McKesson Corporation
Q2 2016 Earnings Call Transcript

Published: 29 Oct 2015

[Operator:]

Good day, and welcome to the McKesson Corporation Quarterly Earnings Call. All participants are in a listen-only mode. Today's conference 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, Investor Relations. Please go ahead

[Erin Lampert:]

Thank you, Audra. Good morning, and welcome to the McKesson Fiscal 2016 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 one hour at 9

[John H. Hammergren:]

Thanks, Erin, and thanks everyone for joining us on our call. Before I recap our quarter, I want to take a few moments to discuss the issue that must be on everyone's mind

[James A. Beer:]

Thank you, John, and good morning, everyone. We are pleased with our second quarter results and our performance in the first half of fiscal 2016. As John discussed earlier, we are raising our previous outlook for fiscal 2016 and now expect adjusted earnings per diluted share of $12.50 to $13. This revised outlook is driven by the following five items. First, a pre-tax gain of $51 million or $0.14 per diluted share from the sale of the ZEE Medical business, which is reflected in both our GAAP and adjusted earnings for the second quarter. The benefit to our full-year adjusted earnings from this divestiture is $0.11, which is net of the $0.03 in adjusted operating profit that we no longer expect to earn from the ZEE business during fiscal 2016. Second, a discrete tax benefit of approximately $25 million related to a U.S. Tax Court ruling during the second quarter which allowed us to revisit a previous tax filing position. Third, the reduction in our expected weighted average shares outstanding for fiscal 2016 from repurchasing $500 million in common stock late in the second quarter. Our updated diluted weighted average shares outstanding assumption for the fiscal year is now 234 million. Fourth, our view that generic pharmaceutical pricing trends will remain weak in the second half of the fiscal year but at a similar level to what we experienced in the second quarter. And fifth, the impact of certain customer contracting decisions since our previous earnings call in late July, including the expiration of our contract with Optum and our new relationship with CVS Omnicare. Before reviewing our second quarter results, I would like to highlight an update to the schedule accompanying our earnings press release. We have expanded Schedule 3 to include supplemental constant currency information to outline both the dollar and percentage impact of currency movements on our reported results. This supplemental information provides a framework to assess how our business performed excluding the impact of foreign currency rate fluctuations. I hope you all find this to be a valuable addition to our ongoing disclosures given the now global nature of our business. During the second quarter and the first half of fiscal 2016, our reported adjusted earnings per diluted share included currency headwinds of approximately $0.03 and $0.08 respectively year-over-year. Therefore, during my prepared remarks, I will reference both the reported and constant currency figures which are provided in Schedule 3. 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 $3.31, which excludes three items

[Operator:]

Thank you. . We'll go first to Lisa Gill at JPMorgan.

[Lisa Christine Gill:]

Thanks very much, and good morning, everyone. Thank you, John for all the detail. I was wondering maybe if we could just start with Europe and Celesio. The last two acquisitions you've made have been in Europe. Can you maybe just give us an update on how you view the European market? What are some of the opportunities? And, you know, how has it played out over the last year and a half versus your expectations when you bought Celesio?

[John H. Hammergren:]

Thanks, Lisa, for the question. Clearly we went into Europe with our eyes wide open on two fundamental things. One was that Celesio wasn't operating at the level we thought it could and should, and certainly under McKesson's ownership. And second was that the European market does have some risk related to the demand profile as well as the regulations and reimbursement structures that exist there. Having said all of that and knowing where we are headed, we're really pleased with the quality of the results thus far. We believe there's significant opportunities for us to grow both organically in that business by penetrating the areas of the market that have yet to be touched by wholesale distribution, and certainly not touched by us. Like Specialty or Oncology or Hospital distribution. And clearly we think there's a great opportunity for us to deploy capital effectively, efficiently, and appropriately in Europe to help build our value proposition in that market. And also, as you know, we brought with us a very large retail footprint which grows through the acquisition of Sainsbury's and it is growing also just organically in Europe as we complete our banner rollouts with our European pharmacy network, et cetera. So all said, I think we feel like we're in really good shape. We have a couple more years of building out our technology capabilities there. We're in the midst of installing SAP and we have some other work to do, but we do believe that we'll get into business position to not only invest in it the way we have started to, but also to get organic growth.

[Lisa Christine Gill:]

John, does the company have a goal for how much of operating profit or revenue of the company will come from outside of North America, say over the next several years? And I know I'm not allowed three questions, but I just need a clarification on the comments out of Celesio that you cleared the transfer agreement. Does that mean that you're de-listing the stock? And then I'll stop there.

[John H. Hammergren:]

Well, certainly on the first part of that question, Lisa, we do have an expectation to grow in all of our businesses, and to grow at rates that are at or above market levels, particularly in markets where we are under-penetrated and there's significant opportunity for us. And that would be the case in Europe. We think there's significant growth prospects for us in most of the markets in which we compete. And as I mentioned, I think this idea of continuing to bring a banner Health Mart-like approach to Europe has been successful and is continuing to show great promise. So you'll see us roll out more Lloyds or Lloyds-like pharmacies throughout Europe. And James, perhaps you can talk a little bit about the...

[James A. Beer:]

Yes. In terms of the Celesio stock, when we gained operating control of Celesio, Celesio was trading on five German exchanges, and we have since then de-listed from three of the five. And on the remaining two, we're still a part of the regulated unofficial market. Those markets are Munich and Dusseldorf. I can't comment on any future plans around de-listing. There are a variety of German legal requirements for us to adhere to, but that's an update on our progress.

[Lisa Christine Gill:]

Great. Thank you very much.

[Operator:]

We'll move next to Steven Valiquette at UBS Financial.

[Steven J. Valiquette:]

All right, thanks. Good morning, John and James. Congrats on the results. So I guess, John, in your prepared comments, you reinforced the notion that there's a lot of change going on in the U.S. pharmaceutical supply channel marketplace. And I guess in light of that, do you think we've reached an era now in the U.S. where large drug distributors could potentially own and operate fairly large retail drug chains in the U.S., similar to what McKesson and others are already doing in Europe? Is this something that you think you could consider now, just given all the U.S. alliances that have already been formed?

[John H. Hammergren:]

Well, thank you, Steven, for the question. And obviously in Europe the construct of the industry is a little bit different in several of the markets where the wholesalers and retailers are part of the same organization. And in most of those cases, it's the same for all the industry participants, that they are both in the retail business as well as in the wholesaling business. We've looked at that phenomenon for a long time in Europe and wondered if it made sense in a U.S. context. I can tell you that we continue to believe that our customers appreciate the fact that we bring to them a focus on their success and that focus is not hampered by our own interest in a business similar to theirs or competing with them. And so I think that there's still, at least at McKesson, a focus on not competing with our customers in these segments and helping them be more successful each and every day.

[Steven J. Valiquette:]

Okay. Can I sneak in just a quick one on the Omnicare? Just for the generic, I'm guessing the sourcing will probably go through Red Oak, but are you saying that you'll still do just the physical distribution of the generics for Omnicare? Or is your distribution retention just on the brand side? Just want to clarify that piece. Thanks.

[John H. Hammergren:]

Well, you might recall that when we started the relationship with Omnicare many years ago, they relied on us for their brand distribution and purchased their generics directly themselves and put it into their own warehousing infrastructure. With our more recent agreement that we worked through with them, you know, we took on the rest of that responsibility, which I think was extremely beneficial to Omnicare. The new structure of the ongoing relationship with CVS will take us back in the direction where our original agreement was with Omnicare, principally focused on the brand side. Now having said that, almost with all of our customers, there is some generic business that we do, principally when there's a shortfall from a centralized warehouse approach or a direct approach. But we'll go back to more of our old relationship. And we're really pleased to be able to do that and to continue to service these Omnicare sites.

[Steven J. Valiquette:]

Okay, got it. Thanks.

[John H. Hammergren:]

Yep.

[Operator:]

And our next question comes from Ricky Goldwasser at Morgan Stanley.

[Ricky Goldwasser:]

Yeah, hi, good morning, and congratulations for the Omnicare contract. Two questions here. The first of all, is there an impact of the deals – you're going back to kind of like the old Omnicare generics, some uncertainty around other deals. Does losing kind of like generic business from these kind of like assets that now have been acquired has any impact on your generic purchasing power as it relates for the rest of your business?

[John H. Hammergren:]

Thanks, Ricky, for the question. Clearly we have had a long run of building significant scale in generic sourcing. And what's interesting about the model that we've built is our customers are choosing to rely on our ability to continue to grow scale and to negotiate favorable agreements and then use us and our assets and our service delivery model to fulfill their needs. We continue to grow our presence quite significantly from a sourcing perspective. You heard me mention a little bit about it when I talked to our continued growth in Health Mart and our new arrangement with Albertsons. And we have over 20,000 pharmacies now that are principally buying all of their generics from McKesson. And so that bulk of business is quite significant and quite attractive to get access to our channel by the generic manufacturers. So, one could argue whether we're number one, number two, number three at any one point in time in any specific market in terms of our generic sourcing. But I believe we have significant scale and are retaining and growing that scale in a way that will be attractive and will bring manufacturers to us in a positive, collaborative way where we can get real value for our customers and for the manufacturers

[Ricky Goldwasser:]

Okay. And then the follow-up is around the branded side. I mean, in the prepared remark obviously you talked about the fact that your assumptions regarding branding inflation are unchanged. There is some uncertainty in the marketplace around inflation, especially given the election debate that's shaping out. How should we think about McKesson's exposure to branded inflation overall and especially when we think about the March quarter, right, being usually a quarter with more inflation than the rest of the year?

[John H. Hammergren:]

Well, in our prepared comments we talked about the fact that we believe the first half of the year was slightly stronger from a branded inflation perspective. But for the full year, we expected it to be in line with our expectations. And that is still our point of view. Now, clearly there is more media attention and there is more discussion about price inflation in the market. But I happen to believe that the manufacturers that we work with at least will largely retain their current strategy. And there may be some outliers that begin to change their perspective slightly, but overall I think we expect the trends to continue.

[Ricky Goldwasser:]

Okay. Thank you.

[John H. Hammergren:]

Yep.

[Operator:]

We'll go next to Robert Jones at Goldman Sachs.

[Robert Patrick Jones:]

Great. Thanks for the questions. John, I actually just wanted to go back to the comments around Europe and Celesio specifically. I know in the prepared remarks you said Celesio has been exceeding your operational expectations, but I'm curious if you could give us an update on the synergy progression there, maybe relative to some of the targets you guys had shared previously. And I guess specifically, just how the generic purchasing benefits are going and if they're flowing through the combined entity today.

[John H. Hammergren:]

I think we've made very good progress. As you know, we established our global sourcing and procurement operations in London, and we have suggested to you in the past that the synergies of $2.75 to $3.25 would be more first half-loaded over a four-year period. So we are in that cycle now and I think we're making very good progress and are on track to accomplish our objectives. So once again, I think the manufacturing community has responded favorably to our global footprint and believe being a strong partner with McKesson will help them grow their business. And that's really the value proposition that we're putting forth and are delivering is that it's a win-win for people that are working closely with us in this collaborative way. So making good progress. And the comments I made earlier about Celesio was more on an operating perspective, that we're beginning to stabilize the operations of the business, put the systems in place and the culture in place along with building on the great management team that is already present. In fact, I was recently both in Italy and in the UK meeting with the management teams there, and there's some exciting things going on and I think the team is really energized about the opportunity of being part of McKesson in the first instance, but also the fact that investment is flowing both in terms of internal investment in warehouses and strategy and in IT systems and infrastructure but also in terms of bringing acquisitions to the table that make sense to grow our business and to grow our platform. So I think that the perspective is quite positive. Now, having said all of that, it's a while before this thing is going to grow the way you know we can grow it. It just takes us some time to put the foundation in place.

[Robert Patrick Jones:]

No. I appreciate all that. And then I guess just one more specific one, James. If I go back to the change in guidance, if I maybe exclude the ZEE Medical and the tax benefit, trying to just get my head around the $0.11 reduction. It looks like buybacks added maybe around $0.10. Could you maybe just walk through the other moving pieces, specifically around the contract decisions you mentioned and then the change in generic inflation assumptions?

[James A. Beer:]

Yeah, well, as we laid out a little bit during the prepared remarks, we have the ZEE gain for $0.11, the updates to our full year tax drives around $0.06, the share repurchase, the $500 million activity that we went into in Q2 drives around $0.09. So when you offset that against the loss of the Optum contract, and we've also talked about the fact that our guide now for the full year includes the new relationship with CVS Omnicare and our expectations for generic price increases, that really fills out the various drivers.

[Robert Patrick Jones:]

Okay, I'm sorry. Just a clarification then. So did the generic assumption change, and that's part of the change in guidance?

[James A. Beer:]

Well, what's important to remember is when we were last talking to you and talking about the guide, we did not have any change for the back half of the year to how we had been thinking about generic pricing right at the start of the year. So what we're doing now is updating the back half of the year from a generic pricing perspective, and we're saying that you would see a similar level of weakness there in line to what we saw in Q2.

[Robert Patrick Jones:]

Okay. That's really helpful. Thank you.

[Operator:]

We'll take our next question from Bob Willoughby of Bank of America.

[Robert McEwen Willoughby:]

Just a quick one. You'd mentioned in an earlier call that some of the assets in Brazil for Celesio were for sale. Is there an update on that?

[John H. Hammergren:]

Well, you're right. We did mention that. And the business has been I think working with potential buyers to portray the high quality assets that we have there, and I think we're still in a process with several interested parties. So I'm hopeful that we'll get that concluded within this fiscal year, if not in the third quarter. So we're making progress and we'll keep you updated as that goes. But yes, that is exactly what we said and we plan to continue with that plan.

[Robert McEwen Willoughby:]

Is there any way to size that, John? Is it bigger than a bread box? Is there a gain or a loss associated with it? Do you expect to associate with it?

[James A. Beer:]

Well, all I'd say is remember that this is part of our discontinued operations now.

[Robert McEwen Willoughby:]

Right.

[James A. Beer:]

So it wouldn't impact – the end result won't impact our adjusted EPS.

[John H. Hammergren:]

And I would say that it's on the small side as bread boxes go. I wouldn't fret about it too much.

[Robert McEwen Willoughby:]

Okay. Perfect. Thank you.

[Operator:]

We'll go next to Garen Sarafian at Citi Research.

[Garen Sarafian:]

Good morning, John. Good morning, James. First on Omnicare, I appreciate the further clarification you made earlier in the Q&A, but I'm curious around the dynamics leading to this result. I would have thought that from a client perspective, all else equal, they'd want to keep both sides of the distribution with a single vendor. And from the distributor side, I thought that branded alone was fairly standardized low margin offering and pretty much a commodity. So I'm just wondering if there's anything unique that you were able to provide or any other unique dynamic that you can offer to help think through this.

[John H. Hammergren:]

Well, it's difficult for me to make blanket statements about what every customer chooses to do. I would say that our current relationship with CVS on the retail side of their business is principally the distribution of branded pharmaceuticals, and their strategy around generics is actually to ship those products directly from their own CVS warehouses and not to order them through distribution. So albeit I can't speak necessarily to what they ultimately will do with all of the Omnicare business, but usually the decision that large customers make is either to put all the generics and all of the brand into the single wholesaler that they've selected to partner with, at least for that store or that business line. Or to bifurcate the two of them and purchase the generics on a direct basis, put them into their own warehouse, manage their own logistics, and ship them to the stores. You might recall when we had the discussion related to Rite Aid last year when they made a decision to get out of the generic business. What they were doing was not moving Rite Aid's generic volume from another wholesaler to McKesson. They were actually moving their generic volume out of their own infrastructure and into McKesson's infrastructure. So I would say that my belief is that CVS is still a self-warehousing customer on generics, and I would imagine that at least there's a strong possibility that what they'll do is move the Omnicare model back to the model that's frequently used within the rest of CVS. So I don't believe there'll be two distributors at Omnicare. I think there'll be a McKesson relationship on brand and perhaps some generic fill-in, and the rest of it will come out of CVS on a centralized, coordinated basis like they do for the rest of their operation.

[Garen Sarafian:]

Got it, okay. That's helpful. And then just moving to Tech Solutions. Your margins were clearly strong leading to the revision to the high end of guidance. But in the prepared remarks, out of the three reasons behind the strength, two of the three were arguably sustainable. So could you just elaborate on how you're thinking about the margin profile of this segment moving forward? I'm just trying to get an idea of why this wouldn't continue its trajectory, at least on the margin front.

[James A. Beer:]

Well, what we have said in the prepared remarks is that we would expect the full-year guide for Technology Solutions' operating margin to be at the upper end of the high teens. So recall that when we gave you original guidance at the start of the fiscal year, we were expecting to be around the low end of the high teens. Now, the primary delta there is the care management gain that we recorded in the first quarter. Now, peeling back from that, we continue to be pleased with the growth we're seeing in our payer provider businesses and the relay connectivity businesses. But of course the growth there is having to be offset by our decision to exit the Horizon Hospital software business. So that will have an impact on technology solutions.

[John H. Hammergren:]

But obviously to reinforce what you're saying, we're pleased with the margin trajectory of that business and we're pleased with the progress we've made in taking as much cost out as we can as we take that Horizon business down over the next couple of years.

[Operator:]

We'll go next to Eric Coldwell at Baird.

[Eric W. Coldwell:]

Hey. Thanks very much. John, I think I generally agree with your views on branded inflation and clearly brand inflation is not as important as it was more than a decade ago under the old industry structure. But I would love it if you could give us a little more detail on sort of the current state of contracts, maybe the percent of sales that are not under fee for service relationships. And then under fee for service, suspending disbelief, if branded price inflation did pare back, what would happen with the model? How would you adjust? What kind of impact might we see? And I'll leave it at that. Thanks so much.

[John H. Hammergren:]

Well, thanks for the question. Clearly as you mentioned, if you go back in history, there have been lots of different models that McKesson has used to create relationships with manufacturers that are beneficial to them and beneficial to ourselves and certainly onward to our customers. And over time we have created relationships with the manufacturers that have been less dependent on price inflation, providing more visibility to the manufacturers on our supply chain and working in partnership with them to give them the data and the things that they might find useful to them in their own production activities and their go-to-market strategies. And in return, they've gone and paid us for that work in these fee for service or distribution relationships contracts that they've have signed. That has frankly taken some of the top off the opportunity on price inflation and taken some of the bottom off on price inflation risk, so the band of performance is probably certainly a little more forecastable. And we've also talked in the past that roughly 80% plus or minus of our business are in structured arrangements that are fee for service type of dialogue or certainly more constructed and documented than the rest of the balance. So that also has helped reduce some of the volatility you might find in this particular lever of profitability inside of our P&L.

[Eric W. Coldwell:]

With the – you talk about the 80%, and I think that is a pretty consistent message. Is the 20% – is a certain percentage of that your Specialty business, or are you talking core traditional brand at retail when you give the 80% figure?

[John H. Hammergren:]

Well, it's really sort of across the board. And I think another response I could give to you and your associates, when you think about inflation risk for McKesson, there are lots of levers we use in our business to drive our performance. And when we try to give you these high level themes, it's because they are important themes, and we talk about them at the annual guidance point. We give you our assumptions because they are drivers of our value. But clearly as you go through the year, there are a lot of things that aren't quite as you expected at the beginning of the year, and if they're part of these larger forces, we'll update you as the year goes on. And James spent some time talking about generic inflation and its relative position against our expectations when we started the year. But there are also lots of other drivers in our business that are going both positive and in negative throughout the year, and I can assure you that the company remains extremely focused on driving our performance as we have over the last 15 years, and we use these other vehicles to offset risk that might be apparent to us in our business as those risks materialize. So, do we have risk on inflation? Clearly we talked about generics today, and we talked about our views of brand inflation. But it's also our responsibility to not only tell you about these things but manage these risks on a proactive basis and be assertive and on top of it. And if there was some fundamental sea change in our industry relative to our views of where these metrics might go over time, then we would begin to reformat our relationship with our customers and our supplier partners and we'd find ways to continue to grow our business. And so I think that that level of confidence is what you should be getting from us today.

[Eric W. Coldwell:]

Okay. Thanks very much

[John H. Hammergren:]

Yep.

[Operator:]

We'll go in next to George Hill at Deutsche Bank.

[George R. Hill:]

Hey, good morning guys, and thanks for taking the question. John, appreciate all the comments around kind of the Rite Aid announcement. I guess, but the company seems a little bit snake-bit by industry M&A lately. I guess either John or James, can you guys quantify the risk around the Rite Aid relationship? And John, I would ask as you think about industry consolidation strategically, do you feel like the company needs to be more aggressive than it has been historically and does it change the risk profile at all for how you think about acquisitions?

[John H. Hammergren:]

Well, thanks for the question here. Clearly we've had a longstanding relationship with Rite Aid and we'll do everything we can to help them in this transition. And we have a great deal of respect for Mr. Pessina and his team at Walgreens and the kind of value they've delivered over a long time. And we've been working with Walgreens for 20 years, and I know Stefano for over 18 years, having traveled back and forth to Europe before he got to the scale that they are today. And so, these working relationships usually help us as we work through transitions in our industry, and we're really proud of the fact that our longstanding relationship with CVS both on the mail side as well as the store side at least came into play when we had the dialogue regarding Omnicare. So are we sometimes on the wrong end of these transactions? Absolutely. But as to the second part of your question, it doesn't mean we're going to deploy capital in a reckless way. We've got a long track record of building value through a portfolio approach and we'll continue to do that. We're not oblivious to the risk that exists as our market consolidates both on the supplier and the customer side. And clearly sometimes we're with the consolidators and sometimes we're not. And when we're not, we have to find a way to either create a relationship or build on an existing relationship or find another avenue to grow our business, which is our ultimate objective. And we have chosen thus far, and we believe this is the right path, to not compete with our customers. So I don't think we'll begin acquiring providers in an effort to offset the risk of provider consolidation in our book of business to deal with it. What we'll continue to do is focus on the value we can deliver for our partners. And as that value creation opportunity expands, then hopefully even through acquisitions, people will find that McKesson is the partner of choice, and they'll build their relationship with us as opposed to discontinuing it. But you can tell also from our guidance that sometimes when these relationships change, it has a negative effect on our margin structure, and that's really what we're reflecting when we talked about some of the puts and takes in the quarter.

[James A. Beer:]

I'd just add that an example, a very recent example of where we're building with the consolidator is Albertsons Safeway. So it's a mix, a natural ebb and flow of the business cycle.

[George R. Hill:]

Yeah, and I guess maybe then just the quick follow-up would be does industry consolidation maybe from an M&A perspective think about how far just from the core that you look? And I guess how, when I think about McKesson's expertises, it's in procurement, it's in supply chain, it's in logistics, it's in distribution. Do you start to look into tangential spaces in healthcare or are there customer groups that you don't serve now where McKesson's expertise can be leveraged that you see opportunities? Thank you

[John H. Hammergren:]

Thanks for the question. Clearly our job is to find ways to grow our business and to do it intelligently and to do it in a risk-bounded way and to deploy capital intelligently. So I think our number one priority is to deploy capital in places where we have a base and an expertise and where it's not a completely new leg of the stool, but it's something that's additive to what we're currently doing. So, I think we evaluate everything and clearly every healthcare or almost healthcare distribution opportunity that comes on the market comes through McKesson and many of them we pass on because it's not straight up our alley or we believe that the price is too high. But otherwise, we're going to stay pretty focused.

[James A. Beer:]

Yeah, and I'd just add in terms of the breadth of our businesses, whether it's Canada, Europe, Specialty, Medical-Surgical, Technology Solutions, and there are a variety of businesses that we have where there will be opportunities that are down the middle of the fairway.

[John H. Hammergren:]

Exactly. We've just been told there are a few more questions pending so we're going to run this call just a little bit later for those of you that have time to do that. So we'll go on to the next question.

[Operator:]

And we'll move to Charles Rhyee at Cowen.

[Charles Rhyee:]

Thanks for taking the question here. John, James, John, I think in your remarks you talked about biosimilars with Neupogen being the first launch. Just curious what you've seen in terms of the uptake in that product and how that might be shaping your views on biosimilars in the future.

[John H. Hammergren:]

Well, thank you for the question. Clearly biosimilars are going to be an important aspect of our business portfolio going forward and we will continue to, I think, see benefit of these biosimilar launches over the coming years. As to the specific launch that we've recently seen, it frankly has not gotten a ton of traction yet, at least not in our business, and it's behaving much more like a branded product than it is a typical quick-to-substitute generic. At some point these biosimilars probably will be more substitutable because their clinical effectiveness and efficacy will have been proven in some fashion. And that's where we'll have more opportunities to make faster transfers of the product. And we think we're very well positioned, particularly when the product are right down the alley of community oncology and we can use our U.S. oncology network to help validate the efficacy of the product and then move market share very quickly, either keep the market share with the originator or move it to the biosimilar to the extent that they're replaceable. So we will look for opportunities going forward.

[Charles Rhyee:]

If I could just follow up there, though, right now then would you say the margin profile also looks more like a brand than a generic? And then in terms of substitutability, though, it seems like in the biosimilar pathway that it doesn't have the same type of A-B substitutability that traditional generics do. Do you think that regulations have to change to allow that for distributors to really benefit from that ability to move share? Thanks.

[John H. Hammergren:]

Well, it is behaving more like a brand, and not only in terms of the way it's being taken to market and its pricing structure, but also in the way that the physicians are viewing it. I think they want to have a discussion about the product itself as opposed to accepting an automatic substitution by a pharmacy or by a wholesaler. I do believe, though, over time that substitutability question will become less and less a question and to the extent that we can help people create evidence that supports the A-B interchangeability or therapeutic substitution, then we certainly will pursue that. In the meantime, though, we look at that as a long-term priority, and I wouldn't consider any of the up and coming pending things in the next six months to a year as being blockbuster, big successes for us, at least right out of the gate

[Charles Rhyee:]

Great. Thank you.

[John H. Hammergren:]

Yep.

[Operator:]

We'll go next to Eric Percher at Barclays.

[Eric R Percher:]

Thank you. I'd like to go back to one of your early comments, John, on consistency. And this may be a question more for James. But I look at the balance sheet and think this is a large lever for you to be able to drive consistency as we look out to the forward years. Particularly today, you mentioned $5.4 billion of cash and $1.7 billion of CFO to come. We saw the revolver put in place. As we look over the balance of the year, I know there was some debt maturity. We've got the international acquisitions. But it feels like there'll still be a pretty substantial capability. So could you walk us through what will be due and maybe what was behind the revolver and where you sit as you look at the remainder of the year?

[James A. Beer:]

Well, we're certainly pleased with the financial flexibility that we have. And I'll start off just by really reminding you of the portfolio approach that we have to capital allocation. And within that portfolio, internal capital expenditures and M&A are the first and second priorities. So certainly want to be clear about that. But given the degree of flexibility that we have, obviously we're also going to look regularly at what we think is a realistic M&A pipeline in the short, medium term. Contrast that against our cash balance and our coming projected free cash flow and make an assessment as to whether there's excess cash available for share repurchases. And you've seen us take that action in terms of buybacks now both in this last Q2 and in the fourth quarter of the last fiscal year. So we're pleased that the board authorized the new $2 billion authorization for share repurchases. So it feels as though we have the liquidity and the right portfolio approach, the right flexibility, to continue to deploy capital effectively on your behalf.

[Eric R Percher:]

And the change in, or the element that has impacted guidance was the $500 million being done earlier in the year. There's no change. The $2 billion issued is not implied to be used in your current guidance. And I guess it also begs the question when you look to Europe, are there $10 billion deals, or are most of these $2 billion, $3 billion, or much smaller?

[James A. Beer:]

Well, in terms of the weighted average shares outstanding, the full-year number that I mentioned was 234 million. Embedded within that is the $500 million buyback. There is nothing assumed about progress against the new $2 billion authorization. In terms of the transaction sizes available to us, I wouldn't want to really comment on anything specific to M&A. You've seen the recent deal sizes with UDG and Sainsbury's. But there's a wide range of opportunities across the very broad set of businesses that we operate.

[Eric R Percher:]

Thank you.

[Operator:]

We'll go next to Dave Francis at RBC Capital Markets.

[Dave K. Francis:]

Hi. Thanks, and congratulations on a solid quarter. Just a real quick one, John. Bigger picture, I appreciate the commentary on what you're seeing from pricing trend perspective across both the brand and generic baskets. Can you talk a little bit about what you're seeing volume-wise in terms of any meaningful change in the marketplace up or down domestically? Is there anything going on in the broad economy that's impacting volume trends as you're seeing them in the U.S. business? Thanks.

[John H. Hammergren:]

Thanks for the question, Dave. I think we see things pretty much in line with what we had expected for the year on a volume basis. And clearly you can see that the numbers that are being posted by the various sources as to prescription volumes. I think we don't see any major changes. There are perhaps some changes that you might see in the physician office perspective, but I would say that the biggest change or trend that we continue to see is that some of our larger customers are growing more rapidly than the rest. And in particular, our largest mail customer has had pretty nice growth. And so that puts a little pressure on our margin structure, particularly on the Specialty products that go through that particular customer. But otherwise, everything's pretty much in line with what we'd anticipated.

[Dave K. Francis:]

Very good. Thank you.

[John H. Hammergren:]

Yep.

[Operator:]

And our next question comes from David Larsen at Leerink.

[David M. Larsen:]

Hey, guys. Can you talk about the generic inflation comp? Like, when do you expect that to start to ease? So inflation rates were obviously very high in calendar 2014. They've pulled in over the past couple of quarters. So next year, and just any general thoughts. Would you expect the comp for generic inflation to ease a bit?

[James A. Beer:]

Well, generic inflation is not forecastable and we certainly don't have any insight from what the manufacturers are planning to do in their businesses. We've updated our assumption for the back half of this fiscal year. And of course we really want to take a step back and emphasize how generic price inflation is just one of a number of variables that drive again this broad set of businesses. So I would urge not to have an over focus, if you will. It's an important issue, as John was mentioning earlier. We included in our initial annual guide, and we update you as the year goes along. But I really think we want to keep this in perspective in terms of the broad number of drivers of our businesses.

[David M. Larsen:]

Okay. Great. And then just any quick thoughts on Target? Have you had any discussions with CVS around Target and that account?

[John H. Hammergren:]

Well, unless you've heard something different, we've not heard of the Target transaction closing, and I would imagine our conversations with CVS would be more worthwhile post that process than today. So I'm not really prepared to comment or speculate on it other than to say we're continue to service the Target business with all of our focus and we want to make sure those stores are in great shape pre the transition to CVS ownership.

[David M. Larsen:]

Okay. All right. Thanks a lot.

[Operator:]

We'll take Ross Muken with Evercore ISI.

[Ross Muken:]

Maybe just not to beat the horse on Rite Aid, but just going back, one of the big questions we've gotten from a lot of investors is just sort of understanding how change of control provisions work on these kind of contracts. Obviously you've dealt with quite a few of them recently. And I guess, secondarily, understanding the sort of pushes and pulls long-term of being a key provider to a large retail chain. Obviously you still have a relationship with CVS and we'll have to see what happens with Rite Aid. But that's on the mail side. How do you think about that? Does it help you at all with the independents? I'm just trying to understand the long-term implications of that as well.

[John H. Hammergren:]

Well, just to make sure that I'm clear, that – our CVS relationship is with both the mail as well as many of their retail stores and now our continued relationship on Omnicare. As to Walgreens and Rite Aid, we've had a long-term relationship with Walgreens. It just hasn't happened to have had distribution as a key component of it for perhaps a couple of decades. Like anything else we're going to work hard to make sure that those Rite Aid stores are serviced and continue to focus on making our customers successful there. And we'll see where things head over time. But remember, customers kind of come and go in people's business, and albeit we've had a bad run here with two or three M&A transactions that were "not our fault" related to losing customers. But you also should expect that we'll continue to work hard to grow our business. And I talked before about the fact that we have a very large base of people who are dependent on us from a generic perspective. And albeit that base continues to grow. We think no matter what happens from a customer perspective, we will still be one of the largest suppliers of generics in the world and a very valuable partner to the manufacturers.

[Ross Muken:]

Great. Thanks. I'm sorry for the poorly worded question.

[John H. Hammergren:]

No, that's okay. I just said I want to make sure everybody else listening was clear on it, Ross. I think we have time for one more question.

[Operator:]

And we'll take that from John Ransom at Raymond James.

[John H. Hammergren:]

John?

[Operator:]

Mr. Ransom your line is open. Please go ahead.

[John W. Ransom:]

Hi. Sorry. Trying to multi-task here and doing it very poorly. I'm sorry if this has been asked, but the Rite Aid contract expires in 2019. Is there a change of control out on the other side? Or do you expect that to remain in place through 2019?

[John H. Hammergren:]

Well, we don't talk specifically about the terms of our agreements other than what we say at the beginning of them. And I think that the comment I made in answer to the question earlier is we plan to continue to serve their business with all of our effort and make sure that they're very successful as they continue through this transaction process.

[John W. Ransom:]

Okay. That's all I had. Thank you.

[John H. Hammergren:]

All right. You're welcome.

[John H. Hammergren:]

Well, I want to thank you, Audra. Thanks also for all of you on the call for your time today. Our industry experiences periods of dynamic change, and this is certainly one of them. And I'm confident that we will continue to participate in that change in an extremely positive way. We remain extremely well positioned to deliver the best service and value in the industry on behalf of our customers. And with that, I'll now turn it back over to Erin for her review of upcoming events for the financial community. Erin?

[Erin Lampert:]

Thank you, John. On November 10 we will present at the Credit Suisse Health Conference in Scottsdale Arizona. And on January 12, we will present at the JPMorgan Healthcare Conference in San Francisco. We'll release our third quarter earnings results in late January. Thank you, and good-bye.

[Operator:]

And that does conclude today's conference. Again, thank you for your participation.