McKesson Corporation F4Q09 (Qtr End 3/31/09) Earnings Call Transcript

| About: McKesson Corporation (MCK)
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McKesson Corporation (NYSE:MCK) F4Q09 Earnings Call May 4, 2009 5:00 PM ET


Ana Schrank - Vice President of Investor Relations

John H. Hammergren - President and Chief Executive Officer

Jeffrey C. Campbell - Chief Financial Officer


Lawrence Marsh - Barclays Capital

Lisa Gill - J.P. Morgan

Charles Boorady - Citigroup

Robert Willoughby - BAS-ML

Ross Muken - Deutsche Bank Securities

Richard Close - Jefferies & Co.

Eric Coldwell - Robert W. Baird & Co.

Constantine Davides - JMP Securities

Ricky Goldwasser - UBS

Eugene Mannheimer - Auriga USA


Good afternoon and welcome to McKesson Corporation's fiscal 2009 fourth quarter conference call. (Operator Instructions)

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

Ana Schrank

Good afternoon and welcome to the McKesson fiscal 2009 fourth 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 will then introduce Jeff, who will review the financial results for the quarter. After Jeff's comments we will open the call for your questions. We plan to end the call promptly after one hour at 6:00 p.m. Eastern time.

Before we begin I'll 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.

Thanks, and here is John Hammergren.

John H. Hammergren

Thanks everyone for joining us on our call. Today we reported a solid finish to fiscal 2009. For the fourth quarter we achieved total company sales of $26.2 billion and fully diluted earnings per share of $1.01.

Looking at our full year results, you can see the strength of our business model. Excluding the AWP charge we were able to grow revenues by 5%, which we leveraged into 14% growth and operating income and in turn, generated another strong year in earnings per share momentum, finishing fiscal 2009 with 23% EPS growth.

Most of our businesses performed extremely well in fiscal 2009 with a particularly solid performance in Distribution Solutions. We had another successful year with our generics program where we use our size, scale, and experience to negotiate great savings for our customers.

Generics continue to be a good source of margin expansion for our business. Our success with generics results from three primary drivers: retention and penetration of our customer base, which brings additional generic volume into the McKesson channel; driving compliance with our customers to ensure that generic purchases are made from McKesson and not alternate suppliers; and the steady pace of generic launches. Sales for our proprietary generics program OneStop grew 26% this quarter and 35% for the year.

We expect fiscal 2010 to be another year of continued profit growth in generics, although the product pipeline is somewhat leaner that it has been in the past two years. There will also be some impact on our year-over-year comparisons from the lapping of the Safeway transition to our OneStop Generics program, which happened in the spring of last year.

In fiscal 2009 compensation under our agreements with branded pharmaceutical manufacturers showed a solid increase year-over-year. We have excellent relationships with branded pharmaceutical manufacturers that have improved the stability and predictability of our earnings. We expect branded price inflation in fiscal 2010 will be similar to that of fiscal 2009 levels.

And we are managing expenses in a disciplined and innovative way, including cost containment initiatives in our global searching programs, while we coordinate and optimize purchasing across the various businesses and geographies of McKesson.

We are operating in a challenging environment though, and growth rates in Distribution Solutions have come down and we began to see some increased pressure on our sell side margins in the U.S. pharmaceutical during our fourth quarter.

In Technology Solutions some hospital and physician office customers are still deferring purchases until they are more comfortable with the environment and we are continuing a more conservative approach to our capital structure given the financial market and economic climate.

So against that backdrop we have taken some steps to continue our progress in fiscal 2010. Starting in the third quarter and continuing in the fourth quarter we implemented cost control actions across the company, including workforce reductions. We held operating expenses flat for the quarter. That was accomplished through thoughtful and well executed cost reduction actions throughout our business. We plan to keep our operating costs flat in fiscal 2010 with focus on additional cost reductions.

As I hope you know, our goal to communicate about our business in a straight-forward, consistent and transparent manner has always been the case. Continuing this tradition of a straight-forward dialogue, let me talk a little bit about the trends in our business and their impact on fiscal 2010.

We started to see slowing growth in our Distribution Solutions revenue, which was evident as we finished the quarter despite the fact that it did not have significant impact on our fourth quarter results. We do expect that pressure on revenues will continue though, in fiscal 2010.

IMS has forecasted negative growth for the industry for the next year. We believe today, and have consistently said in the past, that IMS growth rates do not exactly correlate to our growth rates, as we have grown faster for several years. But we do consider IMS to be directionally correct regarding the industry's slowing growth. So while we are encouraged by the recent IMS data, we are mindful of the realities of the current economy.

Taking this into consideration, we are guiding to modest revenue growth in Distribution Solutions, primarily driven by our expectation for less robust growth in U.S. pharmaceutical revenues for fiscal 2010.

Let me emphasize that we have high expectations for long-term growth in U.S. pharma, particularly in light of the proposed healthcare reform, which has the potential to include almost 50.0 million more Americans in our healthcare system.

For many years we have outperformed the expectations of our customers from the service and value perspective and we've been rewarded for that value with great margin expansion.

Fiscal 2010 will be the first year in many years that our goal of expanding the operating margin in Distribution Solutions will be difficult to attain. We recently lost two customer buying groups, one in the institutional segment and the other in the retail independent segment because we were unable to reach mutually beneficial terms upon renewal. These customer losses, which were not the result of service failures, will put further pressure on our revenue growth during fiscal 2010.

We continue to have very strong relationships with our customers in both segments due to the value and service we deliver and we introduced several new programs in the fourth quarter to further strengthen our relationships with our valued independent customers and the buying groups they are associated with. These programs offer competitive pricing and an industry-leading generic portfolio in exchange for strong compliance on both branded and generic purchases and participation in our flagship franchise program, Health Mart.

In the fourth quarter we also renewed several other large customers. While these renewals lock in the business for the long term, they will create additional margin pressure in fiscal 2010. Together, all these events will drive sell side margins down in fiscal 2010. Going forward, we do not expect future renewals to put further downward pressure on operating margins.

We believe all of these actions will allow us to protect and grow our share of pharmaceutical distribution, maintain our operating margin this year, and begin expanding it again next year and our long-term goal remains to drive margin expansion in this segment.

Turning to our other U.S.-based businesses in Distribution Solutions, in our specialty care solutions we are pleased to be fully through the oncology therapeutics network integration giving us a clear number two position in this higher growth part of the distribution network. Medical surgical revenues are expected to grow in line with the market, although we expect the top line in this segment to be somewhat impacted by the recession.

We expect solid performance in our Canadian distribution business as pharmaceutical market growth is forecast to be slightly strong there than in the United States. We continue to expand our footprint in Canada with our banner strategy which allows independent pharmacies to remain independently owned while achieving the scale and benefits of a larger chain. We are also leveraging our U.S. brand purchasing scale to improve margins in our Canadian distribution business through our global sourcing initiative.

When you take a step back from some of the tougher trends that we face in fiscal 2010 Distribution Solutions is a highly efficient business, run by a seasoned leadership team. I feel confident about our ability manage through the next year and to continue our track record of margin expansion and long-term growth.

Recently I attended the National Association of Chain Drug Stores Conference. It struck me that our customer relationships have much deeper over time and the discussions today are completely focused on the future. Customers want to understand the total value that we offer with solutions such as e-voucher, central fill, and our unique adhere to medication therapy management programs. They see us as part of the solutions to their challenges at a strategic level.

The team's ability to execute flawlessly as they have demonstrated over the last week in the wake of the swine flu outbreak continues to be a source of pride for me and an excellent example of McKesson's vision of transforming healthcare. We were working closely with our pharmaceutical and medical surgical partners to secure flu-related products required to meet our customers' needs in North America.

In situations like this we rely on our emergency preparedness plans where we coordinate with suppliers to ensure that all participants in the supply chain respond in an integrated manner to move products quickly through our distribution network to our customers.

Turning now to Technology Solutions. Fiscal 2009 was a tough year for certain parts of this segment although the segment's diverse portfolio and the fact that much of our revenue comes from predictable recurring streams helped mitigate the impact of the economy. External forces such as a severely constrained access to capital led to a slowdown in software sales to hospital and physician office customers.

We also experienced some delays in implementations which impacted revenue recognition. Our technology segment has a number of solutions that require little capital investment by the customer. For example, the subscription revenues we received from our payor customers, our relay health connectivity business, and our revenue cycle outsourcing businesses all have highly stable revenue streams. Additionally, with the largest base in the industry, we have stable revenues from maintenance on all our installed solutions.

In mid-fiscal 2009 we implemented cost containment measures to position our technology business more conservatively until we had better visibility to the timing of the markets recovery. We reduced our workforce and made significant reductions in discretionary expenses. We also took steps to improve our business infrastructure, which will improve our overall efficiency in this segment.

As a result of the strong performance of some of the businesses within the segment and aggressive cost containment actions revenues were up 3% and operating profit was up 5% for the year.

Looking out beyond the next several quarters we are encouraged about the future of our technology business, particularly in light of the increase focus on healthcare information technology by the policy makers in Washington.

When the President signed into law the American Recovery and Reinvestment Act, McKesson was responsive to our customers by creating our Achieve HIP program which is designed to help healthcare providers optimize and accelerate their efforts to improve care delivery.

We sponsored a CEO summit in Washington, D.C. to explore the concept of meaningful use of the healthcare information technology. We've also been heavily involved with many of our customers in the past few weeks, the vast majority of whom state that the initial threshold requirements set for meaningful use should be achievable and then have additional functionality built in over time to ensure broad success by all.

The ultimate goal is to ensure that we have an efficient automated healthcare system in the United States but the government sets the bar that is too high and will not recognize the practical constraints faced by many of the clinicians who could not achieve this goal if the requirements or excessive or if they come on too soon.

McKesson is not only well positioned to move our customers to higher levels of automation but we also can do so over time on an incremental basis. Our customers are very engaged and excited about the stimulus package. Many are actively re-evaluating their road maps and their plans for the next years and we are working with them to ensure that they meet the criteria for stimulus incentives as soon as possible.

We see a strong pipeline with new and existing customers, helped by the impact of the stimulus package but our expectations for the stimulus-related buying will not drop to the bottom line in significant amount until fiscal 2011. There we expect Technology Solutions' revenue growth will remain at similar levels to fiscal 2009. We expect to get some leverage from revenue growth and show modest operating margin expansion.

Over the last few weeks I've had the opportunity to work closely with the team and examine more deeply the organizations that are building software products across McKesson. The bulk of our software development activities are focused on the hospital market but we also have large teams focused on developing software solutions for our pharmacy and payor customers and we have several development efforts focused on the physician market.

As we continue to connect more and more of our healthcare stakeholders we need an enterprise-wide technology plan that outlines a clear and internally aligned direction for the architecture and technologies that we will deploy.

Last week I announced that the responsibilities of our chief information officer, Randy Spratt, have been expanded and will now also include chief technology officer as one of the roles. Randy will take the collaborative business-focused approach that he has used with our internal technology function and apply that to our customer-facing software products. Software development will still be managed by the businesses while Randy provides our technology teams with visibility and collaborative direction to meet the needs of all of our customers.

Finding the right leader to keep the Technology Solutions business moving forward is a priority for me. In the meantime, I am confident we are making progress with products and solutions and I continue to be impressed by the talented individuals working in this business who recognize the discipline and focus that will be required to drive this business forward in fiscal 2010.

The opportunity to improve the safety, quality, and efficiency of the healthcare system through technology is exciting and McKesson is well positioned to help our customers with our broad set of solutions.

In summary, we enter fiscal 2010 with strength in our branded pharmaceutical manufacture relationships, continued growth in generics, and diversity in our technology portfolio. However, we face some challenges with the slowing economic environment and the sell side margin pressure we experienced during the fourth quarter in U.S. pharma.

The projections we have outlined do not show the growth that we have seen over the past few years so we have taken actions to prepare for the year ahead, including managing expenses, restructuring our workforce and improving our liquidity. I expect my management team to remain focused on earnings momentum and steady cash flow to enable long-term growth.

I believe we have the deepest most talented team in the industry and the quality of our products and services is unparalleled. I am confident in our ability to manage through the current challenges.

Based on the strong position of the company strategically and operationally, we expect 2010 earnings per diluted share of $3.90 to $4.05 from continuing operations for fiscal 2010.

I look forward to reporting to you on our progress throughout the year. With that I will turn the call over to Jeff and will return to address your questions when he finishes.

Jeffrey C. Campbell

As you just heard, this was a solid quarter operationally, capping off a year in which we faced a weakening economic environment to which we responded with increasingly aggressive cost controls.

In my remarks today I will cover both the full year and fourth quarter results. As you've heard me say before we provide our EPS guidance on an annual basis due to both seasonality and the quarter-to-quarter fluctuations that are inherent in our business. In this context, an annual look at our financial results can provide more meaningful insight into some of the key trends. So I will focus more on the annual numbers than on the quarterly ones today and I will also comment on what these trends might mean for fiscal 2010.

Let me begin by reviewing the consolidated statement of operations. I will provide more specifics in my detailed discussion of each segment and as I did in our earnings call last quarter, my comments will exclude the current year impact of the AWP litigation charge and the prior year's securities litigation credit.

Our consolidated revenues were up 5% for the full year but were flat for the quarter with both segments showing this same trend. This reflects the slowing economic environment we face as the year progressed.

Gross profit was up 7% for the year and 1% for the quarter, a modest improvement in gross margin in both periods. This was driven by solid gross profit leverage in Distribution Solutions partially offset by a decline in Technology Solutions' gross margin.

Turning to operating expenses, while the full year was up 4% the fourth quarter slacked, reflecting our increasing cost control efforts. I would remind you that over the course of the full year we absorbed additional expenses to support our 5% sales growth as well as the cost impact of our acquisitions, in particular OTN and McQuarry. This cost trend bodes well for our fiscal 2010 outlook where we expect our operating expenses to remain relatively flat.

Continuing my walk down the P&L, our full year operating income was up a solid 14% to $1.7 billion and up 4% to $498.0 million for the quarter. Other income for the full year and the quarter was impacted by a $63.0 million non-cash impairment charge, or approximately $0.22 per fully diluted share, primarily related to our equity investment in product.

Excluding this impairment charge, other income was down significantly for the year and the quarter compared to the prior year, primarily due to lower interest income. Interest income has been affected by short-term interest rates, which have come down dramatically from prior year and historical levels. Our cash is invested conservatively so we are very sensitive to these short-term interest rate movements.

Interest expense for the year and the quarter increased, due to the $700.0 million of debt we issued in February. This higher debt load will impact our fiscal 2010 interest expense.

Moving to taxes, we ended the year with a tax run rate of 33% that we'd been using all year, which reflects our mix of foreign and domestic income. The full-year tax provision was favorably impacted by a total of $111.0 million of net income tax benefits for discrete items, including the $22.0 million tax reserves release we previously disclosed as something we expected to happen in the fourth quarter. As a result of these discrete tax benefits we had an effective tax rate of 27.2% for the year.

While these discrete tax benefits create some lumpiness in our reported earnings, we are pleased with these outcomes which have materially added to our earnings and financial strength.

Our full year diluted EPS from continuing operations was $4.07, an increase of 23% compared to the prior year. Diluted EPS from continuing operations was $1.01 in the fourth quarter this year including the $0.22 impact from the impairment charge versus $1.04 in the prior-year fourth quarter.

To wrap up our consolidated results, weighted average diluted shares outstanding decreased 6% for the year and 5% for the quarter. The number of shares used in these calculations declined primarily due to the cumulative impact of share repurchases.

Let's now move on to a discussion of our two segments. In Distribution Solutions our U.S. direct distribution revenues grew a solid 11% for the year and 4% for the quarter, primarily driven by expanded business with existing customers and market growth rates. The full year was also favorably impact by our acquisition of OTN.

Our full year warehouse revenues declined 7%, primarily related to lower purchases from one of our customers due to a contract loss which fully lapped in our December quarter. Warehouse revenues were down 4% for the fourth quarter, reflecting reduced purchases from several customers.

We are pleased with our Canadian revenues, with growth on a constant currency basis of 10% for the year and 3% for the quarter, driven by new and expanded distribution agreements and market growth rates.

Canadian U.S. dollar revenues were affected by an unfavorable currency impact of 20% for the quarter and 9% for the year. As I have said in the past, we are fairly hedged to the Canadian dollar on a consolidated basis given our large IT workforce in Canada.

Medical-Surgical revenues were up 6% for the year and 4% for the fourth quarter. As we have previously discussed, we have seen some sequential slowdown in revenue growth leading up to year end in this business.

Gross profit for the segment was up 10% for the full year and 2% for the quarter. For both the year and the quarter gross profit is growing faster than revenues driven by an increased generics contribution and strong branded manufacturer compensation.

While the sell side margin was relatively stable for the full year, we did begin to experience a modest decline in the fourth quarter.

Our Distribution Solutions operating expenses were up 7% for the year but flat for the quarter, in line with our expanding cost control measures previously discussed.

Other income for the full year and the quarter was impacted by the $63.0 million equity impairment charge discussed earlier.

For the full year operating profit was up 11%. Our margin was up 9 points to 159 basis points. This is a tremendous performance, given that we stated at the beginning of the year that we expected mid-single digit operating margin expansion and that this progress includes the $63.0 million impairment charge.

We were able to outperform our original expectations due to the strength of both our generic programs and our relationships with branded pharmaceutical manufacturers, aided by strong price increases.

Turning no to Technology Solutions, revenues were up 3% to $3.1 billion for the year and flat for the quarter at $807.0 million.

Services revenues grew 4% to $2.3 billion for the year and 3% to $615.0 million in the fourth quarter, reflecting the stable and recurring nature of these revenues.

Software and software systems revenues decreased 3% for the full year and 7% for the quarter driven by the slowdown of new purchases of technology primarily in the hospital and physician office sectors.

Our software deferral rate was down 3% to 71% for the full year and down 5% to 72% in the fourth quarter compared to the same prior-year periods.

Consistent with the decline of our higher gross margin software and software systems revenues, gross profits flat for the year and decreased 2% for the quarter.

Operating expenses were down 2% for the year and 3% for the quarter. We have used aggressive cost containment efforts in technology solutions to show some operating profit and margin expansion for both the year and the quarter despite the slower revenue growth environment.

We did not, however, sacrifice R&D investment in our cost containment efforts. We continued to invest significantly in our products, providing solutions that meet the needs of our broad base of customers. As a result, total gross R&D spending for the full year and the quarter was $438.0 million and $121.0 million, up 4% and 9% from comparable prior-year periods.

For the full year and the quarter Technology Solutions capitalized 17% of their R&D expenditures. This compares to our prior-year capitalization rates of 18% for the full year and 22% for the quarter.

Now on to the balance sheet. On the working capital side, our receivables were up 8% from the prior year, to $7.8 billion and our days sales outstanding was up to 24 days. This increase stems from the fact that we have selectively chosen to offer more extended terms to some of our customers. This increase was not driven by any increase in customers being past due on payments or any other deterioration in our receivables.

Compared to a year ago our inventories decreased 5% to $8.5 billion and our payables decreased 2% to $11.7 billion. Our days sales in inventory of 31 days and days sales in payables of 43 days were down two days and one day respectively, on from a year ago.

We made a conscious decision to reduce inventory levels modestly this year, which also impacted our days sales payables.

For the year, we generated $1.4 billion in operating cash flow. Property acquisitions were $195.0 million for the year, reflecting our continued investments in our pharmaceutical distribution center network, as well as in our internal systems.

Capitalized software expenditures were $197.0 million, up from the $161.0 million we spent last year. So overall, we had $392.0 million in capital expenditures in fiscal 2009 and expect to spend in the same general range, $350.0 million to $400.0 million, in fiscal 2010.

Our spending in fiscal 2009 on acquisitions at $358.0 million and share repurchases at $484.0 million slowed due to the financial market and economic environment. We did resume share repurchases in the March quarter, spending $150.0 million, after suspending them in light of last fall's more severe financial market disruption.

With the $700.0 million of debt we issued in February 2009, our gross debt to capital ratio of 29% now approaches the low end of the target capital structure we have talked about for some time, that is having a gross debt to cap ratio in the 30% to 40% range.

Now on to our fiscal 2010 earnings guidance of $3.90 to $4.05 per diluted share. I point you to our press release today, where you will find a detailed list of key assumptions underlying this guidance. I do want to take a minute, however, to provide some additional context to our assumptions.

In general, our 2010 plan assumes that the economy and the financial markets stay about as they have been for the last few months for most of fiscal 2010. We assume we begin to see a modest uptick towards the end of our fiscal year 2010. Importantly, we do assume that neither the economy nor the financial markets gets significantly worse than they are today.

Turning to operating margin, first in Distribution Solutions we expect our operating margin to be flat to up a couple of basis points which, remembering that our FY2009 margin includes the $63.0 million impairment charge, is clearly off our historical trend line due to the challenges John discussed earlier.

In our Technology Solutions business, despite the slower revenue growth environment, our cost control efforts should allow us to achieve some operating margin expansion.

And finally to the issue of quarterly progression. As I have detailed in previous earnings calls, we do not provide quarterly EPS guidance generally due to the variability in the quarterly timing of certain items of our business. That said, we would expect fiscal 2010 to approximate the seasonal pattern of earnings we saw in fiscal 2009, if you take out of the 2009 quarterly progression the unusual impairment, discrete tax, and gain on sale items.

Said another way, the fourth quarter will continue to be our strongest quarter by a fair amount, with the first three quarters showing some modest, sequential build.

In closing, we believe we posted solid results in fiscal 2009 in the face of turbulent economic times. For fiscal 2010 we have aggressively cut costs to offset the headwinds we face while leaving the company strongly poised for the inevitable economic rebound, the growing impact of the stimulus bill and the lapping of some of the sell side pressures we have experienced.

This should leave us well positioned to resume the kinds of growth levels that we demonstrated over the last several years.

With that we will turn the call over for our questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from Lawrence Marsh - Barclays Capital.

Lawrence Marsh - Barclays Capital

The first one for John, I know you don't like to talk too much about individual relationships on the distribution or tech side but you did call out a loss of an institutional retail buying group relationship here. Is there any way to elaborate on that at all?

And then along with that, the message today that the environment is consistent with what you communicated back a couple of months ago, has it gotten progressively any worse or is there any other data point there?

John H. Hammergren

To your point, we normally don't talk about specific customers and I think at this time, because of our change in pace, so to speak, from a performance perspective we felt that it was at least helpful to investors to understand sort of the driving forces behind our inability to get margin expansion this year, at least in a clear view as we come out of the gate.

We did lose about $3.0 billion worth of business in those two CTO contracts. As you mentioned, one is in the independent segment, a company called CTA, and the other is in the hospital segment, a company called HPG. We had long-term relationships with both of those customers that we both spent some time and felt we had created some value but in the end we were not successful in negotiating terms that we felt we could move forward with and as a result went our separate ways.

So I am disappointed with those decisions and clearly we are hopeful that we will continue to drive value in the marketplace and over time regain our positions, not only with them but with any other customer that finds that other alternatives are better. But our focus now is to regain our momentum and move forward this year.

As it relates to the overall economy, I would say that we saw slowing results in the distribution business in the fourth quarter and both med-surg and pharmaceuticals to some extent on the demand side. The technology business remained relative where we expected it to be and the trends there I would say stabilized to some extent, and as we talked about in the past, some of the contracts that had pushed from previous periods pushed into the fourth quarter and I'm sure that some that we expected in the fourth quarter had pushed into fiscal 2010.

But I think the slowness, particularly in our med-surg business and U.S. pharmaceutical business, to some extent on the revenue side, accelerated slightly in the fourth quarter.

Lawrence Marsh - Barclays Capital

And that's because of the loss of the relationships as you talked about?

John H. Hammergren

Those losses really didn't impact the fourth quarter at all. Maybe a little bit on the HPG side but it was really late in the quarter when that started to happen. So I think just a little slowness overall, maybe driven by the unemployment numbers and some of the things that had started to hit. But not significant. I think that just slightly down from where it was before.

Lawrence Marsh - Barclays Capital

And Jeff, your communication is for in the Distribution Solutions business revenues, you were saying revenue growth is going to accelerate slightly for fiscal 2010 or revenues are going to be up modestly for fiscal 2010?

Jeffrey C. Campbell

We were just talking about absolute revenues, up modestly.

Lawrence Marsh - Barclays Capital

And on the tax rate it looks like you will get some benefit this year. Maybe a percent or so from last year. Is there anything in particular that would drive the reduction in your tax rate?

Jeffrey C. Campbell

Our tax rate is really driven by the mixture of foreign and domestic income so the fact that the run rate is going from 33 to 32 should suggest to you that we're growing slightly faster in some of the lower tax jurisdictions where we do business.

Lawrence Marsh - Barclays Capital

And finally, John, you said you said you hope to announce a new head of your new technology business, or is that still way premature?

John H. Hammergren

It's probably premature. As you recall that business is really a bunch of different businesses and so there are presidents running the various segments within MTS and I'm actually enjoying the opportunity of spending a little more time with directly and do a little deeper dive into the businesses and one of the things that I mentioned in my prepared remarks was the accretion of this all-encompassing sort of span breaker job of CTO that will help us transfer knowledge and best practices between some of the ordinary silos that exist in different businesses.

So I am actively in this game to replace the MTS role but I don't feel an urgent need to jump quickly. I would rather get a good sense for what the qualifications are that are going to be most important and to make the selection prudently.


Your next question comes from Lisa Gill - J.P. Morgan.

Lisa Gill - J.P. Morgan

John, on the healthcare IT side, I think that you talked about the opportunity really being more in fiscal 2011 but as I listen to your healthcare IT peers, they're consistently talking about late 2009. Can you maybe just reconcile the two for me? Is it that your customers bases are different or maybe you're just more conservative around your expectations.

And then secondly, are you seeing any opportunities around acquisitions within healthcare IT where perhaps you want to fill some holes within your portfolio? And maybe even pick up a new head of that business as well.

John H. Hammergren

Clearly acquisitions have been a part of our strategy in our technology business and we will continue to look for acquisitions that make sense economically and strategically for us. I don't think we have any particular major holes in our offering but clearly in this environment with capital constraints on our competitors and perhaps the customers that are looking for bigger, all-encompassing relationships that will afford us more opportunities to continue to consolidate in the industry.

So I don’t think we have an urgent need there but I think we can be opportunistic, and clearly we are always looking to bring talent into the company through these acquisitions.

On the timing side, it's difficult for any of us, I would argue even our competitors, to guess as to when these results might actually show up in our businesses. I would tell you that the sales organization is as optimistic as I've seen them relative to the sales channel and the demand that appears on the horizon that is yet to contract for our solutions, so they're very bullish about our ability to pull it in, make it into a contract.

I guess I'm a little less optimistic in terms of getting it implemented and recognizable in a percentage of completion kind of way. Some of our competitors, in fact, might have software that is more shrink wrapped and they're able to recognize revenues when they ship it or when they install and easy physician system for example. Our more complex hospital customers and our physician customers for that matter that are pursuing a more integrated and holistic approach, that complexity might impede our ability to get the revenue rack at the same time that our competitors would, even if the contracts were signed at the same time because of the scale of what we're trying to do.

But whether it happens in December or April, clearly I think we're all saying the same thing and that is that the stimulus package is going to be a positive thing for our industry and we should benefit from it and we are well positioned for it.

Lisa Gill - J.P. Morgan

And I think some of the hospitals have talked about big the opportunity is or how many dollars they think they're going to get from the stimulus. Have you had those conversations? Do you have a number that you've pulled together to say what your potential opportunity is given your customer base?

John H. Hammergren

Well, we've done a lot of internal work and right now we're mapping every one of customers in terms of the applications that are going to be necessary to get the meaningful use, and as important, the implementation required to get the meaningful use. So it's one thing to buy these things, it's another thing to get it implemented and working in a way where they can demonstrate meaningful use. And it's even more challenging when meaningful use hasn't been defined.

So there are a lot of open issues there, but I would tell you that I think that we have significant opportunity, not only in our existing customer base, which we can map more easily, but increasingly customers are coming to us that aren't typical McKesson customers. At least not what we would consider to be our base customers, that might have some applications and some experience with McKesson but they're looking at replacing their incumbent supplier of HIT solutions and McKesson is showing very well in those accounts.

Particularly some of the smaller accounts, community hospitals that want to get there and get there and want to get there quickly and the small software companies that they might have contracted with in the past may not have the products or the financial strength to get them where they need to go. So products like our Paragon product for example, that's selling very rapidly and there's a long queue of customers that are even lined up to get into the demo cycle on that product. So we are excited about the potential that exists.


Your next question comes from Charles Boorady – Citigroup.

Charles Boorady - Citigroup

First on healthcare technology, what metrics can you share with us to support your demand outlook? Is there a number of inbound inquiries or bookings, etc.

John H. Hammergren

We gave you some rough ideas in terms of revenue and profit that we expect next year for FY2010 and I think that we learned a long time ago not to quote sales funnels until they materialize into contracts. So all I can do is kind of quote you from a directional perspective that we believe those pipelines are robust and that those pipelines will turn into bookings and subsequently turn into revenue and earnings. But it's probably premature and probably not appropriate for us to talk about, to bring new metrics into place that we've never really believed in the past, things like sales funnels that we've discouraged our team from counting too much on.

Charles Boorady - Citigroup

And in terms of the margins, one would generally expect margin pressure in a year like this when demand is taking a pause ahead of what's expected to be, an acceleration in demand as a result of this stimulus, and so if you just think about any new hiring and other infrastructure and other investments you would be making in anticipation of an increase in demand, it would seem like that should be a lower margin year. Am I missing something or are there some costs cuts that would offset what otherwise would be a lower margin year?

John H. Hammergren

Well, we're hopeful that it won't be a lower margin year but clearly if software sales are slowing it's going to be harder for us to get operating margin expansion. As Jeff and I both mentioned in our prepared comments, across all of our segments the last two quarters and accelerating into the fourth quarter, we took very aggressive cost reduction moves. Not only in reducing the existing headcount, shutting down open positions, freezing travel, shutting facilities, doing whatever we could to sort of to prepare for a slower growth environment.

But to your point, we also have a responsibility to understand where our customers need us from a manpower perspective to get these implementations going. So some costs will begin to rise on manpower slated for implementation. We clearly have to train these folks, we have to get them ready, and then we have to dispatch them to help bring the customers live. And so we will begin to see some pressure on our business from a margin perspective on the cost side as we get ready for this ramp, but I think that's included in the guidance we've given you. So we still expect to get leverage in the business in fiscal 2010.


Your next question comes from Robert Willoughby - BAS-ML.

Robert Willoughby - BAS-ML

What do you not put into the IT guidance, given some of the uncertainties out there? Are there larger clinical applications that hit that you just don't anticipate or that you can't foresee closing on a quarterly basis?

And then secondarily, do you foresee any material changes in the business mix this fiscal year from any divestitures? Are there assets on board here that might be worth more independently?

John H. Hammergren

I think that on the revenue side of that business, fortunately there is a bunch of predictable revenue and technology where we can see out several quarters if not a year or more, on the revenue and margin that we're going to get.

Some of the larger software deals are more difficult to forecast, not only when they sign, but when we will actually be able to recognize the revenue against them, based on the way the contracts are constructed. So I would think that our projections for fiscal 2010 are plus or minus correct in a relatively narrow range for that business. What we'll see, and we will be able to forecast more aggressively, is these new contracts that will come in related to the stimulus package. But those won't really impact FY2010 we don't think to a large degree.

So as we get through the middle of this year we will probably have a better sight on what FY2011 is going to look like.

As to the portfolio, clearly I think a well-tuned machine would constantly evaluate what's in the asset portfolio and what's necessary, at least ask what's missing. Sometimes you have things you don't need and I think that we have a responsibility to constantly revisit that and you have seen us from time to time make divestitures when we're not scaled and we're not profitable and we have done that. We've done it sometimes with the ventures, like Verispan or we've done with our pharmacy management business. We did it with the acute care business in med-surg, so we're not really stuck in a model if we can't win and get a positive attribute from the way that that business flows to us.

So that's part of what I'm actually doing in this interim phase is doing a little deeper dive on the assets and spending some more time with the executives in MTS to understand what their views are of these businesses.

Robert Willoughby - BAS-ML

Are there any businesses of size or consequence that are unprofitable for you currently?

John H. Hammergren

Yes, I don't think generally speaking, unprofitable, no. We have small businesses that are unprofitable all the time that are trying to grow but they're not really that material to us. I think the biggest thing for us is what prospects do they have for growth and what management time are they consuming that prevents us from being more focused and disciplined on things that give us more opportunity. So I think that that's more likely to be the case. I don't think there's a big value-creating divestiture that we could do on a money-losing venture that would suddenly cause the P&L to expand rapidly.


Your next question comes from Ross Muken - Deutsche Bank Securities.

Ross Muken - Deutsche Bank Securities

You made a point to talk about the financial health of the customer base and as you go through what you've been seeing from a terms perspective or in terms of receivables or bad debt, I'm sure you've gone through a fairly thorough analysis. I mean, are there any particular pieces of business that you're at all concerned with? And what are you sort of tracking of in terms of understanding the relative health of some of the key customers? Maybe some of your larger customers that might have been struggling in this economic environment?

John H. Hammergren

I think we're always concerned about all of our customers and their economic plight and we try to do in on multiple dimensions. First is obviously whether they're paying us on time and whether the channels of communication are open to us. And obviously we have to continue to do our own deep dive research behind the scenes as to what their credit status might be.

Clearly, coming into this environment hospitals were already under significant pressure as were many retailers and we've seen some in our industry experience failures as a result. I think that we do a good job of managing the risk and I can't tell you that we don't have it but I can say that I think we have pretty good visibility to it. And clearly there are some very large risks that we face that have been talked about frequently on calls like this.

Ross Muken - Deutsche Bank Securities

And on the IT side, in terms of adoption, I know a couple of others touched on this in the questions, how do you think about where the initial dollars are going to glow between the hospital and the physician practice. You have your own set ups in each of the different markets but if you had to gauge which one you thought was going to start to see more activity and then if you thought the types of solutions you have on the hospital side, how do you think about that in terms of penetration rates, in terms of what piece of your business do you think on the hospital side specifically so you think you would see the biggest delta where people really need to kind of get up to optimum adoption from a technology perspective?

John H. Hammergren

Well I think the hospitals are going to be the biggest field for revenue and margin creation in this environment. They just have more complex environments and they have to spend more to accomplish their objectives. And so I think the hospital segment is going to be very important to us. And they will probably being buying sooner to accomplish meaningful use as compared to the physician marketplace, primarily because they have more access to capital today but it's going to take them longer to implement the successful integration of some of these systems, and if they don't start really now, at least in the buying cycle, and begin the implementation, they won't be ready by 2011 or 2012 to accomplish the objective.

The physicians can start a little later and can get up to speed faster and so there might be some quick hits on that side a little later but I don't think that overall the number of dollars spent by doctors is going to be as great as the number of dollars spent by hospitals to get into need for use.

And so albeit we should begin to see the buying side of this business this fiscal year because of the complexity, it's likely that the revenue and earnings will fall largely in 2011.


Your next question comes from Richard Close - Jefferies & Co.

Richard Close - Jefferies & Co.

On the sell side margin pressure, maybe some more details along that. You mentioned a couple of renewals at lower levels and the contract losses but not service related. How much [inaudible] on the sell side margin today as opposed to last year or in the past? Maybe if you could walk us through the primary difference there today versus previously.

John H. Hammergren

The model for our businesses remain the same for some time and that is that we get our margins through bringing in revenue, managing our relationships with the branded manufacturers in a way where we can earn a return on that work, and selling more higher value, higher margin products like generics, and those are offset by expenses which we try to control rigorously. And then the sell margin.

And so the business has always been a competitive but in the past we've typically been able to offset any sell margin erosion with expansion in other parts of our profit streams. As we went into this fiscal year it became obvious to us that that was not going to be possible given the challenges that we faced and that's why it's a little different environment.

I think competition is always in the eye of the beholder to some extent. Clearly we are very disappointed that this has been the result of the last quarter and these new data points come on quickly, based on the negotiations, so looking forward, we're continuing to train ourselves for us to sell value. We're focused on making sure that when our customers ask for our best price, they have to give us their best commitment. It has to be a fulsome commitment in terms of volume commitments and share commitments within their book of business and we have to pick up the value-added items of generics, etc. and in an environment where people are asking for this same kind of requirements, sometimes things can get a little distorted.

So we continue to focus on selling value and training our sales force to do that and we are hopeful that we will continue to be successful.

Richard Close - Jefferies & Co.

On the OneStop Generics [inaudible] in the quarter and you mentioned the lapping of Safeway, I guess that has begun or happened in the fourth quarter. Any update on larger customers in the generic programs, like Target or Safeway that you've done in the past? Do you still see opportunities on that front going forward?

John H. Hammergren

I sure think so. I mean, we have been focused in our portfolio and if you go back several years ago we wouldn't have thought these larger customers were even possible targets, so I mentioned in my earlier conversation our focus on our global sourcing initiatives in trying to bring the full book of McKesson's business on behalf of our customers into the marketplace and negotiate on their behalves great deal with these manufacturers and in return giving our manufacturer partners great share opportunities that comes on quickly.

And so I think we are forever focused on expanding our position and I think there's been some press releases recently of our expansion of our generic programs into the hospital marketplace for generics, and so not only are we trying to grow upstream in terms of bigger customers in our existing markets, but also expanding into markets that are willing to use wholesalers as the primary source of the product. And so I remain optimistic we can grow our generic program next year.


Your next question comes from Eric Coldwell - Robert W. Baird & Co.

Eric Coldwell - Robert W. Baird & Co.

I'm curious whether you could comment on the OneStop Generics growth excluding the year-over-year contribution from Safeway.

John H. Hammergren

That's a good question. It would have been lower. I don't think we have the number right in front of us. But we were consistently in double-digit growth, even before Safeway came on so I would assume that number is somewhere above 10% and somewhere probably less than 25%. I know it's a broad range. I can get it to you.


Your next question comes from Constantine Davides - JMP Securities.

Constantine Davides - JMP Securities

Jeff, you talked about more modest growth expectations in the specialty group. Can you elaborate on that a bit and the nature of some of the pressure you're seeing there?

Jeffrey C. Campbell

In the specialty group?

Constantine Davides - JMP Securities

That's right. I thought you made some comments in your prepared remarks about specialty growth being more tempered.

Jeffrey C. Campbell

I don't think so. We didn't particularly comment on specialty. I guess I would make the observation that we are pleased with the position that we are in now and as [inaudible] number two. We are through with the OTN integration and our expectation is you should see that business growing roughly in line with the market. And obviously tagging the market is a little bit of a moving target right now but if I was to take a shot at it, it's probably in the 5% to 7% range.


Your next question comes from Ricky Goldwasser – UBS.

Ricky Goldwasser - UBS

The [inaudible] is this [inaudible] one-time inventory adjustments or do you think that this is just [inaudible] markets.

And then in your guidance, can you just walk us through the low end versus the high end. It sounds like your distribution margin expectations are pretty tight, and you said flat to up a couple of basis points. So without the other factors that forged the $3.90 versus the high end at the $4.05.

Jeffrey C. Campbell

Let me work backwards and you were breaking up a little bit so I'm not sure I actually got the first question, but let me kind of start with the guidance. So we gave a guidance range from $3.90 to $4.05 and I think what I would encourage people to do is really go right to the series of key assumptions that you see us use and a couple of those things are pretty key to what gets you either towards the higher end or the lower end. So exactly what happens with the revenue growth rates, whether branded price inflation stays extremely strong, as it has been for the last year, or softens a little bit.

And you heard us, in both John's remarks and in my remarks, talk about the fact that while we have baked in the pressure we have experienced on the sell side, what we have baked in going forward is really no further significant declines in the sell side that would impact our operating margins. So those are probably the biggest things that I would point to as you think about what's going to drive us toward the higher end or the lower end of the range. And then as to the first question, John is signaling me that he's got it.

John H. Hammergren

I think what you asked was about revenue growth and whether inventory reductions by our customers might have affected our revenue growth or something to do with inventory. So I am happy to have you ask it again.

Our revenue growth in the quarter was pretty good and we had lost a piece of warehouse business in the past that netted against our DSD business but otherwise it fell pretty much in line with our expectations and what we have historically delivered.

Was there something we missed on inventory?

Ricky Goldwasser - UBS

In terms of warehouse sales, you're not seeing inventory adjustments on your customer side?

John H. Hammergren

We might be but not something that's been brought to our attention. The primary change in inventory numbers was driven by—excuse me, in warehouse sales—was driven by the loss of a customer, not by any overt change necessarily in their inventory level.


Your final question comes from Eugene Mannheimer - Auriga USA .

Eugene Mannheimer - Auriga USA

I hate to beat the health IT horse, but let me ask you this. Those customers, are they more motivated by the carrot, i.e. the financial incentives to implement IT or the stick, namely the penalties in not doing so? And that might help us get a sense for when the buying is going to take place.

John H. Hammergren

I don't know that there is a universal answer that would apply to all of them. I have spoken primarily to McKesson's largest hospital customers, I haven't spoken with a lot of physicians, particularly the smaller physicians. I would say the hospitals are motivated by the carrot and they don't want to miss the stimulus and I don't think they want to be non-competitive in their markets by being behind from the technology perspective.

I think there's an awareness that there's a stick following the carrot but I think that that probably will be more the impact will be felt more there on the physician side, frankly, as the laggard physicians finally either retire or have to come up to speed and use technology.

But I think that for the most part the forward-thinking hospitals and the forward-thinking physicians are going to try to get to value and demonstrated meaningful use so they can collect the stimulus and they can remain viable in their markets.

So I want to thank you for your questions and also thank all of you on the call today for your time. I'm confident in our ability to manage through these current challenges and to stay focused on our earnings momentum and steady cash flow and to obviously enable long-term opportunities to continue to be here from a growth perspective.

Ana Schrank

I have a preview of upcoming events for the financial community. On May 12 we will present at the Bank of America-Merrill Lynch 2009 Healthcare Conference in New York. On May 13 we will present at Baird's 2009 Growth Stock Conference in Chicago. On May 19 we will present at the Deutsche Bank Healthcare Conference in Boston. On June 10 we will present at the Goldman Sachs Conference in New York, and we will release first quarter earnings results in late July.


This concludes today’s conference call.

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