McKesson Corporation — Form 10-Q Summary
Reporting period: Quarter ended June 30, 2012, McKesson’s fiscal first quarter of fiscal 2013. Comparisons are with the quarter ended June 30, 2011. Dollar amounts are in U.S. dollars.
Financial performance
| Metric | Q1 FY2013 | Q1 FY2012 | Change |
|---|---|---|---|
| Revenue | $30.798 billion | $29.980 billion | +3% |
| Gross profit | $1.600 billion | $1.509 billion | +6% |
| Gross margin | 5.20% | 5.03% | +17 bps |
| Operating income | $579 million | $472 million | +23% |
| Income before taxes | $531 million | $416 million | +28% |
| Net income | $380 million | $286 million | +33% |
| Diluted EPS | $1.58 | $1.13 | +40% |
| Operating cash flow | $(552) million | $326 million | Down $878 million |
Distribution Solutions generated $29.960 billion in revenue and $500 million in operating profit, up 3% and 5%, respectively. Technology Solutions revenue rose 4% to $838 million, while operating profit fell 7% to $93 million. Distribution Solutions gross margin improved to 4.06% from 3.88%; Technology Solutions gross margin declined to 45.94% from 47.13%.
Reported results included an $81 million noncash pretax gain ($51 million after tax, or $0.21 per diluted share) from remeasuring McKesson’s prior interest in its headquarters building. The quarter also included a $16 million charge to increase the Average Wholesale Price (AWP) litigation reserve. Excluding neither item, reported operating income and earnings growth reflect both underlying performance and these unusual items. Share repurchases also lifted EPS: diluted weighted-average shares declined to 240 million from 254 million.
Financial position and liquidity
- Cash and cash equivalents were $2.013 billion at June 30, down from $3.149 billion at March 31, 2012. Working capital was $1.957 billion.
- Debt totaled approximately $3.580 billion: $508 million current and $3.072 billion long term; no short-term borrowings remained. Debt net of cash was $1.567 billion.
- The company reported a 33.2% debt-to-capital ratio and 17.9% net debt-to-net capital employed ratio. It was in compliance with debt covenants; the revolving-credit-facility covenant ceiling was 56.5%.
- Operating cash use included $273 million of AWP litigation settlement payments, alongside significant working-capital movements, including a $936 million reduction in drafts and accounts payable. Investing activities used $150 million and financing activities used $425 million.
- McKesson said operating cash generation and existing liquidity sources should be sufficient for expected capital, working-capital and other cash needs. Its $1.3 billion revolving credit facility had no borrowings and expires in September 2016; its $1.35 billion receivables facility was renewed through May 2013 and had no outstanding borrowings at quarter-end.
Material changes, outlook and risks
- Revenue growth was driven mainly by U.S. pharmaceutical distribution, including market growth, higher volume and sales to customer warehouses. Canada revenue declined 8%, affected by currency, fewer sales days and provincial generic-drug price reductions. The Katz Assets, acquired in March for approximately $919 million, contributed to Canadian results in the quarter.
- Management attributed improved Distribution Solutions gross margin to higher buy margin, greater generic-drug sales and the Katz acquisition, partly offset by lower sell margin. Technology Solutions profitability was pressured by less favorable revenue mix and higher operating expenses.
- The company bought the remaining 50% interest in its headquarters building for $90 million cash; the remeasurement gain was noncash. A $700 million additional share-repurchase authorization brought outstanding authorization to $1.0 billion. The prior $1.2 billion accelerated repurchase program was completed after quarter-end at an average price of $89.10 per share.
- No specific earnings or revenue guidance was provided in the supplied filing text. Management cautioned that quarterly results are not necessarily indicative of full-year results and that operating cash flow can vary with customer receipts, inventory and vendor-payment timing. It also noted that market disruption could impair liquidity or increase borrowing costs.
- AWP claims remain a material contingency. The AWP reserve was $196 million at quarter-end after $273 million of payments and a $16 million charge. McKesson disclosed that ultimate costs could exceed or fall below the reserve and that it could not estimate reasonably possible losses for many unresolved proceedings. Tax matters include IRS assessments of $98 million and Canadian assessments of $169 million; the company disputed substantial portions and said outcomes could affect tax expense.
- Other identified risks include healthcare regulation and competition, loss or reduced purchases from major customers, technology implementation or cybersecurity failures, foreign-exchange exposure, acquisition integration, and challenges to tax positions. Management reported no material change in market-risk exposure or risk factors from the prior annual report, and said disclosure controls were effective.
Investor verification points
- Assess earnings excluding the $81 million building-related gain and consider the $16 million AWP reserve charge.
- Review the drivers and sustainability of Distribution Solutions margins, including manufacturer compensation, generic-drug mix and pricing.
- Track operating cash flow and working-capital movements, particularly litigation payments and accounts-payable timing.
- Monitor AWP litigation developments, reserve adequacy and the timing and terms of state settlements.
- Follow the resolution of IRS and Canadian transfer-pricing disputes and potential changes in unrecognized tax benefits.
- Confirm post-quarter share repurchases, cash use, debt levels and renewal or replacement of the receivables facility before its May 2013 expiry.