麥卡遜 (MCK) 2007 Q2 法說會逐字稿

Good afternoon and welcome to McKesson Corporation's fiscal 2007 second quarter conference call.

[OPERATOR INSTRUCTIONS]

Today's conference is being recorded if you have any objections, you may disconnect at this time.

I would like to introduce Mr. Larry Kurtz, Vice President Investor Relations. Please go ahead, sir.

Thank you, Laura. Happy Halloween and welcome to the McKesson fiscal 2007 second quarter conference call for the financial community.

With me are John Hammergren, McKesson's Chairman and CEO and Jeff Campbell, CFO. John will provide opening comments and then introduce Jeff who will review the financial results for the quarter. After Jeff's comments, we will open the call for the questions. Time permitting we will address all questions. We do plan to end the call promptly after one hour at 6:00 p.m. to enable you trick or treaters to go out on your rounds.

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.

Thanks, Larry, and thanks everyone for joining us on our call today.

I'm pleased that we followed up our excellent first quarter with very strong performance in the second quarter and the trends remain positive for our company. Diluted EPS from continuing operations excluding adjustments to securities litigation reserves was $0.66.

Our is goal to execute well and deliver operating margin rate expansion across McKesson. And in the second quarter, operating profit growth exceeded revenue growth in all three segments.

During the quarter, Pharmaceutical Solutions revenues grew at the rate of market growth, adjusted for our mix of business and operating margin rate expanded as we continued to provide additional value-added products and services to customers and managed our expenses very well.

In the Medical-Surgical Solutions business, we achieved solid revenue growth and margin expansion while beginning the progress of reorganizing our business to focus on the higher growth, higher margin, alternate site sector of the market. The need for Information Technology Solutions to improve the quality and efficiency of health care is driving strong market demand and revenue growth in provider technologies and we continue to accelerate implementations, which helps us increase profitability. Great trends driving the business and great execution across the Company.

In addition to our strong operating performance, we continued to deploy capital in a disciplined way to create additional shareholder value. In the second quarter, we repurchased $372 million of stock, leaving $345 million remaining on our previous share repurchase authorization. Over the past six quarters, cumulative share repurchases have exceeded $1.6 billion. Cash flow from operations for the first six months was $685 million and we ended the quarter with a cash balance of $2.3 billion and a gross debt-to-capital ratio of 14%.

Our strong balance sheet and solid cash flow should enable us to continue our disciplined portfolio approach to capital deployment combined with consistently strong operating results from having focused businesses in attractive growing markets for health care services, we are well positioned to deliver sustained shareholder value creation. Jeff will review our financial results in detail shortly, but before he does, I will briefly recap a few key trends and performance metrics driving the momentum that we have in our business.

Turning to the segments, we had another outstanding quarter in our U.S. pharmaceutical distribution business. Our top line growth was at market rates, taking into account one less selling day in the quarter, which reduced reported results by about 1.5% on a comparable basis. The revenue growth also reflects the termination of our low margin logistics agreement with OTN earlier this year.

The Medicare Part D drug benefit for seniors is clearly having a positive affect. In its mid-year review, IMS calculated an incremental 1.5% increase to market growth due to Part D. I'm delighted that this program seems to be quite successful in providing seniors with greater access to needed medications.

Our terrific performance on the bottom line is being driven primarily by two factors. First we're seeing the benefits of our continued focus on cost controls and efficiency programs across the business and second we continue to bring new products and services to our customers, designed to improve their operations and profitability.

For example, our generics business continues to grow from the launch of major compounds and greater penetration of our customer base. Beginning July 1st, we welcomed many former D&K customers into our one-stop proprietary generics program.

More customers than ever are benefiting from McKesson's purchasing power and outstanding execution to gain access to new, low cost generic drugs as rapidly as possible. As a result of several major generic drug launches the past four months, an increased penetration of our customer base, including the new D&K customers, one-stop revenues increased 67% from the second quarter a year ago.

Given the projected time line for major branded pharmaceuticals scheduled to lose patent protection, our generics opportunity should continue to be robust. Our generics business should continue to have a significant positive impact on our Pharmaceutical Solutions result throughout this fiscal year and beyond.

Our Health Mart franchise program is another example of value-added service that helps strengthen our relationships with retail independent customers. Health Mart levels the playing field for independent pharmacies by providing its members with the resources they need to compete more effectively in today's increasingly competitive marketplace. Our services include a managed care network, consumer preferred branding, and dedicated merchandising support.

Since July 1st, our Health Mart franchise count increased 350 stores to 850 stores, making it the largest independent pharmacy franchise network in the U.S. We expect to see continued expansion of Health Mart as additional retail independent customers learn the value of this unique and cost effective program. It's a win-win situation since these customers tend to be more loyal and compliant with our programs.

Our McKesson Pharmacy Systems business is another great example of how we improved the competitiveness and profitability of our retail pharmacy customers through technology driven solutions. MPS develops and sells a wide range of software and related services to retail pharmacies.

We recently introduced several timely software enhancements designed to improve our customer's ability to manage their inventories, their point of sale transactions, and their Medicare Part D enrollees. The customer response has been very positive.

Our buy margin with branded pharmaceutical manufacturers and our sell margin to customers both continue to be stable. Speaking of stability, I'm pleased to tell you today that Target stores, a McKesson customer since 1994, when they first opened a pharmacy operation, recently renewed its prime vendor agreement with us.

We'll continue to bring value-added programs such as generics, Health Mart, and our McKesson Pharmacy Systems along with our Perata Pharmacy Automation products to our customers and we will continue our focus on operating expense efficiencies. This should enable us to continue to make progress toward our goal toward of an annual operating margin rate of 150 to 200 basis points for the Pharmaceutical Solutions segment.

In Medical-Surgical Solutions, we have begun the process of reorganizing our continuing operations to focus on what we believe is a great opportunity. The higher growth, higher margin sectors of the Medical-Surgical market, comprising physician offices, clinics, surgery centers, nursing homes, and home health care. Sales to these customers should grow faster than the growth rate of the overall Medical-Surgical supply market and our goal is to have an operating margin rate of 4% to 6% following the completion of our restructuring program.

The early results show we are right on track. Revenues from continuing operations were up 14% in the quarter, and our operating margin rate was almost 4%.

I want to congratulate our Medical-Surgical Solutions team for getting off to a great start with our new business focus and for their productive cooperation with the Owens and Minor team to close the sale of our acute care business. We look forward to supporting the transition of the business and thank our former customers and colleagues for their loyalty and dedication while with McKesson. We wish them the very best.

In Provider Technologies, we had another terrific quarter. We continued to have strong revenue growth reflecting market demand, the value of our solutions, and our focus on reducing the time to installation. Operating profit was up even more strongly, an especially impressive performance as we ramp up investments to increase market penetration and drive future growth.

We plan to continue to invest in R&D, sales expansion, and our promising physician office in Consumer Directed Health Care Solutions to take advantage of the positive trends in the market and our very favorable position. We continue to have great market momentum with our Horizon products, medical imaging, cardiology, and patient folder, all of which are highly rated imaging solutions focused on making clinical information easily accessible and useful for physicians.

While the market for first generation digital medical imaging solutions continues to expand, there is a growing replacement market emerging. 25% of Horizon Medical Imaging sales this quarter were competitive replacements. For the first two quarters of the year, we had 38 medical imaging go live sites. In Cardiology Imaging, in the 12 months since we acquired MedCon, we have signed 37 new Horizon Cardiology contracts, indicating strong market momentum.

We've also had an additional 40 sites go live on or Horizon Patient Folder Document Imaging Solution. We now estimate that 115,000 physicians have access to 6.8 billion documents now stored in our document imaging systems. In addition to our progress in imaging, we had 152 sites go live on other clinical solutions. That's a 20% increase from the second quarter a year ago, and because we use percentage of completion contracting to recognize revenues, it has been a key driver behind our software revenue growth.

I commented last quarter about the resurgence of our Paragon Solutions for community hospital markets. In the second quarter, we signed five new Paragon contracts, several of which were competitive replacements. While clinical solutions continued to account for the majority of our contracts and revenues, managing an increase in the complex revenue cycle is a growing priority for our customers.

The reimbursement environment is clearly becoming more complicated and with the rise in consumer health spending accounts, we are focused on supporting the needs of our customers to manage complex financial funds flows. During the second quarter, seven new sites went live on our revenue cycle sweep. Our $1 million club, comprising hospitals that have documented annual revenue cycle savings of more than $1 million, inducted its 100th member. Our members have now saved collectively $1.3 billion using our systems. Great for our customers, great for the health care system, and certainly good business for us.

For some time we've focused on our strategy for Ambulatory Electronic Health Records, or EHRs. We've done this primarily by extending the IT networks outbound from our customer sites using the hospital as the hub for physician information exchange and interaction. Building on their existing IT investments, hospitals can add capabilities such as secure messaging between physicians or between physicians and patients or other stakeholders as they embark on E prescribing or an Ambulatory EHR system. The resulting modular framework enables hospitals to make technology attractive to physicians from a cost, flexibility, and support standpoint.

In addition to this hospital-out strategy, we made an acquisition, Relay Health, you might recall, to strengthen our position in the emerging market for the free standing physician office information solutions. Final HHS regulations regarding Eprescribing and electronic health records are driving increased interest in our physician EHR strategy, including the Relay Health secure communications network.

We already have great traction with our comprehensive solutions and physician offices with our Horizon practice plus practice management solution and Horizon ambulatory care electronic health record solutions. This is not all futuristic. The demand is beginning to take shape today, with nine go-live sites in the past three months and more than 20 in progress.

Clearly we are extending our reach and penetration far beyond our core hospital base to physician offices and the home, becoming the first true health care information technology solutions vendor. We intend to continue our investments to take advantage of the market trends and our current position.

In conclusion, I'm very pleased with our first half results and the momentum we've taken to the remainder of the year. Our Pharmaceutical Solutions segment continues to outperform and produce great results.

We have an outstanding team that has worked together over a number of years to create significant value for customers and shareholders. They have delivered not just industry-leading supply chain service, but a continually expanding portfolio of solutions that anticipate customer needs for improved efficiency and profitability. It's that kind of leading edge thinking and execution that distinguishes our performance.

We're excited about the potential for our new focus in Medical-Surgical Solutions and I'm confident that our team there has the right plans in place and the capability to execute. We're also seeing a payout for our continuing investments in customer service and product innovation in our provider technology segment.

Demand remains strong for our solutions within our historical customer base and we believe we are now well positioned outside our base and in the rapidly expanding realm of physician offices and customer directed health care. Great execution, positive indicators, and tremendous enthusiasm for the future across the Company.

Based on our year-to-date results and the continued progress in our business, we are raising our guidance. The fiscal year ended March 31, 2007, McKesson expects to earn between $2.65 to $2.75 per fully diluted share from continuing operations. I look forward to reporting to you on our performance as the year progresses.

With, that I'll turn the call over to Jeff for an in depth review of the financial results and I look forward to addressing your questions when he finishes. Jeff?

Thank you, John, and good afternoon, everyone.

McKesson had another great quarter capping a solid first half of the fiscal year. We had strong operating results and continued to deploy substantial capital on behalf of shareholders while still maintaining our financial flexibility to create value over the long-term.

As always, let me begin by reviewing the consolidated income statement. We had revenue growth in the quarter of 5% to $22.4 billion. Our overall revenue growth in the quarter was primarily driven by our Pharmaceutical Solutions revenue growth of 5%, given the size of this segment's revenues. But I am especially pleased with our 14% revenue growth in our Medical-Surgical segment and our 22% revenue growth in our Provider Technologies segment.

Overall gross profit for the quarter was up 18% to $1 billion with all three segments contributing to this strong performance showing gross margin improvement. Moving below the gross profit line, our total operating expenses were up 12% to $718 million for the quarter. Excluding a $6 million pretax positive adjustment to our securities litigation reserves, our operating expenses were up 13% to $724 million.

We actually achieved a bit of operating expense leverage in our Pharmaceutical Solutions segment relative to its 5% revenue growth, so the 12% growth in our operating expenses was primarily related to our revenue growth, acquisitions, and investment spending in the Medical-Surgical and Provider Technologies segments. Additionally in the quarter this year, we recorded $16 million in FAS 123R expenses.

Operating income of $306 million in the quarter was 35% above last year, or 33% if you exclude the $6 million--$6 million positive reserve adjustment related to our Securities litigation. This great performance was primarily driven by the outstanding Pharmaceutical Solutions results and it was also the result of getting operating leverage in all three segments this quarter.

Moving below operating income, our interest expense of $22 million and other income of $32 million were little changed from a year ago. Our reported tax rate was 9.2%.

In the quarter, we recorded a previously disclosed credit to income tax expense of $83 million, which primarily pertains to a favorable ruling from the IRS that the payment of our Securities litigation settlement is fully tax deductible. Excluding this reserve reversal, our tax rate would have been closer to our run rate of 35% and a bit below last year's 36.4% rate.

On a GAAP basis, this quarter we had net income of $229 million or $0.75 per diluted share compared to $167 million or $0.53 per diluted share a year ago. The GAAP numbers include the after-tax $87 million of income or $0.28 per diluted share related to adjustments made to our Securities litigation reserves, as well as the impact of an after-tax $58 million charge or $0.19 per diluted share, primarily related to the sale of our Acute Care Medical-Surgical business, which is reported on the discontinued operations line of our income statement.

Now, the bottom line numbers I would point you to in terms of our core operating performance are at the bottom of Schedule 1 in our press tables. We had $200 million of income from continuing operations, excluding adjustments to security litigation reserves, 32% above last year, and we had diluted earnings per share of $0.66 from continuing operations, excluding adjustments to securities litigation reserves, 38% above last year. Needless to say, we are very pleased with this performance.

Before I move on, I would like to take a minute to go over the loss recorded in discontinued operations in the quarter. The $58 million or $0.19 per diluted share includes an after-tax loss of $67 million for our acute care Medical-Surgical business sold in September, a $5 million after-tax gain on the sale of a former D&K health care resources subsidiary, and an after-tax gain of $4 million for payment of a previously reserved loan associated with a business sold several years ago.

To wrap up our consolidated results in the quarter, our diluted EPS calculation was based on 305 million weighted average diluted shares outstanding compared to 316 million in the prior year. The number of shares used in this calculation declined due to the cumulative impact of our share repurchases, including $372 million of stock repurchased in the second quarter, which brought our total share repurchase for the fiscal year to $656 million and for the past six quarters to over $1.6 billion.

Let's now move on to our three segments. In Pharmaceutical Solutions for the quarter, we achieved revenue growth of 5%. U.S. Health Care direct distribution and services revenue grew 4%, mainly due to the D&K acquisition, which we started servicing on September 1, 2005, offset by having one less selling day in this year's September quarter and the previously disclosed termination of our agreement with Oncology Therapeutics Network.

Warehouse revenues increased 5% from a year ago, again impacted by the one fewer sales day this quarter. So overall, our U.S. Pharmaceutical distribution revenues grew roughly the same as the market, which we see growing at 7%, excluding the positive impact of D&K, the loss of OTN, and considering that we had one less selling day this year.

Our Canadian business continued to perform well, growing at 13%, including a favorable currency impact of 8%. Our sales mix for the quarter was 30% institutional, 23% retail chains, 13% independence, and 34% warehouse.

That breakdown a year ago was33% institutional, 22% retail chains, 12% independence, and 33% warehouse. The year-over-year change is mostly due to the termination of our agreement with OTN and the acquisition of D&K. Gross profit for this segment was up 15% to $650 million for the quarter, including a favorable $10 million antitrust settlement this year.

Both years had a LIFO credit of $10 million in the quarter. The key drivers to our solid gross profit results in the quarter were stable sell margins and higher generics income due to the timing of several high-profile generic launches in our first and second quarters. Our income from manufacturers remains stable as we continue to operate successfully under our new agreements.

As a reminder, we do report our payer business in our Pharmaceutical Solutions segment. So some of you may have expected to see the benefit of our favorable legal and licensing settlement with the TriZetto Group in this segment.

Under the terms of the settlement, TriZetto will pay us a one-time license royalty fee of $15 million. The royalty fee is expected to be amortized on a pro rata basis over the four-year life of the contract beginning in the third quarter.

Our Pharmaceutical Solutions operating expenses were up just 4% for the quarter to $333 million. We are pleased to have fully integrated the D&K acquisition and are now reporting lower operating expense increases. We continue to manage expenses diligently in this segment, and expect year-over-year increases to continue to provide leverage in the second half.

Operating margin for the quarter was 152 basis points compared to 124 basis points in the prior year. This is great progress, as it puts us on track to achieving for the year the low end of our operating profit margin goal of 150 to 200 basis points on an annual basis.

These results stem from seeing more stability on the sell side and branded manufacturer fees, nice leverage on operating expenses, and great results in generics, which continue to be a key opportunity as more branded products are expected to lose patent protection in the next few years. Overall, I would say that this segment, considering its performance and new cash flow characteristics has gone from being a good business to being a great business over the last two years.

Turning to Medical-Surgical Solutions, as John mentioned, we're very pleased with the speed and execution of the sale of our Acute Care Medical-Surgical business. In the remaining business Medical-Surgical revenues were up 14% for the quarter to $580 million reflecting solid growth across all customer sets. We expect continued strong revenue growth for the remainder of the year, as we should see a larger impact from flu vaccine sales in the next third quarter.

Gross profit of $166 million was 17% above last year providing leverage from the 14% revenue growth. We had gross profit margin expansion across all parts of the business and a nice contribution from our recent Sterling Medical acquisition.

Operating expenses in the quarter were 17% above last year. As mentioned earlier, we will be rightsizing the business going forward, and as a result expect to incur approximately $5 million in restructuring expenses in the second half of fiscal 2007. These restructuring charges will be included in our continuing operations.

Operating profit in this segment was up 15% from the prior year, giving us a bit of operating leverage with the margin at 3.97%. We remain committed to our goal of 4% to 6% operating margins after having worked through the transitional challenges in the next several quarters. We are very pleased with the progress we've made so far, which can be attributed to the hard work and dedication of our Medical-Surgical team.

In Provider Technologies, our revenues were up 22% for the quarter to $440 million, another strong performance after 19% growth in the first quarter. Software and Software Systems revenues were up 41% to $93 million driven primarily by faster implementations of our clinical and automation solutions. Service revenues were up 20% to $311 million, primarily due to increased professional services and maintenance revenue associated with all product lines.

Revenues from 81% of this quarter's bookings were deferred into future periods compared to 80% in the prior year second quarter. Gross profit margin in this segment was up 255 basis points to 47.2%. I mentioned last quarter, there is always some volatility in this gross profit margin number in this segment, but this quarter our stronger software and software systems sales helped drive the higher margin.

Provider Technologies operating expenses increased 26% in the quarter to $177 million. For the quarter, MPT had total gross R&D spending of $61.7 million, an increase of 15% from the prior year. Of this amount, we capitalized 20% compared to 24% a year ago.

Expenses also increased due to our continuing investments, the recent acquisitions of Relay Health and Health Com, and $4 million in FAS 123R expense. We will see continued expense increases in the second half of fiscal 2007 as we continue to invest in our R&D and sales force to take advantage of our position in this market.

Even after the step up in spending, which we are doing in light of our belief in the growth potential of this segment, our operating profit this quarter of $33 million was 27% above last year and produced an operating margin of 7.5%, which was 28 basis points above last year. Leaving our segment performance and turning briefly now to the balance sheet, on the working capital side, our receivables increased 4% to $6 billion versus $5.7 billion a year ago.

Our day sales outstanding were lower by one day, going from 22 to 21 days, reflecting our evolving customer mix and the termination of VOTN logistics agreement. Our inventories were $7.8 billion on September 30th, a 5% increase over last year consistent with our 5% sales increase. Our day sales and inventory of 33 was flat versus last year.

As we have talked about in previous calls, we've now reached an inventory level where DSI improvements will be slower and in smaller increments over time. Compared to a year ago, payables were up 5% to $10.4 billion. Our day sales in payables were flat year-over-year at 44 days.

Year-to-date, we generated $685 million in operating cash flow, well in-line with our previously announced annual expectation of generating over $1 billion of operating cash flow for the fiscal year. Year-to-date, capital spending was $51 million, lower than the $82 million a year ago, when we were investing to optimize our distribution center network.

Capitalized software expenditures were up to $86 million from $65 million a year ago, resulting primarily from our continued investment in our internal systems, as well as increased spending on software held for sale. We ended the quarter with $2.3billion of cash, up $115 million on the fiscal year end 2006 balance.

Consistent with our portfolio strategy for capital deployment, in the quarter we repurchased $372 million of shares, paid $18 million in dividends, and had $63 million of internal investments. We still have $345 million of share repurchase authorization left, having purchased $656 million year-to-date and $1.6 billion in the last six quarters. So overall, we had strong second quarter results, which put us on track to outperform our original guidance.

As a result, we are increasing our EPS guidance range for continuing operations, excluding adjustments to the securities litigation reserves to $2.65 to $2.75. Our guidance includes previously disclosed pretax charges of $26 million recorded in the first quarter related to an MPT restructuring and our investment in Perata Systems and also the roughly $5 million in expected future restructuring charges in our Medical-Surgical business.

Our guidance also includes our revised FAS 123R expense estimate, which our expenses will now be approximately $0.10 to $0.12 per diluted share for 2007, an increase of $0.02 per diluted share from our previous expectations. We continue to feel very optimistic about the future of our businesses and the segments in which we compete.

Thanks. Now I'll turn the call over to the operator for your questions.

Thank you. [OPERATOR INSTRUCTIONS]

Our first question comes from Tom Gallucci, and please state your company name.

Thanks, it's John Green on for Tom from Merrill Lynch. Nice quarter. I just wondering if you can give us my more color on the impact of generics on profitability in the quarter and then also bulk revenues were lower than they've been in a year sequentially. Aside from the one less selling day, can you tell us what impacted that? Thanks.

Thanks, John, for the question.

Our generic business continues to be very robust and it's a combination of really three factors. I think the first is clearly the market is available to us as more and more product goes generic and this was no exception in the quarter, and we expect more and more product to go generic as we look forward.

The second is, we are continuing to sign up more and more customers to our generic program and we talked about bringing the D&K independent customer base on to our generic programs in the quarter as well. And the third phenomenon really is our ability to continue to source our generic program very effectively, driving increased profitability from McKesson and a better deal for our customers and frankly better compliance to the program as a result of a better structure in the program.

So it's really a combination of all of those factors that are helping drive our performance there. On the warehouse side, I think the warehouse business really met our expectations in what we had planned for in the quarter. Jeff talked about the one less selling day and the affect that that had on our results.

We continue to see interest by our warehousing customers to move more and more of their purchases to our warehousing structure, but that kind of moves in fits and spurts depending on when customers want to make those transitions. And clearly for us to want to take on their direct business, it has to make good economic sense to us. It's not always that we're open to doing it unless we can get a nice return on the business that we service for those customers.

Thank you. Our next question comes from Ross Muken, please state your company name, sir.

Deutsche bank.

Hi, guys. You continually have put up very strong performance here in your Provider Technology business. How should I think about the sustainability of that growth rate going forward with respect to the core clinical and financial businesses, where we are there in terms of defending the turf versus looking for new deals outside of your existing base? And then could you talk about the market potential in some of these other areas like ambulatory EMR sort of the size and growth there and then the home health market, where you've really been a leader?

Thanks, Ross for the questions.

We have had exceptional growth in our business and we're very pleased with our results and our results today are being driven by decisions that were made three or four years ago to invest heavily in our clinical product lines, including both acquisitions as well as internal development. It's a true testament to our team's ability to not only build product internally but source product externally that fits with our customer's requirements and our needs going forward.

As you mentioned, our growth has primarily been driven thus far by clinical products, but as you know our financial products are a backbone of many of our current customers in the marketplace and we've been bolting on our clinical products on top of those financial customers. A couple of things that are happening right now, if I just talk about the hospital space. The first is our existing hospital customers are beginning to think about their requirements from a financial systems perspective and you heard us talk about the return of our revenue cycle management businesses and how we're beginning to see more and more interest in the revitalization of some of the financial systems that were purchased in some cases a decade or two decades ago by our customers.

As they begin to look for their next step of investment and technology as they finish their clinical implementations, we believe strongly they're going to move to the financial architectures that we're bringing to the market today and will be bringing to the market next year. We also, as you mentioned, have been building up our sales force to start calling on customers that are--that have not typically been McKesson customers. We're getting exceptional results out of that organization. We began building our sales force for the non-McKesson customers a couple of years ago.

Our products really have credibility and now we have great reference sites within our existing customer base and it's earned us the credibility to go to customers that frankly, don't know much about McKesson and earned the privilege to compete for that business and we're winning more than our fair share in the non-McKesson customer bas for the hospital segment.

You should have heard an additional theme and you touched on it that began really heavily last quarter, perhaps the quarter prior to that where I started talking about investing in the non-acute sector and becoming a health care information technology company, not a hospital information technology company. And that certainly has been led by products like our home care product where we've been a market leader for some time, but increasingly, we're investing in our ambulatory and consumer solutions to allow us to put together an end to end solution for health care information technology.

Now, this is both the clinical flow of information around health care, but also the financial flow of information around health care, and increasingly we're extremely well positioned and sought after by our customers to put together a complete package of products and services that allow this interconnectivity to take place. We see a great interest in the marketplace for the ambulatory or physician market to start making investments in this area and the ability for us to connect it together with the rest of the health care enterprise certainly including the pair side of the business sets us apart from the competition.

Jeff mentioned and it and I mentioned, you'll see us continue to invest and that should give you some confidence that we're not milking our IT technology businesses for the current performance, but we're actually investing for future years of performance as well.

Great, John. Thank you very much. Congrats on the good quarter.

Thank you, our next question comes from Ricky Goldwasser, please state your company name.

UBS.

Good afternoon and congratulations on the quarter. Some questions. First of all, on the Target contract, what's the term of the new contract and does it still include generics? And also, when we think about the benefit in the quarter from generic, is it right to look at it as you gaining some of the benefit early on in the generic cycle than you did in prior years, meaning that we're seeing faster conversion rates that priced during the (inaudible-heavy accent) probably came down a little bit more than what it would have been in the past? And finally, if you can just disclose in terms of your benefit from Plavix with how many additional quarters of Plavix do you have--of generic Plavix do you have in your inventory?

Well, there's a lot of questions there. Let me start with the Target contract. We've had the contract with Target for some time, as I mentioned in my comments.

We're delighted with the relationship there and it remains a multi-year relationship and we're very confident that we'll continue to perform exceptionally well under our new arrangement, which, by the way, does include--continue to include the use of generics. As we've talked about in the past, we're increasingly penetrating our larger customers from a generic perspective and our buying power continues to afford us the privilege of serving those customers while still making a nice return on the activity that we do there.

And to your point, we are gaining benefit early on in these transitions. The conversion rate that frankly's being driven by the exceptional ability of our retail customers to drive generic conversions at the store level is allowing us to benefit as well, and so I'd like to take some of the credit there.

We're doing a great job of supplying the stream of product that's required by our customers, but our customers including the PVMs are doing a terrific job of converting customers to generics and we're benefiting from that faster conversion rate. And as to your last question on Plavix, clearly we benefited in the quarter on Plavix, but you've heard us take up our expectations for the rest of the year.

So even without Plavix as we go forward, we're going to perform exceptionally well, I believe, and Plavix is just about through our supply stream here. I don't think you'll see much more Plavix sales from us the remainder of this quarter or into the new year. Next question, please.

Thank you. Our next question comes from Larry Marsh, and please state your company name.

Thanks, Larry Marsh at Lehman. Good afternoon.

Just wanted to echo kudos on the solid results. John, I don't know if you're in a position to comment about the ongoing Pall litigation on what you're a defendant. I know some of your filings suggested some of your concerns with the process that the plaintiffs have taken in coming up with a preliminary settlement without you. Are you in a position to comment at all at this point?

Larry, I appreciate the question and I know it's on people's minds. We have to limit our comments concerning the First Data Bank and the settlement. As you know we don't typically discuss active and ongoing lawsuits.

However, I do think that I can say that McKesson has done nothing wrong and we plan to vigorously defend the case as it relates to McKesson. And certainly if McKesson was the only drug wholesaler being surveyed at the time of the First Data Bank, which is the allegation in the lawsuit, by the way, that we were not aware of the fact and First Data Bank has in fact testified that they never told us that we were the only wholesaler involved.

We don't set AWP and we have nothing to do with their process other than in the past we've participated in their surveys. The action's in its early stages and the discovery is underway on the issue.

As you know, we disclosed it long before the settlement was ever discussed in the press or other discussions that took place and we're not even sure that the case should be certified as a class action. Certainly, McKesson doesn't believe it should be. First Data Bank has entered into a proposed settlement, that's what you're referring to, that calls for a reduction in First Data Bank's published average wholesale price for certain branded drugs.

I guess I should point out that McKesson, for those of you that don't know, is not a party to that settlement. And we don't think there'll be a settlement unless and until the trial court grants final approval and we believe that final approval will probably not be considered by the court for some time, and ;ole;u not before April of next year and we certainly are involved in the process of this class being set in the settlement.

Should the court approve the settlement, the proposed changes to First Data Bank's published AWPs will not have a direct impact on McKesson's business at all, and as we've not bought or sold under AWP, and as I mentioned we plan to continue to vigorously defend the claims that were brought against us.

Very complete commentary. It so sounds like you are among other things concerned about how the class is being certified. So thank you for that.

I guess a follow-up question to Ricky's on the customer renewal. I know you announced early last November to your renewal of your long standing Wal-Mart relationship that was going to be effective November 1st of '04. Do you have any sense of when you would anticipate resolution of that long standing contract?

As you know I've made a habit of not ever guessing what customers are going to do before they do them so I want to keep that tradition alive. We do a great job of servicing our customers and we do a great job of renewing our contracts with our customers as a result of that service and that relationship and as long as our pricing remains competitive and our service remains world class and our relationships remain strong and built on trust and integrity, I'm completely confident we'll continue to renew our relationships, but I really would like not to talk specifically about that one until it's done.

Okay. Very good. And very quickly and I'll get off. Jeff, did you give us an updated expectation of the full-year antitrust settlement benefit after the $10 million credit you got in this quarter?

Larry, I think what I said early in the year in response probably to a question from you is that the number would be down a lot from the prior year and I think we sort of settled on--or most people seem to have settled on a probably $15 to $20 million range for the year and that's probably still a good estimate for the year.

So we got about half of it this quarter. Okay. Very good. Thanks so much.

Thank you, our next question comes from Lisa Gill, and please state your company name.

Hi, good afternoon, it's [Arthur Verhemen] for Lisa. I just wanted to touch on the Provider Technology's business. Your gross profit improved nicely there, but your expenses are also up about 26% you mentioned. Could you provide any additional clarity on what drove the expense of this quarter and then on the ambulatory charge, I think you said nine go live there. What's the outlook there for the rest of the year?

I got the first question about expenses, the second question was around ambulatory?

The EHR--ambulatory EMR?

I can talk a little bit about both of those. The expenses, as we've talked about in the past are coming in a myriad of different areas. Clearly R&D expenses up for us in the segment as we continue to invest in our product portfolios.

We've been investing in sales and marketing resources to focus on the--particularly the non-McKesson customers. We made two acquisitions in the prior quarter that we're beginning to see the near term--short-term, I should say, negative benefit on, and that's the Relay Health and Health Com acquisitions, both of which were going to be a bit of a drag on us early on in their assimilation into our company, and certainly I don't want to forget to mention that FAS 123R hits this is segment in particular harder than its revenues and profits would normally indicate on a pro rata basis on our company because they're such a large professional white collar work force that's involved in those equity plans inside of MPT.

So investment in R&D and products, investment in sales force and marketing activities, Relay Health and Health Com, and FAS 123R and we've been afforded to make these investments and still have such stellar performance. I'm delighted about that.

On the ambulatory EHR, or EMR or PHR product lines, you can use all of those acronyms and they mean different things to different people. We really are focused on investing in those platforms and the connectivity that's afforded to us between not just the physicians and their patients, but the physicians and other physicians and the physicians and the acute providers and clearly the physicians and the payers.

I think we really do stand singular in our ability to bring world class products to all of those constituents and to have a 360 degree view on how information flows between all of these various constituents, both clinical information as well as financial information. Health Com clearly was a financial information acquisition for us. It helps in the payment cycle and Relay Health is a clinical connection system primarily that allows Evisits for patients that are reimbursed by many payers and allows for Eprescribing and lots of other tools to build out our EHR capability. I think you'll see us continue to make intelligent investments there, not the least of which is in the ambulatory space.

Thanks just digging deeper into that. Your plans for the rest of the year in terms of go-live, any way you could elaborate on that?

I'm sorry, I couldn't quite hear you, did you say in terms of go-live?

Correct.

The biggest scale go-live we have going on right now is a large development project with Duke University for the physicians that are servicing that facility both owned and non-owned physicians in the Duke marketplace. That's an important go-live for us as we continue to refine that new version of our Horizon ambulatory product line.

I think that's an important milestone for us as well as many other smaller implementations. We'll keep you up to date in our future conference calls about our progress in ambulatory.

That's great, thank you.

You're welcome.

Thank you. Our next question comes from Andy Speller, and please state your company name.

Hi, It's A.G. Edwards.

Good afternoon. Just a question with regard to the comment that was made with regard to hitting the low end of the operating margin range within Pharmaceutical Solutions. Is that more of an issue with regard to mix meaning you had the lower margin business exiting, or should I look at it more as you're seeing an increase in generics and with a stable sell and buy market?

I think the way I'd think about it is we've made tremendous progress on operating margin in the Pharmaceutical Solutions segment over the last couple of years. If you take a little bit of the noise out from some of the positive antitrust settlements that we've had over the past two years as well as this year, what you see is that we had a--well over a 15 basis point increase last year in our operating margin in that segment and when you do that same comparison to where we're now guiding you for fiscal '07, you're going to see that same kind of increase.

That kind of improvement in the operating margin comes from using every one of the four key levers we have in that business. We've got a stable sell side, we've got great agreements now with the branded manufacturers that are working really well for us. We're back to getting operating expense leverage and of course generics are great for our businesses, both John and I talked about. But the key is to really to making continued progress into our range is using every one of those four levers in the business and we think we've got a pretty good track record of doing it over the last few years.

You'll see us continue to add more value-added solutions to our portfolio and we don't always define what those things are and how they work and how we get paid for them, but the operating margin on a typical Health Mart customer clearly is more profitable than a non-Health Mart customer, and those stores are more profitable, and that's really what we're trying to do is add technology and solutions, whether they're IT solutions or automation solutions that can help these store owners better manage thir stores, leverage the scale of a company like McKesson and do a better job for themselves and for their patients.

The expansion from 300 stores to 800 stores since July is really a remarkable accomplishment. We see that continuing to grow. We're doing lots of things in the Pharmaceutical business to continue to drive margin expansion and they're really focused on finding value out of our existing customer base [technical difficulty].

Okay, thank you.

Thank you, our next question comes from Steve Halper and please state your company name.

Sure, Thomas Weisel Partners. My question is focused on the provider technologies and the operating profit. Where do you think about the long-term target for operating profit margin. We've kind of bounced around in that high single digit range for quite some time. Is it possible to get into that 10, 12, even 15% target longer term? And what are the leverage points?

Clearly, I believe that the low teens, the 10 to 12 kind of range is doable and something that we should focus on trying to accomplish. I think that one of the things that we have been focusing on as well, though, is the ability to continue to grow our revenue at or above market rates and sometimes those investments on the near term are a bit of a takeaway from our margin objectives.

So I think it's a balancing act. We want to continue to grow at or above margin rates in that business and we want to drive margin improvement. We have to make sure that we're manage the mix appropriately and sometimes we'll take a piece of services business that brings the margin rate down as comparison to a software sale, but it still makes great sense to our companies.

So I don't think we've done anything to change our guidance or our expectations around margin levels in the technology business and in fact, if anything, we probably feel even more strongly about them today than we did in the past, but there's always a near-term investment decisions that we have the responsibility to make appropriately.

Great, thanks.

Thank you, our next question comes from George Hill, and please state your company tame.

Yes, from Leerink Swann. I also want to talk about the Provider Technology segment, and you'd briefly touched on the impact of the relaxation of the stark laws and can you quantify what you think the market opportunity is for McKesson due to that?

Clearly the stark law relaxation is extremely beneficial to us, particularly given our extensive footprint in the hospital marketplace. Through a perhaps a more realistic view on how the hospitals can use their technology investments to benefit the physicians that are trying to invest in these technologies, I think will give us a competitive advantage and allow the hospitals to extend their footprint into the marketplace to help physicians onboard to technology more rapidly than they might otherwise have done. We're extremely bullish about any relaxation in stark and we think it plays particularly well to our hospital out strategy using our existing base of customers.

Any chance you could potentially frame it up with some numbers?

I think we've given expectations on an aggregate level for MPT and talked about it and we expect our momentum to continue to grow there. What you should be seeing in the last quarter and this quarter is additional commentary regarding the ambulatory investments in what we're trying to accomplish. I'm feeling very good about that.

Okay, thank you.

Thank you. At this time we have no further questions. I would like to turn it back over to Mr. Larry Kurtz for closing comments.

Great, before I hand it over to Larry, I want to thank you, operator, and I want to say that McKesson is exceptionally well positioned in attractive markets. We continue to refine our strategy to ensure that we're not only in the right businesses for today but also for tomorrow.

We're focused on outstanding execution to drive superior operating performance. We're focused on creating additional shareholder value through strong operating performance combined with a balanced, disciplined use of capital, including targeted acquisitions, investments to drive growth and profit, and margin expansion, share repurchases and dividends.

Our great first half results give us strong positive momentum for the remainder of the year and I want to thank you for your time today. Now I'll turn the call back over to Larry for his quarterly review of upcoming events for the financial community. Larry?

Thanks, John. On November 15th, we will present at the CSFB Health Care conference in Phoenix. On the morning of November 27th, we'll hose our third booth side briefing at the RSNA meeting in Chicago. It will be a great opportunity if you want to know more about some of our medical imaging solutions that are driving that business so well.

On November 28th, we're going to present at the Merrill Lynch Health Care Services conference in New York. On the afternoon of December 6th, we'll host our annual booth side briefing at the ASHP show in Anaheim where you get see a lot of our solutions for the hospitals come together.

We'll present at the JPMorgan Health Care conference here in San Francisco in early January and we plan to release our third quarter financial results and hold our call after the close of market on Thursday, January 25th.

So thank you until we see each other at one or more of these events, good-bye. Happy trick or treating. Be careful out there.

Thank you. This does conclude today's conference call. We thank you for your participation.