McKesson Corporation
Q1 2015 Earnings Call Transcript

Published: 31 Jul 2014

[Operator:]

Good day, everyone, and welcome to the McKesson Corporation Quarterly Earnings Conference Call. [Operator Instructions] Today's call is being recorded. And now, your host for today's call, Ms. Erin Lampert, Senior Vice President of Investor Relations. Ms. Lampert, please go ahead, ma'am.

[Erin Lampert:]

Thank you, Rufus. Good morning, and welcome to the McKesson Fiscal 2015 First 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 9

[John H. Hammergren:]

Thanks, Erin, and thanks, everyone, for joining us on our call. Today we reported a strong start to fiscal 2015 with total company revenues of $44.1 billion with adjusted earnings per diluted share from continuing operations of $2.49. Based on the strength of our Distribution Solutions results in the first quarter and our confidence in the full year, we are raising our previous outlook and now expect adjusted earnings per diluted share 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 2 items. First, I'm pleased with the outcome of the Celesio Annual General Meeting of Shareholders, which was held on July 15 in Stuttgart, Germany. As part of the standard German legal process, at that meeting, shareholders voted to approve the domination agreement between McKesson and Celesio. The domination agreement must be registered with the German courts in order to become effective. Before that registration can take place, minority shareholders may assert challenges, which may be based on substance or technical grounds. Anticipate that at least 1 challenge will be filed. Under German law, there is a limited period of time for such disputes to be heard. Based on our current assessment, we now expect that the domination agreement will be registered with the German courts and therefore, McKesson will be allowed to exercise operating control over Celesio at the end of the current calendar year. This time line represents a modest delay from our previous expectation that we would achieve operating control late in the first half of fiscal 2015. The second item I want to highlight is related to the sale of our International Technology business. Approximately 1 year ago, we talked about a number of actions to better position the company going forward, including our intention to sell our International Technology business. This business consisted of 2 main divisions

[James A. Beer:]

Thank you, John, and good morning, everyone. We are very pleased with our first quarter results, which represent a strong start to fiscal 2015. And as John discussed earlier, we are raising our previous outlook and now expect adjusted earnings per diluted share from continuing operations of $10.50 to $10.90. Today, I will walk you through our first quarter financial results and provide an update on our acquisition of Celesio. Before I move on, let me remind you that in this quarter, both GAAP and adjusted earnings reflect the reclassification of a portion of our International Technology business, referred to as our workforce business, from discontinued operations back to continuing operations. Releases to the workforce business reclassification, we recorded a pretax charge of $34 million or $0.11 per share, largely representing a onetime catch-up of depreciation and amortization on the underlying assets as we move the business from discontinued to continuing operations. It is also important to note that fiscal '14 was recast to include the results of the workforce business. Schedule 9 provides a recast fiscal '14 consolidated and technology segment revenues. Revenues for the workforce business were $31 million during the first quarter of fiscal '14 and $147 million for the full year. Fiscal '14, as recast for the addition of the workforce business, includes $0.04 and $0.21 in contribution to adjusted earnings per diluted share for the first quarter and full year, respectively, as outlined on Schedules 7 and 8. Now let's move to our results for the quarter. My remarks today will focus on our first quarter adjusted EPS from continuing operations of $2.49, which excludes 3 items

[Operator:]

[Operator Instructions] And for our first question, we go to George Hill with Deutsche Bank.

[George Hill:]

I guess, James, maybe I'll just ask a couple of questions about the guidance for back half of the year. Net of the IT charge, is it right to think about that you guys are actually kind of taking the guidance up by $0.20 considering the $0.11 -- or call it $0.21, given the IT charge kind of taken in the quarter?

[James A. Beer:]

Well, certainly, obviously, we do include that IOG charge, workforce business charge, in our adjusted earnings. So absent that, yes, we are upping the formal guide by $0.10. But in the first quarter, yes, you're right. We did absorb an $0.11 charge associated with that workforce business.

[George Hill:]

Okay. I wanted to make sure I understood that quickly. And then maybe just a quick follow-up either for James or John. Generic drug price inflation has obviously been very strong in helping the performance of the IT business. I guess, can you talk about expectations for the back half of the year, given the strength that you saw in the front half of the year?

[John H. Hammergren:]

Well, we did think -- we do think there was some pull-forward, George, of our generic price inflation models for the full fiscal year, but we really don't change -- we haven't changed our outlook if you think about it on a full year basis. So I think right now it's early for our fiscal year, but we believe that the guidance we gave you at the beginning of the year is still reasonable.

[Operator:]

And for our next question, we go to Lisa Gill with JPMorgan.

[Lisa C. Gill:]

I was wondering if maybe if we look at the overall drug distribution revenue, and then, John, I think you talked about the Hep C drug. But if you back out Hep C in the quarter, can you maybe give us an idea of what you're seeing for underlying utilization and any early signs of ACA? We see Rite Aid just reported this morning again strong results on the pharma side. So I'm just wondering what you're seeing in your model.

[John H. Hammergren:]

Well, it's difficult to account for what the Affordable Care Act effect is in our business. We came into the year believing there would be some modest effect from it and we still believe that's the case. We really had strength across the entire segment of Rx revenues, Canada and Specialty, in particular, came in very strong for us. So I think we're pleased with the momentum that we have. And as you mentioned, the Hep C drugs were also a surprise to us, of how quickly they've been taken up, and the volumes that we received there. So I think, overall, we're pleased with the performance of the revenues in that business.

[Lisa C. Gill:]

And then, John, just as a follow up, you mentioned the extension of your relationship with CVS. Are there any changes of note to that new relationship that goes through 2019?

[John H. Hammergren:]

It's basically the same form that we've had with them in the past in terms of the service and the relationship. So we're pleased to have renewed it, and we think it continues to show the quality of the service and the relationships we have with our customers.

[Operator:]

And we go next to Ricky Goldwasser with Morgan Stanley.

[Ricky Goldwasser:]

A couple of questions here. First of all, I think, I heard the comment on the operating margin now expected to grow at mid-single due to mix. So can you guys just give us some more color on the underlying kind of like revenue mix and kind of like what you've seen that was different in your expectations?

[James A. Beer:]

Yes, the driver of my comments around the Distribution Solutions' operating margin is really the impact of the Hep C drugs that we saw really having a very strong rollout in this last quarter, and that is what's driving the margin effect.

[Ricky Goldwasser:]

Okay. And then just kind of like a quick follow-up. On kind of like just the Rite Aid generic contract, I know -- I think you said that you expect to see the benefits flowing through in the September quarter, so is this still kind of like -- is timing still consistent with your earlier expectations?

[John H. Hammergren:]

We're really pleased with the continued performance in our relationship with Rite Aid. I would say that our contract negotiations are -- have progressed the way we had anticipated. The conversation around September was probably more focused on our delivery of generics to their individual stores. So we are probably better than halfway through the implementation of store delivery of generics directed by McKesson, and that will continue to evolve until we have 100% of that responsibility as we get to the fall time frame.

[Ricky Goldwasser:]

Okay. And in terms of contribution to your bottom line, should we see that in the following quarter?

[John H. Hammergren:]

I think you -- our guidance anticipates the effect of Rite Aid's business flowing through McKesson. And so I -- other than the dilutive effect, it has been a bit of a surprise from Hep C from a margin rate perspective. The rest of the performance of the business is right in line with our expectations.

[Operator:]

We'll go next to Glen Santangelo with Crédit Suisse.

[Glen J. Santangelo:]

John, I just want to talk to you about the North American Distribution business. The company continues to post very solid results in that segment and if I hear you correctly, obviously, specialty sort of helped the revenue line maybe volumes also helped the revenue line. But if I filter that down to the operating profit line, we're still seeing very sizable beats. And I'm wondering if you could help us sort of think through what might really be driving that better-than-expected result. Is it the branded and generic price inflation being pulled forward? Is it the volumes? Or -- we're not really sure what the margins look like on the specialty drugs you're talking about. So any sort of help in triangulating what's really driving that operating profit would be helpful.

[John H. Hammergren:]

I think it comes from many of the sources that you just highlighted. Clearly, the brand and generic performance in the quarter was very strong. We're pleased with the revenue growth we received, in particular, out of Canada and in Specialty. But even our standard Rx business has been supported by robust growth really across-the-board. And the continued uptake of our generic portfolio, the strength of Northstar, our ability to continue to bring market share to our customer base and the strength of OneStop, our generic program in our markets, continues to remain very strong. So I really feel like the businesses in North American pharmaceuticals are performing very well.

[Glen J. Santangelo:]

Maybe I'll just follow-up on Celesio. Obviously, they're out with operating results this morning and kind of looking through those results, it seems like maybe some of the segments might have performed a little bit better while some of the other segments continue to be -- face some challenges that I think you've talked about in the past. But maybe could you give us some high-level commentary about maybe what you thought of the results? And is everything kind of performing relative to where you would have expected?

[John H. Hammergren:]

Yes, I think so. Overall, we're basically in line with our expectations. As you noted, in their comments, they've talked a little bit about where their strength is coming and where some of their weaknesses are. And I think that their commentary is generally in line with what we expected.

[Operator:]

Our next question, we go to Robert Jones with Goldman Sachs.

[Robert P. Jones:]

So I just wanted to go back to guidance, a couple of moving pieces here relative to the previous communication. Am I correct to assume that there was some slight synergies assumed previously from the timing of operational control of Celesio and would that now not be included in the new guidance range given the pushout of the expectation on operational control? And then on the International Technology business, I understand that you're absorbing the $0.11 charge. But as we think about the balance of the year, are there corresponding earnings from that business that come back into the P&L?

[James A. Beer:]

Yes, so on the first of your questions, what we've spoken about in the past was that we expected just a modest amount of synergies from Celesio during fiscal '15. So yes, at some level, the pushout of operational control by a few months does have some impact on that. But again, they were modest expectations in the first place, I just want to emphasize that. And in terms of the workforce business and the impact later in the year, I would expect that, that would continue year-over-year because again, we've recast history. So we have all of that in the schedules to the press release. I would expect that, that would continue to create something of a headwind year-over-year for the balance of the fiscal '15.

[Robert P. Jones:]

That's helpful. And then, John, I guess just on the cash deployment, I understand you got probably about 1.5 on hold for Celesio and there's some debt redemptions over the next 18 months. But still a lot of cash with over $4 billion on the balance sheet today, solid cash flow again. Anything you can give us around how we should think about that cash being returned to shareholders or any perspectives on the M&A landscape at this point?

[John H. Hammergren:]

Well, as you point out, there are a couple of uses of the cash that we already have sort of planned into our future. One is the purchase of the remaining outstanding shares of Celesio. We still have 24% left to accumulate, which we believe will happen over time, as well as the debt repayment that we've committed to accomplish as we go forward. We want to remain investment-grade, as we've indicated. And that, as a backdrop, will probably cause us to continue to have a portfolio approach to our capital deployment. But it doesn't mean that we won't return to shareholders, through dividends and share repurchase, some of that cash. But what it does mean is that our priority is to make sure we maintain investment grade and that we avail ourselves of opportunities from an M&A perspective that make sense, which we've done on a regular basis.

[Operator:]

And we go next to Steven Valiquette with UBS.

[Steven Valiquette:]

So a couple of quick ones here. First the 2% revenue growth in the Med-Surg distribution segment, is that an indicative of a normalized run rate that we should expect maybe for the rest of the year?

[John H. Hammergren:]

Well, I think that we believe the Med-Surg business is growing in line with our original expectations. So we think mid-single-digits is probably where we're going to be. So it's a little softer in the quarter than we would have -- we would forecast for the full year. And I think the softness is really in line with what we believe the market performed at for the first [indiscernible] for us. And I have to emphasize that we're really pleased with the continued progress of Med-Surg. From an integration perspective, we are really accomplishing our objectives there, and the team is doing a good job.

[Steven Valiquette:]

Okay. And then just quickly, you guys had that previous commentary about the percent of earnings in the first half of '15 being similar to fiscal '11 through '13 and I know that was kind of loose sort of guidance or commentary previously. But is that still relevant with these 1Q results or does that sort of go out the window with the strength of 1Q?

[James A. Beer:]

Well, I think what I'd say is I'd stick to the annual guide that we've offered. I think given the quarter-to-quarter volatility in our results, it's hard to give directional assistance to you just for a single quarter. And I think this quarter is a good example of that. We saw some price increases both on the branded side and on the generic side move up into this quarter earlier than we had planned. And then also, we saw some of the brand-to-generic conversions that we were expecting pushed further back towards the end of fiscal '15. So I think I'd really just align you to the overall annual guide.

[Operator:]

And for our next question, we go to Ross Muken with ISI Group.

[Ross Muken:]

So it's now been a pretty remarkable period for the company. I mean you obviously had the Celesio acquisition, the Rite Aid agreement. It sort of shows the value you can provide to some of your larger customers. How has that sort of begat discussions with other customers you have in terms of the McKesson value proposition and how you can obviously then prove that you can obviously provide more value to kind of the broader universe as well?

[John H. Hammergren:]

Well, we think our early success with the implementation of the Rite Aid relationship as well as our continued performance in these businesses is an indication of our customers' reliance on our ability to work in partnership with them to deliver superior results. And I think we continue to work with those customers that have not fully availed themselves of the offerings that we have to make sure that they understand the kind of results we think we can obtain together and to help them quantify, not only the savings from sourcing with us, but also the savings associated with having us manage the logistics requirements associated with the purchase of product as well. And there's still significant customers that are somewhat redundant with us related to those deliveries that we think afford both of us opportunities. Having said that, these are big strategic decisions that have to be made and it'll take some time for some customers, I think, to reach the same conclusion that others have already reached. But I think our performance, as the first quarter shows, is an indication of customers' continued reliance on our ability to help them on many dimensions, including sourcing of products.

[Ross Muken:]

That's helpful, John. And maybe just on Technology Solutions I mean, this has been a bumpy ride now for quite a while and I know you've done a lot to sort of scale-down some of the clinical pieces where you've struggled. But as you think about the investment in this space and you think about the footprint, I mean -- so what is, at the board level and at the management level, what is the debate on sort of longer-term aspirations and goals for certain businesses? And then how do you -- how did you figure out what needed to go versus what needed to stay and how does that sort of affect how you're going to continue to look at the portfolio, I guess, going forward?

[John H. Hammergren:]

Well, if you set aside the surprise we had, so to speak, going into this quarter, which was the lack of our ability to exit the portion of the international operations business that we had related to the workforce and to run that contract out as opposed to selling it, if you set that aside and you actually look at the performance of the business, it's basically in line with our expectation. And what we've been focused on there is making sure that we have the appropriate operating margin for businesses of this type. That we're growing the earnings of the business in a way that's responsible and reflects the opportunity that we see in front of us. That the growth coming from the positive businesses in that segment are able to offset the drag associated with businesses that are not growing, as we know that they won't in certain categories there. In particular, the Horizon Clinical business that we're in the process of winding our way out of. And I would say that the last dimension that's important to us is these businesses are significant cash producers for us and I think the management team knows how to operate them. So the bumpiness on occasion is caused by things like IOG that we didn't fully expect to roll back into operations, and we'll work our way through that as well. I think at the portfolio level, we have a responsibility to look at this business as well as all of our businesses, not so much in the aggregate in the way that we report them, perhaps. But if you disaggregate them, there are a lot of the smaller businesses and product lines that make up these 2 large segments -- or 3 large segments now. And I think what we're focused on is how do we make sure that we've got the right portfolio of products and services in those segments to grow the business.

[Operator:]

And for our next question, we go to Greg Bolan with Sterne Agee.

[Gregory T. Bolan:]

Guys, I apologize if I missed this. But for the quarter, James, just thinking about the 14% North America pharmaceutical distribution business, what do you believe was the contribution from the Hep C launches for the quarter, just in terms of contribution to growth rate?

[James A. Beer:]

Well, you've seen Gilead announce their results, and I'd just say that directionally, our revenues coming out of Sovaldi, for example, would have been in line with the overall market share across the 3 big distributors in this country.

[Gregory T. Bolan:]

Okay, that's fair. And then just lastly, on the same topic, as it relates to kind of the margin dilution, if you will, year-on-year from the launch of the Hep C drugs, any noticeable impact just in terms of stomping margin expansion for the distribution solutions segment?

[James A. Beer:]

Well, the guidance that I offered a little earlier, mathematically it represents a very modest reduction in margins for Distribution Solutions. And obviously, those have been going up consistently in recent years. And at Analyst Day, you'll recall that we reset the long-term margin goal for Distribution Solutions up to between 250 and 300 basis points. So modest impact from these Hep C drugs in the short term.

[Operator:]

And for our next question, we go to John Ransom with Raymond James.

[John W. Ransom:]

Sorry to keep beating this horse, but one of your competitors mentioned that generic inflation was higher this year than they thought versus expectations of being lower. You talked about it just being more price pull-throughs earlier than expected, how do you -- how do we square those 2 comments? Has inflation, in fact, been higher than you expected or is it really just timing?

[John H. Hammergren:]

I can't really comment on other's -- other people's comments. But what I would say is that I would reflect on the fact that we all have different fiscal years. We all have different portfolios of generics. We have different proprietary programs in the generic world. We have different relationships with generic manufacturers. And having said all of that, our point of view on generic price inflation for our fiscal year remains unchanged from the guidance we gave you at the beginning of our fiscal year. The only thing that we really tried to clarify in this call was that we believe some of that inflation was pulled forward in the first quarter, but our full year remains sort of intact with our previous view. So I know that it's a complex, complex discussion to have. Just also makes it even more complex when we're trying to forecast the behavior of others in the channel where we don't have complete visibility. So it's -- frustrating, as it may be to you sometimes, we can't tell you what our goal for generic inflection will be for 12 months out. But frankly, it's a little bit of a black box for us as well, and have to make educated and informed estimates as to what we think will happen. And sometimes, those estimates are off either from a timing perspective or from a magnitude perspective. And what we're saying here is that really we're seeing some timing differences. But the magnitude, we think, will remain relatively the same.

[James A. Beer:]

Yes. And that magnitude that we talked about when we offered the guide for fiscal '15 was high single-digit growth year-over-year.

[Operator:]

And with that, ladies and gentlemen, we have no further questions on our roster. Therefore, Mr. Hammergren, I will turn the conference back over to, sir.

[John H. Hammergren:]

Thank you, Rufus, and thanks to all of you on the call and for providing some time today to listen to our results. I'm pleased with our strong first quarter performance. We're certainly excited about the opportunities that lie ahead for us. I want to recognize the outstanding performance of all of our employees and their contributions to these great results. Now I'll hand the call off to Erin for her review of upcoming events for the financial community. Erin?

[Erin Lampert:]

Thank you, John. I have a preview of upcoming events for the financial community. On September 9, we will present at the Morgan Stanley Global Healthcare Conference in New York. On September 30, we will present at the Leerink Partners Healthcare Services Roundtable in New York. And on November 11, we will present at the Crédit Suisse Healthcare Conference in Phoenix, Arizona. We will release second quarter earnings results in late October. Thank you, and goodbye.

[Operator:]

Ladies and gentlemen, thank you for joining today's conference. You may now disconnect. Have a good day.