McKesson Corporation (MCK) Earnings Call Transcript & Summary

Hi. Good afternoon. I'm Brian Tanquilut of the Jefferies Healthcare Services research analysts. Welcome to the 2020 Jefferies Global Healthcare Conference. Our next presenter is McKesson Corporation, one of the largest drug distributors in the world. And joining us this afternoon is the company's Chief Financial Officer, Britt Vitalone. Britt, thank you for joining us. I really appreciate your time. And I just figured we could jump right into it. If you don't mind, I'll throw some questions at you, and we'll just go through a few of the hot topics for McKesson.

Sounds great. Brian, thanks for having me today. Appreciate it.

Awesome. So I guess my first question, Britt, obviously, COVID is a hot topic for a lot of folks right now. There's almost no one in the health care industry that has not been impacted by this. So what are you seeing? What was the company's experience through the early part of COVID? And it seems like there's some recovery happening right now. What can you share with us on that front?

Yes. Thanks again, Brian, for having me here. And we tried to give a little bit of good color and transparency on our earnings call. I think what I would start out with is that the business fundamentals for McKesson have had good momentum and have been improving through FY '21 -- we -- or FY '20. We had a strong FY '20, good finish to the year, and our momentum was building throughout the year. So the fundamentals of the business are strong. And they remain in that place as we entered this COVID period. Certainly, we view this COVID period as an uncertain time frame. We also view it as a relatively short term, that we do believe that health care utilization will come back and we believe that we're well positioned for when that happens. What we saw in March after the WHO indicated that this was a pandemic and declared that as such, we saw spikes in demands in many of our businesses, particularly in our pharmaceutical business in the U.S., in Europe and in Canada. And as the month of March played out and into April, what we saw is business began to trail off in all of our businesses as shelter-in-place and this remote work environment and remote environment for people in general just took place. And as a result of that, we saw some volatility in our businesses, but mostly businesses trailed off in our physician sites, our primary care sites and our non-oncology sites. We have seen some of that business begin to return and recover. We do expect that the first quarter will be the most significantly hit primarily in our physician-oriented businesses, our medical supplies business around primary care sites, our specialty businesses and in the clinic businesses. But we do expect a gradual recovery through beginning in Q2 through the first half of the year and gradually recovering as the year plays out. We would expect that business will return more to normal as we exit the year. But this is an uncertain environment, and we'll have to see how this plays out and we're certainly watching it very carefully.

Now that makes a lot of sense. So Britt, I guess, you said a few things there that are really interesting. So let me ask you first. On your last earnings call, and you just also mentioned this, you saw some -- the oncology specialty business was fairly resilient. You saw weakness in the non-oncology specialty. So would you mind just walking us through what exactly falls in those buckets and what your thoughts are on why you saw that drop off? And then, I guess, on the oncology side, if you can just talk about there's resilience of U.S. Oncology in that business that you guys own?

Yes. So we obviously have some strength and differentiation in our Oncology set of businesses, particularly as you think about the U.S. Oncology Network. We did see cancer visits decline initially. And certainly for nonsurgical oncology, those visits have continued to remain lower than they were pre-COVID. In the clinical -- in the specialty areas that are non-oncology, you think about ophthalmology, dermatology, as an example. Those are areas where people are more willing to put those visits off until such time as we return to a more normal environment, so those types of areas where they're less critical health needs. We have certainly on -- some types of oncology are very critical. People are going to continue to have their treatment and go forward with their treatments. In those areas, we didn't see volumes trend off as much. But I think it's a very big distinction between critical needs or critical oncology visits and surgical oncology versus those areas like ophthalmology and dermatology, where people are willing to put that off. In our medical business, elective procedures, certainly in many ambulatory surgery centers as well as primary care sites, just shut down temporarily, and we do believe that, that will return beginning with our second quarter.

Now that makes a lot of sense. So I guess as I think about what -- you guys just put out your guidance for fiscal 2021 a few weeks ago. From the CFO seat, I mean, how did you view that? I mean a lot of companies have refrained from giving guidance or have even withhold guidance where applicable. How did you approach the guidance setting? What was your philosophy as you looked at the uncertainty in front of you right now?

Yes, it's a great question, and it's -- I think it's an important question. We certainly, like a lot of other companies, we had a discussion on whether we were in a position to give good guidance or not. And as you mentioned, many companies have just decided not to give guidance. We felt that it was important for us to provide as much transparency as we could even in this uncertain environment. We have good insights into the markets that we participate in. And we felt like if we gave the right set of parameters around how we made those assumptions, that it would be important. So as an example, we called out some things that are not part of our guidance. So for example, we didn't include a second wave of this that would preclude health care consumption, and we didn't include systemic insolvency risk. But we did feel that setting those things aside, that we could provide some transparency into the environment that we're participating in, that we're seeing, the trends that we're seeing. And we felt it was important to provide you the assumptions that we had based on the data that was available to us. And so we felt that it's important for our investors to understand how we're seeing the market and how we're thinking about our markets and also to give some indication of the types of the shape of the curve that we would see and that we would expect to see. So we certainly went through a lot of discussions around that. It's difficult as a CFO in an uncertain environment. One thing I said on the call is in the days, weeks and months ahead, there's certainly going to be things that happen that will make everything that I said on May 20 invalid. But at that point in time and over the course of the next coming quarters, we want to provide some visibility into how we're seeing the market.

I appreciate that. But I guess, Britt, as I think about your fiscal 2021, right, this carries over to calendar '21 as well. Obviously, unemployment is a concern. We're facing a recession. And I know you were at McKesson during the last recession, where we saw physician office visits pull back, and that has obviously a flow-through impact to drug utilization. So how are you thinking about that? Or how did you incorporate that into the guidance?

Yes. We certainly looked at some of the things that we experienced in the '08, '09 time period. You're right, I was in the medical business at that time. Brian also was in the medical business at that time, and we did see impacts. But what we've seen over the course of many years is that health care tends to be very resilient. And health care is still going to be utilized. People are going to still go see their doctors. They're still going to take prescriptions. So health care tends to be very resilient. Our businesses are very broad. So if you think about our medical business as an example across the alternate site continuum, we service ambulatory surgery sites, primary care physicians. Certainly, lab is a big part of our business now, and then get into extended care, nursing homes, home health agency and so forth. So it's a very broad business. We think that the services and capabilities that we have will be utilized across all those continuums of care. But generally speaking, while there may be some impact, we do think that health care will continue to be a resilient aspect of life.

That sounds like a fair assumption. So I guess, kind of tying it back again, Britt, to the discussion on the guidance, right? So McKesson was putting up some pretty good growth numbers, adding it to COVID. And I think your numbers before the COVID in the last quarter before the COVID pandemic were pretty good. And then as I look at your guidance, top line implied is, what, low to mid-single-digit growth as well. So how do you think about the company's growth trajectory, the fundamental outlook for that? And then which parts of your business are really driving most of that? I know you've got specialty, you've got services, you've got a traditional distribution segment. How should investors be thinking about the growth once we normalize out of COVID?

Yes. It's a great question. And I think coming into FY '20, we were pleased to be able to guide to a return to growth in our business segments. And so -- and we did experience growth in all of our segments. So we're very pleased with that. And again, that momentum built over the course of the year. If you think about our U.S. Pharma and Specialty Solutions business, again, a very broad-based business, U.S. Pharmaceutical distribution to hospitals and independents and retail national accounts as well as our growing distribution of specialty pharmaceuticals through the clinic space, whether that be non-oncology or multi-specialty, and we continue to see really good growth there, and then the differentiation that we have in oncology. So within that segment, it's a very broad-based business that we've seen good growth in. We've seen some outsized growth within our U.S. Pharmaceutical component of that business. In the retail national account business, primarily our largest customers had grown faster in FY '20 than the broadest base of customers, and we saw a lot of that growth coming through specialty product distribution, which, as you know, over the last several years, specialty is where the innovation has happened and specialty has grown faster. So we would expect that, that will likely continue in the upcoming years. And then in our medical business, we continue to see really strong top and bottom line growth there. Again, that broad base of businesses, we've added lab, we've added Rx to the portfolio there as well as a strong private label that is really -- our customers can access for better cost positions as well as just greater differentiation of product selection. And we have growth in our European business. Our second half of the year in Europe was consistent and it was solid, and it showed growth year-over-year. So really, across our whole set of businesses, we're really pleased that we were able to grow in each one of those businesses. That momentum was nice to see. COVID sets us back, and we talked about that in our guide. A little more uncertain environment, but we do expect to see growth in all of our businesses in the second half of the year as compared to the first half of the year. So I think as we think about it, it's really what is the depth of this pandemic and what is the duration of that. We've laid out for you a curve, a shape of the recovery curve that we expect to happen, but we do expect to return to growth in each of those businesses in the second half of the year.

Yes. That's great. So you mentioned something there, right, where the -- some of the growth has been driven by the expansion of the business relationship you have with one of your bigger clients. One of the questions that has come up with the story over time or at least over the last 6 months has been margins, right, where some people were probably surprised at the margin compression that happened. So philosophically, how are you thinking about the balance between margin percentage and growth in some of these new business areas or new business opportunities that you guys are going into?

I think the most important thing as we think about our business is where can we leverage the capabilities that differentiate us in the marketplace. And we've talked about some of the differentiation and the capabilities and assets we have in specialty, certainly in oncology, and then our manufacturer services portfolio that we've been building over time. So we really focus on where do we have differentiation, where do we have leverage. We have a very scaled distribution platform that allows us to not only have stronger relationships with manufacturers through our growing customer base, but it also allows us to leverage the spend across in a very effective way. So I think it all starts with what is our strategy. We've laid that out very clearly as leveraging the differentiation we have in specialty and clearly, in oncology as well as manufacturer services and then being able to grow operating leverage and good cash flow off of that.

That makes a lot of sense. So -- but I guess kind of related to that, right, I mean, generics, obviously, is a big driver of your business and of your profitability. So that was a big hot topic for the last 2 years. It seems like things have stabilized now. How do you think about the generic world going forward, number one? And then, I guess, with COVID in the background, we've heard of disruptions in India and China. Do you think that's going to have an inflationary impact both buy side and sell side as we look to the back half of this year or early next year?

Sure. Great questions. Let me see if I can order those and answer those in some order. Generics is an important part of our business. It's important to our customers. It certainly gives our customers more choice. It gives them a better cost position. So it will continue to be an important part of our business going forward. And what we're pleased with is over the last several years, we've been able to build -- it starts with a very good foundation on the sourcing side. I was looking yesterday that it's been 4 years since we established the -- or announced the establishment of our generic sourcing consortium with Walmart in that strong partnership. So over the last 4 years, we've built what we believe to be the most -- to be as competitive a sourcing operation and an efficient sourcing operation as exists out there. We think that we bring stability of supply. We think we bring low cost to our customers. And so it starts with that part of the foundation, stability of supply, low-cost capabilities that we bring forward to our customers. On the sell side, what we have seen is a competitive environment. It remains competitive, but a more stable environment. And we're certainly taking a disciplined approach to that sell side of the market. So when you combine those 2 components, we think we bring great offerings to our customers through our strong sourcing organization. And certainly, the disciplined approach that we bring to the sell side has added to that stability in a competitive environment.

Got it. Appreciate those comments. So I guess, shifting gears, one of the things that investors have always liked about McKesson is the strength of your cash flows and your balance sheet. And then obviously, there's a good capital deployment story here with buybacks and the dividend and M&A. So COVID aside, as we normalize, I mean, how are you thinking about capital deployment, sustaining the buyback, the dividend? And then, I guess, from an M&A perspective, where do you see potential need or interest in terms of areas where strategically McKesson could go into?

Yes. Great questions. Our capital deployment starts with a foundation of good cash flow generation. And as a company, we've really been very efficient in our operations and we've been able to generate consistent and solid cash flows for numbers of years now. We expect to continue to be able to generate consistent and strong cash flow in FY '21. So that foundation is in good shape. From there, we really have a balanced approach to capital deployment. In any 1 year, we may skew more towards return to shareholders. You've seen in the past where we've had more M&A activity. But over a longer period of time, we've been very balanced in how we deploy capital for growth, whether that be internal capital expenditures or M&A or how we deploy that back to our shareholders through dividends or share buybacks. And so we'll continue to do that. We want to grow the company. We think that growing cash flows over the longer term will sustain good cash flow generation and the health of the company. From an M&A perspective, we're going to look for M&A that's on our strategy, and again, those areas where we have differentiation in specialty, oncology, manufacturer services. If we can find attractive candidates for that, that are on strategy and offer superior returns, we're certainly going to be interested in that. If we're unable to find those, like in FY '20 is a good example of that, we'll deploy more capital back to our shareholders, and that's what you saw us do. So overall, we want to deploy capital on strategy. We want to deploy it where we have the highest levels of return. Generally speaking, that will be balanced. But in certain years, it might be more tilted towards return to shareholders or in some cases, through growth.

Now I appreciate that. So I guess, Britt, I would be remiss in my duties if I didn't ask about the opioid litigation. It is -- it has been in overhang for, what, a couple of years now. And just talking about capital allocation and capital deployment, if you don't mind just giving us an update on that. And then I guess on a more technical perspective, how do you think that would be accounted for? Is it leverage on the balance sheet? From an earnings reporting perspective, obviously, this will be -- it looks like it will be paid over a multiyear period. Is that something that will be back out in terms of like EBITDA math? Or just wondering what your thinking is and how your auditors are starting to think about that.

Yes. It's a great question, and I appreciate the interest in it. There's really not a lot that I'm going to be able to comment on now. There's not a lot of new information versus what's out there in the public domain today. As we think about right now, our focus is on the COVID pandemic and servicing our customers. We believe that that's where a lot of the focus is from some of these governmental agencies as well. Clearly, we think that getting a settlement is in the right interests of the people who need the funds and so forth. And so getting a global settlement, we think, will be the right approach for all parties that are interested in that. From an accounting perspective and from other aspects of that, I think a lot of it is going to depend on what does the ultimate structure look like, and at that point in time, we'll better be able to answer your questions on the accounting, the tax piece and so forth. So I think it's maybe a little premature to have that discussion. Our auditors are clearly involved in the discussions that we have and are paying a lot of attention to this as you would expect them to do. But at this point, there's not really a lot much more that I can comment on as it relates to the opioid piece.

Now totally understandable. Britt, thank you so much. I really appreciate your time. I really appreciate all the work that you guys have been doing, especially with COVID. And good luck for the rest of the year.

Thanks so much, Brian. I appreciate it.

All right. Thanks, Britt.