How much did the Securities Litigation charge affect McKesson's FY2005 results?

The company recorded a $1.2 billion pre-tax charge, or $810 million after tax. It comprises a $960 million cash settlement of the consolidated class action and a $240 million reserve for other related cases. The after-tax figure includes an estimated $390 million tax benefit, with an $85 million reserve for uncertain tax matters. Without the charge, FY2005 net income would have been $653.3 million, or $2.19 per diluted share.

Is McKesson's margin pressure from pharmaceutical distribution likely to persist?

Management attributes margin pressure to fewer and smaller brand-name price increases, reduced access to secondary-market purchasing and vendor incentives, competitive selling margins, and a rising share of lower-margin institutional and warehouse sales. The company is moving to fee-based manufacturer agreements, expected to be complete by mid-2006, with over 80% of manufacturer compensation then unaffected by price inflation. Pressure could continue until that transition is complete.

How concentrated is McKesson's customer base?

Concentration is high. The ten largest customers accounted for about 50% of FY2005 consolidated revenue and about 49% of receivables at March 31, 2005. Rite Aid alone represented about 10% of revenue and 7% of receivables. A payment default or material reduction in purchases by a large customer could significantly affect results and liquidity.

What capital return and financial flexibility does McKesson have?

The company paid $0.24 per share in annual dividends ($0.06 quarterly) and made no share repurchases in FY2005, leaving about $209 million under its authorization. Liquidity is supported by $1.8 billion in cash and marketable securities and a $1.3 billion five-year revolving credit facility with no borrowings outstanding at March 31, 2005. A $1.4 billion receivables sale facility was also undrawn, though it was set to expire in June 2005.

MCK 10-K FY2005 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed May 13, 2005. Cited figures are marked; the original filing is the authoritative source.

McKesson's fiscal 2005 (year ended March 31, 2005) revenue rose 16% to $80.5 billion^a, driven by the Pharmaceutical Solutions segment, which generated about 95% of sales.

Gross margin fell to 4.30% from 4.67%, mainly from lower pharmaceutical distribution margins and reduced manufacturer price-increase benefits. The company reported a net loss of $156.7 million^b, or $0.53 per diluted share, after a $1.2 billion pre-tax Securities Litigation charge ($810 million after tax). Excluding that charge, net income would have been $653.3 million, or $2.19 per diluted share, roughly flat with the prior year.

The balance sheet is solid. Cash and marketable securities were $1.8 billion^c against total debt of $1.21 billion, leaving net cash of about $599 million, and the debt-to-capital ratio was 18.7%. The company made no share repurchases in 2005 and had about $209 million remaining under its authorization.

The $960 million^d class action settlement is payable later in 2005, and management does not expect difficulty financing it. The key forward-looking issues are the shift from buy-and-hold and inventory management agreements to fee-based manufacturer compensation, which management expects to complete by mid-2006 with over 80% of manufacturer compensation insulated from price inflation.

Customer concentration is high, with the top ten customers at about 50% of revenue and Rite Aid at about 10%. Other risks include the troubled UK NHS payroll contract, with about $114 million invested and no material revenue recognized to date, and a range of remaining litigation, including the Roby employment judgment and government investigations.

02—Key points

Key Highlights

Revenue grew 16% to $80.5 billion in FY2005, up from $69.5 billion, with Pharmaceutical Solutions contributing about $76.3 billion (roughly 95% of total).
Reported net loss of $156.7 million (-$0.53 diluted EPS) reflects a $1.2 billion pre-tax Securities Litigation charge; excluding it, net income was $653.3 million ($2.19 per diluted share).
Consolidated gross margin declined to 4.30% from 4.67%, with Pharmaceutical Solutions margin falling to 2.89% from 3.17% amid competitive pressure and fewer manufacturer price increases.
Operating cash flow improved to $1.54 billion from $595 million, aided by working capital changes, including better supplier alignment and the new Department of Veterans Affairs contract.
Balance sheet is strong: cash and marketable securities of $1.8 billion exceed total debt of $1.21 billion, and the debt-to-capital ratio is 18.7% versus a 56.5% covenant limit.
Customer concentration is significant: the ten largest customers represent about 50% of revenue and Rite Aid about 10%; no share buybacks were made in 2005.
Key risks include the NHS UK payroll contract ($114 million investment, no material revenue recognized, potential material losses), remaining accounting litigation reserves of $240 million, and an unresolved Roby employment judgment.

03—Questions

Frequently Asked Questions

How much did the Securities Litigation charge affect McKesson's FY2005 results?
The company recorded a $1.2 billion pre-tax charge, or $810 million after tax. It comprises a $960 million cash settlement of the consolidated class action and a $240 million reserve for other related cases. The after-tax figure includes an estimated $390 million tax benefit, with an $85 million reserve for uncertain tax matters. Without the charge, FY2005 net income would have been $653.3 million, or $2.19 per diluted share.
Is McKesson's margin pressure from pharmaceutical distribution likely to persist?
Management attributes margin pressure to fewer and smaller brand-name price increases, reduced access to secondary-market purchasing and vendor incentives, competitive selling margins, and a rising share of lower-margin institutional and warehouse sales. The company is moving to fee-based manufacturer agreements, expected to be complete by mid-2006, with over 80% of manufacturer compensation then unaffected by price inflation. Pressure could continue until that transition is complete.
How concentrated is McKesson's customer base?
Concentration is high. The ten largest customers accounted for about 50% of FY2005 consolidated revenue and about 49% of receivables at March 31, 2005. Rite Aid alone represented about 10% of revenue and 7% of receivables. A payment default or material reduction in purchases by a large customer could significantly affect results and liquidity.
What capital return and financial flexibility does McKesson have?
The company paid $0.24 per share in annual dividends ($0.06 quarterly) and made no share repurchases in FY2005, leaving about $209 million under its authorization. Liquidity is supported by $1.8 billion in cash and marketable securities and a $1.3 billion five-year revolving credit facility with no borrowings outstanding at March 31, 2005. A $1.4 billion receivables sale facility was also undrawn, though it was set to expire in June 2005.

04—Continue

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