McKesson Corporation (MCK) Earnings Call Transcript & Summary

Good morning. Thank you for joining our next section here. We're very pleased to have presenting today McKesson. And speaking for the company is Britt Vitalone, Executive Vice President and Chief Financial Officer. Today's session will be a fireside chat. If you have any questions, you can send them in the web chat. We will try to get to them at the end. You can also try to send them by e-mail to [email protected]. So with that, Britt, thank you for joining us this morning.

Thanks for having me, Charles. I really appreciate it.

Yes. It's great. So obviously, you guys had a strong year so far. The outlook looks pretty bright. I'm sure we're going to touch on that a little bit. But maybe if you could just remind folks going into fiscal '22, some of the key priorities that you guys had as a company and really maybe talk again sort of the progress you made against those and then maybe touch on some priorities as you're kind of thinking out for next fiscal year.

Terrific. Again, thanks for having here. Maybe I'll just start by restating our full year FY '22 guidance that we provided on our February earnings call, and that called for full year adjusted EPS range of $23.55 to $23.95. I just want to frame that up for you. Now we have been focused on the development execution of our enterprise strategy and that's been centered around 4 company priorities, and let me just kind of walk through those real quickly. The first company priority is our focus on people, and we continue to invest in our teams and our culture and this has aided our ability to both retain and attract talent. The second priority that we laid out is our sustainable core growth. Our core business, as you talked about, has been growing in each operating segment. We continue to benefit from our role as a centralized distributor for vaccines and ancillary supplies for the U.S. government. But at the same time, we've successfully navigated complex supply chain challenges that many have felt, and we're leveraging our expertise and strong relationship with suppliers. Our third priority is streamlining the portfolio, and we've made great progress in exiting the European market. We've announced divestiture plans for 10 out of the 12 countries that we operate in. And our fourth priority is the expansion of our oncology and biopharma ecosystems. And we continue to be very excited about our progress building out both oncology and biopharma ecosystems. These growth pillars are both large and growing markets, if significant unmet needs and opportunities, and we're positioned to win with our differentiated assets and capabilities. We've also made good progress against key ESG-related initiatives, and we remain committed to further enhancing our ESG program. So as kind of that you started out, we've made solid progress against these priorities, FY '22 is another strong year for us. Our strategy is working and I think you can see that being reflected in the strong operational and financial performance in '22, which we're confident will continue into FY '23.

That's great. And maybe touching on your -- the fourth priority about expansion into oncology. You've had a long focus in oncology, particularly with U.S. Oncology, which you acquired in the mid-2000s and has now continued with the investment in Ontada. Can you talk about how you've differentiated yourself in Oncology? And maybe help just size maybe what the market is for these kind of services?

Absolutely. Again, as you mentioned, it's one of our core priorities. So bringing the platforms for oncology and biopharma services to life is the next exciting chapter in our deep history of evolving to address some of the most acute health care challenges, something that we've done over more than 180 years. Approximately 18 million patients are living with cancer today, and our oncology ecosystem addresses this challenge. We have scale as the #1 distributor in community oncology, operational excellence and expertise as a leading distributor, which is the foundation of the many reasons why McKesson has the right to win in oncology and the foundation of how we built this ecosystem. Our differentiated oncology solutions, they solve long-standing complex problems in ways that bring more speed, impact and efficiency to stakeholders across the ecosystem. And most importantly, they improve health outcomes for people around the world. Now we've built the oncology ecosystem over many years, starting with the scale distribution services that I talked about. And our U.S. Oncology network treats approximately 15% of all new cancer patients. We also have GPO services, practice management, clinical trial services, our U.S. Oncology research organization and, as you talked about recently, our Ontada organization, which is our data and insights platform. So our differentiated market position has interconnectivities between our assets. As an example, our U.S. Oncology practices reside on a single technology platform, which is capturing the data and using that data to create clinical insights. Our oncology ecosystem, we think about it as a flywheel effect that nobody else in the industry can replicate, our providers are benefiting from these unique relationships. Our scale and large oncology network creates unique value for biopharma and for payers. And ultimately, patients are benefiting through better care. So we're excited about the path that we're on and the path to capture an approximately $55 billion market opportunity, which we also outlined at our Investor Day.

Yes. And I appreciate there's a significant opportunity here for you in this area. One other area as we think about the specialty space is biosimilars. Talk about sort of your opportunity, how you see this, particularly now that we're starting to see greater the FDA is starting to provide interchangeability or allowing interchangeability. When we think about insulin when we think about HUMIRA coming up, how does that change the dynamics of this biosimilar market? Should we start to -- do you think we'll start to see this market behave the way small molecule generics behaved, which would push the purchasing leverage back to the buyers here?

Yes. Look, we're excited about this. And clearly, biosimilars are part of our oncology ecosystem as well. Maybe I'll just step back. And the way we think about biosimilar as we think about it as a win-win-win. There's more clinical treatment options for providers. It's a lower cost alternative for patients. And there's better economics for the supply chain as compared to branded drugs. The contribution from biosimilars is continuing to grow, but we believe we're still in the early stages of market development. As of January 2022, 31 biosimilars have been approved and 21 have been launched. So the growth is trending as we expected, and biosimilars continue to remain a long-term opportunity. We're very pleased with the development of biosimilars. We're very well positioned to benefit from their growth, particularly in our oncology ecosystem, as I talked about. The other thing I would talk about here is that the channel does impact profitability profile for biosimilars. Typically, we achieve higher margins in the specialty provider in physician space. And that's because McKesson provides more services, including GPO support. So biosimilars contribution, we believe, is going to continue to grow, particularly as adoption continues to increase as more biosimilars are launched.

That's helpful. And then maybe lastly, in this area, I think if we look back at the distribution space, historically, a lot of the focus had been downstream towards the retail segment, particularly as that customer group really consolidated and providing services there, it seems like this next wave is really providing upstream services to your manufacturing partners. We've just talked a little bit about oncology and specialty. Maybe touch a little bit on the prescription on the RxTS business and sort of what -- maybe highlight some of the key aspects of the services that you're able to provide partners.

Yes, happy to do that. Again, one of our 4 key priorities. And we're very excited about the market opportunity for biopharma services as well. In biopharma, the progress of clinical advancements is limited by some of the challenges of access adherence and affordability. As an example, more than 13 million Americans are skipping or delaying filling prescriptions due to some of these financial considerations. So like oncology, we have developed this ecosystem over many years. We have a range of commercialization services for biopharma that we believe address these challenges. We've acquired and developed several differentiated assets and capabilities, which include RelayHealth, CoverMyMeds and RxCrossroads. Our products are differentiated through scaled and interconnected technology networks, connections to pharmacies, providers and payers throughout the country. And maybe just to give you a sense of our scale. We processed 19 billion transactions annually, connected to over 750,000 providers and 50,000 pharmacies. And our products save patients approximately $5 billion in out-of-pocket costs last year alone. So the growth in this segment is going to continue to be driven by new brands that are joining our platform; expansion of our core capabilities, which include access and adherence solutions; increased transaction volumes; and our continued investment to develop adjacent markets. So we're very pleased with the strong growth momentum of the RxTS segment, and it's achieved an 11% adjusted operating profit compounded annual growth rate since fiscal '19.

That's helpful. And that's pretty impressive here. Maybe moving on here. I wanted to touch on obviously COVID. You talked about sort of your partnership with the CDC. Within the guidance this year, you're expected to realize about $2.50 to $3.10 per share related to COVID items, vaccines, kitting. In the last few months with Omicron, we've seen a lot of -- back -- just the market is really evolving in a very fast way, trending, particularly as cities are loosening the requirements, employers are pushing to go back into the office. How are you thinking about the impact of COVID maybe as we finish this fiscal year going into next year?

Yes. It's a great question. And let me unpack that a little bit because I think there's a lot to really talk about here. And I'd like to just start by breaking the components, the financial components down into a couple of relevant pieces for clarity. Our revised fiscal year '22 guidance as of our February earnings call, the $1.75 to $2.15, which is related to U.S. government vaccine distribution, kitting and storage programs and then $0.75 to $0.95 for COVID test kits. We make a few comments to start about COVID-19 trends and things that we're seeing. As you talked about, it is difficult to predict future trends. And like many, we're closely watching any new guidance around variants. The demand for COVID-19-related products and services has fluctuated significantly over the course of the pandemic, and it generally aligns with the volume of COVID case levels. We've seen the daily COVID case levels have reached their lowest level since July of 2021 with the daily average number of cases over the past 4 weeks about 20% lower than the average over our fiscal third quarter. We've seen that COVID test kits tend to closely correlate with case levels. And so obviously, it's difficult for us to predict future trends. But one thing that we've consistently seen and talked about is that COVID test kits track closely with daily case levels. Let me make a couple of comments about our U.S. government contracts, which I think is important context as well. As it relates to the U.S. government vaccine and kitting programs, our guidance continues to be aligned volume distribution schedules provided by the CDC, and all the decisions around the centralized distribution model are made by the U.S. government. As a reminder, our contracts with the U.S. government as a centralized distributor of COVID-19 vaccines, kitting storage and distribution of ancillary supplies, they're scheduled to expire in July of 2022. We have not received notification from the CDC that the distribution agreement is intended to be renewed beyond July of 2022. But we're prepared and we're willing to support the U.S. government as a centralized distributor for as long as they ask us to do so. If and when the government decides to terminate the centralized distribution model, we anticipate the COVID-19 vaccines will be distributed through normal commercial channels, very similar to the flu vaccine. So let me move on and make a couple of comments and give you a few thoughts on COVID test kits. Similar to what I just mentioned with regard to COVID trends, we have observed a corresponding decline in COVID test kit volumes and vaccine demand in recent weeks as well as lower demand in the production of vaccine kits. For COVID test kits, I would remind you of the trends that we've seen in COVID case levels, again, as our COVID test kit demand tends to closely correlate with case levels. One thing I would note is that what we've seen is an approximate 60% adjusted earnings per share contribution increased in January as compared to the average for Q3. However, from the month of January, we saw an approximate 50% adjusted earnings per share contribution decreased in February. Thus far in March, we've observed another 50% decrease from February levels. This gives you an indication of how closely COVID test kits correlate to case levels. We anticipate that this pace of COVID test kit volumes and vaccine demand will follow this pattern into FY '23. And we'd expect that FY '23 COVID test kit volumes and adjusted EPS contribution will be materially lower in fiscal 2022.

That's helpful. So I mean it sounds like what you're saying is January and February roughly net out. And then -- so probably net-net 4Q, we should be thinking about contribution below Q3 is roughly something in that magnitude?

Well, what I would say is I'd just reiterate the guidance that we've provided for the full year earnings per share contribution from test kits. What I wanted to do is give you a context that we did hit a peak from that contribution from test kits in January, but we've seen significant drops in February and March, and that correlates to the case level counts that we've seen.

And that's just on the kitting side. The vaccine side is still under contract with CDC and that goes through July.

What I was referring to was COVID test kits specifically. We have seen vaccines and kitting also declined as case levels have come down.

Okay. That's fair. So then maybe it's a good segue as we think now, we're getting to the end of the fiscal year here. And obviously, you'll provide guidance when we get the earnings. But when -- as you often have done in the past, you generally provide some -- what are some general puts and takes that as we think about the next year that investors should just remember as we're kind of building out our models?

Yes. Thanks for that. And as you mentioned, we've not provided '23 guidance yet. However, I think it is appropriate for me to make a few comments on some of the items that could impact our fiscal '23 financial performance. First, I talked about at the beginning, I think it's very important to just reiterate here. We continue to demonstrate solid operational and financial performance. At our Investor Day, we laid out our long-term targets and the long-term targets were built on continued momentum, strength and stability in the underlying fundamentals of our core business. And we believe that these fundamentals continue to all be in place as we move towards fiscal '23. That's a good foundation point to start with. As we just talked about COVID and the direction of the disease continues to be a material unknown. But as we've seen forecasting COVID distribution and testing demand more than a couple of months at a time has really been challenging. As we just talked about, we do see lower levels of -- for vaccine and kitting distribution and for COVID test kits as I just gave you an example of what we're seeing in our fiscal fourth quarter. And we expect that this will be in line with lower levels of daily COVID case counts as correlation is important, as I mentioned. We anticipate that this trend will continue to decline further supported by the trends that I laid out a few minutes ago. We will continue to provide you that information on a quarterly basis, and we'll utilize a detailed information is provided by the CDC and information that we're seeing in end markets for COVID-related testing in our medical segment, as I just talked about. We will continue to execute the European divestitures. And our plan is moving forward, as I talked about earlier, and we plan to offset the earnings dilution from these divestitures through capital deployment, principally through share repurchases. We expect to end fiscal 2022 at an adjusted tax rate of 18% to 19%. However, as we continue to exit these European markets, which historically have had lower adjusted tax rates compared to our North American businesses, we anticipate that the mix is going to continue to result in a higher FY '23 adjusted tax rate. With the recent announcement of the approved opioid settlement agreement, we anticipate a lower litigation expense in FY '23. We're still in the process of evaluating open litigation. We can't provide you an estimate of the level of reduction at this time, but we do anticipate being able to provide you an update of this guidance on our May earnings call. But I think it's important to point out with that settlement, we do expect to see lower levels of litigation expense. And we're firmly committed to our company priorities in fiscal '23. And this is going to include continued investment to grow and further differentiate our assets and capabilities, both in biopharma services and in our oncology ecosystem. We have great momentum in the business, solid financial performance. We have a strong balance sheet and credit profile, and we look forward to continuing this growth in our operating segments in FY '23.

If I could just go back to COVID real quick because you talked about the correlation to daily case counts. That's a metric that, obviously, most of us can watch either from CDC or other media sources. Is that usually -- does that lead then demand for COVID-related items? Or is it really more -- so if we were to watch that and that will start to pick up, we would expect is there a lag between when you would start to see that orders come in for demand for those kind of items?

I think what I would just go back to is that there's a close correlation between the 2. Again, it's very difficult for us to predict. And I wouldn't want to get into the business of trying to predict not only case levels, but how closely correlated or the timing of that correlation. But over time and over the period of this pandemic, we have seen that demand for these products and services has been very closely correlated.

Great. And then obviously, capital deployment has been a big priority for you guys or the efficient use of your capital. Clearly, exiting Europe is freeing up a lot of capital for you. You are doing a significant amount of expected share repurchase here in the fourth quarter. You talked about the offset the dilution from the loss of the European businesses, should we then expect, particularly as we think about fiscal '23 and when a lot of these transactions close, that you would front-load the share repurchase to offset the dilution?

I'm not going to get into speculating on timing at this point. Maybe just talk about capital allocation just in general and maybe capture this a little bit for you. We continue to take a disciplined approach to capital allocation. I think it's important to just continue to reiterate. We strategically think about capital allocation in 3 broad categories. The first piece of the framework is our growth investments, and we prioritize growth by investing internally and through M&A. We want to accelerate growth in our strategic priority areas of oncology and biopharma services. Again, as I've talked about, we believe we have differentiated asset scale and network capabilities. From an M&A standpoint, we consider both tactical acquisitions that are going to accelerate growth and strategy imperatives and bolt-on acquisitions. Bolt-on acquisitions can add scale, speed and capability to further expand our value propositions and leadership positions. The second piece of our framework is returning capital to shareholders. This is through a combination of our growing dividend and share repurchases. As of December 31, we have $4.8 billion remaining on the share repurchase authorization. And as I talked about on our February earnings call, we anticipate $3.5 billion in share repurchases for the full year of fiscal 2022. The third piece of the framework is maintaining a strong balance sheet and our investment-grade credit rating. The solid operating performance that we have, combined with our working capital efficiency, it provides us ample liquidity and flexibility to execute this capital allocation approach. And as we've talked about, we do anticipate that we are going to offset the European dilution with capital allocation, that will be principally share repurchases. Beyond this year, we haven't talked about any specific timing.

Okay. That's helpful. In the last few minutes that will be remaining, we do have a few questions. One is, I think, probably more of a clarification. What are the implications of losing the centralized distributor relationships? I think they're obviously referring to the CDC contract.

Yes. Look, we always anticipated that at some point that this model -- the centralized model would go back to a normal wholesale model. And when that happens, whatever the demand is, it will go through what normal distribution channels generally do. Some portion of that, obviously, will touch our customers, and we would expect to pick up whatever volume is required based on what our customer volumes are. We don't know when that's going to happen. But when it does, we expect that it would be normal central -- normal wholesale or distribution model will apply for the industry.

So you'll still retain probably -- is it fair to think probably retain what your regular share as we think about other products in the market relative to your peers kind of thing?

That's what we would anticipate.

Okay. I actually have a few questions that are all a little bit related. So I guess really a lot about disruptions in Europe. So one question is, does the Russian-Ukraine issue going on, obviously, right now have an impact with your planned divestitures. A second aspect of that is, can you talk about inflation dynamics, particularly what's happening in the world with commodity prices in part related to Europe? And then the last part, third question, similarly along those lines, any type of efforts in terms of reshoring initiatives to protect your supply chain, either from future public health events, threats or obviously, trade disputes and disruptions?

Great questions. Let me see if I can unpack those for you. As it relates to the first, first of all, like many, we're watching all of the -- what's happening, the events that are unfolding in Ukraine and certainly aware of that and watching how those events unfold. But they don't impact any of our current European operations. We don't operate in Ukraine. And so in terms of our divestiture plans, there is no impact on that at this point. Obviously, we're continuing our divestiture plans. As I talked about at the beginning, we're pleased with the progress that we've made, and we would expect to continue down that path of exiting Europe, as we've talked about previously. I talked earlier about the fact that we've been able to really manage through some of the complex supply chain challenges that a lot of us have been facing since the beginning of the pandemic. And that's a result of the strong relationships that we have and the scaled capabilities that we have, and we continue to manage very closely with our partners and we'll continue to watch how events unfold and what impact that may have. But our relationships are broad, they're scaled, and we have many relationships that have really bolstered our ability to manage through this. And we expect that we'll be able to manage through this going forward. And as it relates to inflation, certainly, there are aspects of inflation that are hitting not only labor but product perspectives. We don't anticipate any product perspective labor or, I should say, product perspective inflation in FY '22. We've not talked about that beyond '23. We've been able to pass on much of the cost increases that we've seen to date. We did talk earlier this year and again at our February earnings call about labor cost increases in our North American distribution businesses, that's embedded in our FY '22 guidance. And there's nothing more that I would really add beyond that at this point.

And I guess maybe just a follow-up there. At least here through March, have we seen any incremental -- any significant change in terms of what the labor market looks like for you guys?

No change. We have not updated our guidance as we talked about at beginning.

Okay. And then maybe just a follow up. Is there more that McKesson can do as you think about global supply chains as we get past the pandemic and, obviously, the events unfolding around the world here. You talked about keeping an eye on it, working with your partners. What can -- what more is there that McKesson could possibly do in terms of leading on these initiatives?

Well, we think we're a leader today, given our position, not only in pharmaceutical but medical. And given the success that we've had in developing these networks and the success that we've had navigating through these complex challenges, we continue to always evaluate opportunities that we have to improve the supply chain. We'll continue to do that. But I think we're a leader today. And the strength of our relationships, the strength of our networks has shown through in our financial and operating results. So as you would expect us to do, we'll continue to evaluate where or how we procure products going forward.

Great. And then just in the last minute that we have, you talked about the opioid settlement and the -- expecting lower litigation expense. What is generally the thought around the remaining states that have not participated? And just remind us when you think the first initial payments will start to go out to those that are participating in the settlement?

Well, let me just make a few general comments here. The settlement agreement that was announced on the 25th of February includes 46 of the 49 eligible states as well as including the District of Colombia and all eligible U.S. territories. When you calculate by population under the agreement, more than 90% of eligible political subdivisions that brought opioid-related suits against the 3 distributors, they've agreed to participate in settlement or have had their claims addressed by state legislation. We reached separate resolutions with the state of West Virginia and the tribal nations. So Implementing these settlements, I think it demonstrates that we focused on broadly resolving the opioid claims and delivering meaningful relief to communities that have been impacted by the epidemic. We continue to strongly dispute the allegations that are made against us, and we intend to mount vigorous defenses for those unresolved matters. And that's probably what the context that I'll talk about here today in terms of the payment perspective, we did make an escrow payment and that's been disclosed in our financial statements.

Great. And I think with that, we're out of time. Britt, as always, appreciate you taking the time to join us today. Thanks for all the questions that people sent in. And please, everyone, enjoy the rest of the conference. Thank you very much.

Thanks. Thanks so much.