McKesson Corporation
Q4 2019 Earnings Call Transcript

Published: 8 May 2019

[Operator:]

Good day, and welcome to the McKesson Q4 Earnings Call. Today’s call is being recorded. At this time, I would like to turn the call over to Holly Weiss. Please go ahead, ma’am.

[Holly Weiss:]

Thank you, Ebony. Good morning and welcome everyone to McKesson’s Fourth Quarter Fiscal 2019 Earnings Call. Today, I’m joined by Brian Tyler, our Chief Executive Officer; and Britt Vitalone, our Chief Financial Officer. Brian will lead off, followed by Britt and then we will move to a question-and-answer session.

[Brian Tyler:]

Thank you, Holly, and thanks everyone for joining us on our call. Today, we’re going to focus on our fiscal 2019 results and our outlook for fiscal 2020. Britt will cover our financial performance in greater detail, but first let me take a couple of minutes to discuss some of our important accomplishments and why we’re so confident in McKesson’s future. During our fiscal 2019, we saw increasing momentum in our strategic growth initiative, including priority areas that focused on manufacturer value proposition, specialty pharmaceuticals or biopharma services, and the expanding role of retail pharmacy in community health services, all this supported by our ongoing investments in data and analytics. We also continued to optimize our operating model to improve our cost position, and the overall speed and effectiveness of the organization. We recently renewed our CVS agreement. This follows renewal of our Rite Aid agreement and a two-year extension of our Veterans Affairs agreement earlier in the year. We believe our strong value proposition and superior service quality were critical to allow us to continue supporting the success of these customers, and we are very pleased to continue these longstanding partnerships. We made several changes to strengthen our leadership team including the promotion of Kirk Kaminsky as President of our U.S. Pharmaceutical and Specialty Solutions segment; the promotion of Kevin Kettler as the President of our Europe segment; and the hiring of a new leader for our UK business. More recently, we appointed Tracy Faber as our Chief Human Resource Officer to succeed Jorge Figueredo upon his retirement later this year. In our medical business, we acquired Medical Specialties Distributors or MSD, which has among other things, expanded our value proposition with manufacturers and brought specialty infusion capabilities and services. It is progressing in line with its business case. And Change Healthcare filed its S-1 with an intention to complete an IPO, market conditions permitting.

[Britt Vitalone:]

Thanks, Brian, and good morning. Today I’ll provide an update on our fourth quarter and full year fiscal 2019 results, and then I’ll close by providing our fiscal 2020 guidance before turning to your questions. My comments will focus primarily on our adjusted earnings results. However, I want to start by discussing two items that impacted our GAAP-only results. As a result of the dynamic market environment, regulatory headwinds and business performance in our European segment, we recorded an after-tax charge of $1.5 billion in our fiscal fourth quarter, reflecting non-cash goodwill and long-lived asset impairment charges, and restructuring charges that are largely in our European business. The impairment charges were mainly due to declines in estimated future cash flows, primarily attributable to the effects of UK government reimbursement reductions and competitive pressures in the UK. Following this charge, there is no remaining goodwill balance in our European business.

[Operator:]

Thank you. We will take our first question from Robert Jones with Goldman Sachs. Please go ahead.

[Robert Jones:]

Great, thanks for the questions. I guess just to start on the U.S. Pharma business around guidance and specifically around branded inflation, was wondering if you guys be willing to share what the assumption around inflation is that is assumed in guidance? And then more importantly, I was hoping you could provide us an update on how you feel generally around the branded portfolio and renegotiations with branded manufacturers, you have Britt both on the fee-for-service side as you mentioned, but also on that 5% that’s still contingent upon inflation.

[Britt Vitalone:]

Well, good morning Bob. And thanks for that question. Let me see if I can answer those in order. In terms of our guidance for the U.S. Pharmaceutical segment, as I mentioned, our assumption around branded price inflation is mid-single digit. And that’s really in line with what we’ve been experiencing here in our fourth quarter and it’s really aligned with fiscal 2019. Our conversations with our manufacturing partners continue to be very productive, we have conversations with our manufacturing partners on a regular basis, we feel like we’re very well-positioned in those conversations. And there’s nothing in our conversations today that would suggest anything different from the guidance that I provided you. As it relates to the contingent portion, again, I wouldn’t point to anything new here. We continue to have really constructive conversations with our manufacturing partners and we’re really feeling like that fiscal 2020 sets up pretty similar to fiscal 2019.

[Robert Jones:]

Great. And I guess just a quick follow-up, you guys highlighted corporate expense obviously taking a step up, it sounds like in large part because of the ramping opioid litigation. Could you maybe just talk a little bit about the visibility you have into what those expenses will be specifically in 2020? And as we think about where we stand in the timelines of some of those larger cases, it seems like, some of them, the bigger ones are poised to go to trial in 2020 and obviously could be in expense for some time beyond that. Any sense you can give us on how you’re thinking about the run rate around these costs as we move, not just in 2020 but beyond 2020?

[Britt Vitalone:]

Yes, well thanks for that question. Let me start and then I’ll have Brian add some commentary here. As we were going through last year, we provided you the best guidance that we had for fiscal 2019 and we talked about opioid related costs being in excess of $100 million for FY2019. As we said, our guide, again, what we’re doing is giving you the best visibility that we have to those costs. I outlined that as $150 million for FY2020. It’s very difficult to forecast these out, these really are dependent on the speed of the trials, the decisions that the judges make along these cases and it’s hard for us to predict that. And so what we’ve done here is given you our FY2020 view as we sit here today on how we think those trials might progress and what we think those costs might be to defend in those litigation proceedings.

[Brian Tyler:]

Alright, I think, you covered it well Britt. It is difficult to forecast exactly. It’s the little bit of art and a little bit of science obviously. We’re prepared to make the investment we need to make to prepare a proper defense and protect our shareholders’ interests. As information unfolds and judges decisions and schedules and proceedings occur, we’ll be committed to keep this group updated. I would say in general, I think, if you look at the operating expense environment and discipline in the core operations, I’m very pleased with the trajectory and the progress that we’re making. It is being offset by investments in opioid defense and some very specific targeted investments we’re making into the business as part of our strategic growth initiatives.

[Robert Jones:]

Great, thanks for that.

[Brian Tyler:]

Thanks Bob.

[Operator:]

Our next question will come from Eric Percher with Nephron Research. Your line is open. Please go ahead.

[Eric Percher:]

Thank you. Last year we were talking about a lot of unique headwinds and seen significant that CVS is not considered a unique headwind. Brian, I’d be interested in your perspective on what makes for unique or not and whether there is any change to the scope of that relationship. And Britt, it would be helpful if you have any commentary on the cadence of earnings given some of the renewals, and onetimers and acquisitions that are contributing.

[Britt Vitalone:]

Well Eric good morning and thank you for the question. Obviously we’re very pleased to be able to announce the renewal of our CVS agreement this morning. It’s a long time partnership that we’ve enjoyed with them. I would say that I don’t characterize this renewal as really any different than many of the others I’ve been through with CVS, in the years. These are big business relationships, complicated business relationships. And we worked through those discussions in a way that obviously we reached the feeling that it was mutually beneficial for us to continue to go forward. And so we’re really excited about our partnership with CVS and the economics of that renewal as always have been built into the numbers we shared with you this morning.

[Brian Tyler:]

Eric maybe I’ll just answer your second question here. As we think about the progression of earnings over the course of the year we don’t provide quarterly guidance, but what I would say to you is that as we look at the year, you should expect that our earnings will be roughly the same first half to second half is what we experienced in FY’19.

[Eric Percher:]

Thank you for the detail.

[Operator:]

Our next question will come from Ross Muken with Evercore ISI. Your line is open, please go ahead.

[Elizabeth Anderson:]

Hi, this is Elizabeth Anderson on for Ross. Can you talk a little bit more about your expectations on Europe in the coming year? I know, obviously there are a couple of onetime items there, things that are unavoidable in FY’19. But sort of what gives you confidence in the profit growth trajectory for fiscal 2020?

[Brian Tyler:]

Thank you, Elizabeth. Well, we obviously did take a charge of approximately $20 million in the fourth quarter in the UK. But I would say if you step back and look at Europe overall, we were really in line with our growth expectations in most of the countries. And we’re pleased with the performance. We feel like with the headwinds we’ve experienced over the past years in the UK and the management actions that we’ve taken, which includes really, building a new leadership team there, a rationalizing our store portfolio, restructuring the operations, is the work we’ve done that gives us, gives us confidence to feel that we can, you know, get Europe back to very modest growth next year.

[Elizabeth Anderson:]

Okay, perfect, that’s really helpful. And I also wanted to ask you a question in terms of the upside in your cost cutting program, are there any particular areas that you’re seeing additional dollars coming from or any other color you could provide there would be very helpful?

[Britt Vitalone:]

Yes, thanks for that question. I think as we’ve talked about before, there are several areas that we were really focused on as we think about not only cost cuts and spending behaviors and disciplines themselves, but also we’re going through some operating model optimization efforts in our finance operations, in legal HR and our technology and we’ve also talked about investments that we’re making in technology, and data and analytics. We’ve also talked about some things in our finance operating model like the partnership with Genpact as we’ve expanded that. So I wouldn’t think of it just as cost cutting. Spend discipline is important, it’s important component to that. But we’re also going through some operating model optimization capabilities and we’ve made some really great progress, particularly in the areas of technology and in finance. In the area of technology, we’re in a position now to reinvest back into that, invest in infrastructure and also invest in data and analytics capabilities.

[Elizabeth Anderson:]

Perfect. Thank you very much.

[Operator:]

Our next question will come from Kevin Caliendo with UBS. Your line is open. Please go ahead.

[Kevin Caliendo:]

Hi, good morning, everybody. Thanks. I want to get back to the U.S. Pharma business and your guidance there. It assumes, if I’m thinking about this right, I think, it assumes margins to be pretty flattish year-over-year. And I understand there’s some synergies from M&A and some other improvements and growth in specialty and the like. If you can breakdown sort of what your expectations are for generic profitability and the spreads there, like what have you been seeing versus maybe margins and some of the other segments within U.S. Pharma?

[Britt Vitalone:]

Thanks for that question, Kevin. I’ll start and what I would say to you as a starting point is we’re pleased to be able to provide an outlook for our U.S. Pharma and Specialty Solutions segment which returns to growth next year. And I think that’s on multiple dimensions. We’ve certainly made some advances in our specialty business and continue to see good growth there. As we talked about, we’re seeing relative stability in the manufactured price increase area of our business. And as it relates to generics, we don’t provide specific guidance on inflation or deflation rates. What I would tell you though is that we are very comfortable with the sourcing capabilities that we have through ClarusONE and continue to drive good value out of that. And on the sell side, we have great compliance with our customers. We utilize our capability and scale from ClarusONE to provide really good value to our customers. And we believe that we’re continuing to create an appropriate spread, which is in a market that is competitive yet stable. And so we’re very comfortable operating in that environment. And overall, that leads us to be able to provide you an outlook for the segment that has low-to-mid single-digit growth in 2020.

[Kevin Caliendo:]

And just one quick follow-up, speaking of outlook, it feels to me like this guidance is a little bit narrower than we’ve seen recently, especially given the higher number. What would cause guidance to come in at the high end of range versus low end of range, given what you’ve provided us so far? What’s $13.85 versus $14.25, like what needs to happen?

[Britt Vitalone:]

First of all – yes, thank you, Kevin. First all it is narrower than the guidance that we provided last year. We have certainly put together plans and constructed these plans with a lot of really good information and visibility into our business units. I think as you think about the top end of the range, certainly continued growth in our Specialty business would propel us there. We’ve had very strong growth in our Medical-Surgical business, continuing to grow patient home delivery and the investments we’ve made there, we call those out. We think that those are going to deliver some upside in 2020 and beyond. And our ongoing cost management efforts will take hold as we get further into the period to FY2021. On the downside, I think, things that could happen could be the outcome of U.S. drug pricing reform or additional regulatory impacts in our international market, which, again, we called out, we are not contemplating those, but those are things that could happen that drive us to the lower end of that range.

[Kevin Caliendo:]

All right, thanks guys.

[Operator:]

Our next question will come from Michael Cherny with Bank of America. Please go ahead.

[Michael Cherny:]

Good morning. And thanks for taking the question. Brian, you talked before about the CVS renewal and how – wasn’t that different from previous one. That being said, you’ve recently renewed three of your largest customers, CVS, Rite Aid, VA against the backdrop of some of these drug pricing dynamics. You’ve also talked about your engagement with brand inflation manufacturers. How do you think about the conversations that you went into them and thinking about the trade off of services, versus price, versus volume commitments in this new drug pricing world? And was there anything that given the moving piece on drug pricing you are able to essentially pivot the conversation on.

[Brian Tyler:]

Thanks for the question, Michael. Obviously, as we enter these discussions, we are well aware and informed of the regulatory environment as frankly were our customers. And as we have been evolving our model over the past years to think about how we think of different product, classes and the services we provide around those classes and the economics we get with those classes, that kind of all goes into the mix, and is the context in the backdrop for these conversations. As we think about the gross to net environment and things of that nature, I would remind folks that there is a little bit of a natural hedge on the buy and the sell side for us. But at least these are all well considered and well contemplated, frankly, on both sides as we entered into these agreements and we have baked the results of these renewals into the guide that we’ve reviewed to you this morning. And we’re very comfortable in the relationships and excited to extend our business partnership with both Rite Aid and CVS.

[Michael Cherny:]

And then just one quick one relative to the share count guidance, it looks like if my math is correct, you are assuming a higher degree of buyback versus previous years of guidance. Does that have anything to do with your outlook on potential M&A targets relative to where you sit on a portfolio basis or the viability of what you see across the market?

[Britt Vitalone:]

Well, again, I would just point to, as I mentioned, our share count assumption is 185 million at the end of FY2020. As Brian talked about and we’ve talked about in the past, we look at our capital deployment on a balanced perspective and trying to drive the most value for our shareholders. And as we think about FY2020, we think that capital deployment towards share repurchases is still an important component of that. And we believe that our share price is undervalued at this point, so that certainly is going to be a component of how we think about capital deployment.

[Brian Tyler:]

I would just add, I don’t think the message should be that we don’t see good M&A opportunities, or good growth opportunities for this Company. We have had a good track record. And some of our recent deals, I think, have been highly successful for us. But what we are doing is really being very focused on where that M&A might occur and making sure it’s aligned with our strategic growth initiative and the three growth pillars that we have aligned. And we make those decisions, obviously, in the context of where our share price is today and what we think the relative attractiveness of share buybacks versus M&A are. So we do have good opportunities. We are and will continue to be active in looking for growth or capabilities that might come to us through M&A, but doing that in a very disciplined way.

[Britt Vitalone:]

I think MSD is a good example of that that we completed in FY2019.

[Michael Cherny:]

Great, thanks for the color.

[Britt Vitalone:]

Thanks, Michael.

[Operator:]

Our next question will come from Stephen Baxter with Wolfe Research. Please go ahead.

[Stephen Baxter:]

Hi, thanks for the question. I was hoping to get some additional insight into the of the efficiency program. And can you help us understand how much of the cost savings was achieved in 2019? How much incremental you think happens in fiscal 2020? And then how much of that remains to benefit the numbers in 2021 and 2022? Thank you.

[Britt Vitalone:]

Yes, thanks for that question. What we have told you is that we expect to have $400 million to $500 million of cost savings by the end of FY2021 full year. Comfortable raising that target given the actions that we’ve taken here in the last quarter, we haven’t provided specific year-to-year guidance on that. What I have said is that in FY2019 the savings that we generated were largely invested back in the business. We talked about our information technology infrastructure, and data and analytics capabilities. So you should view FY2019 as largely reinvested back in the business. As we progress through the time period over FY2020 and now FY2021, we would expect that those savings will increase over time and then you should expect to see more and more of those hit the bottom line, but we haven’t provided specific year-to-year or quarter-to-quarter guidance on the numbers.

[Stephen Baxter:]

Okay, thanks. And just as a quick follow-up, I think, in the past you said of the cumulative program, most of it will drop through. Is there any update to that or is that still kind of the right way to think about it?

[Britt Vitalone:]

That’s the right way to think about it.

[Brian Tyler:]

And I think about it that we’re in the early phases of our efficiency initiatives are producing, we’re making a calculated decision in some instances to invest that back into the business. As those efficiency efforts continue to grow, the investments will begin to wane off, you’ll see a bigger impact.

[Stephen Baxter:]

Great, thank you.

[Operator:]

Our next question will come from Charles Rhyee with Cowen. Please go ahead.

[Charles Rhyee:]

Yes, hey, thanks for taking the question. I wanted to ask a question regarding sort of the rebate rule and sort of the role you see the distributors play. And then if I’m not mistaken, in some of the comments that the wholesalers have provided to GCMS here is sort of applying sort of a chargeback system that you have had in place with manufacturers for pharmacies to apply for – to apply this for the administration of point-of-sale rebates? Can you talk about sort of the capabilities that you currently have to do that today? How that it works for pharmacies and how quickly could that be applied for the use for consumers directly? Thanks.

[Brian Tyler:]

Thanks for the question, Charles. So first off, I would remind everybody that the Part D safe harbor does not really impact our business model directly. We are not contemplated in that. So what we’re really talking about in the course of that reform is what are the implications for retailers and manufacturers, and then how might that ultimately impact us. We do think that we have some scaled and significant capabilities to help address the solution for this area. That would be not just the wholesaler chargeback infrastructure and technology, which really operates at big scale and highly efficient today, but also through our relay switch business. We are transacting 18 billion, 19 billion transactions at the pharmacy desktop each and every day – well, not each and every day, each and every year as we speak. And so while each one of those solutions by itself is probably not what’s going to be required to administer whatever comes out, and we think it will actually come out pretty soon in terms of a final rule. We think the underlying capabilities will be there. And so what we’re really looking for in the rule is what does HHS, say, relative to transparency? What are they going to stipulate in terms of the service providers that can support this? And frankly, what is the time frame for the implementation? And contemplating all those things, we will look at how we bring our capabilities which are unique to us, not all of them. We all have the chargeback capability but relay switch business is a little bit unique to McKesson. And if the opportunity is there for us to play a differentiated role or be part of the solution, that’s something that we would certainly, look to do. But we’ll also approach it with the seriousness that these are massively scaled transactions with big financial implications for all party and so anything that we would roll out would have to be robust, tested and reliable.

[Charles Rhyee:]

And just a follow-up, I think one concern is particularly as you think about the application of point-of-sale discounts, this potential that particularly like pharmacies or independent pharmacies could be sort of caught on the wrong end carrying sort of a negative float here until sort of a true up on payments. Is that something where you see distributors potentially playing a role kind of supporting pharmacy customers using a balance sheet to sort of help them on the working capital side? Thanks.

[Brian Tyler:]

Yes, really that’s a good question, and that’s one that we’re probably not prepared to answer right now until we see what the final rule looks like. I mean, I will say that we have long been an important part of supporting the independent customer base with a really broad array of solutions from helping on the reimbursement side of the business, helping with the cost, the reporting, obviously, generic procurement programs. And as this rolls out and we see what the impact and evolutions are, we’ll assess our capabilities whether they support the services, our balance sheet, figure out how to best support the independent and retail community pharmacy space. But it would be premature to make any definitive statements.

[Charles Rhyee:]

Great, thank you.

[Operator:]

Our next question will come from Steven Valiquette with Barclays. Please go ahead.

[Steven Valiquette:]

Great, thanks. Good morning, Brian and Britt. Thanks for taking the question. Just to come back for a minute here on the cost savings and the segment reporting. And just kind of thinking out loud for the $400 million to $500 million in cost savings, we’re assuming most of that does show up in the operating profit segment results for U.S. pharma solutions and European pharma solutions, but just curious if any material amount of the savings would show up in the corporate expense line over the next couple of years even though corporate expenses are obviously going up a lot in fiscal 2020. So it does seem like as you described some of the sources of savings, it does seem like some of that would fit into a corporate expense buckets. So just curious if there are some savings factored into that guidance in corporate expense for fiscal 2020. Thanks.

[Britt Vitalone:]

Thanks, Steve, for that question. It’s great question, let me just clarify that. The cost savings programs that we put in place, which include the optimization of our operating models, are enterprise wide. So as we think about cost savings, it’s really disciplined on an enterprise basis which would include our corporate functions. As we think about our operating model optimization efforts, whether that’d be in finance, or technology or HR, clearly those will be enterprise wide as well. So as we think about, these are really holistic programs where we expect the benefits to have an impact not only within the segments, but also within our corporate expense line as well.

[Steven Valiquette:]

Okay. One other quick one here just on the guidance. Normally, you guys will give some comments on contribution from new generic launches and I didn’t hear much about that for FY2020. have launched recently generic Advair and a few others, but just big picture, any view on profits from new generic launches FY2020 versus FY2019.

[Britt Vitalone:]

Thanks for that question. Clearly there will be generic launches in every year. I think as we think about this, we don’t expect a material profit difference in FY2020 than FY2019 from generic launches. So there will be, what we would expect to be, a modest impact from generic launches in FY2020.

[Steven Valiquette:]

Got it. Okay, thanks.

[Brian Tyler:]

Thank you.

[Holly Weiss:]

Operator, we have time for one more.

[Operator:]

Thank you. Our final question will come from David Larsen with SVB Leerink. Please go ahead.

[David Larsen:]

Hi. It looks like you are guiding pretty good operating profit growth for fiscal 2020 across all segments with the exception of other. Can you just remind me what is going on in other that is going to basically cause the entire enterprise’s operating income, it looks like to decline possibly to low-single digits in fiscal 2020. Thanks.

[Britt Vitalone:]

Thanks for the question. As I talked about in my remarks, in fiscal 2019 in our other segment we had the benefit from the $90 million reversal of a contractual liability within our Change Healthcare business. And so that, obviously, we will be lapping that in fiscal 2020, that is the primary change. And that is really partially offsetting some good growth and some good expansion that we’re seeing, particularly in our MRxTS business.

[David Larsen:]

Okay. And then with the opioid litigation costs, I mean, some of the numbers we’re hearing from these litigator are very, very high. Like, would you expect to include those cost of litigation in your adjusted EPS going forward beyond fiscal 2020 or would you view those as one-time items? Thanks.

[Britt Vitalone:]

Yes, thanks for that question. What I would be prepared to say now is our guidance assumes the litigation costs and that number is $150 million. We don’t have any visibility into anything beyond that. So it would be inappropriate for us to really comment on it at this time. As things come up, or there are decisions that are being made, we’ll certainly provide that guidance and visibility to you. But as it relates to our guidance today, it’s the $150 million in opioid-related litigation costs, which are in our corporate segment.

[David Larsen:]

Okay and then just the last one from me. You had $23 million of operating income in European Pharma Solutions this quarter. I mean, it looks like we’re expecting a pretty big rebound in fiscal 2020. Just, what’s going to drive that? And I’ll stop there. Thanks a lot.

[Britt Vitalone:]

I would just remind you that we took a charge in the fourth quarter related to that business and we’ve also been hard at work in terms of optimizing our store portfolio, rationalizing our back office support functions and we think all of those will begin to yield benefit.

[David Larsen:]

Okay. Congrats on a good fiscal 2019, Britt.

[Britt Vitalone:]

Thank you.

[Brian Tyler:]

Thank you, David. And thank you, operator. Unfortunately, we’re out of time. So I want to thank all of you who joined us on the call this morning, particularly those with questions. And we appreciate your support and interest in McKesson. We have a clear strategy and a solid operating plan for fiscal 2020 and exciting growth opportunities across McKesson. I remain confident in our future. Thanks again for joining us this morning. I’ll now hand the call to Holly for her review of upcoming events for the financial community.

[Holly Weiss:]

Thank you, Brian. We will participate in the Bank of America Merrill Lynch Healthcare Conference in Las Vegas on May 14, and we will participate in the Goldman Sachs Global Healthcare Conference in Southern California on June 11. We look forward to seeing you in the new fiscal year. Thank you and goodbye.

[Operator:]

Ladies and gentlemen, this does conclude today’s conference. Thank you for joining today. You may now disconnect. Have a great day.