McKesson Corporation (MCK) Earnings Call Transcript & Summary

Good afternoon, and thanks for joining us for our next presentation. I'm pleased to have with us today, Britt Vitalone, Executive Vice President and Chief Financial Officer for McKesson. We're going to have a fireside chat here and discuss the company's outlook here in a second. If you have any questions, you can ask that question in the -- through the webcast. There should be a box at the bottom that you can type it in. And if we can, we'll try to get that question asked here. So Britt, thanks for joining us today. Really appreciate it.

Thank you. Thank you.

So I want to start talking sort of maybe an overall question and really talk about McKesson's sort of strategic positioning here. I think historically, McKesson has really just been thought of as a pharmaceutical distributor, but really, in fact, if we think about it as a diverse health care services company, can you briefly talk about some of McKesson's other core businesses besides what probably most people are familiar with?

Yes. Again, thank you, Charles, for hosting us this afternoon. Really appreciate it. And I appreciate that question. We are a scaled distribution -- pharmaceutical distribution company as you rightly mentioned. That really has been the core of the business for many, many years. We have evolved over the last several years as we've been building out some ecosystems around some differentiated services and capabilities that we have. In addition to the pharmaceutical distribution business, which again as I mentioned, is a very scaled distribution business, we have differentiation in our specialty business, particularly in the areas of oncology. We built out an ecosystem over the last several years. And we have distribution -- or I should say, differentiation in the areas of biopharma services, we built out some technology and some innovation to really connect patients and providers and manufacturers. We also have a very scaled and successful medical-surgical supply business with capabilities that reach all the alternate site markets. We've built distribution capabilities as well as lab services capabilities. We've expanded into pharmaceutical distribution into the alternate site market as well as building of our private brand. So it's a business that I think has grown and evolved over time. I don't think that value is fully reflected in McKesson today, but it's one that we'll continue to build on those differentiated assets and capabilities.

That's great. And maybe just continuing that train of thought here, in which particular businesses for McKesson, among those differentiated assets, which would you say are the key growth areas going forward that you think investors should really start to focus more on?

Yes, I appreciate that question. So as we've really refined our strategy over the last couple of years in the areas which we're prioritizing, again, building around those differentiated assets and capabilities, a couple of areas that I would talk about: first, in the area of specialty, primarily in the area of oncology, we've built an ecosystem over the last several years and started with distribution. And we've built up scale in our distribution to oncology practices. We've built GPO services, and we've continued to build that ecosystem through our U.S. Oncology asset with over 1,400 community oncologists, and we're the #1 distributor to community oncology. And from that, we've been able to build a business now called Ontada which delivers precision and real-world evidence insights back to manufacturers based on the data and insights that we're gathering from that community of oncologist. So this is an area that we feel is one of our growth pillars going forward. In the area of biopharma services, again, we've built an ecosystem over the last several years, thinking about some of the assets that we put together such as RelayHealth Pharmacy. We've made the acquisition of CoverMyMeds and the acquisition of RxCrossroads, and this has allowed us to put together in some innovative and technological ways, the ability to connect biopharma with the patients and providers to provide access, affordability and hub services programs in a much more intelligent way than the traditional hub services. And then finally, if you think about our Medical business, again, serves all the alternate site markets. Over time, we've been able to continue to add capabilities and one that I would point out here is our lab services capabilities. We made an acquisition back in 2016, a company called Labsco, and that positioned us to continue to evolve our capabilities in the area of lab, which has provided us the ability to continue to grow our business this year in the COVID-19 environment. So I think there's some clear differentiation in these areas and their priority areas for growth as we look into the future.

That's helpful. And as you touch on COVID, obviously, today's announcement with J&J, you announced that you're already starting distribution of the J&J vaccine. Along with the Moderna vaccine, it looks like you are in position here now to distribute to 2 of the vaccines out in the U.S. You recently have revised your '21 guidance, kind of assuming a net benefit of $0.25 to $0.35 related to vaccine distribution. Any kind of assumptions that you could share in terms of doses assumed in that? And does it include any assumptions for J&J at this time?

Yes, appreciate that question. So let me just step back little bit and tell you how we got here. As you will recall, we were the H1N1 distributor as well both for vaccines and kits. And what we've done here with this recent program is leveraged the vaccine for children's program contract that we've had now in place for many, many years. The program does put us as the centralized distributor for COVID-19 vaccines and ancillary kits to provide the vaccines and the administration of vaccines. The government makes all the administration decisions. They will make the decisions on how many will be distributed to what sites and which products will be distributed. Our contract from the vaccine distribution perspective is the refrigerated and frozen not the ultra-frozen which is Pfizer. Pfizer is handling that themselves. So any refrigerated or frozen products which would include the J&J vaccine will be part of the centralized distribution that McKesson manages. And again, we manage all of the ancillary supply kits for all of the different products within the program. The $0.25 to $0.35 is the estimate that we provided for our fiscal '21 contribution to adjusted EPS. That includes all the quantities that will be determined by the government for both frozen and refrigerated vaccines. And then, the ancillary supply kits we provided and updated contribution estimate for '21 of $0.20 to $0.30. So we don't talk specifically about how many doses or which doses will be in what quantity. That's, again, decisions that the government makes in their administration, but we're certainly prepared to handle all volumes that will come through. And as we get closer to our guidance for FY '22, we'll provide some updated assumptions.

Okay. That's helpful. And we'll get to sort of fiscal '22 in a second here. But maybe taking -- looking back, you talked about oncology and Ontada, in particular. It's been a long focus for the company ever since you acquired U.S. oncology quite some time ago. Can you talk about how you're trying to differentiate your offering in the market, particularly in oncology compared to some of your competitors in the distribution space that also have big oncology practices as well?

Absolutely. So again, we started this oncology evolution or ecosystem, if you will, through just building and distribution capability. And from that, we've built capabilities around GPO services, hub services to support manufacturers in the distribution of their drugs. And then the U.S. oncology asset itself is very differentiated. There isn't anything like it in the marketplace. Again, as I mentioned, over 1,400 oncologists, independent physicians are part of the U.S. Oncology Network. And so, this has really positioned us to then take advantage of the immense amount of data that comes through the U.S. Oncology Network as well as community oncology in general and build a new business called Ontada, which utilizes that data, the real-world evidence data to provide precision insights back to the manufacturers to help them with clinical trials as well as commercializing and thinking about innovative technologies and innovative drugs. So as you think about it from an ecosystem perspective, yes, there's scale in the distribution, there's the GPO services, then that differentiated unique asset in U.S. oncology, being able to build and create this new company, called Ontada, which provides those precision insights through the real-world evidence that we gather from that ecosystem. That is very differentiated. And I think when you put that all together, it provides tremendous value, not only to the manufacturers, but certainly the providers and ultimately back to better patient care, better access, better affordability.

And with the GPO part of it, does that extend into drug purchasing as well? And does that help you extend into the biosimilar markets? Because I feel like if we think about biosimilar adoption as it continues to increase, I think you have called it out as being a contributor. At this point, is it a meaningful contributor? And just wondering how you can influence adoption of biosimilars because I think this is one area where people look for as potential growth, but unlike generics, you don't have that interchangeability ability yet. Maybe talk about how you're able to influence choice or choices of biosimilars and how that relates to economics for McKesson?

Sure. Well, certainly, the GPO, among other things, is an avenue to provide scale for purchasing power, which is -- certainly benefits all the members. But as we think about biosimilars, we're excited about biosimilars, we think that in the future, there's certainly going to be a really good opportunity for providers and certainly for patients. We look at biosimilars as a win-win win. It's a win for the patients because it's another alternative and a lower cost of care. It's a win for the providers because it provides certainly another alternative that they can choose to practice medicine and provide better outcomes for patients and it's better for the distributors. It has higher margins than traditional branded or specialty drugs. But as you pointed out, not nearly at that same level as generics. We think that the opportunity is great where we have influence and certainly where there's more choice that is made by providers. If you think about the U.S. Oncology Network, you've got over 1,400 physicians now that are working together to think about the best drugs to be used and the best treatment plans to be used and making those decisions in mass, if you will, certainly has more influence and impact. As more biosimilars come through the oncology space or specialty space in terms of specialty practices, if you will, specialty providers, there's going to be more opportunity for better economics. The channel will make a big difference. So if the channel is going through a traditional health system, that will impact, obviously, adoption, which will impact economics. Where the drugs go through the community oncology or community specialty practices, we think that the adoption rates will be higher and the benefits will be greater for all. So we think that FY '23, you're going to see the pipeline continue to fill up. You're going to see more drugs coming through from a biosimilars perspective and the economics will be really much greater at that point in time.

Are you feeling that you're able to get better-than-average economics on these biosimilars because of the U.S. Oncology Network as well? Are you able to go back to manufacturers and say, "Hey, we, as an organization are -- feel comfortable that your biosimilar is a great first choice"? And are you able to kind of run it back up the chain that way compared to just if there was only a couple of biosimilars in the market for something?

Yes. Look, the economics are really going to be dependent on where there's more influence some where there's higher adoption. And certainly, if you think about the U.S. Oncology Network, you've got 1,400 independent physicians that are making decisions, best outcomes for their patients, but when they make those decisions in larger quantities, that's going to drive higher adoption. And that higher adoption, certainly, is leveraging the scale and the influence of the GPO, and that's going to drive differentiated economics versus individual hospital system by hospital systems. So we do think that, certainly, having the scale and the differentiation of U.S. oncology matters, where you're going to be able to drive a higher adoption rate and those channels is going to make a difference.

Okay. That's helpful. I want to touch on -- for an update on opioid front here. Obviously, this past quarter, you made an accrual of $8.1 billion to reflect the amount that you'd expect to pay over 18 years. Obviously, the latest indication that you, as a group, are close to reaching a global resolution. Can you give us an update on where things stand? And any kind of further progress that's been made with the states since you last spoke?

Yes. There's a limited amount that I can really add here. We've certainly expanded the disclosure that we've provided in our recent 10-Qs. As you mentioned, we did make an accrual in this last quarter. And that was really reflective of what we would say would be significant progress in the negotiations that allowed us to get to the point where we determined -- we have reached a point of probable and reasonably estimable, and that allowed us to book the accrual. We're still hopeful that a broad resolution can be reached. We think that, that's the best outcome. But we're not there yet. We don't have an executed agreement. And until such time, as we do have an executed agreement, we do expect that we'll continue to defend ourselves. We'll still expect to have opioid litigation-related expense. We talked about that being about $160 million for FY'21. And I would just guide that until we've reached that settlement, that would be the appropriate amount to assume as we go forward in FY'22. Again, significant progress, though, has been made, and we're still hopeful that a broad resolution can be reached.

And before we get to fiscal '22, I mean, as we -- even if we do get a global resolution, let's say, sometime in fiscal '22, it's fair to think that opioid-related litigation expense will probably continue after that because we're not going to necessarily cover everything in this one resolution. Is that probably a fair assumption?

Well, our hope is that we could ring-fence the majority of the risk. That's been our hope all along. That's what we're really reaching for. But it's difficult to say that at this time that an executed agreement will ring-fence all of the outcome. And then some level of opioid-related litigation expense would continue. Very difficult to say what level that looks like until we get an executed agreement.

Yes, that's fair. And before we get to fiscal '22, just maybe 2 more items would love to discuss. One is the U.K. retail environment and then talk about maybe the retail environment here in the U.S., due to COVID. And obviously, maybe starting with the U.K. Obviously, some reports out suggesting that McKesson may look to divest some of their -- some of your [indiscernible]. But without maybe speaking specifics, can you talk about what the U.K. environment looks like currently for you? I thought there was some funding from NHS for retailers. Maybe give us an update there.

Yes, absolutely. So I'm not going to really comment on rumors or speculation. If we were to comment on rumors and speculation, we'd be commenting constantly. Look, all of the markets that we're -- we've been participating in have had impacts from COVID. We saw actually an increase in the pressure and headwinds in the end of the third quarter. Certainly, case volumes have gone down here as we've gone through our fiscal fourth quarter. But all markets are really still reflecting the level of volume or level of impact from COVID. In the U.K. specifically, we've made a lot of moves over the last year, 1.5 years to continue to improve that business. We've made restructuring to shrink down the footprint as appropriate. We've moved some back-office functionality into central services. We cut costs in other areas. And we've invested in the business at the same time, investing in digital capabilities like the acquisition we made of Echo, which has really shored up the business. So from a -- just a fundamental perspective, the business reflects the dynamics around COVID, but has improved. And a lot of that is some of the actions that we took. We do think that the NHS has provided us more visibility until -- into the total level of reimbursement in the marketplace. Over the next few years, that's provided a level of stability, at least from a reimbursement perspective. So under that condition, where we have better visibility into reimbursement, and we've continued to work on shoring up the asset itself, as you would expect us to do as a retailer, there's been more stability around the performance of that business.

That's helpful.

And as it relates to your question in the U.S., every quarter this year has, certainly, been almost -- its own core came out of -- in the beginning of the year, we said that the first quarter would be the most impacted related to COVID. Certainly, the biggest shock from COVID would be in the prescription volume space as well as patient visits and elective procedures. That played out. But we saw a rebound at the end of the first quarter faster than we had assumed. As we got through into the third quarter, case volumes picked back up across -- certainly, across the U.S. but other markets as well. And that put a little bit of a headwind into volumes as we exited our fiscal third quarter. So volumes are still not at the level of the pre pandemic and we do expect that they will return to pre pandemic levels. But later than we had originally estimated sometime in FY'22.

Any thoughts within that, how maybe the independent pharmacies are performing. And obviously, we can see how the big chains are generally doing, but [indiscernible] Pharma obviously a big part of your business. You have a lot of strength there with the Health Mart brand. Just curious sort of your thoughts in that segment of the market.

We're really proud of Health Mart. It's grown quite well over many years. And when you look at the independents, they're very resilient, and they've continued to evolve their business over the last several years, whether that's home delivery, whether that's adherence programs, inventory management programs or other ways to utilize the space that they have within their footprint. And they've continued to do quite well. Certainly, have all the pressures that everybody else has as it relates to COVID and other environmental issues. But we've seen independents continue to be resilient, continue to perform well, and we continue to support them. We think that they are a vibrant and important part of community pharmacy. So we've seen really nothing materially different in terms of the independents versus any other site, if you will, but same challenges that others are facing from COVID.

Okay. That's great. So then I think -- obviously, we talked a lot about the different puts and takes to trends. Maybe if you can just kind of put it together, we're exiting fiscal '21 here. When we think about fiscal '22 and these various puts and takes, any thoughts on what the right jump-off point then for fiscal '22 is, things that we should take into account?

Boy, I wish I knew what the right jump-off point was. This is -- as I mentioned, it's been quite a dynamic year, and it's been quite volatile. We've certainly performed well throughout the year. We came into the pandemic, have returned the business to growth. Each of our segments grew last year. And as you look at the fundamentals of the business, they've improved and they're solid and they're stable. That continues to be the case today. The underlying fundamentals of the business remain solid and stable. And certainly, we've shown that certain capabilities that we have, have come to the forefront, like our lab capabilities. Many things I would tell you about in terms of tailwinds and headwinds into FY'22, maybe I'll just point out a few but I'd also say that the tailwinds and headwinds that we've seen this year are not likely to be the same headwinds and tailwinds next year. First of all, let's talk about the vaccine and kitting programs. This year, we began that program in the second half of our year. The vaccine distribution program had an immaterial impact to our Q3. So the $0.25 to $0.35 that we've guided for EPS contribution in FY'21 is mostly fourth quarter-related. In terms of the kitting program, we began that in the second half of the year in advance of the vaccine program. We expect that, that will deliver $0.20 to $0.30 of EPS contribution in FY'21. As a quick reminder, we recognize revenue on kitting as those kits are produced. We recognize revenue on the vaccine as they are distributed. The next thing that I would point out is that in our medical business, we have benefited from the increase in the elevated demand levels around COVID test kits and PPE. Certainly, as the pandemic kicked off, there was increased demand in -- for both PPE and COVID test kits. That's remained high and elevated all year. We would expect that we'll have elevated demands through the end of our fiscal '21, but we do expect that these elevated demands will moderate and that they will moderate in FY'22. We'll provide more assumptions around that as we give you our FY'22 guidance. But what I can say is that these elevated demands that we've seen all year will moderate. As just a point of reference, in our third quarter, we talked about a 52% AOP growth in our medical segment year-over-year. When you pull out the impact of COVID test kits and PPE, that growth rate was 29%. And so that gives you a sense for the size of the impact that COVID test kits and PPE have had on our business this year. We've also had unplanned gains from equity investments in our McKesson Ventures portfolio. As we've talked about, we have a McKesson Ventures portfolio to provide us insights into the marketplace. It holds early stage investments, and we have not and will not forecast the performance there. It's very difficult for us to do that. And our practice has been to not provide forecast on that. However, we have had unplanned gains this year of around $90 million, which we would call as onetime in nature, we would not expect to recur next year. We talked about opioid-related litigation. That's been $160 million this year. That's our forecast. Again, we don't have an executed agreement. So until such time as we do have an executed agreement, I would guide $160 million going forward. And we'll continue to make investments in our business. We talked a little bit about how excited we are about the strategic priorities we have in the differentiated areas of oncology and biopharma services. And I called out a $0.05 to $0.10 headwind in the second half of the year FY'21, related to continuing those investments, and we will continue these investments in FY'22 as well. We're excited about the opportunities and certainly, the returns that we expect over the next several years. So those are a couple of the puts and takes that I would call out. When utilization returns, we do expect it to return to pre pandemic levels sometime in FY'22.

And that's all really helpful detail. Maybe just to follow-up on the incremental investments. You're talking about $0.05 to $0.10 in the back half of fiscal '21 carrying it. Is it going to -- would you -- should we think about that increasing to a higher level in fiscal '22? Or is it that this new level of investment as we get to the back half of fiscal '22 would normalize? So it's not really incremental on the back half, obviously, the first half it would be.

A little early for me to give you that guidance in terms of the specifics. What we're trying to call out here is give you some insight into the incremental investments that we're making in those businesses. We do expect to continue to invest in these businesses. How much of that will be incremental in FY'22 is a little early for me to say. But I do think it's important for everybody to understand that these are higher margin, higher-growth areas that we're investing in. We're in the investment phase, but we expect that we'll continue to invest in these going forward. We expect the returns to be great. That's why we're investing in these strategic areas because we have that differentiated position.

And that's helpful. And then maybe in the last just couple of minutes here, just talk about sort of capital deployment priorities. Even if we factor in global [indiscernible] for opioids, McKesson generates a fair amount of cash here. Shares are very attractive here, given sort of what you're talking about underlying growth in all your segments and the opportunities here in these new areas of focus, talk about sort of how you're looking at share repurchase versus -- and maybe return to M&A to build out some of the [indiscernible].

I appreciate that question. And I should point out that capital deployment has not changed for us. The opioid issue has not changed our approach to capital deployment. We continue to put a balanced approach to capital deployment. Starts with good cash flow, as you mentioned, we've been able to generate stable and solid cash flow for a number of years. We expect to do that going forward. Capital deployment starts for us. The priority is growth. And whether that be internal investment in some of the areas that I just referenced here in terms of oncology and biopharma services or M&A., we think that M&A can accelerate some of these growth areas. So we've been very disciplined in our approach to M&A, and we're looking to grow the business, but it needs to be on strategy, and it needs to be at the right price. And so, we're going to be very disciplined in how we approach that. We're going to continue to return capital to our shareholders. We have a modest, but growing dividend, which we're committed to, and we're committed to continuing to return capital to our shareholders through share buybacks. We've done that in the past. We've done that all year. I do think that the growth areas that I've outlined, that the value is not fully reflected at this point in time. So we're going to look to continue to accelerate those strategies. But again, we will be very balanced. And where we can't find acquisitions or investments that are on strategy and at the right price, we will return capital through share buybacks. All of this is supported by our strong and stable balance sheet and liquidity position. And we remain committed to our investment-grade credit rating.

Great. And I think we're right on time here. So maybe we'll stop right there. And Britt, thank you so much for joining us today, and thank you, everyone, for participating here. If you have any questions, please feel free to follow-up with me afterwards, and have a great rest of the conference. Thank you, everyone.

Thanks, Charles. Appreciate it.