McKesson Corporation — Form 10-Q Summary
Business context and reporting period. This filing covers the quarter and six months ended September 30, 2010, McKesson’s fiscal second quarter and first half of fiscal 2011. The company operates through Distribution Solutions and Technology Solutions. Distribution Solutions generated about 97% of quarterly revenue. Figures below are in U.S. dollars; financial statement amounts are in millions unless noted.
Key financial metrics
| Metric | Quarter ended Sep. 30, 2010 | Prior-year quarter | Six months ended Sep. 30, 2010 | Prior-year six months |
|---|---|---|---|---|
| Revenue | $27,534 | $27,130 | $54,984 | $53,787 |
| Gross profit | $1,366 | $1,335 | $2,758 | $2,638 |
| Gross margin | 4.96% | 4.92% | 5.02% | 4.90% |
| Operating income | $417 | $467 | $891 | $926 |
| Income from continuing operations | $255 | $301 | $553 | $589 |
| Net income | $327 | $301 | $625 | $589 |
| Diluted EPS, continuing operations | $0.97 | $1.11 | $2.07 | $2.17 |
| Total diluted EPS | $1.25 | $1.11 | $2.34 | $2.17 |
| Cash provided by operating activities | Not presented quarterly | $798 | $1,533 |
- Quarterly revenue rose 1% and first-half revenue rose 2%, primarily from market growth. Gross profit increased 2% and 5%, respectively.
- Continuing-operations income fell 15% for the quarter and 6% for the half year. Operating income declined despite higher revenue and gross profit; the filing attributes pressure mainly to the HzERM software impairment, the AWP litigation charge, increased expenses, and the prior-year securities-litigation credit.
- Net income rose 9% for the quarter and 6% for the half year, but included a $72 million after-tax gain on the sale of McKesson Asia Pacific (MAP), equal to $0.28 and $0.27 of diluted EPS, respectively. MAP’s historical results were not material.
- Distribution Solutions quarterly revenue was $26,764, up 2%; segment operating profit was $491, up 18%. Technology Solutions revenue was $770, down 3%; operating profit was $14, down from $116, including the $72 million impairment charge.
- Distribution Solutions’ gross margin improved to 4.07% from 3.64% in the quarter, primarily on higher generic-drug sales and buy-side margin. First-half results also included a $51 million antitrust settlement benefit. Technology Solutions’ margin was reduced by the impairment and continued product investment.
Financial position, liquidity and capital allocation
- At September 30, cash and cash equivalents were $3,050, versus $3,731 at March 31, 2010. Working capital was $3,859, down from $4,492; total assets were $26,792, down from $28,189.
- Long-term debt was $2,279, versus $2,293. Debt net of cash was negative $770 (net cash), compared with negative $1,434 at March 31. The debt-to-capital ratio was 25.1%, up from 23.4%. The $1.3 billion revolving facility had no borrowings; $41 million of letters of credit reduced availability. The receivables facility was increased to $1.35 billion and renewed through May 2011; no balance was outstanding at quarter end.
- First-half operating cash flow was $798, versus $1,533 a year earlier. Management said the prior-year period benefited from improved inventory management; cash flow also depends on the timing of customer receipts, inventory purchases and vendor payments. Investing activities used $95 million, including $109 million of proceeds from the MAP sale. Financing activities used $1,376 million, including $1,547 million for share repurchases and $80 million of dividends paid.
- McKesson repurchased shares for $1.547 billion in the first half, reducing weighted-average diluted shares 3% for the quarter and 2% for the half year. The quarterly dividend was raised from $0.12 to $0.18 per share. In October 2010, the board authorized a further $1 billion repurchase plan.
Material developments, outlook and risks
- Unusual charges and transactions: McKesson recorded a $72 million non-cash impairment of capitalized HzERM software after lowering expected revenues, and a $24 million charge for settling Connecticut AWP claims. The MAP sale generated $109 million of net proceeds and a $95 million pre-tax gain.
- Outlook and liquidity: The filing gives no specific revenue or earnings guidance. Management expects cash generated from operations and existing credit sources to fund capital expenditures, working capital and other cash needs, and believes liquidity will meet financing needs for the foreseeable future. Management estimated fiscal 2011 PSIP expense at approximately $60 million. Future dividends remain subject to board discretion and company conditions.
- Legal and tax exposures: The company reported continuing AWP-related litigation, including new state actions, and stated it could not estimate remaining possible losses in unresolved proceedings. It had received $140 million in Canadian transfer-pricing assessments, most of which had been paid to stop interest accrual; management said it had adequately provided for potential adverse results. Unrecognized tax benefits totaled $631 million, including $407 million that would reduce tax expense if recognized.
- Other risks: Management cited healthcare regulation and competition, drug price changes, customer concentration and defaults, technology implementation and product risks, foreign exchange, tax challenges, litigation, and access to credit markets. It cautioned that market disruption could impair liquidity or raise borrowing costs. The company was in compliance with its debt covenants; the principal debt-to-capital covenant limit was 56.5%.
Most important facts for investors to verify
- Whether Distribution Solutions’ margin gains are sustainable, particularly the contribution from generic drugs, buy-side economics and the one-time $51 million antitrust benefit.
- Whether Technology Solutions can improve performance and realize expected revenues from HzERM after the $72 million impairment.
- The ultimate financial outcome of AWP litigation and other legal matters, and developments in the Canadian tax dispute.
- How cash generation and working-capital needs evolve after the sharp year-over-year decline in first-half operating cash flow and substantial share repurchases.
- Whether the new repurchase authorization and higher dividend remain consistent with liquidity, debt levels and future operating requirements.