McKesson Corporation (MCK) Earnings Call Transcript & Summary

Good morning. Thanks for joining us for the next session here at the TD Cowen Healthcare Conference. And very pleased to have with us McKesson. And speaking for the company is Britt Vitalone, Executive Vice President and Chief Financial Officer. Britt, thanks for being with us today.

Obviously, maybe just to start out, obviously, news this morning, tariffs related to Mexico and Canada have gone into effect. And just maybe just to remind us what if any impact that might have for McKesson?

Yes. First of all, thank you for having us. Appreciate being here. We have been, over the last several years, continuing to diversify our supply chain. And we've been doing that for purposes of quality, regulatory as well as to fulfill sort of a dual mandate of lowest cost for our customers, highest availability of supply. So we've continued to do this over the last several years in our pharmaceutical business to the extent that we can, certainly with our generics consortium and in our medical business. So I feel like we've been proactive on that. Certainly, if there are tariffs that impact some of the products that we have, in some cases, we'll certainly pass those on to our customers. Unfortunately, it will be a higher cost to patients in some cases. But we'll continue to try to fulfill that mandate of having a very diversified supplier base, having a high-quality supply base and having the highest availability of supply to our customers. And I think we've done a really good job of that over the last several years.

So is it fair to say you would expect minimal impact from tariffs and -- certainly exposure to Mexico and Canada is minimal, it sounds like?

Yes. There's no one country that is a really material component of our supplier base. In the cases of Canada and Mexico, we're fairly immaterial in terms of the number of products that come out of there. So we don't anticipate at this time that they will have a material impact on our business.

Got it. In that case, maybe let's want to talk a little bit about the U.S. Pharma segment here. Obviously, great performance over the last several years. I think operating earnings growth has grown roughly, what, 7% plus over the last several years. Maybe remind us a little bit of the drivers that have helped achieve that. And when we think about sort of the long-term targets that you have set 5% to 7% a couple of years back, maybe you can kind of help us think about what's kind of led us to that top end of the range? And how you think about sort of the growth trajectory here in this segment?

Yes, we're really pleased with our U.S. Pharmaceutical segment. It's a very scaled and broad business that has lots of different parts to it that we've continued to invest in over the last several years. Core pharmaceutical distribution, we have a very scaled and efficient distribution business, services, health systems, retail national account customers as well as independents. We have a set of capabilities to support specialty providers, and we've had a growing oncology platform that we're really proud of. The oncology business is one that we've grown over the last several years, and really building out a broad set of solutions within the platform. And we've added providers over the last several years, continuing to add suppliers to -- or I should say, providers to the US Oncology network. That's added and expanded our drug distribution, scale and capabilities, our GPO capabilities as well as the capabilities for more data and clinical trials and clinical trial research. We've seen growth in specialty pharmaceuticals as well as specialty providers. Our business is very broad and very well equipped to handle that growth as well. We've been able to add in a very efficient way, new partnerships. One, this year, we have a new partner this year that we onboarded at the beginning of our second quarter that will help deliver about $32 billion of revenue this year. But it's a partnership over a long term that's based on value that we can provide, and we're really pleased with the transition of that. So it's a broad business. It is in all the channels for drug distribution. It's continued to build on specialty provider capabilities and the growth in oncology and the oncology platform and suite of services that we have.

Maybe focusing a little bit on the oncology space. Clearly, this has been a big growth driver for you and for others. You recently acquired for Florida Cancer Specialists as well, but you're now starting to move a little bit outside of oncology with the acquisition of PRISM. Maybe talk about sort of where you see the opportunities in other specialties, I think oncology is sort of fairly well known. How do you serve other specialties? And what are the needs of those practices that might be maybe a little different from oncology?

Sure. So let me start with oncology because I think this will frame up the PRISM acquisition that we announced and why we did that. When you roll the clock back to about 2006, 2007, we acquired a company called OTN that added distribution scale and distribution capability to the U.S. pharmaceutical distribution that we already had in place. In 2010, we got into practice management through the acquisition of US Oncology. And at that time, added about 1,000 providers that were in the US Oncology network. Over the next several years, we continue to add providers to the US Oncology network. Today, we have about 2,750 before Florida Cancer, which we've announced is still going through regulatory review and is subject to that clearance. But we're certainly excited about the announcement of that acquisition. Over time, we have created GPO services and GPO capabilities for those providers. All of those providers are practicing on a single EMR called iKnowMed. So you've got 2,750 providers all practicing in a clinical way with the same clinical information on the same EMR. That's given us the opportunity to leverage that data and commercialize that data as pharma looks to continue to innovate and make investments in oncology and oncology products. And we've created the opportunity for these providers to participate in clinical trials. We've expanded clinical trial access through our joint venture with Sarah Cannon Research. We're seeing higher accrual rates for these providers. And so from a platform perspective, from drug distribution to GPO services, to the data and data capabilities all the way through research and clinical capabilities and clinical trial capabilities, we've built out a very impressive platform. In other specialties, we are looking to not buy providers and managed providers. That's hard. There's not great economics around that, at least from our perspective, but in the case of retina and ophthalmology, it's an area where we're seeing more drug innovation, more drug investment and increasing levels of drug spend. You combine that with the opportunity for more clinical trials and clinical trial research, we're able to create a platform. And PRISM, we found is a great opportunity for us to build that platform. Where other therapeutic specialties have those characteristics, we'll certainly take a look at that, but we're looking to build platforms, not just managed providers.

Great. Maybe shifting gears a little bit. If we think about what that platform also offers, a lot of patent expirations coming in the specialty space over the next several years. Obviously, the opportunity for biosimilars as well in that regard. Can you talk about sort of the opportunities you see there? And obviously, we saw a big margin uplifts with small molecule generics in several waves, right, during the 2000s and the 2010s. Could we expect to see something similar with biosimilars, particularly as we think about oncology and as that moves to your specialty business over the next couple of years?

Yes. So biosimilars where we think is a great opportunity. I view this as a win-win-win. It's a win for the patients is certainly a lower cost medication. It's a win for a provider because it provides some flexibility from a clinical perspective. And from a distributor perspective, generally speaking, depending on the channel, the margin rates are higher for a distributor. In the case of biosimilars, we've seen roughly 64 biosimilars now come to market, 42 have actually been implemented in the market from a practical perspective. And in the case where a biosimilar goes through a channel where we have more influence, more capabilities, more services and GPO services, we would anticipate to have higher margin rates than perhaps a Part D where we certainly can do the distribution for those particular medications, but we don't have as many services and capabilities to offer. So our margin rates will generally be higher than a branded or a specialty drug, but they may not be as high as a generic drug or certainly a similar biosimilar that goes through a channel where we have more services and capabilities. So we have seen biosimilars go through the oncology channel already today, where we have good adoption, good conversion, generally, our margin rates are higher. And in the platforms that we're building where biosimilars will be a part of that through launches in later years through drug innovation and drug investment, that certainly would be additive to those platforms.

Maybe to follow up. So obviously, from a margin percentage basis, it might not be the case. But if we think about biosimilars, let's say, into the physician office space, like a Part B side, would you say the margin dollars are greater than sort of traditional generics?

It's really going to depend on the particular drug. But again, where there's more competition and there's more flexibility and choice, generally speaking, that leads to better economics.

Got it. Maybe just sticking with generics a little bit. Overall, when you look at the small molecule generic market, we've kind of seen a significant moderation in generic deflation. I think that we've been conditioned to kind of expect that. And if anything, we've seen a little bit of inflation in the market, or at least stabilization over the last few years. Any kind of sense on why we might be seeing that? And how we should think about that state going forward?

So I don't think about generics as a bucket. I don't think about it as deflation or inflation. When you talk about generics and you just talk about the basket of generics and put a label on that, I think that's misleading. We manage each molecule within the generics portfolio. Each molecule will have different characteristics. It will have different API formulation. It could have multiple manufacturers or a single manufacturer, the country where the API comes from or where that particular drug is manufactured. All of those things create a different and unique dynamic for each generic molecule. Within a basket of generics, you could have some molecules that are inflating, some molecules that are deflating, and we manage each one of those on behalf of our customers to drive lower cost and higher availability of supply. And we're able to create a spread on that. That's what we look to do is to source that as efficiently and as low cost as possible, and to be very disciplined on the sell side with our customers to create that spread. In any one particular year, you could have certain -- you could have a subset of molecules within the generics portfolio that are inflating. You could have a subset within that portfolio that are deflating. We manage each one of those. And over time, the basket of generics, they will deflate. That's what they do. But managing each one of those on behalf of your customers, what we really focus on, we're able to do that very efficiently, and we focus on creating a spread on each of those situations.

Okay. That's helpful. Maybe just thinking about the current period that we're in, I just wanted to ask sort of about your -- what you're seeing sort of utilization trends and particularly around what's become a much stronger flu season, right? It's really kind of kicked in here in this quarter. Just remind us sort of what the benefits we could see for McKesson as it relates to flu? Is it mostly just in the pharma segment? Or do you see more in the MedSurg segment? Just remind us a little bit and what you kind of expect?

Sure. So I'll make a couple of comments here. Generally speaking, prescription utilization has been growing. It's been very stable, and we anticipate that's what we will see through the remainder certainly of this year. There's been consistent growth and consistent utilization trends within pharmaceuticals. In oncology, we also certainly manage and measure that given the size of our US Oncology network, we look at patient visits. Total patient visits have continued to grow at a very strong rate given the acquisition of providers. But if we look at same provider growth of patient visits, that's been around 6% to 7% each of the last several quarters. So we're seeing good utilization and good visit traffic in oncology. In the medical space, through the third quarter, so December 31, our fiscal third quarter, we saw very low levels of severity for the illness season. We came into the year we typically plan for what we would call an average illness season if there is an average illness season. But looking at the last 5 non-COVID years, we sort of plan the average of that. And through our third fiscal quarter, we saw very low severity levels. That drives certainly low levels of medical products for the seasonal illness products themselves, flu test kits, COVID test kits, strep, RSV, but it also has an impact on the number of visits and interactions, which have an impact on medical surgical supplies. Beginning in January, we saw a significant increase, obviously, in the severity of the illness season. That has certainly peaked in February. We'll have to see how this plays out for the full quarter. But as we see higher levels of severity, that is going to have a positive impact certainly on our illness -- the illness portion of our business.

Got it. That's helpful. Would love to talk about GLP-1s. Obviously, I think it's a topic that everyone is also interested to hear about. It's been a meaningful driver for U.S. Pharma segment. I think in the past, you've talked about it being not significantly profitable, but certainly margin accretive -- or sorry, dollar accretive, right, in terms of profitability. With shortages, kind of supposedly being -- getting off the shortage list, would you expect then to see sort of a further uptick? Because I think when you look at, let's say, the script data, obviously, it's still growing, but maybe the pace of growth has slowed a bit, sort of what have you perhaps noticed since both of them have kind of come off the shortage list.

So I'll point to a couple of data points, to maybe help frame this. In our fiscal third quarter, in the Pharmaceutical segment, we had revenues around GLP-1s of $10.9 billion. That was growth over the prior year of 45%. To your point versus the prior quarter, our second quarter, it was $10.9 billion versus $10.4 billion. So sequentially, a little flatter. But we've seen a lot of volatility in that over the last few years. But generally speaking, we've seen growth. Obviously, 45% growth year-over-year is pretty significant. The term that we have used to describe GLP-1s within our pharmaceutical business is they have created a margin headwind for the business. They are certainly lower margin. There's higher handling costs, there's higher costs within the distribution center itself in term capacity and other logistics. And so it has created a margin headwind within our pharmaceutical business. Separately, though, we provide prior authorization services and some affordability support for GLP-1s through our Prescription Technology Solutions segment. So that's what differentiates us from others in the marketplaces. We have relationships with all the major biopharma companies for GLP-1s to provide prior authorization services. And that is done in an automated technology way right in the workflow of over 900,000 providers, over 50,000 pharmacies doing that in workflow in an automated way, those prior authorization services is very differentiated. It's a set of economics for us within our Prescription Technology Solutions segment.

And maybe sticking with that, can you just remind us then besides the prior authorization service because I think you mentioned there's some affordability kind of solutions that you also provide. Has the mix of services that you've been providing to GLP-1 makers changed dramatically -- has it changed a lot over the last several years? Were there different kind of services that they wanted from you at the beginning? And maybe this relates to the life cycle of the drug as well. If you can kind of talk through sort of what are the different services you do provide? Maybe not specific to the GLP-1 manufacturers, but maybe in this case, that's what we're talking about. And how those kind of services within Prescription Technology Solutions, whether it's just CoverMyMeds or some of the other offerings that you have, what do you do for manufacturers? And how do they engage those services and maybe how those change over time?

Sure. So our Prescription Technology Solutions segment, there's really three buckets within that, so I'll just step back for a second. We have third-party logistics services which comprise roughly 50% of the revenue within the segment. Those services are more distribution in nature. And so the margins are obviously even more distribution like. The operating profit contribution from third-party logistics is right around 5% of the segment's profits. Then we have access services and affordability solutions. And those each represent roughly 25% of the revenue of the segment. So that gets you about your 100% of revenue. And those are significantly higher margins given the technology base and the automation that is used to support those services. Within affordability as an example, we would have e-voucher services or other discount services that could be done at the point of a provider or at the pharmacy counter itself. We provide those services on behalf of the manufacturer to help patients afford their medication and stay on that medication longer. If you think about these services, we've helped some of our patients save almost $9 billion last year in terms of -- through affordability program, so significant in what we're doing there. On the access side, GLP-1s within our prior authorization services. Within the access set of solutions, roughly 70% of the revenue is prior authorizations. And within that, the subsegment, roughly 55% to 65% of that is GLP-1 prior authorization. So an important part of the business, but I think people associate our prescription technology solutions with GLP-1 prior authorizations, and the business is just significantly larger than that.

Obviously, a question that we do get is around the frequency of prior auths. Some of our survey work has suggested most people -- at least it relates to GLP-1s is sort of about once every 8 months. Just curious whether you've seen -- and it seems like, obviously, as employers try to rein in the drug spend related to GLP-1s, we're seeing more evidence of prior authorizations being put in place. Anything you can share with us in terms of at least what you're seeing internally that are we seeing more prior auth activity from plans or how is that kind of trending in yours?

So we see a mixture across different payers and employers in terms of what percentage of the drugs require a prior authorization. And we also see the frequency for the prior authorization different depending on the drug. So as an example, for a diabetic component of GLP-1, there will be a higher incidence of need for that prior authorization. But the length of time that, that prior authorization exists for could be 12 to 24 months versus the weight loss component that, some payers require that prior authorization to be updated every 8 months. So the frequency of the prior authorization and the percentage of the payers that require that can change by drug and by therapeutic area, and we certainly are capable of managing all of that.

Great. Would like to switch to the MedSurg segment actually. Obviously, it's had a challenging fiscal '25. You talked earlier about sort of the lower incidents on illness season that you didn't kind of expect. Maybe it's obviously picked up here in the last quarter. You've talked about actions to sort of right-size the business as well, driving maybe $100 million of savings through the back of fiscal half of the year. Within all that, you still sort of maintain sort of this long-term target of 10% to 12% operating income growth for the segment. Maybe reflect a little bit on what we've seen so far in fiscal '25? And sort of within the context of the long-term targets, is that still something that investors should look at as a good proxy?

So when we set the long-term target rates for each of our segments, we base that first in the view of the market that we have and the view of the end markets, but also a view in history. And in the case of the Medical Surgical business, if you look over the last 5 years, the compound annual growth rate of AOP is between 9% and 10%. And that includes this particular year, which is a softer year. So those are the factors that really help underpin the growth rate that we set. We don't make changes to the long-term growth rate within the year. We manage the business for the long term. If there's a -- if it's important or is necessary to update that long-term growth rate, typically, we would do that at the beginning of a new fiscal year. So there's nothing further for me to comment on that right now other than to give you insight on how we're managing this particular year. . We've made several investments into this business, both from an automation perspective into our distribution segment for regulatory compliance purposes as well as efficiencies. From an alternate site perspective, outside of the hospital, we have leading services and capabilities in ambulatory care, extended care, all the way to the home, and a small piece now that we're building direct to consumer. We have a strong lab business. We have a strong pharmaceutical business, and we have a very strong presence in private brand with over 5,000 products in private brand that typically speaking, have significantly higher margin rates than national brand. So we have a very good business that for a long period of time, has grown very nicely. It's very well positioned with leading positions in all the alternate sites of care. Certainly, what we've seen this year is the lower severity of the illness season. And we have talked about the fact that in the primary care space, we've seen a lower growth rate than we did certainly before and during COVID. And certainly, the cost optimization plan was important for us to get ahead of that and to take a look at what was the right structure to support that business going forward. And to your point, we announced the cost optimization plan, and we still anticipate generating $100 million of savings in fiscal '25 beginning in the second half of the year.

Any changes that you've seen maybe in the competitive environment that's become more apparent? And I guess the question being more of that, has anything changed in the environment itself, where, let's say, IDN, big health systems are continuing to buy out practices because a long time ago, you had sold off sort of the acute care business, I think Owens & Minor back in the day. And to focus on what was the more attractive part of the market, which was alternate site, has the market maybe come back full circle a little bit where health systems are now acquiring those as well? Is there a need perhaps at some point to rethink sort of how you go to market and does being back in the acute care space to provide maybe a more holistic service, makes sense?

Our focus is in alternate site, follow the patient outside of the hospital. We do have a significant presence in health systems for non-acute physicians, and we believe that we provide a tremendous service there. So ambulatory care for us is the physician space, ambulatory surgery centers, the clinic space as well as non-acute associated physicians to health systems where we also have a presence. And we think that there is a significant opportunity for us there with our Rx program, our lab program and our private brand program. In terms of competition, this has always been a competitive marketplace. It's one that we've competed in quite well over a long period of years. I wouldn't say that I see anything different today than I have the same competitors that we've had for as long as I've been with the company, are still competing with us today. They're good competitors. So it's a competitive space, but one that I feel that we're well positioned to continue to lead in.

Great. And I think in the last few minutes, I'd be remiss if I didn't want to kind of talk a little bit about sort of your thoughts on the outlook coming forward. Obviously, on the last call, you reiterated confidence in the company's ability to grow long-term, EPS at 12% to 14%, maybe perhaps stop short of talking about next year, obviously, since we're coming up on the fiscal year-end. Any reasons why investors shouldn't think '26 is any different from any other year in terms of how you think about McKesson's growth prospects?

We typically provide guidance for the next year in May. When we finish the year out, we provide the guidance at that point in time. What I wanted to do is talk about some of the qualitative factors that are supporting the business that are still in place that supported the growth of the business and our outlook long term. All of those things still remain in place today. We have a very strong set of businesses within U.S. Pharmaceutical, certainly, growth in specialty and specialty provider, the growth that we're seeing in oncology and the oncology platform, those are strong, and they still remain in place today. In RxTS, we have differentiated capabilities in technology solutions for access and affordability programs. We've seen consistent and strong growth in that segment. And we feel comfortable that we have leading positions going forward. In our Canadian business, we are very focused on the distribution and biopharma services capabilities we have in Canada. That's been a business that has performed very well for us for a long period of time, and we continue to believe that we have leading positions in Canada. Our medical business, we've talked about, we've seen obviously, the impacts of a lower severity illness season, slightly lower growth rates in the physician space than we've seen historically. But again, leading positions across alternate site; leading category capabilities in lab, private brands, so very well positioned there. And what I wanted to do is say that our outlook for this business on the long term is unchanged. We still believe that this business will continue to grow adjusted EPS at 12% to 14%. That part is unchanged. In terms of the components within each of the segments, we'll come back, and we'll give you that guidance in May, like we always do.

Great. That's really helpful. And maybe just to close out, capital allocation, remind us sort of how you're thinking about this moment. Obviously, you spent a lot of time on some M&A as well. Maybe just talk about -- just remind us again sort of where the priorities and how they kind of stack up?

Sure. So we have three pillars to our capital deployment plan. The first is we want to grow the company. We want to do that either in an organic or an inorganic way, on strategy, that would be oncology, now retina, obviously, building up that platform and it would be biopharma services. So growth is the number one capability. We also want to continue to return capital to shareholders. We have a dividend that we've been growing in relation to the growth of the business, and we've been returning capital through share buybacks. All of this is underpinned by a stable and strong credit rating, the strength of our balance sheet, which gives us capacity and flexibility.

Great. And I think with that, we're out of time. So Britt, I really appreciate you being with us, and thank you, everyone, for joining us for the session. Thank you.

Thank you.