Business context and reporting period
McKesson Corporation’s Form 10-K covers the fiscal year ended March 31, 2012 (FY2012), with FY2011 as the principal comparable period. The company operates in two segments: Distribution Solutions, which accounted for approximately 97% of revenue, and Technology Solutions.
Unless noted otherwise, financial amounts below are in U.S. dollars and millions. The filing reports full-year results and also provides unaudited fourth-quarter results.
Key financial metrics
| Metric | FY2012 | FY2011 | Change |
|---|---|---|---|
| Revenue | $122,734 | $112,084 | Up 9.5% |
| Gross profit | $6,567 | $5,970 | Up 10% |
| Gross margin | 5.35% | 5.33% | Up 2 basis points |
| Operating income | $2,149 | $1,821 | Up 18% |
| Income from continuing operations | $1,403 | $1,130 | Up 24% |
| Net income | $1,403 | $1,202 | Up 17% |
| Diluted EPS | $5.59 | $4.57 | Up 22% |
| Operating cash flow | $2,950 | $2,338 | Up $612 |
Distribution Solutions revenue was $119,424, up 10%; Technology Solutions revenue was $3,310, up 4%. Segment operating profit was $2,219 for Distribution Solutions and $364 for Technology Solutions, compared with $1,897 and $301, respectively, in FY2011.
At March 31, 2012, cash and equivalents were $3,149, total debt including capital lease obligations was $3,980, and net debt was $831. Working capital was $1,917, down from $3,631. Total assets were $33,093 and stockholders’ equity was $6,831.
Investing cash outflow was $1,502, including $1,156 of acquisitions; financing cash outflow was $1,905, including $1,850 of share repurchases and $195 of dividends paid. Capital expenditures were $225 for property and $178 for capitalized software.
Material changes and unusual items
- Revenue growth primarily reflected market growth in pharmaceutical distribution and the contribution from US Oncology, acquired in December 2010. Higher generic-drug income and the addition of US Oncology helped gross margin; these gains were partly offset by lower sell margins and the absence of a $51 million antitrust settlement benefit recorded in FY2011.
- FY2012 included $149 million of pre-tax AWP litigation charges, versus $213 million in FY2011. The year-end AWP litigation reserve was $453 million. A $31 million tax benefit in FY2012 arose from reversing an AWP-related tax reserve.
- Technology Solutions recorded $51 million of pre-tax product-alignment charges in FY2012, including $24 million of non-cash impairments. McKesson stopped development of its Horizon Enterprise Revenue Management product and plans to converge Horizon and Paragon clinical and revenue-cycle products onto the Paragon platform. FY2011 included a separate $72 million software impairment charge.
- FY2011 net income included a $72 million after-tax gain on the sale of McKesson Asia Pacific. That gain did not recur in FY2012.
- McKesson acquired the Katz Group’s Canadian independent-pharmacy banner and franchise assets for approximately $919 million on March 25, 2012. The acquired operations were not material to FY2012 results and were expected to be included from FY2013.
- Share repurchases reduced weighted-average diluted shares to 251 million from 263 million in FY2011. The company repurchased 20 million shares for $1.85 billion during FY2012 and had a $1.2 billion accelerated repurchase program still subject to final settlement.
Fourth-quarter snapshot
FY2012 fourth-quarter revenue was $31,699, gross profit was $1,845, net income was $521 and diluted EPS was $2.09. The comparable FY2011 quarter reported revenue of $28,853, gross profit of $1,751, net income of $422 and diluted EPS of $1.62. FY2012 fourth-quarter results included a $4 million pre-tax AWP charge and a $9 million product-alignment charge; the AWP item also included a $32 million after-tax benefit, as disclosed in the filing.
Outlook, risks and contingencies
- The 10-K does not give specific FY2013 guidance; it refers investors to the company’s April 30, 2012 Form 8-K for its outlook. Management said it expected operating cash flow, existing cash and available credit sources to meet foreseeable funding needs.
- McKesson entered an agreement with the U.S. Department of Justice in April 2012 to resolve the federal share of AWP Medicaid claims for $191 million, including interest; it paid the amount on April 9, 2012. The company also reported an agreement in principle with a coalition of state attorneys general for approximately $173 million, subject to participating states’ execution of settlements.
- Key exposures include ongoing AWP and other litigation, healthcare reimbursement and regulatory changes, pharmaceutical pricing and generic-drug trends, and customer and credit concentration. The ten largest customers represented approximately 52% of FY2012 revenue and 49% of year-end receivables; CVS and Rite Aid represented 16% and 10% of revenue, respectively.
- The $1.35 billion accounts-receivable financing facility was due to expire in May 2012; management anticipated renewal but noted there was no assurance. The $1.3 billion revolving credit facility was renewed through September 2016. McKesson reported compliance with debt covenants at year-end.
- Other risks include technology integration and cybersecurity, long software sales and implementation cycles, acquisition integration, foreign exchange, tax disputes, and changes in U.S. and Canadian healthcare policy. The company disclosed IRS assessments of $98 million and Canadian tax assessments of $169 million related primarily to transfer pricing; proceedings remained unresolved.
- Management reported effective disclosure controls and internal control over financial reporting; Deloitte & Touche issued unqualified audit opinions on the financial statements and internal controls.
Important facts for investors to verify
- Review the April 30, 2012 Form 8-K for actual FY2013 guidance and compare it with subsequent reported performance.
- Track final costs, payments, and resolution of AWP litigation, including the state settlements and the remaining $453 million year-end reserve.
- Confirm renewal terms and availability of the accounts-receivable facility that was due to expire in May 2012.
- Assess whether the Katz acquisition and Technology Solutions product-platform realignment deliver expected growth, margins, and integration benefits.
- Monitor cash conversion and working capital, particularly the substantial reliance on accounts payable and the decline in reported working capital.
- Evaluate customer concentration, receivable collectability, and the effect of further generic-drug pricing, reimbursement, or supplier-compensation changes.