McKesson Corporation — FY2014 Form 10-K
Reporting period: Fiscal year ended March 31, 2014. The request identifies “2013 Q4,” but this filing reports FY2014; its fourth quarter ended March 31, 2014. Unless noted, amounts are U.S. dollars.
Business context and period highlights
McKesson distributes pharmaceuticals and medical-surgical products and provides healthcare information technology through Distribution Solutions and Technology Solutions. Distribution Solutions generated about 98% of FY2014 revenue.
In February 2014, McKesson acquired a controlling interest in Celesio, an international pharmaceutical wholesaler and pharmacy operator, for $4.5 billion net of cash acquired. Celesio contributed $4.8 billion of revenue and immaterial net earnings from acquisition through year-end. The acquisition materially expanded reported assets, revenue, debt and foreign-market exposure; FY2014 results include only a partial year of Celesio.
Financial results and liquidity
| Metric | FY2014 | FY2013 |
|---|---|---|
| Revenue | $137.6 billion | $122.1 billion |
| Gross profit | $8.31 billion | $6.85 billion |
| Gross margin | 6.04% | 5.61% |
| Income from continuing operations | $1.35 billion | $1.35 billion |
| Net income attributable to McKesson | $1.26 billion | $1.34 billion |
| Diluted EPS, total | $5.41 | $5.59 |
| Operating cash flow | $3.14 billion | $2.48 billion |
| Cash and cash equivalents at year-end | $4.19 billion | $2.46 billion |
| Working capital | $3.07 billion | $1.81 billion |
| Total debt, including capital leases | $10.72 billion | $4.87 billion |
FY2014 revenue increased 12.7%, primarily from market growth, drug utilization and price increases, and acquisitions. Gross margin rose 43 basis points, supported by acquisitions, higher-margin generic drugs and buy-margin gains, partly offset by lower sell margins. Distribution Solutions operating profit margin was 1.83%, roughly flat year over year; Technology Solutions’ margin increased to 12.16% from 10.19%.
Net income attributable to McKesson fell 6% and diluted EPS fell 3%. Higher continuing-operations EPS ($5.83 versus $5.62) was more than offset in total EPS by losses from discontinued operations. The effective tax rate rose to 35.4% from 30.1%.
Cash from operations increased, including from longer supplier payment terms; growth in receivables and inventory used cash. Investing cash use was $5.05 billion, including $4.63 billion for acquisitions. Debt-to-capital increased to 55.7% from 40.8%; net debt to net capital employed rose to 43.4% from 25.5%.
FY2014 fourth quarter: Revenue was $38.14 billion versus $30.52 billion in FY2013 Q4; gross profit was $2.54 billion versus $1.96 billion; net income attributable to McKesson was $371 million versus $259 million; diluted EPS was $1.58 versus $1.10. The quarter included Celesio and a $50 million pre-tax charge reversing the fair-value step-up on its acquired inventory.
Material changes, outlook and risks
- Acquisitions and financing: Celesio was consolidated with $2.3 billion of acquired debt; McKesson issued $4.1 billion of long-term notes to help refinance bridge borrowings. FY2014 included $218 million of acquisition-related expenses and adjustments.
- Unusual items: Distribution Solutions recorded $311 million of net LIFO expense, compared with $13 million in FY2013. A $122 million tax charge followed an unfavorable Canadian Tax Court decision on transfer pricing; McKesson appealed. FY2014 discontinued operations generated a $96 million net loss, including an $80 million non-cash impairment of International Technology. Hospital Automation was sold for $55 million in cash.
- Outlook: Numerical FY2015 guidance is not provided in the filing text; it directs readers to a May 13, 2014 Form 8-K. Management anticipated more branded-to-generic conversions in FY2015. McKesson expected to renew its $1.35 billion receivables facility before its November 2014 expiration. Celesio operational control remained subject to German corporate steps, with control not expected until late in the first half of FY2015.
- Concentration and market exposure: The ten largest customers accounted for about 48% of revenue, and CVS alone about 16%. The ten largest suppliers represented 46% of purchases. Risks include customer or supplier loss, pricing and generic-drug volatility, reimbursement and regulatory changes, European austerity and foreign-exchange movements.
- Legal and regulatory matters: The filing describes government inquiries involving controlled-substance distribution, the CDC Vaccines for Children program and Technology Solutions billing and coding. Potential losses for unresolved proceedings generally could not be estimated. The AWP litigation reserve was $5 million at year-end, down from $42 million; charges were $68 million and payments $105 million in FY2014. Environmental remediation accruals totaled about $27 million for disclosed site matters.
- Liquidity commitments: Contractual obligations totaled $20.06 billion, including $10.37 billion of long-term debt, $3.57 billion of estimated interest and $2.07 billion of operating leases. About $2.4 billion of year-end cash was held outside the U.S.; repatriation could incur U.S. taxes. The company reported compliance with debt covenants.
Investor facts to verify
- Review the May 13, 2014 Form 8-K for numerical FY2015 guidance and assumptions, particularly the treatment of Celesio.
- Track Celesio integration, the timing and terms of operational control, acquired debt obligations and foreign-currency exposure.
- Assess whether the $311 million LIFO expense, generic-drug economics and supplier compensation trends are recurring or likely to affect margins.
- Follow the Canadian transfer-pricing appeal, IRS assessments, government investigations and remaining AWP claims for changes in expected exposure.
- Monitor renewal of the receivables facility and debt maturities, leverage, customer concentration, and the cash and tax implications of funds held abroad.
The independent auditor issued an unqualified opinion on the financial statements and internal control over financial reporting. The control assessment excluded Celesio, acquired during the year.