McKesson Corporation — Form 10-Q Summary
Reporting period: Quarter ended June 30, 2013, the first quarter of McKesson’s fiscal 2014. Comparisons are with the quarter ended June 30, 2012. Amounts are in U.S. dollars.
Financial performance
| Metric | Quarter ended June 30, 2013 | Prior-year quarter | Change |
|---|---|---|---|
| Revenue | $32.208 billion | $30.699 billion | +5% |
| Gross profit | $1.920 billion | $1.561 billion | +23% |
| Gross margin | 5.96% | 5.08% | +88 bps |
| Operating income | $647 million | $576 million | +12% |
| Income from continuing operations | $420 million | $379 million | +11% |
| Net income | $424 million | $380 million | +12% |
| Diluted EPS | $1.83 | $1.58 | +16% |
| Operating cash flow | $716 million | $(552) million | Improved by $1.268 billion |
Revenue growth reflected market growth, drug utilization and price increases, expanded customer volumes, and the inclusion of acquired PSS World Medical in Medical-Surgical results. Brand-to-generic price deflation partly offset growth. Distribution Solutions revenue rose 5% to $31.403 billion; Technology Solutions revenue rose 9% to $805 million. Segment operating profit increased 24% to $619 million in Distribution Solutions and 32% to $119 million in Technology Solutions.
Gross margin improved in both segments. Distribution Solutions benefited from PSS World Medical, higher-margin generic sales, improved buy margin and a lower share of warehouse sales; lower sell margin partly offset these factors. Technology Solutions’ margin benefited from product and service mix. Operating expenses rose 29% to $1.273 billion, including acquisition-related expenses and higher acquired-intangible amortization. The prior-year comparison included an $81 million pretax, noncash gain on the headquarters-building transaction; excluding that unusual prior-year gain, pretax income increased 13% to $594 million.
Cash, debt and liquidity
- Cash and cash equivalents were $2.905 billion at June 30, 2013, up from $2.456 billion at March 31, 2013. Working capital was $2.586 billion, versus $1.813 billion.
- Total debt was approximately $4.874 billion, comprising $352 million current and $4.522 billion long-term; debt net of cash was $1.969 billion. The debt-to-capital ratio was 39.7%, and net debt to net capital employed was 21.0%.
- Operating cash flow benefited from a $592 million increase in drafts and accounts payable and included $20 million of AWP settlement payments, compared with $273 million of such payments in the prior-year quarter. Management cautions that cash flow varies with customer receipts, inventory and vendor-payment timing.
- Investing activities used $184 million, including acquisitions, property purchases and capitalized software. Financing activities used $73 million and included $127 million for share repurchases and $53 million for dividends.
- The company reported no borrowings under its $1.3 billion revolving credit facility and no outstanding balance under its $1.35 billion accounts-receivable facility at quarter-end. The receivables facility was extended through November 2013. McKesson said it was in compliance with its debt covenants.
Material changes, outlook and risks
- PSS World Medical: Acquired in February 2013 for approximately $1.9 billion, including $1.3 billion cash consideration, net of cash acquired, and assumption of debt with a fair value of $0.6 billion. Its inclusion contributed to current-period Medical-Surgical growth and expenses.
- Planned business sales: McKesson committed to sell its International Technology and Hospital Automation businesses and a small Distribution Solutions business. Their results were classified as discontinued operations; the held-for-sale assets and liabilities were $445 million and $260 million, respectively. Discontinued operations contributed $4 million after tax, versus $1 million.
- Inventory accounting: Management anticipated continued pharmaceutical inventory price inflation and LIFO charges to cost of sales, net of a $60 million lower-of-cost-or-market reserve release, potentially beginning in fiscal Q2 2014. The reserve stood at $23 million at June 30, 2013.
- Dividends and repurchases: In July 2013, the quarterly dividend was raised from $0.20 to $0.24 per share for dividends declared thereafter. The board retains discretion over future dividends. The remaining share-repurchase authorization was $340 million at quarter-end.
- Legal and regulatory contingencies: A new Ohio public-entity AWP lawsuit was filed; Arizona AWP litigation continued after denial of McKesson’s motion to dismiss. The AWP reserve was $37 million at quarter-end after $15 million of charges and $20 million of payments. The company said ultimate costs could exceed or be less than the reserve and generally could not estimate reasonably possible losses for unresolved proceedings. DEA subpoenas sought information about controlled-substance distribution at certain facilities.
- Tax exposures: McKesson disclosed $567 million of unrecognized tax benefits and said up to $173 million could potentially be reduced over the next 12 months, subject to ongoing examinations and negotiations. Disputed assessments included $98 million from the IRS and $209 million from the Canadian tax authority; final resolution could materially increase or decrease tax expense.
- Outlook and risks: No specific earnings or revenue guidance was provided in the filing. Management expected cash from operations and existing liquidity sources to fund capital, working-capital and other requirements, while noting capital-market disruption could impair liquidity or raise borrowing costs. Risks cited include litigation, healthcare regulation, customer losses or defaults, technology and systems issues, acquisition integration, foreign exchange and tax matters.
Important facts for investors to verify
- Whether revenue and margin gains persist after accounting for PSS World Medical’s contribution and the unusual prior-year $81 million gain.
- How much of the operating-cash-flow improvement reflects sustainable operations versus timing of payables and lower AWP settlement payments.
- The timing, proceeds and remaining obligations associated with the planned business divestitures.
- Future LIFO expense and inventory-reserve effects as pharmaceutical prices change.
- Developments in AWP litigation, controlled-substance investigations and U.S. and Canadian tax disputes, including any changes to reserves or cash exposure.
- Renewal or replacement of the accounts-receivable facility, which was scheduled to expire in November 2013.