麥卡遜 (MCK) 2007 Q3 法說會逐字稿

Good afternoon and welcome to McKesson Corporation fiscal 2007 third quarter conference call. [OPERATOR INSTRUCTIONS] I would like to introduce Larry Kurtz, Vice President Investor Relations. Sir you may begin.

Thank you, Ed. Welcome to the McKesson fiscal 2007 third 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 opening comments and will then introduce Jeff, who will review the financial results for the quarter in more detail. After Jeff's comments we'll open the call for your questions. Time permitting we'll address all questions.

We plan to end the call promptly after one hour at 6:00PM eastern time. During the course of this call, we will make forward-looking comments. Please see our press release for a full discussion with the risk factors associated with those comments. Thanks and here's John.

Thanks, Larry and thanks to everyone for joining us on our call. McKesson reported great results today with earnings per share from continuing operations of $0.79, up 23% from a year ago. Our earnings momentum was led by another excellent performance in pharmaceutical solutions which was supported by continued solid results in our other two segments. The fundamentals that have driven our business the past several years remain very positive. Based on that we are again raising our annual guidance.

For the full fiscal year we now expect to earn between $2.75 and $2.85 for a fully diluted share from continuing operations excluding certain charges and adjustments.

Turning to the segments, our results in pharmaceutical solutions were simply outstanding. Our U.S. pharmaceutical distribution business which has always been a good business, is better than ever. Our U.S. healthcare direct revenues were impacted by the termination of our low margin logistics contract with Oncology Therapeutics Network which in the third quarter a year ago had revenues of approximately $800 million. OTN is just one example of our discipline around operative margin. Direct revenues were up 9% if you adjust for the loss of OTN.

The demand for drugs continues to grow. The Medicare Part D drug benefit has increased access by seniors to life-saving drugs. We believe that as our population ages and as the value of drugs continues to be demonstrated, their use will continue to expand. At the same time, market revenue growth is being deflated by the significant number of major branded drugs losing patent protection.

The revenue trade-off is very positive because of the benefits the generic drugs deliver across the supply chain. They reduce costs for patients and pairs and as a result are more accessible for patients in need of therapy.

The new generic drug reimbursement structure for Medicaid patients is an important affirmation by congress and CMS that incentives must remain in place to drive increasing use of generics. The generic discount program begun by our customer Wal-Mart stores received tremendous media coverage and we believe that it has expanded the market for generic usage.

But the real story in our pharmaceutical solutions segment is operating margin expansion. Our team continues to focus on the goal of steadily expanding our margin.

This quarter, pharmaceutical solutions operating margin of 153 basis points was up 10 basis points from a year ago, and represents an increase of 27 basis points when you adjust for a $37 million pre-tax gain from an antitrust settlement in the third quarter a year ago. A significant margin expansion continues to be driven by the team's outstanding execution on four key factors that determine profitability in the pharmaceutical distribution.

First, we are seeing the benefits of our stronger relationships with branded drug manufacturers, which improve our visibility to compensation for the services we provide to them. We focus on efficient and safe distribution that is core to our relationships with manufacturers, has enabled us to streamline our working capital and produces a solid cash flow from the business.

Second, we continue to focus on cost controls and efficiency programs across the business. Expanded and enhanced information systems along with our longstanding application of six-segment methodology to improve our processes are driving down our operating expense ratio while increasing our quality of service. McKesson was the first pharmaceutical distributer to fully automate our warehouses and distribution networks with radio frequency and bar code scanning technology and we continue to be a leader in new technologies to further automate and secure the pharmaceutical supply chain.

Third, we continue to bring our customers new products and services designed to improve their operations and profitability.

I spoke last quarter about some of these products and services such as our generic sourcing, our Health Mart franchise and our pharmacy information systems. 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.

Sales of our proprietary One Stop generics programs for retail pharmacies increased 68% in the third quarter, compared to the third quarter a year ago. Our Health Mart franchise program also continues to grow. Since July 1st, our Health Mart franchise count increased from 350 stores to more than 1,000 stores, extending its reach as the largest independent domestic pharmacy franchise network.

The Per-Se acquisition, which we expect to close tomorrow, further enhances our broad offering to retail pharmacy in several important ways. Per-Se offers pharmacy management systems the streamlined and connect pharmacy operations. The systems complement our existing offering from the McKesson pharmacy systems business.

Per-Se also adds to McKesson the nation's largest electronic pharmacy network connecting approximately 90% of the U.S. retail pharmacies and processing nearly 70% of pharmacy claims.

The fourth factor determining pharmaceutical distribution profitability is our relationships with customers. Our industry leading quality of service and the value of our expanding offering for pharmacy have strengthened relationships across our customer base. While competitive pressure provides checks and balances in customer relationships our sale margin to customers remains relatively stable.

During the quarter we also renewed our relationship with Wal-Mart, a prime vendor customer with us since 1988. We are confident with the positive fundamentals are driving our business and continuing to outstanding execution we should continue to make progress toward our goal of an annual operating margin rate of 150 to 200 basis points for the pharmaceutical solutions segment. We expect to reach the low end of the range this fiscal year.

In medical surgical solutions we are executing well. First, we are growing revenues across the business, demonstrating the value of our decision to focus on the higher gross sectors of the medical surgical market. For the quarter, revenues were up 16% driven by strong growth across physician offices, clinics, surgery centers, nursing homes and home healthcare. Our gross profit margin was up from a year ago indicating that we are growing through a superior value proposition to our customers.

Second we are on schedule with our transition out of the acute care business that we sold to Owens & Miner in September. The transition is proceeding smoothly.

We ended the quarter nearly halfway complete with the transition of the business and we expect to be done about the end of our fiscal year.

I am pleased with our progress and I look forward to having our team focus 100% on our ongoing business, which includes as a first key step the right sizing of our infrastructure, which when complete should enable to drive future operating margin expansion. Our goal continues to be an operative margin rate of 4% to 6% for this business.

Turning to provider technologies, we showed solid revenue and profit growth considering the very strong third quarter we had a year ago and we continued to make investments designed to drive future growth. Our revenue growth of 12% reflects the demand for clinical solutions that address critical needs for improved health outcomes and healthcare cost efficiencies.

We continued to focus on accelerated implementations to deliver return on investment for our customers. Software systems revenue growth was just 1%, but that reflects the combination of a tough comparison to a very strong third quarter a year ago, and a much higher deferral rate on new bookings this year compared to last. Operating profit grew more slowly due to our continued investments in new products, sales force expansion and new market initiatives, all of which are designed to enhance our position and drive future growth. We continue to gain share in the digital medical imaging market where both our Horizon Medical Imaging and our Horizon Cardiology products are doing very well in terms of sales and implementations.

In the large hospital market we are seeing increasing demand for replacement packs solutions that include current technology and integrate well with other clinical solutions. Our new agreement with Toshiba has taken us into small hospital and imaging center markets, where our combined solution with easy installation has great appeal. Our revenue growth in digital medical imaging shows no sign of flattening.

We continue to apply our One McKesson strategy to sell additional products and services and strengthening customer relationships. In the quarter, Eisenhower Medical Center of Rancho Mirage, California, already a McKesson customer for pharmaceutical distribution and automation products, signed a $14.8 million contract to purchase Horizon Clinicals and consulting and process redesign services.

We are gaining momentum in physician offices, an area where we have targeted for growth.

Sales of our Horizon Ambulatory Care Electronic Health Record Solution tripled in the quarter compared to a year ago. Our strategy to build out from the hospital combined with new changes under the stark anti-kickback laws is clearly stimulating interest in sales. Shortly after the quarter ended Atlanta Health Systems, a large health system in New Jersey which is also a One McKesson customer, signed to an agreement to purchase Horizon Ambulatory Care for its base of employed and affiliated physicians.

Our R&D investments remain at a high level. Our commit to product innovation and best practice implementation and support continues to pay off in customer satisfaction and endorsement of our solutions. We use the class rankings as a best metric for how our products are viewed by the market and we continued to do very well.

In the 2006 Top 20 year-end Best in Class Awards report, issued in December by Class Enterprises, nine McKesson solutions ranked either best in class or solution category leaders. Overall a total of 17 McKesson solutions ranked in the top three, more than any other company.

McKesson made a particularly strong showing in the community health information systems category, where Horizon Medical Imaging and the Paragon Hospital Information System both received best in class awards in the community clinical ancillary solutions category and the community HIS category respectively.

We are looking forward to the scheduled completion tomorrow of our Per-Se Technologies acquisition. I described how Per-Se compliments our offering and pharmaceutical distribution. Referring to hospital information technology, Per-Se enables McKesson to further strengthen our leading division with expanded transaction services and tools to improve cash flow and business office productivity. Per-Se also enhances McKesson's resource management solutions with a large customer base and software to facilitate staff scheduling. In physician offices, where we continue to aggressively expand our capabilities, Per-Se is a leader in providing practice management software to the small office physician market.

Per-Se also provides business management outsourcing services to hospital-affiliated and academic physician group practices. As a result McKesson is uniquely able to support physician offices of all sizes with a comprehensive solution that includes an electronic health record, practice management software, pair connectivity and physician-patient communications. In addition McKesson provides medical surgical supplies and specialty pharmaceutical services to this large market segment.

The Per-Se acquisition is consistent with our disciplined portfolio approach to capital deployment, using the strength of our balance sheet to create shareholder value through a variety of strategies.

In the third quarter we repurchased about $100 million of stock leaving approximately $250 million remaining on our existing share repurchase authorization. Over the past seven quarters cumulative share repurchases have exceeded $1.7 billion dollars. We ended the quarter with a gross debt to capital ratio of just 14%.

Our strong balance sheet and solid cash flow will enable us to easily finance the Per-Se acquisition. Strategically McKesson is exceptionally well-positioned in attractive markets and operationally we are executing very well. We have great relationships with our customers based on the value that we provide. Acquisitions such as Per-Se will continue to expand our customer base and strengthen our product offerings and relationships. And drive further shareholder value creation.

We have had great year-to-date results and have momentum going into the fourth quarter. Our pharmaceutical solutions segment continues to outperform and produce terrific results. I'm confident that our medical solutions team is on track with their plan to grow the business in the most attractive sectors of the market, and in provider technology demand remains strong for our solutions within our historical customer base and we believe we are now well-positioned outside of our base in the rapidly growing markets such as physician offices and consumer technologies.

Great execution, positive indicators and tremendous enthusiasm for the future across the company. I look forward to reporting to you on our performance. With that, I will turn the call over to Jeff for an in-depth review of our financial results and look forward to addressing your questions when he finishes. Jeff.

Thank you, John. And good afternoon, everyone. McKesson had another solid quarter. Building on the momentum of the first half of fiscal 2007.

We are encouraged by our financial results and continue to invest in our businesses to create long-term value for our shareholders. Let me begin by reviewing our consolidated income statement. We had revenue growth in the quarter of 4% to $23.1billion. The 4% stems from our pharmaceutical solutions segment growing in the market once you back out the termination of our relationship with OTN and our medical and surgical provider technologies growing above the market at 16%, 12% revenue growth respectively.

Overall gross profit for the quarter was up 9%, $1.1billion, and all three segments contributing to the increase. Our margin expansion was even more impressive considering the gross profit in the third quarter a year ago. We had a $37 million pre-tax gain from an antitrust settlement pharmaceutical solutions segment.

Moving below the gross profit line our total operating expenses were up 12% to $743 million for the quarter. Operating expenses in our pharmaceutical solutions segment showed great leverage. They were 1% lower than last year and gained efficiencies from our operations.

Operating expenses in medical surgical increased 27% and in provider technologies increased 17%. I'll provide more specifics on these when I discuss each segment in more detail.

Corporate expenses in the quarter were up 48% from last year to $71 million putting additional FAS 123R charges quarter-to-quarter. To comment a bit more broadly on our FAS 123R charges, I would remind you that our guidance for the year includes an overall FAS 123R expense which will be about $0.10 to $0.12 per diluted share, which we allocate across our business segments.

As I have mentioned in previous calls in prior years we accelerated some of our underwater stock options. As a result given the steady compensation we provide to our key employees our equity-based compensation expense will build over a period of three to four years before we reach steady stage due to the multi-year investing provision in the programs. Our estimate today is that when we reach steady state in fiscal 2010, our expense should be about $0.20 to $0.25 annually.

Turning back now, as I walk down the P&L, operating income, $318 million in the quarter was 3% above last year. Excluding the favorable $37 million anti-trust settlement gain over the prior year it was up 17%. Driven by the outstanding pharmaceutical solutions.

Below operating income our interest expense of $23 million and other income $39 million were little changed from a year ago.

Moving to taxes, our third quarter provision for income taxes reflects a reduction in the company's full-year expected tax rate of either 35% or 34%. The third quarter also included one-time positive tax adjustments totaling $14 million.

On a GAAP basis this quarter we had net income of $243 million, or $0.80 per diluted share compared to $193 million, or $0.61 per diluted share a year ago. The GAAP EPS result this quarter includes $0.01 of earnings from discontinued operations compared to a $0.03 loss a year ago.

In the quarter we had $240 million of income from continuing operations, 18% above last year and diluted earnings per share of $0.79 from continuing operations from continuing operations, $0.23% above last year. This was certainly another great quarter for us.

Throughout the consolidated results in the quarter our diluted EPS calculation was based on 302 net and weighted average diluted -- compared to 316 million in the prior year.

The number of shares used in this calculation declined, primarily due to the cumulative impact of our share repurchases, including $98 million of stock repurchased in the third quarter, brought our total share repurchase for the fiscal year to $756 million the past seven quarters within $1.7 million.

Let's now move on to our three segments. Pharmaceutical solutions for the quarter we achieved revenue growth of 3%. U.S. healthcare direct distributions and services revenue grew 2% and we were up 9% adjusting for the previously disclosed termination of our low margin agreement with Oncology Therapeutics Network. Warehouse revenues increased 5% from a year ago.

Our Canadian business continued to perform well, growing revenues at 10%, including a favorable currency impact of 3%. Our sales mix for the quarter was 29% institutional, 23% retail chains, 13% independent, 35% warehouse. That breakdown a year ago was 31% institutional, 22% retail chains, 13% independent, 34% warehouse.

Gross profit for the segment was up 5% to $671 million for the quarter and the GAAP and up 11% excluding from the prior year the $37 million pre-tax antitrust settlement gain. This is just an outstanding performance.

Turning to LIFO, this quarter we had a LIFO credit of $18 million versus a LIFO credit of $10 million in the prior year. With the strong deflationary trends in generics this year it is possible that we will deplete our remaining LIFO reserves that relate to the pharmaceutical products sometime in our fiscal 2008.

Key drivers to our outstanding gross profits results in the quarter were once again relatively stable sale margins, our agreements with branded manufacturers and increased generic sales. Our pharmaceutical solutions operating expenses were down 1% for the quarter to $343 million, lower operating expenses are due to diligent expense management. The effective operating efficiency programs across business.

Operating margin for the quarter was 153 basis points compared to 143 basis points for the prior year. Our operating margin in the quarter was up 27 points excluding the favorable antitrust settlement from our prior year's results.

These results reflect great execution on all four levers available to us in this segment: brand manufacturer compensation, operating expense leverage, value-added programs, such as generics, and sale margin to customers. I continue to be very positive on the outlook for this segment and its potential for a great return in our invested capital.

Turning to medical surgical solutions. As John mentioned we are on track to transition our acute care business to Owens & Miner and to right side our continuing business. Medical surgical revenues were up 16% for the quarter to $632 million once again reflecting solid growth across all customer sets. Higher sales of flu vaccines from a year ago levels also helped to drive revenue growth in the quarter, as McKesson had access to new sources of flu vaccine supply compared to a year ago when our supply was somewhat strained.

Gross profits of $174 million in the quarter was 22% above last year, providing great leverage on the 16% revenue program. We had growth margin expansion despite our increased flu vaccine sales, which while great business for us do have gross margins that are lower than the margins of our other medical surgical products. Operating expenses in the quarter were $150 million. 27% above last year.

We have yet to right size the operating infrastructure as the transition of our acute care business to Owens & Miner was just beginning in the December quarter. We are focused on providing seamless service to our and Owens & Miner customers and will aggressively address our infrastructure costs once we are fully through the transition.

We also had a $5 million vendor credit in our operating results last year, which partially explains the increase from a year ago. You may recall in our call last quarter we discussed incurring restructuring expenses in this segment in the second half of this fiscal year. At this point we believe that we will not incur any restructuring expense until the first quarter of fiscal 2008 at which point we expect to have fully transitioned our acute care business to Owens & Miner.

Operating profit in this segment of $25 million, down $1 million from the prior year, but up nicely excluding the $5 million vendor credit we had in our results last year. In provider technologies our revenues were up 12% for the quarter to $451 million. [Inaudible] revenues were up 20% to $322 million, due to increase in the patients.

Software and software systems revenues were up just 1% to $91 million, as we deferred more of our bookings in this quarter overlapping a very strong fiscal 2006 third quarter. To be specific, revenues from 83% of this quarter's bookings were deferred into future periods compared to 70% the prior year third quarter. Our software bookings were up strongly versus the prior year. Gross profits increased 14% in this segment providing a gross margin of 47.9% up 76 basis points from the prior year.

Provider technologies expenses increased 17% in the quarter to $179 million. The largest single driver of this increase was our continuing focus on a stepped up R&D effort. The quarter, MPT had total gross R&D spending of $67.4 million, an increase of 22% in the prior year. Of this amount, we capitalized just 21% this year, compared to 25% a year ago.

Expenses were also driven by the acquisitions completed earlier in the year, continued investments and new products, sales force expansion, new market initiatives, all of which are designed to enhance our position and drive future growth. In addition expenses increased $2 to $3 million in 123R expenses allocated to this segment.

Operating profits of $40 million was 5% above last year, lower than our revenue growth due to our investment in this segment which we believe has great long-term potential.

Now turning briefly to the balance sheet. On the working capital size our receivables increased 3% to $6.4 billion versus $6.3 billion a year ago. Our daily sales outstanding were lower by one day going from 23 to 22 days. Our inventories were $8.6 million on December 31, a 7% increase over last year. Our day sales inventory of 35 was one day above last year. Our inventory levels and DSI are impacted in normal seasonal trends. Compared to a year ago our payables were up 9% to $10.9 billion, consistent with the increase in our inventory. Our day sales payables were 44 days or one day higher than last year.

Year to date we generated $550 million in operating cash flow. As you already know, we consumed cash in our third quarter and built inventories for seasonal use. Year to date capital spending was $76 million. Lower than the $138 million we had spent a year ago. And we were investing to optimize our distribution center network.

Capitalized software expenditures were $119 million this year. Similar to the $127 million we spent a year ago. We ended the quarter with $2 billion in cash. Down $126 million from the fiscal year end of 2006 balance.

Consistent with our portfolio strategy for capital employment year to date, we have repurchased $756 million of shares, $54 million in dividends, invested $195 million internally and made $106 million of acquisitions while also generating $175 million in proceeds. We still have approximately $250 million of share repurchase authorization left. Our gross debt-to-capital ratio was 14%. This will increase in the March quarter and as we intend to partially finance our purchase of Per-Se Technologies with the debt. Still, overall we have had three strong quarterly results and are increasing our guidance range from $2.75 to $2.85.

Main operations, excluding adjustments to the securities litigation reserves and charges and certain purchase accounting adjustments associated with the completion of our acquisition of Per-Se Technologies.

Our guidance includes the financial impact of financing the Per-Se acquisition, as well as delusion of the inclusion of the Per-Se operating results the two months of February and March.

Our guidance excludes charges associated with Per-Se, which will include an in-process R&D write-off arising from our purchase accounting for the acquisition as well as certain acquisition and restructuring expenses.

Our guidance also excludes our expectations in purchase accounting adjustments will result in a reduction in recognizable incurred revenues and operating profit in our fourth quarter and for our full fiscal year 2008. When we have finalized these adjustments, we will provide you with the impact on operating profits.

So in summary, we feel great about our financial results year to date and pleased to be raising our fiscal guidance for 2007. We remain optimistic about the great growth potential of our healthcare services industry. Thank you and with that I'll turn the call over to the operator for your questions.

Thank you, sir. [OPERATOR INSTRUCTIONS]

First question comes from Lisa Gill your line is open. State your affiliation please.

Hi, actually is Atif filling in for Lisa. I was wondering if you could talk about the software growth this quarter. The software revenues are up just 1%. I think you mentioned that was because a majority of revenues were deferred. Could you talk about what the time line might be that you might be able to recognize these revenues? And secondly for the provider technology segment too, are there any big international opportunities that you might be working on at this moment?

Sure. Thanks for the questions. I -- On the software recognition, as we have talked about in the past, the software in particular can be kind of lumpy as it comes through our business. It is recognized as we implement the products and from time to time we sell products that we actually incur more deferral on because of the nature of our estimates around the implementations. So as we talked about in the release and in the call, the deferral rates are up in this quarter and that impacted our growth rates.

Yes, I would say the product implementations in our product lines go anywhere from you know within weeks to in excess of a year. And clearly the products that we have sold this quarter had a heavier base on the longer implementation cycles and that is why the revenues were deferred.

As to the second question around international, we have a large presence in international right now from a technology perspective, primarily in the UK and France and the Netherlands, and we continue to feel very strongly about our performance in those markets. And frankly have a very good and optimistic view on where we are headed. We continue to make investments around the globe in all of our business and we look for opportunities to invest both internal and through external acquisitions when it makes sense.

Alright. That's good. Thank you.

Our next question comes from George Hill. Your line is open. State your affiliation please.

Yes. Leerink Swann. I'm going to kind of follow-up on Atif's question. And I'm wondering, Jeff could you maybe put some color up or frame up with some numbers around what bookings growth was in the quarter in the software and systems segment, and maybe dig deep a little deeper and give us some color in what the growth in imaging software sales was year over year?

Well, George we don't disclose specific software bookings numbers. The comment I made about our growth this quarter, I think was important to understand that we continue to feel good about the growth in demand for our products, particularly the clinical and imagining products as you point out, even though the revenue growth was fairly flat this year, because of some of the deferral issues that I mentioned in my remarks John just mentioned.

So we remain very upbeat about the growth potential. The deferral rates will always jump up and down a little bit quarter to quarter just because the mix of the kinds of products we sell varies from quarter to quarter, and as John explained, you get different mixes in terms of how long the installation periods will be across the products.

Maybe then you could just provide a little more color then on what you are seeing in the hospital replacement cycle market for packs, maybe just what you guys are seeing as the macrogrowth rate and if you guys are taking, sure, we can infer you guys are doing better than that?

I think you should infer from this conversation we are very bullish on our medical imaging business and not only are we growing rapidly in the large hospital largely, which to your point larger now a replacement cycle, where we are beating out the incumbent stand alone vendors in hospital packs and replacing them with our new packs systems that are obviously newer technology, but as important more integratable and ingrated to our clinical systems. So I think we have a significant advantage and tremendous momentum in the replacement market.

As you also heard on the call, and George we are expanding rapidly now into the smaller hospital segment. The strength of the Paragon product line and the ability for us to scale down our medical imaging technology to fit with Paragon allows us to do a one-two punch in that category. It really -- there is no other single vendor that can install the clinical systems, the HIS systems and the medical imaging systems in the small hospital market as cost-effectively as we can and with as quick an implementation time line.

So we are delighted with the progress we have made in that segment and for those of you who have followed our company for some time you realize that the recovery of Paragon puts a real viable competitor in the marketplace for small hospitals, and I believe McKesson is rapidly gaining share in the small hospital segment which is largely underpenetrated in clinical, as well as packs system.

It also struck last quarter, I believe we announced it, the deal with Toshiba and that allows us to get into the medical imaging center business, where Toshiba has a great product line from a technology perspective and from the equipment perspective and married and coupled with our software technology allows both of us to advance our position in that marketplace and win more than our fair share.

So I know there have been some players in this market that have talked about a flattening in their revenues. I would suggest to you it is McKesson flattening their revenues not the market going away.

Okay. Thank you.

Our next question comes from Larry Marsh. Your line is open. State your affiliation.

Thank you. Lehman Brothers. Just a clarification if I could and then a question. The clarification. Jeff, are you commenting at all of what sort of delusion you are anticipating seeing from Per-Se in the two months you are going to have it this fiscal year, which is incorporated obviously in your fiscal '07 guidance? And if not, are you going to be giving us that breakdown here tomorrow, I guess, after it closes?

Well, Larry, as you will recall, at the time of the Per-Se acquisition, we made the comment that excluding the various acquisition-related charges, we would expect in the first year the Per-Se acquisition to be neutral to marginally diluted. In the March quarter you'll have two months of results in there. That will be rounding in terms of earnings. And guidance ratings that we have given you includes what we expect to happen in terms of the operating results for Per-Se for the March quarter.

Okay. All right. So not really? And just along with that, have you guys determined exactly how you're going to be reporting the results from Per-Se and how that would coincide with how you'd break up your current business into three categories of software, hardware and services? I mean are you going to break it up, or is there going to be just a line item that's Per-Se?

That is a good question. The majority of Per-Se will roll into the MPT segment. There will be a small piece related to the retail pharmacy systems business that will go into pharmaceutical solutions. You know it will obviously just kind of be rounding to that particular segment. So in terms of modeling purposes you're fairly safe in assuming really of putting for now all of it if you wanted to into the MPT segment.

I think, Larry, as it relates to the three categories, we will attempt to break Per-Se into the service piece of it and the software piece of it, and so that's where those basically almost all of their revenue will go.

Okay. And then one, I guess broad question. You are breaking on generics this quarter you are giving us a specific growth rate of sub 68%, which is the first time I have seen such specificity. Operate about that and what we should infer from that, besides the fact you are doing very well there and are we going to get any more details going forward from your specific book of business in generics?

Well, Larry, we are really proud of our momentum in generics and that momentum has been consistent and strong for the last several years and we have talked in the past about our growth rate in generics as a percentage. We have never really talked about the specific numbers. And the reason we talk about even the percentage is to highlight for investors the importance of generics and the fact that McKesson is growing faster in generics than the generics market overall, particularly in our most important and proprietary programs where where we drive the best value for our customers and the best margin for the company.

So I'm really pleased with what we continue to do in that area. We continue to innovate, both in our ability to source, but also in our ability to bring it to the market and get compliance around it. You might also recall I think it was three years ago, we began investing heavily in IT in the pharmaceutical business and that was really tool sets that would give us visibility to compliance around the pharmaceutical business. And one of the key factors that helps drive margin expansion in our business is getting people to buy all of their generics from us and to stay compliant with those generic spends. So it's a -- it really is a number that reflects the proprietary generics programs not all of our generics sales it is difficult to correlate it to anything.

Okay and finally just a clarification on the LIFO. I guess, Jeff, what you are saying is you are going to move through the entire reserve by the end of this quarter so you might anticipate seeing one more LIFO credit, but then for fiscal '08 you are assuming we should I know you hate giving guidance, yet but we just assume that you know, there won't be any particular LIFO credit to speak of?

Well, Larry, as you know the accounting around LIFO is difficult at times to estimate in advance. And the way I would think about it is last fiscal '06 you saw it pick $32 million the LIFO credit?

Yes.

Year to date in '07 we have taken $38 million. So, just because the way the accounting works you should assume that means that our current estimate is that we'll probably take 50 or so for the year, although that could vary a lot depending on what happens in the next 60 days. So, depending on what happens in the next 60 days I do think we are likely to deplete the LIFO credit completely sometime in fiscal '08, but in all likelihood there will be some '08 credit but significantly less than the '07 one.

Okay. Thank you.

Our next question comes from Bob Willoughby. Your line is open. State your affiliation, please.

Banc of America Securities. Jeff, have you given any guidance in terms of paying for Per-Se the split between debt and cash on hand?

The comment I have made, Bob, is that you should expect us to partially finance the billion aid. I think that probably means that we will issue somewhere in the vicinity of $1 billion of debt initially in some kind of bridge facility, and then probably in the next month or so, termed out into longer-term debt. Okay, and is there any DNA guidance for Per-Se? No. Not yet. And clearly the final number particularly intangibles amortization we will continue to work on and so we'll have that finally nailed down as we report our March quarter results. But not much before that.

Okay. Great. Thank you.

Next question will come from Eric Coldwell. Your line is open. State your affiliation, please.

Thanks very much. First off, just wanting to get some detail around the impact on the OMI transition fees in medical surgical. How is that impacting your model, where does that show up, how should we think of that in the March quarter as well?

Well, remember all of the remaining bits of the acute care business and the transition to [inaudible] in the discontinued operations line, Eric.

Including the transition fees, Jeff?

Yes.

Following very strong growth in the MSS stagnant, again beating our targets this quarter. I think Sterling annualizes next quarter, if I'm not mistaken, what was the impact of Sterling on the growth rate there? Was it just a couple of percent or was it a little higher?

Just a couple of percent.

Okay. Great. Final question and I'll bail out. One of your competitors has pulled out of the flu market for next year citing their belief the flu market is going to have a 50 million dose excess supply in the '07/'08 season. You guys had a good quarter in flu and obviously plan to participate next year. But how are you thinking about the marketplace dynamics, and are you at all concerned that there might be a fairly significant oversupply in the next season?

I think Eric that is a good question. The think the view on flu for next year is still evolving a bit. We did benefit from the flu market this year albeit it didn't reach our expectations, but we performed well particularly against prior year. So, there was I think difficulties in estimating the size of the market and the uptake of the product this year as an industry kind of a comment. As we look into next year, clearly I believe -- McKesson believes we have a responsibility to our customers to fulfill their flu requirements, but we also have a responsibility to make sure we develop programs with the flu manufacturers that provide flexibility as we get more transparency into the demand cycle for flu.

I think you'll find us being careful about how much we commit to from a buy perspective and we'll try to match demand with supply in a much more finite way. But on the subject of med/surg we had a very strong, strong quarter, and it continues to show great momentum and it shows in the gross margin line, and I think to Jeff's point in his comments the ability for us to take the fixed cost out associated with the OMI service contract still exists in the segment report.

So if you actually think about the overhead we have loaded in the business our real goal here is to take that out, but we can't charge it to discontinued ops, because it's still servicing multiple business that exist inside of McKesson. And we really can't address it if we are focused on making sure we live up to our commitment to OMI and joint customers. And that's' why -- we expect in '08 we'll start to see big progress against that objective and that's where you'll see the margin expansion happen.

That is exactly what I was driving to and I don't think I voiced that very well, but the bottom line here is you are going to take your charges and do those bigger cuts in the first quarter of '08 after the transition of OMI? Is that the point?

Clearly our estimate is that it's going to happen in '08. The sooner the better for as our perspective is concerned, but we have to do this the right way and we want a sustainable, healthy business. So we have to be careful as we extract that cost that we don't impact the momentum the sales force has with the customers, and we don't disrupt the service. So -- I don't think we are all buttoned down on what month it happens in yet but I think directionally you are absolutely looking at it the right way and I think it is important as you mentioned that we highlight that extra cost is still in our business and still above the discontinued ops line.

Right. Okay.Thank you very much. Great quarter.

Next question from Sandy Draper. Your line is open. State your affiliation, please.

JMP Securities. One question on the guidance and maybe a follow-up back on that deferral rate on the IT business. Can you comment on the guidance, obviously very strong performance in drug distribution? You have a little bit of dilution coming in as Larry pointed out, not that big from Per-Se. A lower tax rate. Can you sort of quantify? I mean, what was what were the major things that came into the raising the guidance and how much impact did the tax rate really have?

Again Sandy, the way I would think about it, because clearly we put a range of guidance out there and there is a little bit of judgment on our part that goes into that. But overall, I would describe the increase as about half driven by just a stellar performance we have seen year to date in the pharmaceutical solutions business, and the other half driven by the fact that we are really pleased that we see our steady state tax rate coming down and that of course is driven by the exiting business and where our profits are coming from.

Okay. Great. That is very helpful. And then maybe just a different way to ask the question around the deferral rate and the software. Is there a way for you, if you normalized, if the deferral rate was the same as last year what your growth in the provider technologies business would have been. Is that a fair question or is there a way to look at it that way?

It is a fair question but since we don't give you bookings I'm not going to get a precise answer. But it gets into the low double digits.

Okay. Great. Thank you very much.

Next question will come from Glen Santangelo. Your line is open. State area affiliation.

[INAUDIBLE]

Glenn you are breaking up I'm afraid. Can't hear you.

We can't understand what you are saying. Glenn. Glenn. We can't make it out at all, send us an e-mail.

Our next question will come from David Veal. Your line is open. State your affiliation.

It's Morgan Stanley. Just one question, Jeff, on the tax rate. I mean, is it -- is the 34% rate sustainable on a go forward basis?

That would certainly be our expectation. I haven't provided you guidance for '08. But I think that is a reasonable estimate now to use for '08 absent other changes in our business.

Great. Thank you.

Our next question will come from Charles Boorady. Your line is open. State your affiliation.

Thanks. Citigroup. How material is the Health Mart business as those franchises have been wrapping up very quickly what is the impact to the -- to your overall business in terms of are there any near term drags in terms of expenses that you incur while they are getting revved up? And is there any boost in sales as those new stores are building their inventory?

Clearly it is a very important initiative for us and one we talk about. I would tell you that the investment has been relatively nominal in it, because we have used existing sales and marketing resources and retooled them to be very skilled at selling the franchise model to the market. There is a portion of these stores that are incremental to us that are obviously helping us drive momentum in both revenue and in earnings.

And there is a portion of these stores that are existing customers that are aligning in a more strategic way with McKesson. And these are all margin lift opportunities for us, because we sell, frankly, more value to them. They are more compliant with our generic programs. Many of them are systems customers for us and automation customers for us. We do their managed care contracting and we get fees associated with the franchise. So I would say that it's difficult to talk about the specific materiality of each store as it comes on.

But the way you should think about it is as that number rises two things happen for us. Our margins improve and we lock in a customer base in a much longer term more sustainable way than a customer that's not in Health Mart, it just builds a more solid bond between ourselves and our customers.

That is helpful. I guess I wasn't thinking per store basis so much as, with so many stores coming online I'm wondering what impact that's having today that we might not see today as the growth rate slows.

I don't think you should think about it in terms of a one-time impact. I think you should think about it as McKesson locking up its customer base and marginally improving the margin structure. Frankly, most of these customers trials are existing customers that are moving to a more compliant program.

I see. I see. So there is not like a ramping up of your generic products?

Well ,there might be a ramping up of our generic products, but I guess the point is I wouldn't -- we are not going to use its deceleration at some point for having a decelerating momentum. It is not that significant.

Got you. Just a final question. Anyway to quantify just rough parameters the impact from Part D overall to your business?

Positive.

I knew the direction. I didn't know if it was quantifiable. If you have a way of quantifying it.

I'm sorry. Really it's impossible. I'm not sure our customers would say anything to us other than positive. It is kind of difficult to determine how much incremental business there is. But I would think that based on the view our customers are giving to us about their progress, many of them are experiencing an uptake in terms of customers that may not have filled their scrips, or may not have been as compliant, becoming more compliant because the economics are better for them. It is difficult to quantify, though.

Thanks. Just lastly, can you quantify the total EPS impact from currency? You mentioned Canada and an impact there. Do you have any rough EPS impact, including any hedging you do?

Well, we don't actively do any hedging from a trading perspective. To some extent we have a bit of a natural hedge because there is a good chunk of our MPT that is actually in Canada. Not revenue side but we have a lot of, a big center up in Vancouver. So there is from an economic perspective a bit of a natural hedge there. Now of course we call out the good guy because it is very easy to quantify on the Canadian revenues and the expense side of it, which hits the MPT segment is just a little bit of a burden that gets buried in the results.

I see. I see. So you spiked it out on revenues that makes sense, but in terms of earnings impact should I think of essentially no impact to EPS growth?

You should think of it as pretty naturally hedged.

Okay. Thanks.

Our next question is from Constantine Davides. Your line is open. State your affiliation, please.

Thanks. Constantine Davides. Susquehanna. Just shifting gears a little bit. Wondering if you could tell us how you are thinking about your disease management platform sort of strategically over the next one or two year, and I guess more specifically, any kind of color or metrics you can share with us about your first year of participation in the Medicare demonstration program? Thanks.

Thanks for the question. We have had very nice success with disease management overall. We have been building this business organically and have done I think a magnificent job of building a solid business model and great customer base. Our business is primarily built around the state Medicaid and customer bases and we have performed well in those relationships.

On the CMS Medicare pilot, in specifics, we have been recognizing expense through the P&L as we have implemented this program, but have not recognized any revenues. Like others that are in this program, although it is early to really call results, I would say that our early indications are, that although we may be helping patients improve their quality of life, it may not be producing the kind of results that we had expected or CMS had requested in the original relationships under these pilot agreements. So, we are working with CMS as I think others other in an attempt to understand the data that we are receiving and determining whether or not there is a way to rework the relationship to still provide benefit to the customers and continue the programs in an economic way.

There is really no financial risk to McKesson in that trial. However from a Wall Street perspective, because we have not recognized any revenue and we've just got basically an expense burn that at some point if we can't make these things work the way we want them to work we just won't continue the pilots.

Thanks for the color.

Our final question will come from Tom Gallucci. Your line is open. State your affiliation please.

Merrill Lynch. Thanks for taking the time. Most of my questions were asked. Just a couple of quick follow ups. Jeff, I think there was some expectation for a little bit more anti-trust litigation gains through the second half of the year. Was there anything in the quarter or do we expect anything more in the next quarter?

You are correct, Tom. There is nothing this quarter and we are a little bit below where we have kind of been guiding people for the year. As I sit here today, there might be something in the March quarter, but I'm not so sure anymore. These things are very hard to predict. So, we may end up for the year a little below where we thought we would be.

Okay. So that's -- tax rate helped you a little bit that would be and example of something that hurt you a little bit I guess in the overall guidance?

Yes. Yes.

I know you mentioned a fairly robust growth rate on the generics program. Did you mention, I'm sorry if I missed it, growth of your overall generics business?

No, we didn't.

Any color you can offer or --

I think we're doing well in those programs. But our actual -- what we are attempting to do is to take those regular generic sales and turn them into proprietary sales. That is a part of our key strategy is that when somebody buys generics off the program we target them for somebody to do a program purchase. So, we are not interested in expanding generic sales unless they are in one of our proprietary programs and that is our goal. Having said that, if one of our customers orders generics from us, we'll sell it to them, but it is not the kind of program we are trying to grow.

And the percent, I guess -- how penetrated are you now in that program?

Well, I think we continue to look for new customers and year after year the great pharmaceutical sales team surprises us with the fact they continue the penetration, not only in existing customers to move from 50% penetration in an existing customer to 80%, but also bringing new customers into the program. And as we have talked about in the past, we are moving up the supply chain or the food chain to much larger retail customers that are turning their programs over to us to manage under our proprietary programs. It gives them an expense leverage, because they can take their buyers out of the program and it gives us the leverage of using their buy combined with ours to develop even better economics for all of us in the program.

And so that has been our goal and that's what we are doing. So, I don't think we are anywhere near the end of our growth in generics. And I think we're following a multiple prong strategy. One is get more people in the program. Two is to develop better compliance under the program. And three, launch effectively every new product that comes generic, so we take advantage of the market pipelines that exist for us.

Okay, then my last question was around share repurchases. I think you were a little more aggressive in the second quarter than in the third. You said you got 250 left or so. Any idea the timing there that you would expect to complete that program at this point?

Tom we bought 1.7 billion back in shares over the last seven quarters. We remain committed to our portfolio, our approach to acquiring capital. We slowed a little bit in the December quarter because of the Per-Se acquisition, which kept us out of the market a little bit. I think you might expect us to be a little cautious just while we make sure the integration is completely on track in Per-Se. It is the most sizable acquisition we've done in a while. But we remain very committed to continuing the approach and the path we have been on.

Okay. Thank you.

At this time I have no further questions.

Great. I want to thank you all for your participation on today's call. 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 are focused on outstanding execution to drive superior operating performance and we're obviously on focus on creating additional shareholder value through strong operating performance combined with a balance and disciplined use of capital, including targeted acquisitions, investments to drive growth and profit margin expansion and share repurchases and dividends. Our great year-to-date results give us strong, positive momentum as we enter the fourth quarter here and I will now turn the call back over to Larry for his quarterly review of his events for the financial community. Larry

Thank you, John. Glad to be finishing this call in exactly 60 minutes. On January 30th, we'll present at the Wachovia Securities Health Care conference in Boston. On February 7th, we'll be at the Merrill Lynch Global Health Care conference in New York. On the morning of February 26th, and we just sent out the invitation on this yesterday I believe, and happy to see a lot RSVPs already, we are going to host our annual booth-side briefing at the [inaudible] meeting in New Orleans. On March 20th, we'll be at the Lehman Brothers Health Care conference in Miami, and we plan to release our fourth quarter financial results and our fiscal 2008 guidance in early May, as is our custom. So, thank you, and until we see you at one or more of these events, good-bye and take care.

At this time now, that would conclude today's conference. You may disconnect. Thank you for your attendance