Craig Mercer - Senior Vice President, Investor Relations John Hammergren - Chairman and CEO James Beer - Executive Vice President and Chief Financial Officer

Eric Percher - Barclays Lisa Gill - J. P. Morgan Ricky Goldwasser - Morgan Stanley Robert Jones - Goldman Sachs Steven Velazquez - Bank of America Merrill Lynch Garen Sarafian - Citigroup Ross Muken - Evercore ISI Michael Cherny - UBS David Larsen - Leerink Brian Tanquilut - Jefferies Charles Rhyee - Cowen & Company

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

Thank you, Melisa. Good afternoon, and welcome to the McKesson Fiscal 2017 Fourth 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 and full year. 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, our fiscal 2017 adjusted earnings, excludes four items: amortization of acquisition-related intangibles, acquisition related expenses and adjustments, claim and litigation reserve adjustments, and LIFO-related adjustments. Also, James will discuss our operating performance further adjusting for the impact of net charges associated with the cost alignment plan that we announced in March 2016, as well as the non-cash pretax good will impairment charge which is related to our EIS business within our Technology Solutions segment during the second quarter. For fiscal '16, we excluded the income sales of two businesses. Consistent with how we’ve discussed our fiscal '17 results in prior earnings calls, which reconcile adjusted earnings to adjusted earnings excluding these unusual items, the supplemental presentation is useful in reviewing the fiscal 2017 versus fiscal 2016 results discussed today. In connection with the issuance of our fiscal 2018 outlook and in consideration of investor feedback, benchmarking relative to superior companies and in line with management's view of our operating performance, we are revising our adjusted earnings definition. The revision will principally exclude gains from antitrust legal settlements, restructuring charges and other adjustments including asset impairments and gains or losses on disposal of businesses or assets. We filed a second 8-K with the SEC today, which includes the full text of our revise definition of adjusted earnings, as well as the recap of quarterly and full-year of fiscal 2017 results. This will allow you to compare our fiscal 2018 outlook to our revised adjusted earnings for fiscal 2017. For reference, slide 14 of the supplemental presentation provides a visual walk from fiscal 2017 adjusted EPS to adjusted EPS, excluding unusual items. Then it bridges that measures to the fiscal ’17 revise adjusted EPS. We believe the earnings press release, supplemental slides and the recap of 8-K which all includes non-GAAP measures, will provide useful information for investors with regard to the Company's underlying operating performance and comparability of financial results period-over-period. Please refer to these materials, which may be found in the investor section of our Company website, 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. I'm pleased with our fourth quarter results, which were driven by solid execution across both of our Distribution Solutions and Technology Solutions segments. James, will cover our annual financial performance in greater detail. But let me provide some color on the year just concluded. If we recall, as we entered fiscal 2017, we were working hard to mitigate headwinds resulting from moderating generics inflation and customer consolidation. During fiscal ‘17, we implemented a cost alignment plan to achieve improved efficiencies and realize materials savings across our enterprise. We announced a new sourcing partnership for generics with Walmart. We entered into a plan with Blackstone to create a new scaled healthcare technology business, and we announced several acquisitions intended to, among other things, expand our retail footprint and broaden our specialty capabilities. We successfully executed against each of these major initiatives, which were transformative in nature and better position to Company for long term growth. However, we did not anticipate the sizable additional headwinds we experienced around pricing for branded pharmaceuticals in the degree of sell side price competition for generics, particularly within the independent retail pharmacy channel. Let me take a moment to provide an update on those two topics specifically; first on branded pricing. Throughout the past year, there has been increased pressure on manufacturers in the pricing decisions they make, which led the lower inflation levels than we had originally assumed in our fiscal 2017 outlook. However, it is important to note that in the fourth quarter, the compensation that we earn we earned it from brand pricing changes, was largely in line with the expectations that we shared during our last earnings call. As we entered into a new fiscal year, we’ve assumed a mid-single digit rate of brand inflation, less than what we experienced in fiscal 2017. We believe this level assumed inflation is appropriate given the degree of uncertainty around branded pricing and a reality that we’re not involved in setting drug prices. Switching now to generic pricing, while the rate of price changes in our generics pharmaceutical portfolio has varied from year-to-year, we’ve historically experienced deflation, which we define as a reduction in our cost of acquiring generic drugs from the manufactures. For McKesson, our multiple drivers of generic deflation, which included competition, supply and maturity of launched products and our sourcing efforts, the rate of deflation is specific to McKesson’s generic product mix, customer mix, ongoing negotiations and relationships with manufactures and our specific fiscal year. We consider it to be unique and proprietary and thus do not disclose rated deflation for our generic purchases. An additional factor impacting generics is a sale price environment. We operate in a competitive marketplace and the competitive nature of generics is a function of market based pricing. If you recall that in the first half of our fiscal year, we saw increased price competition in the independent retail pharmacy channel, which eventually resulted in reduced volumes for McKesson. Overtime, we’re able to recapture that loss volume and retain our share after adjusting our sell side pricing. Consistent with our update, last quarter, we continue to see a competitive market for selling generic drugs in the U.S., and less pricing variability within this customer segment. In the end, it was important that we were able to recapture our volume, but is even more significant to retain and build upon on our longstanding relationships we’ve established with customer base. This included expanding our Health Mart franchises past fiscal year, adding hundreds of new stores. Next, we’re pleased with the progress of our -- next, I would like to discuss our relationship with Walmart. It was a year ago that we announced Claris 1, our now operational collaborative generic sourcing initiative with Walmart. I am very encouraged with the remarkable progress we’ve made in the short amount of time. Walmart is largely realizing these initiatives benefits from this initiative. And we’re now progressing on discussions with manufacturers based on our joint volumes from which we expect to realize and share in additional synergies. We are encouraged by the ear success of this initiative, which demonstrates how our sourcing expertise delivers significant value. But we are optimistic that we will identify expanded opportunities to partner with Walmart in the future. Next, we’re pleased with the progress of our multi-year initiative to implement differential pricing for brand generic, specialty, bio-similar and OTC drug classes in line with the services we provide to both our customers and manufacturer partners in all of these five categories. We continue to address these important changes as we work through our contract renewal cycles. Moving on to Change Healthcare, I want to thank the current McKesson teams who worked so diligently to successfully launch this new organization. And I want to also thank our former McKesson employees who recently joined a new Company for their ongoing commitment to a thriving healthcare technology enterprise. This dedicated team of individuals successfully delivered on a challenging fiscal '17 Technology Solutions business plan while simultaneously contributing to the closing of the Change Healthcare transaction. I thank them all and congratulate them on their success. Before I wrap up, I'd like to take a few moments to discuss McKesson's role in public policy. Our policy decisions are being evaluated, and McKesson continues to engage as a key stakeholder in educating policy makers, addressing issues that may impact our industry and our business and our customers' business, and helping to drive the necessary change to support access, quality and affordability for a sustainable healthcare system. We continue to engage in dialogue with policy makers as proposals evolve towards legislation. We remain confident in McKesson's path forward, the critical role, the services we provide to the healthcare industry today and our ability to identify and apply solutions to address the most pressing challenges to healthcare systems globally. In closing, our fiscal 2017 was certainly a tough year and we faced multiple material headwinds that impacted our U.S. pharmaceutical business. I was encouraged by a number of things during the year. First, despite industry challenges, the underlying operating performance of the U.S. pharmaceutical business was improved through our focus on operational excellence and best-in-class customer service. This business is growing and is well positioned. Next, absent the material UK reimbursement cuts we've previously discussed, Celesio's business has performed nicely. In addition, we completed multiple acquisitions during the year, which had helped to expand our strong platform for growth. For Canada, the business grew nicely in fiscal 2017. And we completed the acquisition of Rexall, expanding our retail pharmacy footprint in Canada. And in medical surgical, we delivered another year of solid growth and substantially grew in the lab space, complementing our non-acute service platform. Overall, we continue to build the competitiveness of our broad portfolio of businesses, which allowed us to mitigate some of the very material industry challenges we encountered during the year at U.S. Pharmaceutical. I'm extremely proud of this management's team ability to adapt and maintain a constant focus on building the strength of our customer and supplier relationships, which will continue to drive growth and long term value creation for our shareholders. Last, I'd like to take this opportunity to thank our employees for their dedication, leadership and consistent focus on putting our customer success at the forefront of everything we do. With that, I'll turn the call over to James and we’ll return to address your questions when he finishes. James?

Thank you, John and good afternoon everyone. As John discussed earlier, we are pleased by our strong results in the fourth quarter. Adjusted EPS, excluding unusual items, was $3.42 per diluted share which gives us a solid momentum heading into fiscal 2018. I also want to highlight our record operating cash flow in fiscal '17, which allowed us to return more $2.5 billion in cash to our shareholders during the past year. Today, I will review our fiscal 2017 results and introduce our fiscal 2018 guidance range. Before I discuss our fiscal 2018 outlook, I will spend some time walking you through the changes to our definition of adjusted earnings. Now, let’s move to our 2017 results. As I have a lot of information to cover today and we want to provide ample time for Q&A following my remarks, I will primarily focus on our full year fiscal 2017 results. First, our consolidated results. As a reminder, the fourth quarter and full year revenue and operating results of MTS were impacted by the creation of the Change Healthcare joint venture, as announced on March 2nd, to which McKesson contributed the majority of its MTS businesses. McKesson will account for its equity share of Change Healthcare’s earnings on a one-month lag. Therefore, for the month of March, McKesson’s consolidated income statement contained neither the results of the MTS contributed businesses, nor any equity earnings from the new company. Consolidated revenues for the full-year increased 5% in constant currency versus the prior period, primarily driven by market growth and acquisitions. Full year adjusted gross profit, excluding unusual items, was down 2% in constant currency year-over-year, driven by increased competitive pricing in our independent pharmacy business and weaker pharmaceutical manufacturer pricing trends, partially offset by contributions from acquisition closed in fiscal 2017, antitrust legal settlements, greater global procurement benefits and organic growth. Full year adjusted operating expenses, excluding unusual items, increased 2% in constant currency driven by acquisitions closed in fiscal 2017, partially offset by savings from the cost alignment plan and ongoing cost management efforts. Adjusted other income was $101 million for the year, an increase of 63% in constant currency, driven primarily by our equity investment in [indiscernible], a pharmacy operator in the Netherlands. Interest expense of $308 million decreased 13% in constant currency for the year consistent with our expectations. Now, moving to taxes. Our adjusted tax rate, excluding cost alignment plan charges and the impact to the EIS goodwill impairment charge taken in the second quarter, was 22.6% for the year, driven by the beneficial impact of the on-shoring of our MTS intellectual property in the third quarter, our mix of income and discreet tax benefits. Our income attributable to non-controlling interest or NCI was $83 million for the year, an increase of 60% in constant currency. The increase in NCI was primarily driven by Claris 1, the joint sourcing entity that we have created with Walmart, and the acquisition of Vantage Oncology. Our adjusted net income from continuing operations, excluding unusual items, totaled $2.9 billion. Our full year adjusted EPS was $11.61 per diluted share. Our adjusted EPS, excluding unusual items, was $12.91 per diluted share. During the year, we recorded $0.04 charge related to the cost alignment plan and in the second quarter we recorded a non-cash pretax goodwill impairment charge of $1.26 related to our EIS business. Wrapping up our consolidated results, during the fourth quarter, we completed share repurchases of common stock totaling $250 million, bringing our total share repurchases in fiscal 2017 to $2.3 billion. As a result of share repurchase activity, particularly in late fiscal 2016 and during fiscal 2017, our full year diluted weighted average shares outstanding decreased by 4% year-over-year to $223 million. Let's now turn to the segment results. Distribution Solutions segment constant currency revenues of $197.1 million were up 5% year-over-year. North America pharmaceutical distribution and services revenues increased 4% in constant currency, driven by market growth and acquisitions, partially offset by brand to generic conversions. International pharmaceutical distribution and services revenues were $26 billion for the year on a constant currency basis, up 11%, driven by acquisitions and market growth. Revenues were impacted by approximately $1.2 billion in unfavorable currency rate movements. Moving now to the Medical-Surgical business, revenues were up 3% for the year, driven by the market growth and acquisition. Distribution Solutions adjusted growth profit, excluding unusual items, was down 2% on a constant currency basis for the year, driven by competition in our independent pharmacy business and weaker pharmaceutical manufacturer pricing, partially offset by contributions from acquisitions closed in fiscal 2017 antitrust legal settlements, greater global procurement benefits and organic growth. Distribution Solutions segment adjusted operating expenses, excluding unusual items, increased 6% on a constant currency basis for the year. Segment operating expenses reflect an increase related to recently completed acquisitions, partially offset by savings from the cost alignment plans and ongoing cost reduction actions. When removing the impact of acquisitions, adjusted operating expenses, excluding unusual items, decreased year-over-year. Distribution Solutions segment adjusted operating profit, excluding unusual items, was down 11% in constant currency year-over-year at $3.9 billion. The segment adjusted operating margin rate, excluding unusual items, was 200 basis points on a constant currency basis, a decrease of 35 basis points, driven by the same factors as previously discussed. Now, moving to Technology Solutions. As a remainder, our MTS segment for fiscal '17 reflects only 11 months of results for those businesses that were contributed to change healthcare. Revenues decreased 9% for the year to $2.6 billion on a constant currency basis. Adjusted segment gross profit, excluding unusual items, was down 5% on a constant currency basis. Adjusted segment operating expenses, excluding unusual items, decreased 11% in constant currency from the prior year. Despite realizing only 11 months of results from the contributed MTS businesses, adjusted segment operating profit, excluding unusual items, increased 4% in constant currency, resulting in an adjusted operating margin rate of 22.33%, up 295 basis points versus the prior year. We're very pleased with the performance of the Technology Solutions segment in fiscal 2017 as the team works simultaneously to execute their business plans and close the Change Healthcare transaction. I'll now review our balance sheet metrics. As you heard me discuss before, each of our working capital metrics can be significantly impacted by timing, including which day of the week marks the close of a given quarter. For receivables, our day sales outstanding decreased one day to 27 days. Our day sales in inventory decreased two days from the prior year to 30 days. And our day sales in payables increased two days from the prior year to 61 days. We ended the quarter with a cash balance of $2.8 billion with approximately $2.3 billion held offshore. For the year, McKesson paid $4.2 billion on acquisitions, repaid approximately $1.6 billion in long term debt, spent $562 million on internal capital investments and paid $253 million in dividends. In addition, McKesson repurchased approximately $2.3 billion in common stock in fiscal 2017 and we now have $2.7 billion remaining on our share repurchase authorization. In fiscal '17, McKesson generated $4.7 billion in cash flow from operations, inclusive of the $256 million in cash outflows related to the cost alignment plan and our settlement with the DEA and DoJ. The year-over-year growth of approximately 29% was primarily driven by several working capital initiatives across our U.S. businesses and lower cash taxes. To wrap up my fiscal 2017 comments, while McKesson face significant challenges during the year, I'm pleased with how we were able to manage through adversity, drive strong cash flow and end the year in a solid financial position. Now before I get to our fiscal 2018 outlook, let me take a moment to discuss the revision to our definition of adjusted earnings. After careful consideration, we have made the decision to revise our definition of adjusted earnings effective with our fiscal '18 outlook. We believe this revision will allow us to provide better clarity on our underlying operating performance as it closely aligns with both how we internally manage the enterprise and the definition used by others in our industry. Let me walk you through the changes at a high level. First, the revised definition retains the amortization of acquisition related intangible, LIFO-inventory related charges or credits and acquisition related expenses and adjustments; although, this category has been expanded to include certain fair value adjustments. An example of a fair value adjustment is the expected non-cash deferred revenue haircut in fiscal '18, resulting from the Change Healthcare transaction. Second, the revised definition will now adjust for gains from antitrust legal settlements, restructuring charges and other adjustments, which will include impairments, gains or losses on the disposal of businesses or assets and the full month standalone category of claim and litigation charges or credits. The restructuring charges that will be excluded are represented by programs such as the cost alignment plan or other restructuring programs that are considered significant. And the other adjustments category will exclude items such as the EIS goodwill impairment charge we took in the second quarter and gains from sales of businesses, such as the two differences we sold in the fiscal 2016. Again, these adjustments are intended to provide investors a better view of the underlying operating performance at McKesson. I encourage you to review the second 8-K that we filed today for the full description of each item included in our revised adjusted earnings definition, as well as the re-cost of our fiscal 2017 results, utilizing this revised definition of adjusted earnings. Before I wrap up my comments on adjusted earnings, I want to confirm that as you would expect we will continue to provide all the GAAP information that we have historically provided, including the reconciliation of our adjusted earnings to our GAAP earnings. Now, let me provide you with the details of our fiscal 2017 results on this revised basis. In order for you to drive the year-over-year performance we expect in fiscal 2018; then I will provide details on our fiscal 2018 outlook. I will point you to slide 14 of the supplemental presentation, as it provides a fiscal 2017 EPS walk, but includes reconciliation from adjusted earnings excluding unusual items of $12.91 per diluted share to our revised adjusted earnings. From the $12.91 per diluted share, we will now exclude the benefit of $144 million or $0.39 per diluted share in antitrust supplements recorded in fiscal 2017, and $15 million or $0.04 per diluted share in gains on asset dispositions. We will also exclude two headwinds; first, $10 million or $0.03 per diluted share in fair-value adjustments; and second, $10 million or $0.03 per diluted share in restructuring charges. These adjustments result in revised adjusted earnings of $12.54 per diluted share for fiscal '17. Now, turning to our fiscal 2018 outlook. In fiscal 2018, McKesson expects adjusted earnings per diluted share of $11.75 to $12.45. This guidance range reflects a decrease of 6% to approximately flat adjusted earnings year-over-year. To be clear, the fiscal 2018 outlook excludes the negative impact of the non-cash deferred revenue hiccup from the Change Healthcare transaction, which is now expected to be approximately $200 million, as it will be excluded from adjusted earnings based on our revised definition. In lieu of outlining each of the assumptions underpinning our fiscal 2018 outlook, I will refer you to the list of the key assumptions included in the press release we issued today. Instead I will walk you through the key items included in our outlook. First, I’ll start with the overall market environment. We expect Distribution Solutions revenues, which are primarily derived from North America, to grow in the mid-single digits year-over-year, driven by market growth and recent acquisitions. In the U.S. market, branded pharmaceutical manufacturer prices are tuned to increase by a mid-single digit percentage in fiscal 2018. This is a more conservative assumption than the results from fiscal '17. As we do not make these pricing decisions and because there may be variability in the timing, frequency and magnitude of pricing actions taken by manufacturers, we believe our assumption of mid-single digit price increases is prudent. On the generics side, we expect a nominal contribution from generic pharmaceuticals with increase in price in fiscal 2018, consistent with what we experienced in fiscal '17. We also expect the profit contribution from the launch of new oral generic pharmaceuticals in the U.S. market to be nominal year-over-year. As John mentioned, our overall basket of generic pharmaceuticals generally declines in price overtime, reflecting competition, supply, the maturity of launched products, and outsourcing efforts. And for the sell side pricing environment, we see the marketplace was competitive or with less pricing variability, consistent with our remarks on our last earnings call in January. Moving onto Rite Aid, as mentioned in our press release, our guidance range assumes a full year revenue contribution from Rite Aid of approximately $13 billion, and an estimated annual adjusted earnings per share contribution of between $0.20 and $0.40. Given our understanding of where things stand today with the pending merger agreement, we feel confident that we would not see volumes transition in this calendar year. If Rite Aid’s volume were to transition in early calendar 2018, this will only have a small impact on our FY18 adjusted earnings per diluted share; although, we would expect a material one-time transition impact to our cash flow, driven by the mix of our business with Rite Aid. It is worth noting that our ongoing domestic and international sourcing scale is such that the potential loss of Rite Aid's volume was not meaningfully hold up our sourcing economics with manufacturers. Now, let's move to our expanded sourcing agreement with Walmart and the mechanics of Claris 1. We announced our joint souring relationship with Walmart in May 2016. Since that announcement, McKesson and Walmart have worked to build out the new sourcing organization, Claris 1. This new organization first, focused on harmonizing pricing across our respective sourcing arrangement. This was completed late in fiscal 2017. Walmart is likely realizing the benefits from this initiative, and we are now progressing on discussions with manufacturers based on our joint volumes from which we expect to share additional synergies. That being said, because McKesson has control of Claris 1, we consolidate the results of the entity. You will see the full results of Claris 1 in our consolidated P&L, including revenues, gross profit, operating expense and operating profit. We then remove Walmart’s portion of Claris 1 earnings via the non-controlling interest line, which appears below net income in our P&L. However, it is important to note that the economics from Claris 1 included in the NCI line represents only a portion of the overall value of the expanded relationship with Walmart, as a majority of the joint sourcing value is realized in the cost of goods sold line. This COGS value is directly recognized in the accounts of McKesson and Walmart, and is not a part of the Claris 1 accounts. The non-controlling interest line now removes three items from our net income; Walmart share of Claris 1's earnings; the retail dividend; and partner income associated with other smaller non-wholly owned subsidiaries. We expect our income from non-controlling interest to increase approximately 200% from fiscal 2017. Now moving to our international segment. We expect percentage revenue growth in the mid-single digits on a constant currency basis. In addition, we expect the international business to be impacted by additional UK reimbursement cuts; although, at present, the announced incremental cuts that will impact fiscal 2018 are materially smaller than what we experienced in fiscal '17. We will keep you up-to-date on this as the year unfolds. Based on the assumptions outlined, we expect our Distribution Solutions adjusted operating margin to be between 198 and 208 basis points. The way to think about our fiscal 2018 adjusted operating margin is that our adjusted operating profit will benefit from our organic growth, the impact of FY17 acquisitions and the profits of our joint venture partners, such as Walmart in the case of Claris 1, which have consolidated in our results in accordance with GAAP. The margin rate is further aided by our revised addition of adjusted earnings and the inclusion of RelayHealth Pharmacy. Partially offsetting these positive items on margin rate will be impacted by our growing mix of higher priced specialty pharmaceuticals, assumed weaker pharmaceutical manufacturer pricing trends and the lapping effect of increased competitive sell side pricing. Moving now to McKesson’s equity investment in Change Healthcare and other MTS considerations. We expect the adjusted equity earnings contribution from Change Healthcare to be between $370 million to $430 million, which reflects our 70% ownership. To be clear, we’re assuming that our equity interest in Change Healthcare will not be diluted by the impact of a potential IPO. The MTS segment also reflects the contribution from our EIS business, which is expected to generate full year revenues of between approximately $450 million and $500 million, has an adjusted operating margin rate in the single digit range. We continue to make progress on reviewing these strategic alternatives for this business. Now moving to corporate expenses, taxes and our share count. Corporate expenses are expected to be between approximately $435 million and $465 million in fiscal 2018, primarily driven by our technology investments and incentive compensation programs being reset to target expectations. The guidance range assumes a full year adjusted tax rate of approximately 27%, which may vary from quarter-to-quarter. This rate is reflective of the ongoing beneficial impact of an inter-company sale of software in the third quarter of fiscal 2017. Our mix business and the impact of minority interest earnings that are included in profit before tax, but are not taxable to McKesson. We expect the weighted average diluted shares for fiscal 2018 to be $213 million, which reflects the impact of share repurchase activity completed in fiscal 2017. In addition, we expect a negative foreign currency impact of up to $0.05 in fiscal 2018. Switching to cash flow, our operating cash flow is expected to decline by approximately 10% relative to the prior year. This decline is primarily driven by the loss of the majority of MTS' cash flow following the creation of Change Healthcare, as well as very strong cash generation at the end of fiscal 2017. And last, as you think about the quarterly progression of our results in fiscal '18, we expect our results to be waited to the second half of the year, primarily driven by the anticipated strength of fourth quarter results, given the seasonality of branded manufacturer pharmaceutical price increases. And for the first half of fiscal '18, we expect the second quarter will be stronger than the first quarter. 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 to allow others an opportunity to participate. Melisa?

Thank you [Operator Instruction]. And we’ll first take a question from Eric Percher with Barclays.

I'd like to go back to, John, your comments on differential pricing. And I don’t think that was called out as one of the elements impacting the MTS or profit. I know there are quite a few puts and takes there. But has that been a material factor, and could you give us some detail on what you’re trying to do both upstream with the manufacturer and downstream with your customers?

I do think it is certainly an important factor. I'll leave the materiality to the accountants, but it's certainly been important part of our businesses as we look at it, and we've made significant progress. And in our conversations with both our manufacturing partners, as well as our end user customer partners; so we're excited about the progress. I think people understand that the cost of handling certain of these items is different than having them all blended together. And certainly the services we provide are different and the economics associated with and when the products is different and we're pleased with the progress. We’ve more work to do, we do that systematically as our contracts are revised. But I feel good about the progress, Eric.

The key driving services that are unique, or is it segmenting fees and charging separately for what you’re providing?

It's probably a combination of both. clearly, to the extent that our previous discounting didn’t reflect the true cost of handling the products that needed to be modified, and to be extended that customers or manufacturers are asking us to perform new or different services, we’ve taken that on as well. So I think it's simple to mention that. And I don’t think in the past with the way we used to price our contracts, we segmented enough. And as obviously these other categories begin to grow, it's important that we price them in a more discreet fashion than as we’ve attempted to do.

Thank you. We’ll next go to Lisa Gill with J. P. Morgan.

John, I just want to go back to some of your comments on Claris 1. As I truly understand where you are with the manufacturers, obviously today, we saw bad time with Express Scripts and increased the size of their procurement entity. Is there any push back around the manufacturers in the anticipation of potentially losing Rite Aid we’ve had -- I mean how do we think about the contracting from that perspective?

I think, James in his prepared remarks, made a specific comment related to Express and we don’t see any impact related to the potential loss of our Rite Aid business -- and he made a comment about Rite Aid not about Express, so to be clear. And I don’t think that when we get to a certain scale on the certain amount of materiality with the manufacturers, I don’t think there is much of the difference in the way that the manufacturers behave with any of us. I’ve said this before. I believe we’re extremely well positioned and I think our contract is very competitive. I think Walmart has benefitted significantly from the relationship. And as to where we stand in it, the normalization of the agreements between McKesson and Walmart and our respective partners help drive a lot of very quick incremental value to Walmart. And I believe that this next phase as we complete our negotiations the contracting with the manufacturers, we’re already beginning to see a reflection as a combined value of us putting our business together and committing it to these partners for a long period of time. And clearly we have the ability because our customers tell us whether our pricing in the marketplace is competitive or not. And with that customer feedback, we’re constantly adjusting our perspective on what prices, a fair price to sell at and what a fair price to buy at is. And through that intelligence I think we remain very confident in our scale and approach to doing the job it needs to do.

Thank you. We’ll next go to Ricky Goldwasser with Morgan Stanley.

So one question that I have, John, obviously 2017 was a challenging year, but here we are. And you made some changes to how you revise the definition of adjusted earnings you moved some business to distribution. If we think about the operating market guidance to 198 to 208 -- to 2.8 is this, in your base that you feel that you can extend margins from? And along the same lines, now you talk about mid-single growth rate for distribution for the revenue line. How should we think about the growth algorithm for the operating income? Should we think about mid-single digit as well, if you can just give more color on that?

Well, I’ll have James jump in here in just a moment. I think that the principle drivers of our challenge in the previous year was the brand price inflation came in obviously below what we expected it to be. And then the very significant issue related to generic pricing that took the sell side of generics in the marketplace. And I think that we would expect that we will get up margin growth, going forward. And so I obviously always think that, and last year we had a surprise, a couple of surprises. But this year, you can see that we really don't have built into our guidance inflation on the generic side beyond nominal; and the branded inflation, we've guided, I think to a responsible range and the underlying operations of our business continue to perform very well; and the generic pricing challenges we face last year in the independent segment, as we've commented in the past, have been somewhat transitory in their nature; and recently, we have to continue to be competitive in the marketplace. Those kinds of dislocations don't happen on a frequent basis. So having said all of that, our expectation is that our margins will expand from here.

And in terms of the Distribution Solutions’ operating profit, there are few items in through there; first of all, obviously, as we're going to benefit from the acquisitions that we entered into in fiscal '17; then we have these lapping effects of last year's headwinds, both the brand manufacturer price increase situation, as well as on the generic side the sell side environment, particularly through to the independent pharmacists. But setting those headwinds aside, I'm pleased to see U.S. pharma getting back to operating profit growth. And then you add to that the ongoing operating profit growth of remainder portfolio of businesses, which as you know, is quite diverse.

Thank you. We'll next go to Robert Jones with Goldman Sachs.

Just to go back and follow-up on the Distribution Solutions operating margin. If I look back in the guidance you guys provided, I mean, if I think back to October when you guys lowered guidance on competitive pressures and in the moderating inflation. And I think about that in the back half of '17. It seems like the negative impact from those changes would have certainly had your operating margins for fiscal '18 pointing to something down you, and yet here you are giving very encouraging operating margin guidance. So other than something like Claris 1 being an incremental positive year-over-year, did anything changed in your underlying assumptions as far as those two specific pressure points that you talked about last year, competitive pressure and moderating inflation. And I guess you -- one just kind of follow on to that, I know you don't guide to gross profit within Distribution Solutions. But would we anticipate, John, that gross profit would also be growing specifically in North American distribution?

Yes, we certainly would expect gross profit in North American distribution to grow. And I would say, further, we’ve made significant progress in the operations of our Company last year. And continuing this point that progress was largely overshadowed by the significant headwinds that we faced as we went into the back half of last year. And obviously, coming to this year, we’re taking the remainder of those headwinds. But if you actually look under the covers, the rest of our Company is performing quite well and I am pleased with the fact that we can continue to show progress in our business. And clearly, some of the changes James mentioned in terms of the definition of adjusted earnings make our operating performance more clear. And we try to re-cash last years’ and this years’ so you can see how they would have compared. But James jumping here with some other color you’d like to provide…

Yes, it's just kind of say for example two things about that change in the definition of adjusted earnings. And in the second 8-K we have broken out the FY '17 data in line with that new definition. So you'll be able to see the year-over-year type effects there. And then also just to reemphasize that because of the way the accounting looks, remember that our profit from our joint venture partners, such as Walmart's profit as a part of Claris 1, that actually gets counted in our operation profit line and therefore benefits of our operating margin rate lower down at the bottom of the P&L, we have to extract that out in terms of the non-controlling interest. So there is complexity there, and that's very much how GAAP requires us to do things. And again in the 8-K, we've tried to break out in the last of the schedules that we have there both the operating margin on a growth basis, if you will, then also net of that MCI effect. So there are few steps to move through there. But hopefully, we lay things out so you can sort through that.

Thank you. We’ll next go to Steven Velazquez with Bank of America Merrill Lynch.

Just regarding the Rite Aid EPS contribution of $0.20 to $0.40 in fiscal '18, I heard that right. I think most of us have seen that EPS ruin rate could then -- it would have been a little bit a higher than that at 13 point of revenues. I guess if you compare that number for FY18 to Rite Aid contribution of the past couple of years. We've been in that same range, or has that come down perhaps from various reasons? Thanks.

I think it's probably fair to say that when our margins dropped across the Company, and typically in the U.S. pharmaceutical business, I should and know the focus on U.S. pharmaceuticals is a result of the phenomena's we've been talking about that same kind of degradation in the performance of every one of our, probably every one of our customers in the U.S. pharmaceutical business was effected. And it just becomes a question of mix. And so it's fair to say that most of our customers in U.S. pharma are less profitable today than they were a couple of years ago, and you’ve seen it in our overall margin rate in that business…

And you’re correct it was $0.20 to $0.40 of contribution from Rite Aid for the full year.

Thank you. We’ll next go to Garen Sarafian with Citigroup.

Point to your generics assumption, setting aside the down street pressures in this past year, that's now less variable. Have you changed the underlying assumptions in any way that net out to nominal contributions for fiscal '18? And maybe related to that since we’re talking qualitatively and not quantifying, does the lower end of guidance capture worse than expected trends in generics. So that if there were say no contributions from generics increasing in price or maybe the overall generics basket deflating more than your base case. Would you still be in the serious EPS range?

Well, on the generics guide, we talked about a nominal contribution, economic contribution from generics with increase in price; so very much the same guide that we offered this time last year. And then also similarly a nominal economic contribution from brand to generic conversions; we expect to see in fiscal '18. Now, as to the range of the guide, that’s always going to be driven by a mix of all of the variables that we’ve been talking about and have led out in the press release. So it we wouldn’t want to particularly so spend drop on one. But clearly that was nominal for both generic price inflation and generic conversions, I think, appropriately set out very modest expectations.

And I would follow on to the last part of that question related to generic deflation. We’ve talked about it in the past; it's not having much of an effect on our business; and part of our normal operating model when you think about the overall way we manage our generic portfolio; and the fact that we’ve had deflation historically on a basket basis for a long time. And the deflation on our purchase of generics doesn’t necessarily translate into a deflation on the way we sell our market generics, and so that the two are distinct. And the challenge we faced last year was not the rated deflation on what we paid for generics, the issue we faced last year was acceleration in the normally competitive market on generics to become even more competitive on the sell side. And that’s what we faced in the back half of last year that we tried to discuss on previous calls. And to be clear, we don’t anticipate that level of price erosion on the sell side of our generic portfolio. Going back to what we experienced in the last half of last year, we expect it to continue to be competitive, and not as volatile as we experienced.

Thank you. We’ll next question is from Ross Muken with Evercore ISI.

Two part question, so probably the most common thing in my inbox is sort of trying to tease out the comparability of the updated guidance with what was expected versus discreet. And I could ask you to comment on street estimates. But if you can, James, maybe just help us think through the few components that most materially changed and just maybe repeated in terms of the prior year as we think relative to the updated guidance would be helpful. And secondary, a few of the assumptions you are talking about prior, like the deferred revenue piece. Is there anything else aside from that that changed materially that you communicated before? And then if you can help us just figure out what's the most sensitive point here. I mean there is clearly a ton of assumptions. And so when you think about which one you probably have -- not the least confident in, but may be as the widest interval of the outcome. What would you point to one or two things that maybe could be a little bit causing upper end or lower end of the range, more so than others?

Well, obviously, there are a few moving parts here in the guide. I think about some of the bigger economic drivers that would -- to be a real different -- have some of the expectations out there. I point to our assumption around mid-single digits for branded manufacturer price increase. Yes, that is a lower assumption than that that we experienced in fiscal '17. But we think that’s the prudent thing to do for the reasons we talked about in the prepared remarks. Think about the contribution from Rite Aid that we've been quite clear on. The change in the adjusted earnings definition, there's a material impact there because up until today, we've been talking about that deferred revenue haircut that would impact the Change Healthcare income. And so now, we don't have to deal with that in adjusted earnings. And then the other thing I would say is our tax rate is probably at 27% lower than perhaps some expectations, because we've got a variety of drivers there that we're continuing to benefit from as we look forward into fiscal '18. So in terms of user variability, while we'll obviously see what the branded manufacturers actually do during the year; and one of the other important assumptions we've made is around the lapping effect on the generic sale side, the lapping effect of what happened in the independent space last year; as John has been indicating, we're seeing less volatility there. Obviously, the hopeful situation we'll see how things play out in that part of the marketplace.

Thank you. We'll next go to Michael Cherny with UBS.

I know you provided a lot of details, particularly on the change in the non-GAAP adjustments. But I want to just make sure everything is level set again on that front just there are a lot of moving pieces. In terms of the change, specifically, related to the deferred revenue adjustments. I know a lot of companies that in the tax based exempts in the past. Is this just the way you guys are recognizing it going to be a one-time adjustment and then you’ll go back to normalized margins for the Change business. Or is this going to be now part of the base as you take for interest in terms of thinking of how that's going to continue to flow through into your P&L given the 70% ownership structure?

So in essence, we will not take that one-time decline in what would flow off the balance sheet into revenue. So we will not be impacted by what we now quantify as $200 million deferred revenue haircut effect. Obviously, that's part of the GAAP books, but that will not be showing up in our adjusted earnings.

That's related to the transaction of McKesson and Change Healthcare, so it's not a comment on Change Healthcare's treatment of deferred revenue.

Thank you. We'll next go to David Larsen with Leerink.

Can you please just clarify, on the buy side of generics, are you seeing an inflationary environment or a deflationary environment. And then can you also comment on the hospital market, like Cardinal has evolved a lot of new capabilities, especially on the medical side. Are you seeing any sort of more aggressive competition within the facility space or not? Thanks.

Well we, I think in the previous comment, I talked about generic deflation and how we believe it will continue and has for a long time. We don't really comment on the rate of deflation, because it's not a big factor that plays into the way our economics or our P&L operates. The deflation is typically not an issue that we have to guide on or that we miss or make on, it's something just part of our business model and we attempt to manage it. And this is the deflation as it relates to what we buy at. We don't necessarily comment on what we price the product at unless there's some kind of unusual circumstance, like we faced last year when we talked about generic price erosion in the marketplace, that's the sell side comment, that’s not what we will be buy the product for. The second part of your question was related to the hospital market. And we certainly have competed in the hospital market for a long-term and we used to be in the medical supply business and hospitals. And frankly found it difficult to compete with the likes of currently in the hospital market. But as it relates to the business that we retain in the hospital business, it's really in two categories. One, is in the physician office part of medical supply purchases in the hospital segment, where they own the doctors and ask for us to provide shipment to the smaller physician office facilities and practices that they own, we’re very strong there and continue to be strong. And clearly in the pharmacy business of hospitals, we have a very strong value preposition and remain very strong there. And I never take competition lightly, but I don’t believe the continued investment that Carlos is making in the medical surgical business necessarily will correlate to some change in competitive dynamics on the pharmacy side. But that's yet to be seen.

Thank you. We’ll next go to Brian Tanquilut with Jefferies.

I wanted to ask John like as we think about the competitiveness of the sell side that we saw last year. Where does your confidence on part of this lag and recur this year, especially as we had saw what rebate did this morning with bringing on Express Scripts?

I can only speak from 20 plus years now, the experience here at McKesson in watching how the market pricing that has evolved and how our customers have come to us overtime. We continue to build out a very significant value proposition for our customers, particularly independent customers. They always get a competitive price from us, they always get a good deal from us, and our ability to source products, I think, is second to none. Having said that on occasion in the past and infrequently, we’ll see a period of deflation on the sell side that has accelerated or price competition is accelerated and that’s what we faced last year. It may have been seven or eight years between the last year that we experienced in the last time we experienced an event like that. So could it happen every year, we sure it could happen and eventually you raise to the bottom and there is nothing more to give. But I don’t forecast that just based on historical activity. As it relates to rebates activity, certainly, I can't speak to what incremental buying power they may garner as a result of bringing Express Scripts together with them. I don’t feel we've been in a disadvantage, I don’t feel we will be at a disadvantage. And I would also say it's not necessarily a direct correlation that if someone buys better that they determine that they will increase their level of discounts and pass it all back into the marketplace. So if that were to occur, if they bought better and their partners ended up buying better and then they decided to put it into the marketplace, we would have to respond and it would be a year similar to this year.

Thank you. We’ll next go to Charles Rhyee with Cowen & Company.

John, obviously you've given us an outlook here for fiscal '18, and it looks like that things are started to normalize. When we think about the future, you look at some of your peers here and they’re deploying capital into areas of growth outside of let's say of the pharma distribution business. And here we are divesting as a chunk of our technology business into Change Healthcare. Can you talk about how you look at the longer term outlook for McKesson in terms of -- where do you think you’re going to be looking to find growth in? And what should we think about the long term outlook for growth? Thanks.

We like the pharmaceutical business and we like it globally, we certainly like in U.S., and we like in Canada and we like the medical supply business and the option side markets. We believe those markets and also inside medical are growing fast and will continue to grow at a nice pace as people move out of less convenient, more costly settings for their care and have a more value orientation and a more physician centric relationship perhaps. And we like the pharmaceutical business. You can see, as an industry, the pharmaceutical business continues to grow propelled by innovation and bio-similars and new treatments coming out. Clearly, the demographics in pharmaceutical usage is improving and we see that trend globally as well. So I think we continue to feel good about our position. And you see us deploying capital, I think, in a very intelligently in high growth areas, not only in new markets where we can, I think, be a consolidator and a new service provider but also in our specialty acquisitions, you saw us buy Biologics last year -- and then Vantage, which are good acquisitions for us. We made a technology acquisition, called CoverMyMeds, which comes in with a different profit profile. And certainly now it is a good business on it' own that provides significant service to the pharmaceutical manufacturers, the pharmaceutical payers and the patients who are dependent on getting the drugs at the right time and at the right place at the pharmacy counter. And clearly, we continue to make Canadian acquisition, another one of which was announced today. So I think we are well positioned; I think we’ve got a right assets; I think these assets have a correlation across borders and across boundaries in our business; and we have synergy that we can take advantage of that in the end that delivers better value for our customers. So they can do a better job of clinical care and clearly do a better job of the economics associated with delivering that care. I think that was our last question. I want to thank you operator and thank all of your on the call for your time today. We’ve got a very solid operating plan for fiscal 2018. And I am certainly excited about the growth opportunities across McKesson. With that, I’ll turn it over to Craig to answer a few questions about our upcoming events.

Thank you, John. We will participate in the Goldman Sachs Global Healthcare Conference in Southern California on June 15th. We look forward to seeing you in the new fiscal year. Thank you and good bye.

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