Good day, and welcome to McKesson’s Q2 Earnings Call. Today's conference is being recorded. At this time, I'd like to turn the call over to Holly Weiss. Please go ahead.

Thank you, Susan. Good morning, and welcome, everyone, to McKesson's second quarter fiscal 2020 earnings call. Today I'm joined by Brian Tyler, our Chief Executive Officer; and Britt Vitalone, our Chief Financial Officer. Brian will lead off followed by Britt and then we will move to a question-and-answer session. Today's discussion will include forward-looking statements, such as forecast about McKesson's operations and future results. Please refer to the cautionary statements in today's press release and our slide presentation and to the risk factors section of our periodic SEC filings for additional information concerning risk factors that could cause our actual results to materially differ from those in our forward-looking statements. During this call, we will discuss non-GAAP financial measures. Additional information about our non-GAAP financial measures, including a reconciliation of those measures to GAAP results is included in today's press release and presentation slides, which are available on our website at investor.mckesson.com. With that, let me turn it over to Brian.

Thank you, Holly. Good morning, everyone. Thanks for joining us on our call today. Today, we reported second quarter total company revenues of $57.6 billion. Our adjusted earnings per diluted share was $3.60, which was in line with our expectations, and when excluding the $0.33 prior year benefit from the reversal of a contractual liability associated with McKesson's investment in Change Healthcare, second quarter results per diluted share increased more than 10% year-over-year. Our first half fiscal 2020 results give us confidence in our reaffirmed fiscal 2020 full-year outlook of $14 to $14.60 of adjusted earnings per diluted share. This continues to reflect year-over-year adjusted operating profit growth in each of our segments. Before I go deeper into our second quarter results, I want to take a few minutes to discuss one topic I know is top of mind for everyone and that is opioid litigation. Last week, McKesson along with two other distributors, reached a collective $215 million settlement with two Ohio Counties, Cuyahoga and Summit in the first track of the multi-district opioid litigation. McKesson's portion of the settlement was $82 million which was recorded in our second quarter results. We strongly dispute the allegations made by these two counties. However, settling the bellwether trial was in our view an important stepping stone to achieving a broad resolution to opioid litigation and to accelerating relief efforts for the people and communities impacted by this public health crisis. Over the next few months, we will be working hard with other parties on the settlement framework that includes States and their subdivisions. While we have made good progress, there are many details and variables that remain open and still needs to be addressed. We are optimistic that a broad resolution can be achieved and that remains our goal. All along,…

Thanks, Brian, and good morning. I'll begin with a few comments in second quarter results, including changes to our guidance for you to consider as you update your models. We were pleased with our adjusted earnings per diluted share results in the second quarter, which were in line with consensus and grew 10% over the prior year when excluding a one-time $90 million benefit in FY 2019. Our performance to the first half of fiscal 2020 was solid, and we are pleased with the momentum across the business and we're reiterating our fiscal 2020 adjusted earnings outlook of $14 to $14.60 per diluted share. Updated guidance assumptions can be found in our second quarter earnings slides posted to the investors section of our website. Before we get into the details of the results, I want to address two items that impacted our GAAP only results. First, we've concluded it’s the appropriate time to exit our remaining stake in Change Healthcare and we begun activities expected to lead to an exited the investment, which we anticipate will occur within the next 6 months to 12 months. As we previously communicated, we will execute this transaction in a tax efficient manner and we expect that this transaction will continue to deliver value to McKesson's shareholders. We believe that this transaction better positions McKesson to focused on its core set of businesses. As part of this work, we completed a market value assessment and recorded a non-cash pre-tax impairment charge of $1.2 billion in our fiscal 2020 second quarter. It's important to note this charge in no way reflects the future value of Change Healthcare. Rather, it's an adjustment of the book value to the current market value from one of the necessary accounting activities within the planned exit process. Overall, the Change…

Thank you. [Operator Instructions] Our first question comes from the line of Eric Percher of Nephron Research. Your line is open.

Thank you. Maybe to begin, it's hard to disaggregate the underlying gross margin trend and for pharma in particular given what has gone on in the EU. Can you give us some perspective on what gross margin is doing and maybe gross margin and absolute gross profit?

Yes. Hey Eric. Thanks for that question. As we talked about, we had significant growth in revenues in the quarter. And as I mentioned, specifically in our U.S. Pharma and Specialty Solutions business, we had growth that caused us to raise our guidance for the full-year. And I also pointed to the fact that a great portion of that came from specialty products and in particular from the growth of Caremark through growth of new customers there. And that had an impact on our gross profit rate in terms of comparing that to our revenue growth. We did have a 1% impact from foreign exchange. So when you looked at our gross profit, 3% when you exclude the impact of foreign exchange. But I would point you back to the fact that our revenue grew faster than we had anticipated at the beginning of the year. It's largely coming from the onboarding of some customer wins through Caremark and there's a customer and product mix aspect to that where the products are largely coming through specialty products. And that's really what's driving that delta between revenue growth and gross profit growth.

In an absolute basis, you're seeing growth from specialty and is it also reasonable to expect that given the stability you speak to in the generic marketplace and given sourcing that we're seeing generic profitability grow on an absolute basis?

Yes. Eric, we are seeing that. As Brian talked about, we continue to see great benefits coming from our ClarusONE Sourcing organization. We're able to generate a good savings there this year. We're seeing stability on the sell-side and that's allowing us to continue to create a spread from a generic perspective. In our Specialty businesses, Brian, I think talked a lot about our provider business, our advances that we have in manufacturer services, and the lead that we have in from a U.S. Oncology as an asset. But we're seeing a lot of growth that is coming through our full line wholesale distribution. And as I mentioned, that's particularly coming from the growth of large customers like Caremark.

Thank you.

And our next question comes from the line of Lisa Gill of JPMorgan. Your line is open.

Great. Thank you. Good morning. Brian, I just wanted to go back to your comments around the opioid litigation and settlement. If I do the math, 38% of the settlement was McKesson. Should I think about that that was the market share in those two counties, or do you anticipate just given your overall market share with the independence in the U.S. that if we think about any settlement, it would be, somewhere in that type of range on a percentage basis?

Good morning, Lisa. Thank you for the question. You did your math correct. We were 38% of that settlement. Obviously, there is data in the marketplace, the ARCOS data in particular that many of you are aware and familiar with. That data can be cut lots of ways depending on how you look at time periods, and how you look at customer segments, and whether you consider doses, et cetera, et cetera. And so part of the discussions that we had to go through was a methodology and we landed on a data-based methodology, and so you can roughly think of 38% as the McKesson representation of “our share”.

Okay. That's helpful. And then just as we think about the timeline of this. I know you said that you're prepared to defend and litigate if needed. My understanding is that the next court cases until some time next summer. So does that mean that that kind of gives you this time between now and then for a settlement? And any update that you can give us on where you are on a potential global settlement? Because if I remember correctly, I think that's what you've talked about in the past, right. Ring-fencing those and having a global settlement not doing these one-off…

Yes. That's right. Thank you, Lisa. I mean our objective and priority continues to be, we'll call it, sometimes global resolution or ring-fencing and that remains our priority. Our view on these two counties and coming to the settlement agreement we did with them was that that was an important stepping stone or building block or momentum for those, for the more global discussions to progress. And so we're encouraged by the status of the discussions. There is a lot of activity and things that we need to continue to work through, and we are actively working through those. We're working through those with some urgency. But it will take a bit of time to get through those. We're talking about 50 States and we're talking about subdivisions within States. So we've got a framework that we're very optimistic about. The teams are working diligently to address the issues. We'll progress it as quickly as we can, but obviously, we contemplate the two paths we've always talked about. There's a path to litigate, which only can project amount of time and amount of dollars to go down that path. And then there is a path that we think ring-fence is a risk and give us other resolution that it will take the path that we think is most beneficial for our shareholders. We certainly are anxious to find a resolution that takes care of the patients in the communities they serve as quickly as they can. But as we pursue these discussions, we continue to invest in our defense and we think it's only prudent to do that.

Our next question comes from the line of Brian Tanquilut of Jefferies. Your line is open.

Brian, just as I think about your comments about the trends that you saw with the medical side on the primary care physician offices and new supply, how are you strategizing? Or how are you thinking about the emergence of retail-based client care delivery in the primary care side, whether that's Walmart who's your client obviously, or the competitors in the retail space?

Yes. Great. Thank you for the question. Maybe to frame it my answer a little bit, I'll go back in time. I think the medical business has been very successful at following the emergence of new channels in the alternate site settings. At one point in time that was urgent care clinics. We have a large footprint in the retail-based clinics that are out there today. And so we think as these new models for community-based care emerge, the solutions that we have in the medical business are right on point for the needs that those businesses and services will have. So my view is that's just a continued evolution in a new segment and our team has proven quite adept and quite effective at evolving our capabilities, and really leading the way as these segments emerge. And I would expect that's what the team is focused on today.

And then I guess just my follow-up for Britt. As I think about calendar 2020, is there – what are your expectations in terms of brand pricing, just for 1-1?

Yes. What I would say is that we're reiterating our view that brand price inflations mid single-digit. We don't see anything that has occurred on the first half of the year or this quarter that would change that expectation. So we're continuing to view brand price – in the mid single-digits. Obviously, January is a usually an important month historically. But at this point, we're not changing our view on branded price inflation.

And our next question comes from the line of Stephen Baxter of Wolfe Research. Your line is open.

Hi. Thanks for the question. So I'm trying to understand the magnitude of the revenue revision in the U.S. Pharma business. Now I appreciate the color on Caremark, but it sounds like you're suggesting this is coming in a lot better than expected levels. So I guess first, can you help us understand why that is? And then I guess the follow-up will be you're raising revenue guidance here by what looks like roughly 3% to 5%, but not changing your EBIT growth outlook. I get that we're talking about specialty and Caremark, but surprising there isn't really any noticeable drop due to earn ins. So, I guess how should we be thinking about that and is there something about the rest of the business, we should be keeping in mind? Thanks.

Yes. Thanks for that question. So let me just step back to the revenue guidance. Our prior revenue guidance was low single-digit to mid single-digit. And so we've updated that to high single-digit, and that's largely reflective of the growth that we're seeing that's coming from Caremark and particularly, Specialty products that are going through that customer. That's really what's driving this. In terms of the drop due to the bottom line. We're really pleased that we're able to make investments in the business. I talked about $25 million of investments in our oncology and manufacturer services capabilities. And despite those investments, we're pleased to be able to hold and then affirm our guidance for the segment on AOP at that low single- to mid single-digit number. So I would call this as a growth from one of our customers that is primarily coming through Specialty. We're making investments where we have leading positions and great capabilities and I talked about that as being an additional $25 million, but we're still holding and affirming the AOP guide or the segment.

Got it. And I guess just coming back to – like what is better than was expected going into the year? Is there any clarity you can provide on that? I appreciate what the driver is in absolute terms, but understanding what is prior expectation would be great? Thanks.

Sure. Well, I'd just reiterate a couple things that branded price inflation is performing as we had anticipated. We're seeing really good progress out of ClarusONE and so our – from a generic perspective, everything is performing as we had anticipated, still stable competitive marketplace. I think a couple of things that I would point out that Brian really talked about is our Specialty Provider business is performing quite well. And certainly the investments that we've been making in our manufacturer services capabilities and that we're continuing to make there, that’s also performing well. So I think as you think about our Specialty business, we're getting a lot of growth through customer wins in our Wholesale Distribution business. We're making great advances in our Provider business and our manufacturer services capabilities.

And our next question comes from the line of Michael Cherny of Bank of America Merrill Lynch. Your line is open.

Thanks so much for taking the question. So I wanted to go back to the comment you made, Brian, about the stability of what you're seeing on the sell side relative to generics. And now it's been about three years since we had a shift in the independent market, you also highlighted some of the value that you provide in terms of the independent customers. And so I guess as we go forward, how do you think about the activity and the kind of – the puts and takes that go on with the independent market, and how they think about negotiating, especially as they all tend to get into their own specific buying groups?

Yes, sure. Thank you. Thank you for the question. I mean I referenced in my comments the RxOwnership program and the fact that 700-ish pharmacy – new pharmacy owners, we helped in opening or establishing or transferring into the business. And that's not a unusual number. I mean if you go back many, many years, we often see lots of exits, in the Independent Pharmacy segment. Some of those are family planning and transition exit. Some are script file sales, but we also see as many new – as many new openings or many new storefronts come into play. And so it's been remarkably stable over the years. And that trend we continue to see today. And we do, over the years we have and we continue to invest in these tools and these services that we think help independent pharmacists stay independent, stay healthy businesses and stay vibrant in the communities and the patients that we serve. But we really haven't seen anything that I would say was a massive trend break in terms of there's always ins and there's always outs in the Independent segment.

Thanks. And then just one quick question on capital deployments, as you think about the discussions and debates going on relative to the push for a global settlement? Does that have any impact on your cash availability or capital deployment priorities? And I know not from a reserving perspective per say, but do you think about keeping some level of cash to present itself for any type of potential settlements?

I would say this. I think we've been pretty clear on what our capital deployment philosophy has been in the past, a very balanced approach to that. What I would say is we have not made a change to that for that portfolio approach. We continue to make investments internally that we think will drive future growth. We continue to be open to M&A, where we can find that the M&A that makes sense, balancing obviously valuation expectations, where our share prices, what alternate returns of that capital are. But that was a long answer to give you the short answer that we really – it really has not impacted our approach to capital deployment.

And I think if you look at how we've deployed capital in the first half of the year, it's pretty historical amount of capital that's been deployed. We've returned a lot of capital to our shareholders, particularly in the second quarter. And as Brian mentioned, we'll continue to evaluate, really on a balanced perspective. But we haven't made any changes to the amount or how we're deploying capital at this point.

Our next question comes from the line of Charles Rhyee of Cowen. Your line is open.

Yes. Hey, thanks for getting the questions. So I just wanted to go back, Brian, about the framework here. You're optimistic about in terms of getting sort of more global kind of settlement here. Just to clarify, with this any kind of discussions, is it clear to you that you’ve encompass all point us you might have mentioned, I just didn't catch that clearly.

You were breaking up a little bit. Let me – I think the question was, coming back to the framework, is it going to be all encompassing of all the litigation. And what I would say is that relative to the States and relative to the subdivisions in those States, our goal is to get as comprehensive of a settlement within that framework as we can. And that is the majority of the outstanding litigation. But it is not all of the cases.

Is that something mechanically that, you kind of reach this framework and then wait for all the parties to then look at it and say, we're okay with this. And that sort of – and if there's some type of from your standpoint and you kind of look at them and thanks. This is enough that we will move forward or not enough and we will not agree to this because it's maybe you might have thought, some large percentage, we're okay with that. But in the end, a lot of them subdivisions say, this is not – we're not satisfied with this. And in this case you go to the - different tracks?

Yes. So I guess that the easiest way to answer that is to say that, this is a complex legal situation. We have established a framework and had good discussion around that framework. It is very much a process though, and we are very much working through the details of how that process will unfold. And it's really not a lot more I can add to it at this time.

Okay. Very good. And Britt, just a follow-up one real quick question on the European segment from the guidance. Is it that you’re still looking for operating profit guidance to low single-digit and really size heavy back half maybe a little bit more thoughts on what's going to get there in the back half? Thanks.

Yes, thanks for the question. I think as we've talked about, we expect that the business will continue to improve its performance in the back half, and then Brian also talked about some nominal increases in the tariffs in the UK. And we would expect that there could be additional increases in the back half of the year. So that's really what is driving that second half performance.

Our next question comes from the line of Steven Valiquette of Barclays. Your line is open.

Great. Thanks. Good morning. Thank you for taking the question here. So I guess this has been touched on a little bit, I guess I'm looking for any update on the ClarusONE progress and tied into that, based on a little bit of the margin compression in the U.S. Pharmaceutical and Specialty business, should we assume that the relationship between the procurement price on generics versus your sell-side pricing, it may have fallen off a little bit during the quarter or in your mind, was that relationship still relatively consistent during the quarter? Thanks.

Yes. Thanks for that question. We're really pleased with the performance of ClarusONE and it's performing in line with what our expectations were at the beginning of the year. We're continuing to see that organization drive great value, which is very helpful. As we think about the sell-side, which is – as we've talked about now for several quarters. So competitive, but stable environment. We're pleased with ClarusONE. It’s performing as we had anticipated. We think that there's still great value to be gained out of that organization. And we were pleased with the partnership that we have with our partner Walmart as we continue through – in that relationship as well.

Okay. And what about the relationship then between the buy-side versus the sell-side pricing? Was that consistent during the quarter or was there some slight erosion? Just curious to – just a high level comment on that.

Yes, sure. No, I say it's consistent. We're seeing consistency over the last several quarters now and again, a good performance on ClarusONE in a stable competitive environment on the sell-side, and that's in line with our expectations and what we've seen now for the several quarters.

And our next question comes from the line of Bob Jones of Goldman Sachs. Your line is open.

Great. Thanks for the questions. I guess just a couple to go back to Specialty, Brian, if I could. You discussed the three main areas within Specialty, it sounds like generally very pleased with the performance across the board there. And I think most of us get the mixed dynamic that you guys have discussed within Specialty Pharmacy and Caremark, specifically. But I guess if we take a step back, the operating profit for the overall Pharma and Specialty segment was up 1% in the quarter. Just sounds like there's a lot of secular tailwinds there. So I guess just wondering if you could shed a little bit more light on how you think about overall EBIT growth as it relates specifically to what seems like some pretty strong tailwinds within specialty?

Yes. Great. Thank you. And we reflected on the questions we've had over the last few quarters and that's why we included a little more description or color on the Specialty businesses that we have in the Pharmaceutical Solutions segment. And if you think about the three segments we highlighted, they are all performing very well. And we think in all cases, we have assets that are not only competitive with the market, but probably one of the most robust set of solutions and services when taken in the aggregate. And so those businesses are continuing to perform well. They're delivering good growth and they're performing right in line with where we thought they would for the year. Obviously, there is another segment in specialty that is the more retail mail order oriented specialty products. And Britt talked a lot about the impact we've seen of the growth in the Caremark book of business that has been – the mix has been slanted towards those specialty products, which tends to be the lower margin profile for us. So when you net all out, that's where you get – that's how you get to the results that you're seeing today.

And then I guess just to follow-up on that, maybe Britt. I mean, just to maybe understand that a little bit better. I mean these kind of outsized growth within Caremark products. I mean these aren't margin or EBID dilutive I guess I would say. And then just on the $25 million investment that you mentioned in the back half, maybe just a little bit more specificity around what area within specialty those would be pointed out would be helpful too. Thanks.

Yes, as we've talked about before and as we think about specialty distribution in our wholesale – line of wholesale business, they do have a dilutive impact on the rate. We still participate in the profit dollars. It's just grown a lot faster than we had anticipated and that's at a much more dilutive impact on the rate of growth. As we think about the investments that we're making as Brian talked about, we are very pleased with our positions in oncology, our positions that we're developing in manufacturer services, and as we think about this $25 million, it will be largely invested in oncology capabilities and assets. But again, we're continuing to invest in our manufacturing services capabilities as well. But you should think about this investment as investing where we have leading-edge positions and oncology is certainly one of those.

Yes. Just to build on that. I mean, these investments are tied to our strategy. Our strategy is anchored and where we typically – we have differentiated capabilities and we have good marketplace growth. And so we're very happy to be able to say we're continuing to make these investments and still delivering on the year as we committed.

Operator, we have time for one more.

Okay, great. Our last question for today is Kevin Caliendo of UBS. Your line is open.

Hi. Thanks for getting me in guys. I appreciate that. If we think about the CVS relationship in the fact that it was just sort of re-upped for June, is there some anticipation that over time the margin with them could get better, meaning like are we in a situation right now where the first sort of 12 months of this relationship, the margins from that contract might be worse and over time they could get better?

Well, first let me say, we are always happy to renew our customers and we're always happy when they grow. We are experiencing a shift in the mix of business – on our margin rate perspective as you see in our results, I mean great topline growth, but there is a margin rate impact in there. We're never disappointed when our customers grow and we think it's always additive to the business.

One quick follow-up. Can you talk about the performance and impact NorthStar would have had in the quarter?

We don't specifically talk about NorthStar, but when we think about our generics portfolio, NorthStar is obviously a critical part of that and we're very pleased with the performance of NorthStar, and we're pleased with the progress that we're making there.

I think the relationships with the manufacturers in NorthStar have really evolved over the years that are quite productive, and I think that's what's supporting the success that we're seeing there.

Okay. Well, thank you everyone for your questions, and thanks again for your interest in giving us some of your time this morning. Thank you, Suzanne, for facilitating this call. Just maybe to conclude, I really think the fundamentals inside the business were strong. The macro healthcare environment is supporting a stable market. We executed well in the second quarter. I'm very proud of the teams and the execution. We're continuing to drive cost savings. We're continuing to speed up our decision making. We're continuing to make investments where we think we have opportunities for growth, and I feel good about our fiscal 2020 full-year outlook. My confidence is of course, rooted in the 80,000 employees that come to work every day for McKesson for our shareholders, really embodying our values, including integrity. They do the right thing and our execution and success are a direct result of their contribution. So I want to say thank you to them. None of this is possible without you. And now let me hand the call over to Holly for review of our upcoming events. Holly?

Thank you, Brian. We will participate in the J.P. Morgan Healthcare Conference in San Francisco in mid-January and we will release third quarter earnings results in late January. Thank you, and goodbye.

And thank you for joining today's conference call. You may now disconnect and have a great day.