麥卡遜 (MCK) 2006 Q4 法說會逐字稿

Good afternoon and welcome to McKesson Corporation fiscal 2006 conference call. [OPERATOR INSTRUCTIONS] Today's call is being recorded, if you have objections you may disconnect at this time. I would now like to introduce Mr. Larry Kurtz, Vice President, Investor Relations. Thank you, sir, you may begin.

Thank you. Good afternoon and welcome to the McKesson fiscal 2006 fourth quarter conference call for the financial community. With me today are John Hammergren, McKesson's Chairman and CEO; and Jeff Campbell, CFO. John will provide a business update with quarterly highlights and we will then hand the call off to Jeff who will review the financial results for the quarter in more detail. After Jeff's comments we will open the call for your questions. Time permitting we will address all questions. We plan to end the call promptly after one hour at 6:00 p.m. at Eastern time. During the course of this call we will make forward looking comments. Please see our press release for a full discussion of the risk factors associated with them. Thanks, and here's John Hammergren.

Thanks Larry and thanks everyone for joining us on our call today. McKesson had another solid quarter overall led by excellent performances in pharmaceutical solutions and provider technologies. Capping off an outstanding year for these segments and providing great momentum into our next fiscal year. For the quarter revenues were up 12% and earnings per diluted share excluding a small securities litigation credit were $0.68. For the year revenues were up 10% and diluted EPS from continuing operations excluding the securities litigation reserve adjustments were $2.44.

The strong performances at Pharmaceutical Solutions and Provider Technologies combined with our new agreements with pharmaceutical manufacturers generated exceptional cash flow of $2.7 billion. We used this cash flow to continue to execute a balanced, flexible strategy of capital deployment for shareholder value integration. We spent 603 million in acquisitions, 958 million for share repurchases and 73 million for dividend payments. Even after securities settlement payments of 1.2 billion including our 960 million escrow payment to settle the consolidated class action the Company ended the year with a cash balance of $2.1 billion. Our 960 million payment in the consolidated class action fulfills the Company's obligation under our settlement agreement with the class.

Looking ahead, with improving performances in our pharmaceutical solutions and provider technology segments our strong balance sheet and our solid cash flow with and our security litigation almost fully behind us, McKesson is in a great position to continue a flexible and opportunistic strategy for further shareholder value creation. During the fourth quarter McKesson repurchased $379 million of stock, virtually completing the previously announced repurchase programs. I'm pleased that at our most recent meeting the Board of Directors authorized an additional $500 million share repurchase program.

Turning to our segment results, we saw another quarter of strong growth in Pharmaceutical Solutions with both direct revenues and warehouse sales up 13%. Pharmaceutical solutions revenues for the year were up 10%. We still believe that it is too early to assess the potential long-term impact of the Medicare drug benefit for seniors on our revenues, but I will note that pharmaceutical distribution growth in our U.S. core customer base was stronger in March than in recent months. For the time being however we see no reason to depart from the industries projections for growth in the mid single digits for both the U.S. and Canadian pharmaceutical markets in 2006.

We've said in the past that we will not retain business that does not meet our threshold for targeted returns. We terminated our logistics arrangement with oncology therapeutics network due to its low level of profitability. The business had annual revenues of about $3 billion, so the termination does affect our growth rate for the coming year in revenues.

It is best to look at gross and operating profit for a full year as a measure of our progress with the evolution of our agreements with manufacturers compared to a year ago. For the full year Pharmaceutical Solutions gross profit was up 14% and gross profit rate was 2.99% compared to 2.88% a year ago, reflecting also an increased mix of higher margin generic products antitrust settlements and the stabilization of sell margins to customers.

In the past two years we have focused our sales teams on margin rate expansion while still delivering increased value to our customers. We plan to use generics as a vehicle to expand our margins with existing customers and avoid the temptation to build the margin into reduced pricing overall. We will continue to focus on operating margin rate expansion as a key vehicle for shareholder value creation in this segment. We continue to make progress towards that goal. Operating profit margin rate was 1.45% for the fiscal year ending 2006 compared to 1.41% for the prior fiscal year.

As I noted a moment ago, increased sales of higher margin generic drugs play a key role in expanding our margin rates. Sales growth in our proprietary one stop generics program for our retail pharmacy customers once again exceeded the growth rate for branded pharmaceuticals and was up 20% for the quarter and 23% for the year. We continue to expand our capabilities in our generics business and have initiatives underway to increase penetration of our proprietary U.S. generics programs in every customer class.

For example we recently launched One Stop Generics Connect, a teleservice based business that uses a team of specialists to provide generics management support to our independent and small chain customers. We are focusing on just McKesson customers and to date we have involved more than 1,000 in the program with our remaining customer base being rolled out by fall of 2006.

While the growth rate of pharmaceutical distribution revenue has slowed in both the United States and Canada it is due in large part to the increasing number of significant drugs losing patent protection and becoming generic. As we've said in the past we not only have a higher gross margin rate on generics compared to branded drugs but also see more gross profit dollars on the generic version of the predecessor branded drug.

With a projected $20 billion of branded drugs facing patent challenges and/or patent expirations in the United States in 2006, the trend of increasing profit contribution from our domestic generics business should continue to have a positive impact on future segment margins and earnings. Our pharmaceutical solutions segment also includes McKesson Health Solutions, our business focused on disease management and criteria and claims management software for payers and providers. Our disease management business provides chronic care support and guidance to 1.5 million Americans through contracts in nine state Medicaid programs and one Medicare program. During fiscal 2006, McKesson renewed or extended four of these state programs and signed a new program with the state of Pennsylvania and implemented its Medicare program in the state of Mississippi with an outstanding 75% enrollment rate.

This is a growth business for us albeit on a small scale. We think this business has tremendous opportunity and we remain extremely optimistic about its future. As a result we continue to invest heavily in its growth which is dilutive to segment margin improvement. On the software side of the payer business more than 3500 health plans, hospitals, academic medical centers, government agencies and care management organizations currently use McKesson's InterQual tools to support clinical decisions for individual patients across the continuum of care. In fiscal 2006 we added 250 new customers to these important products.

To summarize, our pharmaceutical solutions segment continues to have great momentum. We had a very strong year with potential upsides from future generic conversions and the new Medicare drug benefit. As a result of well executed strategies and plans both buy side and sell-side margins have stabilized. Our additional businesses in disease management and payer software will provide further potential upside as we look to the future.

Turning to medical surgical solutions, our operating profit for the quarter and the year was clearly disappointing and well below our expectations for this business when the year began. Revenue growth in alternate site continued to be strong but overall revenues were dampened by weakness in acute care. Over the past couple of years we've invested time, money and resources in programs to improve our competitive differentiation in acute care. We have also made structural changes in an effort to cut costs and evaluated potential acquisitions both of which were designed to compensate for our lack of scale.

These strategies have not closed the gap and it is clear that we are at a competitive disadvantage in acute care. As a result we are examining strategic alternatives for the acute care portion of our medical surgical business.

We continue to focus on expanding and enhancing our higher growth, higher margin alternate site business. Two years ago we acquired More Medical and that acquisition has performed very well, expanding our telemarketing sales into alternate sites. In early April we completed the acquisition of Sterling Medical Services, a national provider of medical supplies and health management services to the home care market. This expands our presence in this rapidly growing subset of the alternate site.

Finally, in provider technologies we had another strong quarter that capped off another outstanding year. For the year revenues were up 18% with software revenues up 31%. Operating profit was up 34% for the year and operating margin was 9.27%. I simply couldn't be more pleased with the results we are achieving in this business. We are benefiting from our previous significant investments in product development, customer service, and support. We continue to invest heavily to take advantage of our market momentum.

Our innovation and product leadership in McKesson provider technologies and private increased sales activity both inside and outside of our customer base. As a result, in April we implemented a restructuring designed to further accelerate product innovation and deliver greater efficiency. The savings from this restructuring will enable us to expand our market presence with the addition of almost 100 new sales representatives.

Accelerated implementations are driving software revenues and operating margin improvement. During fiscal 2006, the MPT organization implemented more than 1,000 go lives including our 100th Horizon Care record site. 62 sites went live in Horizon Expert Documentation for Nursing, twice the rate of fiscal 2005. Currently more than 500,000 registered nurses rely on McKesson solutions to deliver safe care. That's about one out of every five nurses in the U.S. More than 70 million medications annually are now administered using McKesson's barcode scanning solutions. Our systems are preventing 203,000 medication errors every week.

Horizon expert owners is now live at Vanderbilt University where it was back installed at the location from which it was originally licensed. We believe it is the first time in our industry where an enterprise wide product has been purchased from a large academic medical center, re-architected and then reinstalled.

In parallel Vanderbilt rolled out our Horizons Med manager product and is implementing Horizon Expert Documentation. As of last week nearly 14,000 orders are being entered daily into expert orders from the adult and children's hospitals at Vanderbilt. This success clearly shows our ability to execute on complex projects, deliver our products to complicated environments, expand our relationships through additional product sales and build truly world class partnerships with our customers.

Our rapidly growing automation business continues to be a strong market differentiator. In fiscal 2006 60% of automation deals also included one or more IT products, clearly a sign that One McKesson is working in our customer base. Automation, along with our medical imaging, surgical manager, and document imaging solutions is opening the door to new business and new customers, enabling to us deliver value quickly and then expand our footprint. Automation revenues grew at a rate more than double the growth rate for the segment as a whole, simply an outstanding performance.

We are also accelerating our growth in the ambulatory electronic health record and physician market. After featuring our offering at their annual HIMSS meeting we added two customers representing 2,500 physicians in just the last 120 days of the fiscal year. That's more physicians than most of our smaller competitors have automated since their inception.

In the fourth quarter we signed a $17 million agreement to provide Wheaton Franciscan healthcare with a major electronic health record solution designed to enhance patient safety, and standardize healthcare processes. Wheaton will implement our Horizon Clinicals suite of solutions including Horizon ambulatory care which will be used to automate their newly formed Wheaton Franciscan medical group. Wheaton will also deploy our document imaging dog-footed medication administration and clinical decision support solutions across the board.

We are clearly continuing to win in the U.S. market but we are also pleased with our expanding business in Europe. We are making great progress with our implementation of a new payroll and HR system for the national health service of England and Wales. To date, 185,000 employees out of approximately 1.2 million total employees have been activated on the system. About half of the NHS sites are now in various stages of implementation and we are right on schedule for our goal of full implementation during fiscal 2009. Our success with this implementation sets the stage for more opportunities in the UK. We are one of a few NHS vendors to get it right and it's a privilege to serve this very important customer.

Turning to the continent, on March 31, McKesson France signed a contract to provide electronic health records, Horizon physician portal, a bedside information system, and Horizon medical imaging to Claremont Frond University hospital one of the largest hospitals in France. This win came after successful go lives and system acceptance by the first of nine French Army hospitals that are currently on track to deploy McKesson solutions including a full electronic patient record and the French version of the Horizon physician portal. Both of these prestigious wins come against major European and U.S. competitors.

Given the sustained demand we're seeing for healthcare information technology solutions, the markets positive response to our offering and our commitment to product innovation, customer quality, and organizational efficiencies we expect to see strong growth in provider technologies and continued long term margin expansion.

In conclusion I am very pleased with our solid quarter and the excellent past full year results delivered by our teams in both pharmaceutical solutions and provider technologies. Based on our operating progress and strategic investments over the past six years McKesson enters fiscal 2007 exceptionally well positioned in large and growing markets for healthcare services and technologies. We are the number one pharmaceutical distributor in the United States and Canada. We are the largest distributor of generics in North America at a time when the availability and consumption of these drugs is projected to increase significantly. We are focused on expanding our generic sales to our wholesale distribution customer base.

Our business providing software and disease management services to payers is poised for significant growth. We are very well-positioned in the attractive alternate site medical surgical market. Demand for software and automation solutions across healthcare remains very strong and McKesson has a large installed base of hospital customers and a very well regarded product offering for both acute care and ambulatory care.

Based on this positive momentum for the fiscal year ending March 31, 2007, McKesson expects to earn between $2.55 and $2.70 per fully diluted share. A strong balance sheet and operating cash flow expected to be in excess of $1 billion provides additional resources to further the creation of additional shareholder value.

We look forward to continuing to build on the great momentum we have achieved this past fiscal year. With that I will turn the call over to Jeff and look forward to addressing your questions when he finishes. Jeff.

Thank you, John. And good afternoon, everyone. As you heard from John, this was a solid quarter and we are extremely pleased with our overall results for both the quarter and the year. We are excited about our outlook for the upcoming year and the opportunities before us as we continue to leverage our strong balance sheet and cash flow, and continue to execute our strategy to create shareholder value.

Let me begin by reviewing the consolidated income statement. We have strong revenue growth in the quarter of 12% to 23.1 billion, primarily driven by our acquisition of D&K as well as continued organic growth in all segments. For the full year we had revenue growth of 10% to 88.1 billion. For the full year we were able to increase our gross margin so on the 10% growth in revenues we grew our gross profit by 12% to 3.9 billion. Gross profit for the quarter was up just 3%, primarily because in our Pharmaceutical Solutions segment our new agreements with manufacturers had reduced seasonality resulting in a higher proportion of gross margin dollars being earned in the first three quarters compared to the prior year.

Moving below the gross profit line our operating expenses were up 13% to 736 million for the quarter and increased 11% for the full year to 2.7 billion. Over the course of the year we lost a bit of operating leverage in our Pharmaceutical Solutions segment primarily due to the acquisition of D&K which drove certain one time integration costs and also have a higher cost to serve customer base. We did achieve operating expense leverage for the full year in both our medical/surgical and MPT segments.

Overall operating expenses we had a positive $8 million pretax adjustment to our Securities Litigation reserve this quarter. This adjustment was reflective of the fact that in addition to making the $960 million payment this quarter for the class action settlement, we have now resolved most of the other separate actions. A few still remain which could drive some final adjustments to the remaining reserve. But we don't expect any potential adjustments to have a material impact on the Company as a whole.

Excluding our Securities Litigation settlement adjustments, operating income was down 16% for the quarter but up 15% on a full year basis. Again this difference was driven by the reduced seasonality in our pharma-solutions segment. Below the operating income line our strong cash flow and balance sheet continue to benefit us. Interest expense was down 14% to $24 million in the quarter, reflecting lower debt levels from the prior year. Other income increased 86% to 42 million for the quarter, primarily due to increased interest income on our higher cash balances.

Our reported tax rate for the quarter was 37%, a big jump from last year's March quarter when the reported rate was 31.7%. This change caused an approximately $0.08 swing year-over-year and had two drivers. First, our mix of income had a higher domestic component this year relative to last year. Second, this year's -- this quarter’s provision included $12 million of unfavorable tax adjustments while last year's March quarter included favorable income tax adjustments of 12 million. Our effective rate for the year and our fiscal 2007 guidance remains 35%.

To wrap up the consolidated income statement excluding the Securities Litigation credit, net income for the quarter was $215 million or $0.68 per diluted share. Our full year net income was $767 million, or $2.44 per diluted share, excluding Securities Litigation adjustments and discontinued operations.

Our EPS calculation in this quarter is based on 314 million weighted-average diluted shares outstanding compared to 305 million in the prior year. And 316 million for the full year compared to just 301 million a year ago excluding the impact of the Securities Litigation charge. This is a significant year-over-year increase. Despite repurchasing 7 million shares in the fourth quarter and 19 million shares for the full year, the number of shares used in this calculation has continued to rise as option exercises have been robust. We continue to have a goal over time of repurchasing shares to offset the dilution resulting from the exercise of stock options and, as John noted, the Board has increased our share repurchase authorization by another $500 million.

I would note that even though our tax rate and diluted share count were significantly higher than our original forecast for fiscal '06 our EPS for the full year, $2.44, exceeded the top end of our original guidance range.

Let's now move on to our three segments. Pharma-Solution revenues were up 13% to 21.9 billion for the fourth quarter, and up 10% to 83.4 billion for the year. In the fourth quarter, you may notice that we changed the way we record some of our incentives to customers. Historically these incentives reduced our cost of goods. We now record them as a reduction in sales. This change had no impact on our reported gross profit or operating income but reduced revenues by a little more than $300 million on 83 billion of revenue in fiscal year 2006. The prior year numbers have been recast for comparative purposes.

Our revenue mix for the quarter for our U.S. pharmaceutical distribution business was 32% institutional, 22% retail chains, 13% independents, and 33% warehouse. That break out a year ago was 35% institutional, 21% retail chains, 11% independence, and 33% warehouse. The primary factor driving the shift was the addition of D&K revenues substantially all of which are from independent pharmacy customers.

Gross profit for the segment was flat, at $686 million for the quarter including $7 million from an antitrust settlement. As mentioned earlier we have reduced the seasonality of our compensation from manufacturers and are less dependent on the timing of price increases. Additionally we recorded a LIFO credit of $12 million this quarter versus a credit of $29 million in the fourth quarter of last year. Given the changing seasonality or full year gross margin is more representative of our progress in this segment and it increased 14% to $2.5 billion as we achieved our goals on our agreements with manufacturers and had increased profit from our proprietary generics programs along with a relatively stable customer sell margins. John mentioned our priority here and our sales force focus is having an impact.

Our Pharmaceutical Solutions operating expenses were up 13% for the quarter to $346 million, primarily reflecting expenses associated with D&K as we executed our integration plan. We have completed all planned DC closures and in the first quarter we will complete the system conversion on the 3 D&K DCs we are keeping open and close the last two other sites. In the quarter we recorded operating profit of $351 million and operating margin of 161 basis points. For the full year, our operating profit was 1.2 billion which was 13% above last year. We ended the year with an operating margin of 145 basis points, making steady progress towards our goal of getting the operating margin in this segment back into the 150 to 200 basis point range.

Turning to medical surgical solutions our results were clearly disappointing. Revenues were up 5% for the quarter and 7% for the year. Our alternate site revenues were up more strongly, 8% for the quarter and 9% for the year. Our gross margin in this segment has been under pressure all year, particularly in acute care. And this pressure combined with some one time charges that drove operating expenses up this quarter, resulted in the unacceptable results for the quarter and the year.

Turning to Provider Technologies, we achieved another strong performance with 17% revenue growth for the quarter to $431 million. Software and software systems revenue were up 30% in the quarter to 104 million. For the year, total revenues were up 18% to 1.5 billion, with software and software systems revenue up 31% to 322 million. Software bookings were up 17% for the year, an indicator of continued strong growth in the future. We had strong software backlog pull through driven by the accelerating pace of clinical and imaging solutions implementations as well as excellent results in automation. Automation revenues were up 46% for the quarter and 39% for the year, as sales of our robots, cabinets, and patient safety solutions continue to be strong. This caps an outstanding year for us in this segment.

Provider technologies operating expenses increased 20% in the quarter to 164 million. For the full year, operating expenses increased 15% to $590 million, providing some operating leverage based on revenue growth of 18%. We do continue to invest heavily in this business given the growth potential in the markets so our operating leverage is lessened by increased R&D to support new product development, increased sales and marketing to expand growth and the operating expenses of the MedCon acquisition.

In addition the first quarter of fiscal 2007 will include a 6 to $8 million restructuring charge in this segment for the restructuring John described earlier which should allow us to enhance innovation and deliver further revenue growth in future periods.

Our software revenue deferral rate during the quarter was 85% compared to 80% in the fourth quarter a year ago. Consistent with the prior year our full year software deferral rate was 80%. For the quarter MPT capitalized 24% of their R&D expenditures, compared to 22% a year ago. For the year capitalized 24% compared to 26% a year ago. Total gross R&D spending for the full year was 216 million, up 25% from the prior year. Representing about 14% of revenues and showing our increasing R&D commitment given the great view we have for the potential of MPT.

For the full year our operating profit was up 34% to $143 million, and our operating margin was 9.27%. For the quarter operating profit grew 4%, as the year-over-year comparison was impacted by the combination of our higher software deferral rate in the quarter, the increased investments we are making for future growth and the comparison to a very strong fourth quarter a year ago.

Leaving our segment performance now and turning briefly to the balance sheet and cash flow statements. On the working capital side our receivables were up 11% from the prior year to 6.4 billion and our days sales outstanding remain flat at 23 days. Our inventories were 7.3 billion, an actual decline from 7.5 billion a year ago, despite the 10% sales increase, a tremendous outcome, reflective of our new agreements with manufacturers and our continued focus on achieving inventory efficiencies. Our days sales and inventory of 30 days was down five days from March a year ago. Compared at a year ago our payables were up 15% to 10 billion, with days sales in payables at 41 days, up 1 day from last year.

These great working capital results and our strong operating performance this year together generated truly exceptional operating cash flow of $2.7 billion, even after litigation settlement payments of 1.2 billion and the combined 1.6 billion we used to create shareholder value through acquisitions, dividends, and share repurchases. We ended the year with approximately $2.1 billion in cash, up from the 1.8 billion we held a year ago. Obviously we enter fiscal 2007 with an extremely strong balance sheet.

Returning to our cash flows, capital spending was $167 million for the year, higher than the 136 million we spent in the prior year. The largest driver here was ongoing investments in our pharmaceutical distribution center network where we opened two large new DCs, replacing three older DCs that were closed. Capitalized software expenditures were $160 million for the year, also up somewhat from the $136 million we spent last year driven primarily by activity associated with the NHS implementation.

So overall, we are pleased about our strong quarter which capped an excellent year for us overall. Our momentum for fiscal 2006 leads to our expectations for our diluted EPS for fiscal 2007 of between 2.55 and $2.70 per share. We expect to generate operating cash flow in excess of $1 billion. I point you to our press release today where you will find a detailed list of key assumptions underlying this guidance, but I want to take just a few last minutes to highlight a few of the major assumptions. Although new agreements with pharmaceutical manufacturers provide a higher level of predictability for compensation, a seasonal pattern of earnings is expected to continue. I want to stress that while the operating margin rate in Pharmaceutical Solutions will fluctuate less from its highs to its lows than in the past, because of the mechanics of some of our manufacturer agreements, the fourth quarter will continue to represent a peak quarterly margin.

While we expect a strong full year performance in Pharmaceutical Solutions, we do face challenging comparisons in the first and third quarters due to antitrust settlements of 51 million and 37 million in those periods respectively in fiscal '06. Now, we expect these antitrust settlements will be significantly less in fiscal 2007 and while a small amount is included in our guidance range, obviously the difference creates a challenge for our fiscal '06 to fiscal '07 GAAP EPS comparison. We will also have the 6 to $8 million MPT restructuring charge I described in our first quarter, which we have also included in our guidance range.

The first quarter will also be when we first implement the provisions of SFAS 123R on expensing equity based compensation. As background in response to these evolving accounting requirements and trends in corporate compensation practices, McKesson has restructured its long-term compensation plans. We are reducing our use of stock options while increasing or evolving our use of performance based restricted shares, long-term cash incentives, and our employee stock purchase plan. The overall goal is to continue to provide long-term incentives to our key management personnel at market levels. Given the new accounting rules, $0.08 to $0.10 is what we expect to show as our total equity based compensation in fiscal 2007. This expense will be allocated to segments according to employee participation and will thus have a more significant impact on provider technologies operating profit.

Also, as you know, this is our first year expensing equity based compensation. You may recall that in prior years we accelerated some of our under water stock options. As a result our equity based compensation expense will build over a period of three to four years before we reach steady state. Due to the multi-year investing provisions in the programs. Our estimate today is that when we reach steady state in fiscal 2010 our expense would be $0.20 to $0.25.

Last, the guidance range assumes continued share repurchases to offset stock option exercises over time. Shares used in the calculation of earnings per share dilution are expected to average 310 million for the year, but will begin at 316 million in the first quarter and then decline over the course of the year which will obviously also have an impact on the quarterly progression of EPS.

So a very solid quarter, capping an outstanding year overall and guidance we believe shows continued strength for the coming year. Thanks and now I will turn the call over to the operator for your questions.

[OPERATOR INSTRUCTIONS] Our first question comes from Robert Willoughby. Please state your company name.

Banc of America. Good afternoon, John or Jeff, just on the MedSearch supply business on the acute care side, is the acute care business in itself profitable and can you give us any indication, the PP&E and inventory that might be tied up with that franchise?

Bob, our profitability in that segment is largely driven by our nonacute care segments and those businesses continue do grow very well for us. We have got great market positions in those businesses and as I mentioned in my prepared comments our acute care business is suffering from a scale problem, a lack of vertical integration and we've tried many efforts to try to counter those challenges. So we clearly believe that a strong portion, if not all of our profitability today, is being driven out of the alternate site segment of our business. We believe that's where the value is going forward and that's where we are going to spend our energy.

What kind of capital though is tied up with the hospital, DCs and inventory?

Somewhere probably between 100 to $200 million but I'm not really prepared to get into the specifics.

Okay. That's great. Thank you.

Our next question comes from Tom Gallucci. Please state your company name.

Merrill Lynch, good evening. Just two quick ones if I can. First, John on the generics business you talked about a new teleservice support type of a business that you've started up. It sounds like it's focused on your own customers. Is that something potentially that you would roll-out to try and capture business elsewhere? Would be the first question, and then you talked internationally particularly in your provider solution business some of your peers have seemed like they are talking more about pursuing the international opportunities potentially in the drug distribution space, do you have any comments on your thoughts in that front? Thank you.

Thanks, Tom. The telemarketing program that we talked about is focused on McKesson's customer base and we believe there is significant opportunity there for us to mind from a margin enhancement perspective. As you know the industry today is largely characterized by prime vendor relationships with wholesale distribution partners and that prime vendor relationship really allows us to get tremendous leverage inside of our existing customer base and drive incremental profitability for ourselves and cost savings for our customers.

There is a significant amount of leakage in the generic business inside of our customer base and that's really what we are focused on capturing either through direct sources of some kind in some cases on the larger wholesale distribution relationships and for the independents there are many other smaller telemarketing kinds of organizations that have attempted to attack the opportunity that we think that through our program we can better educate our customers and more frequently educate our customers as to the value of McKesson's generic program and retain a higher portion of our existing customers’ generic demand. Clearly we would have utility outside of our customer base, but we feel that the most appropriate thing given our continued relationships with our existing customers is to focus our efforts there.

On the international front we clearly see tremendous opportunity for all of McKesson's businesses in Canada. Clearly we have well in excess of $6 billion in presence up there now, a significant portion of the market and we've over the last five years expanded McKesson's footprint in Canada to really replicate what we have here in the U.S.

We had a specialty pharmacy distribution business in Canada. We have our IT businesses, our automation businesses, increasingly some of our other specialty businesses in Canada. So we are really pleased with our position there and have terrific long-term relationships. So we've already been international in Canada and Mexico with pharma-distribution. The utility for pharma-distribution for at least from our view in other parts of the world, we believe might be a little bit more limited.

That being said in other part of our business like our IT business, we are expanding rapidly internationally and then some of our payer businesses and disease management services we've had success in places as far away as Australia and New Zealand.

We do think of ourselves as a global company and we are expanding carefully in these other markets but we are also carefully expanding in places where we think we can get margin rate and where we can get revenue growth rate accretion. And so we are hesitant to buy into markets where the growth rates are slower, the margin rates are down and that sort of guides our activity.

Thank you.

Our next question comes from Lisa Gill. Please state your company name.

Good afternoon, JP Morgan. John, when we look at generics we think that this is something that clearly differentiates McKesson from some of your competitors and I was wondering if maybe you could just go into a little bit of detail as far as the number of manufacturers you would like to see in the market for optimal margin around generics and then secondly I think you made a comment that the gross profit dollars are always better on generics than they are on branded. Is that true? I mean some of the other competitors are saying that if the price of the product drops below 25% of the branded they can't make the same amount of gross profit dollars. I'm just hoping you can comment on that.

Well, let me talk a little bit about our position. Clearly as the largest or certainly one of the largest purchasers of generic drugs we think we have an opportunity to use our combined power from a buying perspective to source product at the lowest possible cost and because our programs are very sophisticated and well managed on the sell-side to our customer base we think we are able to harvest as much margin as possible on our generic business outbound to our customers.

We see the generic opportunity as a way to lift our margin rates in our wholesale drug distribution business. We don't plan to use generics as a vehicle to expand our share and we don't plan to use generics as an offensive price kind of a weapon. We see it more as a margin enhancement opportunity for our company and that's been our focus.

As to the value of generics to us internally in almost every circumstance we see a significant rate expansion to the point of if a product goes from $100 to $1 are we going to get more gross margin dollars out of it, probably not. But we don't see many examples of drugs that have that type of a precipitous fall from a pricing perspective and even if they do, evidence shows that over time generic manufacturers drop out of those unprofitable categories and thus the profitability returns because you will end up with two or three manufacturers left and those manufacturers price responsibly and when they price responsibly in the market we are able to get enough margin spread out of that to accomplish our goal and the goal that we have realized thus far which is margin dollar and margin rate expansion on our generic portfolio.

So we are extremely pleased with our business in this area and we are continuing to harvest the value of the chain in our McKesson customer base, selling to increasingly more sophisticated and larger buyers of generics which affords us even more buying power as we go back and source. We think our relationships with our existing generic company supply partners are very strong and we think we are afforded as well or better business transaction partnership margins as compared to anyone in the business.

Is there a key number of manufacturers where you make the most amount of profitability or it doesn't really matter based on your business model?

Well, I think it does matter at some level. Clearly there has been some discussion in the marketplace about these exclusivity periods. We are really not troubled by them. Usually they are provided to partners that we use frequently and we are going to use after the exclusivity period expires and therefore we are able to continue to get tremendous value from the move to generics even if there's only one or two players in the market. That value will be enhanced obviously as the market gets more competitive. And as to the number that makes the most sense for us I think it's probably all over the map depending on the compound and the players that are in the market and the pricing pressure that they are under. But I think the point here is that the generic portfolio that we have both the products and the customers are driving tremendous opportunities for us and we see those opportunities continuing to expand as we go forward.

Thanks, John, that was helpful.

Our next question comes from Ricky Goldwasser. Please state your company name.

UBS. A couple of follow-up questions. First on Lisa's generic question you talked about the dollar gross profit as being more profitable than the branded one. Can you also talk about the dollar profitability in terms of operating dollar profit for generic versus branded? And then I have a question on the guidance, I think you said that the antitrust in guidance is significantly less than it was last year, if you could just define significant, is it 80% below what it was last year, and does it offset the restructuring cost? You mentioned that is included in your guidance as well?

Thanks, Ricky, I will let Jeff handle the conversation around the securities or excuse me, the antitrust settlements. On the operating profit, I think not only is the gross margin expanded through the sale of generics but I actually think the operating profit is probably expanded even more because these products are not difficult to handle typically. There is no special handling, refrigeration, all of that kind of stuff that goes with it. They are in our systems today and so if anything we have equal or better utility and drop value to the bottom line from gross margin with the sale of generics. Jeff?

On the guidance Ricky as you point out we would include in our guidance range anything we see on the antitrust settlement side. Now '06 was a remarkable year. We had around $94 million of antitrust settlements that helped our 2006. And the pipeline is very clearly slowing very significantly as we look out at '07 so while we still see a couple in the pipeline they are very modest in size, probably more along the size of the $7 million that we recorded in the March quarter we just had. So we don't expect them to be nearly as material in '07 as they were in '06 which is one of the challenges as we think about the year-over-year GAAP EPS growth we are trying to get to.

And that's 7 million per each case?

Yes, that's a reasonable estimate, yes.

Okay. And then lastly on the exclusivity period, I understand that a big picture it doesn't matter, but could it be actually somewhat better for you on a dollar basis to have the 180 day exclusivity period on a product like a Zocor?

Yes, absolutely. Because there's usually more dollars left in the product so you are absolutely right. I think there's been some confusion over these matters and I think the message is, just to be clear, we have never seen a generic conversion that we don't like and the issue of timing, we want them sooner rather than later and even if that includes an exclusivity period that's better for us in many cases as well so we are like I said very optimistic about generics and they play a very important role in our business.

Is the assumption for generic Zocor exclusivity is factored into guidance?

Yes, the guidance we gave you includes that.

Thank you.

Yes.

Our next question comes from Larry Marsh. Please state your company name.

Thanks, Lehman Brothers. Good afternoon everyone. Jeff, just to make sure I understood you correctly in response to Ricky's question you are thinking a couple of these antitrust settlements could still be in the pipeline for fiscal '07 and you size them at roughly, closer to the 7 million in the fourth quarter, so a couple means sort of two or three?

Yes.

Okay. Are you assuming -- a couple other questions on the guidance just to make sure I understood, the LIFO credit as you had said came in well below last year. Are you suggesting any LIFO credit for fiscal '07?

You're correct. The credit for '06 was well below what we had in '05, what we are expecting in '07, these things are a little hard to predict but what we currently would expect would be a very similar number in '07 to what we had in '06.

Okay, thanks. Just another clarification, the option expense commentary, thank you for breaking that out into '010 but the $0.20 to $0.25, if you had not accelerated vesting this past year would that be the '07 run rate or is that just something that would you build up to anyway?

The short answer is yes, so the $0.20 to $0.25 is what you get to when you are fully back at steady state. If that math confuses you as to why that's not a multiple of three or four of the first year when our equity compensation vests over three or four years it's because there are certain legacy compensation that sort of tails off over the next few years as some of the new compensation programs kick in. And in sum, but the $0.20 to $0.25 is really the comparable number you want to think about for our all in cost of running the long-term compensation programs we run through our key management personnel.

Okay. All right. And one more, and just would be the timing of the evaluation, strategic options for your acute care med surg business, when would you hope to resolve that and did you say that the acute care business lost money in the quarter or was just break even.

We expect to resolve the acute care issue or opportunity depending on how you want to look at it very soon. This is a top priority for us and we have been working on it for some time. As to its profitability, we don't really manage segment profitability discreetly or haven't in that business and that's why you've never seen it. However, we believe strongly through our analysis that has been going on now for some time, that the comment that I made about as profitability is accurate so we would expect that the segments as separate operating entities you would find that the profitability is largely being driven in the nonacute care segment and that would be our expectation.

Larry, I just want to follow-up on one other comment you made on compensation just so the people are clear here. We saw this expense issue coming and we did a lot of work in advance of it to manage our total long-term compensation expense rates down. I think we have taken nearly half of our option eligible employee population and taken them out of our option programs. We have significantly remanaged our recharacterized them and tried to manage the expense down to the lowest possible number and that's another reason why you are not ending up with a multiple of what was in the 123R disclosures in the proxy statements in the past is not only was a lot of that based on options that were out of the money, but a lot of it was at option levels that were much higher than the option levels we are currently granting or even started granting last year. So we've done a lot of work to manage our compensation expenses down to what we believe is not only market based but perhaps leading the market in terms of where we think people are headed ultimately.

Okay. Very good. And one final one and I'm running over, John, you are confirming today like you did last quarter, stable buy and sell-side margins, a little bit different tone than some of your public competitors on their calls, just why do you think that is? And any elaboration would be great. Thanks.

Well, we are very disciplined on managing pricing. That's not to say that they aren't, but we're heavily focused on it, our sales forces, we've beaten it into their heads over the last two years that we are not going to compete on price unless we are forced to in our incumbent customer base in terms of matching the competition. Furthermore we are trying to sell the full value of McKesson including generics and as I mentioned we are trying to get generics to be a lift for us as opposed to some offset to margin degradation in our business. The last thing we want to do is to have a tremendous opportunity in generics and wake up two years from now and find out we didn't deliver any of it to our bottom line because we gave it away in market pricing. So we've remained very focused on paying our sales force in the right way and delivering value to our customers in the right way so it doesn't require additional discounting. We think competing on prices is frankly a losing strategy and a zero sum game.

So we are pleased with where we are. I can't speak for the competition. Clearly it's something we have to keep an eye on and we have to stay ever vigilant to it and occasionally we have a sales rep off the reservation or a region that you have to deal with, but overall our strategy has been finely tuned and delivered with a, I would say firm guidance.

Very good. Thank you.

Our next question comes from Christopher McFadden. Please state your company name.

Thank you, good evening, Goldman Sachs. First, a clarification. In terms of the guidance for F '07, the $2.55 to $2.70, I want to clarify that includes the $0.08 to $0.10 in ESO expense that you included as one of the key assumptions for '07.

Yes.

And then building on the question about the strategic evaluation, is there a scenario, John, in which including alternate sites as part of that strategic review for the medical products segment would be a consideration, is there a scenario in which that might become part of the discussion?

Well, we believe the alternate site business is growing at very attractive rates probably in the 6 to 8% kind of range. We think the margin opportunity in the alternate site segment which is about $2 billion of our $3 billion in revenues, the margins in that business, operating at kind of a stable rate should be in the four to 6% kind of range. So we think it's a very attractive business. It's got good growth characteristics to it.

Actually, we are beginning to get leverage in that business between our MPT business and the physician business and our specialty business and the physician business. So we are pleased with our position in that marketplace. Our problem in medical primarily has been in the acute care segment and that's what we are focused on.

Understood. My recollection is that most of the distribution infrastructure there is cohabitated within the same facilities. I know you've done a lot of technology upgrade work. How do you think that affects your evaluation? Does that make that easier or harder?

That's as I mentioned on the other -- in the other question we have spent some time studying this matter probably for several quarters now and trying to understand what the margin structure and the cost structures are for these businesses in a more separate way than might be currently available to us in the way we are organized. The distribution centers some are commingled and some are exclusive to different segments. Those that are commingled, the evaluation from a profitability perspective is a little bit more difficult. We've I think been able to decipher that and feel strongly that the alternate site businesses in particular are very profitable and have good growth trajectories in front of them.

Very good. Then lastly, you are highlighting here in the release that you've exited your OTN relationship and it seems like it's been a busy quarter for that particular line you added the Genentech exclusivity and I think you made a small GPO acquisition in that field. Is that -- should we think that's going to be a big focus for McKesson going forward and could you talk about the cap program as a dynamic in that marketplace that I'm sure you've had to evaluate as you've thought about your positioning in the oncology marketplace? Thanks.

Well, clearly we think the specialty business is an important segment for us and clearly a high growth opportunity. But having said that, profitability is very important to us and it should be a theme that you hear as I've talked today. The profitability of the OTN business or lack thereof caused that decision to be made and the cap program as we analyzed it we couldn't find a way to make that profitable and therefore we didn't participate aggressively in the way the program was developed and rolled out. That's not to say that we wouldn't be involved in future programs but we analyzed that one and felt it didn't make any sense. We think the industry has consolidated and we think there is room for a few value providing participants. But once again, we have to make sure we watch the pricing structure in that industry to see if there's enough room for margin so we can get a good return for our investment.

Very good, thank you for the detail.

You're welcome.

Our next question comes from George Hill. Please state your company name.

Leerink Swann. Thank you. John, you guys won the IT business in France. Can you talk about the competitive environment there and how your win fits into the country's plan for national procurement?

We are really pleased with our win in France. We've been in France, I think, since the early or mid 1990s in our IT business and have been strategically building that business quietly sort of on the sidelines without making a lot of noise about it. We are extremely pleased with our progress and I talked about the Army hospitals early implementations. The wins at the Army hospitals and now this most recent win I think sets a basis and a platform for a countrywide discussion around the implementation of a more holistic IT strategy. And we are heavily involved in those discussions and believe that we have a very solid seat at the table to make sure that we are well represented.

Clearly once again we have to make sure that our contract are well constructed, that there is a great return on our investment and that we have bounded the risk associated with doing business within some of these international places. My point to our U.K. implementation of our NHS contract, we might be one of the only contractors that has thus far delivered tremendous success in those implementations. And we are pleased with our progress. The learnings there extend to our activities in France both from a contracting perspective, but also perhaps as important from an implementing perspective.

Our products are now being adapted for those European markets and that's another reason why we are gaining success and we are putting more and more on McKesson personnel overseas and hiring great people in country to augment our efforts on a broader international basis. So we think that our technology products are infinitely exportable particularly when compared to some of our service business that you might go into markets that have either already consolidated or highly fragmented or have cultural norms and activities that are different than what we pursue here in the U.S. that make them less perhaps valuable to us but these IT businesses and automation businesses we think are very promising.

And one small follow-up if I can. I thought you had said you spent 24% of segment revenue on R&D. Is that correct?

I believe--.

No, it was 14% of segment revenues.

Up 24.

Yes.

Okay. Then that makes my question moot. Then I will just follow-up with, do you feel like you guys will compete in other regional procurement programs in Europe?

I think we are there now and we are competing. I think the point you should take away is that we are well-positioned to compete, but we have also learned through our competition how to do these things right. We've seen others win these deals and then find themselves in a real problem in future periods trying to execute and we are not going to find ourselves in one of those positions.

Okay. Thank you.

Thank you. I want to thank you all for your time and attention this morning. I'm sorry, we've run out of time for additional questions. But I really, I'm excited about our future. I think that we have tremendous opportunity. I want to thank you for your time.

We are really excited about our position in these growing and dynamic markets in healthcare both here in the U.S. and as we've been talking about in Europe and beyond. We are in the right markets at exactly the right time. We are very pleased with our performance in fiscal 2006 and the momentum we are taking in 2007. The upsides in our business and the tremendous assets and opportunities we have to further enhance shareholder value creation are certainly here for us and we continue to sharpen our focus on businesses that represent the greatest potential for creating value and plan to be disciplined in our operations and with our deployment of our cash. With that I will turn it over to Larry and he can talk a little bit about our future here.

Thank you, John. May 10, we are going to be at the Robert Baird conference in Chicago. On May 17, we are going to be presenting at Beve Securities healthcare conference in Las Vegas. On June 14, we will be down at Dana Point to present at the Goldman Sachs healthcare conference. On June 22, we are going to host our annual investor day in New York City, that will start around 8:30 in the morning and we will be sending out details for you shortly on that. But plan for basically 8:30 to noon.

We are planning to host another event for the financial community at our annual trade show for Independent Pharmacies, that's going to be in Las Vegas this year and that event would kick off on the 26th of June. We plan to release our first quarter results and hold our call after the close of market on Thursday, July 27. So that's a lot of things going on. We look forward to seeing you at one or more of these and until then good bye and take care.