麥卡遜 (MCK) 2009 Q2 法說會逐字稿

Good afternoon. Welcome to McKesson Corporation fiscal 2009 second quarter conference call. All participants are in a listen-only mode. During the question and answer session, (OPERATOR INSTRUCTIONS). Today's conference is being recorded. If you have any objections, you may disconnect at this time.

I would now like to introduce Ms. Ana Schrank, Vice President, Investor Relations. Please go ahead, ma'am.

Thank you Angie. Good afternoon, and welcome to the McKesson fiscal 2009 second quarter conference call for the financial community. With me today are John Hammergren, McKesson's Chairman and CEO, and Jeff Campbell, our CFO. John will first provide a business update, and will then introduce Jeff, who will review the financial results for the quarter. After Jeff's comments, we will open the call for your questions. We plan to end the call promptly after one hour at 6:00 P.M. Eastern Time.

Before we begin, I remind listeners that during the course of this call, we will make forward-looking statements within the meaning of the Federal Securities law. These forward-looking statements involve risks and uncertainties regarding the operations and future results of McKesson. In addition to the Company's periodic, current, and Annual Reports filed with the Securities and Exchange Commission, please refer to the text of our press release, for a discussion of the risks associated with such forward-looking statements.

Thanks, and here is John Hammergren.

Thanks, Ana. Thanks everyone for joining us on our call today. I am pleased that McKesson turned in solid results for the quarter, despite tough economic conditions. While we are not immune from the effects of a weak economy, our second quarter performance demonstrates that our diverse portfolio of businesses, operated in resilient markets, for the impact to our overall financial model thus far has been relatively modest. But it isn't enough to operate in great markets. It is even more important to have a leadership position, which we do.

We are the leader in Pharmaceutical Distribution, not only in the United States, but across North America. We have a leading position in Medical Surgical distribution in the alternate site market, and out strategic acquisition of Oncology Therapeutics Networks made us a much stronger player in the specialty market. With the broadest portfolio in the industry, we are the leader in Healthcare Technology Solutions.

Although the equity markets may not be responding favorably to healthcare right now, our second quarter earnings demonstrate that despite a challenging macro environment, we continue to post solid financial results. The majority of products and services that we provide have steady demand, and we have seen our businesses maintain their volume momentum across most parts of our Company.

Our solid base of revenue and profits, a range are products and services that deliver value to clients, and a strong and flexible financial foundation give McKesson a competitive edge. Even with slight moderation in the short-term demand, we remain confident in our business outlook.

Turning to our second quarter results, our solid performance for the quarter was driven by the Distribution Solutions segment, which accounted for the largest portion of earnings, and provides a great base for our Company. We gave guidance at the start of our fiscal year, that we would grow revenues at the market, and adjust that growth rate based on our mix of business, which is very positive. Our mix of customers is very favorable, as our customers have grown slightly faster than the market.

We also are integrating two acquisitions, Oncology Therapeutics Networks in our Specialty Care Solutions business, and McQueary Brothers in our US pharmaceutical business, both of which have helped accelerate revenue growth. Despite industry concerns about slowing prescription trends, we see steady growth from our customers. In US Pharmaceutical, excluding our acquisitions of OTN and McQueary, and one extra day of sales, our core direct revenues grew a healthy 7%.

In Canada, revenues were up a solid 13%, excluding one extra day of sales. Short-term we do not view our distribution business as particularly sensitive to slowing prescription trends. Our strong revenue growth this quarter again demonstrates that we grow faster than the growth rates reported by IMS. We believe IMS is directionally correct, but not a perfect correlation to our top line. Looking long term, we remain bullish about the broader demographics in North America, and what that will do for future demand for pharmaceuticals.

Most of you are familiar with the two main sources of gross margin value in our business, our relationships of branded manufacturers and our relationships with generic manufacturers. For those of you that are new to our story and our model, or those who might have questions about how we will perform in a difficult economic climate, here is how it works.

For our branded manufacturing partners, we are a highly effective logistics provider, ensuring products reach patients safely and on time. We manage the complex financial transactions associated with pharmaceutical delivery, ensure the integrity of the supply chain, and manage the credit risk of our customer base.

Our sophisticated systems, particularly our redistribution center, allow manufacturers to minimize supply chain costs, and maintain consistency across all markets. With the various services we provide to branded manufacturers, we are typically compensated through formal arrangements, that specify the level and type of complication based on each service we provide.

These agreements have improved the visibility and the predictability of our compensation. We do have a big role in serving the demand create by informed consumers, that are not only aging but also recognizing that drugs are the first and best line of defense, against increased costs, and more medical challenges later in life. It all starts with a complete supply of the product at the time the drug is needed, and goes much further as we improve the operation and dispensing, for both manufacturers and our retail and hospital customers.

In addition to the services we provide to branded manufacturers, we provide the generics manufacturers with significantly more value, because we manage and influence demand, we are compensated with higher margins than on the branded side. We deliver significant market share to the generic manufacturers, and have greater execution with rapid and complete customer supply.

We have picked the right partners on both sides of the transaction, and we make a market that is efficient and effective. It couldn't happen without the wholesaler. This has made McKesson a crucial launch partner for generics manufacturers, both at the time of the launch, but also well into the later life cycle of the products.

The market is more efficient and effective with us putting together buyers and sellers, and then managing the details of the business. McKesson, our customers and patients all benefit, because the cost base for the generic drug is lower than the branded drug. Because we have the value I described earlier, we earn a much higher margin, and have developed business models that deliver a higher return on our investment. So the generic model has superior profitability and lower working capital investment, resulting in higher return on capital.

We have been able to grow our generic penetration faster than the market, using our customer centric approach, with programs designed for each segment of our customer base. We add tremendous value for our customers when we take over the generic purchasing. They trust us and we deliver. They win as we win.

While we are reasonably well penetrated with generics in the independent segment, we are positioned for growth with retail chains, hospitals, and long-term care. The programs for these customer segments have been developed over the last several years, and are now gaining momentum. All of our customer segments have opportunities for incremental sales growth, as market momentum builds and customers look for generic drug purchasing, and Distribution Solutions with a proven track record.

A strong generics pipeline and our ability to grow our base of customers in OneStop generics, our proprietary generics program, are crucial components of our strategy to drive margin expansion over the next several years. This quarter we benefited from both new launches and penetration at the customer base, to bring additional generic volume into the channel. As a result, sales grew for OneStop, an impressive 49%, once again significantly above market growth.

We continue to deliver great value to our customers, and they continue to reward us. Just one year after becoming a US pharmaceutical distribution customer, Pamida, a regional retailer with stores primarily in the midwest, named McKesson as the Vendor Partner of the Year. McKesson was recognized for the flawless integration of it's 144 pharmacies into the US Pharma network, and for the value we provide through our proprietary generics programs. In addition to participating in OneStop generics, Pamida uses our RxPak program, and is a customer of RelayHealth.

Turning now to our Specialty business. We are now a clear #2 player in this space, which is important to us, as the market continues to include some of the fastest growing categories of drugs in the United States. Last week you learned of our decision to sell our Specialty Pharmacy business to Walgreens. At the time of the OTN acquisition, we determined we would dispose of Specialty Pharmacy, but we wanted to do a careful review as we went through the integration process. Specialty Pharmacy was a small part of our overall Specialty Care Solutions business, so this sale will not have a material impact on our financial expectations.

We did not see a way to get this business to the level of share and profitability that McKesson requires. This business and the McKesson teammates that helped drive it, should be a good fit for Walgreens, which has an existing business in this space. The remaining parts of Specialty Care Solutions will continue to deliver services to manufacturers, payors, and providers, including distribution, coordinated reimbursement and clinical services. Our Onmark GPO, our world class linked technology platform and clinical tools, provide value-added information that helps improve efficiency and patient safety.

Going beyond US Pharmaceutical, there was strong performance from other businesses within Distribution Solutions. In the second quarter, we had solid growth in Canadian Distribution businesses, from new and expanded customer agreements. We also had positive results in Medical Surgical Distribution, with particularly strong results again reported from our Home Care group. In the second quarter, we also benefited from an early sales season for the flu vaccine.

In summary, I am pleased with the solid performance of Distribution Solutions. We have a terrific combination of assets that perform exceptionally well. Thus far, I feel confident about our momentum, and our ability to grow in this tough environment, and our ability to achieve our full-year plan in these businesses.

Turning now to Technology Solutions. Our second quarter growth of 7% reflected higher revenues from maintenance and outsourcing, and from our expanded customer base, and strong performance from within our payor businesses. Operating profit was up 8%, and we held margins steady despite a difficult economic environment.

For several months, we have been monitoring the impact of the weakening economy on our customer base. In this quarter, particularly in the last two weeks, we saw customers delay purchasing decisions. So while our second quarter results reflected growth, they did not meet our expectations. It is still too early to say for certain what will happen in the near term. There are parts of Technology Solutions that have been stable, despite challenges in the economy.

For example, we have a steady stream of recurring maintenance revenues from our large installed base. In addition, our automation business continues to perform well, and this quarter we had strong revenue growth across the product line, including robots, cabinets, and our MedCarousel. We gained share both with new customer wins and competitive replacements. We have also seen success with our RelayHealth business, which processes more than $1 trillion in charges and payments each year. We are experiencing strong demand for RelayHealth Financial Clearance and Settlement Solutions, which enjoyed a record quarter.

In addition, our medical imaging base has grown to more than 1,600 unique facilities, and competitive replacements represents the majority of bookings this year for all imaging solutions. Horizon Cardiology has seen strong growth during the past three years, from a minor presence in 2005, to capturing more than 10% market share last year. These products and service offerings are relatively quick to deploy, and help customers improve their financial position.

Earlier this year, we introduced our Horizon Enterprise Revenue Management solution. As you know, hospitals today are under tremendous pressure to manage their revenue streams, in a world of complex reimbursement models, that are too sophisticated for their old patient accounting systems. This results in a significant amount of uncollected payments that negatively impact the hospital's bottom line.

Horizon ERM is designed to improve the economics of hospital care delivery. I am pleased to report that during the quarter Horizon ERM went live at Gwinnett Health System in Georgia. In September, Gwinnett turned on the access management part of the product, and is using it to reinvent 23 access points for registration within their health system.

As we continue to roll out the solution at Gwinnett, we are also moving forward with our second pilot, which will also focus on revenue management portions of the solution. We are making good progress introducing Horizon's ERM to our customer base, and they are excited about the functionality of the solution.

You have heard me talk about the tremendous difficulties that payors face today, as they struggle to manage their medical loss ratios, and manage their administrative costs. These are very complex processes that require sophisticated analytics. McKesson's supplies payors with solutions that give them visibility and transparency to the costs associated with managing their populations.

A good example is our successful implementation of ClaimsXten at Wellpoint's affiliated health plan in Georgia. Initially, this will support over 3 million members, and will help with their ongoing efforts to achieve consistency, accuracy, efficiency, and transparency in claims processing. Another good example is a relationship recently announced with IBM, to create an enterprise-wide payor analytic solution, to address increasing medical loss ratios. By combining our clinical content with IBM's world-class technology, we will create a new solution to enable payors to facilitate smarter, faster decision making across their businesses.

Despite these positive developments, there are parts of our Technology Business that may be more susceptible to the economy. We are seeing a temporary slowdown on some of our hospital solutions and physician office products. It is difficult to determine if the delay in purchasing we experienced in late September was temporary, or if it will continue.

Therefore we are going to take a slightly more conservative view of the back half of the year. Given this view, we are following a prudent course of action, and positioning our technology business more conservatively, until we have better visibility to the timing of the market's recovery. We are focused on controlling our costs and driving efficiency through our organization.

In the interim, we are uniquely prepared to support our customers through this period with new technologies that can be installed quickly, and will directly impact cash flow and financial performance. Before I turn this over to Jeff, I want to touch on the topics of capital deployment and balance sheet management, which have become even more critical during the past six weeks.

We continue to take a portfolio approach to capital deployment. Year-to-date we have deployed capital at about the same level as we did during the first six months of last fiscal year. Jeff will provide more details, but we are comfortable with our balance sheet and our liquidity position. However, we do believe that with the lack of visibility to when the financial markets will stabilize, and the impact of higher borrowing costs, it is prudent to run the company more conservatively.

We remain committed to using acquisitions and share repurchases to further enhance shareholder value, although the broader economic environment could impact how active we are in the near term. We do plan to remain opportunistic, but are mindful of the realities of today. We remain confident in the tremendous earnings potential of the Company, driven by both Distribution and Technology growth. We are making moves now to take out cost where demand is slowing, and to manage both the Company and balance sheet more conservatively. We believe this is a sensible course of action.

Like all companies, we have to be a little more visible to the timing of the markets, and aware of their recovery. Based on the healthy fundamentals underlying our business, and our ability to execute on our objectives, we are maintaining our guidance of $4.00 to $4.15 per diluted share from continuing operations for fiscal 2009. I look forward to reporting to you on our continued success throughout the year.

With that I turn the call to Jeff, and will return to address your questions when he finishes. Jeff?

Thanks, John. Good afternoon, everyone as you just heard, McKesson posted a solid quarter in light of the challenging economic environment. We are confident in our overall earnings potential, despite some additional caution around the back half of our fiscal year, resulting from the lack of visibility into the timing of an economic recovery, particularly as it impacts our Technology business. We will talk more about this later.

Let me begin by just focusing on our financial results for this quarter. As always, I will first review our consolidated results, providing more color when I discuss each segment in more detail. Similar to what you saw in our June quarter, consolidated revenues for the September quarter grew 9%, $26.6 billion, and $24.5 billion last year.

While our overall revenue growth is of course driven by the growth in Distribution Solutions, which was up 9% from last year, Technology Solutions posted revenue growth just a bit below this rate coming in at 7%. Gross profit for the quarter was up 10% to $1.3 billion. Distribution Solutions gross profit increased 12%, providing nice gross margin expansion in the segment, while Technology Solutions gross profit was up 5%.

Moving below the gross profit line, our total operating expenses were up 12% to $921 million for the quarter. Higher expenses in the quarter were primarily driven by growth in the business, and to the impact of several acquisitions, particularly OTN. Operating income for the quarter grew 6% to $381 million, $359 million a year ago.

Moving below operating income, Other income of $33 million was 8% below last year. There are two things going on here. First, as we have discussed, beginning with our guidance assumptions last May, lower interest rates on short-term investments, combined with our lower cash balances this year, have resulted in a significant drop in our interest income. This drop is partially offset this quarter by the sale of our equity investment in Verispan. The pretax gain on the sale was $24 million, and is included in the Other income line. The after-tax gain was $14 million, or approximately $0.05 per diluted share.

Interest expense of $35 million was relatively unchanged from the prior year. Now you should note that the expense associated with the use of our receivable sales facility is reported as an administrative cost in operating expenses, and does not show up in interest expense. In the second quarter, this administrative expense was approximately $3 million.

Moving to taxes. Our effective tax rate of 13.7% primarily reflects two factors. First our run rate, which remains at the 33% that we have been using all year. Second, $76 million in positive discrete tax items in the quarter, equating to $0.27 per diluted share, which included the tax observed relief we had mentioned last quarter. Going forward, we continue to expect our run rate to be 33% for the year, excluding the impact of further discrete items. Net income in the quarter was $327 million up 32% from the prior year, while earnings per diluted share of $1.17 was up 41%, from $0.83 a year ago.

This EPS leverage was driven by the impact of the aggressive $1.3 billion of share repurchases we have made over the last four quarters, which lowered our diluted shares outstanding by 6% year-over-year to 280 million shares. Year-to-date our portfolio approach to capital deployment has resulted in net deployment at about the same level as we did in the first half of last year. We have spent more on acquisitions, $320 million as compared to 51 million last year, and more on our increased dividend, $50 million as compared to $36 million last year.

We have repurchased less stock, $334 million as compared to $684 million last year. But this was somewhat offset by the lower number of option exercises we have seen this year, bringing in just $65 million of proceeds as compared to $183 million last year. Obviously in recent weeks, we have become more cautious about the financial climate, and so you should expect to see us act more conservatively in our share repurchase activity going forward, until we have more visibility into the reality of the climate in which we will be operating.

Let's now move on to Distribution Solutions. In this segment, we achieved overall revenue growth of 9%, compared to the same quarter last year. US Pharmaceutical direct distribution and services revenue grew 16% to $16.6 billion. About 7 points of this growth stemmed from our acquisitions of OTN and McQueary Brothers, with another 2 points coming from having an additional sales day this year.

That leaves 7% growth, driven primarily by strong performance across our entire customer base. Warehouse revenues declined 7% to $6.3 billion. As we have seen over the last few quarters now, the primary driver of the warehouse decline was the loss of a contract by a large warehouse customer, coupled with decreased purchases from several other customers. Canadian revenues continue to grow strongly, increasing 15% for the quarter to $2.2 billion.

While we did have one additional sales day this quarter, for the first time in a few quarters, there was no currency impact on our Canadian results. So this performance is driven by our continued success in securing new and expanded distribution agreements across our customer base.

Medical Surgical Distribution revenues were up 9% for the quarter to $700 million. We have seen earlier sales of flu vaccine this year, which accounted for 2 to 3 points of growth, with the core business growing at what we believe to be market rates. Gross profit for the segment was up 12% to $951 million, on a 9% revenue growth, representing a nice improvement in gross margin of 11 basis points.

The increase in gross profit for the quarter was driven by an improved mix of higher margin products and services, particularly sales of OneStop generics, with some benefit also, from the lower mix of warehouse sales. These gains were partially offset by the timing of when we received compensation under our agreements with branded pharmaceutical manufacturers, which this quarter showed a modest decline year-over-year.

As you recall, we talked last quarter about the fact that we experienced a stronger buy-side impact year-over-year. So our June quarter was stronger than the prior year, while the September quarter was weaker, just due to a shift in the timing of our compensation between the two quarters. Year-to-date, these quarters mostly offset one another, and our compensation is on-track relative to our expectations.

Our Distribution Solutions operating expenses were up 16% for the quarter to $570 million, reflecting growth in our businesses, and the acquisitions of OTN and McQueary Brothers. Operating margin rate for the quarter was 157 basis points, compared to 154 basis points in the prior year. So this year's results for the segment, include the impact of the sale of our interest in Verispan. As you know, given the quarterly volatility in this segment, we always focus on full year margins. In this context, we remain on track for the full year to see modest expansion in the operating margin of this segment.

In Technology Solutions, revenues were up 7% for the quarter to $762 million. Services revenues were up 8% in the quarter, while software and software systems revenues of 140 million in the quarter, were relatively unchanged from a year ago. As John mentioned, we have clearly seen some of our hospital and physician office customers deferring purchase decisions. This impact is reflected in the software lines in particular.

Gross profit was up 5% from the prior year to $351 million. For the quarter, Technology Solutions had total gross R&D spending of $100 million, an increase of 10% from the prior year. Of this amount, we capitalized 17% compared to just 11% a year ago. Technology Solutions operating expenses increased 4% in the quarter to $282 million, as we have kept fairly tight controls on expenses, even in advance of some of the changes John talked about. Our operating profit in our Technology Solutions segment this quarter was $71 million, up 8% from a year ago. Operating margins in this segment were 9.32% for the quarter, compared to 9.27% in the prior year.

Leaving our segment performance, and turning now to the balance sheet, let me start by reminding you about our liquidity profile, given the financially turbulent times. We have a total of $2.3 billion in short-term liquidity facilities. This consists of a $1 billion accounts receivable sales facility, which we renew annually each June, and a $1.3 billion unsecured revolving credit facility, that expires in June of 2012. Both of these facilities are led by large money center banks. Historically, we have had access to short-term capital through the receivable sales facility and the revolving credit facility that I just discussed, as well as through selling commercial paper.

As we have discussed in the past, we use these vehicles to manage our short-term cash flows, which can vary significantly on a daily basis. At times, commercial paper is our best short-term borrowing option. When you look at our cash flow statement, you will see $3.5 billion in short-term borrowings and repayments year-to-date. Most of which was done using the commercial paper market.

More recently, we have not had access to the commercial paper market, but we have had no trouble with access to short-term capital, because we are able to rely on our receivable sales facility and revolving credit facility. Turning to long-term debt, we have no scheduled payments due before February 2010, when our Series B senior notes for $215 million comes due. Our cash is invested very conservatively, generally in overnight government security-backed repos or money market funds. We he have no significant derivative expose, that would expose us to counterparty risks.

Now to our working capital metrics. You will see in each of our working capital metrics, the impact of timing, both in term of the particular day a quarter ends, and in terms of the pattern of our inventory buying, which can impact both our inventory and payable balances. Adding back the $497 million sale of AR at quarter end, our receivables increased 10% to $7.5 billion, which is a bit faster than our rate of sales growth.

Our Days Sales Outstanding, therefore increased a day to 23 days. We have not seen any changes in payment patterns driven by the economic climate. The added day this year is just a function of our customer mix and timing. Our inventories were $9.2 billion on September 30, an 11% increase over last year, and our day sales in inventory of 33 was 1 day higher than a year ago.

Compared to a year ago payables were up just 3% to $12.1 billion. So our Days Sales in Payables decreased 3 days from a year ago to 43. Year-to-date, we have generated $51 million in operating cash flow, excluding the benefit of the $497 million receivable sale. It is slow relative to the last few years, and was driven primarily by the timing of inventory purchases, including the fact that we did some of our normal seasonal inventory build for the winter a bit early this year, impacting both our DSIs and DSPs. There were also a few other peer timing-related impact issues that impacted our year-to-date cash flow.

Going forward, we continue to target generating over $1.5 billion of operating cash in fiscal 2009. Capital spending was $80 million for the first two quarters, about flat with the prior year. Capitalized software expenditures were $90 million, up from $78 million last year. Our annual guidance for capital and software expenditures in the range of 350 to $400 million remains unchanged.

We ended the quarter with $1.1 billion in cash and cash equivalents, down from the 1.4 billion we held at year end. So overall, our second quarter results were solid and on track, however we have become more cautious about the back half of the year operating results, given the current economic environment. This caution has translated into us maintaining our EPS guidance from continuing operations for the year at $4.00 to $4.15. Our caution about our operating results is offset by two non-operating items we recognized in the September quarter.

Let me take you through each of these in turn. First, in terms of the non-operating items, we are benefiting from the $0.05 gain on the Verispan sale, and second, the discrete tax items this quarter came in $0.04 cents what we had communicated to you as our expectation last quarter. As John discussed, we are more cautious in our outlook for our Technology Solutions segment, given the uncertain environment for technology spending. Also in today's financial climate, we are planning on being a bit more conservative with our share repurchases. This combined with the higher cost of our short-term borrowings, and lower interest rates on our cash balances will lower our back half earnings.

So the gain from the Verispan sale and the discrete tax benefits, are tempered by the cautious tone of the latter two items, which leaves us maintaining our guidance. Our cautious tone for the Technology Solutions segment, particularly applies to the December quarter. Overall, as is historically the case, and as we have discussed all year, we expect the March quarter to be our strongest quarter. In conclusion, we feel McKesson is well-positioned for the current difficult environment.

Thanks, and with that, I will turn the call over to the operator for your questions.

Thank you. (OPERATOR INSTRUCTIONS). Our first question today will come from Tom Gallucci.

Merrill Lynch. Good evening everybody. Two quick questions here. First, in the IT business, you talked about reducing costs, trying to be more efficient. Can you give us some idea of how flexible that business really is, and the types of things you can do? The second one is just a quick one. You said you built inventory a little earlier this year given the credit environment. You seem to be spending a bit less on buy back and things, but you built inventory early so any reasoning there would be helpful? Thank you.

Thanks, Tom, for the question. I will take the IT question. and ask Jeff to comment a little bit about inventory. Clearly, the first thing we can do really company-wide is to crank back on some of our discretionary spend, things like travel and other kinds of activities that will hopefully have a nominal effect on sales, but have a big effect on expense, are places we will go to first.

The Technology business in particular, we are not likely to touch any of our development activities, or any of the things that have long-term paybacks. But in some areas where customers may not be ramping up their deployments on products, or implementations because they are trying to reduce their own costs, or in areas where they may be shifting their purchases of one product to another, we could reorient our organization in a different direction, and in some places we may have some workforce reductions. So I think that we will be able to effectively offset some of the change in demand here.

Clearly we are not likely to get the kind of margin expansion we had hoped for in the IT business this year, but we still expect to get positive leverage in both of our businesses. One of the real positive things that Jeff mentioned, particularly when he was talking about Distribution Solutions, was the fact on a full-year basis we still expect to get a margin lift. If you look at our sales rate in that business, it is very strong. If we get margin lift on a business that is growing that well in sales, we are going to get great earnings throughput in the last half of this year, particularly the fourth quarter. We are still excited about that business in particular, and how it is positioned.

And Tom, on the inventory side, there are really quite a number of factors that go into this, both in terms of manufacturers and their own production patterns, incentives they offer, depending when we buy certain inventory.

Really we have the same factors on the customer side, where customers buy in different patterns, and we are constantly evolving our relationships with customers. Those all happen to come together as of September 30th, to give you the results we had this year, which caused us to us use a little bit more cash on inventory, than we usually do in the first six months of the year. As I said, as we look out for the rest of the year, we would expect those things to reverse, and wouldn't necessarily see it as indicative of how the rest of the year will progress.

Next question, please.

Thank you. Lisa Gill, please state your company name, and you may ask your question.

Great. Good afternoon. It is JPMorgan. Jeff, thank you for all of the detail on the guidance. I am just wondering if maybe could you just give us some idea, as to why the guidance range remains so wide at $4.00 to $4.15, maybe just some thoughts on the upper end and lower end of your guidance?

Secondly, John, when you talked about generics and you talked about providing value to your customers, do you believe that in this economic slowdown we will see more utilization of generics? Could that be a great driver for you, and opportunities around some of these additional customers, or is it just additional penetration into the existing customer base? Thanks.

Thanks, Lisa. Let me take the second question first, and then Jeff can comment on the guidance. I think, clearly we are trying to be cautionary about the Technology business. Time will tell as to how concerned we should be, or need to be about that business.

Clearly the products that we are sell have high demand, and we are very optimistic that customers will need to buy these products. Once these financial markets settle out, they will begin to sign those orders. So part of the range is, gee, how much are they going to buy and how soon are they going to buy, is part of that question. There are other factors the Jeff will cover.

On the generic side, I do think that customers are going to be much more sensitive to the purchase of generics. I think the transitions have already been very robust, relative to brand to generic switches, so that will accelerate as well. I think people in any way that they can get to the generic faster, they are going to do it. McKesson has a great track record of delivering generics to our retail customers, as soon as anybody gets into the market, our customers get them. I think that is a real positive.

Really the last point and the highlight of many of the comments I made on this call, and in previous calls. The adoption rate of McKesson's generic programs continues to accelerate. That is a sign that we are doing a great job for our customers, and our customers are finding not only are we more efficient, but we get them better economics in that entire transaction. So I remain very bullish on both Distribution Solutions, as well as the role generics will play in our success this year.

Just as a follow-up to that, John, we are very early in the stages of this economic downturn. Are you already starting to see from just a prescription trend basis, more generic utilization at the hospital level, at the chain pharmacies, long-term care, et cetera, or is it just that you are seeing the opportunity because you are penetrating your accounts? I am just trying to understand where each of the pieces are coming from?

I think it is difficult for us to see the dispensing activity with the kind of clarity that a retailer might see. Clearly our pull-through of generics is expanding and increasing. I would say we are probably getting a combination of more generics at the retail end, but certainly more retailers and hospitals choosing to buy their generics from us. That is a big part of the equation for us.

Okay. Great.

Lisa, on the guidance, I think actually historically for this time of the year, we are not particularly any wider in the range than we have been historically. There are really two sets of being uncertain. You have got the uncertainty about the IT area, which John talked about, and we are just trying to be prudent and cautious in our forward comments.

Frankly, you have got uncertainty in the capital markets area. Our short-term borrowing costs have spiked up, and frankly the interest income we get of sticking cash in government-backed repos has gone down quite a bit. We are also not quite sure when the longer term capital markets will open up, and when and how much we will feel comfortable really opening up the spigots on a share repurchase.

So those are really the big drivers of why I certainly feel more comfortable with a little wider range as we go into the rest of the year. I would say in the Distribution Solutions segment, I feel pretty confident of our results, and you just don't have the kind of uncertainty there, that you do probably in these other two areas.

That is very helpful. As a follow-up to that though, Jeff, you don't believe that we will see any changes in utilization patterns? Should we see unemployment go up dramatically from where it is today? That doesn't have anything to do with the current guidance range?

It really doesn't. A couple of points I would make is those effects tend to happen over a period of time, and and we are a couple of steps removed from the immediate impact. The second point I would remind you of, is we are a 150 basis point business in our Distribution business. So short-term impacts in volume, actually have very little impact, not zero, but very little impact on our bottom line. We are much more sensitive to trends in generics, which I think will in fact, be moving in our direction, and to what happens with our compensation from the branded manufacturers.

Great. Thank you very much.

Thank you. Glen Santangelo. Please state your company name, and you may ask your question.

Thanks. It is Credit Suisse. Jeff, I just wanted to follow-up on one more guidance question, it seems like you have maintained the guidance, but now you are including an additional $0.09 of those two items that you outlined. Could you maybe give us I sense for how much you intend to scale back your share repurchasing, and maybe how much less interest income you will have? I am trying to get a sense for how you are really changing your projections on IT, versus how you intend to deploy your cash?

You are correct, Glen that $0.09 is really the number you are settling for. The biggest piece of that is our conservatism, or our caution around the Technology Solutions business. Certainly we don't give guidance on exactly how much share repurchase we are going to do, but I would say through a combination of being, or making some assumptions around higher interest rates on our borrowings, lower interest rates on our investments, and a little less share repurchase, you get a couple of cents, $0.02 to $0.04, and the rest is probably somewhere in the Technology business.

Thanks. Maybe if I could ask one more follow-up question for John with respect to the balance sheet, obviously compared to a lot of your competitors, your balance sheet is in a lot better shape, and it seems like you're taking a little bit more of a conservative turn here, in terms of deploying that cash. How do you think about your priorities as you move into 2009, with respect to maybe acquisitions as valuations in the marketplace, may be down compared to your own stock, which is at a single digit PE multiple, which we have never seen before?

Well, I think it is clear that we have a great balance sheet going into this environment, and it is also clear that there are many opportunities that are much more affordable to us, including the repurchase of our own shares. I think the phenomenon we are describing, we believe is a relatively short-term phenomenon, and we don't expect the markets will stay in this kind of credit condition for the long haul. I think that we have to temper our discussion by short-term versus long term, and the problem is the definition of those two, the tails on both of those statements.

I think that our view is that we will continue to use a portfolio approach to capital deployment. We will continue to use share repurchases, we will continue to be opportunistic in acquisitions. And obviously, we already doubled our dividend, and we have continued to pay it. So I think your point is right, we are in a great position, and we should be in a position to take advantage of this marketplace.

Okay. Thank you.

You are welcome.

Larry Marsh, please state your company name, and you may ask your question.

Thanks. Barclays Capital for the record. One of the goals I guess, John, I wanted to get you to comment on that Paul Julian highlighted at the Analyst Day this past year, was to retain 100% of your key customers this fiscal year. Just checking in, is that still on track, and how do you think about terms around customer renewals, given the economic environment, and just even more broadly, how do you even think about things like customer receivables reserves, when the environment is so challenging on the Distribution side?

Well, it is clear that from our track record perspective, we have done a great job of retaining our customers. We generally retain our customers. Our goal is to retain 100% of our customers. I might refine that a little bit, 100% of the customers we want. So sometimes we get into positions where we may be in a place where the returns aren't where we want them to be, or we have other reasons that cause to us move in a different direction.

Overall, I would say that we are on track for the renewals we expect this year, and our teams continue to work very closely with our customers to earn the privilege of continuing to service their needs, and as their typically, there is very little customer churn in our industry. On occasion, clearly you have some movement, but it typically is not really across the board.

As it relates to receivables, we work very closely with our customers, and out of all of our businesses, I would say our pharmaceutical distribution business probably does the best job of maintaining visibility to receivable risk, and managing the collection process. We have very little customer delinquency in that business, very little aged receivable, and I think we feel comfortable with the kind of small reserves that we have on our books for receivables are adequate. So our largest receivables from our largest customers continue to be paid on time, and we have very close working relationships with them, and a very close dialogue. So I think that is sort of steady as she goes. Clearly, we have to be aware of this environment of the credit issues our customers may face, and we need to be prudent about new business we bring on, and how we manage existing business and contract renewals. I think at this point, we are sort of steady as she goes.

A quick clarification. When you talk about sort of your more cautious view of the Technology business, and suggest that the timing delay may be temporary, when you think about that, John, are there sort of gating factors? Is it an access to capital issue, that we heard about earlier this year with the auction rate securities? Is it impairment of current capital, or is it really a change in the business environment for your customers, that is sort of the delta in terms of temporary versus a more permanent change?

I'm not sure that we know clearly yet across the board, what it is today, or where it is ultimately going to go. I would say first off that our technology is really the solution to many of the problems our customers face. So I think in my mind it is not a question of if they buy our stuff, it is a question of when they buy our stuff.

I think they may put off the new wing on the hospital, or the rehab for the emergency department, but they are going to have to put in systems to reduce their rework, to make their labor more efficient, and to reduce errors. Some of this will be mandated through government regulations that have already been passed around error reduction in hospitals, and not being paid for rework, especially with errors, and some of it is going to be simply the great return on capital they get when they invest in our systems.

That being said, I think the snapshot we had at the end of the quarter was just fear induced. Customers, if they haven't purchased a system, I am sure the CEO and CFO looked at each other and said, we could probably wait a couple of weeks to sign this PO, even though it has been approved up through our Board. I think some of that occurred. So I think that fear, or that uncertainty, or opening up the 'Wall Street Journal' every day, caused people to have an immediate pullback to some degree in some settings. I think the realities of what happened in the marketplace, relative to access to credit, which I think is temporary, probably caused some more people to sit back, and maybe not finish those signatures.

I think over the long term, the financial condition of our customers may deteriorate slightly, but I think the demands are still there, and I think the reimbursement schemes that are likely to come up with the next administration, are unlikely to negatively affect our customers in such a way that they can't afford to do any assistance purchases. I think it was the immediate first blush, Larry was wow, I think I will stop doing what I am doing for a while, and take a breath. Then after that, it probably a process of working through their own analysis of their balance sheet.

Very good. Thanks a lot.

Yes.

Eric Coldwell, please state your company name, and you may ask your question.

Thanks. Robert W. Baird. Two questions. First one is brief, John or Jeff, can we quantify the growth of OneStop generic, excluding the transition of McQueary accounts?

I think most of that was non-McQueary. McQueary really hasn't started yet. I am trying to read lips here. I don't think McQueary has really rolled in, we haven't started on, we converted it to our distribution center network. That integration has been done. But the real selling process to move them to our generics really has not happened yet.

So I think what you are seeing is the uptake of our existing customers. I might remind you we did buy D&K a year and a half ago. That roll-through, two years ago, and that roll through has already happened. I think this is primarily net new customers. I talked about Pamida and the fact that they came on with our generics, last quarter, I talked about Safeway renewing with our generics. There were some big wins with generics the last couple of quarters, that you are seeing evidence of in our results.

That is actually fantastic. I was thinking some of that might have been McQueary derived. The second question is maybe a bit of a statement, a bit of a question. I wanted to make sure that we are all on the same page with growth, given some of the comments about caution and the environment, which I think are very, very understandable. As we look at the December quarter ahead, we are going to have a very tough year-over-year comp on growth.

You are going to annualize OTN. One fewer sales day. Canada will probably go negative on the FX contribution, and possibly materially so. You sold the specialty business, or are in the process of doing so. You have also pulled some of your flu vaccine forward with an earlier than expected start this year. Top line growth will obviously be pretty challenged in the December quarter.

Are there any other things that we are missing, and how do we prevent maybe the market from interpreting some of these one-time issues or comparisons, or optics items, from leading people to believe that the actual fundamentals of the core business have slowed even more than perhaps they are? Does that make sense?

You had a very good list of items there. Clearly many of those items are fact based, and we have tried to discuss a lot of them. That is one of the reasons that Jeff and I tried to net the days in this conversation this quarter. We tried to take out OTN and McQueary from our revenue number, when I gave you a same store growth number.

Yes, our growth rates are going to come down. We won't have a 16% increase in direct store revenues in pharmaceutical distributions. I do think that we feel comfortable that we will continue to grow in that high end of the range for the mix of customers we have that IMS has provided. IMS recently took down their range. We really don't see the kind of softening in our revenues that that indication would portray as in our future. So I think we still feel comfortable. Things are going to slow, because we are lapping a lot of this stuff. We are still going to get great leverage in our business. Jeff?

Eric, just to put a fine point on it, in times of guidance. We obviously don't provide quarterly guidance. I would just point to the comments I made in our prepared remarks that our caution about Technology Solutions, particularly applies to the December quarter, on top of all of the other things you cited, and certainly historically, the March quarter is always our biggest quarter. We would expect that to be true.

If you look at Distribution Solutions, and you go back to last year's December quarter, we also had some things happening there, that will be more challenging as we lap them. We feel very good about the back half of the year and the guidance we have given, but it certainly will be heavily Q4 weighted.

I completely understand, and pretty admirable results given the environment we are in. Thanks, guys.

Great. Thank you, Eric.

Thank you. Charles Rhyee. State your company name, and you may state your question.

Yes, Oppenheimer. Had a couple of quick clarification questions if I could, particularly the IT section. You talked about the slowdown of some of your customers. Can you give us a sense for the revenue cycle piece, particularly in the Per-Se business. Have you seen sort of a slowdown, in terms of the number of claims that you are processing on behalf of physicians.

In other words, are you able to get any read on whether we are seeing a slowdown in physicians visits. Certainly anecdotal evidence would suggest that doctors are seeing fewer patients, at least over the last couple of months.

Then also just a clarification on the Verispan sale. It looks like to comes out of the Other income on Distribution. Am I right in thinking that is 24 million?

Jeff, why don't you talk about Verispan.

Yes, Verispan is in the Other income line of Distribution Solutions on Schedule 2, if you will, in our press release. If you look at the consolidated income statement, it shows up on the Other income line as well.

As it relates to Per-Se, that acquisition case continues to perform well for us. We actually have seen I think an increase in interest in Per-Se's revenue cycle outsourcing business, which is the business you referred to, where we might be able to see some indication of slowdowns at the physician level, in terms of billings or office visits. People are beginning to say I don't need to carry the cost of some of these operations. Increasingly people are coming to us saying can you take on my back office responsibilities, and so we are optimistic, that we will find even more opportunities in this challenging time, as customers look for things to unload that aren't core to their operations.

As to whether physicians are seeing less patients, and whether demand is falling, clearly there are some anecdotal conversations we have with people about canceled physicians visits, or scripts that weren't picked up, or those kinds of things. But it is such a small amount of evidence, I think it is difficult for us to comment on it. In the scheme of our Medical Surgical business, or our Revenue cycle outsourcing business, sometimes it is hard to discern what was a missing unit, because a patient didn't show up, versus share gains that we have picked up in our business, or other kinds of items that offset those things. I don't think we are experts on physician office visit activity. But I will tell that you those businesses continue to be very promising. You saw on our MedSurg business, a good performance there, and even if you take the flu vaccine out, that business is performing well, and getting good leverage in it's operations.

Thanks for the comments. One more follow-up question on Distribution. We saw a pretty strong quarter in terms of gross margin, but we also had kind of a tick-up at least sequentially in the SG&A for Distribution. Was there anything in there that might be different, or that was sort of one-time in nature, or might not necessarily repeat as we move to the back end of the year?

I would say there is a bunch of acquisition costs that still exist in those SG&A lines. One of the reasons Jeff and I are remaining so bullish on the Distribution Solutions segment, is that if you actually look at the revenue rates and the gross margin pickups. When we get those expenses down, because we lap OTN and McQueary, and some of the other items that fall into those categories, we should get good leverage back on the P&L, and that is how we get the margin expansion back in the business, particularly in the fourth quarter.

So that is really where we are headed, and why we are optimistic. It has got to start with gross margins. Even if revenue starts to diminish a little bit, if we can make up for those revenue shortfalls, by selling more generics and get gross margin to grow, which is really our focus, how do we grow grow margin, and then get leverage off the gross margin to our expenses, that is a great model to grow operating income.

Thanks for the comments, guys.

Yes.

Thank you. John Ransom, state your company name, and you may ask your question.

Thanks. Raymond James. Two quick questions. On generics, if we take a typical generic today and run it through the profit cycle, is there any change in sort of dimunition of the profit as you move from say the 180-day, to the Wal-Mart $4 model? Are the profits dropping for you any more quickly than they always have, or does it still look like about the same?

I would say the model is the same. I think the big advantage we have is what is improving in the model for us, is more generics and more customers buying generics. The actual way the profits move through it John, are very similar to what they were before.

That is good. Then just shifting gears to your Technology business. What percent of that business would you estimate is hospital based, versus physician and other alternate site based at this point?

Well, I would guess that quite a bit of it is hospital based, especially in what we would have called MPT. That is primarily a software business for hospitals and physicians, along with our revenue cycle outsourcing business. Now, RelayHealth is a transaction processing business that obviously sits above all of that. Then you have got our Payor business in there. So I am going to give it some quick relativity, but I am guessing that we have somewhere in the neighborhood of, our profits are probably half out of the hospital business, and half out of the other businesses.

And when you say the slowdown, is it more pronounced in hospital, or are you just kind of taking an across the board reset on it?

It is much more, it is really across the board. Most of it is in the hospital and physician business. I would say the Payor and Pharmacy businesses are actually growing nicely for us. Remember the Pharmacy business is the transaction engine. So that is really an issue of volume going through pharmacies.

The Payor business, those customers are large customers that are using technology to improve their operations. I think the biggest slowdown we saw was in the hospital business and obviously a little bit in the physician marketplace. That is not as material to us as hospital CFOs holding up the POs.

Thank you. Just to drill down one more step. Have you noticed any difference in behavior of, say, large investment grade hospitals, compared to BBB hospitals and below? Or have you gotten that granular in your analysis?

I think it is a little too early to tell. Like I said, the first couple of weeks of this mess it didn't really matter. It was kind of sporadic.

You had some people to say listen, we are going to stop everything for a while and think about things. We had other people moving forward, and I am not sure that it was necessarily related to their credit rating. But clearly as we settle these things out, our larger more creditworthy customers, are going to continue to advance the ball.

I guess the last question, I mean, on share repos, what is kind of ironic and frustrating is at the very moment your stock is roughly a 9 to 10 PE, is the very moment that you are pulling back from the market, and you have kind of earned yourself a pretty good balance sheet.

I mean, specifically are you just concerned when the commercial paper market goes away, are you just concerned that you are going to get a freak-out in the bank market, and you find yourself with only, your cash available to you at some point in time, what is the nightmare scenario for companies like yourself, which really shouldn't have to worry about the things that you are trying to guard against?

Well, John, you should rest assured that we are as frustrated by the puzzle you just cited, which is obviously with our multiples where they are. We would see that as an opportune time to buy stock.

On the other hand, multiples are where they are because the financial environment is unprecedented, and who would have thought four months ago that you would see many of the events that we have seen? So clearly, the most important thing for our shareholders is that we manage the company prudently for the long term, that we position ourselves so that as John said, our strong balance sheet allows to us take advantage of opportunities that are sure to arrive in this environment. But that may not mean in the very near term being really aggressive about buying stock.

It is liquidity that specifically you just want to make sure you have liquidity to work through the 1929 scenario?

Yes. Short answer.

Thank you.

We have got time for one more question, operator, if we have got it.

Thank you. Our last question comes from Bret Jones. State your company name, and you may ask your question.

Thank you. Good evening. From Leerink Swann. Not to beat a dead horse here John, but I want to get a sense of the slowdown you are really seeing within the IT business. I know you talked about delays in the purchasing decisions. But I think it is the comment you made on the slowing implementations. Have you seen the slowdown spread beyond purchasing, and into customers actually delaying implementations? Thank you.

I guess, no we haven't to be frank about it yet. I guess the question is, it takes money on the hospital side to deploy and to implement, and it takes staffing. So I think one of the cautionary thinks Jeff and I are trying to talk about in a very transparent way, is gee, what happens if the customers don't have the wherewithal to implement the products that they have already purchased at the timeframe that we expected them to purchase them, because we want to make sure that we have an opportunity to understand that before we take away that caution.

And as to the buying cycle, I think there are still very focused on making these decisions. You have most of our product champions at the customer level continuing to tell us that they are going to buy the systems that they are working on, and our sales forces remain very optimistic and bullish about the funnel, and about the progress of the product lines, and sales cycle through the funnels. So one of the reasons that Jeff and I kept the range wider than some of you may appreciate for the rest of this year, is that as we get closer and closer to the fourth quarter, we are going to see how these orders start to loosen up.

Obviously, there is a whole bunch of this business that isn't order dependent, and that is why the bottom hasn't fallen out of our guidance. In excess of $3 billion in revenues there, there is a preponderance of it that is repeating revenue that stays there and is steady state, well over $2.5 billion of it is recurring kind of business in it's nature. So we are talking about the high margin software that has the chance to move us in the upper end of those ranges that we have given you, or not come in. That is really what we are focused on, is how do we get those order across the finish line.

None of the customers have said to us we are not going to buy them. None of the customers have said we are not going to buy the rest of the year. They have basically just said listen, we just want to take a pause here for a second, and re-evaluate our economic position from a balance sheet perspective, before we make any more major capital commitments.

I think that is fair, and I think that is probably prudent, certainly for some of our customers to take that position at the end of our quarter. Frankly as it stands right this moment, many of them might actually be moving through the buy cycle, as these markets begin to be more clear for our customers.

Thank you for that last question. I want to thank you, operator also, and I want to thank all of you on the call today. We do remain very excited about our offering across healthcare, and our ability to turn that into value for our customers and our shareholders. We appreciate your support, and the questions you asked today.

With that, I will turn it over to Ana, to give us some ideas of where we are going to be here in the coming weeks.

Thank you John. I have a preview of upcoming events. On November 4th, we will present at the Oppenheimer Annual Healthcare Conference in New York. On November 12th, we will present at the Credit Suisse Healthcare Conference in Phoenix. Our third quarter earnings release will be in late January. We look forward to seeing you at one or more of those events. Thanks and good-bye.

Thank you. That concludes today's conference. You may now disconnect from the audio portion, and thank you for your participation.