McKesson Corporation — Form 10-Q summary
Business context and reporting period. This filing covers the quarter and six months ended September 30, 2015, McKesson’s second quarter and first half of fiscal 2016. McKesson operates Distribution Solutions and Technology Solutions; distribution generated about 99% of quarterly revenue. Amounts below are in U.S. dollars unless otherwise stated.
Financial performance
| Metric | Quarter ended September 30, 2015 | Prior-year quarter | Six months ended September 30, 2015 | Prior-year six months |
|---|---|---|---|---|
| Revenue | $48.761 billion | $44.160 billion | $96.307 billion | $87.636 billion |
| Gross profit | $2.844 billion | $2.864 billion | $5.692 billion | $5.596 billion |
| Operating income | $954 million | $787 million | $1.885 billion | $1.468 billion |
| Income from continuing operations | $636 million | $491 million | $1.235 billion | $910 million |
| Net income attributable to McKesson | $617 million | $469 million | $1.193 billion | $872 million |
| Diluted EPS attributable to McKesson | $2.63 | $1.99 | $5.08 | $3.71 |
| Gross margin | 5.83% | 6.49% | 5.91% | 6.39% |
- Quarterly revenue grew 10% reported, or 14% excluding a 4% unfavorable foreign-exchange effect. Management attributed growth mainly to market growth and higher volumes with existing North American customers, partly offset by brand-to-generic price deflation.
- Quarterly operating income rose about 21%; operating margin was approximately 1.96%, versus 1.78% a year earlier. Net income attributable to McKesson rose 32%, and diluted EPS rose 32%.
- Gross margin contracted, principally reflecting lower Distribution Solutions margins. Management cited higher customer volumes, foreign exchange, weaker generic drug price increases, and business mix as factors; the first-half comparison also benefited from antitrust settlement proceeds.
- North American pharmaceutical distribution revenue increased 16% in the quarter. International pharmaceutical distribution revenue declined 13% reported, but increased 2% excluding foreign exchange. Technology Solutions revenue declined 6%.
Cash flow, balance sheet and liquidity
- For the first six months, operating cash flow was $1.251 billion, compared with $165 million a year earlier. Receivables and inventory growth used cash, partly offset by increased accounts payable.
- Investing activities used $69 million, including $204 million of net proceeds from business sales. Financing activities used $1.190 billion, including $605 million of share repurchases, $498 million of long-term debt repayments, and $114 million of dividends paid.
- At September 30, cash and cash equivalents were $5.359 billion; working capital was $3.974 billion. Total debt was approximately $9.388 billion, and debt net of cash was $4.029 billion. The company reported a 51.7% debt-to-capital ratio, down from 55.2% at March 31.
- Current assets were $38.749 billion and current liabilities $34.775 billion. Management said cash generated from operations and existing credit sources were expected to be sufficient for anticipated capital, working-capital and other cash needs, while cautioning that market disruption could impair liquidity or raise borrowing costs.
- In October 2015, McKesson entered a new $3.5 billion, five-year revolving credit facility, replacing existing syndicated facilities; it also gave notice to terminate its $1.35 billion receivables facility.
Material changes, outlook and notable items
- Quarterly results included a $51 million pretax gain from selling ZEE Medical. First-half results also included a $51 million pretax gain from selling the nurse triage business and $59 million of cash proceeds from antitrust settlements. These items boosted reported results.
- Income tax expense included a $25 million discrete tax benefit related to management’s assessment of a U.S. Tax Court decision. Reported effective tax rates were 27.7% for the quarter and 28.8% for the first half, versus 31.2% and 31.0%, respectively.
- McKesson agreed to acquire UDG Healthcare’s pharmaceutical distribution business for approximately $457 million, subject to approvals, with closing expected in the first half of calendar 2016. It also planned to acquire 281 Sainsbury pharmacies for approximately $190 million, subject to approvals, with closing expected in the fourth quarter of calendar 2016.
- The quarterly dividend increased from $0.24 to $0.28 per share. The Board authorized up to $2 billion of additional repurchases in October 2015; the earlier authorization was fully used by September 30.
- There was no specific earnings or revenue guidance in the provided filing text. Management identified market growth and customer volume as supports, while noting brand-to-generic price deflation, margin pressure, foreign-exchange exposure and working-capital variability.
- Discontinued operations generated a $6 million after-tax quarterly loss and a $16 million first-half loss. The Brazilian distribution business remained planned for sale; a warehouse fire in April could affect its estimated fair value despite property and business-interruption insurance.
Risks and contingencies
The filing describes ongoing litigation, government inquiries and tax matters. It says the company could not estimate reasonably possible losses for several unresolved proceedings, including a trade-secret lawsuit and a putative class action alleging improper marketing faxes. VAT assessments were at various appeal stages; management said their ultimate outcome could not be estimated but did not expect a material adverse effect based on available information. The filing also highlights risks involving healthcare regulation, foreign currency and overseas operations, acquisitions and integration, major customers, technology and cybersecurity, legal proceedings, and access to credit markets. The stated risk factors were not materially changed from the 2015 Annual Report.
Important facts for investors to verify
- How much reported earnings growth reflects recurring operating improvement versus divestiture gains, antitrust proceeds and discrete tax benefits.
- Whether Distribution Solutions can sustain revenue growth while restoring or protecting gross margins amid generic-drug pricing and volume-related margin pressure.
- The cash conversion and working-capital impact of receivables and inventory growth, and the availability and terms of the replacement credit facilities.
- Potential cash requirements from the Celesio noncontrolling shareholders’ put rights and pending appraisal proceedings; the timing and amount of any payments remain uncertain.
- Approval, closing, funding and integration outcomes for the UDG and Sainsbury acquisitions, and the valuation and sale outcome for the Brazilian business.
- Developments in pending litigation, government inquiries, tax audits and VAT assessments, for which some potential losses cannot currently be estimated.