McKesson Corporation — Form 10-Q Summary
Business context and period: This unaudited filing covers the quarter and nine months ended December 31, 2013, McKesson’s fiscal 2014 third quarter. The company operates in Distribution Solutions and Technology Solutions; Distribution Solutions generated about 98% of quarterly revenue.
Financial performance
| Metric | Quarter ended Dec. 31, 2013 | Year-over-year change | Nine months ended Dec. 31, 2013 | Year-over-year change |
|---|---|---|---|---|
| Revenue | $34.306 billion | +10% | $99.468 billion | +9% |
| Gross profit | $1.840 billion | +12% | $5.769 billion | +18% |
| Gross margin | 5.36% | +7 basis points | 5.80% | +46 basis points |
| Operating income | $485 million | Down from $498 million | $1.811 billion | Up from $1.680 billion |
| Income from continuing operations | $156 million | Down 49% | $992 million | Down 8% |
| Net income | $64 million | Down 79% | $892 million | Down 17% |
| Diluted EPS | $0.28 | Down from $1.24 | $3.83 | Down from $4.49 |
Quarterly diluted EPS from continuing operations was $0.67, versus $1.27 a year earlier; nine-month continuing-operations EPS was $4.26, versus $4.51. Quarterly and nine-month losses from discontinued operations were $92 million and $100 million, respectively.
- Cash flow: Operating activities provided $472 million for the nine months, compared with $276 million in the prior-year period. Investing activities used $422 million; financing activities used $73 million. Cash and cash equivalents were $2.431 billion at December 31, 2013.
- Liquidity and debt: Working capital was $3.330 billion, versus $1.813 billion at March 31, 2013. Total debt was approximately $4.874 billion, yielding reported net debt of $2.443 billion. Debt to capital was 37.8%, compared with 40.8% at March 31, 2013. The company reported compliance with its financial covenants.
- Dividends: Quarterly dividend declared per share increased to $0.24 from $0.20 in July 2013.
Material changes and unusual items
- Revenue growth primarily reflected market growth, drug utilization and pricing, business mix, and the PSS World Medical acquisition. Brand-to-generic conversions and related price deflation partly offset growth. PSS also contributed to higher Distribution Solutions revenue and gross profit.
- Distribution Solutions’ quarterly operating profit was $552 million, up 5%; Technology Solutions’ was $37 million, down 60%. Technology Solutions recorded $57 million of quarterly charges for product alignment, integration and workforce reductions, including asset impairments and severance.
- Higher pharmaceutical inventory inflation drove LIFO charges of $142 million for the quarter and $186 million for the nine months, compared with $2 million and $5 million in the respective prior-year periods. The charges reduced gross profit.
- The company recorded an $80 million non-cash impairment charge for its International Technology business, classified in discontinued operations. It also sold its Hospital Automation business for $55 million net cash proceeds and recorded a loss on sale.
- A $122 million tax charge followed an unfavorable Tax Court of Canada decision on transfer pricing for 2003; McKesson appealed. The reported quarterly effective tax rate was 61.8%.
- Quarterly results included $18 million of AWP litigation charges; nine-month charges totaled $68 million. AWP litigation reserve was $24 million at December 31, 2013, after $86 million of payments during the nine months.
- McKesson recorded $35 million of Celesio-related expenses in the quarter, including professional fees, foreign-currency-option costs and bridge-loan fees.
Outlook, risks and contingencies
Management stated that operating cash flow, cash balances and available credit sources were expected to fund working capital, capital expenditures and other requirements. It also cautioned that cash generation is affected by customer collections, inventory and vendor-payment timing, and that market disruption could impair liquidity or raise borrowing costs. No specific operating or earnings guidance was provided.
After the quarter, the original Celesio tender offers failed to meet the 75% minimum condition. On January 23, 2014, McKesson entered into revised agreements to acquire about 75.99% of Celesio’s outstanding shares at €23.50 per share and related convertible bonds; the filing described an approximately €6.4 billion transaction including assumed debt. McKesson arranged a new $5.5 billion, 364-day bridge facility and expected to refinance some or all borrowings with longer-term financing. The company identified acquisition financing, foreign-exchange exposure, integration execution, management distraction and realization of anticipated benefits as risks.
Other significant exposures include the Canadian transfer-pricing dispute, U.S. tax assessments, AWP claims, and a Department of Justice investigation into controlled-substance distribution involving the former Landover, Maryland distribution center. The filing generally states that it cannot estimate reasonably possible losses for unresolved proceedings. Management reported disclosure controls were effective and no material change in internal control over financial reporting during the quarter.
Investor verification priorities
- Track reported results against underlying performance, particularly the effects of LIFO charges, litigation costs, technology restructuring and discontinued-operations impairments.
- Verify the final terms, funding, debt impact and integration progress of the Celesio acquisition, including any later tender-offer results and refinancing.
- Monitor the Canadian transfer-pricing appeal, U.S. tax examinations and movements in unrecognized tax benefits.
- Review developments in AWP litigation and the controlled-substance investigation, including potential losses not estimable in this filing.
- Assess cash conversion and working-capital needs, especially receivables and inventory, alongside debt maturities and credit-facility renewals.