McKesson Corporation — Form 10-Q Summary
Reporting period: Quarter ended June 30, 2016, McKesson’s first quarter of fiscal 2017. Unless noted, amounts are U.S. dollars. The filing compares the quarter with the quarter ended June 30, 2015.
Financial performance
| Metric | Quarter ended June 30, 2016 | Prior-year quarter | Change |
|---|---|---|---|
| Revenue | $49.733 billion | $47.546 billion | +5% |
| Gross profit | $2.907 billion | $2.848 billion | +2% |
| Gross margin | 5.85% | 5.99% | Down 14 basis points |
| Operating income | $972 million | $931 million | +4% |
| Income from continuing operations | $673 million | $599 million | +12% |
| Net income attributable to McKesson | $542 million | $576 million | −6% |
| Diluted EPS | $2.38 | $2.45 | −3% |
| Operating cash flow | $1.859 billion | $454 million | Up $1.405 billion |
Revenue growth primarily reflected market growth, acquisitions and expanded customer business, partly offset by customer losses. Distribution Solutions generated $49.009 billion of revenue; Technology Solutions generated $724 million. Distribution Solutions gross margin was 5.13%, down 20 basis points; Technology Solutions gross margin was 54.42%, up 619 basis points.
Continuing-operations pretax income rose 7% to $912 million. The effective tax rate was 26.2%, versus 29.9%, including net discrete tax benefits of $35 million in the quarter. Diluted EPS from continuing operations increased to $2.88 from $2.50. Total net income and EPS were reduced by the Brazilian business disposal loss.
Cash, debt and liquidity
- Cash and cash equivalents were $4.659 billion at June 30, 2016, versus $4.048 billion at March 31, 2016. About $2.5 billion was held outside the United States, primarily for foreign operations and research and development.
- Working capital was $2.464 billion, down from $3.366 billion at March 31. Management noted that working capital can vary substantially with sales, inventory needs and vendor payment timing.
- Total debt was approximately $8.110 billion, nearly unchanged from $8.107 billion at March 31; $2.168 billion was current and $5.942 billion long-term. The debt-to-capital ratio was 42.5%, compared with 43.6%.
- Operating cash flow benefited from a $1.549 billion increase in drafts and accounts payable, partly offset by cash use from receivables and inventories. Investing activities used $1.154 billion, including $1.819 billion of acquisition payments; financing activities used $82 million.
- The company reported no borrowings under its $3.5 billion revolving credit facility or commercial paper program at quarter-end and said it was in compliance with credit covenants. Management expected operating cash, credit facilities and commercial paper access to meet foreseeable funding needs, while cautioning that capital-market volatility could affect liquidity or borrowing costs.
Material changes and unusual items
- Acquisitions completed April 1 included Vantage Oncology for $515 million, Biologics for $692 million and UDG Healthcare businesses for $447 million. The acquisitions contributed to revenue growth and increased goodwill.
- McKesson completed the sale of its Brazilian pharmaceutical distribution business on May 31 and recorded an after-tax loss of $113 million, or $0.50 per diluted share. The sale also involved an approximately $100 million payment.
- Gross profit included $142 million of cash receipts representing McKesson’s share of antitrust settlements, compared with $59 million a year earlier. LIFO inventory expense declined to $47 million from $91 million.
- Prior-year results included a $51 million pretax gain from selling the nurse triage business. The comparison also reflects a $20 million prior-year severance charge in Technology Solutions.
- Operating cash flow was substantially higher year over year, principally reflecting working-capital movements, including a larger increase in accounts payable.
- Quarter-end goodwill was $11.127 billion, up from $9.786 billion at March 31, mainly reflecting acquisitions, partly offset by foreign-currency translation.
Outlook, management commentary and risks
- Cost Alignment Plan: Expected total pretax charges are approximately $270–$290 million; $238 million had been recorded through the quarter. Management anticipated $170–$190 million of net pretax savings in fiscal 2017 and an additional $70–$90 million in fiscal 2018. Implementation was expected to be substantially complete before the end of 2019.
- Technology joint venture: McKesson agreed to contribute most of McKesson Technology Solutions to a proposed joint venture with Change Healthcare, retaining RelayHealth Pharmacy and Enterprise Information Solutions. McKesson expected to own approximately 70%; closing was subject to conditions including antitrust clearance and expected in the first half of calendar 2017. The joint venture had commitments for $6.1 billion of debt financing. McKesson also began reviewing strategic alternatives for EIS.
- Pending acquisitions: The proposed Rexall Health acquisition, for C$3 billion, remained subject to regulatory approval and was expected to close in the second half of calendar 2016. The proposed Sainsbury pharmacy-business acquisition remained under U.K. competition review.
- Management cited weaker expected generic-drug pricing, lower branded-manufacturer compensation, customer consolidation and customer losses as pressures. Benefits from procurement arrangements, acquisitions, antitrust settlements and lower LIFO expense partly offset these factors.
- Risks include healthcare regulation, foreign currency and economic conditions, competition, acquisition and integration execution, customer concentration or loss, technology and cybersecurity disruptions, tax matters, and pending litigation and government investigations. The filing stated that losses on unresolved proceedings generally could not be reasonably estimated; adverse outcomes could materially affect the company.
Key facts for investors to verify
- Whether acquired businesses deliver the expected growth and integration benefits, and how provisional purchase-price allocations change.
- Whether the technology joint venture and proposed Rexall and Sainsbury transactions close on the expected terms and schedules.
- Whether projected restructuring savings are achieved, relative to remaining charges and implementation costs.
- How recurring margins and earnings perform as generic pricing, customer mix, manufacturer compensation and antitrust settlement receipts change.
- Whether working-capital cash-flow movements normalize, and how the Celesio put rights and unresolved legal or regulatory matters affect future cash requirements.