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What happened

After reporting fiscal-quarter results shy of industry watchers' expectations and offering a cautious view of future drug price trends, shares in McKesson Corporation (MCK 0.29%) are falling 24% at 1:00 p.m. EST today.

So what

McKesson is one of the largest drug distributors in the United States, and after the bell yesterday, management reported that fiscal second-quarter sales inched up just 2% to $50 billion, and that adjusted EPS was $2.94. Both of those figures were shy of analysts' consensus forecasts. Industry watchers were hoping for $51.2 billion in sales and $3.05 in EPS. 

The under-performance stems largely from fallout tied to growing payer pushback on generic and brand-name drug price increases. McKesson entered its fiscal year recognizing that scrutiny, which surged last year in the wake of revelations of unchecked price increases on long-standing drugs, would crimp growth opportunities; however, it appears management's assumptions weren't pessimistic enough, and that deflationary drug price pressure from customers is increasing as revenue from brand-name drug price increases falls.

John Hammergren, McKesson's CEO, summarized:

In our first quarter, we witnessed some evidence of inflation and pricing softness in line with our original assumptions. However, this softness became much more pronounced in our second quarter, first around brand inflation and later, around customer pricing.

Now what

McKesson inks contracts with brand-name drugmakers that include charges derived as a percent of revenue managed and delivered by McKesson. These charges vary by manufacturer and service level, but the tie to drug revenue means drug price inflation (or lack thereof) can meaningfully affect results. Thus, a slowing in brand-name drug price increases is presenting a headwind this year.

Hammergren's team has remodeled its expectations for the year based on those challenges, and they now believe pricing and brand-name drug inflation will be a negative $1.60 to $1.90 per share drag on fiscal-year results. The company should be able to offset some of that, but it won't be able to overcome all of it, and as a result, McKesson has adjusted its EPS guidance for fiscal 2017 lower to between $12.35 to $12.85 from prior forecasts for between $13.43 to $13.93.