McKesson Corporation — Form 10-Q Summary
Reporting period: Quarter and nine months ended December 31, 2016 (McKesson fiscal 2017 third quarter). Unaudited results; amounts are in U.S. dollars unless stated otherwise.
Business context
McKesson operates Distribution Solutions and Technology Solutions. Distribution Solutions generated about 99% of quarterly revenue. The period included acquisitions, including Rexall Health, and preparation for a proposed healthcare technology joint venture with Change Healthcare.
Financial performance
| Metric | Quarter ended Dec. 31, 2016 | Year-over-year | Nine months ended Dec. 31, 2016 | Year-over-year |
|---|---|---|---|---|
| Revenue | $50.130 billion | +5% | $149.820 billion | +4% |
| Gross profit | $2.812 billion | −2% | $8.475 billion | −1% |
| Gross margin | 5.61% | 6.00% prior year | 5.66% | 5.94% prior year |
| Operating income | $831 million | $920 million prior year | $2.383 billion | $2.805 billion prior year |
| Income from continuing operations | $649 million | $642 million prior year | $1.647 billion | $1.877 billion prior year |
| Net income attributable to McKesson | $633 million | $634 million prior year | $1.482 billion | $1.827 billion prior year |
| Diluted EPS | $2.85 | $2.73 prior year | $6.56 | $7.81 prior year |
| Operating cash flow | Not separately presented | — | $3.309 billion | $566 million prior year |
Quarterly continuing-operations diluted EPS was $2.86, up from $2.71. Nine-month diluted EPS from continuing operations was $7.07, down from $7.86. Nine-month results included a $290 million non-cash goodwill impairment charge ($282 million after tax) and a $113 million after-tax loss on the sale of the Brazilian distribution business.
Quarterly Distribution Solutions operating profit declined 10% to $813 million; Technology Solutions operating profit increased 8% to $132 million. For the nine months, segment operating profit was $2.592 billion for Distribution Solutions and $126 million for Technology Solutions, the latter reflecting the goodwill impairment.
Liquidity, debt and capital
- Cash and cash equivalents were $2.434 billion at December 31, down from $4.048 billion at March 31, 2016. Working capital was $1.094 billion, down from $3.366 billion.
- Total debt was approximately $9.123 billion: $1.406 billion short-term borrowings, $1.748 billion current long-term debt and $5.969 billion long-term debt. The debt-to-capital ratio rose to 47.9% from 43.6%.
- Nine-month investing cash outflow was $3.619 billion, including $4.174 billion paid for acquisitions; financing cash outflow was $1.145 billion. McKesson repurchased 14 million shares for $2.0 billion and paid $192 million in dividends.
- The company reported $1.4 billion of commercial paper outstanding at a weighted average rate of 1.05%; its $3.5 billion revolving credit facility was undrawn, and it reported compliance with its covenants.
Changes, outlook and notable items
- Revenue growth reflected market growth, acquisitions and expanded business with existing customers, partly offset by customer losses. Management cited weaker pharmaceutical pricing, competitive pressure, customer consolidation and business mix as drivers of lower gross profit and margin.
- Quarterly LIFO inventory accounting produced a $155 million credit, versus a $33 million charge a year earlier. Management anticipated LIFO credits for full-year fiscal 2017, based on lower expected price increases; actual LIFO valuation is determined at fiscal year-end.
- The cost-alignment plan is expected to incur $250 million–$270 million in total pretax charges. Management projected $170 million–$190 million in net pretax savings in fiscal 2017 and a further $70 million–$90 million in fiscal 2018.
- The proposed Change Healthcare transaction was expected to close in the first half of calendar 2017, subject to remaining conditions. McKesson expected to own about 70% of the jointly governed company and stated it expected to recognize a gain at closing. Related transaction costs were $58 million for the nine months. Core MTS assets and liabilities classified as held for sale were $1.9 billion and $0.7 billion, respectively.
- Management said available operating cash, credit facilities and commercial paper were expected to fund foreseeable requirements, while noting capital-market volatility could impair liquidity or raise borrowing costs. No specific earnings guidance was provided in the supplied filing text.
- In January 2017, McKesson paid $150 million under final agreements resolving controlled-substance suspicious-order reporting claims; the amount had been accrued in 2015. Other legal matters remained, and the company generally could not estimate reasonably possible losses for unresolved proceedings.
Key investor verification points
- Assess whether distribution margins and operating profit can stabilize amid pricing pressure, customer consolidation and competition; consider the unusually large LIFO credit.
- Check the final economics, timing, closing conditions and accounting outcome of the Change Healthcare transaction, including the expected gain and retained interest.
- Review acquisition integration and financing impacts, including Rexall and the subsequent CoverMyMeds agreement, which contemplated about $1.1 billion plus up to $0.3 billion of contingent consideration.
- Track cash, working capital, short-term borrowing and debt-to-capital trends following acquisitions and share repurchases.
- Monitor the EIS business after its impairment and the Brazilian sale loss, as well as remaining restructuring charges, legal contingencies and Celesio noncontrolling-interest obligations.