McKesson Corporation — Form 10-Q Summary
Business context and period: The filing covers the fiscal second quarter and first six months of fiscal 2012, ended September 30, 2011; comparisons are with the corresponding periods of fiscal 2011. McKesson operates Distribution Solutions and Technology Solutions. The distribution segment generated about 97% of consolidated revenue. Figures below are in U.S. dollars; financial statement amounts are in millions unless noted.
Financial performance
- Quarter: Revenue rose 10% to $30.216 billion; gross profit increased 21% to $1.647 billion, with gross margin of 5.45% versus 4.96%. Operating income was $478 million versus $417 million. Continuing-operations income rose 16% to $296 million; diluted continuing-operations EPS increased 22% to $1.18. Net income was $296 million versus $327 million, and total diluted EPS was $1.18 versus $1.25.
- Six months: Revenue increased 9% to $60.196 billion; gross profit rose 14% to $3.156 billion, with gross margin of 5.24% versus 5.02%. Operating income was $950 million versus $891 million. Continuing-operations income increased 5% to $582 million; diluted continuing-operations EPS rose 12% to $2.31. Net income declined 7% to $582 million, and total diluted EPS was $2.31 versus $2.34.
- Segment trends: Quarterly Distribution Solutions revenue rose 10% to $29.391 billion, while segment operating profit fell 3% to $477 million; its operating margin declined to 1.62% from 1.83%. Technology Solutions revenue increased 7% to $825 million, and segment operating profit was $108 million versus $14 million. The prior-year comparison included a $72 million software impairment charge.
- Cash flow: Six-month operating cash flow was $1.395 billion versus $798 million. Investing used $349 million versus $95 million, including $191 million of business acquisitions. Financing used $685 million versus $1.376 billion; share repurchases were $672 million versus $1.547 billion. Cash increased $331 million to $3.943 billion.
- Balance sheet and liquidity: At September 30, cash was $3.943 billion, current assets $23.262 billion, current liabilities $19.845 billion, and working capital $3.417 billion. Current and long-term debt totaled about $3.992 billion; reported debt net of cash was $49 million. Debt-to-capital was 35.9%, and net debt-to-net capital employed was 0.7%. Stockholders’ equity was $7.116 billion.
- Other measures: Interest expense for the quarter rose to $64 million from $44 million, and for six months to $128 million from $87 million, primarily reflecting $1.7 billion of debt issued in February 2011 for the US Oncology acquisition. The quarterly dividend increased to $0.20 per share from $0.18. The company repurchased $672 million of shares during the six months.
Material changes and unusual items
- Revenue growth reflected market growth in Distribution Solutions, including drug utilization and price increases, partly offset by brand-to-generic price deflation; the US Oncology acquisition also contributed. Canadian revenue benefited from currency movements, while generic drug price reductions in some provinces were an offset.
- McKesson recorded a $118 million AWP litigation charge in the quarter, compared with $24 million a year earlier. Its AWP litigation reserve was $442 million at September 30, up from $330 million at March 31. The company also disclosed an October 2011 agreement to pay $82 million to settle claims in the Douglas County, Kansas action, subject to court approval.
- Prior-year net income and total EPS included a $72 million after-tax gain on the sale of McKesson Asia Pacific. Consequently, current-period net income and total EPS declined despite growth in continuing operations. Prior-year six-month results also included a $51 million antitrust settlement receipt, while the Technology Solutions comparison included the $72 million software impairment.
- Operating expenses increased, reflecting the higher AWP charge, US Oncology-related costs and higher employee compensation. Acquisition-related expenses were $8 million for the quarter and $18 million for six months; acquired-intangible amortization was $50 million and $98 million, respectively.
Outlook, risks and contingencies
- Management said operating cash flow, existing cash, the accounts receivable facility, revolving credit facility and commercial paper were expected to fund working capital, capital expenditures and other cash needs. No specific earnings or revenue guidance is provided in the filing text.
- The company renewed its $1.3 billion revolving credit facility, which matures in September 2016, and its $1.35 billion accounts receivable sales facility, which expires in May 2012. Neither facility had borrowings outstanding at September 30. Management cautioned that capital-market disruption could impair liquidity or increase borrowing costs.
- Key exposures include AWP litigation and other legal proceedings, healthcare regulation, customer concentration or defaults, competition, technology implementation and product risks, acquisition integration, foreign currency, tax disputes, and access to credit. McKesson said it could not estimate reasonably possible losses for many unresolved proceedings and that ultimate AWP costs could exceed or fall below the reserve.
- Other notable contingencies include a Nevada Propofol case in which a jury found a subsidiary liable for $6 million compensatory and $18 million punitive damages; the subsidiary planned post-trial motions and, if needed, an appeal, and noted the manufacturer’s indemnity. Canadian tax assessments and U.S. tax disputes remain under challenge. The company reported $654 million of unrecognized tax benefits and said up to $163 million could potentially be reduced over the next twelve months, subject to ongoing tax-authority proceedings.
- Management reported disclosure controls were effective and no material change in internal control over financial reporting during the quarter. It reported no material change in market-risk exposure and no material change to the prior annual report’s risk factors.
Important facts for investors to verify
- Progress and final court approval of the $82 million Douglas County settlement, and whether the $442 million AWP reserve adequately reflects other claims and potential costs.
- Whether Distribution Solutions can sustain revenue and gross-margin growth while recovering from lower segment operating profit and higher litigation and operating expenses.
- US Oncology’s ongoing contribution to growth and profitability, integration costs, and finalization of its acquisition-date fair-value measurements.
- Cash-flow sustainability and working-capital movements, particularly receivables, inventories and payables; also the May 2012 expiration of the accounts receivable facility.
- Outcomes of the Propofol litigation, tax disputes and government investigations, including potential effects not quantifiable from the filing.