear some manufacturers talking today about having a policy around how much inflation they think they should be able to provide to the industry over time. Some of them are making those statements more publicly than others. And clearly, there might be some near-term changes in their behavior that will be different over the longer haul. We do think that innovation requires profitability. We think the lack of new product launches in the face of generic conversions causes pressure to branded manufacturers and that they ought to have the ability to raise price appropriately on branded drugs to help fund their R&D requirements and their profitability requirements. And so I think that a common person's view would be that you'd still see inflation at some levels. I think that the outer bounds of inflation that had been experienced in the past by our industry, that we've had conversations about in the past, are probably likely to not exist anymore. So I just think those heavy outliers on both brand and generic, those outliers will come in, which obviously will have an effect. But, yeah, it's probably a little bit early to speculate. And I think as we get through the rest of this year, we've given you some assumptions about directionally where we think it's going to be the balance of this year. As we get into the next fiscal year, we'll give you a sense for where we think it's going to be. Charles Rhyee - Cowen & Co. LLC: Thanks. Is it possible to renegotiate these contracts on the fly, or is it you have to wait as the terms come up? And I'll stop there. Thanks.

Well, I think anything is possible. We typically have renegotiated the contracts when they come up as opposed to whenever we're under significant pressure. I think that we always have the opportunity to go back to manufacturers and demonstrate once again the value that we deliver. And in particular, where manufacturer's behavior has changed dramatically from its previous behavior and we had come to depend on those mechanisms as part of our funding source with that manufacturer, I think we have every right to go back to those manufacturers and say, listen, we need to open the dialog again because by your unilateral decision, you have significantly impacted our profitability on your particular product lines and we don't think that's fair and we want to recover that lost margin. So I think that that certainly is something we plan to pursue. Charles Rhyee - Cowen & Co. LLC: Thank you.

Our next question comes from Ricky Goldwasser with Morgan Stanley. Ricky R. Goldwasser - Morgan Stanley & Co. LLC: Yeah. Hi. Good evening. So a few questions here. First of all, just to clarify, John, when you talk about inflation being meaningfully lower, I hear you saying that year-to-date you're seeing greater than a third reduction. And I think going back to past comments, I think you saw 12% last year for your fiscal year. We're getting to around fiscal year 7% year-to-date. But when you think about the December quarter and the March quarter, which usually has a lot of inflation, in your assumption are you assuming that the second half you're going to see that same reduction that you've seen year-to-date? Or are you assuming some acceleration in that given that all the commentary we're hearing about the industry trying to self-regulate? I'm just trying to better understand are you clearing the decks here with this $1.60 to $1.90? Or could there be potentially more downside if in the second half of your fiscal year brand inflation decelerates even more?

James, why don't you...

Yeah. Ricky, to answer your question very directly, what we've assumed for the back half of fiscal 2017 is a continuation of the inflation rate that we have experienced year-to-date. Ricky R. Goldwasser - Morgan Stanley & Co. LLC: Okay. So basically the same type of price increases that we've seen year-to-date to continue for the next couple of quarters.

Yes. Ricky R. Goldwasser - Morgan Stanley & Co. LLC: Okay. And then when we think about the sell side pressure that you're talking about, is that a number that we can take and annualize into next year? And I think my point being is that, obviously, it's a (57:26) and when we think about the margin implication. Is it fair to assume that you just repriced that portion of the contracts that are perennial for this year, or have you also gone proactively to your customers and locked in contracts that are going to come up in the next year or two at a new pricing level?

Well, I think those are, obviously, both good questions. I think to the point that James is making when he answered it a moment ago, we typically see stronger price inflation as you get into our third and fourth quarters. And so when we say we're guiding on a year-to-date basis, that already tells you that we believe there'll be some moderation in those quarters relative to previous behaviors. On the sell side, it's a little bit more difficult to make projections because we're basically in a position where we are reacting to some extent and not being the people that are making the decision. I think that our view is that we have made a very significant change in our pricing practice to match where the market is today. And we, like I said to answer another question that was asked, we have seen this kind of event happen in the past as well and we didn't see a continuation of the event. And our objective is to continue to maintain our market share. So I think we believe we provided guidance that has reasonable expectations from that perspective and that you can count on the range. That's one of the reasons that the range is somewhat wider, though, is it's somewhat dependent on what happens going forward. Ricky R. Goldwasser - Morgan Stanley & Co. LLC: So I think that one of the things that we are all trying to get a better sense of is when we think about fiscal year 2018 and I fully understand that you're not guiding to 2018 and there are a lot of moving parts, but is it reasonable for us to take that $1.60 to $1.90 in EPS impact that we're going to see in the second half of the year and just use it as a run rate for fiscal year 2018 just for these two components?

Well, at this very early stage, Ricky, it's really I don't think it's appropriate for us to try to make any predictions about FY 2018. So I think really we should leave that for closer to the start of that fiscal year. And we'll, obviously, be getting into our guidance process as normal. Ricky R. Goldwasser - Morgan Stanley & Co. LLC: I'm just assuming all steady state, right? So if you're seeing the step-down in your sell side margin, traffic to the EPS impact is going to just slow through...

Yeah. No, I... Ricky R. Goldwasser - Morgan Stanley & Co. LLC: I guess that's the question right now.

I understand the logic. It's just hard for me to take a position on FY 2018 at this very early stage.

Yeah, I think it's a difficult question to answer. But I think – I did try to at least bound the conversation around customer pricing, in that this is a pretty significant step-down, and we believe that that allowed us to maintain the relationships with our customers, given what was a pricing environment where we were higher-priced than where we needed to be, and that has occurred, and it's baked into the guidance that we have provided you, in terms of the range that we just refreshed. Now, I think to James' point, it's pretty early to speculate on what branded inflation might be next year, and what else might happen with our customer base. But we tried to give you as much visibility as we possibly can. I know you guys are on a short timeframe. Let me close this call, if I can, and let you know that – I know you share with us the disappointment in today's news. This is not what we had expected, and certainly not what we want. But despite this downward revision to our outlook, we do believe in and remain committed to the value we demonstrate every day to our customers and our manufacturing partners. And as I mentioned a few moments ago, we believe the increased competitive pricing activity does not build sustainable customer relationships or long-term shareholder value, and we are all about sustainable relationships, and creating long-term shareholder value. And we're supported by McKesson's great tradition of customer focus, operational excellence and disciplined execution. And our talented workforce, robust cash flow generation, and strong balance sheet position us for the long-term value creation that we strive to obtain. We remain as committed as ever to our value proposition. And I'll now hand the call off to Craig for his review of upcoming events for the financial community. Craig?

Thank you, John. I have a preview of upcoming events for the financial community. On November 8, we will present at the Credit Suisse Healthcare Conference in Scottsdale, Arizona. On January 10, we will present at the JPMorgan Healthcare Conference in San Francisco, California. We will release third quarter earnings results in late January. Thank you, and good-bye.

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