McKesson Corporation ($MCK)

[indiscernible] health care tech and distribution analyst here at Bank of America. We are delighted to have McKesson here. We have Britt Vitalone, Executive Vice President and CFO. Thank you, Britt, for joining us.

Kicking off with the North American pharma business. We've gotten a lot of questions just around what, if anything, has changed as we went from 2025 to 2026. As we think about utilization, drug price changes, as you think about going from 2025 into 2026 in that North American pharma business, has anything changed? Is there a deration at all going on within that business as we think about gross profit dollar growth? And we'll start there.

Yes. First of all, thanks for having us here today. And maybe I'll just step back and say we're really pleased with how we finished our fiscal '26. We had a very strong fourth quarter in terms of revenue growth, adjusted operating profit growth and adjusted EPS. We had 3 of our 4 segments have double-digit adjusted operating profit growth. And for the full year, not only do we have strong revenue growth, but we had 15% AOP growth and 18% EPS growth, all above the long-range targets that we set. So there's a lot of really good momentum in the business. As we think about our North American Pharmaceutical Distribution business, we continue to see stable and growing utilization. That's really one of the foundational building blocks for our business. So that continues to be strong. We continue to see innovation and growth in Specialty Pharmaceuticals. We're very well positioned there. We have a very scaled set of capabilities there. Our Specialty Distribution now is over $100 billion and growing. So we're pleased with the growth there. And it's not only across our North American Pharmaceutical Distribution businesses and health systems and retail, but also across our multi-specialty business, including oncology. We're continuing to see growth in GLP-1s. As part of that, the GLP-1s last year were roughly $53 billion in revenue, which was well over 25% growth. Sequentially, we did see a slowdown in the fourth quarter, but it still was over 20% growth in the fourth quarter, and we expect and anticipate that GLP-1s will continue to grow. We have a strong customer set. We have strong relationship with manufacturers. So all of those building blocks are in place that are supportive of not only a strong fiscal '26, but the guidance that we set for fiscal '27, again, from an adjusted operating perspective is at the upper end of the range for the long-range targets that we set. In terms of what are we seeing a little bit different, clearly, we saw some manufacturer list price or WAC declines in the fiscal fourth quarter, which I would just remind you, they have a revenue impact. But from a gross profit and adjusted operating profit perspective, really no impact. Again, just to remind, we are paid a fixed -- we are paid a fair value on a fixed fee-for-service basis for the services that we provide on behalf of the manufacturers and their products. And so if there's a change in that WAC or list price, it doesn't have an impact to us. we retain the value through that fair value of services that we provide. So yes, there's a revenue impact. But underneath that, there's stability in prescription transaction volume. There's retention in terms of the fair value for the services that we provide. And in fact, in the fourth quarter in that segment, we saw adjusted operating profit margin expansion of 9 basis points, which I think is supportive of those comments. So we feel very well positioned very scaled business, and it sets up very nicely for the guy we put forward for '27.

As we think about some of those moving pieces, you called out the IRA WAC price changes. You called out GLP-1s. As we think about the fiscal 2027 guidance and we think about the free cash flow guidance and the change there year-over-year, are either of those 2 items impacting free cash generation? When we typically think about McKesson's business, we don't really look too much at revenue. It's more about operating profit growth. But as we think about the working capital and free cash flow generation, is IRA or GLP-1 sales, are those impacting the change in cash flow on a year-over-year basis? Or is there something else going on there?

Yes. I mean from year-to-year, actually from quarter-to-quarter, our cash flow can have variability really related to the timing and the day of the week that the quarter ends on. It could be reflective of changes that we make to our own internal business and fiscal '27 is an example -- or '26 as an example. We continue to use automation and AI tools to develop more and more efficient ways of managing our working capital. We think that that's going to sustain itself over the next few years. So as we continue to grow profitability, our cash flow will continue to follow that. If you really look at a moving average over the last 7 years, you're going to see growth. And you're going to see growth that is in line with the growth of the business. So we think about it more from that perspective rather than quarter-to-quarter. The free cash flow generation continues to be strong. The conversion of our working capital to free cash continues to be quite strong. And that really puts us in a strong position from a balance sheet perspective and the flexibility we have to deploy that. So all of these things that are happening, we can manage through that through our efficiency of working capital and the working capital management, and we've done that quite well.

There's been a lot of investor questions around STELARA, similar to the questions around HUMIRA a couple of years ago. And what the large PBMs are doing there. Can you just talk about the level of profitability of those specific drugs. And as we think about the pipeline for Part D drugs, can you talk about how big of a market there is for those Part D biosimilars and whether or not there's any potential impact to your business?

Yes. So again, these are large revenue drugs, where we're providing a set of basic logistic and supply chain services for that. From a profitability perspective or from a margin rate perspective, they're going to be lower margin rate as a result of services that we provide, and of course, the size of the revenue. We believe that biosimilars are going to be a long-term opportunity. We are supportive of biosimilars because they offer more choice. They offer lower-cost options for both clinicians when they choose the drug that they're going to practice with as well as lower cost to patients. We think that they provide more operational simplicity, more efficiency. So as these drugs convert over to a biosimilar, it's really supportive of access and affordability, which we're -- which we support. As you think about biosimilars, the channel that, that drug goes through does have a determination on the profitability. So if you think about a retail channel where there's fewer distribution and logistics services that we provide, the margin rates that we're going to earn on that are going to be lower because again, they're going to reflect the fair value of the services that we provide. In the case of it going through a channel where it might be a provider channel where we provide more services, GPO services, other wraparound services, we're going to be delivering more fair value, and that's going to be an opportunity for greater margin enhancement for us. But most importantly, better access and more affordability for clinicians and for patients. So as these things happen, they have a bigger revenue impact. Depending on the channel that these drugs go through, that will determine really the margins for a distributor like McKesson. Generally speaking, biosimilars are going to have better margin opportunity than the innovator drug.

I want to move on to the oncology part of the business. You've owned U.S. oncology for a very long period of time. So you have a lot of perspective here that others may not have. Can you talk about some of the historical biosimilars in oncology, Avastin, Herceptin, Rituxan that went biosimilar? As it relates to your MSO, your provider business, can you talk about the economics at the MSO level, at the provider level. When those drugs go biosimilar, does that improve the economics of the practice? Would love to get a sense of what the history is with those drugs in that setting.

Yes. Well, I'm not going to comment on the economics of provider. That's not really appropriate for me to do. What I will do though is talk about the relationship that we have with the providers and what we do. What we do is the scaled capabilities that we have to provide distribution services as well as GPO services that provide more choice to the clinicians. So if the clinician decides for clinical purposes that they want to practice with the innovator drug, they can do that. They want to practice with the biosimilar, they can do that. Our job is to provide them that choice, that availability on stability of supply and low cost. The clinicians make the choice. We do not practice, we do not make clinical choices. But we do everything else to be supportive of the practice and the decisions that they make. And so we believe that, generally speaking, biosimilars offer that additional choice and at a lower cost, and also with good supply stability. So I don't want to comment on the provider economics themselves. They make those choices on those 2 parameters of clinical decision-making as well as cost, we provide all the services that allow them to make that right decision.

A similar question. McKesson recently added a biosimilar to its North Star portfolio Stimufend, a biosimilar for Neulasta. Can you talk about that product specifically? It's sort of a change in strategy for McKesson a little bit going into -- so talk a little bit about the strategy there? And what is the initial demand from customers look like there?

Yes. It follows right on what I was just talking about. We've had North Star for many years in the generic space where we think that we can provide opportunity in terms of choice, lower cost, better supply stability. That follows on in the biosimilar space. Again, what we're doing here is we're selecting a drug that we think that we can provide supply stability at a low cost for clinicians to make that choice. And so this is our first entry into this. Again, the clinicians will determine whether they want to practice with this biosimilar that we're producing or not. But we believe that it gives them additional choice, operational simplicity and stability of supply. So that's really what the strategy is here is it really follows on. When we talk about what the mission at McKesson is, very important in that is access and affordability, access and affordability in our provider space, access and affordability options in our prescription technology space. So providing a drug like this and producing a drug like this really falls right into that.

Okay. And I'd love to compare that Neulasta biosimilar with the forward outlook for biosimilars in that clinic setting. There are several large biosimilar launches that are going to take place over the next several years. I would flag KEYTRUDA in oncology and EYLEA in retina. Is it reasonable to assume that McKesson could pursue a similar strategy as with the Stimufend? Or is there something different about those specific medications that maybe you wouldn't pursue that type of opportunity?

Yes. I think it's something that we'll evaluate. Obviously, we're very early into this particular drug. So we want to learn from this and see what the reception is to this. And over time, if we think that it's going to advance affordability and access. We think that there's going to be receptivity to the additional choice that's available. I'm sure it's something that we'll study, but again, anything that's going to advance access and affordability, better choice, better stability of supply, better operational simplicity, those are things that we will study and evaluate.

And then the last question on the oncology and multispecialty business. You've been very acquisitive over a period of many years here. would just like an update on what the pipeline looks like there, how you think about where M&A fits within your capital deployment strategy, if there's any change there versus maybe a year ago?

Yes. So let me start with our capital deployment strategy to begin with and I'll kind of fold this in. We think about capital deployment really across 3 main pillars. Our primary priority is to grow the business. We can do that through M&A. We can do that through organic investment. We do both. As we think about growing the business, we want to make capital deployment decisions that are on strategy. So those strategies are growing our oncology multispecialty business growing our biopharma services business. And of course, they have to have the right financial return and profile. Where we can find those opportunities, we're going to deploy capital against that. Secondly, if we can't find those opportunities, we're going to be efficient with the balance sheet. We're going to return capital to our shareholders through share repurchases. And we're going to continually do that where those opportunities are, and we're going to continue to increase the dividend in relation to earnings growth. We think that, that's important to do as well. All of this is underpinned by a strong balance sheet. And our balance sheet, I think, is as strong as there is out there. It's a BBB+ rated. It's got a lot of flexibility to it, and we think that is supportive of the capital deployment that we have in place. As we think about oncology and multi-specialty generally, and I'm speaking mostly to retina and ophmology, we think that there's still opportunities to add providers and practices. Recently, we added Cancer Care Northwest, the Usan network. We've added a couple of opportunities here to our retina and ophthalmology, most recently Retina Macular Institute. So we're expanding that we're where providers practice similarly to the platform and where we think that there's opportunity to grow in geographies that make sense for us to do that. And we think that there's going to be continued opportunities to deploy M&A dollars against that.

That's great. And then shifting gears to the RxTS segment. You gave first time fiscal '27 guidance, low to mid-single-digit top line growth but really strong AOI growth within that segment. Can you unpack the drivers of the revenue growth there? It's a pretty material deceleration versus fiscal '26, but there's a lot of different businesses within RxTS. What's driving that change in revenue growth? And how should we think about the cadence of revenue growth over the course of fiscal '27?

Absolutely. To your point, there are a couple of different businesses within that segment. From a revenue perspective, roughly 55% of the revenue is comprised of third-party logistics services. Those services are more distribution like other services that we do, obviously, for biopharma. The contribution to AOP or adjusted operating profit from third-party logistics is less than 5%. So big revenue number, low contribution to overall segment adjusted operating profit. There's a lot of variability within third-party logistics. It could be the timing of a program launch. It could be a delay in a program launch. It could be a delay in a product launch. So even within third-party logistics, you're going to see variability from quarter-to-quarter. And again, it's 55% of the segment. The rest of the segment is made up of access services, such as prior authorizations, affordability solutions, things like e-voucher and other discount type cards and affordability programs. And those are all technology driven, so they have better margin profile. We're seeing really good growth in both of those businesses. But again, there could be variability from quarter to quarter depending on the timing of a product launch, the timing of a program launch. It could be the requirements that are necessary from a payer or a formulary requirement. It could be investments that we make into these business. We've been expanding our capabilities, whether that be in prior authorization as an example, adding capabilities like denial conversion and reject conversion and reporting lots of different things that we're now adding into port of these programs for manufacturers. We're continuing to see brands being added to our technology businesses. I think we added over 40 new programs last year as an example of the receptivity to the programs that we have. Again, specialty is growing the fastest of all the product categories that fits right into the technology services that we have, which are supportive of access and affordability, mostly for specialty drugs. So quarter-to-quarter, we're going to have some variability on the top line. But if you look at the growth in adjusted operating profit and the growth in the margin rate of that business are both expanding and they're expanding above the long-range target growth rate that we set. So we think that we're well positioned despite some of the variability that you're going to see on the top line, which is driven mostly from the distribution side of the house.

Yes. The AOP growth was really, really strong for fiscal '27 relative to our expectations. And I want to talk about probably your favorite topic, which is GLP-1s. As we think about prior authorizations, going from calendar '25 to calendar '26, or I guess, fiscal '26 to fiscal '27, there's been a very rapid shift in the beginning of calendar 2026 from insurance covered to direct-to-consumer offer GLP-1s. And based on our math, and it may not be completely accurate, but what we saw at the end of 2025 is that GLP-1 insurance-eligible scripts were growing 70%. And then in January, that slowed to high single digits. We'd love to get a sense directionally about the GLP-1 prior authorization momentum you're seeing in the business, is it slowing materially as you've entered calendar or fiscal '27. You said on the call that it's still growing, but would love to kind of unpack that a little bit more if it is slowing, maybe a little bit more.

Well, first of all, when we talked about the distribution of GLP-1 medications, we did see a sequential slowdown from our third fiscal quarter to our fourth. Again, we are going to see variability from quarter-to-quarter. We've seen that over the last 3 years. In terms of the prior authorization business, that continues to be very strong. And we are seeing now the adoption of orals and that coming into the market early days. But what we're seeing on that aspect is that orals are actually additive to the overall GLP-1 market, not taking volumes away from injectables, we're seeing that being additive. Over time, there could be an expansion of the availability of these drugs through Medicare. That certainly could be an opportunity depending on what the requirements are around formulary restrictions or other payer restrictions or formulary requirements. We continue to see good growth in that business. And so I think we're not seeing any slowdown at this point. From a direct-to-consumer basis, it's still a fairly nonmaterial number to the overall overall population of GLP-1s. We do have some opportunities on the direct-to-consumer, where we do some back-end pharmacy-related services and fulfillment services. for cash payer direct-to-consumer. So there's multiple different ways that we're involved in this process. We think the market is still growing. And there's still an opportunity for not only in the distribution side, but in our prior authorization side to continue to see that expansion through '27.

Is -- you mentioned Medicare Advantage. Is McKesson involved in the Bridge program? Or does that get outsourced to the MA providers? How does that...

We're not involved directly in those programs.

Okay, got it. But if there is expansion to Medicare Advantage plans for GLP-1s and prior authorizations are part of it, would McKesson be...

Yes.

Okay. Got it. And then another thing -- another question that we get is just around the prior authorization revenue model. Just from a high level, we talked about the direct-to-consumer offerings. If the -- in a -- let's use an example, let's say, a patient goes to a direct-to-consumer platform that adds an eligibility check on that specific DTC option. They go -- it goes through, but it says they are denied and then they ultimately get a direct-to-consumer script for a GLP-1. Can McKesson still get paid in that scenario where someone is actually not going through and getting approved and they actually go to the direct-to-consumer channel?

As I mentioned, we do have some back-end fulfillment services that we provide to that channel. If there are prior authorization services required, as we've mentioned before, we have the relationships with the manufacturers on the majority of these GLP-1 programs. As I also mentioned, we have products like denial conversion and handling rejects and other reporting. So we've continued to expand our offering to help supplement and make sure that there's higher adherence to these drugs in supportive of the programs that the manufacturers provide. So yes, there is opportunities for us in the DTC channel. It's maybe a different type of fulfillment service that we would do rather than just the general billable GLP-1 prior authorization, but we have expanded our capabilities outside of that.

Great. And then this is around the RxTS business, but maybe it's even a broader question. You talked about AI and automating some manual or human workflows. And I think over the past couple of quarters, you've talked about during the blizzard season, each employee has been able to handle more transactions to manage costs. Can you talk about where McKesson -- or I guess, first, what is McKesson spending money on there that's driving the improvement in margins? And where are we? If this is a 9-inning game, how do you think about the opportunity to continue to leverage AI with that specific use case in mind, but maybe even more broadly for the rest of your business?

I continue to be fascinated. All investors are baseball fans, but I used to watch baseball, but I don't know what inning we're in. I'd say we're in the early innings, maybe we're in the third inning. AI is something that we've been focused on. And I wouldn't just say AI, AI is just used as a term ubiquitously, but wherever there's an automation opportunity, it could be robotic process automation, it could be AI, it could be some other automated aspect here, we're looking to implement these across the business. It could be automation that we're doing to better -- do better demand planning and supply chain logistics. It could be AI, in our oncology practices where they're using Ambient Scribe as an example. Certainly, in the RxTS business, it could be AI to further the technology and the automation that we already have in place for our solutions. It could be chat bots that are used in a call center where we used to have humans. It could be lots of different ways. Wherever there's human or manual processes and there's an opportunity to make it more efficient, that's an opportunity for us that we're looking at. So I think a lot of these automation opportunities and AI opportunities play right into the strengths that we already have in our RxTS business.

Got it. I'm not a huge baseball fan. What I'm going to say it's the end of the first period about...

There we go.

As we think about the LRP, you reiterated the LRP this quarter. Can you talk about the sources of confidence, maybe just a high-level overview of what informed the reiteration of the LRP this quarter?

Well, I think it's several things. It's the consistent performance in the results that we've shown for several years now. It's the building blocks that I talked about. It's stable and growing prescription utilization. It's continued growth of specialty drugs and specialty drugs across not only our North American pharmaceutical, but across specialty and multi-specialty providers. It's the continued opportunities that we see in our access business and our affordability business. So all of those things play into sort of the key building blocks. I would say that another important piece here is the operating expense leverage that we've been able to drive over the last several years on a consistent basis. Some of that is borne out of the automation solutions that we've put across our business to be more efficient. I talked about in the last quarter that we saw a 293 basis points of operating leverage as you think about operating expenses as a percentage of gross profit. So we're continuing to drive more efficiency through our operations. All of those things give us confidence that not only did we reiterate our long-term growth targets, but our guide for this year for each of our 3 core segments is slightly above or at least at the high end of that range. So we have good visibility into fiscal '27 to place those growth rates in that outlook at the high end of the range.

And then moving on to the MedSurg segment. Would love high-level comments on the deal [indiscernible] on that agreement with Apollo. What was the rationale for that? Can you provide any more commentary on the terms of that deal? Who came to who? Any additional information would be helpful.

Yes. So we're about a year now since we announced our intent to separate the business. In that year, we've done a lot of work. So we have -- the business is now operationally and legally separate. We've worked on putting in place TSAs to run that business on an independent basis. We've got audited carve-out financial statements, which is no small task, a lot of work there. And we've done the first leg of putting in an independent capital structure. So we put a revolving credit facility in place in our early April as well as some term loan A issuance as well. We plan on doing more in the first half -- the back end of the first half of this year. All of that is really foundational for us. We thought the opportunity to add somebody like an Apollo and the Apollo Funds who has experience in some of these complex carve-outs and certainly have both the operational and financial experience and in the public markets experience would be additive to the business. And certainly, it credentializes the business, it sets a valuation target and a valuation number that we think is important to have in place. And we think that they'll bring a lot of experience to the Board operationally, but also their experience with some of these complex carve-outs and certainly with the public markets.

Sticking with MedSurg here. Can you talk about how does the volatility in commodity prices impact the MedSurg business for basic products like gloves and surges? And how should investors think about that moving forward?

We've seen volatility in commodity prices, fuel prices really over the last 10 years, it's been pretty constant in the business. So I think we do a good job managing through that. We have lots of manufacturing partners that allow us to manage through that. We're -- I think we've done a good job of managing the cost side of it and certainly protecting the margin side of it. So this -- certainly, there's a little more volatility now than there maybe has been in the last couple of years, but volatility in these types of products in fuel and transportation costs.

Last question here with about a minute left. Just on the utilization. There was always someone there who lived it with you. We did because everything feels more possible and someone has your back.