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Executives

John Hammergren - Chairman, Chief Executive Officer and President

Ana Schrank -

Jeff Campbell - Chief Financial Officer and Executive Vice President

Analysts

Lisa Gill - JP Morgan Chase & Co

Ricky Goldwasser - Morgan Stanley

Robert Jones - UBS

Steven Valiquette - UBS Investment Bank

Robert Willoughby

Thomas Gallucci - Lazard Capital Markets LLC

Lawrence Marsh - Barclays Capital

Glen Santangelo - Crédit Suisse AG

Charles Rhyee - Oppenheimer & Co. Inc.

Eric Coldwell - Robert W. Baird & Co. Incorporated

McKesson (MCK) Q2 2011 Earnings Call October 26, 2010 5:00 PM ET

Operator

Good afternoon, and welcome to the McKesson Corporation Fiscal 2011 Second Quarter Earnings Conference Call. [Operator Instructions] I would now like to introduce Ms. Ana Schrank, Vice President of Investor Relations. Please go ahead.

Ana Schrank

Thank you, Peter. Good afternoon, and welcome to the McKesson Fiscal 2011 Second Quarter Earnings Call. With me today are John Hammergren, McKesson's Chairman and CEO; and Jeff Campbell, our CFO. John will first provide a business update, and we'll 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 meanings 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.

Thanks, and here is John Hammergren.

John Hammergren

Thanks, Ana, and thanks, everyone, for joining us on our call today. Let me start by saying that I'm pleased overall with our company's results for the second quarter and the first half of our fiscal 2011. This quarter, we achieved total company revenues of $27.5 billion and fully diluted earnings per share from continuing operations of $1.3, excluding adjustments to the litigation reserves.

Let me quickly highlight three items that impacted our financial statements this quarter. As we announced on October 19, we reached an agreement to settle an action filed by the state of Connecticut relating to First Databank's published drug reimbursement benchmarks, which are commonly referred to as Average Wholesale Prices. The settlement resulted in an after-tax charge of $0.06 per diluted share.

This agreement includes an expressed denial of liability, and as we've consistently stated and continue to believe, this case is without merit because McKesson does not and never did set PWPs. We will continue to work our way through the remaining public entity matters, and our goal is to resolve them in a reasonable manner that is in the best interest of our shareholders.

This quarter, we're pleased to complete the sale of our McKesson Asia Pacific business. And as a result, we recorded an after-tax gain of $0.28 per diluted share. The sale of this business is a great example of our ability to create shareholder value. And lastly, we recorded a noncash, pre-tax asset impairment charge of $72 million related to our revenue cycle management product, Horizon Enterprise Revenue Management. Both Jeff and I will discuss this in more detail on this call.

Looking beyond the asset impairment charge, our results were strong for the company as a whole, particularly for Distribution Solutions and there's a lot to like about our second quarter results. Additionally, during the first six month of our fiscal year, we made significant progress deploying capital, including fully using the $1.5 billion available on our share repurchase authorization and increasing our dividend. Based on the operational momentum in our business and the results of our share repurchase activity, we are maintaining our fiscal 2011 guidance range of $4.72 to $4.92 per diluted share from continuing operations, excluding adjustments to the litigation reserve.

Let me highlight the second quarter trends in both segments. In Distribution Solutions, we had a strong double-digit growth and operating profit, with margins expanding an impressive 25 basis points. U.S. Pharmaceutical, Canada, Medical-Surgical and Specialty Care Solutions all contributed to that outstanding performance. Our market leading generics offering filled much of the margin expansion in the second quarter. Over the years, we built solutions based on the differing needs of our customers, and we've been very successful at demonstrating the value of our generics offering to our customer base.

In addition, we use a global sourcing approach to the procurement of generics, with coordinated purchasing across the various businesses and geographies at McKesson. This maximizes efficiencies and optimizes the value we deliver to our customers. With a favorable generics launch schedule and our comprehensive offering, we anticipate continued profit growth in generics for fiscal 2011 and beyond.

Our U.S. Pharmaceutical Distribution business is performing at an exceptionally high level. We continue to benefit from our long-standing relationships with branded manufacturers, delivering great value to them and earning steady levels of compensation in return.

Again, this quarter, U.S. Pharmaceutical's results benefited greatly from generics. Sales of generics through our proprietary program, OneStop, grew 21% due to the steady pace of launches and a high degree of compliance that our customers have with our value-added programs. Generics have also been very beneficial to our Specialty Care Solutions business, and we expect that trend to continue for the remainder of this fiscal year.

We have been talking a lot about oxaliplatin for the past year, and we are still benefiting from this generic drug with sufficient inventory that last through the end of our fiscal year. In addition, we are now increasingly optimistic about two other specialty generic introductions, so we expect another outstanding contribution this year from our Specialty business.

Our Medical-Surgical revenues grew 5% in the second quarter. We remain focused on delivering value to our Medical-Surgical customers by optimizing outsourcing of the McKesson brand, where we deliver high quality, private label products at great savings. In addition, we continue to drive leverage through aggressive cost management. Combined, these initiatives are resulting in margin expansion.

Our Canadian Distribution business had solid performance in the second quarter. Revenues had been impacted by price reductions on generic drugs, driven by changes in public policy in certain provinces during the year, as well as the launch of the generic version of Lipitor, which happened in May of this year. The team has done an outstanding job to offset these challenges and deliver solid results this quarter.

In our Canadian business, we have a comprehensive set of solutions and leading physicians in every market segment. It is still our expectation that will work through the public policy changes in Canada with only modest financial impact that we can manage within our guidance range for this fiscal year. We are still evaluating the longer term impact of the changes and our responses to them.

I'm pleased with the second quarter results in Distribution Solutions. We have a terrific combination of assets and a seasoned leadership team that performs exceptionally well. I have great confidence in our full year performance.

Turning now to Technology Solutions. Setting aside the asset impairment charge for Horizon ERM that I mentioned earlier, let me point out that as expected, our first half results are down quite significantly versus prior year. For the full year, we still expect modest operating margin improvement, heavily weighted to the back half. While this quarter's results are in line with our expectations, they are certainly not indicative of what we expect from this business long term.

Now let me come back to Horizon ERM. This is McKesson's next-generation revenue cycle management solution that we designed to improve the economics of patient care for our hospital customers. Revenue cycle management products must keep pace with the changes in health care because the environment is only going to become more complex. Horizon ERM is one of the most functionally rich solutions available to hospitals. Given all of the changes that RO is driving and the rapidly changing needs and priorities of our customers, we are continuing our product development efforts on Horizon ERM.

Over the past few quarters, we have been focused on improving our customer and quality focused by strategically prioritizing our investments and delivering integrated solutions that enable greater customer success. We've also ramped up our Six Sigma efforts to prioritize opportunities for process enhancements, including streamlining our product focus and improving speed of installations.

We continue to make organizational changes that will further our efforts to provide integrated offerings and a greater focus on customer success. We are now combining our Horizon clinical and revenue cycle groups to form a new organization known as Health Systems Enterprise Solutions, which will be lead by Rod O'Reilly, reporting to Dave Souerwine. Rod has been running our very successful Medical Imaging Group for some time. He's got a great track record of innovation, execution and collaboration. And I know many of you on the call know Rod personally. The integration of the clinical and financial systems has become increasingly important for our customers who must demonstrate not only the clinical quality of care they provide, but also the costs associated with that care.

We are always committed to supporting our customers, and in particular with their current priority, clinical implementations as they navigate the RO requirements and the changing healthcare environment. We are increasingly confident in our clinical products and the value they would bring to our customers. We have confirmed test dates for most of our EHR products starting to mid-November, and we expect to achieve certification shortly after testing is complete. We are pleased to report that one of the first products we submitted for testing, our RelayHealth platform, which is a Software as a Service offering, received the modular certification this week.

Before I turn the call over to Jeff, I want to spend a moment on capital deployment. In addition to the $1 billion accelerated share repurchase program we completed in July, we subsequently repurchased $531 million in stock during our second fiscal quarter, fully using our authorization. Today, the board approved a new $1 billion authorization.

Along with our increase in the dividend earlier this fiscal year, the share repurchase activity demonstrates our confidence in our business and in our future cash flow generation. We continue to target a portfolio approach to capital deployment, which would also include acquisitions. You should feel confident that we intend to continue deploying our capital wisely and strategically.

In summary, we are seeing solid overall performance, and our strong balance sheet and tremendous cash provides us with many growth opportunities. I believe we are well positioned for continued success. And with that, I'll turn the call over to Jeff, and we will return to address your questions when he finishes. Jeff?

Jeff Campbell

Well, thanks, John, and good afternoon, everyone. Our overall second quarter results reflect the solid performance at this halfway point fiscal year. We're showing operational results in Distribution Solutions above our initial expectations coming into the year. Our balance sheet remains strong, and we're pleased with our progress on capital deployment.

Our Technology segment performance, while weak for the quarter, was in line with our expectations other than the asset impairment charge, which I'll explain in more detail in a few moments. We continue to expect a strong finish to the year and remain committed to enhancing shareholder value through a measured and thoughtful capital deployment approach.

Before I begin reviewing our financial performance, let me start by pointing out that we completed the sale of our McKesson Asia Pacific business this quarter. The $0.28 after-tax gain on sale is recorded as a discontinued operation. And as you know, we focused on our results from continuing operations.

Therefore, my discussion today will focus on our $1.3 EPS from continuing operations, which also excludes the impact of the $0.06 AWP litigation charge this quarter. It is important to note, however, that this $1.3 EPS that we'll focus on does include the asset impairment charge of approximately $0.18. With this background, as always, I'll begin with a review of our consolidated results and then provide additional color when I discuss each of the segments in more detail.

Revenues for the quarter grew 1% to $27.5 billion from $27.1 billion a year ago, and total gross profit increased 2% from the prior year. Outstanding gross profit growth in Distribution Solutions were somewhat offset by the asset impairment charge in Technology Solutions, which was recorded in the cost of sales. Excluding the asset impairment charge, overall gross profit would have increased 8% for the quarter versus last year.

Moving below the gross profit line. Our total operating expenses are up 4% to $925 million for the quarter. For the full year, I would continue to expect our operating expense growth to be more modest than this 4% as our back half results will face easier year-over-year comparisons.

Other income was relatively flat year-over-year, while interest expense declined 6% to $44 million for the quarter. Interest expense has been favorably impacted this fiscal year, primarily due to the repayment of $215 million in long-term debt in March of fiscal 2010.

Moving now to taxes. We have raised our full year estimate of tax run rate from 32% to 33%, primarily driven by a change in our domestic foreign business mix. As a reminder, last year's second quarter's tax run rate was 32%, and we benefited from $13 million of favorable discrete items, equating to about $0.05 per diluted share.

Net income for the quarter was $271 million, and our diluted earnings per share from continuing operations, excluding the litigation charge, was $1.3, which, as a reminder, includes the approximate $0.18 asset impairment charge. To wrap up our consolidated results, this year's EPS number was aided by the cumulative impact of our share repurchases, which lowered our diluted weighted average shares outstanding by 3% year-over-year to 262 million shares for the quarter.

Earlier, you heard John talk about our year-to-date fiscal 2011 share repurchases of over $1.5 billion. Taking this into account, we now expect that our full year average diluted share count will come in a bit below the original guidance assumption, 267 million shares outstanding.

Let's now move on to our segment results. In Distribution Solutions, total revenues grew 2% in the quarter to $26.8 billion. Looking at the components, our U.S. Pharmaceutical Distribution and Services revenues increased 1% versus the prior year, with direct revenues up 6% and warehouse revenues down 15% for the quarter.

The warehouse revenue decline, when adjusted for shifts of customer business to direct-store delivery, was something closer to 10% to 11%, which is still a significant decrease. Drivers of this decline were brand-to-generic conversions, which particularly impacts our warehouse revenues as well as some of our customers' business losses.

However, when you look at direct distribution revenue, which is our most profitable revenue stream, we're pleased with the good growth we showed. After adjustments for shifts from warehouse to direct distribution, we grew direct revenues by 4% to 5%. Importantly, I'd remind you that we typically make lower margins on our warehouse revenues relative to the margins on our direct revenues.

So to sum up, while our total revenue growth may look low, it was driven by trends that allowed us to, in fact, significantly grow our gross profits this quarter. We've been saying for a while now that it is important to focus more on gross profit rather than revenue, and this quarter's results really exemplify the strength.

Moving on to Canada. On a constant currency basis, revenues declined 1% for the quarter. Including a favorable currency impact, Canadian revenues increased 4% versus the prior year. The combined effect of government-imposed price reductions on generic drugs and the launch of generic Lipitor in Canada resulted in about a 5% decrease to revenues.

Medical-Surgical revenues were up 5% for the quarter to $770 million. In addition to a solid performance from our core business, we have also seen earlier sales of flu vaccine this year, which essentially offset the large amount of revenue from flu test kits that we shipped in the prior year.

Gross profit for the segment was up 14% to $1.1 billion. On 2% revenue growth, this represents a nice improvement in gross margin of 43 basis points versus the prior year. The increase in gross profit for the quarter was primarily due to strong growth in our generics profit and the timing of the compensation we received from branded manufacturers.

Distribution Solutions' operating expense increased 5% to $574 million for the full year, similar to our expectations for the overall company. I would expect our growth and expenses to be more modest. Operating margin rates for the quarter were 192 basis points, an impressive increase of 34 basis points versus the prior year.

Given the quarterly volatility in this segment, we always focus on full year margins. In this context, based on our strong first half performance in this segment, we now expect our full year fiscal 2011 operating margin to be within the range of our prior-year GAAP operating margin of 188 basis points. Now we're very pleased with this forecast. As I remind you, the prior year benefited from the positive impact of our efforts around H1N1, making it a particularly difficult benchmark to match this year.

Turning to Technology Solutions. Let me start by talking about the $72 million noncash, pre-tax asset impairment charge, which is approximately $0.18 after-tax based on our effective tax rate.

Here at McKesson, we amortize our capitalized software over three years. As you recall, we began amortizing our Horizon ERM product late in the second quarter of our fiscal 2010, and it has been running approximately $8 million of expense per quarter. We do a calculation each quarter comparing the unamortized capitalized software costs to the projected net revenues during the remaining amortization period. Based on our most recent evaluation, the net revenues we foresee in the remaining 24-month amortization period were not sufficient to recover the unamortized costs, which resulted in the asset impairment charge. We remain committed to the product and would expect to expense most of our future development costs.

Now turning to the rest of the segment results. Total revenues were down 3% from the prior year to $770 million. Part of this result was driven by the sale of our McKesson Asia Pacific business. While the profits from this business were financially insignificant, it did contribute approximately $17 million in revenues in last year's second quarter. We will continue to see the McKesson Asia Pacific revenues impact our year-over-year revenue results in the services line of our P&L through the first quarter of fiscal 2012.

Also, as a reminder, the prior year was favorably impacted by the recognition of $22 million of previously deferred revenues. Majority of these deferred revenues were associated with ancillary products included as part of a bundled purchase, and were triggered when our Horizon ERM solution became generally available late in the second quarter of fiscal 2010. So adjusting for these two items, you'd see revenue growth of about 3% this quarter.

Moving on from revenues. Excluding the asset impairment charge, Technology Solutions' gross profit declined 7% to $348 million for the quarter. Contributing to this year-over-year result is the prior-year deferred revenue recognition, which had equated to $16 million in gross profit.

Operating expense increased just 1% in the quarter to $263 million. We had total gross R&D spending of $107 million compared to $102 million in the prior year. This is a demonstration of our continued commitment to developing our products for our customers. Of this amount, we capitalized 16% compared to 20% a year ago. Our Technology Solutions' operating profit was down 26% versus a year ago to $86 million, excluding the asset impairment charge.

To summarize, excluding the asset impairment charge, the overall Technology Solution results, while weak, were in line with our original expectations. We continue to expect a stronger back-half performance from Technology Solutions this fiscal year and modest improvement in the full year operating margin rate, excluding the asset impairment charge.

Leaving our segment performance now and turning to the balance sheet and our working capital metrics. Our receivables were $8.2 billion, which is up from the prior year balance of $7.8 billion and our days sales outstanding increased by one day to 24 days. Inventories increased 2% to $8.8 billion, while our payables increased 1% to $12.8 billion. This resulted in our days sales and inventory remaining flat at 30 days, and our days sales and payables remaining flat from the prior year at 44 days.

These relatively stable working capital metrics resulted in McKesson generating $798 million in operating cash flow year-to-date. Based on the start to the year, we now expect to generate a bit more than our original expectation of $1.5 billion in full year cash flow from operations in fiscal 2011.

We ended the quarter with a cash balance of $3.1 billion, down slightly from our first quarter balance of $3.3 billion. Our great financial flexibility provides us good opportunity to continue our portfolio capital deployment strategies. Capitalized spending was $182 million for the first six months of the fiscal year, and we continue to expect full year capitalized spending between $400 million and $450 million.

And the last, let me turn to our outlook. Our guidance range remains at earnings from continuing operations of $4.72 to $4.92 for fully diluted share excluding litigation charges. What this means is that we have absorbed in our range both the $72 million pre-tax asset impairment charge and the related increase in our full year tax rate assumption from 32% to 33%. These two items are significant hurdles, but we can see a pathway to achieving our original guidance range due to the outstanding performance thus far in Distribution Solutions, our expectation of a stronger back half in Technology Solutions and our lower full year share count assumption.

One other point about the rest of the year, keeping in mind that we don't routinely provide quarterly EPS guidance. Sitting here today, we anticipate our fourth quarter to be unusually strong this fiscal year, both measured by its growth year-over-year and as a percentage of our overall earnings for the full year. Given the timing shifts in some of the economics we have with branded and generic manufacturers, we can directionally estimate that our December quarter EPS will be more in the range of our first and second quarters.

In closing, we're pleased with the overall performance across McKesson, and we believe our financial flexibility positions us well for future capital deployment. Thanks, and with that, I'll turn the call over to the operator for your questions. In the interest of time, I would ask that you limit your questions to just one per person to allow others an opportunity to participate. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] And first we'll go to Glen Santangelo with Crédit Suisse.

Glen Santangelo - Crédit Suisse AG

John, just a couple of quick questions. I mean, the margins in both your businesses were clearly higher than I think what most of us were expecting. For years, I kind of feel like you've been targeting an operating margin goal in Distribution Solutions of between 1.5% and 2%. Now you're continuously bumping into the upper bend of that. Can you maybe talk about what's driving that? Is there anything beyond generics? Is it more on the specialty side? Just listening to Jeff's comments, you're talking about a big March quarter already. I mean, are we now going to be looking at sustained operating margin north of 2%, and is that really just generics driving that?

John Hammergren

Obviously, we have continued to focus on margin improvement, particularly in our Distribution businesses and in particular, U.S. Pharmaceutical. When we guided to the 150 to 200 basis point range, we were probably down to mid-120s. And I think people believed that was a stretched objective and perhaps we were out of our minds to target that kind of improvement. We believe it was possible by looking at our historical performance and really, global performance of wholesalers and we believe that margin rate is still a great tribute to our success and our teams. I think it's a little premature for us to guide to future revenue goals or targets other than to say that our, I would say, we are continuing to focus on margin improvement as part of our business model, and that clearly a mix is assisting us there. We are selling more generics, as you mentioned. We are also selling a more private brand, and we continue to have great relationships with the branded benefactors. And so a combination of all of those things. Disciplined cost management and disciplined sell-side management as it relates to our relationships with our customers are all coming together to allow us to expand our margins. So we're really pleased with the results, and we're pleased that we're able to do that while we're still saving our customers' money.

Glen Santangelo - Crédit Suisse AG

John, maybe if I could just ask one quick follow-up to that. I mean, are you having success going to some of your big chain customers in selling your generics offering into those guys? I mean, ultimately, as we look out over the next 12 to 24 months, given the patent cliff, are you nervous about some of that branded volume? Any leakage outside of the system as those guys go direct, or have you been successful selling generics into some of those big chain customers?

John Hammergren

Well, clearly, we continue to penetrate the marketplace with our generics programs because they're increasingly more and more competitive than people might be able to achieve on their own. Clearly, there's an infrastructure cost that our customers can deleverage. And as I mentioned, we have a great portfolio of products where we do a terrific job of buying them. I think it probably is a stretch to think about the very largest customers buying their generics from us because they're very sophisticated in their own buying. But on occasion, we do sell generics to them, particularly when their own supply is not available to them. And we do see some revenue impact when our large chain customers buying a brand from us. And when it goes generic, they buy the generic on their own. But frankly, our margin structure and a lot of those relationships, particularly on the warehousing side, is so low that even if we lose the revenues, it's not a significant impact to us. And clearly, it's more than offset by the generic pull-through in the rest of our customer base where we have significant opportunities to save them money, take the patient money and include better margin structures for ourselves simultaneously.

Operator

Next, let's go to Larry Marsh with Barclays Capital.

Lawrence Marsh - Barclays Capital

The way I'm looking at it is your Distribution Solutions business, given your margin guidance, is about $0.20 accretive to earnings relative to what I think we assumed earlier this year. Without going through specific nuances, I'm curious how much of that do you think is driven by incremental margin in your Specialty business? And in the context, just sort of customer relationships, are you in a position to comment about the IPC serve-all relationship and the value add you have there?

John Hammergren

Sure, why don't I talk about the IPC serve-all situation, and Jeff can talk a little bit about the margin and its accretion to our earnings. And the IPC serve-all relationship has been a long one for us. It's obviously unfortunate that they've elected to take this action as filing a lawsuit. But we believe, obviously, the case is without merit and we intend to vigorously defend ourselves. In the meantime, we continue to focus on servicing our IPC customers and doing the best job we can as we have over the past decade, delivering high-quality product, highest service levels in the industry and great customer relationships. So I think that we have to focus on the customer, and we have to see if we can come to some mutual, acceptable end to this. And that's our goal, but we'll have to see where it lands.

Jeff Campbell

And Larry, on the Distribution outperformance, we could calculate the number a different way. But I think you're in the ballpark with the tremendous strength that, that collection of businesses is showing relative to our initial expectations. And there's really a lot of drivers. I would agree with you that generics are the biggest driver, and it's important to think about the fact that that's generics in Canada, it's generics in our traditional U.S. Pharma business and it's generics in our Specialty business. And we're gaining in all three of those areas. We also, as John talked about, continue to we create growth in some of our private brand efforts, which is helping us in the Canadian environment. Some of the regulatory changes have been deferred a little bit from what we initially thought in our plans. And frankly, our team up there is doing a little bit better job than we might have anticipated it, managing their way through that. So it's really a function of all those things combined with the steady and strong economics we have in our relationships with the branded manufacturers that is so far driving us to a much stronger year than we have initially anticipated in those Distribution businesses.

Lawrence Marsh - Barclays Capital

And John, I know in Canada, just a quick follow up, you quantified kind of how we should think about potential impact this year. Given your record of performance, are you able to quantify how we should think of mitigating factors as we think about next year? And should we think about Canada as being a little bit more uncertain in its visibility for next year? Or is that way too soon to come to that conclusion, given customers and mix?

John Hammergren

Clearly, the regulatory changes around generic pricing has a negative effect on that business. And this year, as we've mentioned, we've been able to offset and mitigate most of that risk, partly because we've had a lot of actions and plans underway that have been very positive for us. And partly because, as Jeff has mentioned, some of this has been rolling out later in the year, which gives us less of the challenges. If you think about the full year impact in the next fiscal year, it's probably premature to say what we'll be able to mitigate and offset versus what will perhaps be a visible drag in the business. Our goal, clearly, is to offset as much of this as we can and to work with our partners in Canada to find ways to do that, and hopefully, come out to the other side in good shape. But clearly, it's a challenge as we think about fiscal '12.

Operator

From Lazard Capital Markets, let's go to Tom Gallucci.

Thomas Gallucci - Lazard Capital Markets LLC

I was wondering if you could comment on the OneStop growth driver. Is there any new customers in there that we could think about some other sort of adjustment number? Or is that sort of the real number? And how much of that thing is newer generics that are available versus maybe growing your penetration within your customer base?

John Hammergren

Well, clearly, I think it's driven by many factors, including more generics in the marketplace. But we are growing faster than the market. So it would show that we are taking a larger portion of our customers' generic spend. So our goal has been, and we'll use the words penetration and compliance, we are focused on really trying to make sure that our customers understand that we have the best basket of generic products available for them at the best possible price and it's to their advantage to buy the holistic portfolio of products and not to attempt to go around it and construct activities. It would not be beneficial to them and clearly, would be dilutive to our compliance and penetration of the total spend. So I think I share of their wallet is growing up, and I think that's showing in our OneStop generic performance. We've also talked about the fact that we're expanding the program into other sectors, including the hospital sector, which we've talked about on previous calls. So we have new customer bases. We're starting out with a very little market share of their existing generic spend, and we're pointed into our proprietary programs. So I think it's a combination of a good market in the right time with the right dynamics. A great program, well developed, it's capturing a fair share of the margin structure available for us. And then lastly, laying the pipes into our customers and then getting them to buy our solution set.

Thomas Gallucci - Lazard Capital Markets LLC

And then to follow up, Jeff, could you just clarify some of the issues that are sort of driving that unusually strong fourth quarter? You mentioned maybe the timing of some branded manufacturing payments. Anything else there that you're thinking about?

Jeff Campbell

It's really, in Distribution Solutions, just that, just the way the year has worked out on both generic and branded economics. And then of course, we've been talking all year about the unusually strong back half in Technology Solutions, particularly the March quarter, just the way that the implementation schedules, and frankly, some of the certification and other product development issues around our clinical product suite have played out.

Operator

And Robert Willoughby with Bank of America Merrill Lynch.

Robert Willoughby

Jeff, you mentioned flu vaccine contribution in the quarter. Could you throw out a number of range of contribution from that? And I guess, we dropped that down then in the third and fourth quarter that we won't see that number again. And then if you had some reasons for just the sequential uptick in profitability for that IT business. It's a good effort. Just wanted to know what you thought the main drivers there were.

Jeff Campbell

Well, one at a time. So if you start in our Medical-Surgical business, I'd remind you that, that, in the context of overall, McKesson is a small business. And our seasonal flu profits are modest by the standards of the company overall as you're talking a couple of pennies a year. When you look, however, at the year-over-year results this quarter, we have gotten off to a much earlier start with seasonal flu vaccine. And that's a good thing. I will tell, I won't really know until we get to the end of the next quarter, whether it's a good thing but not that great because demand didn't continue or whether in fact it continued and we sold the rest of our vaccines. That business is important to us because it's important to our customers that we provide that service. There's always a little bit of variability here in how it goes. Today, we have in Technology business, really the drivers, as we've talked about are that, in our Hospital business, you got customers almost exclusively focused on buying and implementing clinically oriented systems. We have made significant investments in our people to make sure we've got the right teams in place to both finish the necessary development on the products, to meet the final requirements as well as get implementations done quickly for our customers. There's just a lot of implementation schedules to be done in both the December and March quarters. You also got a couple of the key clinical products that have both a certification that needs to be done as well as a general availability target time line that needs to be hit. And both of those things, for certain customers, are tied to when we recognize revenue as well. So it's really that focus that drives the strong back half.

Robert Willoughby

I was actually wondering about the quarter itself, Jeff. You were up a few hundred basis points sequentially, and I just thought that was a bit more than I would have thought you would have been able to do.

Jeff Campbell

Well, it's nice to get a pat on the back, and maybe we're so just focused on it. It's down year-over-year, and as John said, that's not the kind of result we expect to the business in the long term. But everything I just said applies to this quarter. So it was at its trough, if you will, in the first quarter of this year as we had invested a lot in additional people and a lot of resources and had very little getting through to the end of implementations, and got a little bit better this quarter. We'll get, I think, more significantly better next quarter and then a lot better in the March quarter.

Operator

Lisa Gill at JPMorgan.

Lisa Gill - JP Morgan Chase & Co

Jeff, I was just wondering if you could talk about the timing aspect on the new $1 billion share repurchase? And what is currently built into the expectation for your '11 guidance?

Jeff Campbell

Well, we certainly, Lisa, never made comments about when we might buy shares back. We're opportunistic on that, and we think about it in the context of our overall portfolio approach to capital deployment. It's our commitment to our shareholders that we've talked about it, and we do intend to close for our target leverage and that could be through acquisitions, could be through using the new share repurchase. And we'll make those decisions as we go forward. If you think about the guidance, what I said is that while we started the year with an assumption that for the full year our weighted average shares outstanding would be 267 million, just based on what we've already done, we will clearly be a little bit below that. But we haven't necessarily built into our guidance additional share repurchase.

Lisa Gill - JP Morgan Chase & Co

And then can you just remind us, John or Jeff, as to how you are looking in acquisitions and areas that you think you would potentially be interested in? And maybe John, just talk about the competitive landscape right now and where you think there might be opportunities from a acquisition standpoint.

John Hammergren

Sure, Lisa. I think the first thing we have to think about is whether the acquisitions make financial sense. And clearly, if you look at the effect of the use of the cash, the value of the target alternatives for use of that same cash, and it has to make financial sense. Perhaps not in the acquisition quarter because of one-time related issues, but certainly over time, it has to make sense. And we have to get a return for our investors that is superior to other alternatives that we might be evaluating, including the safer versions of share repurchases and dividends. It has to have a strategic sense for us. It has to be something that we know and understand and can build upon and we can grow and leverage. And hopefully, there are synergies that can be captured that our shareholders wouldn't be able to capture on their own if they purchase the asset on their own, particularly if it was a public company and they're holding it that way. So I think those are the big buckets. I don't feel like we're particularly constrained on our view of which segments we would buy into. And I don't think we're particularly constrained on geographic preferences. I don't think we're particular constrained on the size of the deal as long as you can kind of fit in those three broad sweeping categories. And we, frankly, are evaluating acquisitions all the time and have been for as long as I've been here. So you will hear from time-to-time that we're looking at something, and then you'll either hear that nobody bought it or it was never for sale or somebody else bought. But just because we're involved in evaluating transactions, it doesn't mean that we're always going to end up with the target in the end. So I think it's an ongoing process. I think we've got a skilled team with a proven track record of being able to pick the right targets, integrate them appropriately and get the value for our shareholders. And clearly, as was discussed earlier on this call, things like Oncology Therapeutics Network, OTN, which was a drag on us, I think, for almost two years, as I recall, we told you it was going to be dilutive upfront and it was going to be very beneficial for our shareholders over the longer haul. Frankly, it positioned us extremely well in a very high-growth sector in specialty and oncology, and we're really pleased we have that asset. So it may not be apparent always upfront. But the value of paying for the acquisition is equated in the near-term results. But clearly, if we have a plan that we can execute, then we'll go forward and we'll deliver against those expectations that we have in that acquisition as well as per se and the many distribution acquisitions within where we just rolled companies into our Distribution structure so...

Lisa Gill - JP Morgan Chase & Co

So having said all that, I think that this management team has done a good job around making acquisitions and laying out the prospects, for example, around OTN. So what's holding you back right now, John? I mean, you have a great balance sheet. You've got lots of cash. Is it that the price of the assets in the marketplace or something that you think would fit in isn't currently available in the marketplace? I mean, how would you characterize it?

John Hammergren

Well, I think sometimes it's a combination of all of those things. It might be the assets we want are not available, or maybe the assets we want are not priced where we want them to be priced or we're busy doing something else that it's got our team focused on another activities. And so now you may not see results from those activities. It could be that we're rebuilding our technology management team right now. And we may not be actively pursuing technology acquisitions. Dave Souerwine is there focused on that recovery of that business. So from time-to-time, we're in and out of the markets, and I don't think you should draw any major conclusions out of it other than when we are able to successfully execute on one, you'll hear about it. And also, Lisa, I might just mention it. It's clear that when we don't have acquisitions in front of us, we're not afraid to do share repurchases, and we've done over $1.5 billion this year. And I think our shareholders should be comforted in the fact there we're not waiting around for decades to deploy capital, that we understand the value associated with doing it sooner rather than later.

Operator

Next, let's go to Robert Jones with Goldman Sachs.

Robert Jones - UBS

I just wanted to touch on the Medical side and utilization. I was curious if you guys could delve a little deeper into what you're hearing and seeing out there just given the IT exposure to hospitals and the distribution exposure to the physician office. As far as it relates to the trends throughout this year, has it stayed the same, gotten worse, maybe gotten a little bit better?

John Hammergren

Well, I think that the trends we see in our Medical businesses, and to remind you, we're not really involved in the acute care medical supply business. And our systems business in acute care is really not affected by patient demand levels. So we see very little -- we don't track data related to admissions in hospitals or surgery procedures in hospitals because the sale of our product in the hospital marketplace, the system sale, is not really related to that. It's more driven by the need to upgrade their systems or they'd become our compliant, et cetera. On the nonhospital business where we are strong, physician offices, home care, long-term care and emergency centers, emerging care centers, those kinds of things, surgery centers, we have seen relatively flat demand. But I think our team has done a particularly good job of continuing to expand our footprint, not only within our existing customers like selling through our private label product, but also expanding beyond our existing customer base and probably taking a share, in particular, in home care, where we've got a very good presence. So I think we are continuing to see our ability to grow revenue in Medical-Surgical as evidenced by the 5% growth this quarter, and we hope those trends will continue. And our team is now really focused on continuing to execute. And a larger view of physician office visits, et cetera, clearly, I think that those really haven't changed much in the last 12 months. But that's sort of a 40,000 foot view.

Robert Jones - UBS

And I just have one follow-up on the Technology business. As we think about the improvement in the segment in the back half, I was wondering if you could just remind us how much of the pickup is related to you lapping the increased expenses, or investments, I should say, versus incremental sales recognition as we move to fiscal 3Q and 4Q?

Jeff Campbell

It's really almost all just seeing the revenue pick up. So our expense base, operating expense base, like we mentioned, was only up 1% this quarter, for example, and is fairly flat going forward. So it's really all about hitting the milestones around implementation, certification and GAs between now and March 31.

Operator

And with Morgan Stanley, let's go to Ricky Goldwasser.

Ricky Goldwasser - Morgan Stanley

I have a few follow-up questions on guidance. First of all, Jeff, to make sure that I heard it right, the third quarter guidance you said between first quarter to second quarter level, so for first quarter should we use the $1.10 and then for the second, $1.03 (sic) [$1.3]?

Jeff Campbell

I think the answer is yes, and I'm just searching for a piece of paper, which I will confirm that answer to you in one second. So why don't you go ahead with your next question while looking that up.

Ricky Goldwasser - Morgan Stanley

Sure. And then if it is $1.07 then, which is the midpoint, what are the swing factors to the third quarter? So what could grow better than what you're kind of factoring it now? And then secondly, I think you gave us all the pieces of the puzzle, except for the new share count that you are seeing in guidance. So I think the prior share guidance was 267 million? If you can provide us the new share count.

Jeff Campbell

Well, we didn't give a specific number, Ricky, because as you know, it's going to depend on exactly where our stock price is, exactly how many people exercise options. So there's always a little bit of uncertainty. So that's why we went with just telling you, look, it's going to be down a bit. And you can kind of do the math based on what happened this year. That's probably going to get you to a number likely somewhere between 261 million and 265 million.

Ricky Goldwasser - Morgan Stanley

And then on Horizon, can you walk us through by how much you lowered your revenue expectation for Horizon?

Jeff Campbell

Well, I didn't break out a specific number, Ricky. What I would tell you is that the revenues from Horizon ERM in fiscal '11 were not material. If you look out over the next two years, the remainder of the amortization period, we certainly had an original plan to sell and implement sufficient customers to justify the asset that we had on the balance sheet. What's really happened is that our customers in there, complete focus on clinicals, have not just stopped buying things for now other than clinical, but they've also pushed out implementations and stop implementing. You combine that with the fact that as we look at the way the environment and requirements to what this product needs to do has evolve, we also, frankly, decided that given what was going on with our customers, it made sense for us to step back, and frankly, focus on finishing out the development of this product to meet all the new and latest requirements. That's going to take us a number of quarters. And as we do that, we're going to aim for those few customers that want to implement. We're going to push some of those implementations out. The combination of all those things is what pushed the revenues out beyond the remaining amortization period. I think it's important to realize though that these products, these kinds of products are products that should have usable life spans of 10, 20, 25 years. So there's this accounting convention where we need to look at the next three years. But our full expectation and hope here is that we're building the next equivalent of some of our legacy revenue cycle product, which we still have happy customers running 20, 30 years after they put them in. And quite frankly, it's a pretty good financial proposition for us at that point in time.

Ricky Goldwasser - Morgan Stanley

And Jeff, if we think about it really as we think about Horizon conflict [ph] over that time period, for the next couple of years, I mean, are we being too conservative assuming that Horizon would have accounted for 10% as kind of like your provider expected [ph]?

John Hammergren

I think the way to think about Horizon ERM, the Enterprise Revenue Management product, and our view from a revenue perspective and the long-term plans is that, as Jeff mentioned, because of the push out from our customers' perspective nor it could support from an accounting perspective the balance sheet amortization that we have. As we think about the long-term growth of that segment for us, I don't think we'll directionally change our discussions. I think that it's a part of the portfolio approach of products that we bring to the marketplace. And as we talked about this year, that sector we thought was going to grow in the 4% to 6% kind of range from a market perspective, and that we thought we would grow in those kinds of ranges. We haven't given FY '12 guidance. But I don't think sitting here that we will have a significant change in our view on how we're going to grow relative to the market because of this specific product line in the massive MTS, which is a much larger organization than financial systems for hospitals.

Jeff Campbell

And Ricky, just to come back, to be clear for everyone, so our guidance of $4.72 to $4.92 is based on a first quarter EPS of $1.10 and this quarter EPS of $1.3 and all of that is continuing operations. We do exclude the litigation adjustments. And other than that, those are the numbers we go with.

Operator

And we'll take that from Eric Coldwell with Baird.

Eric Coldwell - Robert W. Baird & Co. Incorporated

But I'm just curious, Horizon Enterprise isn't the only revenue cycle pull that you have. So are you seeing strength in any revenue cycle or practice management-related products, number one? Number two, I just want to clarify that you're saying this is a situation of not seeing market demand versus the market choosing other solutions. And I want to verify that that's across all of your customer types, from small solo practices up to the large IDNs, that it's not just these largest IDNs filling in things. Just hoping for a little more color on those topics.

John Hammergren

Sure. I'll attempt to answer the question. I think that the discussion that we've been having around Horizon Enterprise Revenue Management is isolated to hospital financial systems, and it's not a commentary on the rest of our software or physician software, even Horizon Clinicals. It really is the hospital market place saying to us -- our customer base where we would naturally go to sell these enterprise revenue management products, our customers are saying to us, "We're happy running that 20-year-old to 30-year-old software we bought from you 20 or 30 years ago." And our priority is

to is to get you clinical systems installed and to make sure we purchase the right systems and we get to our meaningful use and be able to document that from a regulatory and a compliance perspective to get the stimulus dollars that the industry is chasing. I don't believe that Horizon Enterprise Revenue Management that we are losing any hospital customers or potential customers to competing systems. Once again, I'm really talking about our existing customer base was the natural place to sell this product and those customers are largely looking to build out McKesson solutions as opposed to taking out McKesson solutions. That's not to say that we, on occasion, don't lose a customer. And it's not to say that we haven't lost a clinical customer or a financial customer. I'm just talking about enterprise revenue management, and the revenue issues we have in that product really are not product-based as much as they are market-based. And then I believe competitive market since our customers' interest has gone to a different direction. As it relates to the overall portfolio and we think about financial systems that our customers are buying, frankly, they're not replacing their old legacy HIS systems. They are buying some what we call the bolt-on products on occasion to augment the systems that they already have deployed. And in fact, RelayHealth is selling many of those products. Some of them delivered Software as a Service where they can easily augment the functionality of existing McKesson STAR systems with Relay Software as a Service applications, where they're able to get a quick return on investment. And so when they see a quick return on investment and something they could put into the system very quickly and make use of if they're doing it, but they're not going to undertake, at least in this near-term environment, a complete redo of their financial systems in these hospitals when they're busy with clinical implementations. Does that answer your question, Eric?

Eric Coldwell - Robert W. Baird & Co. Incorporated

It does. And I guess at the end of the day, I'm not the kind of guy who's going to jump on these calls and try to get a derivative call for another company. But when somebody is visible and large as McKesson, making the comment that could be misinterpreted as no customers are buying revenue cycle tools right now, it has the potential to cause some damage across other companies, some of which people on this call might be invested in. So I just want to make sure that you're really talking about large enterprises with your existing customer base, and you're not making a blanket statement that no customers are buying revenue cycle tools today. And I think you've cleared that up.

John Hammergren

That's correct, Eric. I was not making a market commentary other than our existing customer market that are using 30-year-old STAR systems. And I know there's lots of competitors out there that we compete, with add-on, bolt-on products like our Relay products. And customers are still buying those products. But they're just not interested in redoing their big financial systems in the midst of redoing their big clinical systems. Does that make sense, Eric?

Eric Coldwell - Robert W. Baird & Co. Incorporated

Yes, it does.

John Hammergren

Yes, and I'm sorry about the confusion. I wasn't intending to make a market comment.

Operator

Let's go to Steven Valiquette with UBS.

Steven Valiquette - UBS Investment Bank

Just trying to get a little more color on Distribution as well. So I guess, if you look at the sequential acceleration in Distribution profit growth in September quarter versus June quarter, again, the year-over-year growth, just trying to get a sense if the anniversary-ing of the lost retail and GPO contract and maybe even anniversary-ing the CDS care more [ph] contract renewal. Would that have played a large role or a small role in the sequential acceleration in the profit growth?

Jeff Campbell

Steven, I'm always very conscious about looking at sequential trends because the reality is the timing of our economics with generic and branded manufacturers vary every year. And we have a pretty darn good sense of how those economics are going to play out over a 12-month period. But we don't have a very good sense of which quarter, and it varies every quarter. So part of our really strong year-over-year performance in the September quarter in Distribution Solutions was just a difference in timing that I mentioned in terms of our branded compensation. So you shouldn't, in anyway, relate sequential trend into that. In fact, some of the strong September quarter, that's why I made more moderating comments about the December quarter and what that will look like.

Steven Valiquette - UBS Investment Bank

And I know you also don't like to talk about individual products, but just curious if the generic Wilbenaux [ph] played a meaningful role in the quarter. Was that product not really material or just singled out? Just curious for your quick thoughts on that.

John Hammergren

No, it wasn't really material. It went up to single out, and it was built into basically our thoughts for the entire year. It has a little bit different profile than most generics because it has a substantial utilization in institutional customers. But I don't think it was a big deal for us.

Steven Valiquette - UBS Investment Bank

If I heard this right, I think you said so the EBIT margin now for Distribution should be somewhere in the ballpark of the 188 bps from a year ago. And kind of a small routing number, not that critical, but does that include or exclude the AWP litigation charge from this reported quarter?

Jeff Campbell

It exclude it.

Operator

That will come from Charles Rhyee with Oppenheimer.

Charles Rhyee - Oppenheimer & Co. Inc.

Jeff, maybe just going back to the expected margin ramp in IT as we move in the back half of the year. I know you addressed this a little bit. As we think about that waiting, is it really more in the March quarter or is it really maybe more spread evenly? And I don't know if you happen to gave this number in the past. How much of deferred revenues are we talking about maybe perhaps in dollar terms? And then as we think about that next year, we would assume a big pickup in the margins but then sort of normalized next year?

Jeff Campbell

Well, a couple of comments. The March quarter in every year is always by far our biggest quarter just due to it being the end of the sales year. And what you will see this year, that will be compounded by the implementation schedule and the certification and GA schedule. All that said, you should still see sequentially and year-over-year a much stronger December quarter than what you've seen from us the last two quarters. But March will be unusually strong. On the deferred revenue, we don't call out a number. There is a number on our balance sheet, which is not a particularly helpful number because frankly, it's driven by the very large annual payments customers make to us for maintenance. And again, we do that once a year, and then pull it out to that balance sheet item. So the number that's on the balance sheet is not huge. It's a part of what needs to happen and what will get recognized in the December-March quarter. But it's not the majority piece. The majority of it is just things that are not on the balance sheet today and will get recognize as we hit milestones.

Charles Rhyee - Oppenheimer & Co. Inc.

And just to clarify something you said earlier, I think in response to some else's question, between implementation that will just occur naturally versus revenues tied to certification. You said the vast majority is tied to the implementations?

Jeff Campbell

Yes.

John Hammergren

Thank you, and I want to thank the operator and everybody on the call today for your time. We had a very solid first half, and I'm optimistic about the many opportunities that lie ahead. I'll now hand the call over to Ana for her review of upcoming events for the financial community. Ana?

Ana Schrank

Thank you, John. I have a preview of upcoming events. On November 11, we will present at the Crédit Suisse Healthcare Conference in Phoenix. On November 17, we will present at the Lazard Capital Markets Healthcare Conference in New York. On January 10, we will present at the JPMorgan Healthcare Conference in San Francisco. We will release third quarter earnings results in late January. We look forward to seeing you at one of these upcoming events. Thank you, and goodbye.

Operator

With that, we'll conclude today's conference call. Thank you again for your participation. Have a nice day.

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