filings.toolsItem 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
INDEX TO MANAGEMENT’S DISCUSSION AND ANALYSIS
GENERAL
Management’s discussion and analysis of financial condition and results of operations, referred to as the “Financial Review,” is intended to assist the reader in the understanding and assessment of significant changes and trends related to the results of operations and financial position of McKesson Corporation together with its subsidiaries (collectively, the “Company,” “McKesson,” “we,” “our,” or “us,” and other similar pronouns). This discussion and analysis should be read in conjunction with the condensed consolidated financial statements and accompanying financial notes in Item 1 of Part I of this Quarterly Report on Form 10-Q (“Quarterly Report”) and in Item 8 of Part II of our Annual Report on Form 10-K for the fiscal year ended March 31, 2022 previously filed with the Securities and Exchange Commission on May 9, 2022 (“2022 Annual Report”).
Our fiscal year begins on April 1 and ends on March 31. Unless otherwise noted, all references to a particular year shall mean our fiscal year.
Certain statements in this report constitute forward-looking statements. See “Cautionary Notice About Forward-Looking Statements” included in this Quarterly Report.
Overview of our Business:
We are a diversified healthcare services leader dedicated to advancing health outcomes for patients everywhere. Our teams partner with biopharma companies, care providers, pharmacies, manufacturers, governments, and others to deliver insights, products, and services to help make quality care more accessible and affordable.
We report our financial results in four reportable segments: U.S. Pharmaceutical, Prescription Technology Solutions (“RxTS”), Medical-Surgical Solutions, and International. Our organizational structure also includes Corporate, which consists of income and expenses associated with administrative functions and projects, and the results of certain investments. The factors for determining the reportable segments include the manner in which management evaluates the performance of the Company combined with the nature of individual business activities. We evaluate the performance of our operating segments on a number of measures, including revenues and operating profit (loss) before interest expense and income taxes.
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McKESSON CORPORATION
FINANCIAL REVIEW (CONTINUED)
(UNAUDITED)
The following summarizes our four reportable segments. Refer to Financial Note 14, “Segments of Business,” to the accompanying condensed consolidated financial statements included in this Quarterly Report for further information regarding our reportable segments.
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U.S. Pharmaceutical** is a reportable segment that distributes branded, generic, specialty, biosimilar, and over-the-counter pharmaceutical drugs and other healthcare-related products. This segment also provides practice management, technology, clinical support, and business solutions to community-based oncology and other specialty practices. In addition, the segment sells financial, operational, and clinical solutions to pharmacies (retail, hospital, alternate site) and provides consulting, outsourcing, technological, and other services.
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Prescription Technology Solutions** is a reportable segment that combines automation and our ability to navigate the healthcare ecosystem to connect pharmacies, providers, payers, and biopharma companies to address patients’ medication access, affordability, and adherence challenges to help people get the medicine they need to live healthier lives.
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Medical-Surgical Solutions** is a reportable segment that provides medical-surgical supply distribution, logistics, and other services to healthcare providers in the United States (“U.S.”).
*•*International is a reportable segment that includes our operations in Europe and Canada, bringing together non-U.S.-based drug distribution services, specialty pharmacy, retail, and infusion care services. During fiscal 2022, we entered into agreements to sell certain of our businesses in the European Union (“E.U.”) and our retail and distribution businesses in the United Kingdom (“U.K.”), as well as completed the sale of our Austrian business. In April 2022, we completed the sale of our retail and distribution businesses in the U.K. These divestitures are further described in the “European Divestiture Activities” section below.
European Divestiture Activities
On July 5, 2021, we entered into an agreement to sell certain of our businesses in the E.U. located in France, Italy, Ireland, Portugal, Belgium, and Slovenia, along with our German headquarters and wound-care business, part of a shared services center in Lithuania, and our ownership stake in a joint venture in the Netherlands (“E.U. disposal group”) to the PHOENIX Group for a purchase price of €1.2 billion (or, approximately $1.2 billion) adjusted for certain items, including cash, net debt and working capital adjustments, and reduced by the value of the noncontrolling interest held by minority shareholders of McKesson Europe AG (“McKesson Europe”) at the transaction closing date. For the three and six months ended September 30, 2022, we recorded net gains of $23 million and $35 million, respectively, and for the three and six months ended September 30, 2021, we recorded charges of $491 million in total operating expenses to remeasure the assets and liabilities of our E.U. disposal group to fair value less costs to sell. The fiscal 2022 charges also included impairments of certain internal-use software that will not be utilized in the future, prior to adjusting the E.U. disposal group as a whole, and a $226 million loss related to the accumulated other comprehensive income balances associated with our E.U. disposal group. The transaction closed on October 31, 2022 and we received net cash proceeds of $892 million after the adjustments listed above.
On April 6, 2022, we completed the previously announced sale of our retail and distribution businesses in the U.K. (“U.K. disposal group”) to Aurelius Elephant Limited for a purchase price of £110 million (or, approximately $144 million), including certain adjustments. As part of the transaction, we divested net assets of $615 million and released $731 million of accumulated other comprehensive loss.
As of September 30, 2022, we had $2.8 billion of assets and $2.0 billion of liabilities classified as “Assets held for sale” and “Liabilities held for sale,” respectively, in the Condensed Consolidated Balance Sheet related to our E.U. disposal group described above. Refer to Financial Note 2, “Business Acquisitions and Divestitures,” to the accompanying condensed consolidated financial statements included in this Quarterly Report for more information.
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McKESSON CORPORATION
FINANCIAL REVIEW (CONTINUED)
(UNAUDITED)
Executive Summary:
The following summary provides highlights and key factors that impacted our business, operating results, financial condition, and liquidity for the three and six months ended September 30, 2022.
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On November 1, 2022, we completed our acquisition of Rx Savings Solutions, LLC (“RxSS”) to expand on connecting biopharma and payer services to patients. RxSS is a prescription price transparency and benefit insight company that offers affordability and adherence solutions to health plans and employers. Transaction consideration included a payment of approximately $600 million made upon closing and a maximum of $275 million of contingent consideration based on RxSS’ financial performance through calendar year 2025. The financial results of RxSS will be reported within our RxTS segment as of the acquisition date in the third quarter of fiscal 2023;
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On October 31, 2022, we completed a transaction with HCA Healthcare, Inc. (“HCA”) to form an oncology research business, combining McKesson’s U.S. Oncology Research (“USOR”) and HCA’s Sarah Cannon Research Institute (“SCRI”), to advance cancer care and increase access to oncology clinical research. Transaction consideration included the transfer of full ownership interest in USOR to the combined business and $173 million of cash paid to HCA. The financial results of the combined business, in which we have a 51% controlling financial interest, will be reported within our U.S. Pharmaceutical segment as of the acquisition date in the third quarter of fiscal 2023. Separately, on October 31, 2022, we acquired Genospace, SCRI’s personalized medicine platform. Genospace is a leading innovator in precision medicine and clinical trial matching and will enhance McKesson’s oncology data and analytics capabilities;
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On October 31, 2022, we completed the sale of our E.U. disposal group and received net cash proceeds of $892 million, as discussed in further detail in the “European Divestitures Activities” section above;
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In July 2022, we exited one of our investments in equity securities within our U.S. Pharmaceutical segment for proceeds of $179 million and recognized a gain of $142 million within other income, net during the second quarter of fiscal 2023;
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McKesson continues to play a leading role in the fight against the pandemic disease caused by the SARS-CoV-2 coronavirus (“COVID-19”). For a more in-depth discussion of how COVID-19 impacted our business, operations, financial results, and outlook, refer to the COVID-19 section of "Trends and Uncertainties" included below;
*•*For the three months ended September 30, 2022 compared to the prior year, revenues increased by 5%, gross profit decreased by 8%, total operating expenses decreased by 30%, and other income, net increased by 26%. For the six months ended September 30, 2022 compared to the prior year, revenues increased by 6%, gross profit decreased by 4%, total operating expenses decreased by 25%, and other income, net increased by 4%. Refer to the “Overview of Consolidated Results” section below for an analysis of these changes;
*•*Diluted earnings per common share from continuing operations attributable to McKesson Corporation increased 278% to $6.46 and 143% to $11.71 for the three and six months ended September 30, 2022 compared to the prior year, respectively, primarily driven by year over year favorability from fair value remeasurements of our E.U. disposal group since it was classified as held for sale in July 2022 and a lower share count due to the cumulative effect of share repurchases; and
- We returned $1.6 billion of cash to shareholders during the six months ended September 30, 2022 through $1.5 billion of common stock repurchases both under an accelerated share repurchase (“ASR”) program completed in August 2022 as well as through open market transactions and $139 million of dividend payments. In July 2022, our Board of Directors (the “Board”) approved an increase of $4.0 billion in the authorization for repurchases of McKesson’s common stock and raised our quarterly dividend from $0.47 to $0.54 per common share. The total remaining authorization outstanding for repurchases of the Company’s common stock at September 30, 2022 was $5.8 billion.
Trends and Uncertainties:
Legislative Developments
On August 16, 2022, the U.S. government enacted the Inflation Reduction Act of 2022 (the “IR Act”). Among other provisions, the IR Act includes a 15% corporate minimum tax, a 1% excise tax on certain repurchases of an entity’s own common stock after December 31, 2022, and various drug pricing reforms. Based on our preliminary assessment, we do not currently expect the IR Act to have a material impact on our results of operations, financial position, or cash flows in the foreseeable future; however, we will continue to evaluate the full impact of these legislative changes.
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McKESSON CORPORATION
FINANCIAL REVIEW (CONTINUED)
(UNAUDITED)
The Impact of Inflationary and Global Events
Our business and results of operations, financial condition, and liquidity are impacted by broad economic conditions including inflation, increased competition for talent, and disruption of the supply chain, as well as by political or civil unrest or military action, including indirect results such as commodity price increases from the conflict between Russia and Ukraine (“Russo-Ukrainian War”). Cost inflation generally affects us by increasing transportation, operational, and other administrative costs associated with our business operations which we might not be able to fully pass along to our customers. Although it is difficult to predict the impact that these factors may have on our business in the future, they did not have a material impact on our results of operations, financial condition, or liquidity for the three and six months ended September 30, 2022.
COVID-19
COVID-19 has continued to evolve since it was declared a global pandemic by the World Health Organization on March 11, 2020. We continue to evaluate the nature and extent of the ongoing impacts of COVID-19 on our business, operations, and financial results. Refer to Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part II of our 2022 Annual Report for additional disclosure of trends and uncertainties due to COVID-19. The disclosures below include significant updates that occurred during the first half of fiscal 2023 and the financial impacts compared to fiscal 2022.
Our Role in the Distribution of COVID-19 Vaccines and Ancillary Supply Kits
As a diversified healthcare services leader, we are well positioned to respond to the COVID-19 pandemic in the U.S., Canada, and Europe. We work closely with national and local governments, agencies, and industry partners to ensure that available supplies, including personal protective equipment (“PPE”), and medicine reach our customers and their patients.
In December 2020, we began distributing certain COVID-19 vaccines in support of the U.S. government through a contract with the Centers for Disease Control and Prevention (“CDC”). In July 2022, we renewed our relationship with the CDC, under which we serve as a centralized distributor of COVID-19 vaccines and ancillary supplies used to administer vaccines. The results of operations related to our vaccine distribution are reflected in our U.S. Pharmaceutical segment. We also extended our contract to manage the assembly, storage, and distribution of ancillary supply kits as directed by the Department of Health and Human Services (“HHS”), the results of which are reflected in our Medical-Surgical Solutions segment.
McKesson Canada and McKesson Europe support governments and public health entities through distributing COVID-19 vaccines and administering them in pharmacies as well as distributing COVID-19 tests and certain PPE.
Trends in our Business
We observed stability in prescription volumes within our U.S. Pharmaceutical segment and patient visits in our primary care business within our Medical-Surgical Solutions segment during the three and six months ended September 30, 2022 compared to the same prior year periods. The contributions from COVID-19 tests and our vaccine and related kitting distribution programs have decreased year over year primarily driven by lower demand.
Impacts to our Supply Chain
We continue to monitor and address the COVID-19 pandemic impacts on our supply chain. Although the availability of various products is dependent on our suppliers, their locations, and the extent to which they are impacted by the COVID-19 pandemic, we proactively work with manufacturers, industry partners, and government agencies to meet the needs of our customers. During the first half of fiscal 2023, we had an increase in supply chain costs primarily related to transportation and labor; however, this did not materially impact our results of operations for the three and six months ended September 30, 2022. As potential shortages or disruptions of any products are identified, we address supply continuity which includes securing additional products when available, sourcing back-up products when needed, and following allocation procedures to maintain and protect supply as much as possible. We utilize business continuity action planning to maintain and protect operations across all locations and facilities.
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McKESSON CORPORATION
FINANCIAL REVIEW (CONTINUED)
(UNAUDITED)
Impact to our Results of Operations, Financial Condition, and Liquidity
For the three months ended September 30, 2022, COVID-19 tests and the kitting and distribution of ancillary supplies for COVID-19 vaccines in our Medical-Surgical Solutions segment contributed approximately $227 million and $65 million to segment revenues and segment operating profit, respectively, and for the three months ended September 30, 2021, contributed approximately $545 million and $93 million to segment revenues and segment operating profit, respectively. For the six months ended September 30, 2022, the contribution was approximately $428 million and $114 million to segment revenues and segment operating profit, respectively, and for the six months ended September 30, 2021, the contribution was approximately $868 million to segment revenues and including total inventory charges that are further described below, increased our segment operating profit by approximately 1%.
The distribution of COVID-19 vaccines in our U.S. Pharmaceutical segment decreased during the second quarter and first half of fiscal 2023 when compared to the same prior year periods. The contribution was less than 10% to segment operating profit for each of the three and six months ended September 30, 2022 and 2021. The financial impact from our COVID-19 response efforts in the International segment during the three and six months ended September 30, 2022 and 2021 was not material to our consolidated or segment operating results.
Additionally, we recorded inventory charges totaling $164 million on certain PPE and other related products in our Medical-Surgical Solutions segment during the six months ended September 30, 2021. We have taken measures to mitigate risks for market price volatility and changes to anticipated customer demand that may require additional write-downs in future periods of other PPE and related product categories.
Excluding the prior year inventory charges on certain PPE and other related products for the six months ended September 31, 2021 mentioned above, these COVID-19 related items had a net unfavorable impact on consolidated income from continuing operations before income taxes for the three and six months ended September 30, 2022 compared to the same prior year periods, primarily driven by lower demand for COVID-19 tests as well as COVID-19 vaccines and related ancillary supply kits.
During the three and six months ended September 30, 2022 and 2021, we maintained appropriate labor and overall vendor supply levels and experienced no material impacts to our liquidity or net working capital due to the COVID-19 pandemic.
Opioid-Related Litigation and Claims
We are a defendant in many legal proceedings asserting claims related to the distribution of controlled substances (opioids) in federal and state courts throughout the U.S., and in Puerto Rico and Canada. The plaintiffs in these actions have included state attorneys general, county and municipal governments, tribal nations, hospitals, health and welfare funds, third-party payors, and individuals.
The Company and two other national pharmaceutical distributors (collectively “Distributors”) settled with 46 of 49 eligible states and their participating subdivisions, as well as the District of Columbia and all eligible territories (collectively, “Settling Governmental Entities”) effective on April 2, 2022 (“Settlement”). Under the Settlement, the Distributors will pay the Settling Governmental Entities up to approximately $19.5 billion over 18 years, with up to approximately $7.4 billion to be paid by the Company for its 38.1% portion. Consent judgments have been entered in all participating states and territories, and approximately 2,000 cases have been dismissed pursuant to the Settlement. A minimum of 85% of the Settlement payments must be used by state and local governmental entities to remediate the opioid epidemic. Most of the remaining percentage relates to plaintiffs’ attorneys’ fees and costs, and is payable over a shorter time period. Under the Settlement, the Distributors will establish a clearinghouse to consolidate their controlled-substance distribution data, which will be available to the settling U.S. states to use as part of their anti-diversion efforts. The Settlement provides that the Distributors do not admit liability or wrongdoing and do not waive any defenses.
The Settlement only addresses the claims of attorneys general of U.S. states and territories and political subdivisions in participating states and territories. Governmental entities not participating in the Settlement may continue to pursue their claims. The states of Alabama, Oklahoma and Washington chose not to participate in the Settlement, but, since the announcement of the Settlement, we have reached separate agreements with the attorneys general of these states to settle the claims of the states and their subdivisions. The Distributors previously settled with the Cherokee Nation and reached an agreement to settle the claims of federally recognized Native American Tribes.
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McKESSON CORPORATION
FINANCIAL REVIEW (CONTINUED)
(UNAUDITED)
Our total estimated liability for opioid-related claims was $7.3 billion as of September 30, 2022, of which $703 million was included in “Other accrued liabilities” for the amount estimated to be paid within the next twelve months, and the remaining liability was included in “Long-term litigation liabilities” in our Condensed Consolidated Balance Sheet.
Although the vast majority of opioid claims have been brought by governmental entities in the U.S., the Company is also a defendant in cases brought in the U.S. by private plaintiffs, such as hospitals, health and welfare funds, third-party payors, and individuals, as well as four cases brought in Canada (three by governmental or tribal entities and one by an individual). These claims, and those of private individuals or entities generally, are not included in the Settlement or in the charges recorded by the Company, described above. The Company believes it has valid legal defenses in these matters and intends to mount a vigorous defense.
Because of the many uncertainties associated with ongoing opioid-related litigation matters, we are not able to reasonably estimate the upper or lower ends of the range of ultimate possible loss for all opioid-related litigation matters. In light of the uncertainty, the amount of any ultimate loss may differ materially from the amount accrued.
Notwithstanding the Settlement, we also continue to prepare for trial in pending matters. We believe that we have valid defenses to the claims pending against us and, absent an acceptable settlement, intend to vigorously defend against all such claims. An adverse judgment or negotiated resolution in any of these matters could have a material adverse impact on our financial position, cash flows or liquidity, or results of operations. Refer to Financial Note 12, “Commitments and Contingent Liabilities,” to the accompanying condensed consolidated financial statements included in this Quarterly Report for more information.
Risks and Forward-Looking Information
Recent events such as the COVID-19 pandemic, the Russo-Ukrainian War, and associated economic impacts have disrupted the global economy and exacerbated uncertainties inherent in estimates, judgments, and assumptions used in our forecasts. We have experienced and may experience difficulties in sourcing products and changes in costs and pricing due to the effects of these events on supply chains. Our participation in government-sponsored vaccination distribution and related ancillary supply kit programs with the CDC and HHS exposes us to various uncertainties, such as the scope and length of related agreements and the amount of COVID-19 vaccines and ancillary supply kits that we are contracted to distribute, which could materially impact our future financial performance. Additionally, we periodically review our intangible and other long-lived assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable. Key assumptions and estimates about future values in our impairment assessments can be affected by a variety of factors, including the impacts of socio-political events on industry and economic trends as well as on our business strategy and internal forecasts. Impairment charges have been recognized in prior periods due to the impact from the COVID-19 pandemic. Material changes to key assumptions and estimates could decrease the projected cash flows or increase the discount rates that could potentially result in future impairment charges. Refer to Item 1A - Risk Factors in Part I of our 2022 Annual Report for a discussion of risk factors that could cause our actual results to differ materially from our projections.
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McKESSON CORPORATION
FINANCIAL REVIEW (CONTINUED)
(UNAUDITED)
RESULTS OF OPERATIONS
Overview of Consolidated Results:
| (Dollars in millions, except per share data) | Three Months Ended September 30, | Six Months Ended September 30, | |||||||||||||||||||||||||||||||||||||||
| 2022 | 2021 | Change | 2022 | 2021 | Change | ||||||||||||||||||||||||||||||||||||
| Revenues | $ | 70,157 | $ | 66,576 | 5 | % | $ | 137,311 | $ | 129,250 | 6 | % | |||||||||||||||||||||||||||||
| Gross profit | 3,095 | 3,352 | (8) | 6,118 | 6,384 | (4) | |||||||||||||||||||||||||||||||||||
| Gross profit margin | 4.41 | % | 5.03 | % | (62) | bp | 4.46 | % | 4.94 | % | (48) | bp | |||||||||||||||||||||||||||||
| Total operating expenses | $ | (1,971) | $ | (2,813) | (30) | % | $ | (3,958) | $ | (5,277) | (25) | % | |||||||||||||||||||||||||||||
| Total operating expenses as a percentage of revenues | 2.81 | % | 4.23 | % | (142) | bp | 2.88 | % | 4.08 | % | (120) | bp | |||||||||||||||||||||||||||||
| Other income, net | $ | 175 | $ | 139 | 26 | % | $ | 190 | $ | 182 | 4 | % | |||||||||||||||||||||||||||||
| Loss on debt extinguishment | — | (191) | (100) | — | (191) | (100) | |||||||||||||||||||||||||||||||||||
| Interest expense | (55) | (45) | 22 | (100) | (94) | 6 | |||||||||||||||||||||||||||||||||||
| Income from continuing operations before income taxes | 1,244 | 442 | 181 | 2,250 | 1,004 | 124 | |||||||||||||||||||||||||||||||||||
| Income tax expense | (271) | (132) | 105 | (470) | (158) | 197 | |||||||||||||||||||||||||||||||||||
| Reported income tax rate | (21.8) | % | (29.9) | % | 810 | bp | (20.9) | % | (15.7) | % | (520) | bp | |||||||||||||||||||||||||||||
| Income from continuing operations | $ | 973 | $ | 310 | 214 | % | $ | 1,780 | $ | 846 | 110 | % | |||||||||||||||||||||||||||||
| Loss from discontinued operations, net of tax | (6) | — | — | (4) | (3) | 33 | |||||||||||||||||||||||||||||||||||
| Net income | 967 | 310 | 212 | 1,776 | 843 | 111 | |||||||||||||||||||||||||||||||||||
| Net income attributable to noncontrolling interests | (41) | (43) | (5) | (82) | (90) | (9) | |||||||||||||||||||||||||||||||||||
| Net income attributable to McKesson Corporation | $ | 926 | $ | 267 | 247 | % | $ | 1,694 | $ | 753 | 125 | % | |||||||||||||||||||||||||||||
| Diluted earnings (loss) per common share attributable to McKesson Corporation | |||||||||||||||||||||||||||||||||||||||||
| Continuing operations | $ | 6.46 | $ | 1.71 | 278 | % | $ | 11.71 | $ | 4.82 | 143 | % | |||||||||||||||||||||||||||||
| Discontinued operations | (0.04) | — | — | (0.03) | (0.02) | 50 | |||||||||||||||||||||||||||||||||||
| Total | $ | 6.42 | $ | 1.71 | 275 | % | $ | 11.68 | $ | 4.80 | 143 | % | |||||||||||||||||||||||||||||
| Weighted-average diluted common shares outstanding | 144.1 | 155.8 | (8) | % | 145.0 | 156.9 | (8) | % |
All percentage changes displayed above which are not meaningful are displayed as zero percent.
bp - basis points
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McKESSON CORPORATION
FINANCIAL REVIEW (CONTINUED)
(UNAUDITED)
Revenues
Revenues increased for the three and six months ended September 30, 2022 compared to the same prior year periods primarily due to market growth in our U.S. Pharmaceutical segment. Market growth includes growing drug utilization, price increases, and newly launched products, partially offset by price deflation associated with branded to generic drug conversion. This revenue growth was partially offset by lower revenues in our International segment driven by the completed divestiture of our U.K. disposal group in April 2022 and unfavorable effects of foreign currency exchange fluctuations.
Gross Profit
Gross profit decreased for the three and six months ended September 30, 2022 compared to the same prior year periods primarily in our International segment driven by the completed divestiture of our U.K. disposal group in April 2022 and unfavorable effects of foreign currency exchange fluctuations. For the six months ended September 30, 2022, this was partially offset by an increase in gross profit in our Medical-Surgical Solutions segment due to prior year inventory charges on certain PPE and other related products and favorability in our primary care business. Gross profit for the six months ended September 30, 2022 was also favorably impacted by growth of specialty pharmaceuticals in our U.S. Pharmaceutical segment as well as increased volume with new and existing customers in our RxTS segment.
Last-in, first-out (“LIFO”) inventory credits were $23 million for each of the three months ended September 30, 2022 and 2021, and $36 million and $46 million for the six months ended September 30, 2022 and 2021, respectively. LIFO credits were lower in the first half of fiscal 2023 compared to the same prior year period primarily due to higher expected brand inflation. Our U.S. Pharmaceutical business uses the LIFO method of accounting for the majority of its inventories, which results in cost of sales that more closely reflects replacement cost than under other accounting methods. The business’ practice is to pass on to customers published price changes from suppliers. Manufacturers generally provide us with price protection, which limits price related inventory losses. A LIFO expense is recognized when the net effect of price increases on pharmaceutical and non-pharmaceutical products held in inventory exceeds the impact of price declines, including the effect of branded pharmaceutical products that have lost market exclusivity. A LIFO credit is recognized when the net effect of price declines exceeds the impact of price increases on pharmaceutical and non-pharmaceutical products held in inventory. Our quarterly LIFO credit is based on our estimates of the annual LIFO credit which is impacted by expected changes in year-end inventory quantities, product mix, and manufacturer pricing practices, which may be influenced by market and other external factors. Changes to any of the above factors could have a material impact to our annual LIFO credit. The actual valuation of inventory under the LIFO method is calculated at the end of the fiscal year.
In October 2022, we received proceeds of $129 million related to our share of an antitrust settlement. A lawsuit was filed against a brand manufacturer alleging that the manufacturer, by itself or in concert with others, took improper actions to delay or prevent generic drugs from entering the market. We were not a named party to the litigation but were a member of the class of those who purchased directly from the pharmaceutical manufacturer. We will recognize a gain in that amount within "Cost of sales" in the Condensed Consolidated Statement of Operations in the third quarter of fiscal 2023 related to the settlement within our U.S. Pharmaceutical segment.
Total Operating Expenses
A summary of the components of our total operating expenses for the three and six months ended September 30, 2022 and 2021 is as follows:
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Selling, distribution, general, and administrative expenses (“SDG&A”): SDG&A consists of personnel costs, transportation costs, depreciation and amortization, lease costs, professional fee expenses, administrative expenses, remeasurement charges to the lower of carrying value or fair value less costs to sell, and other general charges.
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Claims and litigation charges, net: These charges include adjustments for estimated probable settlements related to our controlled substance monitoring and reporting, and opioid-related claims, as well as any applicable income items or credit adjustments due to subsequent changes in estimates. Legal fees to defend claims, which are expensed as incurred, are included within SDG&A.
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Restructuring, impairment, and related charges, net: Restructuring charges are incurred for programs in which we change our operations, the scope of a business undertaken by our business units, or the manner in which that business is conducted as well as long-lived asset impairments.
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McKESSON CORPORATION
FINANCIAL REVIEW (CONTINUED)
(UNAUDITED)
| Three Months Ended September 30, | Six Months Ended September 30, | ||||||||||||||||||||||||||||||||||||||||
| (Dollars in millions) | 2022 | 2021 | Change | 2022 | 2021 | Change | |||||||||||||||||||||||||||||||||||
| Selling, distribution, general, and administrative expenses | $ | 1,950 | $ | 2,669 | (27) | % | $ | 3,909 | $ | 4,901 | (20) | % | |||||||||||||||||||||||||||||
| Claims and litigation charges, net | (9) | 112 | 108 | (4) | 186 | 102 | |||||||||||||||||||||||||||||||||||
| Restructuring, impairment, and related charges, net | 30 | 32 | (6) | 53 | 190 | (72) | |||||||||||||||||||||||||||||||||||
| Total operating expenses | $ | 1,971 | $ | 2,813 | (30) | % | $ | 3,958 | $ | 5,277 | (25) | % | |||||||||||||||||||||||||||||
| Percent of revenues | 2.81 | % | 4.23 | % | (142) | bp | 2.88 | % | 4.08 | % | (120) | bp |
All percentage changes displayed above which are not meaningful are displayed as zero percent.
bp - basis points
For the three and six months ended September 30, 2022, total operating expenses and total operating expenses as a percentage of revenues decreased compared to the same prior year periods. Total operating expenses were impacted by the following significant items:
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SDG&A for the three and six months ended September 30, 2022 reflects lower operating expenses due to the completed divestiture of our U.K. disposal group in April 2022;
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SDG&A for the three and six months ended September 30, 2022 includes gains of $23 million and $35 million, respectively, and for the three and six months ended September 30, 2021 includes charges of $491 million to remeasure the assets and liabilities of our E.U. disposal group to fair value less costs to sell. The fiscal 2022 charges also includes impairments of individual assets, such as certain internal-use software that will not be utilized in the future. The fiscal 2022 remeasurement adjustment includes a $226 million loss related to the accumulated other comprehensive income balances associated with our E.U. disposal group;
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SDG&A for the for the three and six months ended September 30, 2021 includes a gain of $59 million related to the sale of our Canadian health benefit claims management and plan administrative services business;
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SDG&A for the three months ended September 30, 2022 and 2021 includes charges of $9 million and $36 million, respectively, and for the six months ended September 30, 2022 and 2021 includes charges of $28 million and $71 million, respectively, of opioid-related costs, primarily litigation expenses;
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Claims and litigation charges, net for fiscal 2023 was not material and for the three and six months ended September 30, 2021 includes $112 million related to our estimated liability for opioid-related claims of government entities, including Native American tribes. Claims and litigation charges, net for the six months ended September 30, 2021 also includes a charge of $27 million related to an agreement to settle opioid-related claims with the State of New York and its participating subdivisions, including Nassau and Suffolk Counties, and a charge of $47 million related to our estimated liability for a comprehensive proposed agreement to settle opioid-related claims of participating states, their political subdivisions, and other governmental entities. Refer to the Opioid-Related Litigation and Claims section of "Trends and Uncertainties" for further discussion;
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Restructuring, impairment, and related charges, net for fiscal 2023 was not material and for the three and six months ended September 30, 2021 includes charges of $15 million and $110 million, respectively, related to our transition to a partial remote work model approved during the first quarter of fiscal 2022 as further described below; and
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Total operating expenses were favorably impacted by foreign currency exchange fluctuations for the three and six months ended September 30, 2022.
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McKESSON CORPORATION
FINANCIAL REVIEW (CONTINUED)
(UNAUDITED)
Goodwill Impairment
We evaluate goodwill for impairment on an annual basis and at an interim date, if indicators of potential impairment exist. We voluntarily changed our annual goodwill impairment testing date from October 1st to April 1st to align with the change in timing of our annual long-term planning process. This change was not material to our consolidated financial statements as it did not delay, accelerate, or avoid any potential goodwill impairment charge. Refer to Financial Note 7, “Goodwill and Intangible Assets, Net,” to the accompanying condensed consolidated financial statements included in this Quarterly Report for more information.
The annual impairment testing performed in fiscal 2023 and fiscal 2022 did not indicate any impairment of goodwill and no goodwill impairment charges were recorded during the three and six months ended September 30, 2022 and 2021. However, other risks, expenses, and future developments, such as additional government actions, increased regulatory uncertainty, and material changes in key market assumptions limit our ability to estimate projected cash flows, which could adversely affect the fair value of various reporting units in future periods, including our McKesson Canada reporting unit within our International segment, where the risk of a material goodwill impairment is higher than other reporting units.
Restructuring Initiatives and Long-Lived Asset Impairments
During the first quarter of fiscal 2022, we approved an initiative to increase operational efficiencies and flexibility by transitioning to a partial remote work model for certain employees. This initiative primarily included the rationalization of our office space in North America. Where we ceased using office space, we exited the portion of the facility no longer used. We also retained and repurposed certain other office locations. We recorded charges of $15 million and $110 million for the three and six months ended September 30, 2021, respectively, primarily related to lease right-of-use and other long-lived asset impairments, lease exit costs, and accelerated depreciation and amortization. This initiative was substantially complete in fiscal 2022 and remaining costs we recorded and expect to record under this initiative are not material.
Refer to Financial Note 3, “Restructuring, Impairment, and Related Charges, Net,” to the accompanying condensed consolidated financial statements included in this Quarterly Report for further information on our restructuring initiatives.
Other Income, Net
Other income, net increased for the three and six months ended September 30, 2022 compared to the same prior year periods primarily due to a gain of $142 million recognized in July 2022 related to the exit of one of our investments in equity securities held within our U.S. Pharmaceutical segment.
This was partially offset by prior year net gains from our equity investments held within Corporate of $97 million and $104 million recognized for the three and six months ended September 30, 2021, respectively, compared to net losses of $3 million and $25 million recognized for the three and six months ended September 30, 2022, respectively.
We are a party to a certain tax receivable agreement (“TRA”) entered into as part of the formation of the joint venture with Change Healthcare Inc. (“Change”), from which McKesson has since exited. The TRA generally requires Change to pay McKesson 85% of the net cash tax savings realized, or deemed to be realized, by Change resulting from the amortization allocated to Change by the joint venture. In October 2022, Change exercised its right pursuant to the TRA to terminate the agreement. We received $126 million in the third quarter of fiscal 2023 due to early termination of the TRA, which will result in a gain within “Other income, net” in the Condensed Consolidated Statements of Operations within Corporate.
Loss on Debt Extinguishment
The loss on debt extinguishment recorded for the three and six months ended September 30, 2021 of $191 million includes premiums of $182 million as well as the write-off of unamortized debt issuance costs and transaction fees incurred of $9 million, and was driven by our July 2021 tender offer to redeem a portion of our existing debt. Refer to Financial Note 8, “Debt and Financing Activities,” to the accompanying condensed consolidated financial statements included in this Quarterly Report for more information.
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McKESSON CORPORATION
FINANCIAL REVIEW (CONTINUED)
(UNAUDITED)
Interest Expense
Interest expense increased for the three and six months ended September 30, 2022 compared to the same prior year periods, which includes unfavorable impacts from changes in our derivative portfolio as a result of our European divestiture activities. This was partially offset by a decrease in interest expense driven by lower existing debt due to our tender offer in late July 2021. Interest expense may fluctuate based on timing, amounts, and interest rates of term debt repaid and new term debt issued, as well as amounts incurred associated with financing fees.
Income Tax Expense
For the three months ended September 30, 2022 and 2021, we recorded an income tax expense of $271 million and $132 million, respectively. For the six months ended September 30, 2022 and 2021, we recorded income tax expense of $470 million and $158 million, respectively. Our reported income tax rates were 21.8% and 29.9% for the three months ended September 30, 2022 and 2021, respectively, and 20.9% and 15.7% for the six months ended September 30, 2022 and 2021, respectively. Fluctuations in our reported income tax rates are primarily due to non-cash charges related to remeasuring the value of our E.U. disposal group held for sale, changes in our business mix of earnings between various taxing jurisdictions, and discrete tax benefits recognized in the quarters. Refer to Financial Note 4, “Income Taxes,” to the accompanying condensed consolidated financial statements included in this Quarterly Report for more information.
Net Income Attributable to Noncontrolling Interests
Net income attributable to noncontrolling interests for the three and six months ended September 30, 2022 and 2021 primarily represents ClarusONE Sourcing Services LLP, Vantage Oncology Holdings, LLC, and the accrual of the annual recurring compensation amount of €0.83 per McKesson Europe share that McKesson was obligated to pay to the noncontrolling shareholders of McKesson Europe under the December 2014 domination and profit and loss transfer agreement (the “Domination Agreement”). Noncontrolling interests with redemption features, such as put rights, that are not solely within our control are considered redeemable noncontrolling interests. Refer to the “Selected Measures of Liquidity and Capital Resources” section of this Financial Review and Financial Note 5, “Redeemable Noncontrolling Interests and Noncontrolling Interests,” to the accompanying condensed consolidated financial statements included in this Quarterly Report for more information on changes to our redeemable and noncontrolling interests that occurred during the first quarter of fiscal 2022.
Net Income Attributable to McKesson Corporation
Net income attributable to McKesson Corporation was $926 million and $267 million for the three months ended September 30, 2022 and 2021, respectively, and $1.7 billion and $753 million for the six months ended September 30, 2022 and 2021, respectively. Diluted earnings per common share attributable to McKesson Corporation was $6.42 and $1.71 for the three months ended September 30, 2022 and 2021, respectively, and $11.68 and $4.80 for the six months ended September 30, 2022 and 2021, respectively.
Weighted-Average Diluted Common Shares Outstanding
Diluted earnings per common share were calculated based on a weighted-average number of shares outstanding of 144.1 million and 155.8 million for the three months ended September 30, 2022 and 2021, respectively, and 145.0 million and 156.9 million for the six months ended September 30, 2022 and 2021, respectively. Weighted-average diluted shares outstanding for the three and six months ended September 30, 2022 decreased from the same prior year periods primarily due to the cumulative effect of share repurchases.
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McKESSON CORPORATION
FINANCIAL REVIEW (CONTINUED)
(UNAUDITED)
Overview of Segment Results:
Segment Revenues:
| Three Months Ended September 30, | Six Months Ended September 30, | ||||||||||||||||||||||||||||||||||||||||
| (Dollars in millions) | 2022 | 2021 | Change | 2022 | 2021 | Change | |||||||||||||||||||||||||||||||||||
| Segment revenues | |||||||||||||||||||||||||||||||||||||||||
| U.S. Pharmaceutical | $ | 60,059 | $ | 53,411 | 12 | % | $ | 117,006 | $ | 103,430 | 13 | % | |||||||||||||||||||||||||||||
| Prescription Technology Solutions | 1,018 | 932 | 9 | 2,084 | 1,813 | 15 | |||||||||||||||||||||||||||||||||||
| Medical-Surgical Solutions | 2,843 | 3,124 | (9) | 5,435 | 5,652 | (4) | |||||||||||||||||||||||||||||||||||
| International | 6,237 | 9,109 | (32) | 12,786 | 18,355 | (30) | |||||||||||||||||||||||||||||||||||
| Total revenues | $ | 70,157 | $ | 66,576 | 5 | % | $ | 137,311 | $ | 129,250 | 6 | % |
U.S. Pharmaceutical
Three Months Ended September 30, 2022 vs. 2021
U.S. Pharmaceutical revenues for the three months ended September 30, 2022 increased $6.6 billion or 12% compared to the same prior year period. Within the segment, sales to pharmacies and institutional healthcare providers increased $6.4 billion and sales to specialty practices and other, which reflects the results for the distribution of COVID-19 vaccines, increased $235 million. Overall, these increases were primarily due to market growth, including growth in specialty pharmaceuticals driven by higher volumes from retail national account customers, and branded pharmaceutical price increases, partially offset by branded to generic drug conversions.
Six Months Ended September 30, 2022 vs. 2021
U.S. Pharmaceutical revenues for the six months ended September 30, 2022 increased $13.6 billion or 13% compared to the same prior year period. Within the segment, sales to pharmacies and institutional healthcare providers increased $13.0 billion and sales to specialty practices and other, which reflects the results for the distribution of COVID-19 vaccines, increased $550 million. Overall, these increases were primarily due to market growth, including growth in specialty pharmaceuticals driven by higher volumes from retail national account customers, and branded pharmaceutical price increases, partially offset by branded to generic drug conversions.
Prescription Technology Solutions
Three Months Ended September 30, 2022 vs. 2021
RxTS revenues for the three months ended September 30, 2022 increased $86 million or 9% compared to the same prior year period due to increased volumes with new and existing customers primarily in our third-party logistics and wholesale distribution services as well as higher technology service revenues.
Six Months Ended September 30, 2022 vs. 2021
RxTS revenues for the six months ended September 30, 2022 increased $271 million or 15% compared to the same prior year period due to increased volumes with new and existing customers primarily in our third-party logistics and wholesale distribution services as well as higher technology service revenues.
Medical-Surgical Solutions
Three Months Ended September 30, 2022 vs. 2021
Medical-Surgical Solutions revenues for the three months ended September 30, 2022 decreased $281 million or 9% compared to the same prior year period. Within the segment, sales to primary care and extended care customers decreased $227 million and $8 million, respectively. The decrease in our primary care business was driven by lower sales of COVID-19 tests, partially offset by underlying core business growth. Other sales declined $46 million driven by lower contribution from the kitting and distribution of ancillary supply kits used to administer COVID-19 vaccines.
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McKESSON CORPORATION
FINANCIAL REVIEW (CONTINUED)
(UNAUDITED)
Six Months Ended September 30, 2022 vs. 2021
Medical-Surgical Solutions revenues for the six months ended September 30, 2022 decreased $217 million or 4% compared to the same prior year period. Within the segment, sales to primary care customers decreased $140 million and sales to extended care customers increased $2 million. The decrease in our primary care business was driven by lower sales of COVID-19 tests, partially offset by underlying core business growth. Other sales declined $79 million driven by lower contribution from the kitting and distribution of ancillary supply kits used to administer COVID-19 vaccines.
International
Three Months Ended September 30, 2022 vs. 2021
International revenues for the three months ended September 30, 2022 decreased $2.9 billion or 32% compared to the same prior year period. Within the segment, foreign currency exchange fluctuations were unfavorable by $633 million and sales in Europe declined by $2.5 billion, partially offset by increased sales in Canada of $231 million. Excluding the unfavorable effects of foreign currency exchange fluctuations, revenues for this segment decreased 25% largely due to the completed divestitures of our U.K. disposal group in April 2022 and Austrian business in January 2022.
Six Months Ended September 30, 2022 vs. 2021
International revenues for the six months ended September 30, 2022 decreased $5.6 billion or 30% compared to the same prior year period. Within the segment, foreign currency exchange fluctuations were unfavorable by $1.2 billion and sales in Europe declined by $4.8 billion, partially offset by increased sales in Canada of $400 million. Excluding the unfavorable effects of foreign currency exchange fluctuations, revenues for this segment decreased 24% largely due to the completed divestitures of our U.K. disposal group in April 2022 and Austrian business in January 2022.
Segment Operating Profit (Loss) and Corporate Expenses, Net:
| Three Months Ended September 30, | Six Months Ended September 30, | ||||||||||||||||||||||||||||||||||||||||
| (Dollars in millions) | 2022 | 2021 | Change | 2022 | 2021 | Change | |||||||||||||||||||||||||||||||||||
| Segment operating profit (loss) (1) | |||||||||||||||||||||||||||||||||||||||||
| U.S. Pharmaceutical (2) | $ | 896 | $ | 760 | 18 | % | $ | 1,592 | $ | 1,442 | 10 | % | |||||||||||||||||||||||||||||
| Prescription Technology Solutions | 120 | 128 | (6) | 264 | 232 | 14 | |||||||||||||||||||||||||||||||||||
| Medical-Surgical Solutions (3) | 299 | 296 | 1 | 555 | 371 | 50 | |||||||||||||||||||||||||||||||||||
| International (4) | (37) | (146) | (75) | (43) | (93) | (54) | |||||||||||||||||||||||||||||||||||
| Subtotal | 1,278 | 1,038 | 23 | 2,368 | 1,952 | 21 | |||||||||||||||||||||||||||||||||||
| Corporate expenses, net (5) | 21 | (360) | 106 | (18) | (663) | (97) | |||||||||||||||||||||||||||||||||||
| Loss on debt extinguishment (6) | — | (191) | (100) | — | (191) | (100) | |||||||||||||||||||||||||||||||||||
| Interest expense | (55) | (45) | 22 | (100) | (94) | 6 | |||||||||||||||||||||||||||||||||||
| Income from continuing operations before income taxes | $ | 1,244 | $ | 442 | 181 | % | $ | 2,250 | $ | 1,004 | 124 | % | |||||||||||||||||||||||||||||
| Segment operating profit (loss) margin | |||||||||||||||||||||||||||||||||||||||||
| U.S. Pharmaceutical | 1.49 | % | 1.42 | % | 7 | bp | 1.36 | % | 1.39 | % | (3) | bp | |||||||||||||||||||||||||||||
| Prescription Technology Solutions | 11.79 | 13.73 | (194) | 12.67 | 12.80 | (13) | |||||||||||||||||||||||||||||||||||
| Medical-Surgical Solutions | 10.52 | 9.48 | 104 | 10.21 | 6.56 | 365 | |||||||||||||||||||||||||||||||||||
| International | (0.59) | (1.60) | 101 | (0.34) | (0.51) | 17 |
All percentage changes displayed above which are not meaningful are displayed as zero percent.
bp - basis points
(1)Segment operating profit (loss) includes gross profit, net of total operating expenses, as well as other income, net, for our reportable segments.
(2)Operating profit for our U.S. Pharmaceutical segment includes the following:
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McKESSON CORPORATION
FINANCIAL REVIEW (CONTINUED)
(UNAUDITED)
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a gain of $142 million related to the exit of one of our investments in equity securities in July 2022 for the three and six months ended September 30, 2022; and
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cash receipts for our share of antitrust legal settlements of $34 million and $46 million for the three and six months ended September 30, 2021, respectively.
(3)Operating profit for our Medical-Surgical Solutions segment for the six months ended September 30, 2021 includes $164 million of inventory charges on certain PPE and other related products.
(4)Operating loss for our International segment includes the following:
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charges of $143 million and $237 million for the three and six months ended September 30, 2022, respectively, and charges of $342 million for the three and six months ended September 30, 2021, to remeasure the assets and liabilities of our E.U. disposal group to fair value less costs to sell and, in fiscal 2022, to impair certain assets, including internal-use software that will not be utilized in the future; and
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a gain of $59 million for the three and six months ended September 30, 2021 related to the sale of our Canadian health benefit claims management and plan administrative services business.
(5)Corporate expenses, net includes the following:
*•*gains of $166 million and $272 million for the three and six months ended September 30, 2022, respectively, and charges of $149 million for the three and six months ended September 30, 2021, primarily related to the effect of accumulated other comprehensive loss components from our E.U. disposal group;
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charges of $112 million and $186 million for the three and six months ended September 30, 2021, respectively, related to our estimated liability for opioid-related claims;
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charges of $9 million and $36 million for the three months ended September 30, 2022 and 2021, respectively, and charges of $28 million and $71 million for the six months ended September 30, 2022 and 2021, respectively, of opioid-related costs, primarily litigation expenses;
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restructuring charges of $19 million and $81 million for the three and six months ended September 30, 2021, respectively, primarily due to the transition to a partial remote work model for certain employees; and
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net gains (losses) of $(3) million and $97 million for three months ended September 30, 2022 and 2021, respectively, and $(25) million and $104 million for the six months ended September 30, 2022 and 2021, respectively, associated with certain of our equity investments.
(6)Loss on debt extinguishment for the three and six months ended September 30, 2021 consists of a charge of $191 million related to our July 2021 tender offer to redeem a portion of our existing debt.
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McKESSON CORPORATION
FINANCIAL REVIEW (CONTINUED)
(UNAUDITED)
U.S. Pharmaceutical
Three Months Ended September 30, 2022 vs. 2021
Operating profit for this segment increased for the three months ended September 30, 2022 compared to the same prior year period primarily due to a gain recognized from the exit of one of our investments in equity securities in July 2022 and growth in specialty pharmaceuticals, partially offset by net cash proceeds received in the prior year representing our share of antitrust legal settlements.
Six Months Ended September 30, 2022 vs. 2021
Operating profit for this segment increased for the six months ended September 30, 2022 compared to the same prior year period primarily due to a gain recognized from the exit of one of our investments in equity securities in July 2022 and growth in specialty pharmaceuticals. This was partially offset by net cash proceeds received in the prior year representing our share of antitrust legal settlements and a decrease in the contribution from our COVID-19 vaccine distribution program.
Prescription Technology Solutions
Three Months Ended September 30, 2022 vs. 2021
Operating profit for this segment decreased for the three months ended September 30, 2022 compared to the same prior year period primarily due to higher operating expenses related to annual support of customer programs.
Six Months Ended September 30, 2022 vs. 2021
Operating profit for this segment increased for the six months ended September 30, 2022 compared to the same prior year period primarily driven by increased volumes with new and existing customers due to growth in our access, affordability, and adherence solutions.
Medical-Surgical Solutions
Three Months Ended September 30, 2022 vs. 2021
Operating profit for this segment was flat for the three months ended September 30, 2022 compared to the same prior year period. Operating profit increased due to favorability in our core primary care business, which was offset by lower sales of COVID-19 tests.
Six Months Ended September 30, 2022 vs. 2021
Operating profit for this segment increased for the six months ended September 30, 2022 compared to the same prior year period largely due to prior year inventory charges on certain PPE and other related products.
International
Three Months Ended September 30, 2022 vs. 2021
Operating loss for this segment improved for the three months ended September 30, 2022 compared to the same prior year period largely due to a decrease in fair value remeasurement charges related to our E.U. disposal group, partially offset by a gain recognized in the prior year from the sale of our Canadian health benefit claims management and plan administrative services business.
Six Months Ended September 30, 2022 vs. 2021
Operating loss for this segment improved for the six months ended September 30, 2022 compared to the same prior year period due to a decrease in fair value remeasurement charges related to our E.U. disposal group and the cessation of depreciation and amortization expenses from its assets classified as held for sale, as well as lower restructuring expenses due to optimization programs in Canada. This was partially offset by unfavorable impacts from the completed divestitures of our Austrian business and U.K. disposal group as well as a gain recognized in the prior year from the sale of our Canadian health benefit claims management and plan administrative services business.
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McKESSON CORPORATION
FINANCIAL REVIEW (CONTINUED)
(UNAUDITED)
Corporate Expenses, Net
Three Months Ended September 30, 2022 vs. 2021
Corporate expenses, net decreased for the three months ended September 30, 2022 compared to the same prior year period primarily due to year over year favorability from the fair value remeasurement of our E.U. disposal group, which includes the effect of accumulated other comprehensive loss components, and lower charges related to our estimated liability for opioid-related claims, partially offset by prior year net gains recognized from our equity investments.
Six Months Ended September 30, 2022 vs. 2021
Corporate expenses, net decreased for the six months ended September 30, 2022 compared to the same prior year period primarily due to year over year favorability from the fair value remeasurement of our E.U. disposal group, which includes the effect of accumulated other comprehensive loss components, lower charges related to our estimated liability for opioid-related claims, and prior year restructuring charges for the transition to a partial remote work model for certain employees. This was partially offset by lower net gains recognized from our equity investments.
Business Combinations
Refer to Financial Note 2, “Business Acquisitions and Divestitures,” to the accompanying condensed consolidated financial statements included in this Quarterly Report for our disclosures on business combinations.
New Accounting Pronouncements
New accounting pronouncements that we have recently adopted as well as those that have been recently issued but not yet adopted by us are included in Financial Note 1, “Significant Accounting Policies,” to the accompanying condensed consolidated financial statements included in this Quarterly Report.
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McKESSON CORPORATION
FINANCIAL REVIEW (CONTINUED)
(UNAUDITED)
FINANCIAL CONDITION, LIQUIDITY, AND CAPITAL RESOURCES
We expect our available cash generated from operations and our short-term investment portfolio, together with our existing sources of liquidity from our credit facilities and commercial paper program, will be sufficient to fund our short-term and long-term capital expenditures, working capital, and other cash requirements. We remain adequately capitalized with access to liquidity from our $4.0 billion revolving credit facility. At September 30, 2022, we were in compliance with all debt covenants, and believe we have the ability to continue to meet our debt covenants in the future.
The following table summarizes the net change in cash, cash equivalents, and restricted cash for the periods shown:
| Six Months Ended September 30, | |||||||||||||||||
| (Dollars in millions) | 2022 | 2021 | Change | ||||||||||||||
| Net cash provided by (used in): | |||||||||||||||||
| Operating activities | $ | 166 | $ | 170 | $ | (4) | |||||||||||
| Investing activities | 116 | (157) | 273 | ||||||||||||||
| Financing activities | (1,753) | (3,894) | 2,141 | ||||||||||||||
| Effect of exchange rate changes on cash, cash equivalents, and restricted cash | 24 | 18 | 6 | ||||||||||||||
| Change in cash, cash equivalents, and restricted cash classified within Assets held for sale (1) | 470 | — | 470 | ||||||||||||||
| Net change in cash, cash equivalents, and restricted cash | $ | (977) | $ | (3,863) | $ | 2,886 | |||||||||||
(1)This change reflects a reversal of cash, cash equivalents, and restricted cash previously classified within assets held for sale at March 31, 2022 as part of the U.K. disposal group and is offset by cash outflows primarily related to the settlement of liabilities which is reflected in operating activities. Refer to Financial Note 2, “Business Acquisitions and Divestitures,” to the accompanying condensed consolidated financial statements included in this Quarterly Report for further information.
Operating Activities
Operating activities provided cash of $166 million and $170 million during the six months ended September 30, 2022 and 2021, respectively. Cash flows from operations can be significantly impacted by factors such as the timing of receipts from customers, inventory purchases, and payments to vendors. Additionally, working capital is primarily a function of sales and purchase volumes, inventory requirements, and vendor payment terms.
Operating activities for the six months ended September 30, 2022 were affected by net income adjusted for non-cash items and changes in receivables, drafts and accounts payables, and inventories classified as held for sale. Refer Financial Note 2, “Business Acquisitions and Divestitures,” to the accompanying condensed consolidated financial statements included in this Quarterly Report for further information on our European divestiture activities. Operating activities for the six months ended September 30, 2022 were affected by increases in drafts and accounts payable of $2.3 billion, receivables of $1.9 billion, and inventories of $1.5 billion, all primarily driven by higher revenues and timing. Our litigation liabilities also decreased by $915 million due to payments made during the first half of fiscal 2023 associated with the Settlement and separate settlement agreements of opioid-related claims of participating states, subdivisions, and Native American tribes.
Operating activities for the six months ended September 30, 2021 were affected by increases in drafts and accounts payable of $1.4 billion, receivables of $2.3 billion, and inventories of $1.2 billion, all primarily due to timing and higher revenues. Other non-cash items for the six months ended September 30, 2021 includes non-cash inventory charges totaling $164 million on certain PPE and other related products in our Medical-Surgical Solutions segment.
Investing Activities
Investing activities provided cash of $116 million and used cash of $157 million during the six months ended September 30, 2022 and 2021, respectively. Investing activities for the six months ended September 30, 2022 reflects proceeds from sales of businesses and investments of $496 million, including $202 million of cash from the completed divestiture of our U.K. disposal group in April 2022 and $179 million of cash from the exit of one our investments in equity securities in July 2022. Investing activities for the six months ended September 30, 2022 and 2021 includes $222 million and $279 million, respectively, in capital expenditures for property, plant, and equipment, and capitalized software.
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McKESSON CORPORATION
FINANCIAL REVIEW (CONTINUED)
(UNAUDITED)
Financing Activities
Financing activities used cash of $1.8 billion and $3.9 billion during the six months ended September 30, 2022 and 2021, respectively. Financing activities for the six months ended September 30, 2022 and 2021 includes $1.5 billion and $1.3 billion of cash paid for share repurchases, respectively, as well as $139 million and $134 million of cash paid for dividends, respectively. Financing activities also includes cash receipts and repayments of $100 million and $3.0 billion for the six months ended September 30, 2022 and 2021, respectively, for short-term borrowings, primarily commercial paper. Cash used for other financing activities generally includes shares surrendered for tax withholding and payments to noncontrolling interests.
Financing activities for the six months ended September 30, 2021 includes a payment of $1.0 billion to purchase shares of McKesson Europe through exercises of a put right option by noncontrolling shareholders. The put right option expired on June 15, 2021 as further described below. In July 2021, we completed a cash tender offer and paid an aggregate consideration of $1.1 billion to redeem certain notes with a principal amount of $922 million and also redeemed our 0.63% Euro-denominated notes with a principal amount of €600 million (or, approximately $709 million) prior to the maturity date of August 17, 2021 using cash on hand. This resulted in total repayments of long-term debt during the six months ended September 30, 2021 of $1.8 billion, including $184 million of cash paid for premiums and transaction fees. This was partially offset by the issuance of long-term debt in August 2021 from a public offering of 1.30% notes due August 15, 2026 for proceeds received of $498 million, which was utilized for general corporate purposes.
Share Repurchase Plans
The Board has authorized the repurchase of McKesson’s common stock from time-to-time in open market transactions, privately negotiated transactions, through ASR programs, or by combinations of such methods, any of which may use pre-arranged trading plans that are designed to meet the requirements of Rule 10b5-1(c) of the Securities Exchange Act of 1934. The timing of any repurchases and the actual number of shares repurchased will depend on a variety of factors, including the Company’s stock price, corporate and regulatory requirements, restrictions under the Company’s debt obligations, and other market and economic conditions. The ASR programs discussed below were designed to comply with Rule 10b5-1(c).
In May 2022, we entered into an ASR program with a third-party financial institution to repurchase $1.0 billion of the Company’s common stock. The total number of shares repurchased under this ASR program was 3.1 million shares at an average price per share of $321.05. We received 2.6 million shares as the initial share settlement, and in August 2022, we received an additional 0.5 million shares upon the completion of this ASR program.
In February 2022, we entered into an ASR program with a third-party financial institution to repurchase $1.5 billion of the Company’s common stock. The total number of shares repurchased under this ASR program was 5.1 million shares at an average price per share of $295.16. We received 4.8 million shares as the initial share settlement in the fourth quarter of fiscal 2022, and in May 2022, we received an additional 0.3 million shares upon the completion of this ASR program.
In May 2021, we entered into an ASR program with a third-party financial institution to repurchase $1.0 billion of the Company’s common stock. The total number of shares repurchased under this ASR program was 5.2 million shares at an average price per share of $193.22. We received 4.3 million shares as the initial share settlement, and in August 2021, we received an additional 0.9 million shares upon the completion of this ASR program.
During the three and six months ended September 30, 2022, we repurchased 1.5 million of the Company’s shares of common stock for $524 million through open market transactions at an average price per share of $355.75, of which $40 million was accrued within “Other accrued liabilities” in the Company’s Condensed Consolidated Balance Sheets for share repurchases that were executed in late September 2022 and settled in early October 2022. During the three and six months ended September 30, 2021, we repurchased 1.4 million of the Company’s shares of common stock for $280 million through open market transactions at an average price per share of $203.20, of which $16 million was accrued within “Other accrued liabilities” in the Company’s Condensed Consolidated Balance Sheets for the period ended September 30, 2021 for share repurchases that were executed in late September 2021 and settled in early October 2021.
In July 2022, the Board approved an increase of $4.0 billion in the authorization for repurchase of McKesson’s common stock. The total remaining authorization outstanding for repurchases of the Company’s common stock at September 30, 2022 was $5.8 billion.
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McKESSON CORPORATION
FINANCIAL REVIEW (CONTINUED)
(UNAUDITED)
Selected Measures of Liquidity and Capital Resources
| (Dollars in millions) | September 30, 2022 | March 31, 2022 | ||||||||||||
| Cash, cash equivalents, and restricted cash | $ | 2,958 | $ | 3,935 | ||||||||||
| Working capital | (1,909) | (2,235) | ||||||||||||
| Debt to capital ratio (1) | 113.2 | % | 114.5 | % |
(1)This ratio describes the relationship and changes within our capital resources, and is computed as total debt divided by the sum of total debt and McKesson stockholders’ equity (deficit), which excludes noncontrolling interests and accumulated other comprehensive loss.
Cash equivalents, which are readily convertible to known amounts of cash, are carried at fair value. Cash equivalents are primarily invested in AAA-rated U.S. government money market funds and overnight deposits with financial institutions. Deposits with financial institutions are primarily denominated in U.S. dollars and the functional currencies of our foreign subsidiaries, including Euro, Canadian dollars, and British pound sterling. We mitigate the risk of our short-term investment portfolio by depositing funds with reputable financial institutions and monitoring risk profiles and investment strategies of money market funds.
Our cash and cash equivalents balance as of September 30, 2022 and March 31, 2022 included approximately $921 million and $1.5 billion of cash held by our subsidiaries outside of the U.S., respectively. Our primary intent is to utilize this cash for foreign operations for an indefinite period of time. Although the majority of cash held outside the U.S. is available for repatriation, doing so could subject us to foreign withholding taxes and state income taxes. Following enactment of the 2017 Tax Cuts and Jobs Act, the repatriation of cash to the U.S. is generally no longer taxable for federal income tax purposes.
Working capital primarily includes cash and cash equivalents, receivables, inventories, and net assets or liabilities classified as held for sale, net of drafts and accounts payable, current portion of long-term debt, and other accrued liabilities. Our businesses require substantial investments in working capital that are susceptible to large variations during the year as a result of inventory purchase patterns and seasonal demands. Inventory purchase activity is a function of sales activity and other requirements.
Consolidated working capital improved at September 30, 2022 compared to March 31, 2022 primarily due to increases in receivables, inventory, and net assets classified as held for sale related to our European divestiture activities, partially offset by an increase in drafts and accounts payable and a decrease in cash and cash equivalents.
Our debt to capital ratio decreased for the six months ended September 30, 2022 due to a decrease in our foreign currency denominated notes driven by foreign currency remeasurement and an improvement in our stockholder’s deficit driven by net income for the year-to-date period, partially offset by share repurchases.
In July 2022, we raised our quarterly dividend from $0.47 to $0.54 per common share for dividends declared on or after such date by the Board. We anticipate that we will continue to pay quarterly cash dividends in the future. However, the payment and amount of future dividends remain within the discretion of the Board and will depend upon our future earnings, financial condition, capital requirements, and other factors.
Redeemable Noncontrolling Interests
Our previously recognized redeemable noncontrolling interests primarily related to our consolidated subsidiary, McKesson Europe. Under the Domination Agreement, the noncontrolling shareholders of McKesson Europe had a right to put (“Put Right”) their shares at €22.99 per share, increased annually for interest in the amount of five percentage points above a base rate published semi-annually by the German Bundesbank, less any compensation amount or guaranteed dividend already paid by McKesson (“Put Amount”). During the six months ended September 30, 2021, we paid $1.0 billion to purchase 34.5 million shares of McKesson Europe through exercises of the Put Right by the noncontrolling shareholders, which reduced the balance of our redeemable noncontrolling interests.
The Put Right expired on June 15, 2021, at which point the remaining shares owned by the minority shareholders, valued at $287 million, were transferred from redeemable noncontrolling interests to noncontrolling interests and as a result, we no longer have redeemable noncontrolling interests presented in our condensed consolidated balance sheets at September 30, 2022 or March 31, 2022. Our noncontrolling interest in McKesson Europe was included in the sale of our E.U. disposal group.
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McKESSON CORPORATION
FINANCIAL REVIEW (CONCLUDED)
(UNAUDITED)
Additionally, we were obligated to pay an annual recurring compensation of €0.83 per McKesson Europe share (the “Compensation Amount”) to the noncontrolling shareholders of McKesson Europe under the Domination Agreement. The Compensation Amount was recognized ratably during the applicable annual period. The Domination Agreement does not expire, but it may be terminated at the end of any fiscal year by giving at least six months’ advance notice.
Refer to Financial Note 5, “Redeemable Noncontrolling Interests and Noncontrolling Interests,” to the accompanying condensed consolidated financial statements included in this Quarterly Report for additional information on redeemable noncontrolling interests.
Credit Resources
We fund our working capital requirements primarily with cash and cash equivalents as well as short-term borrowings from our credit facilities and commercial paper issuances. Funds necessary for future debt maturities and our other cash requirements, including any completed and anticipated acquisitions, or future payments that may be made related to our total estimated litigation liability of $7.3 billion as of September 30, 2022 payable under the terms of various settlement agreements for opioid-related claims, are expected to be met by existing cash balances, cash flow from operations, existing credit sources, and other capital market transactions. Long-term debt markets and commercial paper markets, our principal sources of capital after cash flow from operations, are open and accessible to us should we decide to access those markets. Detailed information regarding our debt and financing activities is included in Financial Note 8, “Debt and Financing Activities,” to the accompanying condensed consolidated financial statements included in this Quarterly Report.
We believe that our future operating cash flow, financial assets, and current access to capital and credit markets, including our existing credit facilities, will give us the ability to meet our financing needs for the foreseeable future. However, there can be no assurance that an increase in volatility or disruption in the global capital and credit markets will not impair our liquidity or increase our costs of borrowing.
CAUTIONARY NOTICE ABOUT FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 2 of Part I of this report, contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Some of these statements can be identified by the use of terminology such as “believes,” “expects,” “anticipates,” “may,” “will,” “should,” “seeks,” “approximately,” “intends,” “projects,” “plans,” “estimates,” or the negative of these words and other comparable terminology. The discussion of financial trends, strategy, plans, assumptions, or intentions may also include forward-looking statements. Readers should not place undue reliance on forward-looking statements, which speak only as of the date such statements were first made. Except to the extent required by law, we undertake no obligation to update or revise our forward-looking statements. Forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those projected, anticipated, or implied. Although it is not possible to predict or identify all such risks and uncertainties, they include, but are not limited to, factors described in the Risk Factors discussion in Item 1A of Part I of our most recently filed Annual Report.
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