McKesson Corporation (MCK) Earnings Call Transcript & Summary

Good morning, everybody. Thank you for coming to the UBS Healthcare Conference. I'm Kevin Caliendo, UBS Healthcare IT distribution analyst. And we are really, really proud and happy to have Britt Vitalone, who is the Executive Vice President and Chief Financial Officer of McKesson. Britt, thanks so much for coming today.

Thanks for having me.

It's been a great few years. It's been a great more than a few years, but it's been especially great few years. Maybe take us through a little bit, I want to start with North American Pharmaceutical because you've had this business for a long time. You broke it out this year. You separated the Specialty business from North American Pharma. And I was a little bit surprised to see the margins of North American Pharma stand-alone were stronger than I thought they might be ex the Oncology or ex the Specialty business. I know you rolled Canada into that. But are they -- if we go back and look, like what's changed in that business? What's made it stronger for you in the past, and we still track the generic stuff and generic pricing and generic mix and everything, that doesn't seem to be changing. So something else is improving. Maybe just talk a little bit about that?

Yes, I'm happy to. Maybe I'll just start at a little bit higher level, what we've been doing over the last several years. And we've had a number of what I would say, transformations within the portfolio, which I think is really important, it's kind of got us to where we are today. The most recent Investor Day, what we did is we resegmented our business first to help provide a little bit more clarity on where our strategies are going forward. That includes our North American Pharmaceutical business, which is our U.S. Pharma business plus our Canadian Distribution business, separating our Specialty Oncology, it's an area that we've made a lot of investment in over really the last 15 years, our U.S. Oncology business, now the addition of PRISM and building out a new platform around Vision, specifically retina and ophthalmology. And then our third piece remains unchanged is the segment, which we call our Rx Technology Solutions business, which is focused on our biopharma services capabilities. It's important to kind of backtrack because what we've done over the last few years is focusing on our strategy where we have a right to win, where we can win and then focusing on how we do win. And that's leveraging what we believe are differentiated capabilities that we have, both in Oncology, multi-specialty and in biopharma services. In our North American Pharmaceutical business that you asked about specifically, I think there's a number of factors that are really delivering this year. First of all, we've seen solid and consistent utilization over the last several years now. So it's been a consistent growth. I think the continued demographics and demographic trends and continued in innovation in drug development, drug distribution are all playing a part of that. We have continued to invest in this business and in automation and technology and capabilities that are driving operating expense leverage. And I think just the breadth of services that we have, the breadth of channels that we support, our sourcing capabilities, both on the generic side as well as on the branded and specialty side. All of those are leading to a more scaled, efficient and effective North American Pharmaceutical business. We think the continued growth of specialty and specialty drugs is also playing into that. And again, that's being leveraged against the broad platform, the efficient platform that we have.

So to that end, you're saying utilization is stronger. Is there a change in mix in any way, shape or form in the North American business? I don't want to get into specialty, but is there a mix happening there that's benefiting you or is it just the fact that you're able to leverage the OpEx line because through automation, through the investments that you made, is that what's driving the higher AOI margins?

I think there's a couple of things. I think there is a mix that continues to shift more to specialty drugs in specialty distribution. Generics are an important part of the basket that we provide as a full-line wholesaler, but the impact that generics have today is less than it was 10 years ago. I mean, there's fewer launches, although there are still launches that happen and then the growth of specialty. And so I think specialty has become a bigger part of the bucket. The scaled business that we have and the footprint that we have allows us to be more efficient combined with the investments that we're making in automation and into our distribution network. I think all of that is factoring into higher margins.

Specialty drugs 5 years ago, 6 years ago, 8 years ago, weren't necessarily moneymakers for you, right, on the core distribution side. They were treated similarly to brands. So what's changed there? Or tell me I'm wrong, but that was always the impression I had. Listen, everything was built around getting generic share. Now it sounds like specialty is a way to make money in the core North American distribution business. Is that...

Well, this started many, many years ago. We were very focused on making sure that we earn a fair value for the services we provide in each category of services. So clearly, in Generics, it's a -- there's a buy spread opportunity there, and we use our capabilities in sourcing. We use the scale that we have to drive a buy-sell spread that's beneficial for our customers as well as the company. But we've been very focused with branded products, specialty products, now biosimilar products to make sure that we're paid a fair value for the services that we provide. Regardless of price, regardless of the product, whatever is needed by the manufacturer, we negotiate with them to make sure that whatever services we provide that there's an applicable value associated with that. So there's greater focus on each individual category and each individual product to make sure that, that fair value is reflected.

And that's with the manufacturer, not necessarily with your pharmacy partners in this business, right? You're getting better economics from manufacturers.

We're getting fair value from our manufacturers. That's being reflected in the prices that our customers pay us. And so I think it's just a focus of making sure that there's fair value across all categories has been important, and it's something that we started many, many years ago.

I think we don't appreciate the automation and the costs. If you look at McKesson and take the gross profit line as you report it in the operating income line as you report it, it's been a fantastic rise in terms of the margin there, just looking at those 2 line items as opposed to the revenue number that you defined. I'm assuming that's mostly because of automation, and that's because you become more efficient. It's hard for us to see that in the outside world. Can you talk a little bit about it? And where can it go? I mean, are we at a point where OpEx can stay flat even if you're growing 3%, 4%? How much of it's tied to the actual cost? Is there more improvements that you can make maybe through automation, AI, whatever it might be?

Yes. So we've talked about this for as long as I've been with the company, the term that we've used is operational excellence. And operational excellence not only means delivering the product at the right time to the right customer at the right price and doing that in a very efficient manner. It also means doing it in an operationally cost-effective manner. Four years ago at an Investor Day in 2021, I talked about some of the improvements that we were seeing in our operating expense leverage. We measure that as operating expenses as a percentage of gross profit. And we were seeing some of the benefits of the focus that we are making at that point in time. You fast forward to this past Investor Day, we've continued to implement new technologies, new automation. We just opened a DC in Ohio that is now 90% automated. Now that's a tremendous efficiency. It's tremendous accuracy and our customers feel the benefit of that as well. But those types of investments, improved processes, improved efficiencies, improved processes in the back office, all of that is continuing to drive operating expense leverage. At Investor Day, I talked about the fact that over the last 5 years, our operating expense leverage has improved over 1,000 basis points. And it's not something that we look at each quarter. It's year to year to year, we're making the right improvements to be more efficient, more accurate and those benefits will flow through to both our partners and in the manufacturing world as well as our customers. And so I'm really proud of that focus. I think it delivers better value to our customers, and I think that we can continue to do that, the early stages of AI. We've been investing in this now for the last 18 months. The pace of AI innovation inside McKesson is picking up. More and more people are becoming aware of the capabilities and they're now introducing it into their daily jobs. In fact, I was just -- Kirk Kaminsky is here, we have a leadership meeting this week in Dallas, 2 days, and it's going to be focused on how do we use automation and AI in all of our processes. We're bringing together the top 150 leaders at McKesson to talk about that. And it's something that we believe is going to continue to drive really good benefits for the company, for our customers and over time, it will deliver more efficiency.

So in 5 years, when you were sitting back here again, you're going to talk about another 1,000 basis points of...

I think the opportunities are certainly there to continue to -- I think we're in the very early stages. A lot of the things that we're doing today are low-hanging fruit opportunities. There's more transformative opportunities, I think, out there in front of us. But again, we've got the power of thousands of people across McKesson that are now being introduced to these capabilities. And that technology mindset, I think, will pick up steam over the next several years. I'm not predicting 1,000 basis points, but we're on this journey. And I think that's going to be an important part of our story.

Got it. A couple of specific things. Understanding that specialty is so much more important than Generics. But we did notice a step down a little bit in specialty generic pricing and the data that we track in September, maybe a little bit into October. Is this something -- is there anything there, like we used to -- the first question every conference call was what's happening with generic pricing? Should we care about the nuances month-to-month or over a quarter or something in terms of generic? I know you have a spread, but I'm just saying when you -- we track the spread and it felt like the spread got a little bit tighter, yes, in specialty.

I mean, we manage the business for the long term. And obviously, we look at the same set of data that you do. I don't really worry about a month-to-month change. I look at trends over time. And I look at the underlying trends. The pricing environment has been stable. And it's been consistent, it's competitive, but it's stable. I think month-to-month, you could see variations for a whole lot of different reasons. It could be mix related. It could be the introduction of a new product. If you look at it on a year-to-year basis, there's good stability in the pricing environment.

Pricing has obviously been a big factor, a big headline over the last couple of months with TrumpRx and everything else. So maybe it's a good transition to talk about it. And what was announced on Friday with the GLP-1s and how that could impact you. Do you see any way where government gets involved in Medicaid pricing or TrumpRx has a list price where prices are clearly lower than what they -- does this impact you guys in any way, shape or form? Maybe first on the core North American Pharmaceutical business, and we can talk about specialty and RxTS.

Yes. So we're going to continue to work with the manufacturers to be paid a fair value for the services we provide. So if there's a distribution of one of these products regardless of whether it's on TrumpRx or it's going directly from the manufacturer from us to a patient, whether it's direct-to-consumer, again, where we distribute that product, we'll be paying a fair value for those services. So we don't see any direct impact from the announcements that happened on Friday or similar ones that we anticipate could happen. So direct-to-consumer as an example, has been around for more than a decade. We have plenty of capabilities that would support continued expansion of direct-to-consumer. It's pretty small today. We expect that it's going to continue to be a pretty small component of overall pharmaceutical distribution. But we have a lot of capabilities to support this. On the distribution side within CoverMyMeds, we have Central Fill as a Service where as a patient, we can direct your prescription to your particular pharmacy of choice or to your home. We have pharmacy capabilities with Biologics by McKesson, where we have an independent specialty pharmacy distribution arm, which can again support rare and oncolytic type specialty drugs, where we can send it directly to a patient's home as well as well as the clinical support services that go with that. And then we have a number of pharmacy-related capabilities through CoverMyMeds, which really in a comprehensive way, try to integrate what's necessary with a brand manufacturer's patient portal. It could be helping with the intake, the fulfillment and the distribution of that back to a particular patient. So it's been around. It's been pretty small for a number of years. We anticipate it will continue to be small. But we are aligned with an array of assets that would support this going forward.

So what I understand getting paid your fair value for what you do. I know you also get paid for working capital and taking on working capital, right? And so if the price -- are you still getting that part of your fee based on what the price -- the list price is or what the price is, I don't want to say post rebate or post discount. You understand what I mean, if a GLP-1 is $1,000 and you're taking on $10 million worth of it, the working capital fee or this does not matter because it's such a small piece of the fee that you're getting. I'm just wondering how the working capital aspect changes? And is that, in any way, affect your profitability on a script?

So we're paid a fixed fee for service for the fair value for those particular products. If the cost to us to deliver that is, let's just say, $5, it doesn't matter whether the cost of the drug is $1,000 or $100. We're still going to be paid a fixed fee for service based on the fair value that we provide. In terms of the working capital, again, it's -- we take on that responsibility to manage the inventory as well as the receivable. We still have to be efficient in that. Again, regardless of what the price of the drug is, we're still managing that working capital on behalf of the manufacturer and on behalf of the customer and the efficiency that we do that is going to drive a cash outcome. And so we're very focused on having efficient working capital.

So if I'm thinking about this same drug, lower price, lower working capital, your margin actually will look better presumably because you're still getting that fixed fee. I mean, I know we're talking about a small thing. I just -- understanding how this works for you has always been a little bit complicated. Let's talk a little bit about Oncology and multispecialty. At Analyst Day, you talked about some of the deals that you've done, including the addition of Florida Cancer Specialists. Is there more opportunity in Oncology? It feels like the biggest assets have been scooped up by either you or your peers. But is there more opportunity there? And you also said at Investor Day that you were going to start looking at other specialties. Maybe talk about what those might be because I have some questions about that.

Yes. So we're really pleased with the platform, starting with U.S. Oncology that we've built really now over the last 15 years. And we -- now with the addition of Florida Cancer, have a little over 3,350 providers in the network that are providing clinical services in over 27 states. So there is still some opportunity in certain geographies for us to go into. I think the largest players have probably been spoken for or signed at this point in time. But there's still opportunities for us to continue to add in certain geographies. What we're really focused on, though, is what kind of value can we provide for these providers, whether that be through drug distribution, through the GPO services that we provide. Certainly, there's a lot of clinical data that's available for clinical practice that the providers provide as well as upstream information for the manufacturers as they look to continue to innovate within their drug pipeline. And then there's the clinical trial side of this. There's a lot of clinical research being done in Oncology. I think there's 41% of all new drug trials are still focused on Oncology drugs. So we have an opportunity there through our Sarah Cannon Research Institute joint venture to continue to provide clinical trial access, site management, clinical trial management, which will help the over 1,300 research providers today that are doing research and clinical trials within the network. So we think that the opportunity with drug distribution is still good. We think the opportunity to grow some of these other services, whether that be data, whether that be clinical trials, some clinical research capabilities is still that next leg for us. At Investor Day, we talked about the total opportunity being about $115 billion, about $80 billion of that, we estimate is drug distribution. That leaves a wide opportunity for us in some of these other platform building capabilities. And you mentioned other platforms that we're looking at. What we're focused on is moving in and building platforms where there is high innovation, high drug spend and the ability for us to build a platform around that. We're not looking to just go out and buy a bunch of providers in a particular therapeutic area. There's practice management associated with that, but it's hard to manage providers. And the economics and the return on invested capital for that, we don't believe is high where you can build a platform around drug distribution, GPO services and clinical research and clinical capabilities, we believe the return is good there. We think that retina represents that opportunity for us. There's good drug innovation. There's increasing drug spend and there's a lot of clinical research in that area. So we believe beginning to build that out is going to be another platform for us to deliver a lot of value through.

Okay. A couple of follow-ups here. Do you have all the assets that you need to provide the services to these providers or -- that you need to have, that you just described, $115 billion. A couple of years ago, I remember there was a lot of chatter for lack of a better term around McKesson being interested in CRO or CRO-related assets.

I never heard that.

I know you only had to address it about a 100 times. But you did say CRO -- certain pieces of CROs you were interested in, do you feel now that you've developed those capabilities to provide all these services at this point? Does McKesson have what it needs?

So what we are interested in is where there are clinical capabilities within the areas that we've chosen to build platforms on. So going out and being a general CRO would be difficult. There's strategically where there are capabilities that support Oncology or Retina or Ophthalmology that makes sense because we're building a platform around that. I think the Sarah Cannon Research Institute JV is a good example where we identified an opportunity for us to add capabilities around expanding clinical trial access, expanding site management. That's a good example of adding to the platform. I think there will be other opportunities for us to add some of these clinical capabilities that support the platforms that we're building around Oncology, Retina and Ophthalmology.

With these provider assets that you have, have you ever contemplated going at risk with the providers or just you simply just comfortable with the current reimbursement model? And I say that, I'm not talking necessarily about value-based care. But when I -- when you had your partnership with Optum, right, they love to be innovative. You guys love to be innovated out. The first thing I thought was, hey, maybe there's going to be something they can do in Oncology here where both sides would benefit, right? There could be -- now it's -- I don't know that the world wants to hear you guys would be doing something like that. But have you thought about it? Is there an opportunity either in that relationship or broadly with the assets that you have to maybe benefit for some of the care providing that you do in and above just getting paid for the services?

Well, what I would say is that our providers are already doing a lot of value-based care. The Oncology care model is a good example where we had a significant portion of the providers within the U.S. Oncology network participate and drive a significant amount of savings. And in the enhanced Oncology care model, we're seeing similarly that U.S. Oncology providers are participating at high levels and driving significant value. That's a choice that our Oncology providers make to do value-based care or not. And we're seeing that they're leaders in value-based care. In terms of getting more innovative, I mean, certainly, we have -- one of the things that we talked about at Investor Day is we have large customer relationships, how we can deepen and broaden those relationships out over time. HCA is a good example. We started with the Sarah Cannon Research Institute joint venture, where we could build out more clinical capabilities around Oncology. And that extended into a distribution partnership. Similarly, we've seen that with Walmart and with other customers where we start with a particular aspect that we have good skill and capabilities in. And over time, if it makes sense, we will broaden that relationship out. In terms of your specific question, I don't really have an answer for that today. I mean, I think we're always open to areas where we have skills and capabilities, and we have differentiation that we can build on. That's not one that we have looked at today. In the future is that one that we could look at, possibly, but it's not where our focus is today.

You sort of answered a question that I had when you said you have certain -- when you're looking at new specialties, which you said at Analyst Day, some of the things they need to have is high drug spend. We get in Ophthalmology, we certainly get it in Oncology. It's hard to understand, are there other specialties out there that have a lot of high drug spend? And the 1 area that I've heard private equity has been scooping up everything is sort of infusion centers, right, which would have a high amount of drug spend. But I don't know that, that's necessarily what you're talking about, but it feels like there's something going on in that world as well. What other specialties have that kind of spend or can you talk maybe a little bit more broadly, what goes above and beyond Ophthalmology and Oncology in that space?

Yes. Well, look, we start with every year, we go through a 3-year process where we look at the drug pipelines in both branded areas, specialty area, biosimilars and generics. And from that work, we look and see where the concentration of innovation is going to be where the pipeline is going to be in. What we see today is that Oncology still has the largest spend and the largest innovation in it. We see new drugs coming to market, even biosimilar type drugs in the Vision space, so that was obviously an opportunity for us. Those are the 2 areas that we see today that make the most sense for us to build a platform around. There's a lot of research going on in other therapies. But in terms of the drug innovation and drug spend on the market, it's not there today, certainly could be over time. So we look at the pipeline on a regular basis. If there's a particular therapeutic area that shows promise from an innovation and drug spend perspective, that could be an area where we could build a platform around. But the 2 areas that we're focused on today are in the Vision space as well as in Oncology.

So infusion by itself as an infusion center or whatever, that's not an interesting opportunity for McKesson?

It's not something today that we have spent a lot of time on. But again, we look at a lot of different things, and we try to assess whether there's an opportunity and whether there's a breakout from a growth perspective. I can't really say why private equity does what they do. They have a lot of capital to invest.

Fair enough. The 3% operating margin in the specialty in Oncology and multispecialty business was a little bit lower than I was expecting it to be. For whatever reason, it doesn't matter. That's my opinion. But the -- when we break out how to think about the margin between the MSO and the GPO, I know this is something you don't necessarily want to get into a lot of detail about. But how do we think about -- how big is the GPO? Does the GPO just service McKesson oncologists? Are you outside of the 3,300 oncologists that you have in purchasing for more? How does it work? Can the MSO work without the GPO? Can the GPO work without the MSO?

Well, there's a lot to unpack in there. I would say that when we build out a platform is to build out a whole breadth of services, GPO being one of those. The GPO that we have today services thousands of multi-specialty providers. So outside of the U.S. Oncology network, there are multi-specialties that access and utilize our GPO as well. So from that perspective, it is a -- I think it's a scale GPO that many benefit from inside of McKesson and outside McKesson relationships. That's maybe how I would answer that. I mean, back to your question on the margins, again, today, a lot of the platform is still driven off of drug distribution. And so again, we were paid a fair value for the services that we provide for those particular drugs. Over time, we see more and more growth beyond just drug distribution, and I talked about that already.

Got it. I think one thing that we look at as we see a drug like KEYTRUDA, which I think has been a big driver of oncology drug spend. It's a fantastic drug. It's used in a lot of different indications. I'm sure your GPO is purchasing a lot of KEYTRUDA. What happens -- KEYTRUDA's on the IRA drug list, right? We know that. What happens when that price goes down or the biosimilar comes? Can you just sort of explain how it impacts the GPO and MSO aspect? And this isn't until 2028, right, or 2029 when this is going to happen. But just mechanically, what happens to McKesson when that happens?

So you have 2 different things in there. So let me just parse those out. You talked about biosimilar.

[indiscernible] at the same time, there could be a lower [indiscernible]

Yes. So let me just -- let me bifurcate those. From a biosimilar perspective where there are drugs that go biosimilar that we provide more services to support those that would go through the U.S. Oncology channel as an example, where we provide more services, more GPO services, more wrap around services on the platform, our economics are going to be better than they would be for the innovator drug itself, generally speaking. So channel matters from that aspect. Biosimilars are going to go through the retail channel, if you will, a Part D drug where the services required by McKesson are less, our economics will be lower than -- they're probably better than the innovator drug themselves, but they won't be as high where we're providing more services. That's the biosimilar aspect to that. In terms of KEYTRUDA itself, I mean, I think we're kind of speculating on what will happen here. My understanding is that drug has been pushed back to 2029 for MFP pricing. What that price looks like, I couldn't speculate on that. Is that going to be the same as the particular price that ASP is reimbursed at today? I don't know the answer to that. If it is a lower MFP price, those units will be part of the overall ASP calculation and there will be reimbursement impact from there. I also can't tell you what's going to happen to the reimbursement for providers because we fully believe and we believe that many others see the same trends that the most efficient and economical place provide cares in the community. And so we believe that whatever changes are taking place today is not intended to impact community providers. So I think we have a number of years to see what will happen. But in terms of where community providers are placed, we still think they're the most effective and the most economical.

We have about 5 minutes left. And I want to talk a little bit about Prescription Solutions. The announcement on Friday about GLP-1s coming to market at a lower price shouldn't affect RxTS. It may actually help, right, if there's maybe more prescriptions depending on how it works. Do you anticipate there being any change from payers in terms of what they're interested in doing in terms of prior authorizations? Or any change just from a lower price, maybe there's more prior authorization. What do you expect the impact to be on RxTS just simply from lower GLP-1?

You're going to hate this answer, but I don't know the answer to that. But what I can say is that it could actually open up more coverage and more coverage could be more volume that goes through the system. Now the prior authorizations are typically different, whether it's a diabetic product versus a weight-loss product. There could be different restrictions on a diabetic product versus a weight loss product, the time to renew the prior authorization for a diabetic product versus a weight loss product. That time could be different, and that changes payer to payer. So I think it's a little early to say what the reaction is going to be putting these on the Medicare platform themselves, making them available to more Medicare patient could open up more volume. I think we'll have to see how that plays out.

Has there been any change in the economics to McKesson over the last year from GLP-1s in terms of what you get paid for a prior auth and a second prior auth or anything like that? How has it worked? I know GLP-1s are not as important as they were for Prescription Solutions, but I'm sure they're still important. I'm just wondering how they've changed.

Well, it's going to depend on the manufacturer. It's going to depend on the specific product. And it's going to depend on what the manufacturer is looking to drive out of those products. Do they just wanted a basic initiation and submission for the prior authorization? Certainly, there's going to be economics around that. Are they looking for help with appeals or denial conversions or rejects or services to support that prior authorization monitoring, reporting? So there's a whole host of adjacent products to support a particular product, depending on what the manufacturer is looking for, depending on where it is in its life cycle. So yes, economics will change depending on like any other prior authorization really depending on where the product is in its life cycle, what the manufacturers' needs are to support that particular drug.

Do you think there'll be any difference for you with -- when oral solids come to the market versus injectables?

There could be. Again, it's going to depend on what restrictions are necessarily placed on those particular drugs, what services are going to be needed. So there could be.

Okay. I want to ask because we only have 2 minutes left, but is there any messaging -- we're through 2Q, 2 quarters. I know the way the guidance has played out, it was pretty clear. Is there anything we should think about in terms of seasonality, anything to consider for the second half of the year? I know you and I talked about the step down in the pharma growth, but you said there was no change in the actual LRP. This is just adjusting for Optum in the deals. But is there anything else we should think about in the second half of the year for this year in terms of the guidance, seasonality tax rates? I know things move around a lot.

Yes. So we're really pleased with the performance that we've had thus far this year. If you look at our guide on adjusted EPS, $38.35 to $38.85, that's 16% to 18% growth. And when you exclude the McKesson Ventures gains that we had last year in the first half of the year, that really represents 18% to 20% growth. So that's above the long-term ranges that we provided. So we're really pleased with that. To your point, there are a couple of things in the North American Pharmaceutical last year. We had the onboarding of a strategic customer in the first quarter of the year. So we're obviously lapping that in the first half of this year. And in the back half of the year in our Canadian business, which is now part of this segment, we had the benefit from held-for-sale accounting for Rexall and Well.ca, so we're going to be lapping that in the second half of the year. We have some investments that we're making that we talked about that are going to increase in the second half of the year in our Rx Technology Solutions business. And then the tax rate, as you mentioned, we've got an 18% to 19% full year tax rate. We anticipate that the third quarter will be 23% to 25%. And that it's really related to the mix of our business and the timing of discrete items. But again, that 18% to 19% is relatively in line with what we provided slightly higher with the third quarter being a little bit elevated.

Sir, thank you very much.

Appreciate it. Appreciate it.