McKesson Corporation — FY2018 Form 10-K Summary
Business context and reporting period
McKesson is a healthcare distributor and services provider operating in pharmaceutical distribution, specialty care, medical-surgical supply distribution, retail pharmacy and healthcare technology. This filing covers the fiscal year ended March 31, 2018 (FY2018); fiscal 2017 is the principal comparable year. The company reported two segments: Distribution Solutions and Technology Solutions.
During FY2018, McKesson completed the sale of its Enterprise Information Solutions business, following its 2017 contribution of most technology businesses to Change Healthcare. McKesson retained an approximately 70% equity-method interest in Change Healthcare. Beginning in FY2019, it planned to report three segments—U.S. Pharmaceutical and Specialty Solutions, European Pharmaceutical Solutions, and Medical-Surgical Solutions—with remaining activities in Other.
Financial performance and position
| Metric | FY2018 | FY2017 |
|---|---|---|
| Revenue | $208.36 billion | $198.53 billion |
| Gross profit | $11.18 billion | $11.27 billion |
| Gross margin | 5.37% | 5.68% |
| Operating income | $762 million | $7.11 billion |
| Income from continuing operations | $292 million | $5.28 billion |
| Net income attributable to McKesson | $67 million | $5.07 billion |
| Diluted EPS attributable to McKesson | $0.32 | $22.73 |
| Cash from operating activities | $4.35 billion | $4.74 billion |
Revenue rose 4.9%, driven mainly by North American pharmaceutical distribution growth, acquisitions and expanded business with existing customers. Gross profit declined 0.8%, and margin contracted 31 basis points. Results were heavily affected by $1.74 billion in non-cash goodwill impairments, $567 million in restructuring and asset impairment charges, a $248 million equity-method loss from Change Healthcare, and a $122 million debt-extinguishment loss. FY2017 included a $3.95 billion pre-tax gain from the Change Healthcare transaction, making the year-over-year earnings decline unusually large and not directly indicative of underlying operating trends.
FY2018 included a $1.32 billion provisional tax benefit from remeasuring deferred taxes under the Tax Cuts and Jobs Act and a $457 million provisional transition-tax expense. McKesson reported a $53 million income tax benefit overall. The quarterly pattern was uneven: fourth-quarter revenue was $51.63 billion, while McKesson recorded a $1.09 billion loss from continuing operations and a $5.58 diluted loss per share, largely reflecting impairment charges.
At March 31, 2018, cash and equivalents were $2.67 billion, working capital was $451 million, total debt was $7.88 billion and the debt-to-capital ratio was 40.6%. Total assets were $60.38 billion. Operating cash flow of $4.35 billion exceeded capital expenditures of $405 million; investing activities used $1.52 billion and financing activities used $3.08 billion. The company cited operating cash flow, cash, credit facilities and commercial paper as expected sources of liquidity. Its $3.5 billion revolving facility was undrawn, and the company was compliant with its covenants. Contractual obligations totaled $18.42 billion, including debt, interest, purchase commitments and operating leases.
Material changes versus the prior comparable period
- Revenue increased 4.9%, but gross profit and gross margin declined; weaker manufacturer pricing trends, competition and U.K. reimbursement cuts weighed on profitability.
- Net income attributable to McKesson fell to $67 million from $5.07 billion. FY2017 benefited from the large Change Healthcare transaction gain; FY2018 included substantial impairments and other charges.
- Cash from operations declined by $399 million. Working capital fell from $1.34 billion to $451 million, primarily reflecting higher payables and lower receivables, partly offset by higher inventory.
- Total debt decreased from $8.55 billion to $7.88 billion. McKesson repurchased $1.65 billion of shares in FY2018 and declared dividends of $1.30 per share, up from $1.12.
- Goodwill impairments totaled $1.74 billion: $1.28 billion for McKesson Europe and $455 million for Rexall Health. McKesson Europe also recorded $446 million of long-lived asset impairments and $74 million of restructuring charges.
Outlook, commentary, risks and unusual items
Management described a multi-year strategic growth initiative announced April 25, 2018, aimed at improving patient care delivery, increasing efficiency and supporting profit growth. A related restructuring plan was expected to be substantially implemented by the end of 2019, with estimated after-tax charges of $150 million to $210 million during FY2019. The 10-K directs readers to a May 24, 2018 Form 8-K for FY2019 outlook; it does not provide a clear numerical operating forecast in the filing text summarized here.
The company expected remaining McKesson Europe restructuring charges of approximately $16 million to $56 million pre-tax, within a total estimated range of $90 million to $130 million. Subsequent events included a definitive agreement to acquire Medical Specialties Distributors for $800 million, subject to regulatory approval, and Board approval to terminate the frozen U.S. defined-benefit pension plan. The pension termination could result in a settlement expense, but its amount and timing were not estimable.
- Controlled-substance litigation and regulation: McKesson had been served with 394 complaints alleging claims related to controlled-substance distribution; the company said it generally could not estimate reasonably possible losses for unresolved proceedings. It had paid $150 million in 2017 to settle DEA and DOJ claims regarding suspicious-order reporting, and DEA registrations at four distribution centers were subject to suspensions for limited periods.
- Customer concentration: The ten largest customers represented 51.7% of revenue, and CVS Health alone represented 19.9%. Loss of, or reduced purchases from, a major customer could materially affect results, liquidity and cash flow.
- International retail pressures: U.K. reimbursement reductions and weaker script growth, plus Canadian generic reimbursement reductions and wage increases, drove impairment charges and could lead to further impairments.
- Other material risks: Generic drug pricing and supply volatility, healthcare reimbursement and regulatory changes, competition and industry consolidation, cyber and privacy incidents, foreign exchange movements, acquisition integration, and the performance and governance of the Change Healthcare joint venture.
- Other unusual items: McKesson pledged $100 million to a public-benefit foundation focused on opioid education and treatment access; payment was expected in FY2019. A further goodwill impairment could arise following the FY2019 segment realignment; the company said it could not reasonably estimate the potential charge.
Most important facts for investors to verify
- Review the FY2019 outlook in the referenced May 24, 2018 Form 8-K and distinguish that forecast from the 10-K’s qualitative initiative commentary.
- Assess normalized earnings and cash generation apart from the FY2017 transaction gain, FY2018 impairments, tax effects, restructuring and other unusual items.
- Track progress and operating performance in McKesson Europe and Rexall, including reimbursement trends, store actions and potential additional impairments.
- Monitor controlled-substance litigation, related investigations and any financial, regulatory or operational developments beyond the settled $150 million DEA/DOJ matter.
- Check customer concentration, working-capital movements, debt maturities, share repurchases and the potential cash requirements associated with the Change Healthcare investment and McKesson Europe minority-shareholder put rights.