McKesson Corporation

Good day and welcome to the McKesson Q1 earnings call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Holly Weiss. Please go ahead.

Thank you, Justin. Good afternoon and welcome everyone to McKesson's first quarter fiscal 2020 earnings call. Today, I'm joined by Brian Tyler, our chief executive officer, and Britt Vitilone, 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 thanks to everyone for joining us on our call today. We're pleased today to be able to report a strong start to our fiscal year 2020 and For the first quarter, we achieved total company revenues in excess of $55 billion and adjusted earnings per diluted share of $3.31, ahead of our original expectations. On our fourth quarter call in May, I discussed that we were entering the fiscal year with positive momentum, and I feel really good about this, underpinning our first quarter results. We're seeing healthy growth across many parts of our business, which is a direct result of the actions we have been and are taking to execute on our strategic imperatives, which are enabling us to become a more focused and efficient company. And our balance sheet remains strong, giving us the flexibility to deploy capital that can differentiate McKesson and create shareholder value. As a result of our first quarter performance, combined with our confidence in the business as we look ahead, We're raising our fiscal 2020 adjusted EPS guidance range to $14 to $14.60. This is from our previous range of $13.85 to $14.45. Now turning to the business. I'll summarize our first quarter results and then turn the call over to Britt to elaborate. The U.S. pharmaceutical and specialty solutions had a good start to the year. driven by our broad set of specialty biopharmaceutical capabilities focused on both providers and manufacturers. I'm particularly pleased as this demonstrates the progress we're making on one of our three key strategic imperatives. We continue to see biopharma dynamics that are trending in line with our annual guide of mid-single-digit price increases on branded drugs. In addition, given our presence in the provider space and particularly oncology, where we are well positioned as biosimilars continue to become prevalent. Talking about generics for a moment. Similar to the last few quarters, our CLARIS-1 sourcing platform continues to deliver yield in line with our expectations. With its scale, we're able to buy at prices that are competitive with our peers. On the sell side, we continue to see a market that is competitive but stable. A few comments on Europe. Our UK retail business performance was impacted primarily by temporary wide NHS underfunding, which we believe should improve in the second half, and to a lesser extent, volume weakness. Performance in the other European countries was not enough to fully offset these challenges. Britt will speak to the expected full year impact. Before I address the NHS more specifically, let me remind you of the actions we've previously taken in the UK and across Europe to reposition the business for long-term profitability. With new leadership at the helm, we're making solid progress towards further rationalizing our store footprint and streamlining our back office functions, and we continue to evaluate our cost structure as we do in all our businesses. Turning back to the NHS, we're pleased by recent announcements first to increase the retail tariff beginning in August, and we would expect to see further upward revisions in tariffs later in the year, which should make up partially for any underfunding. The NHS also announced the new five-year community pharmacy contractual framework. This framework brings greater clarity and long-term certainty by maintaining the current level of industry funding for community pharmacies for the next five years. While certain elements of the funding allocation are yet to be fully defined and could evolve over the five-year time horizon, we view this as an incrementally positive development for our European business. McKesson remains active in its support of and direct discussions with the UK government on the future of community pharmacies and healthcare in the UK. Turning to MedSurg, our medical surgical business continues to generate above-market strong organic growth with its focus on delivering care in low-cost patient settings and we have now lapped the medical specialties distributor, or MSD, acquisition, which is delivering results in line with our expectations. We saw good growth across multiple markets and product categories, including lab, pharmaceutical, and McKesson private label. The non-acute space continues to be an encouraging area for us. Like others in healthcare, we continue to see care shift to these non-acute settings where we currently operate. With investments such as MSD and our new technology and our distribution centers, we're continuing to expand our services to these providers and to their patients. Turning to the other segment, which primarily consists of Canada, McKesson Prescription Technology Solutions, or MRXTS, and our investment in Change Healthcare. We see improving prescription trends in our own Canadian retail business, which reflects our focus on the retail customer experience. We've made investments in people and in reconfigured pharmacy formats. With strengthening fundamentals, we believe this can reinforce the role that community pharmacy plays in Canadian healthcare. Within MRXTS, we continue to see good growth in Cover My Meds and the Relay Health Pharmacy, driven by unique technology offerings that resonate with both our retail and biopharma partners. We continue to make investments in this business to position us for future growth. Change Healthcare achieved an important milestone with the completion of its initial public offering in June. Britt will speak more about this and what we can expect going forward. We're also investing in platforms that enhance our data and analytics capabilities. We realize benefits across the enterprise in the first quarter, and we expect to see expanding benefits in the future. I now want to touch upon drug pricing reform and the policy landscape. I had the opportunity recently to spend a few days in Washington, D.C. McKesson continues to engage as a key stakeholder in educating policymakers to address issues that may impact patients, our industry, and community-based pharmacy and medical practices, and helping to drive the necessary change to support access, quality, and affordability for a sustainable healthcare system. These objectives align with the administration's goals and we're committed to continuing the dialogue with policymakers and industry partners on sound, sustainable, and pragmatic solutions. It remains a dynamic environment, yet we remain confident in McKesson's path forward. The critical role of the services we provide to the healthcare industry today and our ability to identify and apply solutions to address the most pressing challenges to the healthcare system globally. Let me address two of the most recent developments. The Senate Finance Committee published a package of measures last week. We anticipate there might be further modifications as the package makes its way through the legislative process. So at this point, we're not in a position to go into great detail on specific provisions. However, we will continue to engage with policymakers and industry partners to ensure that these reforms support the efficiency, sustainability, and security of the supply chain as we seek to improve cost, quality, and access. Finally, earlier today, the U.S. Department of Health and Human Services, or HHS, and the U.S. Food and Drug Administration, or FDA, announced a safe importation action plan. Given how recent this announcement is, we haven't yet had the full time we'd like to digest or study this plan, but maybe a few just quick preliminary thoughts. Obviously, McKesson's presence in both U.S. and Canada gives us a unique perspective on supply chain considerations and the impacts to stakeholders and patients as we navigate this complex question of importation. There are legitimate concerns that importation could potentially introduce counterfeit or fraudulent products into the U.S. Importantly, we have a primary responsibility to maintain a safe, secure, and efficient supply chain and to ensure that we conform to FDA safety and efficacy standards in addition to the safeguards put in place by the 2013 passage of the Drug Supply Chain Security Act. These objectives are paramount as we evaluate the two pathways announced in today's plan. Before I wrap up, I'd like to spend a couple of minutes on the opioid epidemic. We continue to believe distributors are being disproportionately targeted Given our important but limited role in the supply chain, filling orders from licensed pharmacies who are in turn filling prescriptions written by licensed health care providers, any suggestion that McKesson drove demand for opioids in this country would reflect a fundamental misunderstanding and mischaracterization of our role as a distributor. We will continue to fight that mischaracterization in the multiple venues, both state and federal, where lawsuits have been filed by thousands of plaintiffs. These are clearly novel, complex, and unprecedented claims that must be navigated. I remain deeply concerned about the impact of this crisis on families and communities across the U.S. and are passionately committed to using Kesem's capabilities to be part of the solution. This includes partnering with government, industry, social institutions, and other players to help bring this crisis to an end. I've spoken about it before, but let me remind you of the investments we've made and continue to make in our programs, our processes, our technologies dedicated to preventing diversion, and our corporate initiative announced last spring to help address the epidemic. Those include educating the pharmacies and hospitals to whom we deliver about the importance of compliance with DEA regulations, creating a nationwide clinical alert system that uses patient prescription history to identify patients at risk of opioid overuse, abuse, addiction, or misuse. and actively advocating for public policies that will help address the opioid epidemic. In addition, we contributed $100 million to establish the Foundation for Opioid Response Efforts, a foundation dedicated solely to driving solutions to the epidemic. I'm proud of our teams and our team members who ensure the safety and security of our supply chain day in, day out. With that, let me turn the call over to Britt.

Thanks, Brian, and good afternoon. McKesson posted another solid quarter and strong start to fiscal 20. Slides I'm reviewing with you this afternoon are posted to the investor section of our website and include our full year fiscal 2020 guidance assumptions. Today we reported first quarter adjusted earnings of $3.31 per diluted share ahead of our original expectations, and we're raising the full year fiscal 20 outlook by 15 cents. a range of $14 to $14.60 per diluted share, from our previous outlook of $13.85 to $14.45 per diluted share. Let's move right to our first quarter results. Our first quarter adjusted earnings of $3.31 per diluted share were up 14% year-over-year, driven by strong performance in the U.S. pharmaceutical and specialty solutions business, medical surgical solutions, and our MRXTS businesses. a lower share count, higher contribution from our equity investment and change healthcare, a one-time gain from investment activities, and expense timing. These items were partially offset by the anticipated year-over-year increase in opioid litigation and technology costs, which we outlined with our initial outlook in May. Also had a lower profit contribution from the Europe segment and a higher adjusted tax rate. Let me start with the details of our consolidated results, which can be found on slide four. Consolidated revenues for the quarter increased 6% year-over-year, primarily driven by growth in our U.S. pharmaceutical and specialty solutions segment. Adjusted gross profit increased 2% year-over-year, mainly driven by a few key operational items. Within our medical surgical business, the contribution from the MSD acquisition, which we have now lapped, and above-market growth from pharmaceutical products, volume growth across our MRX TS offerings, and growth in our specialty provider solutions business within the U.S. pharmaceutical and specialty solutions segment. These items were partially offset by foreign currency effects and lower retail pharmacy margins in the U.K. First quarter adjusted operating expenses increased 1 percent year-over-year, partially driven by the acquisition of MSD in the prior year. Adjusted income from operations was $933 million for the quarter, 9% above the prior year. Interest expense was $56 million for the quarter, a decrease of 8% compared to the prior year, primarily due to lower commercial paper balances. Our adjusted tax rate was 22.6% for the quarter, mainly driven by our mix of business. We continue to assume a full year adjusted tax rate of approximately 18 to 19%. which may vary from quarter to quarter and includes anticipated discrete tax items that we expect to realize during the course of the year. Income attributable to non-controlling interests was $54 million for the quarter, a decrease of 7% compared to the prior year and in line with our expectations. Our adjusted net income from continuing operations totaled $625 million, And our diluted weighted average shares outstanding were 189 million for the quarter, a decrease of 7% year-over-year. Next, I'll discuss our segment results, which can be found in slides five through eight. And I'd like to start with U.S. Pharmaceutical and Specialty Solutions. First quarter revenues were $44.2 billion, up 8% year-over-year, driven by solid contributions from our largest retail national pharmacy customers growth across our specialty businesses, and continued solid performance within our health system segment, partially offset by branded to generic conversions. Segment adjusted operating profit for the quarter increased 11% to $600 million, primarily due to strong growth in our specialty businesses, continued strong performance by our sourcing operations, and the lapping of prior year opioid related expenses. As a reminder, the State of New York adopted the Opioid Stewardship Act in the first quarter of McKesson's fiscal 2019. Although the act was being challenged in court, we recorded an accrual in both our GAAP and adjusted results of $15 million in the first quarter of fiscal 19 in our U.S. pharmaceutical and specialty solution segment, which accounted for the estimated portion of the annual assessment. This legislation was later ruled unconstitutional, and the accrual was reversed in the third quarter fiscal 19. The segment-adjusted operating margin rate was 136 basis points, an increase of four basis points. Next, European pharmaceutical solutions. First quarter revenues were down 3% year-over-year to $6.7 billion. On an FX-adjusted basis, revenues were up 3%. driven by market growth in the distribution wholesale business. Segment adjusted operating profit was down 50% to $37 million on an FX adjusted basis, mainly due to the weak retail pharmacy environment in the UK. The segment adjusted operating margin rate was 52 basis points on an FX adjusted basis, a decrease of 55 basis points. Our first quarter results were lower than expectations resulting from weak retail pharmacy margins in the UK due to industry-wide underfunding by the NHS. We anticipate this underfunding will modestly improve in the second half of fiscal 20. As Brian discussed earlier, in fiscal 19, we took actions in the UK and across Europe to reposition the business for long-term profitability. These actions included further store rationalization and cost actions, and we continue to execute against these restructuring actions as we further evaluate our cost position. As a result of the UK outlook, we now expect European segment adjusted operating profit growth to be on the low end of our original assumption of low to mid single digit percent growth. Moving now to medical surgical solutions, first quarter revenues were $1.9 billion of 12% year over year. Excluding the MSD acquisition, which closed on June 1st of 2018, Segment revenue increased 4% driven by growth in our primary care and extended care businesses, including strength in pharmaceutical products and our home delivery business. Segment adjusted operating profit for the quarter increased 27% to $159 million, driven by organic growth and contribution from the MSD acquisition. The segment adjusted operating margin rate was 836 basis points, an increase of 102 basis points due to market growth and cost management. Finishing our business review with other, revenues were $3 billion for the quarter, down 1% year-over-year. On an FX adjusted basis, revenues grew 2%, driven primarily by growth in our MRX TS business. Other adjusted operating profit increased 31% to $279 million on an FX adjusted basis. mainly driven by increased equity income from our investment in Change Healthcare and continued strength in our MRXTS business. Included in other, adjusted equity income from Change Healthcare was $108 million for the quarter as compared to $64 million in the prior period. Let me take a minute and update you on our equity investment in Change Healthcare. On June 27th of 2019, Change Healthcare began trading on the NASDAQ. This was an important milestone for Change Healthcare. While Change Healthcare is now a publicly traded company, McKesson will continue to report the equity income from our interest in Change Healthcare based on our equity ownership percentage, and we will continue to report Change Healthcare results on a one-month lag. As a result of the IPO, McKesson's equity ownership in Change Healthcare is approximately 58.5 percent, effective beginning with McKesson's second quarter. When taking into account McKesson's new equity ownership percentage, as well as Change Healthcare's repayment of long-term debt following the completion of its IPO, we anticipate the adjusted equity income attributable to our interest in Change Healthcare in fiscal 20 to be unchanged from the prior range of $250 to $270 million, which had assumed 70% ownership throughout fiscal 20. I would point out that our adjusted equity interest assumption for Change Healthcare as well as our future results and commentary on change healthcare, will be specific to McKesson's ownership interest based on the McKesson definition of adjusted earnings, our equity ownership percentage in change healthcare, and the period for which we are reporting, which again will be on a one-month lag. Any questions related to the operating performance or the outlook for change healthcare will be addressed by the change management team. The IPO was an important next step in McKesson's efforts to unlock value for our shareholders as we progress towards exiting our investment in Change Healthcare in a tax-efficient manner. As we've detailed in the past, there are lockup periods and other milestones which must be met prior to our exit, which include, first, the customary six-month lockup period following the IPO. Then Blackstone, our equity partner in Change Healthcare, has the opportunity to do a secondary offering covering up to a three-month period. Following that, there would be a three-month lockup period. Given all of these factors, our exit could extend to a period of 12 to 18 months. However, depending on the necessity of certain milestones, we may have the opportunity to exit by the end of our fiscal 2020. We will provide updates as we progress through the respective lockup periods and milestones as we move closer to our eventual exit. Moving now to corporate expenses. The custom recorded $137 million in adjusted corporate expenses in the first quarter, an increase of 44% compared to the prior year. The year-over-year growth was primarily driven by the increase in opioid-related litigation costs and the overall timing of technology investments in the fiscal year, partially offset by a one-time benefit recorded in the first quarter of approximately 10 cents. As it relates to opioid-related litigation costs, McKesson recorded $36 million in expenses in the first quarter. We continue to assume opioid-related litigation costs will be approximately $150 million in fiscal 2020. Based on the one-time benefit recorded in the first quarter, we now anticipate corporate expenses to be on the low end of the original assumption of $725 to $775 million. Turning now to cash, which can be found on slide nine. We ended the quarter with a cash balance of $1.9 billion. During the quarter, we had negative free cash flow of $162 million. This performance was ahead of our expectations. I would remind you that cash flow will vary from quarter to quarter, impacted by timing, including the day of the week that marks the close of a quarter. We continue to expect free cash flow of approximately $2.8 to $3 billion for fiscal 2020. Investment and growth opportunities remains a key priority for McKesson. During the quarter, we made $111 million of capital expenditures and spent $46 million on acquisitions. And we continue to focus on internal investments in areas such as data and analytics and information security. We used cash in the quarter to continue returning value to our shareholders. We repurchased $684 million in common stock and have $2.8 billion remaining on our share repurchase authorization. We also paid $75 million in dividends in the quarter. And yesterday, the board approved an increase to our quarterly dividend of $0.02 to $0.41, an increase of 5%, which will be payable to shareholders in October. In closing, we are pleased with a strong start to the year. In the first quarter, we had growth across the majority of our businesses, which more than offset the weakness in the retail pharmacy market in the UK. Our results for the first quarter, which include an unplanned one-time benefit of $0.10, have given us confidence in our full-year fiscal 20 outlook. As a result, we're increasing our adjusted earnings guidance by $0.15 to a range of $14 to $14.60 per diluted share, which represents solid growth of approximately 5% at the midpoint versus fiscal 2019. I would remind you that we do not provide quarterly guidance. To better inform your modeling, we continue to expect the percentage of adjusted earnings per diluted share in the first half of the year as compared to the second half to be similar to fiscal 19. Overall, we're pleased with the focus, the execution, and the performance across the company, and we're off to a great start in fiscal 2020. And with that, Brian and I are happy to take your questions.

Thank you. If you would like to signal with questions, please press star 1 on your touchtone telephone. If you're joining us today using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, that will be star 1 if you'd like to ask questions. And our first question will come from Lisa Gill with JPMorgan.

Thanks very much, and good afternoon. Congratulations on a nice start to the year. You know, Brian, I know that it just came out, you know, this new safe importation action plan, but just being in Canada, how realistic is this that the manufacturers are going to allow product to go to Canada and then come back to the U.S. and just given the size of the Canadian market? And what role do you think that McKesson can play as the largest distributor in Canada to make sure that, one, product that is meant for Canada stays in Canada, and two, anything that does potentially come back to the States is safe?

Thank you, Lisa, for the question. We do think McKesson is in a uniquely informed position, given our business in Canada. and our presence here in the U.S., obviously. There were two tracks discussed in the plan that came out today. I will say I was encouraged by the fact that it was an invitation for industry and industry participants to bring their perspectives and knowledge into the discussion, and we will plan to be actively engaged in that. Our first and foremost responsibility and priority will be the safety and security of the supply chain, both in the U.S. and in Canada. Now, you rightly point out the Canadian market, from a population standpoint, is less than a tenth of the U.S., and I suppose that various manufacturers will adopt various perspectives on what they may or may not do. We will carefully evaluate supply with various industry partners, what the opportunity may be. But the overarching goal will be safety and security for citizens both north and south of the Canadian-U.S. border.

And just as a follow-up, clearly what they're trying to solve here is overall drug pricing. You or Britt, can you talk about what we saw in the quarter around drug pricing relation on the branded side as well as the generic side? You know, clearly quarterly results coming better and better, especially on the drug distribution U.S. component of the business. So just wondering some of the key drivers there, as well as what you're seeing on both inflation, deflation, and generics and branded.

Thanks for that question, Lisa. I'll start and Brian can add. You know, as we talked about in Brian's remarks, on the branded side, what we saw from an inflation perspective was right along in line with our expectations. As you know, the first quarter is generally a softer quarter for brand inflation historically. And what we saw this quarter was really in line with our expectations. And as we think about the full year, we are reaffirming our guidance of mid-single-digit inflation on the branded side. On the generic side, we continue to be very pleased with the performance of our sourcing operation, Claris I. What we've seen thus far in terms of our sourcing performance is right in line with our expectations. And on the sell side, as Brian mentioned, we continue to see a competitive market, but we continue to see a stable market. And so we're pleased with our ability to continue to source very competitively, which is certainly benefiting our customers. And we're certainly pleased with the ability to bring that to the sell side and our customers.

Great. Thanks for the comments.

And next will be Michael Cherney with Bank of America.

Good evening. Thanks for all the comments so far. Britt, I want to dive in a little bit more into the U.S. pharma performance, maybe as a microcosm for the rest of the business. It seems like just given the sheer magnitude of the performance and the outperformance on revenue relative at least to your guidance that a lot of it has to be driven by pharma. That being said, we didn't see a ton of gross margin pull through. That might be splitting hairs a little bit here, but can you talk a little bit about the dynamics here? in terms of what was the rationale for the slower gross profit growth relative to the revenue growth?

Sure. Thanks for the question. As I mentioned in my comments, some of the revenue growth that we saw came from some of our largest national retail customers. And as you might expect, they don't generate as great a contribution to gross profit. We did see broad-based strong performance across the segment, not only with our largest national retail customers, but we saw good performance in our health system segment, and we continue to see very strong performance in our specialty business, and so we're quite pleased with that. Overall, in the segment, while our gross profit was lower on a consolidated basis, within our U.S. pharma and specialty solutions segment, we saw very good performance at the adjusted operating profit line. So we're very pleased with the performance. We saw a very broad-based performance across that segment, and we think that we're well-positioned to continue and achieve our guidance for the rest of the year.

And just on the contribution from change, the way to think about the fact that the numbers didn't change despite the fact that you had a lower ownership stake versus guidance simply driven by the outperformance of contribution for 1Q, or is there anything else that changed in terms of just the methodology aside from just the pure less ownership stake?

I would say that it's a combination of the lower ownership stake being offset by the deleveraging that changed it as a result of raising the funds from the IPO. Okay, great. Thanks so much.

And next will be Kevin Caliendo with UBS.

Great. Thanks for taking my call. A question around the guidance. By 30 cents, you only guide it up by 15 cents. I know you mentioned the EU business is now expected to be at the lower end of the range. You also mentioned corporate expenses are going to be lower. Is there any other deltas there? Is this conservatism? How should we think about the guidance relative to the beat in the quarter?

Sure. I think there's a couple things there, Kevin. First of all, we had good performance We also called out a one-time gain from investment activities that is within our corporate expenses. That was about $0.10. So while we had strong performance across really a broad base of our businesses, we did see weaker performance in our European business, and we did lower the range for the full year as a result of that. We had the one-time unplanned benefit. We had some favorable timing in our corporate expense line. Again, we called out at the beginning of the year We intend to continue to make investments in our business, both on a data and analytics side and in a technology side. So we had strong, broad-based performance across the business. We had a one-time gain within our corporate expense line. And I think it's early in the year, but we feel very confident and confident enough to raise by 15 cents.

Okay. And just a quick follow-up on the medical segment. You give us the revenues ex-MSD. They would have been up 4%. What would the EBIT growth have been ex-MSD and medical as we're now lapping it, just to give us a little bit of a better view of sort of what that business might look like going forward?

We don't break that down specifically, Kevin, but what I would tell you is we had strong organic performance within that business. And as I mentioned, we had strong pharmaceutical sales performance as well as continued strong performance in our home delivery business. So we're pleased with the overall performance of the segment. We're pleased with the execution against the MSD acquisition. And as I mentioned, across the broad base of that business, we had growth in pharmaceuticals. We had growth in our primary care business as well as our home delivery business. So good organic growth as well as the MSD contribution. Great. Thanks so much.

Next will be Ricky Goldwasser with Morgan Stanley.

Yeah, hi, good evening. So, some follow-up questions here on the guidance. Obviously, you had a very good performance on the top line, but when we look at your U.S. Pharmaceutical and Specialty Solutions guidance for the remainder of the year, it would suggest that revenues are going to normalize where we're getting to around plus 4 to negative 1% on the revenue And on the operating profit as well, kind of like negative two to about 3.3% growth. So was there any kind of like pull forward of revenues this quarter that's going to normalize for the remainder of the year? Or what kind of like drove that strength? I understand that it's your largest customers, but if you can give us some more color behind that.

Sure. Thanks, Ricky. There's nothing unusual about the revenue development in the quarter. There's nothing that I would would call out as a pull forward, to use your terminology. And we had very strong performance. It was primarily in our largest retail national accounts. But again, as I mentioned, we had broad base of revenue growth across the business. The one thing I would point out about our adjusted operating profit for the quarter, as I talked about in my opening remarks, last year we did have the opioid litigation costs that were included. in that segment's results. And as I mentioned, we recorded $15 million last year for the New York State assessment. So I think you should factor that in. We're very pleased with the performance. We continue to expect to see growth in this segment for the remainder of the year, and we're very pleased with the revenue development.

Okay. So let me ask a follow-up on specialty. I think this is kind of like the third quarter is both you and your peers are highlighting the strength in specialty as benefiting results. So can you just share with us a little bit more color and specialty in whether you've seen any contractual changes in the last year that would explain the improvement in benefit? Because I'm assuming that it's not coming from branded inflation. So how should we think about that benefit and how should we think about the sustainability of that benefit. And I think that historically you talked about specialty margin as being below traditional branded drugs. Is that still the case or should we assume that margins have re-rated higher?

I'll take this one and Britt can jump in if you'd like. So when you think about the specialty as a segment, obviously the pipeline of innovation continues to be heavily slanted towards these types of products. In the old legacy core U.S. pharma business, the margin profiles and structures you'd be accustomed to, I would characterize as still being in place. And so while we do benefit from that specialty growth through good volumes, and it is It is beneficial for us on the gross profit line. It does continue to be modestly dilutive to the rate. I would remind you, though, we also have a very good business in the community setting related to specialty products, and that's both our U.S. Oncology network and our unaffiliated community provider business. And those are the businesses where we continue to see really good momentum, really good growth, and benefit from the pipeline of both innovative products and, frankly, biosimilars as they emerge and come to market. And we have a very robust value proposition, obviously a complete value proposition in the case of U.S. oncology, and then a wide assortment of tools and services we offer to the unaffiliated community providers. And we think that that value proposition continues to earn us the right and the ability to grow and to benefit from the specialty pharmaceutical pipeline in general.

And next will be Ross Muecken with Evercore ISI.

Good afternoon, guys. So I just wanted to go back to kind of the change in other math again, because I don't think I have it straight. You know, in terms of the 108 million versus the prior year, and then, and that's for change, and then sort of the full-year guide, I'm not sure I understand sort of what caused the upstep in cadence and then sort of the notable down step. I know the ownership percentage is changing, but it still seemed like a big delta, and I'm guessing that's essentially what caused the spike in the other segment profits. So, I'm just trying to figure out sort of why that cadence was kind of funkier than what I think one would have expected.

Sure. Thanks for the question, Ross. So let me start with just the other segment just generally. Within that segment, we have our Canadian business. We have our MRXTS businesses, which are very strong businesses and growing very well for us. And we have our equity investment and change. Now, at first, I'd I'd point out that our Canadian business continues to perform well. We certainly talked about the impact from the generic legislation at the beginning of the year, and that team really did a great job in mitigating that, and we're pleased with the performance of Canada. Our MRXTS businesses continue to grow very well, and we're continuing to make investments in those businesses. Within our change asset, we did have the ownership change from 70% to 58.5%. effective in our second quarter. And in that second quarter, you'll also see the impact from the delevering. Within the first quarter, though, there are a couple things that I would point out. First of all, change had, as most companies, had the implementation of the revenue recognition standard, and that created a timing element for the year. For the full year, that's not going to have an impact on McKesson. But it does have an impact earlier, a favorable impact earlier than year, and then it'll reverse out as year goes on. And then, of course, as you think about that business, there's a mix of income between taxable and non-taxable, depending on the legal entity. So what I would say is primarily for the first quarter, you see some timing impact from the revenue recognition standard, and you see a mix of income between the entities of taxable and non-taxable.

Got it. And then maybe just thinking about sort of, you know, maybe business development activity or the M&A, you know, side of things, you know, a lot of things in services, including your own asset, obviously have challenging multiples. You know, there's a lot of political wins going on. I guess how do you sort of frame what's the right time to be more active again on sort of tuck in M&A and how the risk-reward sort of is there versus just continuing to buy your own equity, which, given its cash flow yield, seems like a reasonable investment?

Yeah, thanks for the question. And I think we would characterize our M&A activity in recent quarters as being relatively light. That doesn't mean that we're out of that space. I mean, when you think about capital allocation, We're always very focused on where are the opportunities to deploy capital to build platforms and businesses and services for sustainable growth over the long term. We are being very diligent to make sure that as we look at this process that that is guided by our strategy, that's guided by our focal areas, it's guided by the markets and segments where we think we have good businesses, strong teams, the right to win, And anywhere in those segments we can find assets that are complementary and an accelerant to our business, we're quite interested in those. We obviously consider alternative uses to capital and returns to capital in making those calculations and final determinations of what's the best way to deploy that capital on behalf of our shareholders. We continue to be active. We continue to be in deal flow. We continue to look carefully at the landscape with an eye to make sure it's aligned strategically, that it's an investment, that it's an accelerant, and that it is the smartest way to deploy capital across the various uses of capital that we have.

Thanks, guys.

And moving on to Stephen Baxter with Wolf Research.

Hi, thanks for the question. I wanted to ask about the sell-side environment. You've said in the past that in general your contracts last about three years, so it appears you'd be coming up against some of the independent pharmacy contracts that were renewed during 2016. It'd be helpful if you could give us a sense of what proportion of those contracts have been addressed at this point, and also any color you can ride on what the discussions look like in terms of helping your pharmacy partners deal with the pressure they're under would be very helpful. Thanks.

So typically, as we've talked about, we would renew roughly a third of our contracts in any one given year. We've recently got through two big retail national account renewals successfully, which was great news. And I'd say I'd characterize this year as having a fairly normal portfolio of renewals and renewal activities. So I wouldn't point to anything particularly unusual in that regard. We work with our partners, you know, over the life of these contracts. We're typically engaging in, you know, day-to-day and discussions. We begin conversations well in advance of any sort of sudden renewal activity, so we really view it as kind of an ongoing dialogue and an ongoing partnership over the course of these contracts, and you'll be well familiar with our track record of renewing these particularly larger deals. As it relates to to independence in general and, you know, what are we doing to help independence. You know, I would say independence has probably long been at the core of McKesson as a company. It's a key part of our commitment to community practice as we think being central to addressing the access cost and quality issues this country faces. Independence, you know, continue to benefit from the programs and services that we invest in. They can choose to consume that in a sort of all-encompassing way through a relationship with Health Mart and our access reimbursement services that come along with that. But, you know, we are constantly looking at how we innovate for them, both in how they interact with their patients, how they attract patients and draw footfall to their stores, how they monetize that footfall both in front and behind the counter. And we work with them, you know, day in, day out in the just efficiency of the operation of their businesses. Community Pharmacy today feels reimbursement pressure. It's felt that pressure every year I've been in the business, and that's almost 23 years now. So we partner with them very closely to help ensure their position to survive and adapt and innovate. And independent community pharmacies do tend to be creative individual business folks who find ways to meet unmet needs in the communities they serve.

Okay, thanks. I appreciate the color. And then just one quickly on capital deployment and the pacing of share purchase. So it looks like if you carry this magnitude of share purchase through the balance of the year, you'd end up with something a few million shares below where your guidance is, which looks like, you know, 185 million shares unchanged versus previous. So I was wondering if you could help us understand the progression of share purchase and how you guys approach the balance between opportunism and planned activity throughout the year. Thanks.

Yeah, thanks for the question. I would just, you know, reaffirm that we've not changed our assumption on our diluted shares for the end of the year. We don't have a set amount that you should think about for modeling to take it from quarter to quarter. We think about capital deployment, as Brian mentioned. We think about it, opportunities on strategy, and where we have opportunities to invest on strategy or invest internally, we do that, and certainly we've had an opportunity this quarter to return more to our shareholders. So we make those decisions on a regular basis. But in terms of our guide on shares for the end of the year, we've not changed that.

And our next question will come from Eric Persher with NIFON Research.

Thank you. I'd like to go back to the gross margin question and maybe give them the comments around independence. I know that was one segment that hasn't been driving the same contribution that some of the other areas, the retail nationals and other less profitable accounts may be. As you think about the growth in revenue and what that translates into at a gross profit growth level at a period of time where independents aren't driving it and a period of time where generic contributions aren't as high, What do you see as the natural growth rate?

Well, Eric, what I would point to is if you look at our consolidated gross margin, there's multiple factors to consider in here. And one of the things that impacted our gross margin in the quarter was the weak retail results in our UK business within Europe. Clearly, we had a large proportion of revenue being driven by our largest retail national accounts. We had a very broad base of revenue growth across our business. And overall, I would just say that one of the things that impacted to the negative side was not only the mix of revenue, but the impact from a weak retail environment in the UK. If we think about our independent customers within U.S. Pharma, we haven't seen anything different this quarter from the previous couple of quarters. I don't know that there's anything really to call out specific about that.

Yeah, when we look at the kind of reimbursement environment that retail independents are facing, I think we talked last quarter about the fact that if we look at our data, we really see an aggregate, a very normal headwind that has been established, something that's kind of been consistent with prior years. And on average, that's a true statement. Now, within that average, there are, based on patient mix and contracts, the government, private, commercial, product mix, and really the patient population in your catchment area, you can see some winners and some losers. But in a blended way, it really feels like the same steady reimbursement headwind we've been accustomed to.

So I think we see that, and certainly the headwind in Air National on gross margin is evident. But my question is really where we don't see at a distribution and specialty segment level, what are your thoughts on the ability to drive gross profit growth relative to revenue growth? That's really the question I was getting at.

Well, as we've talked about previously, Eric, the growth of specialty products is going to have a dilutive impact on the rate. It's certainly... very good for us from a margin dollars perspective. As I think about that, the U.S. pharma and specialty solutions business, again, it's a business that is broad-based from a distribution perspective, both in the nature of the products and the customers, but also the specialty businesses that Brian talked about, you know, our U.S. oncology asset, our provider base that we have. And also the manufactured life capabilities, the services that we provide to the manufacturer, those also add to our gross margin profile. So when I think about it, our distribution business is very scaled, certainly is impacted by the product mix, but the fact that it's broad-based in terms of our U.S. oncology asset, our other specialty assets, and then our manufactured services assets I think that really does give us the opportunity to develop that gross profit over time. Thank you.

And our next question will come from Brian to Qualit with Jefferies.

Hey, good afternoon, guys. Congratulations. Britt, just wanted to follow up on Ricky's question from earlier to clarify that question again. So you put up an 8% growth number in the U.S. for Q1. And yet you're maintaining the guidance, you know, kind of like low to mid single digits. So is there anything we should be thinking about that could drive a deceleration in growth? I mean, you've talked about specialty being strong. Or, you know, is there anything to call out there?

Yeah, the thing that I would point out is I think we saw a larger proportion of revenue from our largest retail national accounts in the quarter. We still expect to see very strong revenue growth in the mid single digit range for the year. I think as you just think about the quarterization of that, we saw a larger proportion of that coming from our largest accounts, and that had obviously a very favorable impact in the quarter.

All right. Got it. All right. Thanks, guys.

Thanks, Brian.

Our next question will come from Robert Jones with Goldman Sachs.

Great. Thanks for the questions. I guess a similar one, Britt, on the corporate expense side, you're pointing towards the lower end, but just looking at where you ended up in the quarter, it still seems like quite a big ramp through the year to get there. Anything you know of or that you anticipate on the corporate expense side that it would be terribly different than what we saw in the quarter? And then I guess, Brian, just I'll throw my follow-up out there. I'm sorry if I missed this in the prepared remarks, but you know, large proposed generic merger out there. Curious, you know, if or how impactful that would be on not only Clarison, but on McKesson in general. If you had a view, that'd be great. Thanks.

Thanks for the question. I'll start, and then I'll turn it over to Brian. As we think about our corporate expenses, at the beginning of the year, we talked about the things that are driving the higher corporate expense year over year. We talked about the increase in opioid litigation costs, We talked about the increased investments that we were making in technology, particularly infrastructure and data and analytics. We still intend to make those investments throughout the year. We had a favorable timing-related impact in the first quarter, but our intention is to continue to invest in those capabilities as we go throughout the rest of the year. We also, in my remarks, I talked about our opioid litigation cost projection for the full year still remaining at $150 million. And then the thing that I did talk about that is included on our corporate expenses was the one-time benefit we had from investing activities, which reduced our corporate expenses in the quarter. And that allowed us to take our guide for corporate expenses down to the low end of the range that we provided at the beginning of the year.

Robert, to your second question, we actually did not comment on this, I think, in our opening remarks. So thank you for the question on the Pfizer-Miland merger. So I would start by saying that, you know, we have strong relationships with both of these organizations, and they've been important partners for us in McKesson and in CLARIS-1. You know, the rationale for the merger, as I understand it, is broadening of the portfolio. There is some cost synergy, some efficiency. You know, and frankly, at the scale that we operate and buy, you know, being partnered with large-scale healthy organizations that are capable of continuity of supply and competitive pricing can be a good thing. So, you know, we'll evaluate how this merger comes together. We'll continue to be in dialogue with them. But I wouldn't say it poses any imminent concerns from our perspective.

And our next question will come from Charles Rhee with Cowen and Company.

Yeah, hey, thanks for taking questions. And I think you touched on biosummers being a benefit, particularly in the oncology network. Can you talk about sort of your outlook here? You know, I think there's some talks about, I think, insulin moving over to jurisdiction by the, I guess, the biologics group in FDA, CBER, And that could pave the way for interchangeability on, at least with biosimilar insulin. Maybe your thoughts on where you're seeing sort of that regulatory landscape right now and how you think about that opportunity and what it means, you know, further down the road for you.

Well, I mean, the biosimilar landscape in general, you know, we feel pretty positive about, you know, more choices. more substitutability or interchangeability. That gives clinicians more choices, hopefully helps address cost challenges we see in the marketplace. And we think with the footprint of providers that we have in the community, we're particularly well positioned to take advantage of those trends. Now, we also continue to work with innovators. First and foremost, as we think about these, It's a patient outcome. It's a clinical-oriented decision. It's what product is best on the formulary to meet the clinical need. To the extent there are a variety of choices and interchangeability, that tends to be good for a company like us with the markets and channels that we serve. That choice tends to be a positive thing for us.

Is that something, though, you think is coming close and that you're trying to plan ahead of that, or is that you feel is still a ways off?

That's really hard to comment on what the regulatory pathways will be and timing. And, you know, our recent experience in the policy arena tells us anything. It gets very difficult to forecast, you know, what may come out. There's lots of discussion what may come out ultimately and what it may look like in its final form. It would probably not be my best judgment to try to predict that for you.

OK, fair enough. And just one last question. You talked about the FX impact being sort of net neutral. But if I look, it seems like particularly the pound and the euro have been getting weaker relative to the dollar. You know, how are you guys thinking about that or sort of what's your expectations around that? Thanks.

Yeah, I don't want to predict the direction of the pound. On a consolidated basis, it doesn't have a material impact. But as I called out, it did have an impact on revenues within the Europe segment for the quarter. So obviously we'll watch that very carefully. But as we think about it on a consolidated basis, we don't see an impact.

Great.

Thank you. Yep.

Operator, we have time for one more question.

Certainly. That question will come from Eric Coldwell with Robert W. Baird.

Hey, thanks very much and good evening. Most of my main ones were covered, but I'll shift gears a bit. I'd like your thoughts on generic introductions for the rest of the year, if possible, expected to be a good guy or a bad guy to profitability on a year-over-year basis. And then specifically, if I dare ask, Lyrica comes out with roughly 10 manufacturers, a very low initial price. How did that impact, you know, pretty big product, how did that impact your thinking on generic profitability and trends in that market, seeing so many manufacturers launch at such a deep discount to the brand?

Yeah, thanks for that question. Generic launches, as we've talked about, do not have the size of impact that they used to have. They have a modest impact on our profitability. So we don't see that having any change from our previous views on that. In terms of Lyrica, we are very fortunate to have a strong sourcing organization like Claris One, where we can partner with multiple manufacturers. We don't see that Lyrica is going to change the direction of our generic profitability. It'll certainly be a benefit for us, and it'll certainly be a benefit from our customers, but it'll have a modest impact at most.

Great. Well, thank you everyone for your questions and thank you Justin for facilitating this call. I want to thank everyone on the call today for your time. McKesson is off to a strong start for our fiscal 2020 and I'm real excited about the opportunities ahead of us. I do want to take a minute to recognize the outstanding performance of really all of the McKesson employees and team members and their contributions to help our customers improve lives and deliver opportunities to make better health possible. So thank you, Team McKesson. Have a good evening, everyone.

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