McKesson Corporation — Form 10-Q Summary
Reporting period: Quarter and nine months ended December 31, 2015; this is McKesson’s fiscal third quarter of fiscal 2016. Amounts are in U.S. dollars unless noted.
Business context and results
McKesson operates Distribution Solutions, its principal business, and Technology Solutions. Distribution Solutions generated about 99% of consolidated revenue for the nine-month period. The statements are unaudited interim results; the company cautions that they are not necessarily indicative of full-year results.
| Metric | Quarter ended Dec. 31, 2015 | Prior-year quarter | Nine months ended Dec. 31, 2015 | Prior-year nine months |
|---|---|---|---|---|
| Revenue | $47.899B | $46.484B | $144.206B | $134.120B |
| Gross profit | $2.872B | $2.898B | $8.564B | $8.494B |
| Operating income | $920M | $800M | $2.805B | $2.268B |
| Income from continuing operations | $642M | $521M | $1.877B | $1.431B |
| Net income attributable to McKesson | $634M | $472M | $1.827B | $1.344B |
| Diluted EPS | $2.73 | $2.00 | $7.81 | $5.72 |
Quarterly revenue rose 3% reported and 5% excluding unfavorable currency effects; nine-month revenue increased 8% reported and 10% excluding currency. Growth was primarily in North American pharmaceutical distribution, supported by market growth and expanded business with existing customers. Reported international pharmaceutical distribution revenue declined 11% in the quarter, largely reflecting currency; Technology Solutions revenue declined 8%.
Margins, cash flow, debt and liquidity
- Gross margin was 6.00% for the quarter versus 6.23% a year earlier, and 5.94% for nine months versus 6.33%. McKesson attributed the declines principally to lower Distribution Solutions sell margins.
- Operating cash flow was $566M for nine months, down from $1.229B. Working-capital movements included increases in receivables and inventory; the filing notes cash flow is sensitive to payment and inventory timing. Investing used $228M and financing used $2.247B.
- Cash and equivalents were $3.406B at December 31, 2015, versus $5.341B at March 31, 2015. Working capital was $3.782B, compared with $3.173B.
- Total debt was approximately $8.711B, comprising $996M current and $7.715B long-term debt. Debt net of cash was $5.312B, up from $4.503B at March 31. Debt-to-capital was 44.8%, down from 50.3%; net debt-to-net-capital employed was 37.4%, up from 36.0%.
- The company reported no borrowings under its new $3.5B revolving credit facility at quarter-end and said available operating cash, credit facilities and commercial paper access should meet expected requirements. It held about $2.4B of cash outside the U.S.; repatriation could incur U.S. taxes.
Material changes and unusual items
Profit growth reflected improved operating results in both segments, lower acquisition-related costs, lower LIFO expense and tax benefits, as well as one-time gains and settlement proceeds. Nine-month results included $103M in pre-tax gains from selling ZEE Medical and the nurse triage business, and $76M in pre-tax antitrust settlement proceeds. The quarter included $17M of those settlement proceeds. Nine-month LIFO expense was $215M versus $287M; the quarter’s $33M expense included a $65M charge partly offset by a $32M reversal of prior-period expense following an estimate change. Nine-month results also included $45M of net discrete tax benefits.
Nine-month repurchases, including shares surrendered for tax withholding, used $960M of cash, compared with $106M in the prior-year period. The Board authorized a new $2B repurchase program in October; $1.6B remained authorized at December 31. The quarterly dividend increased from $0.24 to $0.28 per share in July.
Outlook, risks and contingencies
No specific earnings or revenue guidance is provided in the supplied filing text. Management anticipated completing a review of administrative costs in the fourth quarter of fiscal 2016 and said restructuring or related charges could result. Two proposed acquisitions—UDG Healthcare’s Irish distribution business for approximately $445M and Sainsbury’s U.K. pharmacy business for approximately $185M—were subject to approvals and expected to close in the first half of calendar 2016.
Risks highlighted include pharmaceutical pricing and LIFO estimate variability, customer consolidation or loss, foreign exchange, acquisition integration, technology and cybersecurity issues, and legal and regulatory proceedings. A West Virginia lawsuit filed in January 2016 alleges failures concerning suspicious controlled-substance orders. An appellate court reversed dismissal of a German takeover-law case against a subsidiary; McKesson planned to appeal. The PSKW trade-secret trial had concluded, with a verdict pending. The company said it could not estimate reasonably possible losses for many unresolved proceedings. It also disclosed $564M of unrecognized tax benefits, with up to $123M potentially reduced over the next twelve months. Celesio noncontrolling shareholders hold put rights; the timing and amount of any resulting cash payments are uncertain. The Brazilian distribution business remained classified as discontinued operations after a $241M pre-tax impairment recorded in the prior fiscal quarter, and a further loss on disposal remained possible.
Investor verification priorities
- Assess how much earnings growth came from recurring operations versus divestiture gains, antitrust proceeds, LIFO estimate changes and tax benefits.
- Track operating cash conversion and working-capital requirements, particularly receivables and inventory, against reported earnings.
- Verify the impact of drug pricing, customer mix and volume on Distribution Solutions margins and LIFO expense.
- Monitor completion, funding and integration of the proposed UDG and Sainsbury acquisitions, and any cost-review charges.
- Follow the Brazilian business disposal, Celesio put-right exposure, legal proceedings and tax audits for potential cash or earnings effects.