Business context and reporting period
McKesson Corporation filed this audited Form 10-K for the fiscal year ended March 31, 2019 (FY2019), with FY2018 as the principal comparable period. The request labels the period “2018 Q4,” but the filing covers the full fiscal year, including its fourth quarter. McKesson distributes pharmaceuticals and medical-surgical products and provides related services and technology. It reports U.S. Pharmaceutical and Specialty Solutions, European Pharmaceutical Solutions, Medical-Surgical Solutions, and Other.
Financial performance and position
| Metric | FY2019 | FY2018 |
|---|---|---|
| Revenue | $214.3 billion | $208.4 billion |
| Gross profit / gross margin | $11.754 billion / 5.48% | $11.184 billion / 5.37% |
| Operating income | $886 million | $762 million |
| Income from continuing operations | $254 million | $292 million |
| Net income attributable to McKesson | $34 million | $67 million |
| Diluted EPS attributable to McKesson | $0.17 | $0.30 |
| Cash from operating activities | $4.036 billion | $4.345 billion |
| Cash and cash equivalents at year-end | $2.981 billion | $2.672 billion |
| Working capital | $839 million | $451 million |
| Total debt, including capital lease obligations | $7.595 billion | $7.880 billion |
Gross margin improved 11 basis points year over year. Net income attributable to McKesson fell despite higher revenue and gross profit; the company recorded $221 million of net income attributable to noncontrolling interests in FY2019. The reported FY2019 tax expense was $356 million, a 58.4% effective rate, affected particularly by nondeductible goodwill impairments. Capital expenditures for property, plant and equipment were $426 million; net cash used in investing activities was $1.381 billion. Share repurchases totaled $1.627 billion and cash dividends paid were $292 million.
Revenue by segment: U.S. Pharmaceutical and Specialty Solutions $167.763 billion (+3%); European Pharmaceutical Solutions $27.242 billion (approximately flat); Medical-Surgical Solutions $7.618 billion (+15%); Other $11.696 billion (-1%). Segment operating results included U.S. Pharmaceutical and Specialty Solutions profit of $2.697 billion, European Pharmaceutical Solutions loss of $1.978 billion, Medical-Surgical Solutions profit of $455 million, and Other profit of $394 million.
Material changes versus the prior comparable period
- Revenue rose 2.9%, while gross profit increased about 5%. Management attributed growth mainly to market expansion, existing-customer business and acquisitions, partly offset by lost customers.
- Net income attributable to McKesson declined 49% to $34 million, and diluted EPS declined to $0.17 from $0.30. FY2019 included $1.776 billion of non-cash European goodwill impairment; FY2018 included $1.738 billion of goodwill impairment across Europe and Rexall.
- Operating cash flow decreased $309 million. Working capital increased from FY2018, primarily reflecting higher cash, receivables and inventory, partly offset by increased payables.
- Debt declined by $285 million, while the debt-to-capital ratio increased to 43.3% from 40.6%, mainly because stockholders’ equity decreased.
- FY2019 gross profit benefited from $210 million of LIFO credits and $202 million of net antitrust settlement proceeds. The LIFO credit was higher than FY2018’s $99 million. FY2017 results included a $3.947 billion pre-tax gain on the Change Healthcare transaction, making comparisons with that year particularly distorted.
Outlook, commentary, risks and unusual items
Management said operating cash flow, cash and short-term investments, credit facilities, and commercial paper were expected to be sufficient for near- and long-term cash requirements. The filing refers investors to separate May 8, 2019 Forms 8-K and 8-K/A for FY2020 outlook; it does not provide a clear numerical guidance value in the supplied text.
- Impairments and restructuring: FY2019 included $1.776 billion of non-cash goodwill impairment in European reporting units, $210 million of long-lived asset impairment primarily in U.K. retail, and $597 million of restructuring and asset impairment charges overall. Both European reporting units had no remaining goodwill at year-end. Additional cost-optimization programs are expected to incur $300–$350 million of pre-tax charges through completion by the end of 2021. Separate announced initiatives and the headquarters move also carry estimated charges.
- Legal and regulatory exposure: McKesson faces extensive litigation alleging improper controlled-substance distribution, including approximately 1,700 federal cases in consolidated pretrial proceedings and more than 240 similar state-court cases. The company said it could not reasonably estimate possible losses for many matters. FY2019 opioid-related costs were $151 million, primarily litigation expense. A West Virginia state settlement was reached in May 2019 after year-end, involving $14.5 million paid and five further annual installments of $4.5 million; the company denied wrongdoing.
- Customer concentration: The ten largest customers represented 49.9% of revenue; CVS Health alone represented 19.4%. McKesson extended its CVS distribution relationship to June 2023 in May 2019. Loss of a major customer or a material payment default could affect earnings, liquidity and cash flow.
- Other operating risks: Management highlighted pharmaceutical pricing and generic-drug supply volatility, reimbursement cuts, competition, healthcare regulation, cybersecurity and privacy, foreign exchange, Brexit uncertainty, and acquisition/integration risks. U.K. reimbursement reductions and competitive pressures drove European impairments and operating losses.
- Liquidity and commitments: Contractual obligations totaled $17.914 billion, including $7.595 billion of long-term debt, $2.656 billion of operating lease commitments, and $4.631 billion of purchase obligations. The company expected adoption of new lease accounting to add more than $2.0 billion of operating lease liabilities to the balance sheet. A termination of the frozen U.S. pension plan was expected to be completed in 2020, with settlement expense not yet reasonably estimable.
- Unusual earnings effects: FY2019 also included a $97 million escrow settlement gain related to Rexall and a $90 million pre-tax credit from extinguishing a Change Healthcare tax receivable agreement liability. McKesson’s share of Change Healthcare’s equity-method loss was $194 million.
The independent auditor gave unqualified opinions on the financial statements and internal control over financial reporting; management also concluded controls were effective at March 31, 2019.
Most important facts for investors to verify
- Review the separate FY2020 outlook filing and compare guidance with subsequent reported results.
- Track the opioid litigation, regulatory investigations, settlement developments and any potential loss estimates or accrual changes.
- Assess whether European operations stabilize after reimbursement reductions, store closures and the substantial goodwill and asset impairments.
- Verify whether cash generation and working-capital needs support debt service, shareholder returns and planned restructuring costs.
- Monitor customer concentration and the terms and performance of the CVS distribution agreement through June 2023.
- Check the effects of lease-accounting adoption, pension-plan termination and other significant contingent obligations on reported leverage and cash flows.