Good day, ladies and gentlemen, and welcome to today's McKesson Q3 Earnings Call. I'd like to remind everyone this call is being recorded. And at this time, I'll turn the floor over to Craig Mercer. Please go ahead, sir.

Thank you, Greg. Good afternoon, and welcome to the McKesson Fiscal 2019 Third Quarter Earnings Call. I'm joined today by John Hammergren, McKesson's Chairman and CEO; Brian Tyler, McKesson's President and Chief Operating Officer and incoming CEO; and Britt Vitalone, McKesson's Executive Vice President and Chief Financial Officer. John will provide opening remarks. Brian will provide a business update. And Britt will review the financial results for the quarter. After Britt's comments, we will open the call for your questions. We plan to end the call promptly after 1 hour at 3:00 p.m. Eastern Time. Before we begin, I remind listeners that during the course of this call, we will make forward-looking statements within the meaning of 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 next - please refer to the text of our press release and forward-looking statements slide 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, we will reference adjusted earnings, adjusted operating profit and margin and free cash flow and items excluding foreign currency exchange effects. We believe these non-GAAP measures 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 third quarter fiscal 2019 results and the supplemental slide presentation for further information and a reconciliation of the non-GAAP performance measures to the GAAP financial results. The supplemental presentation is useful in reviewing the fiscal 2019 versus fiscal 2018 results discussed today. Finally, for those who have not yet met her, I would like to introduce Holly Weiss. Holly Weiss was recently appointed Senior Vice President of Investor Relations. My transition to Holly will be completed ahead of our year-end earnings call. On a personal note, I would like to thank John, Brian and Britt as well as the investment community for the opportunity to work with everyone over the last few years. And with that, thank you. And here is John Hammergren.

Thanks, Craig. As you're probably aware, as he just mentioned it, this is his last earnings call. I want to thank you, Craig, for your invaluable service to our team over many years and in various roles, and I wish you the best in your future endeavors. And Holly, welcome as you -- as our new Head of Investor Relations. And thank you all for joining us on our call today. This is my 79th earnings call with our investor community, and this call also marks my final earnings call as the leader of McKesson. I previously announced my retirement that takes effect at the end of our fiscal year. We are making solid progress with our strategic growth initiative. And despite some headwinds, the company is in a strong financial position. McKesson's future is bright. It's been my great honor and privilege to leave this company as Chairman and CEO for nearly 20 years. Together, we've created an organization that plays a unique and significant role in health care. No one is better equipped than Brian to lead McKesson into the future. He is a gifted leader and an innovator, with deep industry knowledge and unwavering commitment to customers' success. He has a strong vision for the future of health care, both in the U.S. and globally, as well as for how McKesson will continue to play an integral role in helping improve efficiency and effectiveness for patient care delivery. Perhaps most important, Brian personifies our ICARE shared principles. In fact, he helped me create them as a member of my leadership team nearly 20 years ago. Throughout his tenure at McKesson, he has always placed the enterprise first, focused on teamwork, collaboration and communication and has consistently made employee engagement a high priority. I know that Brian is…

Thank you, John, and good afternoon, everyone. I want to be the first, probably of many, to recognize and congratulate John for the lasting impact he has had on McKesson. He and I, as he mentioned, have been colleagues and friends for a long time, and I am truly humbled by the opportunity to succeed him as McKesson's CEO. His leadership and vision for the past 20 years have allowed McKesson to achieve the level of success that few companies ever accomplish. I'm excited to build upon his legacy. I've had the privilege of running nearly every major business in McKesson as well as leading our corporate strategy function. I know our teams. I know our capabilities, our markets, our customers, and importantly, our employees well. To lead McKesson at this point in time is energizing, and I look forward to advancing the tremendous culture, solid foundation and global platform established by John and his team. The health care industry continues to undergo change as we focus on addressing affordability, access and quality outcomes for patients. I'm confident that McKesson is the partner of choice for biopharma, providers and pharmacies in all segments across health care to help improve the delivery of health in our communities. As I mentioned on our last earnings call, our strategic growth initiatives are gaining momentum. Most of the top leaders within McKesson were involved in developing our strategy to accelerate growth, supported by cost savings initiatives and operating model efficiencies, like our recently announced headquarter's move to Las Colinas. To succeed in today's evolving market, we will need to find new ways to innovate, speed up decision-making and empower our teams so that we can provide even better value to our customers and patients everywhere. More than 20 years ago, John helped guide our…

Thank you, Brian, and good afternoon. Today, my comments will focus solely on our third quarter results and fiscal 2019 guidance. We will provide guidance for fiscal 2020 when we report fourth quarter results in May. As Brian discussed earlier, we are pleased with our fiscal '19 third quarter results, which were ahead of our expectations. We continue to make very good progress on our strategic growth initiatives, operating model and cost optimization program. As a result of this performance, we are narrowing our fiscal '19 adjusted earnings outlook to $13.45 to $13.65 per diluted share in fiscal '19 from the previous range of $13.20 to $13.80 per diluted share. Let's jump right into our third quarter results. Third quarter adjusted EPS of $3.40 was flat compared to the prior year, which was primarily driven by a lower share count and growth in our Medical-Surgical business, offset by higher tax rate, lower profit contribution from our U.S. Pharmaceutical business and higher corporate expenses. Let me take a minute to discuss tax as it relates to the higher tax rate compared to the prior year. I'll remind you that our adjusted tax rate in the third quarter of fiscal 2018 of 11.5% included discrete tax benefits of approximately $54 million as well as the cumulative catch-up adjustment related to the Tax Cuts and Jobs Act of 2017 to reflect the new lower federal tax rate of 21%. In addition, McKesson's fiscal 2018 adjusted tax rate was positively impacted by the intercompany sale of software related to our former Technology Solutions segment in the third quarter of fiscal 2017. Now let's turn to the details of our consolidated third quarter adjusted earnings, which can be found on Slide 10. Consolidated revenues for the third quarter increased 5% versus the prior period, primarily…

Thank you, sir. [Operator Instructions] And from Evercore ISI, we have Ross Muken.

Good afternoon, guys and again John, congrats, it’s been a pleasure working with you over the years. So I know you probably haven't had a ton of time to kind of digest and prepare, but there obviously was a number of things that came out after hours from HHS around rebates and antikickback. And so it looks like they're trying to push forward with some of the proposals we heard earlier in the year. I guess, at a high level, I know this is something you feel strongly, you can sort of recruit the economics that goes into place. But I guess, how are you thinking about that in the context of just a disruptive force potentially, at least in the short term in the business, and how hard the government is going to push at least on this one piece?

Hey, Ross. It's Brian. Thanks for the question. I didn't see that flash across my e-mail screen as I walked into the conference room here. I thought we might get a question. First, let me say that we support programs that enhance access, quality and cost. And if we think about the wholesaler model and how our economics and the supply chain works, we're not directly predicated on the safe harbor in question. Our economics really come from the manufacturer and revolve around the fair value of the services that we provide to them. We continue to believe that we run a highly efficient distribution and supply chain service and that they, over the years, have reinforced that view. And through various evolutions in our market and our industry, we continue to be paid fair value for the services that we provide, and that's based on the conversations that we've been engaged in today. We continue to believe that, that will be the case. So I might also just comment that we are not just a supply chain company in terms of logistics, but a pretty sophisticated financial operation as well. And on behalf of our manufacturers today, we administer lots of contract prices between manufacturers and hospitals or manufacturers and pharmacies. And millions of -- literally millions of price item customer combinations today, we do it at scale and we do it with great accuracy. And in our pharmacy technology businesses that you heard Britt talk about in terms of their strong credit performance, we have very sophisticated at-scale pharmaceutical-related transactions, over 17 billion a year, connecting directly at the pharmacy counter. So clearly, we will continue to engage in conversations with our manufacturer and other partners as people shift through the implications of what has just come out. But I focus you back on -- we continue to believe that we deliver a very important service in the pharmaceutical supply chain. We continue to be paid for that service that has evolved over the years. We expect it will continue to evolve. But the net-net, we would expect we'll continue to be paid appropriately for the services that we provide.

No, that's super helpful color. And just maybe relative to the quarter, is this -- I feel like all of the segments, sort of relative to your expectations, came in at least in line or maybe even a touch better in some places. Do you feel like this is sort of evidence of, aside from some of these pieces that -- the hiccups that come now, again, like what happened with Shopko, aside from something unusual like that, the underlying trends in each of your businesses that leave sort of that worst or flat and maybe in some cases are certainly maybe even a touch better. And we're starting to see that bottoming that hopefully should be the jump-off for growth eventually in sort of the out years?

Well, we were certainly pleased with the operational performance of many of our businesses in the quarter. And as we've talked over the past months, we did see brand inflation come in line with where we had expected it to. That was a good development and provides some good underpinning for us. We see the generic market as reaching some point of stabilization. It's always competitive, but it's competitive in the sense we feel confident, are comfortable historically. And we do think that the focus that we've had over the past few months on the operating models and the discipline is beginning to resonate across our businesses. So I think I would say I feel real good about the quarter -- the operational quarter that the business put up.

Thanks so much, Brian.

Thank you, Ross.

And moving on, we have Charles Rhyee with Cowen and Company.

Hi. This is James Auh for Charles. It looks like the MedSurg business performed better than at least we had expected, and the margins improved 12 basis points year-over-year. Can you just talk more about what drove that margin expansion and maybe what gives you confidence to improve the outlook, as evidenced by your revised segment operating profit guidance?

Thanks for the question, James. And we were pretty pleased with medical business. I would characterize it as pretty solid performance really across the business. Most of our segments performed on or ahead of where we had expected them to. We performed well on the gross profit line. I think we saw them upside from expenses, and this is an environment where we're operating in a normalized flu season, where in a typical year, we would expect a little more tailwind from flu. We're in more normal than, say, last year's really strong season. And I think part of it is just good execution. We're obviously continuing to benefit from the MSD acquisition. And as we progress in the integration of the MSD acquisition, we feel good about the progress we're making, and it continues to be on track. So I look at the medical business and just feel a pretty solid performance really up and down the P&L.

And I might just underpin that as I mentioned in my remarks, excluding the MSD acquisition, which Brian mentioned is performing well in terms of integration, grew at about 8% growth year-over-year. So that's really solid for our growth within the ongoing business really across that business. So 8%, excluding MSD, I think it really underpins Brian's comments about the solid performance of that segment.

Okay. Great. And also can you maybe talk about the reimbursement environment in the U.K.? Do you get any sense of visibility into any incremental cuts?

Well, as I've mentioned in past comments, we always expect some level of reimbursement headwind. We have experienced in the prior few years abnormally high headwinds, I would say. That's clearly challenged the business. If I think about the current reimbursement landscape, there were -- the NHS typically does a 3-year plan, and this is the third year of the plan, and that plan would have called for them to push through some pharmacy-specific cuts, which they elected to not do, which we took as a mild positive that the NHS in tune with the landscape of community pharmacy in the U.K. Obviously, they've come out with the 10-year -- the NHS England's 10-year plan and community pharmacy was highlighted in that plan as having an important role in addressing cost, access and quality for them. This -- just this week, yesterday or maybe even this morning, in fact, NHS announced some incremental funding into the provision of community health around GPs, but also including other health care professionals, which we think just continues to reinforce their view of the importance of community provision of health and addressing the cost challenges of NHS. We're still digesting a lot of that. And I would not want to ever declare a victory on the reimbursement front, just given recent experience. But we would like to think that we've probably gone through the most significant of that. Now it's really a matter of how we continue to evolve the retail pharmacy model and to be a more integrated part of health care delivery in the communities in England.

Great. Thank you.

Thank you.

Moving on, from JPMorgan we have Lisa Gill.

Thanks very much. Good afternoon. John, I sincerely want to wish you the very best. I hope you enjoy time with your family. I may be the only one on the call today that has been on all 79 earnings calls with you from the beginning. So I will truly miss you, as you know. My question would be, though, Brian, you made a couple of comments. One, you talked about the Q3 being ahead of the internal expectations. Was there anything that was pulled forward from Q4? Because you also made a comment that the early indication of feeling good about where you stand for Q4. So I just want to understand if there was anything, #1, that was pulled forward? And then secondly, as we think about the fourth quarter, if there's any moving parts? Because if I look at the new revised guidance, it does come in kind of towards the lower end of where the Street is on the midpoint.

Yes, thank you, Lisa. I'll may be make a couple of remarks and then let Britt add some color. Just with regards to the performance of the business in Q3, I think I characterize it as pretty solid and feeling good across many of our businesses. I don't believe there was any unique pull forward, or I think of it as just core solid operating performance.

And Lisa, maybe what I would add to that, I agree with everything that Brian said. As we think about Q4 and one of the things that I mentioned in my remarks is really around branded price inflation. And although we've talked a bit more of our branded, compensation is about 95% now fixed in nature and less variable, there still is that contingent part obviously that we've talked about briefly at JPMorgan. We feel comfortable on our mid-single-digit range. And again, we had very strong performance that we believe will continue in through Q4.

That’s helpful. Thank you.

Moving on, we have Eric Percher with Nephron Research.

Thank you. Congrats to John and many thanks to Craig. For Brian and Britt, the question on opioids. I think the first part is, relative -- you've given some of the solutions that McKesson has taken part in. I'd be interested, Brian, to hear your perspective on the role that McKesson or a distributor plays and maybe some of the responsibility or limitations of responsibility that distributor should hold? And then, Britt, a $100 million in legal expense, that's a significant number. Is there a lot of early stage work, and will that ever inflow? Or is that where we're going to be for foreseeable future?

I'll take the first part of your question, Eric. And as you well know, it's -- the health care supply chains are incredibly complicated with lots of actors playing various different roles. I mean, as it particularly relates to opioid, we get the products to DEA-licensed pharmacies. They fulfill those based on scripts written by DEA-licensed physicians. And the DEA itself even controls the overall quantity of opioids in the marketplace. And so while we have a role in that physical supply chain, I would say that we would -- we feel like a disproportionate amount of the attention has been placed on wholesalers to this point.

Eric, I'll take your second question. Again, we've updated our guidance on the opioid litigation costs. And again, we -- our best view on it right now is that it'll be in excess of $100 million for the year. I think it's challenging for us to really have visibility on what the cost could be over the longer term. These costs have continued to increase over the balance of this year. And I think as we think about going forward, projecting the cost going forward will be difficult. It will depend on a lot of different things. Decisions that the judge will make in the various cases, how the judge will schedule certain milestones in each of the cases. It is very difficult for us to predict how each of those situations will play out. So we'll continue to update you as we go forward. And what we've given you now is our best projection on those costs for at least for this year.

And we do take this responsibility in a very serious way. At this point, where we are, we think it's very important that we invest in the legal defense, that we get the best lawyers to represent us in that defense. And as Britt said, it's very difficult to predict where and how and when these things will evolve. But our commitment is to be good stewards of the capital that you have invested in us, and we will continue to keep you updated as the process unfolds.

Thank you.

And next, we have Brian Tanquilut with Jefferies.

Good afternoon, guys. Just a question on CVS on that contract. I mean, what are your expectations around the ability to retain the current services that you provide them? And then what are your thoughts on any additional services that you can provide -- yes, additional services that you can add to the contract?

Thanks, Brian. I'll start with we have a long-standing relationship with CVS. We've been long time partners. And we think that we service their business to the highest standards and levels that can be found in the industry. So we value and appreciate the relationship we've had with them over the years, and we would fully expect that we will continue that relationship. We are in discussions with them currently around the renewal and extension of that agreement. And like we've said many times, I think if you look at the industry, there's a pretty good track record of renewing these. And certainly for McKesson, we feel very strongly that our track record of renewing and maintaining these relationships is strong, other than the occasional loss from the acquisition-related activity. We think CVS well respects the work their associates do on their behalf. And so we enter into these discussions. We have every full expectation to renew it. Now we often talk about CVS as the big customer for the U.S. Pharma business, and that certainly is true. We also have relationships with them in our RelayHealth and some other parts of the company as well. So it's a pretty big broad comprehensive relationship overall, and we're optimistic that we will continue that relationship.

Thank you.

Next we have Michael Cherny with Bank of America.

Great. Thanks so much for the color today. I know it's addressed earlier in terms of the HHS and the rebate rule. I'm not expecting, as you said, a view on this. I think we've asked this question in the past, but when you talk about going back and making sure you get the appropriate compensation, what else goes into the conversation in terms of, is this creating an opportunity with your customers to explore new services, to pitch them on some of these things, whether it's CoverMyMeds and some of the other areas that they haven't passed me over the past? Are there others services that they're throwing back and asking you to try and pursue over time? Just trying to understand if a situation like this with uncertainty around how the pricing paradigms going to play out for pricing as a whole could create incremental strategic opportunities for the company that historically has been pretty active on the M&A front.

Yes, great. Thank you for that question. As I -- we think about addressing an issue like this. And when I think about health care, it's pretty fundamentally connected upstream, downstream. I mean, whether it's employers, payers, PBMs, wholesalers, retail pharmacies, it's a pretty interconnected system. And we're fortunate in McKesson that really have businesses, solutions and relationships across multiple of those constituents. So we tend to talk on these calls a lot about the dialogues we have with manufacturers, but we certainly have dialogues with those other constituent customers as well. And I think one of the great strengths of McKesson is breadth of reach that we have and the capabilities we have, including some unique capabilities like CoverMyMeds and RelayHealth, which we would think there is good potential for some opportunities. It's contingent, of course, on how this evolves. But when we meet with our partners, whether that's upstream or downstream, we try to bring the fully capability and complement of McKesson into those discussions, not to let it get narrowly focused on just one piece.

Thanks.

And next from Leerink, we have David Larsen.

Hi. Congrats on the good quarter. Can you talk a little bit about the Rite Aid renewal? Are those renewal rates reflected in this quarter's results or the new guidance for fiscal '19? And then can you maybe talk a little bit about the sell-side market environment as it relates to generic pricing? Thanks a lot.

David, thanks for that question. I'll start, and then I'll Brian jump in. As we've talked about before, we were very pleased obviously with renegotiating or renewing Rite Aid for a longer period of time. We think that there's strategic opportunities for both of us. As we've also said, this was renewed within our guidance. So there will be -- with the guidance that we gave you today includes the renewal with Rite Aid.

Is it in the quarter? Is it fully reflected in the quarter, this quarter?

Fully reflected in our numbers, in our results, yes.

Okay, great. And then can you may be just touch on generic deflation? Like how is that trending relative to expectations without getting too specific? One of your peers said mid-single to high single-digit deflation rates is what they're seeing. Is that what you're seeing as well or...

Yes, we don't give specific ranges on the rates of generic deflation. But as Brian mentioned, we're seeing a more stable or more normalized environment around generics. Again, I think it's important to look at both the sell-side as well as the buy-side. On the sell-side, we are seeing a competitive marketplace, as we've seen for many years. And then we expect that to continue, but we're seeing a very stable environment. And then on the buy-side, we're very pleased with the performance that we have at ClarusONE. We think that, that entity is still performing quite well and it is providing us the opportunity to continue to work very closely with the manufacturers. And we think that the buy-side environment is more normal in terms of historical ranges, and it's a more stable environment than it has been several quarters ago. So we're very pleased with the environment that we're in. It's a competitive environment, but a more stable one.

Thanks. I appreciate it.

Next question comes from Ricky Goldwasser with Morgan Stanley.

Hi, good evening and John and Craig wishing you all the best and enjoy your time. And Brian and Holly, I'm looking forward to working with both of you. So Craig, this might be a question for you other than to congratulate you. When you think about it -- I know earlier in the call, you said that you're going to focus only on fiscal year '19. But I do note that starting next week, starting Monday, most of the questions we're going to get will be on fiscal year '20. So just if you can just help us think about this factor that we should consider -- I mean, obviously there is Rite Aid and CVS that you already talked about, which are likely to be headwinds next year. But how should we think about any other factors that we should consider, any other tailwind that you -- we factor in as we think about next year?

Yes. Thanks for the question, Ricky. Maybe another call, you can congratulate me on something.

I hope that you have a long tenure going ahead.

Thanks for that. So I think as we've talked about, we're very pleased with the quarter, and there's a lot of things that both Brian and I outlined and we view as providing momentum as we go into Q4. And certainly, we feel very strongly about as we move forward. We talked about our medical business and we had very good performance in our medical business, not only from the acquisition of MSD, but the rest of the business performed quite well also. We talked a little bit about our McKesson Prescription Technology business, and we were certainly seeing good -- new product growth as well as good revenue growth in that business. And then our U.S. Pharmaceutical and Specialty Solutions business, again, as we talked about, we had the customer charge in the quarter. Outside of that customer charge and the reversal from the New York State Opioid Stewardship Act, we would have had growth in the quarter. And so we feel that there's really strong growth underneath in that business as well. So there is a number of areas in our business that are performing quite well. We certainly feel good about the position that we're in as we close the third quarter and as we have momentum going into the fourth quarter. Those will be a few of the areas that I would point out to you right now.

Okay. So nothing in '20. So let me ask you another question here. The -- obviously, the health care market is changing and may be faster than we'll anticipate and we would appreciate heading into this year. So Brian, from your perspective, as you look ahead, as you look at, matter of fact, your first year as a CEO of the business, what do you think is kind of like the one area or maybe the 2 areas that are going to be your top priorities? Or where you think that you're going to spend most of your time on? There's the opioids. There is -- obviously, the relationship with the manufacturers, a number of different things. So from your perspective, what are really kind of like the things that your key priorities will be?

Yes. Thank you for the question. It certainly is a dynamic time in our industry. And we often, I think in these calls, focus on clouds. And the fact of the matter is, when I look at McKesson and I look at the breadth of the businesses we have, I look at the reach in the channels, I look at the positioning in the community-based channels and the capabilities whether they're supply chain, whether they're software, pharmaceutical transaction or Medical-Surgical related, I think we've got this a tremendously broad set of assets and capabilities, unbelievably talented teams. And that change creates great opportunities for companies like ours that can bring these assets together in unique and differentiated ways on behalf of biopharma partners, on behalf of provider customers. I think to me that's the really exciting part of it, and that's the real opportunity that lies ahead. And so that's where I'll be spending my time, with our partners upstream, downstream and with our teams that are dedicated on delivering the value to those partners in and out every day.

Thank you. And congrats, again.

Thank you, Ricky.

One last question?

All right. So the final question from Goldman Sachs, we have Robert Jones.

Great. Thanks for sneaking me in John. Wish you the best Craig. It’s been a pleasure. I guess, Brian, just going back to this idea that you discussed that there are services that you are the wholesaler, provide for hospitals and other channels that aren't currently being leveraged in the retail channel. I heard something obviously very similar from one of your peers this morning. Obviously, the HSS news seems to be kind of pushing us towards this kind of net pricing world, which seems to play a part in this. Could you maybe just level set us and maybe just elaborate a little bit on what specifically the services are, that changing or current pricing dynamic would allow for a wholesaler to leverage into the core channel?

I think - the reality is we're going to see how things evolve here and how various constituents respond to the proposal that's been laid out. What I feel good about when I think about the capabilities at McKesson, and I mentioned this in my comments, is the fact that we do financial transactions, we do pharmaceutical transactions today in various parts of our business at scale with high accuracy, with really mature, developed, established incredible reputation for performance around those. And so I do think, as we looked how the markets will respond, how various segments will respond, we are in a good position to be able to provide solutions, kind of whatever that evolution is.

Thank you very much.

Thanks, Robert. And thank you, Craig. I'd like to thank all of those of you on the call with us for your time today. I certainly look forward to engaging with you and the rest of our investor community going forward. I want to acknowledge John one last time, thank him one last time for just the terrific career accomplishment and the impression he has left on me and that I know he's left all across the teams of McKesson. He'll be greatly missed. I want to thank our employees for their dedication to our customers and partners in line with our ICARE value of putting the patient and the customers first in everything we do. In closing, I'm excited about the opportunities ahead of us. McKesson continues to execute against our fiscal 2019 plan, and we look forward to updating you with our fiscal 2020 outlook in a few months' time. I'll now hand the call back to Craig for his review of upcoming events for the financial community. Craig?

Thank you, Brian. On Thursday, February 28, we will present at Leerink Partners 8th Annual Global Healthcare Conference in New York, and we look forward to releasing our fourth quarter earnings results in early May.