McKesson Corporation — Form 10-Q Summary
Reporting period: Fiscal third quarter and first nine months ended December 31, 2010; comparisons are with the corresponding 2009 periods. The filing is unaudited. Unless noted, figures are in millions of dollars.
Financial results
| Metric | Quarter | First nine months |
|---|---|---|
| Revenue | $28,247 vs. $28,272 | $83,231 vs. $82,059 |
| Gross profit / margin | $1,461 / 5.17% vs. $1,455 / 5.15% | $4,219 / 5.07% vs. $4,093 / 4.99% |
| Operating income | $307 vs. $509 | $1,198 vs. $1,435 |
| Continuing-operations income | $155 vs. $326 | $708 vs. $915 |
| Net income | $155 vs. $326 | $780 vs. $915 |
| Diluted EPS | $0.60 vs. $1.19 | $2.96 vs. $3.36 |
Quarterly revenue was essentially flat and nine-month revenue rose 1%. Net income fell 52% for the quarter and 15% for the nine months. Nine-month net income included a $72 million after-tax gain on the sale of McKesson Asia Pacific; excluding that gain, the decline would be greater. Quarterly diluted EPS declined 50%; nine-month diluted EPS declined 12%, partly cushioned by share repurchases.
Quarterly operating income fell 40%, and nine-month operating income fell 17%. The quarter’s $189 million Average Wholesale Price (AWP) litigation charge was a major factor. Reported gross margin edged up 2 basis points for the quarter and 8 basis points for the nine months. Nine-month results also included a $72 million non-cash software impairment and a $51 million antitrust settlement benefit in gross profit.
Cash flow, balance sheet and capital
- Nine-month operating cash flow was $1,338, down from $1,725. Investing used $466, compared with $203; financing used $1,396, compared with $237.
- Cash declined to $3,213 at December 31 from $3,731 at March 31, 2010. Working capital fell to $2,008 from $4,492.
- Total debt was approximately $4,062 ($1,757 current and $2,305 long-term), compared with $2,296 at March 31. Debt net of cash was $849, versus net cash of $1,434. Debt-to-capital was 36.5%, up from 23.4%.
- The increase in debt and current liabilities reflected the December acquisition of US Oncology and its assumed debt. The company reported compliance with debt covenants; the stated maximum debt-to-capital covenant was 56.5%.
- Cash used for share repurchases was $1,548 during the nine months. The quarterly dividend had been raised from $0.12 to $0.18 per share; the company said it anticipated continuing quarterly dividends, subject to board discretion.
Business developments and material changes
- Distribution Solutions generated $27,457 of quarterly revenue, essentially unchanged, and $80,912 for nine months, up 1%. Quarterly segment operating profit declined to $289 from $558, including the AWP charge. Management cited H1N1-related demand weakness, generic conversions and customer-warehouse sales declines; market growth and generic-drug sales provided offsets.
- Technology Solutions revenue rose 2% for the quarter and 1% for nine months. Nine-month operating profit fell to $184 from $300, including the $72 million software impairment. Quarterly profit improved to $106 from $81, partly reflecting recognition of $23 million of previously deferred disease-management revenue.
- On December 30, McKesson acquired US Oncology for approximately $2.1 billion, including $0.2 billion cash net of cash acquired and assumed liabilities. Preliminary purchase accounting included $774 million goodwill and $1.1 billion of identifiable intangibles. US Oncology results were not material to this quarter; the filing said they would be included in Distribution Solutions beginning in the fourth quarter of fiscal 2011.
- McKesson sold McKesson Asia Pacific in July for $109 million net proceeds, recording a $95 million pre-tax and $72 million after-tax gain as a discontinued operation.
Outlook, risks and contingencies
- No specific revenue or earnings guidance is provided. Management expected operating cash flow and existing liquidity sources, including credit facilities and short-term borrowing capacity, to meet near- and long-term cash needs; it also anticipated using long-term financing to refinance acquisition-related needs.
- McKesson borrowed $1 billion under its bridge facility on January 31, 2011, after the reporting date. The facility is due no later than December 30, 2011. The company planned to redeem acquired notes using cash and bridge borrowings, and anticipated replacing bridge borrowing with long-term financing.
- The AWP public-payor litigation reserve was $330 million at December 31, after the quarter’s $189 million charge and earlier charges. Management said ultimate losses could be higher or lower and could not estimate possible losses in unresolved cases. An Arizona agency proposed $101 million in penalties and a $112 million assessment; McKesson intended to challenge them. Several related state claims remained unresolved.
- Other exposures include a $169 million Canadian tax assessment concerning transfer pricing for 2003–2007, which McKesson disputed, and FTC and Texas Attorney General investigations into a US Oncology physician-practice transaction. The filing also describes customer guarantees, legal claims and other contingencies.
- Management identified risks including litigation outcomes, healthcare regulation, competition, drug-price changes, customer concentration, technology implementation and cybersecurity/data access, acquisition integration, tax disputes, foreign exchange and capital-market disruption. It reported no material change in disclosed risk factors and no material change in market-risk exposure.
Most important facts for investors to verify
- How the AWP litigation reserve compares with potential settlements and remaining claims, particularly the Arizona proposal and unresolved state and federal matters.
- Final US Oncology purchase-price allocation, integration results and the cost and timing of refinancing its assumed debt and the bridge loan.
- Whether operating cash flow and working capital recover after the year-over-year decline, given the substantial distribution-business working-capital requirements.
- Whether the $72 million software impairment signals further weakness in HzERM revenue estimates or additional impairment risk.
- How much of reported nine-month earnings and cash flow reflects non-recurring items, including the MAP gain, antitrust settlement, litigation charges and share repurchases.