McKesson Corporation — Form 10-Q Summary
Reporting period: Quarter ended June 30, 2009, McKesson’s first quarter of fiscal 2010. Comparisons are with the quarter ended June 30, 2008, unless otherwise noted. Figures are unaudited and in U.S. dollars.
Financial performance
| Metric | Quarter ended June 30, 2009 | Prior-year quarter | Change |
|---|---|---|---|
| Revenue | $26.657 billion | $26.704 billion | Approximately flat |
| Gross profit | $1.303 billion | $1.268 billion | Up 3% |
| Gross margin | 4.89% | 4.75% | Up 14 basis points |
| Operating income | $459 million | $371 million | Up 24% |
| Income before taxes | $421 million | $358 million | Up 18% |
| Net income | $288 million | $235 million | Up 23% |
| Diluted EPS | $1.06 | $0.83 | Up 28% |
| Operating cash flow | $907 million | $314 million | Up $593 million |
- Segment results: Distribution Solutions revenue was $25.914 billion and operating profit was $430 million, versus $25.960 billion and $384 million. Technology Solutions revenue was $743 million and operating profit was $103 million, versus $744 million and $66 million.
- Margins and costs: Distribution Solutions gross margin rose to 3.68% from 3.60%; Technology Solutions rose to 46.97% from 44.89%. Operating expenses declined 6% to $844 million, or 3.17% of revenue versus 3.36%. Interest expense increased to $48 million from $34 million, principally due to the $700 million notes issued in February 2009.
- Cash and liquidity: Cash and equivalents were $2.644 billion at June 30, up from $2.109 billion at March 31. Working capital was $3.121 billion. Net debt was negative $133 million (net cash), compared with net debt of $403 million at March 31. The debt-to-capital ratio was 28.6%.
- Debt and facilities: Total balance-sheet debt was approximately $2.509 billion, including $217 million current and $2.292 billion long-term. No revolving-credit borrowings or commercial paper were outstanding at quarter-end. The $1.3 billion revolving facility expires in June 2012; the receivables facility was renewed at a committed $1.1 billion through May 2010, subject to eligibility and concentration limits.
- Cash uses: Investing activities used $86 million; financing activities used $303 million, including $298 million for repurchases and $34 million of dividends paid. The company repurchased 7 million shares for $275 million under its program, with $555 million remaining authorized at quarter-end.
Material changes and management commentary
- Revenue was essentially unchanged: market growth was offset by lost business. U.S. direct pharmaceutical distribution revenue increased 4%, while sales to customers’ warehouses declined 9%, partly reflecting a shift to direct delivery and the loss of a large customer.
- Canadian pharmaceutical revenue fell 5% in reported dollars due largely to a 15% unfavorable currency impact; it increased 10% on a constant-currency basis. Medical-Surgical revenue rose 9%, supported by acquisitions, market growth, and increased H1N1-related demand.
- Management attributed improved earnings to higher operating profit in both segments, improved gross margins, lower operating expenses, and fewer diluted shares following repurchases. Distribution Solutions benefited from buy-side margins, generic-drug sales, and a lower warehouse-sales mix; Technology Solutions benefited from product mix and cost reductions.
- Operating cash flow was supported by improved management of receivables, inventory, and payables. The prior-year comparison included $325 million of accelerated receivables proceeds from the sales facility, so cash-flow comparisons are affected by working-capital timing.
- The company acquired regional distributor McQueary Brothers Drug Company for approximately $190 million, funded with cash; about $126 million of the purchase price was allocated to goodwill.
Outlook, risks, and unusual items
- No specific earnings or revenue guidance was provided. Management expects operating cash generation and existing liquidity sources to be sufficient for capital expenditures, working capital, and other cash needs, while cautioning that credit-market disruption could impair liquidity or raise borrowing costs.
- The company reported $581 million in unrecognized tax benefits at June 30, including $345 million that would reduce tax expense if recognized. Audit resolutions and expiring statutes could reduce unrecognized benefits by up to $27 million over the following 12 months; the amount may change.
- McKesson had recorded a $350 million current liability for the private-payor Average Wholesale Price litigation settlement. Approximately $55 million had been paid into escrow; the balance was expected to be paid during the second quarter of fiscal 2011. The filing also refers to a $143 million reserve for pending and expected public-entity claims. Public-payor litigation and other proceedings remained unresolved; management said remaining possible losses could not be estimated.
- Customer guarantees included maximum inventory-repurchase guarantees of $92 million and other customer guarantees of $11 million; none was accrued. Some other indemnification exposures could not be reasonably quantified.
- Principal stated risks include litigation outcomes, healthcare regulation and competition, drug-price and generic trends, loss or default of large customers, technology implementation and security/service disruptions, foreign-exchange exposure, tax challenges, acquisition integration, and capital-market volatility. Management reported no material change in market-risk exposure, no material change in internal controls, and effective disclosure controls.
Most important facts for investors to verify
- Whether the earnings improvement is sustainable given flat revenue, customer losses, and the contribution of cost reductions, product mix, drug margins, and share repurchases.
- The timing and final amount of AWP-related settlement payments, the adequacy of the $143 million public-entity reserve, and developments in remaining litigation.
- Cash-flow sustainability after accounting for working-capital timing and the prior-year receivables-sale comparison.
- Receivables-facility availability and renewal terms, debt covenant headroom, and exposure to credit-market or borrowing-cost changes.
- Acquisition integration and realized synergies from McQueary Brothers, as well as the quality and recoverability of goodwill and other intangibles.