McKesson Corporation — Form 10-Q Summary
Business context and reporting period: This filing covers the quarter and six months ended September 30, 2013, the second quarter and first half of McKesson’s fiscal 2014. McKesson operates Distribution Solutions and Technology Solutions; Distribution Solutions generated about 98% of quarterly revenue. Amounts below are in U.S. dollars.
Financial performance
| Metric | Quarter ended September 30, 2013 | Prior-year quarter | Six months ended September 30, 2013 | Prior-year six months |
|---|---|---|---|---|
| Revenue | $32.954 billion | $29.755 billion | $65.162 billion | $60.454 billion |
| Gross profit | $2.009 billion | $1.683 billion | $3.929 billion | $3.244 billion |
| Gross margin | 6.10% | 5.66% | 6.03% | 5.37% |
| Operating income | $679 million | $606 million | $1.326 billion | $1.182 billion |
| Income from continuing operations | $416 million | $399 million | $836 million | $778 million |
| Net income | $404 million | $401 million | $828 million | $781 million |
| Diluted EPS | $1.74 | $1.67 | $3.56 | $3.25 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $813 million | $459 million |
Margins and segments: Distribution Solutions quarterly revenue rose 11% to $32.169 billion and segment operating profit rose 10% to $685 million; its operating margin was 2.13% versus 2.14%. Technology Solutions revenue rose 8% to $785 million and segment operating profit rose 23% to $113 million; its operating margin increased to 14.39% from 12.62%. Consolidated operating margin was approximately 2.06% in the quarter, compared with 2.04% a year earlier.
Financial position and liquidity
- At September 30, 2013, cash and cash equivalents were $2.960 billion, up from $2.456 billion at March 31, 2013; working capital was $3.166 billion, versus $1.813 billion.
- Total debt was approximately $4.874 billion ($353 million current and $4.521 billion long-term). Debt net of cash was $1.914 billion. The debt-to-capital ratio was 37.9%, down from 40.8%.
- Six-month investing cash outflow was $274 million, including acquisitions, property acquisitions, and capitalized software. Financing cash outflow was $37 million, including $99 million of dividends paid and $128 million of share repurchases.
- The company reported no borrowings under its $1.3 billion revolving credit facility at period-end and was in compliance with debt covenants. Its $1.35 billion accounts-receivable sales facility was due to expire in November 2013; renewal was anticipated but not assured.
Changes versus prior comparable periods
- Quarterly revenue increased 11% and six-month revenue increased 8%, driven primarily by market growth, drug utilization and pricing, business mix, and the PSS World Medical acquisition. Brand-to-generic price deflation partly offset growth.
- Quarterly diluted EPS increased 4%; six-month diluted EPS increased 10%. Share repurchases reduced weighted-average diluted shares by about 3% in both comparisons.
- Gross margin improved in both segments. Management cited PSS World Medical, improved buy margin, higher generic-drug sales, and a lower share of lower-margin warehouse sales; higher operating expenses partly offset the benefit.
- Six-month operating cash flow increased to $813 million from $459 million, including substantially lower AWP litigation settlement payments ($20 million versus $438 million).
- The prior-year six-month comparison included an $81 million pretax gain on the headquarters-building transaction; no comparable gain was recorded in 2013.
Outlook, management commentary, risks and unusual items
- No specific earnings or revenue guidance is provided in the filing. Management said available cash, operating cash flow, and credit sources were expected to fund ongoing requirements, while noting that market disruption could affect liquidity or borrowing costs.
- McKesson committed to sell its International Technology and Hospital Automation businesses and a small Distribution Solutions business; their results are reported as discontinued operations. Discontinued operations produced a quarterly after-tax loss of $12 million and a six-month loss of $8 million. A Hospital Automation sale for $52 million was agreed after quarter-end, with completion expected in fiscal 2014’s third quarter.
- In October 2013, McKesson agreed to acquire a majority stake in Celesio and make offers for remaining shares and convertible bonds. The transaction was valued at approximately €6.1 billion, or about $8.3 billion at the stated exchange rate, including assumed debt. Completion depended on regulatory and other conditions, including acquiring at least 75% of Celesio’s fully diluted shares. A $5.5 billion, 364-day bridge loan was arranged; the company expected to refinance some or all of it with longer-term financing.
- AWP litigation charges were $35 million for the quarter and $50 million for the six months. The AWP reserve was $72 million at September 30; management cautioned ultimate costs could be higher or lower. Some proceedings remained unresolved, and the company generally could not estimate a reasonably possible loss range.
- Tax matters include $567 million of unrecognized tax benefits, of which $411 million would reduce tax expense if recognized. IRS and Canadian transfer-pricing assessments were disputed; final resolution could materially change tax expense.
- A $44 million LIFO charge in the quarter and six months reflected net inflation in pharmaceutical inventories, compared with $3 million in the prior-year periods. The filing also reports a $44 million foreign-currency translation loss reclassified to other income following the Nadro investment sale; it did not materially affect earnings because it had been considered in the prior impairment assessment.
Important facts for investors to verify
- Progress, financing, regulatory approvals, minimum ownership threshold, and integration risks for the proposed Celesio acquisition.
- Renewal and availability of the accounts-receivable sales facility and the eventual cost and terms of permanent acquisition financing.
- Developments in AWP litigation and tax disputes, including whether recorded reserves remain adequate.
- Execution and proceeds from planned divestitures, and the continuing results of discontinued operations.
- Whether gross-margin improvement persists given LIFO volatility, generic-drug price deflation, customer changes, and distribution margins.