McKesson Corporation (MCK) Q2 2015 Earnings Report, Transcript and Summary

Good day, and welcome to the McKesson Corporation Quarterly Earnings Call. [Operator Instructions] Today's call is being recorded. If you have any objections, you may disconnect at this time. I would now like to introduce Ms. Erin Lampert, Senior Vice President of Investor Relations. Please go ahead.

Thank you, Melissa. Good afternoon, and welcome to the McKesson's Fiscal 2015 Second Quarter Earnings Call. I'm joined today by John Hammergren, McKesson's Chairman and CEO; and James Beer, McKesson's Executive Vice President and Chief Financial Officer. John will first provide a business update and will then introduce James, who will review the financial results for the quarter. After James' comments, we will open the call for your questions. We plan to end the call promptly after 1 hour at 6 p.m. Eastern Time. Before we begin, I remind listeners that during the course of this call, we will make forward-looking statements within the meaning of federal securities laws. These forward-looking statements involve risks and uncertainties regarding the operations and future results of McKesson. In addition to the company's periodic, current and annual reports filed with the Securities and Exchange Commission, please refer to the text of our press release for a discussion of the risks associated with such forward-looking statements. Finally, please note on today's call, we will refer to certain non-GAAP financial measures, in which we exclude from our GAAP financial results, acquisition expenses and related adjustments, the amortization of acquisition-related intangible assets, and LIFO-related adjustments. We believe these non-GAAP measures will provide useful information for our investors. Please refer to our press release announcing second quarter fiscal 2015 results available on our website for a reconciliation of the non-GAAP performance measures to the GAAP financial results. Thanks. And here's John Hammergren.

Thanks, Erin, and thanks, everyone, for joining us on our call. Today, we reported solid results for our second quarter with total company revenues of $44.8 billion and adjusted earnings per diluted share from continuing operations of $2.79. We've seen strong execution across all of our businesses, and I'm pleased with the great performance of our team in the first half of the fiscal year. We remain confident in our outlook for the full year and we continue to expect adjusted earnings per diluted share from continuing operations of $10.50 to $10.90 for fiscal 2015. Before I begin my comments on our business performance for the quarter, I want to provide a brief update on our acquisition of Celesio. Currently -- excuse me, approximately, 1 year ago, we announced our intention to acquire Celesio, the former global leader in health care services, by bringing together the strengths and expertise of 2 companies with complementary geographic footprints, shared values and common histories as trusted partners to our customers. The next important milestone in bringing together our 2 companies is the registration of the domination and profit and loss transfer agreement with a relevant German court, which we continue to expect by the end of calendar 2014. The registration of this agreement will effectively allow McKesson and Celesio to begin our cooperative work to develop and deliver the synergy case we have outlined, where we expect to achieve 277 -- $275 million to $325 million in annual synergies by the fourth year following the registration of the domination agreement. We remain excited about the opportunities ahead of us to continue to lead in an increasingly global pharmaceutical supply chain and to enhance our customer's ability to deliver better and more efficient health care services. Moving now to our business results for the quarter. Distribution Solutions had strong results in the second quarter with revenues of $44 billion, up 37%, and adjusted operating profit of $1.1 billion, up 29% on both a reported and constant currency basis. Based on the strong revenue trends we have seen year-to-date, we now believe full year revenue growth in North America will be in the low double digits, driven primarily by strong demand for recently launched drugs for the treatment of hepatitis C and the timing of certain generic launches, which will come later than we had originally planned. We also now expect adjusted operating margin for the Distribution Solutions segment to be flat to modestly up year-over-year, driven primarily by our expectation they will have a much stronger mix of branded pharmaceutical business in fiscal 2015 compared to our original plan, specifically driven by the higher-than-anticipated revenue from hepatitis C drugs and the delay in certain generic launches. Our updated full year outlook for Distribution Solutions operating margin also includes an assumption that margin in our international pharmaceutical distribution and services business will come down modestly from the prior year. North American distribution and services, which includes our U.S. Pharmaceutical business, McKesson Specialty Health and McKesson Canada, delivered strong results for the second quarter. Within North America, revenue growth in our U.S. Pharmaceutical business exceeded our expectations in the second quarter, driven by the continued strength and demand for 2 recently launched drugs for the treatment of hepatitis C as well as solid growth across our hospital, national retail and independent customers. Our U.S. Pharmaceutical business continues to innovate and expand the boundaries of operational excellence in everything we do for our customers and our manufacturing partners. We perform an essential and valued service for our branded manufacturing partners and continue to earn steady levels of compensation in return. We also benefit from the growth across our portfolio of generic pharmaceuticals, where we are extremely well positioned with our customer-focused proprietary programs and the value we provide across our extensive generic offerings. We continue to see strong growth in our proprietary OneStop Generics program as a growing number of our customers benefit from the strength and scale of McKesson's sourcing expertise. An important addition to our OneStop program in the first half of the fiscal year has been the volume associated with Rite Aid. I'm very pleased to report that during the quarter, we completed the operational transition associated with the implementation of our expanded agreement with Rite Aid, which we first announced back in February. I want to recognize the outstanding efforts of our U.S. Pharmaceutical team and the team at Rite Aid for successfully completing the transition, with a clear focus on ensuring great service through Rite Aid stores. McKesson's direct-to-store deliveries to all of Rite Aid's more than 4,500 stores helps to ensure operational efficiencies, excellent service levels and improved product availability for Rite Aid's customers. Our expanded agreement with Rite Aid is delivering the savings envisioned by both organizations by driving additional efficiencies in the distribution and sourcing of pharmaceutical products and the significant savings associated with improved working capital utilization. Our team does an outstanding job day-in and day-out by aligning our interests with our customers' interests, and we know that their success is our success. The strength, skill and scale of McKesson's global procurement team ensures we are providing our customers with the results that are better than they would have achieved on their own, with the highest levels of product quality and availability. By working together with our customers, we are able to truly create a winning formula that delivers savings and efficiencies in the delivery of pharmaceutical products. In summary, I'm pleased with the performance of our U.S. Pharmaceutical business in the second quarter and the outstanding results we have delivered in the first half of the fiscal year. Turning now to our Specialty business. We had another quarter of solid results and we continue to see strong growth across the business. I'm pleased with the growth in our oncology business, where we are focused on delivering the highest-quality cancer care in a payment model that rewards value. And we continue to see growth in our other specialties, such as ophthalmology and rheumatology, where we believe we can leverage our distribution and sourcing expertise along with our technology assets to help ensure specialist physicians continue to grow their practices and deliver high-quality care to their patients. And our Canadian business had another solid quarter with the results that were in line with our expectations. We continue to grow our Canadian business through our focus on operational excellence, ensuring we have an optimized and efficient distribution infrastructure in place, investing in important and growing markets, such as Specialty Services and Distribution, and growing our presence in private label generics in the Canadian market. Turning now to our results for international pharmaceutical distribution and services. Revenues for the second quarter were $7.3 billion, an increase of 4% on the underlying results of Celesio on a constant currency basis. As you may have seen in Celesio's results announced this morning, we continue to expect revenue to increase modestly year-over-year on the underlying results of Celesio and now expect a modest decline in operating profit year-over-year, driven by market pressure in Germany, France and Brazil, partially offset by continued strong performance in our U.K. businesses. Turning to our Medical-Surgical business. Revenues were $1.5 billion for the first quarter, an increase of 4% over the prior year. Our Medical-Surgical team continues to do an excellent job with the integration of PSS, bringing together and optimizing the sales, distribution and information systems platforms within the business. Integration and our pursuit of synergies from the acquisition remain on schedule and in line with our expectations. Critical to our success to date has been the significant progress we have made in our integration efforts while maintaining strong momentum with our customers. We continue to make great strides leveraging the best sales force in the industry to serve our customers and drive strong performance in our customer service and satisfaction across the expanded customer base. In summary, I am pleased with the strong second quarter results in Distribution Solutions. Technology Solutions' revenues were down 6% for the second quarter, driven primarily by anticipated revenue softness in our Horizon Clinicals software platform and the disposition of a product line as contemplated in the original guidance we provided for fiscal 2015. Adjusted operating margin in this segment was 18% in the quarter, primarily due to favorable revenue mix and timing. For the full year, we continue to expect adjusted operating margin in the mid-teens for the Technology Solutions segment. I'm pleased with the progress we've made in our Technology Solutions portfolio and the year-to-date improvement we've seen in the core operating margin profile of this segment. Last quarter, I provided an update on the CommonWell Health Alliance, where McKesson and the other members are pioneering solutions to lead our industry in addressing the issue of data interoperability, to make health information available to the providers who need it when they need it, regardless of where the care occurred. I continue to be encouraged by the Alliance's ability to demonstrate real-world progress, including the continued addition of new members across the health care ecosystem, successful pilots in 4 geographies, demonstrating real-world data exchanges across disparate systems and most recently, a multiyear agreement for nationwide commercialization of the services, with the core services being provided by RelayHealth. At McKesson, we are committed to improving health care through data interoperability. Our systems are built on open, contemporary architectures that are low-cost and easy to implement for our customers. The CommonWell Health Alliance members join us in making data available to providers in their current systems, expanding down their current investments without having to replace their existing systems. As McKesson and other CommonWell members now look to drive nationwide deployment and expansion, we continue to encourage other organizations to help lead our industry and our country in moving the information between platforms to enable better patient care. In summary, we will continue to focus on our key strategic priorities for Technology Solutions: including helping our customers reduce cost and operate more efficiently; providing our customers with solutions to drive improved analytics; and supporting our customer's transformation to a world of value-based care. Now to wrap up my comments for fiscal Q2. I'm pleased with our results for the second quarter and the strong execution across all of our businesses in the first half of the fiscal year. We remain confident in our outlook for the full year, and we continue to expect adjusted earnings per diluted share of $10.50 to $10.90 for fiscal 2015. In addition to the strength of our operating performance, we continue to have a strong balance sheet. For the first half of the fiscal year, we've generated cash flow from operations of $165 million, and our expectation to deliver cash flow from operations of approximately $3 billion for fiscal 2015 remains unchanged from our original guidance. With that, I'll turn the call over to James, and we'll return to address your questions when he finishes. James?

Thank you, John, and good afternoon, everyone. We are very pleased with our second quarter results and our performance in the first half of fiscal 2015. Before reviewing our second quarter results, I'd like to address a request from some of our investors related to the impact of foreign currency rate movements on our results. As you might recall in our original guidance for fiscal 2015, we assumed an exchange rate of $1.36 per euro for the full year. For the first half of the year, the average exchange rate was in line with this assumption and thus, foreign exchange did not have a material impact on either our first or second quarter results. However, given the recent strengthening of the U.S. dollar, we are now assuming an average exchange rate during the second half of our fiscal 2015 of $1.27 per euro. This would drive a full year average exchange rate of $1.31 per euro. This equates to a negative foreign currency translation impact of approximately $0.04, net of the Celesio noncontrolling interest, during the back half of our fiscal year. However, as John mentioned, we are maintaining our full year outlook for adjusted earnings from continuing operations of $10.50 to $10.90 per diluted share. Now let's move to our results for the second quarter. My remarks today will focus on our second quarter adjusted EPS from continuing operations of $2.79, which excludes 3 items: amortization of acquisition-related intangibles; acquisition expenses and related adjustments; and LIFO-related adjustments. Turning now to our consolidated results, which can be found on Schedule 2A. Consolidated revenues increased 36% for the quarter to $44.8 billion. On this 36% revenue growth, adjusted gross profit for the quarter increased 46% to $3 billion, driven by Celesio and the strong performance of our other Distribution Solutions businesses. Total adjusted operating expenses of $1.9 billion were up 59% for the quarter. Excluding the impact of Celesio, operating expenses increased 1% for the quarter. Other income was $23 million during Q2. Interest expense increased 68% versus the prior year to $99 million, driven by debts issued and assumed related to our acquisition of Celesio. Now moving to taxes. Our adjusted tax rate for the quarter was 32%. As usual, I would expect this tax rate to fluctuate somewhat from quarter-to-quarter. As a reminder, we still expect our full year adjusted tax rate to be approximately 31.5%. Adjusted income from continuing operations for the quarter was $658 million, with our adjusted earnings per diluted share from continuing operations at $2.79. Wrapping up our consolidated results, diluted weighted average shares outstanding increased by 1% year-over-year to 235 million. Now let's turn to the segment results, which can be found on Schedule 3A. Distribution Solutions' segment revenues increased for the quarter to $44 billion, up 37% on a reported and constant currency basis. North America pharmaceutical distribution and services revenues increased 14% to $35.1 billion. On a constant currency basis, revenues increased 15%. Current quarter revenue growth primarily reflects higher-than-expected demand for Sovaldi and Olysio, 2 recently launched drugs for the treatment of hepatitis C, market growth and our overall mix of business. For the year, we are forecasting higher-than-planned branded drug sales, which reflect our strong market demand for the 2 hepatitis C drugs and delays in certain generic launches, including Nexium and COPAXONE. As a result, we now expect that our North America revenue will increase by a low double-digit percentage for the full fiscal year. International pharmaceutical distribution and services revenues were $7.3 billion for the second quarter. On a constant currency basis, revenues increased 4% on the underlying revenues of Celesio. Medical-Surgical revenues were up 4% for the quarter, driven by market growth. Distribution Solutions' adjusted gross profit increased 58% for the quarter on a 37% revenue growth, resulting in an 80 basis point improvement in our adjusted gross profit margin, driven by our acquisition of Celesio and market growth. Adjusted operating expense for the segment increased 88% for the quarter due to our acquisition of Celesio. Excluding Celesio, operating expenses for the segment increased 4% year-over-year. The segment-adjusted operating margin rate for the quarter was 242 basis points, a decline of 15 basis points versus the prior year, driven by a higher mix of branded drug sales, including the effect of the hepatitis C drugs and the brand to generic delays that I just mentioned. Excluding the impact of both hepatitis C drugs, segment-adjusted operating margin was approximately 250 basis points for the current quarter. As a reminder, for the full year, our expectations for branded and generic drug price inflation remain unchanged, although we expect some variability in the impact of pharmaceutical prices from quarter-to-quarter. Based on the impact of the 2 hepatitis C drugs and the delayed generic launches as well as our assumption that operating profit in our international pharmaceutical distribution and services business will be down modestly year-over-year, we now expect full year Distribution Solutions' adjusted operating margin to be flat to modestly up over the prior year. Turning now to Technology Solutions. Revenues were down 6% for the quarter to $770 million. This decline was primarily driven by the anticipated revenue softness of the Horizon Clinical software platform, the planned elimination of a product line and the wind-down of our U.K. workforce business, partially offset by growth in our other technology businesses. Adjusted operating expenses in the segment decreased 5%, driven primarily by restructuring actions taken in the prior year. Despite the anticipated decline in segment revenues, second quarter adjusted operating profit for the segment was flat at $139 million. And the adjusted operating margin rate was approximately 18%, representing an increase of 102 basis points versus the prior year. This increase was based on a favorable revenue mix in the second quarter as well as the effect of reduced expenses. I'll now review our balance sheet metrics. As you've heard me discuss before, each of our working capital metrics can be significantly impacted by timing, including which day of the week marks the close of a given quarter. In addition, our working capital metrics also include Celesio. For receivables, our days sales outstanding increased 2 days versus the prior year. Excluding Celesio, our days sales outstanding remained flat at 24 days. Our days sales in inventories were flat year-over-year at 30 days. Our days sales in payables increased by 1 day year-over-year to 49 days. Excluding Celesio, our days sales in payables increased 3 days to 51 days. We generated $165 million in cash flow from operations during the first 6 months of fiscal 2015. Overall, for the full year, we continue to expect our cash flow from operations to be approximately $3 billion. We ended the quarter with a cash balance of $3.8 billion, with $2.1 billion held offshore. Internal capital spending was $272 million for the first half of fiscal '15. Now I'll turn to our adjusted EPS outlook for the year. As I mentioned earlier, our fiscal 2015 guidance for adjusted earnings from continuing operations per diluted share of $10.50 to $10.90 is unchanged but now assumes a second half $1.27 per euro exchange rate. Before I conclude, I will make a few remarks regarding our acquisition of Celesio. As John mentioned, we continue to expect that we will achieve operating control of Celesio by the end of calendar 2014. By the fourth year after obtaining operating control, we continue to expect to realize annual synergies between $275 million and $325 million. And finally, with respect to our expected GAAP earnings per share for the full year, we now expect $1.32 per share in amortization of acquisition-related intangible assets and $0.57 of acquisition expenses and related adjustments. We also expect to exclude between $0.97 and $1.07 per share in LIFO-related adjustments. In summary, McKesson delivered strong financial results during the first half of fiscal 2015, and we are well positioned for the second half of our fiscal year. Thank you. And with that, I will turn the call over to the operator for your questions. [Operator Instructions] Melissa?

[Operator Instructions] Our first question comes from Lisa Gill with JPMorgan. Lisa C. Gill - JP Morgan Chase & Co, Research Division: John, can you maybe just talk about drug price inflation in the quarter on the Generics side? The last few quarters, it's been pretty strong, but I didn't hear you specifically call it out in this quarter. Is there anything that's changed?

As we chatted on the first quarter, we believe that some of our second quarter inflation was pulled slightly ahead into the first quarter. Our outlook for the year remains unchanged, down slightly from the inflation rates we experienced last year but still pretty robust. So the second quarter came in line with exactly where we thought it would be when we finished the first quarter comments. Lisa C. Gill - JP Morgan Chase & Co, Research Division: And then James, just a numbers question. If I listen to what you said around the delay in Nexium, COPAXONE and the foreign currency, am I right thinking that versus your initial expectations that those things combined are somewhere in the neighborhood of a $0.10 headwind versus the initial guidance that you gave us?

Well, in terms of the initial guide, certainly -- obviously, we're reaffirming the guide that we've outlined earlier in the year so we feel very comfortable with the range. We have been surprised by the strength of the hepatitis C volumes. And they come along with lower margins, as I intimated. Without those 2 hepatitis C drugs, our margin would have been right around the 250 basis point level for Distribution Solutions. So hopefully, that gives you some sense as to the impact of those hepatitis C drugs on our quarter. So that was really an important driver, but overall, we still feel good about the guide even though we have the $0.04 currency headwind that I mentioned as well. Lisa C. Gill - JP Morgan Chase & Co, Research Division: Right. As well as the delay in the Generics, right?

Yes. Lisa C. Gill - JP Morgan Chase & Co, Research Division: So the combination of those, that's an incremental headwind to what we would have expected post last quarter?

Yes, that's right. So we referred to generally strength in branded pharmaceutical sales in terms of the mix. And those delays of products like Nexium and COPAXONE are important drivers within that theme.

Our next question comes from Eric Percher with Barclays.

Could you speak to the way that you're looking at the noncontrolling interest and your willingness to put cash to work as long as the noncontrolling interest is outstanding? I guess more specifically, do you think that your minimum cash balance, as long as the interest is out, has to encapsulate it? Does it need to be $1.4 billion to $1.6 billion-plus, whatever it takes to run the business. Or if this looks like it's going to go on for a long period, would you consider using the cash that is offshore?

Well, in terms of capital allocation, we obviously have to be mindful of the noncontrolling interest that you're mentioning there. Also, we have to be focused on the larger debt maturities that we have coming due in fiscal '16, where the maturities move to the $1.5 billion type level, whereas this year, debt maturities have just been a couple of hundred million dollars in total. So those are important things to bear in mind. But having said that, nothing has changed in terms of our overall portfolio thinking towards capital allocation. And historically, that has meant a balance between M&A, internal capital expenditures as well as share buybacks and dividends. So that's how we're really thinking about cash and the capital allocation equation.

I also think, Eric, it's difficult to forecast when the minority interest or noncontrolling interest purchase would take place. And I think that's one of the other challenges is it may not be 100% in our control, given that they have the ability to put those shares to us.

Sure. So -- but it sounds like you're still approaching the noncontrolling interest as you would any capital allocation decision? Or is there a strategic need to own it?

Well, again, those minority holders have the right to put their shares to us or we would continue to pay them a defined annual dividend. So this equation is very much in their hands.

Right. But you don't feel the need to chase that?

Well, as we've said for our full year guidance -- fiscal '15, we're assuming 76% is going to be our ownership level for Celesio. And again, the core process defined through our independent evaluation are the rights for the minority.

And also, I would remind the listeners that the operating -- operational control process that we're pursuing, that we believe will be completed by the end of the year, is not affected by the ownership position of the company. Once we surpass the 75% ownership position, it allowed us to pursue this activity, which will give us the ability to begin to realize the synergies that we've outlined. And so I -- they are 2 separate and distinct discussions: one is operational control, which is the process that's underway; and the second is the ownership -- the remaining ownership of the 24% that is not currently held by McKesson. And to affect operational control, we do not need to buy any of the additional outstanding shares.

Our next question is from Ricky Goldwasser with Morgan Stanley.

John, can you give us a little bit more color on kind of like your thoughts about -- on the European market dynamics in line of the Celesio-revised guidance and your comments on the 3 geographies in Europe and how that compares to kind of like your thought when you provided guidance and entered a transaction?

Well, clearly, the Celesio management team has a responsibility to comment on their results, and I think they did so this morning. I think stepping away from Celesio specifically and looking at the markets, clearly, there is continued price pressure in Germany, in the wholesaler side of the business, and which I think the industry has been talking about for some time. Clearly, the French economy has not performed at the level that some would have had expected. And there's additional pressure in that market. And Brazil has been a challenge for many of the companies that are competing in the Brazilian market. I think the -- anybody that has followed Celesio specifically would recognize that there have been certain operating challenges that they have faced and I believe that they're beginning to address. However, McKesson really can't be involved in their decisions and their actions to correct some of their challenges. I would also remind everyone that the synergies that we believe come from gaining operational control and that we've outlined on a continued basis remain very significant and we believe would also provide another vehicle to offset some of the operating challenges that may exist on a country level within Celesio. And clearly, they highlighted the strength of the U.K. business and the continued performance there, which I think is a positive.

Okay. And then just one quick follow-up. I think John, you mentioned in the prepared remarks that Rite Aid operational -- operation transition was completed. Should we assume that the contribution from Rite Aid in the quarter is now at full run rate? And also, around kind of like along those lines, you announced that you've extended your contract with CVS from 3 years to 10 years a couple of months ago. Should we assume that, that was also in your updated guidance, assuming that the step-down in pricing is you normally see with product renewals and extensions? Or is this something that we should factor in through fiscal year '16?

Well, the Rite Aid operational completion took place in the quarter, so I would suggest that not 100% of the results were realized in the quarter. But I do think it's certainly bounded by the range that we've provided and continue to support. Likewise, I would say the CVS contract renewal or extension was a -- was contemplated also as we thought about our comments last quarter and this quarter. So I don't think there will be any specific changes to our guidance going forward based on either of those 2 events.

Our next question comes from George Hill with Deutsche Bank.

John and James, I wonder if I can kind of revisit Lisa's question in a different way, which is if we look at how you guys came out of Q1, results were really strong and you got the guidance raise. And then kind of as we've moved through now, the company has seen some significant headwinds, but the guidance has been maintained. You talked about the $0.04 euro impact and the FX impact. There's probably a couple of pennies of just weakness in the Celesio business as France and Germany and Brazil deteriorate. Nexium and COPAXONE get pushed out. I guess, what I want to know is would you quantify kind of if we were to -- kind of back to Lisa's $0.10 question, is that the right number? Or would you guys kind of quantify the things that have changed in your -- the things that have changed versus your original expectations, kind of what were they worth and how should we think about those moving pieces?

Well, I won't have a specific issue-by-issue breakdown for you. But as you note there in your question, we have changed during the year our guide for Distribution and Solutions margins. So originally, before we saw the hep C type volumes, we were thinking that we could grow those margins high single digits. And then as we got a better understanding of the hep C volumes during Q1, we brought that down to the mid-single-digit growth that we talked about 90 days ago. And what we're doing today is again updating that view for these continued growth on the hep C side as well as these other items that you're mentioning that are coming into play, particularly around the brand to generic conversion time lines. So you can kind of think of that margin point progression along the lines of the impact of the hep C drugs originally, and then this quarter, both hep C and the brand to generic conversion.

And I also would say, George, I guess to be more specific, I think you're accurate in your assessment that the strength of the underlying business has offset some of these challenges that we didn't contemplate. So as much as we are missing the margin related to 2 product launches, we've largely been able to grow through that by the strength in our proprietary OneStop Generics program, which even without the Rite Aid volume, grew by more than 20% in the quarter. And the strength in the rest of our operations that continue to deal with the headwinds delivered by the delay in the Generics, the headwind delayed -- the headwind related to the FX, the currency exchange rates, and the headwind delivered by Celesio's revised view of the rest of their year. All of those are built in and yet, we're still optimistic that we'll be within the guidance range that we've provided. So I think people should feel good about the underlying operating results of the business, given those circumstances.

Yes. That's kind of where I'm going, John. And maybe then just a quick follow-up is I'm actually not looking at the margin mix impact, I'm looking at the absolute gross profit dollar growth impact. And kind of x these things, it's safe to assume that gross profit dollar growth would have been stronger than you guys reported. So I guess, James, I would just ask, you talked about the hep C drugs. You guys are making an absolute gross profit dollar on them, they're not loss leaders for you guys. So they're additive to the gross profit line, right?

They are, but very much more dilutive than the norm from a margin perspective.

Our next question is from Bob Jones with Goldman Sachs.

We've heard from some of the retailers about pressures they're experiencing from both generic inflation and reimbursement pressure from payers. I'm just curious, do either of these issues that they're facing have any collateral risk to you? And along those lines, are any of these issues that have arisen at the retail level made others more skeptical of joining some of these purchasing platforms, obviously, specifically McKesson's purchasing platform?

I think it's interesting when you talk about customers because each one of our customers experience their business in an individual way because they're a mix of payers, their view of inflation, their contracting processes, how they price their book, are all different. So I think it's difficult to lump everybody into a giant basket and say this is how they're being affected. And I think that independents clearly have a different book of business than the large chains do and certainly, mail orders, et cetera, have different vehicles by which they offset or take advantage of trends in the business. I would say that McKesson continues to focus on the success of our customers, and we remain extremely flexible in our relationships with our customers to make sure that they're afforded an opportunity to continue to enjoy the efficiencies of doing business with a wholesaler, while at the same time, taking advantage of the opportunities that they may have enjoyed outside of the wholesale channel in the past. I'm absolutely convinced that with the exception of perhaps one of our customers, all of our customers would benefit by buying their generics strictly through McKesson. And I believe that we will continue to make progress on our ability to grow our business on the Generics side more rapidly because of our increased penetration of our existing customers and the strength of our model going forward. So I have no doubt that we will continue to evolve our partnership with our customers in a way that adds value to them and grows our business at the same time.

That's helpful. And I guess just my follow-up around generic purchasing. There is some chatter or concern in the marketplace that maybe some of the synergies that were originally mapped out on paper relative to these purchasing consortiums might not be translating at the actual negotiations level with generic manufacturers. I'm just wondering if you could comment around how your negotiations have progressed as you've gone out to the generic manufacturers around buying better with more scale? And any change relative to the original or previous expectations that you laid out around the procurement benefit?

Well, you've heard us talk regularly and repeatedly about our success with our relationship with Rite Aid, which is clearly our largest example of an alignment of a customer buying off of our contract book and our ability to work together with our combined volumes in a way that delivers benefit to both enterprises. And I think that is the best proof point. I would point out that there are many voices in this discussion. And the voices have different objectives perhaps. And that maybe the objectives of some of those voices is to try to make sure that these purchasing collaboratives, cooperatives, joint ventures, whatever you want to call them are not successful in aggregating volume because it may be to the disadvantage of other people in these channels. And so I -- all I can speak to is the fact that we continue to get the benefits that we had expected as we entered these arrangements. Or we continue to build our book of business, which adds significant value to the manufacturing partners that are part of our solution going forward and deliver significant value to the customers that have availed themselves of not only the price points that are available through McKesson because of our scale, but also to the service offering that we make available to our customers that take them out of the logistics business that is clearly more superior coming from McKesson. So I would say that we remain extremely optimistic, and the data that we're seeing continues to possibly reinforce the decisions we've made around generic sourcing.

And until we get operating control, we can't even have discussions with the manufacturing partners that include Celesio's volumes.

Right. So that's yet to begin.

Our next question is from Steven Valiquette with UBS.

So I'll also pile on and ask a question on generics as well. But for me, I guess on the inflation, if I recall, I think you were previously including some of the new product launches in your generic inflation outlook, of the high single digits for this year. So I guess with your inflation view unchanged, but with some of these delays and some of the big launches that you've talked about, I presume we would have been high margin. Could we potentially infer that maybe the inflation trend on the older base of generic products is perhaps greater than expected to offset those launch delays? Or am I just -- perhaps I'm reading too much into that?

Well, I think Steven, you asked a very good question, and this is a very confusing discussion for almost everybody involved in it because the definition of generic inflation is done differently by different people in the business. So I think it's important for us to explain how we think about it when we talk about our view of generic inflation being unchanged from the point from which we gave guidance coming into this year. Maybe James can give you a little color on how we define generic inflation.

Yes, our definition is for generic drugs beyond their exclusivity period. So you can think of those as the more mature drugs. So we would specifically exclude from our commentary those drugs that are just now converting from brand to generic. So again, the experience that we've had thus far this year leaves us comfortable with our full year guide that we would see generics outside of their exclusivity period, rising high single digits year-over-year. So as John alluded to a little bit earlier on one of his responses, that's a smaller year-over-year increase than we saw last year, but still clearly well above the historical norms for generic price inflation.

Okay. Yes, I appreciate that clarity, but I guess at the same time, it leaves me scratching my head though on the discrepancy then on your view of the generic inflation outlook versus some of the peers that I thought were also definitely excluding those new launches from their inflation outlook but were suggesting lower numbers. So I guess we can follow up off-line on that.

Yes...

The other thing I'd say, Steven. I know you're off the line now, but I would say that remember, everything we say is related to McKesson's book of business and our mix. So I'm not sure that everybody's mix would be similar to ours or book, so that might be an additional variable that people can't reconcile.

And then also the way we think about the dollars that we drive from those price increases are very much related to the inventories that we have for those drugs that are seeing the price increases. So you would, I think, naturally see between that as well as the mix point that John is making, a variability across different parties.

And different fiscal years as well.

The next question is from Ross Muken with ISI Group.

So it seems like Medical continues to track along reasonably well. Can you talk about sort of the next phase of sort of the PSS integration and synergies? It seems like we've sort of moved on from the initial profit capture there. And it seems like the margin profile is still maintaining quite well and hopefully, moving up. And so maybe just give us a little bit of a picture of kind of how that is trending currently.

Now sure, Ross. And the PSS integration has been trending very positively for McKesson. We are through the phase which included the retention of the sales forces and the combination of our sourcing activities and the things we are doing around the brands and compensation systems, et cetera. And now we're into sort of the heavy-lifting phase, which is the consolidation of some of the distribution and transportation infrastructures of the 2 companies. Probably less risk, but maybe even more work, given the amount of energy that has to go into making these consolidations happen, but clearly, there's a lot of value left to harvest out of the integration as we take out some of this duplication from an expense perspective. But most important, I think, was our ability to retain the sales forces with their great relationships with our customers, to continue to focus on our customers' success and our performance with those customers, and now to take some of the cost out that's redundant.

And maybe just on Tech Solutions. Obviously, a very good margin print this quarter. But the revenues, given some of your actions, continue to drag. And it seems like maybe by the end of the year, into early next year, we could possibly get back to revenue growth. I mean, is it your belief, once we sort of comp through these changes, that we can sort of maintain sort of the margin trajectory, hopefully, up to the mid- to upper teens while also kind of -- sort of starting the growth engine in that piece?

That's probably premature to guide on what we might see in the fiscal year ahead or beyond. I would say that our businesses are well positioned, that we know of the business that we've had the biggest challenge with in the EMR kind of space. We do -- we believe that our long-range guidance on margins should be in the high teens. And so clearly, we see that as a continued objective for us in the business. And we should be growing the businesses at or above market rates when we're post this transition of Horizon to Paragon. So I think we remain cautiously optimistic that we're in the right places at the right time. I would certainly point to you and to other listeners that know this business, that we have a very large footprint in medical imaging. Although we have a very significant market share there, the customers have not been focused on imaging products, they have been focused on buying products to meet their requirements from a Meaningful Use perspective. So some of the revenues in that business have been not growing, that we hope will grow again once people get past their obligations to meet government regulations.

Our next question comes from Dave Francis with RBC Capital Markets.

John, as it relates to the kind of ending process of getting operational control of Celesio, is there anything out there in that process either in or outside of your control that might change your expectations relative to the calendar and timing of when you guys do achieve operating control?

I think it's difficult to speak about this process with certainty. I can tell you that our expectations remain that we will get operational control this calendar year. There is a process that's outlined for it, and the parties that are involved have presented their facts and their cases as they see them in the process. And we're hopeful that we'll get an outcome that allows us to move forward with domination, like I said, by the end of the fiscal year. So I think it's difficult to say other than the fact that we remain optimistic and there's been no new news that would cause us to change our view of being optimistic about making it through this process.

Is it -- a quick follow-up then, switching gears a little bit. On the logistics side of your business, given the sharp decline in fuel prices here of late, is there any way -- or I guess, is there a meaningful contribution to lower expenses that you guys are seeing from lower fuel prices generally? And is there any way that you guys might be able to help us quantify that benefit?

Well, clearly, there's a benefit in our transportation cost centers across the corporation when fuel prices are in a decline. I'd have to say though, Dave, they're -- in aggregate, they're not a material impact at all to McKesson. And that's something that we focus on in a real specific way. And a portion of our transportation is already outsourced so the benefit would fall to those contract agents that we use in logistics. But I think that it's certainly not a negative event, and we are encouraged by it, but it won't have any meaningful impact on our business.

Our next question is from Eric Coldwell with Robert W. Baird. Eric W. Coldwell - Robert W. Baird & Co. Incorporated, Research Division: A little bit of a leading question, perhaps, but thinking about hep C, well, it's perhaps a little bit more than you expected obviously to begin the year and maybe even this quarter. I doubt The Street mismodeled hep C by the nearly $2 billion that you beat in North America pharmaceutical, if I adjust for international. And your Med-Surg revenue also was pretty good. So when I think about that, I think about Owens & Minor this morning beating by 2.5%, 3%. It seems to me like overall market activity, utilization volumes, et cetera, are up. But I haven't really heard you talk much about that tonight, and it's always good to get a distributor to true-up what we're hearing from the labs and hospitals. So I'll just ask you for your comments on the overall market environment.

Sure, Eric. Thanks. We do see, I think, at the margin, an increase in utilization across all of our businesses. I think that almost every one of our executives would say that they believe that there is a certain amount of revenue increase being driven by just more patients in the system and patients in the system that have the appropriate coverage or at least some coverage from an insurance perspective. So I think that it has been a positive component to our results. And I think I'd also add that as people take on more risk for the patients and they're paid for performance, whereas we've talked about paid for value or outcomes, we find that the utilization of pharmaceuticals increases. It's the first and best avenue for people to go to if they have responsibility for a patient to make sure they're on their meds, they stay on their meds, and that I think also will continue to be a fuel for our industry. So I think that in light of what's happening, I think we remain optimistic that this is having some -- at least at the edges, some effect on revenue growth.

And we'll take our next question from Charles Rhyee with Cowen and Company.

John, if I could ask you this question, I think 1 large European pharma manufacturer is talking about diabetes this morning, talked about some big price competition going on with some of its other competitors. It's kind of new in the sense that these are large-branded categories, would not really need generic competition. I saw a little bit of that, I think, with -- sorry, asthma drugs, a little bit earlier. Can you talk about some of the dynamics you're seeing in the market on the brand side here? And does that have any positive or negative effects for you as the distributor?

Well, we continue to see innovation on the brand side as we've talked about with some of the specialty drugs that have come out. I have to admit that I'm not that close to some of the diabetes work that you refer to. And I do think that as we've talked about, we continue to see price increases on the brand side in line with our expectations and sort of the historical performance. So I think what -- reflecting that at a 40,000-foot level, I think we're pleased to see innovation returning to the brand world, and these companies are not only going to make a difference in people's lives, but they certainly will help provide additional fuel for our industry. So I think that, that would be my takeaway.

Great. Then maybe if I can just follow up then on hep C more specifically. As we go into next year and we get more competition in the class, does that offer you some opportunities? Or is it really a function here that brand drugs remain -- that the margins, regardless of the manufacturer, will likely be small for you guys in this category?

Well, it's difficult to forecast specialty drugs or new drug launches in a sort of a uniform way. Clearly, some of these drugs will be launched in oncology, and we're very optimistic that when new launches happen in oncology, they're not only better for the patients, but they're also, because of our position in oncology, better for our business. And we benefit from the position we have in that marketplace and can help the manufacturers get their product not only through clinical trial, but also utilized in the correct fashion. And that provides an opportunity for us economically. The hep C product, because of its unusual orientation towards government buyers and mail-order buyers, has an unusual distortion, so to speak, in our volume because of our footprint in those markets. And so I would say that other specialty launches may not have a similar characteristic in terms of the uptake of the product. And so each channel has a different characteristic for us from an economic perspective. But overall, we're happy to see the innovation happen.

We'll take a question from David Larsen with Leerink Swann.

So as more hep C drugs come to market, say, next year, is that generally a positive for your margins?

Well, hep C has been a negative for our margins. As James discussed, it was a significant impact in the quarter for our margins and will continue to be a drag on our ability to get to our guided margin for the year, and that's why we've changed it and were specific about it. Over the long term, clearly, we believe this stuff will flow through the system and we were still confident with our long-term objectives of 250 to 300 basis points for Distribution Solutions. Clearly, we need to continue to evaluate the economics of these products as related to the service we provide to both the manufacturers and to our customers. And we need to make sure we're being properly paid by the channel for the role that we play. And hep C clearly would be a product that we would focus on, and future products of this characteristic, we would have to focus on to make sure that the dilutive margin effect that it's had doesn't continue.

Yes. It's clear that as a percentage of revenue, your gross margins would have an unfavorable impact. But as more competing hep C products come to market, relative to having only, say, 1 vendor like Gilead, would you generally earn more gross profit dollars as competition comes to market for that therapeutic class?

Well, that's a good question. I think the ability for us to be paid for affecting the competition would require us to have some role in the channel. And it's not clear to me that we would be in a position to tell our mail order customers, for example, which hep C drug they're going to put on their formulary. So in that specific example, it may be difficult for us to increase our margins specifically because of an additional launch in the category of another branded product. It will probably not provide the same ability for us to move share that, for example, generic drugs provide us. So I'm not particularly optimistic about that single event.

Okay. Great. And then just any preliminary thoughts around fiscal 2016, the impact of new generic launches? It seems like with these pushes, there could be a positive comp impact for fiscal '16, and it seems like there could be some pretty big ones, Nexium, COPAXONE, ABILIFY, maybe Enbrel and Advair. Any general thoughts around that?

Well, clearly, to the extent that these positives are pushed into next fiscal year, then that's where they will be realized. And so I think we remain optimistic that our position in Generics is doing nothing but improving. And that as our scale and our footprint expands globally, we'll be able to bring even more value to the market relative to the generic manufacturers and to partner even more closely with them. So yes, I'd say on the margin, we're excited about the Generic portfolio as we look forward.

We will take our last question from Garen Sarafian with Citi.

I wanted to go back to Celesio. You stated how your expectations are to have operational control by year-end and the fast-track approval. So I'm wondering if it's not, what's the alternate method entail? So maybe if you could give a worse case or best case range of outcomes there, I would really appreciate it.

Well, thank you for the question, Garen. I don't know that we have a firm view on the time line or the potential outcome in terms of how long it would take us to gain operational control. I think if we don't get it in the fast-track process, we remain extremely optimistic that we will get it. And then it's just a question of why didn't the fast-track happen and what do we need to do to facilitate the right decision, which is to give us operational control later on in the process. And so I think it's difficult to speculate.

But all of that said, we still remain confident that we are going to get operating control in this calendar year.

Well, I want to thank you, operator, and also, I want to thank all of you on the call for your time today. I'm pleased with our solid results in the second quarter and I want to recognize our employees who dedicate themselves to focusing on our customer's success and continue to drive outstanding performance across our businesses. I will now hand the call off to Erin for her review of upcoming events for the financial community. Erin?

Thank you, John. I have a preview of upcoming events for the financial community. On November 11, we will present at the Crédit Suisse Health Care Conference in Phoenix, Arizona. And on January 13, we will present at the JPMorgan Health Care Conference in San Francisco. We will release third quarter earnings results in late January. Thank you, and goodbye.

Thank you for joining today's conference call. You may now disconnect, and have a good day.