Good day and welcome to McKesson's Q3 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, Jack. Good morning and welcome, everyone, to McKesson's third 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 forecasts 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. And good morning and thank you, everyone, for joining us on our call this morning. Before I get into our third quarter results, I wanted to take a few minutes to provide a brief update on opioid litigation. As you know, we've been engaged in complex discussions with the state attorney generals and others about a settlement framework with the goal of achieving a broad resolution of opioid-related claims. Those discussions continue to narrow what's left to address to achieve resolution on all the items that remain. However, to the extent our efforts to reach a broad resolution settlement framework are unsuccessful, McKesson continues to be prepared to litigate and vigorously defend the mischaracterizations that our company drove the demand for opioids in this country. McKesson remains firmly committed to being part of the broader solution to this crisis. Given, however, the discussions and litigation are ongoing, I'll be somewhat limited in what I can say. I do appreciate your understanding. Now, let's get to our business results. Today, we reported third-quarter total company revenues of $59.2 billion. Our adjusted earnings per diluted share was $3.81 and I'm pleased with our third quarter and year-to-date execution across the majority of our businesses in our fiscal 2020. Also today, we reaffirmed our fiscal 2020 full year outlook of $14.60 to $14.80 of adjusted earnings per diluted share which we first provided on January 13. This update reflects our outlook for growth in our U.S. Pharmaceutical and Specialty Solutions segment, primarily driven by specialty, strength in our medical surgical segment, lower-than-anticipated corporate expenses and the benefit from share repurchase activity in the third quarter. Our U.S. Pharmaceutical and Specialty Solutions segment performed well in the quarter, reflecting stable macro fundamentals and good execution, and was aided by the continued…

Thank you, Brian. And good morning, everyone. I'm pleased to be here this morning to talk about a solid third quarter for McKesson. I'll focus on our third quarter results and full-year fiscal 2020 guidance, including changes you could consider as you update your models. Brian walked you through high-level puts and takes as we think about our fiscal 2021 guidance and we'll provide detailed assumptions for fiscal 2021 when we report fourth-quarter and full-year results in May. We're pleased with our adjusted operating profit and adjusted earnings per diluted share results in the third quarter which were ahead of our expectations and represent solid execution. We continue to see momentum across the business as we execute against our strategic initiatives. As a result of this momentum and based on the confidence in our fourth-quarter outlook, on January 13, we raised and narrowed our fiscal 2020 adjusted earnings outlook to a range of $14.60 to $14.80 per diluted share from the previous range of $14 to $14.60 per diluted share. And today, we're reaffirming that adjusted earnings per diluted share guidance. Updated guidance assumptions can be found in our third quarter earnings slide presentation, which is posted on our Investors section of our website. Before I provide more details on our third quarter adjusted results, I want to address one item that impacted our GAAP-only results in the quarter. During the third quarter, we reported a pre and post-tax charge of $282 million, with a remeasurement to fair value of the net assets from the majority of McKesson's German wholesale business in relation to the expected formation of a new German wholesale joint venture with Walgreens Boots Alliance. Moving now to the adjusted earnings results for the quarter. Our third quarter adjusted EPS was $3.81, an increase of 12% compared…

Thank you. [Operator Instructions]. Our first question will come from Charles Rhyee with Cowen. Your line is open.

Yeah. Thanks for taking the question. Maybe, Brian, if I start with – just on opioids real quickly. What are the remaining points that are being negotiated? You kind of said that the negotiations are going well or seem to be progressing and some of the points are being resolved. Maybe you can give us a sense of what are some of the remaining kind of sticking points perhaps. And if I understand correctly, the framework is being discussed among – or is being led by four state attorney generals. During these kind of discussions, are the other constituents, let's say, the other states or some of the bigger municipalities that are in this lawsuit or part of this multidistrict litigation? Are they able to sort of see the progress as well and understand what is being kind of negotiated, so that when we get to maybe a final framework, the process with them to review and to accept is kind of in tandem or is this kind of being done in kind of a closed session and then opened up later?

Thank you for the question, Charles. And I think the way you frame the question, naming the number of parties or counterparties or folks involved in this discussion helps to frame why it's moving at the cadence that it's moving. We do continue to be in constructive dialogue with the AGs. The AGs have broadened their group and they continue to talk amongst themselves. The good news from my perspective is the basic framework that we've laid out is still the framework that's being discussed and the details for the many component parts of that are progressing well. There is still a long way to go with regard to ultimately getting as broad of AG support as we can and then AGs themselves going to their subdivisions and extending that broad support. So, there is a lot of work that is ongoing. The discussions are really continuous. It would be too early for me to try to project a timeline or where the finish line might be. But I am pleased that the framework that we've been negotiating continues to be the framework, the details are progressing. And I think as we get through the coming months, we'll begin to assess what the various AG and sub-municipality positions are.

Great. If I could have a follow-up, just on the core business, obviously, you increased your outlook on the core pharmaceutical segment here. It seems like a lot of things are moving in the right direction. Is there anything you'd point to specifically that is kind of driving the improved outlook here? Thank you.

Maybe I'll start and then Britt may want to offer a few comments. I think if you think about the general kind of industry fundamentals, the brand price inflation has been in line with where we thought it would be. The generic market is continuing to behave in a way that we had forecast. And by that, I mean our skill sourcing entity continues to produce in line with our anticipation. We are going in the market with a very disciplined approach, reflective of the transition our industry has been in. And we think that the competitive – the sell side in the generics market remains stable. It's competitive and there's pressures, but it's stable. I think we're seeing the benefits of a lot of the work and planning that we've been – for the last several quarters, we've been executing and implementing. And so, combining that I think with the market fundamentals and our really good positions in specialty is driving the results that you see.

Maybe I might just add. I think Brian you hit on it here. The focus and our execution against our differentiated assets, particularly specialty, and you talked a lot about that, I think is really driving a lot of this. And then, I would just reiterate that our cost programs are really driving, not only in our corporate line, but also across our segment. And so, that focus is not only on our core set of differentiated assets, but just disciplined and focus around costs across not only our corporate segments, but our business segments.

Thank you.

Thank you, Charles.

And next will be Brian Tanquilut with Jefferies.

Hi. Good morning. And congrats on a good quarter. So, I guess, the question for me, as I think about it, Brian, you talked about the execution and how you guys seem really positive about it. So, how do you think about the runway remaining in specialty as we head into fiscal 2021, without going into guidance specifically, and just how you're looking at the volume outlook from the key accounts because it sounds like that's a volume driver that's been driving some upside as well? Thanks.

Yeah. We're really pleased with our specially businesses. We talked a few weeks ago about the "core," the distribution of these products to hospitals and retail pharmacies as being our biggest segment. Clearly, we benefit there from the growth that these products have just in general. And the pipeline, if you look at the pipeline of the innovative products coming, they tend to look that way. And as you know, we've got established scale channels across both of these segments. And then, if you think about community setting, oncology, we have a clear leading stake. We're a leader in many of the other multispecialty settings. They're going to benefit from that same pipeline. And I also think, if you step up from a more macro view, if you think about the challenges that the cost of healthcare represents in this country, we have a fundamental belief that to get access, cost and quality, care needs to continue to shift into the community-based settings. So, that's where our community provider business, I think, from a macro standpoint is well positioned. And then, our US oncology business, we have particular depth and strength in oncology. And if you look at the pipeline there, that continues to be strong. So, I would say all those things are what are giving us our confidence. But at the bottom, at the end of the day, it's really the execution of the business that lets you capitalize on those macro trends and opportunities.

I guess my follow-up, Britt, you mentioned the cost cuts and the opportunities that you've found there. So, do you think there's a lot of runway left as we think about cost opportunities both on the corporate side and also on the operations side?

Yeah, our cost program, Brian, what we talked about, we would capture these cost savings by the end of fiscal 2021. So, we're still making progress not only in leveraging the scale of our enterprise across all of our business units, but some of the things that we've talked about previously in terms of back office function transformation, and there's still opportunities there as the size of our enterprise allows us to continue to work across and collaborate and drive additional cost synergy. So, I would say that that program, as we talked about, is – we expect it to be substantially complete by the end of fiscal 2021. However, as the business grows and our focus and execution in specialty continues, there's still opportunities for us to leverage our scale and transform our back office function.

Efficiency is a core part of the way you have to run a business like this at this scale. So, it is a program that we implemented a few years ago. But most importantly, for me, it's a mindset. It's a part of the way we think about how we manage and run the business.

Got it. Thank you.

And next will be Robert Jones with Goldman Sachs.

Great. Thanks for the questions. I guess just to go back to the segment guidance, and specifically the US Pharma segment, it seems like if I look at what's implied with 4Q, at the high end, it seems like you're kind of calling for year-over-year flat EBIT there in that segment. I know there's a number of moving pieces, Britt, but maybe could you just help us think about what the major swing factors are in 4Q because you guys highlighted the business there, in particular specialty seems to be performing well and there're some momentum, but it seems like 4Q, you're implying at least that things could potentially slow a bit? So, just want to make sure we had the moving pieces there correctly.

Yeah, sure, Bob. You're right about the implied. What I would just come back to and point out is that I've talked about, in a business the size of ours, with customers that are growing and you have mix that is changing in terms of customer and product mix, we are going to see fluctuations from quarter to quarter. We've seen that historically. I think we're seeing that a little bit more of this year, some of our larger retail national customers are growing a little bit faster. I think what we're pleased with, though, as Brian talked about, there're some stability in the pricing environment, particularly with branded pricing, certainly continue to – good progress against generics. But what you should expect, as I talked about at the beginning, is that we are going to see some items that are going to fluctuate from quarter to quarter. We don't manage our business that way. We manage our business for the long haul. We look at our business on an annual basis. And these items do tend to balance out over the course of the year. We're very pleased that we started the year with being able to guide back to growth in this segment and we're very pleased that, given the momentum and the execution that Brian talked about, particularly in our specialty business, we could raise that guidance today to the upper ends. We're making good progress, but I think you should expect to continue to see some fluctuation in our quarterly results.

No, that's fair. And then, I guess, Brian, you opened the door to a little bit of preliminary 2021 thoughts, and so I know we'll get more detail in May, but if I heard you correctly, it sounds like core drivers playing out in line this year with your expectations. You guys have highlighted the VA is not a material headwind. It sounds like cost savings will continue. It could be a benefit from capital allocation. All seem pretty neutral to tailwinds. Is there any major headwinds you would have us start to contemplate as we start to think about framing 2021 more specifically?

Well, look, as we come to May, we'll try to be very thoughtful and share with you our view of the thinking. If I think about what could materialize as headwinds, the policy arena has been dynamic probably for most of my career, but certainly for my tenure as CEO. And yet, while the clouds always seem to be gathering, nothing has really materialized. I would suspect we'll hear some commentary tonight. I think as we come into the face of election year, we'll be evaluating not only the policy proposals, but the politics that surround – that sort of set the framework for the likelihood of any of that really getting done. But to me that's just a normal part of being in healthcare and a normal part of being in this business. I think, though, our European business is coming off of a good quarter, but our experience there, particularly in the NHS, has been – been challenges around being – having good line of sight into how the reimbursement mechanisms really play out. So, while we're encouraged that we have a five-year macro agreement with NHS for the pharmacy community there, I think underneath the nuances of the timing and the different mechanisms that make up that framework, we'll have to continue to monitor and evaluate. And those are the two things that first pop to mind. Anything you want to add, Britt?

No, I think you captured them correctly, Brian.

And next will be Lisa Gill with JPMorgan.

Good morning. Brain, I just want a follow-up on that last point as you talk about the policy arena. Clearly, specialty has been a growth area. You've talked the whole call about specialty. What are your thoughts around IPI and what it could mean your specialty business? And then, secondly, as we think about the European markets, what have you learned from the European markets where it is a fixed cost environment versus here in the US?

Great. Thanks, Lisa. I'll take the IPI business first, the question first. So, IPI is – I guess there's been a lot of different constructs around getting to part B. There's been discussions of caps or limiting ASP rates, future caps on allowable inflation. IPI would be a proposal to index what the US pays based on a basket of internationally referenced prices for various products. I think there's even been some debate or discussion around MFN or most favored nation type clauses. So, the proposals have really been very wide in the spectrum. And without commenting on any of them specifically, I would say, first and foremost, we think any reform in Part B should be constructed – and we work with industry, the government and our partners to advocate for this – in a way that pushes care into the community. It's clearly the low cost, high access setting and we believe it has extremely high quality as well. So, it kind of hits all the three macro principles. And so, any reform that were to happen in our view should move care to the community. Anything that would move the opposite way would be counterproductive really for the US spend on healthcare in general. Now, relative to IPI, if something were to occur, the way I think about this is, in most instances, in our core pharma distribution, in our community provider setting, this is an implication to our customer. So, it'll be a secondary effect really from a wholesaler perspective. The one place we would have some exposure would be in The US Oncology Network, where – I'd remind you – through our partnership we share in the practice economics. So, we continue to watch this very closely. I'm not sure there's been a proposal that's had more commentary and more aligned commentary to kind of come out against it because of that impact potentially to patients and patient access and cost of care, but I suppose we'll see what we hear tonight.

Great. And then, just my follow-up, I just – Britt, you talked about the Change exit as being one of the key component to 2021. And you said it's consistent with what you've said before. Can you just remind us what you've said before on the timeline of the exit?

Sure, Lisa. So, what we've said previously, dating back to our Q2 earnings call, from that point in time, we would expect to exit our transaction in 6 months to 12 months, although it could be before the end of our fiscal 2020. So, I would reiterate that language today.

And next will be Ricky Goldwasser with Morgan Stanley. Your line is open.

Yeah. Hi. Good morning. I had follow-up question on the cost cutting initiative. I think you reduced your corporate expense guidance by about $45 million. Part of it is flow through of cost savings to the bottom line and some timing of investments. By our calculation, it's about $0.18 of EPS. So, as we think about the ongoing benefit of cost cutting, can we just kind of like run rate that $45 million that you said in the fourth quarter?

Yeah. Let me answer that, Ricky. Certainly, we are pleased with the progress that we're making against our cost initiatives. And I reiterate that we expect to generate $400 million to $500 million of savings by the end of 2021. So, the cost programs are ongoing. As I called out at the beginning of the year, there were some additional investments that we were going to be making, particularly in the areas of information security management and data and analytics. We continue to make those investments, but we're seeing good efficiency across the organization. So, I don't think you can necessarily take our performance this quarter and just run it out. We're continuing to make investments in the business, but we're also continuing along getting the efficiencies from scale and some of the back office function. So, what we wanted to do today was to update our guidance based on some of the benefits that we've seen in performance and execution, but we're continuing to make investments along as we generate those savings.

Okay. And then, one follow-up up on Change. Obviously, I understand that the exit is tax efficient, but can you just remind us, directionally, kind of like the mechanics? Should we expect Change – what should we expect in term of impact? Would it be neutral to UPS, accretive or dilutive? And same, how should we think about just directionally the impact to cash?

Yeah. So, let me just remind you that today is the filing that is another step along our exit. We have nothing included in our FY 2020 guidance related to Change. So, there's no additional information that I can provide you on that. And in terms of when we exit, depending on – regardless of how we exit, there'll be no cash impact.

And next will be Elizabeth Anderson with Evercore.

Hi. Good morning, guys. Just a broader long-term picture on the specialty side, how do we think about the ramp up in sort of additional specialty services you're providing, in particular on the US oncology side, but maybe also in the core business? Are there key moments that cause either providers or other customers to take up those services? Is it something gradual? I'm just sort of looking for a longer term vision of that.

Yeah, it's a great question and it's obviously an area that we have some excitement about and we have spent really a good part of the last 10 years or 15 years building out, some through internal development and some through acquisition, a set of capabilities that are really oriented around helping manufacturers identify which patients are appropriate and should be benefiting from their therapy, finding those patients and getting them started on that therapy and then ensuring that they stay on that therapy through the full clinically appropriate course, so that they can get the best possible outcome. So, the first good news in that is that the patient gets the best outcome. We think it's good for the patient, it's good for the healthcare system. Obviously, for our biopharma partners, that can result in more patients benefiting from their products. That has obvious benefit to them and that's a service. Therefore, they're quite interested in paying us for it. So, as we think about building off of really our 20-year experience in this marketplace, building off of sets of assets that we've required for the commercialization of these products, there's opportunities to both refine and deepen and develop the tools we offer today. A few weeks ago, I shared an example of a program like that, we're calling, Access for More Patients, which fundamentally is getting at the same issue, but it's doing it in a more automated, efficient way that lets us find more patients and get them on those therapies faster. As we look at that as a core, we think there are opportunities to extend downstream and to get earlier stage services to support pharmaceuticals. And as we think about some of our provider segments, there's opportunity to do some integration with providers downstream. So, this is an area that we think, as you look at the pipeline, as you look at the products, as you look at what's happening in terms of – in the clinical trial space and the fragmentation of population that there's going to continue to be a good opportunity here for McKesson.

Perfect. That's really helpful. Thank you.

And next will be Eric Coldwell with Baird.

Thanks. Good morning. So, maybe just focus on the Med Surg segment for a second. You've mentioned the early flu season, consistent with peers. I'm curious if you could carve out for us what you think the incremental benefit of early flu was or heavy flu. And then, I know it's probably a bit early and maybe evolving situation, but coronavirus, any issues with sourcing out of the Asia-Pac region or pricing changes, demand changes in the US as maybe some facilities pre-stock certain gloves, gowns, masks et cetera? Just any questions on interzone coronavirus impact so far would be interesting. Thanks so much.

Good morning, Eric. This is Britt. I'll take the first one and let Brian comment on the second. As I talked about in my remarks, we're really pleased with the performance of the medical business. We had good organic growth really across our business, but primarily in our primary care business. And then, I also called out higher pharmaceutical volumes as one of the drivers. We did see some modest impact from early flu season. I would remind you, though, that typically the flu season has a larger impact on our fourth quarter than our third quarter. We did plan the year for a normal flu season, so we saw a little earlier start than we had anticipated. But, again, I would just remind you that the strong core organic growth across our primary care business, which was inclusive of higher pharmaceutical volumes, was really the driver for the performance.

I'll take the coronavirus. Maybe before that, we've been around this business for a long time. And we chart every year what the flu season – influenza season looks like in the US. And every season has its own cycle of rhythm, if you will. And so, I think it's fair to say, we have seen an early start. Ultimately, how that plays out will depend on the duration and the severity and it's probably hard to predict that right now. Relative to coronavirus, I guess, let me start by first saying, our thoughts and sympathies go out to those, particularly in China, but really Asia, that are obviously dealing with this in a very real time way. We, at McKesson, have really been working across industry partners, peers, trade associations, government agencies for the better part of three or four weeks. So, we try to jump on these things early and get ahead of them. And so, we're monitoring this very, very closely. I would remind everybody that we don't manufacture these products. We procure them, we sell them and we distribute them. And we do have a domestic supplier base, although the majority of the products, the masks and the disinfectants and gowns are sourced from Asia or China. I guess, fortunately or unfortunately, depending on your perspective, we had some experience with SARS and H1N1. And so, what we're doing is implementing the protocols, the monitoring capabilities that we built up through these prior experiences and working in close coordination with government agencies and industry partners to make sure we can keep the continuity of supply. Now, what that ultimately looks like depends really on how does the virus continue to proliferate. Does it stay contained in a region? So, those are things that we just have to watch. But we wake up every day thinking about the markets that we serve and how we make sure we have products available for our customers that operate in those markets.

And next will be Michael Cherny with BofA Securities.

Thanks so much for taking the question. I guess, a lot of the key topics have been asked.The one thing that did stand out, you highlighted the recent success of the transaction side medical, really rocking it. Pretty low so far from an acquisition perspective, at least in terms of your historical spend year-to-date. As you're heading into fiscal 2021, as you are getting rid of the Change position on the balance sheet and the ownership stake, as you think forward of the portfolio, are there any macro trends that you think would drive some areas or opportunities for you to go and drive inorganic growth or anything from a broader picture perspective where your customers are really asking you to pursue an area that you may not be in or as strong as you would like to be right now?

Great question. I think we probably, if you look back over the past few years, we came through a cycle of pretty heavy M&A as we really bolstered some of the capabilities and assets that we thought surrounded our specialty biopharma manufacture value prop and our oncology business or ecosystem, however you want to think about that. And as we've done the work to integrate those, and it's a lot of work to integrate these things and to integrate them properly, in parallel, we've really been refining our strategies. And you've probably heard me say this before. All good M&A follows a good strategy. And so, as we've put this strategy together, we've identified the areas that we think we have differentiated capabilities in markets that have good overall growth prospects. So, when I think about capital deployment, we've obviously got to deploy capital to be invested in efficiency and some client and safe, secure, always-on environments. And then, the second area we'd look for is growth, but those growth investments, meaning M&A investments, have to be closely aligned to the strategy, and I think that that's what you should expect from us. So, we like growth investments. We like growth capital, either extend our capabilities or add scale to the places that we have capabilities. And while we always have to balance, I would say your strategy can't be based on M&A. It takes a buyer and a seller and it takes a price that you can agree on. So, as we've looked at the market and looked at those tradeoffs, obviously, the past 12 months or so, we've been favoring to deploy our capital or buy back our shares because we think those are a great investment, but we continue to be very active in looking for areas we can inorganically help support the growth.

And next will be Stephen Baxter with Wolfe Research.

Hi. Thanks for the question. So, I wanted to ask about the generics business. You guys have been very clear that gross profit is growing here and that appears to be a pretty different result than the rest of the industry. So, from a macro point of view, it looks to us like the broader market is relatively flat. Just hoping to better understand what's driving your growth here in bigger picture terms. Are you growing generic revenue against the backdrop of stable margins, stable revenue with improving margins, really any color you can add on how you're achieving those results, so we can better assess sustainability going forward would be appreciated. Thank you.

Good morning. I'll start and certainly Brian can add on. As we've talked about previously, we're really pleased with a couple of dimensions that lead – that are around our generics business. First of all, we have a scaled and efficient sourcing operation. We think we source as well as anybody and we continue to find opportunities from a sourcing perspective. We continue to be disciplined in a stable, yet competitive environment. We think that those dynamics are leading to our ability to generic gross profit growth. We are seeing some growth in units. And you combine that with scale in a competitive, but stable market, we think that those are dynamics that are really helping us be very successful in the generics area.

Operator, we have time for one more question.

Certainly. That question will come from Eric Percher with Nephron Research. Your line is open.

Thank you. A quick one on Europe. Loud and clear on expense reduction and a little benefit from the UK helping the uptick this quarter on op profit. Is it correct that the German business has not been moved to discontinued ops? So, is that still flowing through? And at some point, would we see that a benefit or maybe a loss might be removed from that segment when the JV is struck or approved?

Good morning, Eric. It is true we have not moved it to discontinue operations as it doesn't qualify for discontinued operations. I did talk about a GAAP-only charge that we took in the quarter. And we have the assets as held-for-sale on our balance sheet.

And can you state anything on whether that is in a loss position?

I'd just go back to my comments in terms of the loss that we reported from a GAAP-only perspective in the quarter of $282 million.

Okay. Well, I think that runs us out of time. I want to thank everyone for your great questions and your continued interest in McKesson. I want to thank Jack for facilitating this call. To conclude, McKesson continued to execute well in the third quarter and we remain confident in our fiscal 2020 outlook. I am extremely proud of how our employees are embracing the team McKesson culture, and I want to thank them for everything they do day in and day out, not only to deliver these results, but most importantly to improve care in every setting we serve. Thanks again for your interest in McKesson. We will release fourth quarter earnings results in early May. Look forward to talking to you then. Goodbye.

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