McKesson Corporation — Form 10-Q Summary
Reporting period: Quarter and nine months ended December 31, 2017 (McKesson fiscal 2018 third quarter and year to date). Amounts are in U.S. dollars unless stated otherwise.
Business context and results
McKesson distributes pharmaceuticals and provides related services, with operations reported in Distribution Solutions and Technology Solutions. Comparisons are affected by the March 2017 contribution of most of McKesson Technology Solutions to the Change Healthcare joint venture, the transfer of RelayHealth Pharmacy, and the October 2017 sale of Enterprise Information Solutions (EIS).
| Metric | Quarter | Nine months |
|---|---|---|
| Revenue | $53.617 billion, up 7% | $156.729 billion, up 5% |
| Gross profit | $2.715 billion, down 3%; margin 5.06%, down 55 bps | $8.109 billion, down 4%; margin 5.17%, down 49 bps |
| Operating income | $834 million, versus $831 million | $1.706 billion, down from $2.383 billion |
| Income before taxes | $697 million, down 11% | $1.333 billion, down 40% |
| Net income attributable to McKesson | $903 million, up from $633 million | $1.213 billion, down from $1.482 billion |
| Diluted EPS | $4.33, versus $2.85 | $5.76, versus $6.56 |
| Cash from operations | $1.323 billion for nine months, versus $3.309 billion |
Quarterly diluted EPS rose despite lower gross profit and pretax income, with results benefiting materially from a $263 million income tax benefit, including discrete benefits related to the 2017 Tax Act, and fewer weighted-average diluted shares. The tax benefit included a provisional $370 million discrete benefit for the nine-month period. Nine-month results also reflect impairments, restructuring costs, the Change Healthcare investment loss, and the prior-year Brazilian business disposal loss.
Cash, debt and liquidity
- At December 31, 2017, cash and equivalents were $2.619 billion; working capital was $2.543 billion, versus $1.336 billion at March 31, 2017.
- Total debt was approximately $8.794 billion, including $749 million of short-term borrowings and $8.045 billion of long-term debt. The debt-to-capital ratio was 39.5%, versus 39.2% at March 31.
- Nine-month investing cash outflow was $483 million and financing cash outflow was $1.147 billion. Share repurchases, including shares surrendered for tax withholding, used $951 million; dividends paid were $192 million.
- Management said operating cash, existing credit facilities and the commercial paper program should be sufficient for expected cash needs. The $3.5 billion revolving facility had no borrowings outstanding, and the company reported compliance with its covenants.
Material changes, outlook and risks
- Revenue growth was driven mainly by North American pharmaceutical distribution market growth, acquisitions and expanded customer business. Management cited drug utilization, price increases and new products, partly offset by brand-to-generic price deflation.
- Gross profit was pressured by competitive pricing, UK government reimbursement reductions, lower LIFO credits and the absence of prior-year antitrust settlement proceeds. LIFO credits were $2 million for the quarter and $5 million year to date, compared with $155 million and $151 million in the prior-year periods.
- McKesson recorded $350 million of goodwill impairment and $189 million of other asset impairment, plus $53 million of restructuring charges, for the first nine months, principally related to McKesson Europe and UK retail operations. It expected total fiscal 2018 McKesson Europe impairment and restructuring charges of approximately $650 million to $750 million; $592 million had been recorded by December 31. Further goodwill impairment remained possible if projections or market conditions worsened.
- McKesson recorded a $90 million quarterly and $271 million year-to-date equity-method loss from Change Healthcare. It expected to recognize its share of a provisional Change Healthcare tax benefit of approximately $70 million to $110 million in the following quarter; the estimate could change.
- The EIS sale generated $169 million of net cash proceeds and a $109 million pretax gain. The filing also reports acquisitions, including CoverMyMeds, and a January 2, 2018 acquisition of RxCrossroads for $724 million.
- Legal exposure includes numerous state and federal cases alleging claims concerning controlled-substance distribution, consolidated federal litigation, and other proceedings. The company generally could not estimate reasonably possible losses for unresolved matters. It warned that adverse outcomes could require substantial payments, injunctions or operational changes.
- Other key risks include pharmaceutical pricing and competition, reimbursement and regulatory changes, foreign exchange, acquisition integration, Change Healthcare performance, customer concentration, cyber and technology disruption, tax uncertainties and access to credit markets. No material changes to previously disclosed risk factors were reported.
- Management anticipated a change in operating segment structure beginning in fiscal 2019. It also said it expected to continue quarterly dividends, subject to Board discretion and future conditions.
Most important facts to verify
- How much of quarterly earnings growth was attributable to the provisional tax benefit and share-count reduction, rather than recurring operating performance.
- Whether UK reimbursement pressure, restructuring execution or other assumptions lead to additional McKesson Europe impairments or charges beyond the stated estimate.
- Whether working-capital requirements and operating cash flow recover after the sharp year-over-year decline in nine-month operating cash generation.
- Change Healthcare’s subsequent operating performance, investment valuation and expected tax benefit.
- Developments, potential financial exposure and any operational consequences from the controlled-substance litigation and investigations.