McKesson Corporation — Form 10-Q Summary
Reporting period: Three months ended June 30, 2020, McKesson’s first quarter of fiscal 2021 (fiscal year ended March 31). Unaudited results are compared with the three months ended June 30, 2019.
Business context: McKesson distributes pharmaceuticals and medical-surgical products and provides specialty care, retail pharmacy, and healthcare technology services. Its reported segments were U.S. Pharmaceutical and Specialty Solutions, European Pharmaceutical Solutions, Medical-Surgical Solutions, and Other.
Financial performance and position
| Metric | Quarter ended June 30, 2020 | Prior-year quarter | Change |
|---|---|---|---|
| Revenue | $55.679 billion | $55.728 billion | Flat |
| Gross profit | $2.700 billion | $2.787 billion | Down 3% |
| Gross margin | 4.85% | 5.00% | Down 15 basis points |
| Operating income | $678 million | $634 million | Up 7% |
| Income from continuing operations | $495 million | $483 million | Up 2% |
| Net income attributable to McKesson | $444 million | $423 million | Up 5% |
| Diluted EPS from continuing operations | $2.72 | $2.27 | Up 20% |
| Operating cash flow | Use of $1.062 billion | Use of $51 million | Greater cash use |
- EPS growth benefited from a lower weighted-average diluted share count, 163 million versus 189 million; the filing attributes the decline largely to the March 2020 separation of Change Healthcare. Net income growth was more modest.
- Operating expenses were $2.022 billion, down 6%. The quarter included a $131 million net insurance gain from settlement of a shareholder derivative action. Restructuring, impairment, and related charges were $56 million, versus $23 million.
- Segment revenue: U.S. Pharmaceutical and Specialty Solutions $45.062 billion, up 2%; Europe $6.246 billion, down 7%; Medical-Surgical $1.801 billion, down 5%; Other $2.570 billion, down 13%. U.S. segment operating profit rose to $608 million; Europe reported a $10 million operating loss; Medical-Surgical profit was $89 million; and Other profit was $98 million.
- Cash and cash equivalents were $2.613 billion at June 30; restricted cash was $251 million, making cash, cash equivalents, and restricted cash $2.864 billion. Working capital was $82 million, versus negative $402 million at March 31.
- Total debt was $7.448 billion, including $1.053 billion current and $6.395 billion long-term. The debt-to-capital ratio was 50.9%, down from 52.1% at March 31. The $4 billion revolving credit facility had no borrowings, and the company reported compliance with its covenants.
- Quarterly operating cash use primarily reflected a $4.214 billion reduction in drafts and accounts payable, partly offset by $2.291 billion collected from receivables. Investing activities used $130 million; financing activities provided $61 million. Cash declined by $1.159 billion, including the effect of exchange rates.
- Cash dividends paid were $74 million. No shares were repurchased in the quarter; $1.5 billion remained authorized. On July 29, the company raised its quarterly dividend from $0.41 to $0.42 per share.
Material changes and management commentary
- COVID-19 reduced distribution volumes and customer demand across geographies. Doctors’ office closures, deferred or cancelled elective procedures, and lower pharmacy traffic weighed on European and Medical-Surgical results. Higher U.S. market growth and demand for PPE and COVID-19-related products partly offset these effects.
- Gross profit and margin declined despite higher LIFO inventory credits ($52 million versus $15 million). Management said lower operating expenses, including travel and payroll savings, partly offset reduced volumes; increased transport, sanitization, and employee-protection costs were offsets to those savings.
- Management described liquidity as strong and said it expected operating cash generation, cash balances, credit facilities, and commercial paper access to fund requirements. It highlighted uncertainty around pandemic duration, demand, customer payment patterns, and working-capital variability. No numerical earnings or revenue guidance was provided.
- Restructuring programs were expected to incur total charges of approximately $470 million to $555 million; $342 million had been recorded to date. Remaining charges were expected mainly for facility exit and employee-related costs. Programs included U.K. transformation and store reductions, other cost-optimization measures, and the headquarters relocation, expected to finish by January 2021.
- McKesson announced a future reporting realignment to four segments: U.S. Pharmaceutical, International, Medical-Surgical Solutions, and Prescription Technology Solutions, with retrospective segment presentation planned from the second quarter of fiscal 2021.
Risks, contingencies, and unusual items
- Opioid litigation: The company faced approximately 2,800 federal MDL cases and about 360 similar state-court cases, among others. A proposed framework discussed by four state attorneys general contemplated up to $6.9 billion from McKesson over 18 years, subject to numerous conditions and broader participation. The company said settlement was not probable, could not reasonably estimate a loss, and had recorded no liability for the proposed framework. An adverse judgment or resolution could materially affect results, cash flows, or liquidity.
- Other legal matters: On July 21, 2020, after quarter-end, McKesson received a U.S. Attorney’s Office letter alleging controlled-substance reporting and documentation deficiencies at a former facility and a Memphis distribution center and seeking civil penalties. The filing did not provide a clear estimate of potential loss.
- The company received $131 million net of attorneys’ fees from insurers under a shareholder derivative settlement and must maintain specified corporate-governance enhancements for at least four years.
- Assets and liabilities held for sale were $844 million and $509 million, primarily related to the planned German wholesale joint venture transaction, which remained subject to regulatory approvals and was expected to close within six months.
- Management warned that COVID-19 could materially affect future operations and estimates. It also noted elevated goodwill impairment risk for McKesson Canada and possible impairment following planned reporting-unit changes; no triggering event had been identified as of June 30.
Important facts for investors to verify
- How much of reported earnings and EPS growth reflects the $131 million insurance gain, LIFO credits, and lower share count, versus recurring operating performance.
- Whether COVID-19-related volume declines and deferred healthcare procedures persist, and how they affect segment margins, customer collections, and working capital.
- Developments in opioid litigation and the Tennessee government inquiry, including any subsequent settlement terms, accruals, or loss estimates.
- Completion, timing, and consideration for the German wholesale transaction, and actual restructuring costs against the stated $470 million to $555 million estimate.
- Debt maturities, cash generation, liquidity, and the effect of the announced dividend increase and any future share repurchases.