麥卡遜 (MCK) 2018 Q2 法說會逐字稿

Good day, and welcome to the McKesson Second Quarter Earnings Call. Today's conference is being recorded.

At this time, I'd like to turn the conference over to Craig Mercer. Please go ahead, sir.

Thank you, Jessica. Good morning, and welcome to the McKesson Fiscal 2018 Second Quarter Earnings Call. I'm joined today by John Hammergren, McKesson's Chairman and CEO; and James Beer, McKesson's Executive Vice President and Chief Financial Officer. John will first provide a business update, and then James will review the financial results for the quarter. After James' comments, we will open the call for your questions. We plan to end the call promptly after 1 hour at 9:00 a.m. Eastern Time.

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

Finally, please note that on today's call, we will refer to certain non-GAAP financial measures. In particular, John and James will reference adjusted earnings, adjusted operating profit margin, excluding noncontrolling interests, and items excluding foreign currency exchange effects. We believe these non-GAAP measures provide useful information for investors with regard to the company's operating performance and comparability of financial results period-over-period. Please refer to our press release announcing second quarter fiscal 2018 results for further information and a reconciliation of the non-GAAP performance measures to the GAAP financial results.

Thank you. And here is John Hammergren.

Thanks, Craig, and thanks, everyone, for joining us on our call. Today, we reported solid operational performance across our business as we make continued progress towards a strong finish to our fiscal 2018. For the second quarter, we achieved total company revenues of $52 billion and adjusted earnings per diluted share of $3.28. And we are reiterating our fiscal 2018 adjusted earnings range of $11.80 to $12.50 per diluted share.

Before I dive into the details of the quarter, let me briefly touch upon today's announcement that Paul Julian will be retiring at the end of the calendar year. I'd like to acknowledge the tremendous contributions by Paul over the past 2 decades. Paul's business acumen and strategic leadership have helped us expand our market reach as well as the breadth of services and solutions we offer to our customers. His dedication and tireless commitment to our people, our customers and the industry set him apart.

Starting in McKesson Health Systems, the company's distribution business for hospitals, he led many of the businesses that now comprise our Distribution Solutions segment. Paul has had a 4-decade career in health care. He has received numerous awards and throughout his career, been recognized for his many contributions. He has demonstrated exceptional character, accomplishment and leadership in the industry and in the community.

I've worked closely with Paul for many years, and he is my friend as well as a close colleague. His perspective and insights are critical to the growth and success of McKesson, including building a deep bench of talented leaders to carry McKesson into the future. On Paul's retirement, the Presidents of these businesses within Distribution Solutions will report to me. I will miss working with Paul and wish him the very best in this new chapter of his life.

Turning now to our business results. Our North American pharmaceutical distribution and services businesses, which include U.S. Pharmaceutical, McKesson Specialty Health, McKesson Canada and our recently formed McKesson prescription technology solutions business, had year-over-year revenue growth in the second quarter of 5% on a constant-currency basis.

I'd like to discuss a few highlights in our U.S. Pharmaceutical business. We are recognized as a leader in delivering novel solutions to the market. We find innovative ways to expand our value proposition across the entire supply chain. For example, AccessHealth continues to successfully partner with independent pharmacies, enabling improved financial performance and broadening access to narrow patient-payer networks.

We also recently closed the BDI Pharma acquisition. This business complements our existing plasma offerings and allows us to expand Plasma and Biologics distribution into specialty pharmacy and homecare with differentiated expertise.

And ClarusONE, which is performing in line with our plan, leverages our scale and our unique in-house sourcing capabilities.

These examples demonstrate our ongoing strategy to build scale, expand our pharmaceutical offerings, enhance our manufacturer value proposition and enable our customers continued success.

Next, we're pleased with the progress of our multiyear initiative to implement differential pricing for brand, generic, specialty, biosimilar and OTC drug classes as we work through our contract renewal cycles.

Finally, Walgreens' asset purchase of a number of Rite Aid stores was approved by the FTC last month. Based on Walgreens' public statements, that they began last week to transition stores and will carry through the spring of 2018, we expect to be impacted in our fourth quarter as stores progressively migrate to Walgreens over the transition period.

We've been having constructive dialogue with Rite Aid on how we can continue to support their success during the transition period and beyond to the mutual benefit of both parties. And as I've mentioned in the past, Rite Aid has only a modest impact on our P&L, and we are comfortable that our sourcing scale and capability will not be impacted by this transition.

Turning now to McKesson Specialty Health. With the closing of the intraFUSION acquisition earlier this quarter, along with the BDI Pharma acquisition I spoke about a moment ago, I'd like to highlight how we continue to enhance our specialty capabilities across the organization.

We provide manufacturers with an integrated solution set, starting from clinical research and development to drug launch and distribution services, and from patient reimbursement and access solutions to real-world evidence-based capabilities. Biologics and biosimilars continue to represent an emerging opportunity for the industry. We are proud to be a leader supporting clinical trials for these and other innovative new therapies for many years. And I'm excited about the opportunity that CoverMyMeds provides across our businesses with the e-referral platform for specialty prescriptions connecting providers with specialty pharmacies and payers and improving care coordination and care manager for complex health conditions.

I'll move next to our Canadian business, where we saw a nice growth in the quarter with constant-currency results that were in line with our expectations. During the quarter, McKesson Canada closed the Uniprix banner acquisition, where we will continue to offer Uniprix owners retail banner management expertise and best-in-class supply chain network, designed to ensure patient safety and reduce costs.

All of these services help strengthen independent pharmacies. Unit pre-integration activities are progressing well as are those supporting the GMD Distribution acquisition. And our McKesson prescription technology solutions business continues to make progress on the CoverMyMeds integration. We are encouraged by the level of collaboration we are already seeing between CoverMyMeds and our other businesses.

Turning now to our results for International pharmaceutical distribution and services. On our last earnings call, we mentioned that recently announced reimbursement cuts in the U.K. were in excess of historic levels and also greater than what we had planned for in fiscal 2018. After studying the nature of the cuts, we decided it was necessary to take action to position the business for sustained, long-term growth by initiating a plan to rationalize our store footprint and streamline our back-office operations. As a result, we recorded certain charges within our U.K. retail operations. James will provide more detail on these items.

We see our global retail presence as a way to stem the tide of growing health care costs as we anticipate more services migrating from higher-cost locations into the lower-cost pharmacy setting. And we believe the pharmacist plays an important role in providing a range of health care services.

And finally, our Medical-Surgical business continues to deliver consistent results, benefiting from the shift of care to lower-cost sites. In summary, I was pleased with our how our Distribution Solutions segment performed in the quarter.

Turning now to our Technology Solutions segment. We reached another milestone on October 2 with the sale of our Enterprise Information Solutions or EIS business. This represents another important step in the strategic shift to realign our business focus on Distribution Solutions, following the creation of Change Healthcare earlier this calendar year.

It's a testament to the team at EIS when we consider the results they achieved for the first half of the year, given the uncertainties around the extended strategic review process that is now complete. In addition, I have confidence that the EIS customers have a partner committed to their success.

For Change Healthcare, we continue to see encouraging progress against the execution of the business case and the realization of the anticipated cost synergies.

And to summarize, McKesson's fiscal second quarter results represent solid execution across the enterprise, and we are reiterating our adjusted earnings range of $11.80 to $12.50 per diluted share for our full year fiscal 2018 outlook. We are extremely well positioned to execute our portfolio approach to capital deployment and deliver value for our shareholders through a mix of internal capital investments, acquisitions, share repurchases and dividends.

Before I hand the call over to James, I'd like to spend a moment on a topic of national importance, the opioid epidemic. This is a crisis that has touched many Americans and including many Americans that live here at McKesson and are part of our family. McKesson takes our role in the supply chain very seriously. We've invested considerable time and resources to help stop diversion at a time when diversion tactics are constantly changing. We've implemented sophisticated analytic tools, hired experienced diversion investigators and enhanced the effectiveness of our controlled substance monitoring program.

We have worked collaboratively with the DEA to better understand diversion trends. This working relationship is critical since the DEA has singular line of sight into the total volume of opioids sold to any licensed pharmacy or hospital. The trends in this crisis continue to evolve, and we are regularly enhancing our programs to further limit the misuse and abuse of prescription opioids by simultaneously protecting the availability of the appropriate treatments for patients with serious illnesses and injuries.

But our company's and our industry's commitment to public health and safety was recently called into question by certain media outlets. Those outlets sought to place blame for the tragic opioid epidemic on distributors and elected officials, who, with bipartisan Congressional support and after consultation and input from the DEA and the Department of Justice, enacted a clarifying enforcement bill that was signed into law. As recent Congressional testimony indicated, since the passage of the law, the quantity of opioids distributed has decreased and the number of enforcement actions by the DEA has increased.

Many press articles have since corrected the misinformation that resulted from those earlier media stories. And subsequently, there's also been more attention put on the need to control the annual production of opioids, on the illicit opioids entering our country from other sources and on the critical role of health care professionals who are at the front lines in dealing with patients and ensuring that only patients with legitimate medical needs receive the appropriate amount of these medications.

McKesson is also committed to helping promote forward-looking solutions to this public health problem. That's why over a year ago, we convened a task force of policy and clinical experts to help create a public policy white paper, which outlined a set of proposals to help combat the epidemic going forward. These proposals include changing the medical community's approach to prescribing opioids, requiring e-prescribing to avoid modification or manipulation of the prescription and creating a national patient safety network that provides real-time patient information to pharmacists while they are directly interacting with the patients seeking these drugs. We look forward to continuing to work with all parties, federal, state and local governments, manufacturers, insurance companies, pharmacies and the medical profession to implement practical and effective solutions.

And last, let me touch upon the tragedies that recently unfolded across the U.S. and Puerto Rico. McKesson was fortunate to have avoided material impacts to our operations or to our facilities from the devastation resulting from Hurricanes Harvey, Irma and Maria and the recent fires across Northern California. We are proud to have played a role in the emergency efforts providing pharmaceuticals and medical supplies to the affected areas. Our employees in the McKesson Foundation have been extremely generous with their support for displaced coworkers and other residents, contributing more than $700,000 in relief efforts. We continue to aid in the recovery of our affected employees, customers and communities.

With that, I'll turn the call over to James, and will return to address your questions when he finishes. James?

Thank you, John, and good morning, everyone. Today, we reported second quarter adjusted EPS of $3.28, which was slightly better than our previous expectations. And we are reiterating our fiscal 2018 adjusted earnings outlook of $11.80 to $12.50 per diluted share.

Unless stated otherwise, the underlying assumptions that were detailed in our fourth quarter fiscal '17 press release and on our first quarter fiscal '18 earnings call are being reiterated today. I will talk in more detail about our outlook. But first, let's review our results for the quarter.

GAAP earnings per diluted share from continuing operations equated to $0.01 for the second quarter. These earnings include impairment and restructuring charges of $2.60 per diluted share related to our retail pharmacy business in the U.K.

As we discussed on our last earnings call in July, the U.K. government announced additional reimbursement cuts, which were incremental to their more typical annual reimbursement reductions and to those assumed in our plan. Primarily as a result of these cuts, we have identified and started to implement initiatives to partially offset the impact of these cuts, which include approximately 190 store closures and divestitures.

The resulting savings from this program are expected to more meaningfully benefit our fiscal 2019 performance. The program's total asset impairment and restructuring charges are expected to be between $650 million and $750 million. Specific to the second quarter, we recorded goodwill and other long-lived asset impairment and restructuring pretax charges totaling $586 million. As a reminder, these charges will impact our GAAP financial results. However, they will be excluded from adjusted earnings.

Now let's turn to our second quarter adjusted earnings, which exclude the following items: amortization of acquisition-related intangibles; acquisition-related expenses and adjustments; LIFO inventory-related adjustments, gains from antitrust legal settlements; restructuring charges; and other adjustments.

Turning now to our consolidated results, which can be found on Schedules 2 and 3. Consolidated revenues for the second quarter increased 4% in constant currency year-over-year. Second quarter adjusted gross profit was up 2% in constant currency from a year ago. And second quarter adjusted operating expenses increased 6% in constant currency year-over-year.

Adjusted other income was $27 million for the quarter, an increase of 8% in constant currency. Adjusted equity income from Change Healthcare was $75 million for the second quarter. We are encouraged by the progress of Change Healthcare and continue to expect our adjusted equity income from Change Healthcare's joint venture will be between $250 million and $310 million in McKesson's fiscal 2018 P&L.

Interest expense of $69 million decreased 12% in constant currency for the quarter, driven primarily by the refinancing of debt at lower interest rates.

Our adjusted tax rate was 23.6% for the quarter, driven by our mix of business. Our full year tax rate for McKesson is now estimated to be approximately 24%, down from our previous estimate of 25%, reflecting our mix of business.

Our income attributable to noncontrolling interests, or NCI, was $55 million for the quarter, an increase of 218% in constant currency. As a reminder, the increase in NCI year-over-year is primarily driven by fee income from ClarusONE, our joint sourcing entity with Walmart. We now expect income attributable to noncontrolling interests to be between $210 million and $230 million in fiscal 2018, reflecting ClarusONE's ongoing success at sourcing generics at prices lower than we originally expected.

Our adjusted net income from continuing operations totaled $689 million, with our second quarter adjusted EPS at $3.28 per diluted share, up 11% compared to $2.96 in the prior year. Second quarter EPS growth was driven by organic growth across multiple business units, including ClarusONE, a lower share count and incremental profit contribution from acquisitions, which more than offset the year-over-year lapping effect of increased price competition in our independent pharmacy business in fiscal 2017 and the impact of reduced reimbursement in our U.K. retail pharmacy business.

Wrapping up our consolidated results, diluted weighted average shares outstanding were 210 million, down 8% compared to the prior year period.

Let's now turn to the segment results, which can be found on Schedule 3. Distribution Solutions segment revenues were $51.9 billion. On a constant-currency basis, revenues were up 5% year-over-year. Reported revenues benefited from $344 million in favorable currency rate movements.

North America pharmaceutical distribution and services revenues increased 5% in constant currency, driven by market growth and acquisitions, partially offset by brand-to-generic conversions. International pharmaceutical distribution and services revenues were $6.8 billion for the quarter. On a constant-currency basis, revenues were up 4%, driven by acquisitions and market growth. Reported revenues benefited from $237 million in favorable currency rate movements.

As a reminder, our previous full year assumption was that foreign currency exchange rate movements would have a net unfavorable impact of up to $0.05 per diluted share year-over-year. During the quarter, foreign currency rates trended favorably versus our original assumptions. As a result, we now expect foreign currency exchange rate movements will have a net favorable impact of approximately $0.10 for the year.

Moving now to the Medical-Surgical business. Revenues were up 2% for the second quarter, driven by market growth. Distribution Solutions adjusted gross profit was up 15% on a constant-currency basis for the quarter, driven by acquisitions, organic growth across multiple business units, including strategic sourcing benefits from ClarusONE, and increased branded compensation, more than offsetting the planned year-over-year lapping effect of increased competition in our independent pharmacy business in fiscal '17 and the impact of reduced reimbursement in our U.K. retail pharmacy business.

As we discussed previously, following the close of the second quarter, we have now fully lapped the impact of increased competition in our independent pharmacy business. And the sell-side pricing environment continues to remain competitive with less pricing variability.

Now let me turn to branded compensation and branded pharmaceutical price increases. As noted on our first quarter earnings call, based on our previously discussed differential pricing effort, we renewed contracts with 2 large branded manufacturers during the first quarter. These renewals drove lower compensation in the first quarter and a resultant step-up in compensation in the second quarter.

Additionally, in the second quarter, we also benefited from a pull-forward of certain branded compensation that we had expected in the third quarter. That said, our expectations for the full year contribution from branded compensation remain unchanged. I'd like to remind everyone, however, as is typical based on our historical experience, that the majority of manufacturer pricing activity is expected to occur in our fiscal fourth quarter.

Distribution Solutions segment adjusted operating expenses increased 18% on a constant-currency basis for the quarter. Segment operating expenses reflect an increase driven by acquisitions and the increased mix of retail business in the segment, partially offset by our ongoing cost management efforts.

Going forward, we expect our full year adjusted operating expenses, as a percent of revenue, to be at levels roughly consistent with the first half of this year.

As we diversify our Distribution Solutions businesses, our adjusted gross profit margin rate benefits from our recent retail pharmacy and technology acquisitions. Similarly, these acquisitions are increasing our adjusted operating expenses as a percent of revenue.

Now to our adjusted operating profit. Distribution Solutions segment adjusted operating profit was up 12% in constant currency year-over-year at $1 billion. The segment adjusted operating margin rate was 201 basis points on a constant-currency basis, an increase of 13 basis points, driven by the same factors as previously discussed, partially offset by our customer and product mix, including the growth of higher-priced specialty pharmaceuticals. As a result of this revenue mix and the pressures on our U.K. business, we now expect our full year Distribution Solutions adjusted operating margin rate to be at the lower half of our previously guided range of 198 to 208 basis points.

Now moving to Technology Solutions. As a reminder, in fiscal 2018, MTS segment revenues, adjusted gross profit and adjusted operating expenses contained only the results of our Enterprise Information Solutions business or EIS. Revenues were $120 million while adjusted segment gross profit was $60 million. Adjusted segment operating expenses were $44 million and adjusted operating profit, excluding the equity contribution from Change Healthcare, was $17 million.

Additionally, following the close of the quarter, we completed the sale of our EIS business. As a result, there will be no contribution from this business in the second half of fiscal '18. As a result, going forward, MTS operating profit will represent only the equity contribution from Change Healthcare.

I'll now review our balance sheet metrics. As you've heard me discuss before, each of our working capital metrics can be significantly impacted by timing, including which day of the week marks the close of a given quarter. For receivables, our days sales outstanding increased 1 day from the prior year to 27 days. Our days sales in inventory increased 2 days from the prior year to 31 days and our days sales in payables increased 2 days from the prior year to 61 days.

We ended the quarter with a cash balance of $2.6 billion, with approximately $1.9 billion held offshore. And in the first 6 months of fiscal 2018, McKesson generated $1.3 billion in cash flow from operations.

We continue to deploy capital in line with our portfolio approach. In the first 6 months of fiscal '18, we spent $255 million on internal capital investments and repaid $545 million in long-term debt.

In the second quarter, we repurchased $400 million in common stock. The FY '18 EPS impact of this buyback approximately offsets the loss of EIS's earnings in the back half of this fiscal year. Share repurchases during the first 6 months of fiscal '18 now total $650 million. And we now expect our weighted average diluted shares to be approximately 211 million for the full year, reflecting share repurchases completed in fiscal '18.

We have approximately $2.1 billion remaining on our share repurchase authorization. We spent $1.9 billion on acquisitions during the first 6 months of fiscal '18, which includes the second quarter acquisitions of intraFUSION, BDI Pharma and Uniprix, all of which we discussed at Investor Day. And yesterday, the Board of Directors approved the next quarterly dividend of $0.34.

Now let me briefly touch on Rite Aid. Our original guidance range assumed a full year revenue contribution from Rite Aid of approximately $13 billion and an estimated annual adjusted earnings per share contribution of between $0.20 and $0.40. We also noted that should Rite Aid be acquired by Walgreens, we would expect a material onetime cash flow impact driven by the favorable working capital terms associated with our Generics business.

In September, Walgreens announced it had received regulatory clearance to purchase approximately 40% of Rite Aid's stores and that some store transitions would begin this month and all impacted stores would be a part of Walgreens' operations by the spring of 2018.

We will keep you updated on the earnings and cash flow impact of the eventual store transition program during the next 2 quarters. While our relationship with Rite Aid will be smaller going forward, the performance of ClarusONE continues to illustrate the competitiveness of our global sourcing scale and operations.

Now let me provide more detail on our fiscal 2018 adjusted EPS outlook. We are reiterating our fiscal 2018 adjusted earnings of $11.80 to $12.50 per diluted share. This reiterated range includes: the earnings headwinds of the recently completed sale of our EIS business; an estimate of the impact of the Rite Aid store transition; and our projection of the challenges expected in the U.K. during the remainder of FY '18.

Offsetting these headwinds, our guidance range benefits from: share repurchases completed in the second quarter; the anticipated favorability to results driven by foreign currency exchange rate movements; and the new estimated adjusted tax rate of approximately 24%. The various items that I've just mentioned largely offset one another, resulting in our reiteration of the previously guided range.

Each year, as we develop our annual plan, we contemplate a range of possible outcomes. Based on our performance year-to-date, I continue to be comfortable with the midpoint represented by our full year guide.

As for our quarterly progression, let me remind you of my earlier comments regarding the pull-forward of branded compensation that we had originally expected in the third quarter. And, as in most previous years, we expect our fourth quarter to be our largest in terms of EPS contribution in the fiscal year.

In closing, our second quarter results were somewhat ahead of our expectations, driven by timing. And I'm pleased to be able to reiterate our full year guide in the face of the sale of EIS, the transition of the Rite Aid stores and the U.K. headwinds. And as a reminder, our fiscal 2018 adjusted earnings of $11.80 to $12.50 per diluted share excludes the following items: amortization of acquisition-related intangibles of $2.40 to $2.70 per diluted share; acquisition-related expenses and adjustments of $0.90 to $1.10 per diluted share; LIFO inventory-related charges of $0.20 to credits of $0.10 per diluted share; gains from antitrust legal settlements of up to $0.10 per diluted share; restructuring charges of $1.10 to $1.40 per diluted share; and other net charges of $1.40 to $1.60 per diluted share.

Thank you. And with that, I will turn the call over to the operator for your questions. (Operator Instructions) Jessica?

(Operator Instructions) And we'll first go to Robert Jones of Goldman Sachs.

James, a lot of moving parts but wanted to make sure I understood what was factored into the full year guidance today versus the previous update. So just is it correct to assume that guidance now contemplates roughly an additional $30 million from additional U.K. reimbursement cuts that weren't in the previous guidance? And then, with the EIS divestiture or sale intra-quarter, is that about $35 million that you're absorbing into the full year range that's unchanged? Are those the 2 biggest new things that we should be thinking about in the full year guidance range?

Well, in terms of the 3 headwinds, U.K., EIS and Rite Aid, so in the U.K., I would say the figure is higher than what you were mentioning there. So we'll update you as time goes by. With EIS, as I mentioned, feel as though the EPS impact in FY '18 of the buyback roughly offsets what we would have benefited from EIS in our back half of the year. And for Rite Aid, you can think about the original guide that we put out of $0.20 to $0.40. Effectively, we're going to have about a 10% effect of that in the balance of the fiscal year. So hopefully, that helps give you a little bit of direction around that.

No, it does. I guess just ultimately, trying to get a better sense that there really was not a change to the core drug distribution outlook then as we think about the previous update relative to this update. Is that a fair statement?

That's right because again, the 3 items, the U.K., the EIS and Rite Aid, obviously 2 of those are embedded within the Distribution Solutions business. Those are, in essence, being offset by share count, tax rate and FX assumptions.

Okay, great. And then just, John, a quick follow-up, 2 significant management departures announced this week. Can you talk about the process as you think about backfilling big shoes to fill with Paul and Mark's departures announced this week?

Sure. As you might expect, the management team and the board have a very rigorous process of not only talent development and talent review and sort of talent planning, but also a lot of work is done particularly at the higher levels in terms of succession planning. So Paul and I have worked together for an awfully long time. And one of the priorities we've had together for that entire tenure together has been the development of a very strong bench. We announced very quickly a replacement for Mark Walchirk upon his departure. And we're really pleased that not only the contribution he's made to us over his career, but the fact that he landed an important job, and it shows that McKesson executives are sought after and that they're well trained and that they can take on big responsibilities. So I think that's the good part of that news for him certainly. And we're excited that we are able to replace him in the new combined responsibility for both our U.S. Pharmaceutical business and our specialty business with Nick Loporcaro. You probably met Nick on occasion on our Investor Days. Nick runs our specialty business now and will also have the combined responsibility for our U.S. Pharmaceutical business. And frankly, I think Nick is very well suited for this job. He ran all of our Canadian distribution and operations businesses in Canada. He knows retail pharmacy well. He knows hospital pharmacy. He knows independents and chains. He understands the manufacturing environment. He certainly understands what we think is a significant going-forward opportunity in specialty, so -- but we're excited about his leadership and what he can do for us. And as I said, it's not as if Paul was going to be here forever. And we've been always thinking about how are we going to make sure that we're well positioned in the event that he decides to pursue retirement. So I'm excited for Paul, excited for Mark and especially excited for Nick.

And we'll now go to Charles Rhyee from Cowen & Company.

Just to follow up on the cadence in the guidance, James. Is there any -- you talk about the pull-forward -- or, I'm sorry, the step-up in 2Q from the manufacturer contracts. Are there any kind of step-downs in the back half of the year that we should be aware of?

Well, I would say, as you think about the progression of Q3 and Q4 and the relative contribution of those quarters to the full year, I would see Q4 generating a number of percentage points more than Q3 will. And indeed, I commented on that, that brand pull-forward into Q2 from Q3. So I think that, hopefully, helps a little bit on the sequencing of the quarters.

Okay, that does. And then, John, you talked about moving into differential pricing. Can you comment on the progress that you've seen so far? And in particular, are you seeing any kind of pushback from clients, maybe from some of your larger ones? And maybe can you help characterize what those discussions look like?

Thanks for the question, Charles. We have been in a consistent process with our renewals of our agreements with our customers. And I think we've been quite successful. I mean, our customer base understands that the pricing that we used 20 years ago, which were basically brand and generic, and even mostly brand if you go back that far, it just doesn't work in today's environment. And having a more specific approach to pricing categories or products that are more similar to one another, we think is better for us and frankly better for them as well. You're not mixing discounts between different types of products and different revenue and margin characteristics and it just provides better clarity for both of us. So I think we've been almost universally successful in getting this accomplished. And we feel confident we will continue to do so as we finish this contract renewal cycle over the next several years.

And we'll now move to George Hill from RBC.

And if Paul's listening, I want to wish him well, John, because I know he's served you a long time. I guess, James, I would ask, is there any chance that you can quantify kind of the impact of ClarusONE and the brand drug pull-forward in the quarter? And should we think of the brand drug impact as not repeatable in Q3 but ClarusONE should be a more sustainable contribution? And I'm just trying to make sure I have a good understanding of the cadence of the balance for the year.

Yes, in terms of the branded conversation, as I mentioned, where we do have these timing elements from Q1 to Q2, from Q3 into Q2. But for the overall year, we're not expecting a change in the branded comp that we would receive. In terms of ClarusONE and their work around the generics, we've been very pleased with how that has proceeded. I mentioned in my remarks that the NCI line reflects the progress that ClarusONE has been making at sourcing pharmaceuticals at lower prices than we had expected at the outset of the year. So our COGS are benefiting -- our Walmart colleagues' COGS are benefiting from the progress that ClarusONE is making.

Okay. Then maybe my follow-up would just be a little bit nuanced, as the outperformance in the quarter, I guess, versus consensus expectations was pretty strong. Should we think of that largely as the timing of the brand contribution versus maybe what The Street might have been expecting for the year?

Yes, that's certainly one driver of it. Obviously, tax rates has come down as well. We've updated our full year guide in that regard, so -- and I did note that Q2's results were slightly ahead of where we had planned to be originally at the start of the year.

Our next question comes from Ricky Goldwasser from Morgan Stanley.

So 2 questions. First, John, for you, we're hearing obviously a lot of discussion and getting a lot of questions on Amazon. Can you just share with us your thoughts? And also, do you see opportunity for you guys to work together with Amazon if they were to enter the drug supply chain?

Thanks for the question, Ricky. To some extent, we were Amazon before it was cool to be Amazon. If you think about our business model, largely it is an online order relationship from an order processing perspective that is very well functioning, that has been in place for a long time, next-day delivery and a complete process from a logistics perspective. But it's also supported by field salespeople, return goods management, sometimes private trucking and certainly, things like controlled substance management, billions of dollars of inventory and very significant back-office operations that reconcile the significant delta in various pricing strategies that our manufacturer partners built in medical supplies as well as in pharmaceuticals rely upon with us in partnership. So I would say in some ways, it's very similar to what Amazon would do maybe logistically. But if you actually think about what's behind the scenes in terms of us taking credit risk, in terms of us processing invoices and processing returns and then processing pricing on a regular basis, it's quite significant and more nuanced perhaps than it would appear on the surface. Clearly, we are also heavily focused on trying to make sure that our customers have the right tools and capabilities to help them with all of their -- particularly in the independent side, with all of their requirements in terms of patient relationships, to make it more than just a transaction and make it a health care experience supported by a professional pharmacist that really understands the nuances of drug-to-drug interaction, understands what it means to dispense things like opioids and other products and understands certainly, the regulatory framework and the larger clinical issues that may be facing the patients that they're working with every day. So the easiest thing to talk about in the world of wholesaling is the logistics function. But I would say that that's probably the simplest part of our business. And clearly, we try to excel in myriad of other areas that we think differentiate us. Having said all of that, we don't take the entry of any competitor lightly. And we continue to evolve our strategy so that our value to both the manufacturer and to our customers is unique and superior.

Okay. And then just a follow-up question in terms of the guide and the progression. So you've tightened the range on your LIFO credit. So what are you seeing in terms of the deflationary environment? And how do you think about the progression for the second half of your fiscal year? And then also, how should we think about that in context of your distribution operating margin goals for the fiscal year?

Well, in terms of generic deflation, as we've discussed before, ClarusONE is doing an excellent job. We're purchasing pharmaceuticals at lower prices than we'd expected when we first put the plan together. Now, again, as we've discussed, that equation of optimizing our cost of goods sold is quite separate to the economic equation on the sell side, where I mentioned in my prepared remarks that certainly, the environment is still competitive but with less pricing volatility than we would have been looking at this time last year. In terms of our Distribution Solutions operating margin guide, I felt appropriate to really direct you to the lower half of that original guided range based on the U.K. situation that we've been discussing at some length. And then, of course, there'll be some effect on the P&L that will impact the Distribution Solutions operating margin from Rite Aid as well as those stores transition at a yet-to-be-determined rate.

We will now go to Lisa Gill from JP Morgan.

I also want to add my congratulations to Paul on his retirement, and we'll definitely miss him, John. First, I'm just trying to reconcile a number of the statements that have been said today. James, you just talked about sell-side pressure continuing, being less volatile. You talked about the benefit to COGS on ClarusONE. Is the expectation as we move throughout the rest of the fiscal year that you have to share some of that ClarusONE savings back with customers? I'm just trying to understand how do we think about ClarusONE specifically as we're thinking about the cadence of the quarters.

Well, actually, I think the best way to think about it, as James mentioned a moment ago, is really in 2 distinct buckets. Our ability to manage our costs across the board are an important aspect of what we do. And whether it's a cost of our operations and the productivity improvements we get, or whether it's the cost of the goods we purchase, driving those costs down to market levels or below should be our priority. And our focus has always been to buy right and to manage right and to be efficient. The second priority is to make sure that our customers are getting the deal that they need to continue to be competitive in the marketplace. And largely, that's determined on what the market price is for products. And we have a completely separate team that decides what we're going to sell products for from what the team is that does the buy-in of our activity. And we're focused on making sure that we have the right data on both sides of those operations to assure ourselves of market competitiveness. And that's what we're attempting to do. And that's where the margin comes from is our ability to manage those operations with hopefully solid execution. So that's the way we think about it. So the more we overachieve with ClarusONE and the more stable the market can be, then the more likely it is for us to get margin expansion over time to grow our business. That should be our priority for it to create value.

Okay, that's helpful. And then secondly, John, you did mention in your prepared comments in talking about the opioid issue in the U.S. and talking about these media reports. Over the last several years, the drug distributors have had several settlements around DEA issues, et cetera. Can you maybe just talk about what your anticipation is around opioids? Would you expect that there will be some cash flow impact, we'll see incremental settlements? Or do you think that that's largely behind you at this point, and this is more of a regulatory issue rather than the states coming back to the drug distributors looking for some kind of settlement?

Well, in a larger context, not even speaking necessarily about this particular issue, when you're faced with litigation or litigation risk, you usually find opportunities to try to determine whether or not there's any real risk there or any data that would support the alleged activity or risk that you may be facing. And you trade that off against what would it cost for us to not -- to eliminate that risk and the associated potential liability effect if you're not successful. So I think all of those decisions are made on their own and probably in isolation from one another. Are we concerned about opioid and the continued risk in things that are going on in the marketplace? Certainly. But we're probably more focused -- as I tried to mention in my conversation at the beginning here, we're more focused on solutions that we think can make a difference. Frankly, lawsuits from various parties and settlements don't solve the problem. What solves the problem is thinking in a broader context and putting the solutions in place that can actually prevent this from happening. And when I mentioned physicians at the start of this, it really is related to how they think about the prescriptions they are providing to their patients and the quantities that they're writing in those scripts. Clearly, whether the script is legitimate or not, when it shows up at the pharmacy, if we use electronic prescribing, that can make a difference. And third, if we have information about the patient real-time in the workflow at the pharmacy, when they're doing the rest of their adjudication of the claim, if they understood that the patient recently had 4 other scripts filled in the last 2 weeks from 5 different pharmacies across state lines, it might give them a little bit of a pause before they fill one more script. And that's certainly a portion of the problem. And we think those solutions can be easily implemented. We think the technologies are available today. And it will make a material impact certainly on that source of the opioid diversion epidemic challenge. There's a whole another source. If you watch the news today, they talk about coming over borders. They talk about it being imported from other countries and online ordering of these kinds of drugs that are packaged in different types of packaging to avoid detection. There's all kinds of sources of these products. And clearly, at the very start of this whole thing is how do we help prevent people from becoming addicted to these drugs to begin with. So it is a much larger problem. We're trying to focus on solutions. And I -- some people ask me if this is going to be a tobacco overhang. And I don't think that's what we're going to face as an industry. I mean, clearly, we have a role to play. But we don't see the patient. We don't prescribe the drugs. We don't dispense the drugs. We don't have all the data on the care. And I don't know how we could be responsible solely for this challenge.

And we'll now go to Kevin Caliendo from Needham & Company.

So a question -- another question on ClarusONE. Looking at the noncontrolling interest line, it was sort of flat sequentially. And for the year, your guidance implies not a significant amount of growth in that number over the course of the year. I guess my question is, is ClarusONE a growth opportunity sort of going forward? Or are we sort of peaking? Is this something that can grow as we get into fiscal '19?

Well, I think when we talk about ClarusONE, it's important to think about the 2 places on our P&L where it drives the benefit. So the first place is the cost of goods sold.

Yes. And maybe I can jump in there because the NCI is really not an indication of ClarusONE's opportunity and its growth. It is an accounting-related matter that James will address here in just a moment. But we see a great opportunity with ClarusONE, frankly. Today, it's focused primarily on generics. And as James mentioned, we actually overachieved our objectives in terms of the results of our sourcing activity. And it's being reflected in our cost of goods. And obviously, we're pleased with that. But beyond just generics and beyond just generics in the U.S., we think ClarusONE can grow. Walmart is very satisfied with what we've done thus far. And our ability to expand into other product categories and other geographies in partnership of Walmart, we think will be continued opportunities for us to grow the ClarusONE relationship, and thus the impact on ClarusONE's cost of goods into our businesses and other categories. And that may or may not affect the NCI line. The NCI is really an artifact of the curve construct of the generic relationships we have and the JV partnership that we have and it's an output basically from that relationship as opposed to something else that we put into this category, OTCs or something else, may not have an NCI component to this.

So think of the cost of goods sold line as the line that receives the primary benefit from the work of ClarusONE. Then the NCI line is -- as I mentioned in my prepared remarks, is fee income. So think of that as the fees earned by ClarusONE, which is a contracting entity in many ways. And so again, in the text, I mentioned that the future guide for the NCI line is really underpinned by the fact that as ClarusONE continues to have more success than we originally planned for in its sourcing capabilities, then there'd be a lesser level of fee income enjoyed by ClarusONE. So I think that's an important distinction to make between COGS and the NCI line, and then focusing on the NCI line as fee income from a contracting outfit.

And there are other things at NCI that aren't related to ClarusONE at all.

Yes, there are multiple other drivers in the NCI line. So those can drive volatility in any 1 particular quarter.

That's incredibly helpful. One just quick follow-up, you've spent about $1.9 billion in acquisitions. You've highlighted them to us already. Is there any potential impact from these acquisitions in the second half of this year? Or is it -- would the benefits be mostly a fiscal '19 type of event?

Well, I think it's most likely going to fall into FY '19. We contemplated the closure of some of these acquisitions as we provided the original guidance. And we knew that certain of these transactions were going to close. But I don't think they'll have any material impact on our FY '18 guidance. And whatever impact we do anticipate is embedded in our reaffirmation of that guidance today.

And we'll now go to Eric Coldwell from Baird. Hearing no response, we'll move to Erin Wright from Crédit Suisse.

In follow-up to the last question, I guess, can you give us an update on the performance and where we stand with some of the potential synergies and contributions from some of the recent acquisitions, like CoverMyMeds and Rexall and Biologics? And can you also speak to maybe the profit profile of some of the more recent acquisitions that you've done?

Yes, I'd say that our approach to the integrations of those various transactions that you note are going along nicely. We're hitting our synergy cases and so forth. So no, we're pleased. We feel as though those acquisitions fit very nicely with the strategies that we're pursuing across our organization. So here, in terms of...

The margin profile. I'll just say, I mean, that's going to follow more aligned with the kind of businesses that they are. So the distribution-related businesses will have more of a distribution margin and the technology businesses, like CoverMyMeds, will have a margin rate that's much more higher -- much higher and much similar to the rest.

Yes. And one further thing that I would note, going back to how we were talking about operating expenditure for the full year, multiple of those transactions, those acquisitions, fall into either the retail arena or the technology arena. And in those types of businesses, you tend to have more operating expenditures as a percent of revenue than would be the norm for our traditional business.

That's in the OpEx line, right?

Okay, great. And then I guess a follow-up to that one as well. I mean, as you think about your capital deployment strategy and the priorities there in terms of acquisitions, do you see sort of a healthy pipeline out there, opportunities potentially in tangential businesses? And what sort of annual deal spend do you continue to expect at this point?

It's probably difficult to speculate on what the annual deal spend would be. I think what's best for us to sort of reaffirm here is that we do prefer M&A. But as you know, we do this in a portfolio way. We're not afraid to do share repurchases. We talked about our share repurchases in the quarter. We clearly talked about our dividend again in this press release and we talked about M&A. The critical thing from my perspective is that the M&A has to make financial sense. And we focus on our long-term cost of capital and making sure that these acquisitions come in well above our cost of capital and that we get the kind of returns that are appropriate on these investments. And to answer the other part of your question, we do have a pipeline of acquisitions that we actively work almost seemingly all the time. And sometimes, they come to be and sometimes they don't for various reasons. But I think we're pleased that there are still opportunities for us in various markets.

And we'll go to John Ransom from Raymond James.

Just one thing in our model. There seemed to be a big sequential drop in depreciation from the second quarter. So the EBIT number was better, but the EBITDA number was a little below our number. Can you provide some help on that number? Is this the new normal, given some of the portfolio changes that you've made?

Well, perhaps one thing to note is that as we proceeded to be close to the sale of EIS to Allscripts, that transaction closed on the first day of Q3, but in terms of the way our accounting runs, we've put it as held for sale in Q2. So that might be one of the items that you'd want to focus on.

But I mean -- so you were running about, what, $27 million or something in depreciation in the third. It was like a $70 million drop. I'm just asking on a go-forward basis, is this the right depreciation number for the back half of the year?

Well, I wouldn't expect anything material in terms of the rate and pace of change in depreciation. But we can certainly follow up with you, John, on the specifics.

And that is all the time we have for questions today. I'll turn the conference back over to our presenters.

Thanks, Jessica. And thanks to all of you on the call for your time today. I also certainly want to once again say thanks to Paul Julian for nearly 25 years of friendship and 21 years here at McKesson. And I'm confident that, in return, that he and I are going to continue to stay close. And I wish he and Michelle all the best and his family going forward.

McKesson continues to execute against our fiscal 2018 plan. And I'm excited about the opportunities ahead of us. I want to recognize the outstanding performance of our employees and their contributions to help our customers improve lives and deliver opportunities to make better health possible as most clearly demonstrated this quarter by how we came together to provide the support to those impacted by the recent natural disasters.

I'll now hand the call over to Craig to review upcoming events for the financial community. Craig?

Thank you, John. I have a preview of upcoming events for the financial community. On November 7, we will present at the Crédit Suisse Healthcare Conference in Scottsdale, Arizona. On December 5, we will present at the Global Mizuho Investor Conference in New York City. And on December 6, we will present at the Citi 2017 Global Healthcare Conference in New York City. And on January 9, we'll present at the J.P. Morgan Healthcare Conference in San Francisco. We will release third quarter earnings in late July.

Thank you, and goodbye.

And this concludes today's presentation. Thank you for your participation.