Business context and reporting period
McKesson Corporation’s unaudited Form 10-Q covers the quarter and six months ended September 30, 2014, the second quarter and first half of fiscal 2015. Unless noted, financial amounts below are in millions of U.S. dollars. Comparisons are with the corresponding 2013 periods. Results include Celesio, acquired in February 2014; its inclusion materially affects year-over-year comparisons.
McKesson operates Distribution Solutions and Technology Solutions. Distribution Solutions generated about 98% of quarterly revenue.
Financial performance and position
| Metric | Quarter ended Sep. 30, 2014 | Quarter ended Sep. 30, 2013 | Six months ended Sep. 30, 2014 | Six months ended Sep. 30, 2013 |
|---|---|---|---|---|
| Revenue | $44,758 | $32,985 | $88,816 | $65,224 |
| Gross profit | $2,923 | $2,021 | $5,720 | $3,951 |
| Operating income | $788 | $686 | $1,476 | $1,341 |
| Income from continuing operations | $491 | $423 | $916 | $851 |
| Net income attributable to McKesson | $469 | $404 | $872 | $828 |
| Diluted EPS attributable to McKesson | $1.99 | $1.74 | $3.71 | $3.56 |
| Gross margin | 6.53% | 6.13% | 6.44% | 6.06% |
Quarterly revenue rose 36%, McKesson-attributable net income rose 16%, and diluted EPS rose 14%. For the first half, revenue rose 36%, net income rose 5%, and diluted EPS rose 4%. Operating expenses grew faster than revenue, reflecting Celesio, integration costs, and higher amortization. Interest expense increased to $99 for the quarter and $200 for the first half, primarily due to acquisition-related debt and Celesio debt.
- Segment trends: Quarterly Distribution Solutions operating profit was $793, up 16%; its operating margin fell to 1.80% from 2.13%. Technology Solutions operating profit was $125, up 4%; first-half operating profit declined 22% to $193, including a $34 non-cash charge related to the retained workforce business.
- Cash flow: First-half operating cash flow was $165, versus $813 in 2013. Investing activities used $307 and financing activities used $168. Cash declined $389 to $3,804. Working-capital changes included increases in receivables of $1,535 and inventory of $1,161, partly offset by a $1,502 increase in payables.
- Liquidity and debt: Working capital was $4,542, up from $3,072 at March 31, 2014. Debt, net of cash, was $6,768; debt-to-capital was 54.2%, compared with 55.7%. The company reported compliance with its debt covenants, including a 65% debt-to-capital limit under its revolving facility. Cash included approximately $2.1 billion held outside the United States, primarily intended for foreign operations; repatriation could incur U.S. taxes.
- Other notable items: Foreign-currency translation losses were $677 for the quarter and $579 for the first half, contributing to a quarterly comprehensive loss attributable to McKesson of $63. Quarterly dividends declared were $0.24 per share.
Material changes, outlook, and risks
- Drivers and pressures: Management attributed revenue and gross-profit growth mainly to Celesio, growth in other distribution businesses, and market activity. Brand-to-generic price deflation, business mix, lower-margin hepatitis C drug sales, and higher LIFO inventory charges pressured results. LIFO charges were $94 for the quarter and $192 for the first half, versus $44 in each 2013 comparison period.
- Acquisition and integration: McKesson owned approximately 75.9% of Celesio at September 30. First-half acquisition and related expenses were $111, including $75 associated with Celesio integration. A German domination and profit-and-loss transfer agreement was approved by Celesio shareholders but remained subject to court proceedings and registration. McKesson expected it to become effective by year-end 2014; under its terms, McKesson would compensate Celesio annual losses and provide specified compensation and put rights to minority shareholders.
- Discontinued operations and unusual charges: The quarter included a $14 net loss from discontinued operations. McKesson sold its Hospital Automation business and recorded a loss; it also recorded an $80 non-cash impairment charge on its International Technology business in the prior-year comparative period. The company decided to retain and wind down its workforce business in 2016 and recorded the $34 non-cash charge noted above.
- Liquidity outlook: Management expected cash generated from operations and existing facilities to fund working capital, capital expenditures, and other requirements, while noting that market disruption could impair liquidity or raise borrowing costs. The $1.35 billion accounts-receivable sales facility was due to expire in November 2014, and management anticipated renewal. No earnings or revenue guidance was provided in the supplied filing text.
- Legal and tax contingencies: The company disclosed ongoing investigations concerning controlled-substance distribution, including inquiries relating to its Landover and Aurora distribution centers; it could not estimate a reasonably possible loss range for unresolved matters. A Canadian transfer-pricing dispute involved $261 of reassessments, with appeals pending. Unrecognized tax benefits totaled $580; the company said up to $158 could potentially be reduced over the next twelve months. The AWP litigation reserve was $5. The Vaccine for Children’s Program matter was settled and dismissed.
- Other risks: The filing highlights healthcare regulation, acquisition integration, competition, customer concentration/defaults, technology and cybersecurity, foreign operations, litigation, tax positions, and access to credit markets. Management reported no material change in market-risk exposure and no material change to previously disclosed risk factors.
Important facts for investors to verify
- How much reported growth and margin change reflects Celesio consolidation versus organic growth, mix, and pricing?
- Whether operating cash flow improves as receivables and inventory levels normalize, and how LIFO charges evolve.
- Progress on renewing the accounts-receivable facility and the effective date and financial consequences of the Celesio agreement, including minority-shareholder rights.
- Developments in controlled-substance investigations, Canadian tax appeals, and other litigation where potential losses were not estimable.
- Whether integration costs, acquired-intangible amortization, foreign-exchange effects, and Technology Solutions’ business changes continue to affect earnings.