Business context and reporting period
McKesson Corporation’s unaudited Form 10-Q covers the quarter and nine months ended December 31, 2009, the third quarter and first nine months of its fiscal 2010. Comparisons are with the corresponding periods ended December 31, 2008. McKesson operates Distribution Solutions and Technology Solutions; distribution generated approximately 97% of quarterly revenue. Dollar amounts below are in U.S. dollars.
Financial performance and position
| Metric | Quarter | Nine months |
|---|---|---|
| Revenue | $28.272 billion, up 4% | $82.059 billion, up 2% |
| Gross profit | $1.455 billion, up 8%; gross margin 5.15% versus 4.95% | $4.093 billion, up 5%; gross margin 4.99% versus 4.87% |
| Operating income | $509 million versus a $54 million loss | $1.435 billion versus $698 million |
| Net income | $326 million versus a $20 million loss; diluted EPS $1.19 versus $(0.07) | $915 million, up 69%; diluted EPS $3.36, up 73% |
| Operating cash flow | Not separately reported for the quarter | $1.725 billion versus $734 million |
Quarterly operating expenses were $946 million versus $1.397 billion; the prior-year quarter included a $493 million AWP litigation charge. Nine-month expenses were $2.658 billion versus $3.215 billion, including a $20 million litigation credit in 2009. Interest expense rose to $47 million from $33 million for the quarter and to $142 million from $102 million for nine months, primarily reflecting $700 million of notes issued in February 2009.
At December 31, 2009, cash and equivalents were $3.428 billion, working capital $3.936 billion, and total debt approximately $2.511 billion, leaving net cash of $916 million. The debt-to-capital ratio was 26.1%, versus 28.9% at March 31, 2009. Total assets were $27.539 billion and stockholders’ equity $7.123 billion. Nine-month investing cash use was $203 million and financing cash use was $237 million; cash increased by $1.319 billion.
Changes versus the prior comparable periods
- Revenue growth was attributed mainly to market growth, higher direct-store-delivery sales, and flu-season demand, partly offset by lost business. U.S. pharmaceutical distribution revenue rose 2% for the quarter; sales to customers’ warehouses fell 20%, partly reflecting a shift to direct delivery and the loss of a large customer over the nine-month period.
- Distribution Solutions’ quarterly operating profit was $558 million versus a $54 million loss, substantially reflecting the absence of the prior-year AWP charge. Nine-month segment profit rose to $1.403 billion from $736 million. Technology Solutions’ revenue increased 3% for the quarter, but quarterly operating profit declined 11% to $81 million; nine-month profit increased 32% to $300 million.
- Higher distribution gross margins reflected flu-related mix and generic-drug sales, partly offset by lower sell margin. Technology Solutions’ quarterly margin was pressured by software revenue deferrals, product amortization and costs; nine-month results benefited from previously deferred revenue recognized after a product became generally available.
- Nine-month cash from operations increased, supported by accounts-payable and inventory management. Comparability also reflects prior-period cash from the receivables sales facility, the current-period $350 million AWP settlement payment, and changes in working capital.
Outlook, risks and unusual items
Management said operating cash flow, existing cash, the receivables sales facility, and credit sources should be sufficient for expected short- and long-term requirements. No quantified earnings or revenue guidance was provided. Management cautioned that capital-market disruption could impair liquidity or increase borrowing costs. The $1.1 billion receivables sales facility was due to expire in May 2010; no receivables were outstanding as sold at December 31. The $1.3 billion revolving facility, expiring in June 2012, had no borrowings outstanding. The company reported covenant compliance; its principal debt-to-capital limit was 56.5%.
The $493 million 2008 AWP litigation charge comprised a $350 million private-party settlement and a $143 million estimated accrual for public-payor claims. Private-party actions were concluded and the settlement paid; the public-payor actions remained pending, and management could not estimate possible losses in unresolved proceedings. Other legal matters include the Roby case and a proposed Angeles Chemical settlement. Management said it believes provisions are adequate but litigation outcomes are uncertain and could materially affect results.
Other items to note: the October 2009 sale of McKesson’s 50% interest in McKesson Logistics Solutions produced a $17 million pretax gain. Nine-month 2009 results included $80 million of discrete tax benefits, while the prior-year quarter’s tax benefit included $182 million related to the AWP charge. At December 31, unrecognized tax benefits were $609 million, including $368 million that would reduce tax expense if recognized; a $61 million Canadian transfer-pricing assessment had been paid and appealed. The company also disclosed customer guarantees of up to $117 million for inventory repurchases and $14 million for other customer guarantees, neither accrued.
Forward-looking risks include legal outcomes, healthcare regulation, competition, drug-price trends, customer losses or defaults, technology implementation and cybersecurity/service interruptions, foreign exchange, tax matters, acquisitions, and public-health events including H1N1. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether public-payor AWP claims or other litigation lead to additional payments beyond recorded accruals.
- Whether revenue growth and distribution margins persist after flu-related demand and the effects of lost customers.
- Renewal or replacement of the receivables sales facility before its May 2010 expiration, and resulting liquidity needs.
- The quality and sustainability of operating cash flow, including working-capital movements and settlement-related cash flows.
- Technology Solutions’ ability to manage product costs, software deferrals, and implementation risks.
- Developments in tax audits and unrecognized tax benefits, including the Canadian transfer-pricing appeal.