McKesson Corporation — FY2017 Form 10-K
Reporting period: Fiscal year ended March 31, 2017. The filing is an annual report, not a standalone 2016 fourth-quarter report; it includes quarterly data, including FY2017 Q4.
Business context
McKesson is a healthcare distributor and services company operating through Distribution Solutions and Technology Solutions. Distribution Solutions generated $195.9 billion, or about 99%, of FY2017 revenue. On March 1, 2017, McKesson contributed most of its core technology businesses to Change Healthcare, retaining a 70% equity interest accounted for under the equity method, as well as RelayHealth Pharmacy and Enterprise Information Solutions (EIS).
Financial performance and position
| Metric | FY2017 | FY2016 |
|---|---|---|
| Revenue | $198.5 billion | $190.9 billion |
| Gross profit | $11.27 billion | $11.42 billion |
| Gross margin | 5.68% | 5.98% |
| Income from continuing operations | $5.28 billion | $2.34 billion |
| Net income attributable to McKesson | $5.07 billion | $2.26 billion |
| Diluted EPS | $22.73 | $9.70 |
| Cash from operating activities | $4.74 billion | $3.67 billion |
| Cash and cash equivalents, year-end | $2.78 billion | $4.05 billion |
| Total debt, including capital leases | $8.55 billion | $8.11 billion |
| Working capital | $1.34 billion | $3.37 billion |
FY2017 net income included a $3.947 billion pretax ($3.018 billion after-tax) gain from the Change Healthcare transaction. It also included a $290 million pretax EIS goodwill impairment and a $124 million after-tax loss from discontinued operations, principally the Brazil business sale. The reported earnings increase therefore substantially reflects the transaction gain, rather than comparable operating growth.
Revenue rose 4%, driven mainly by North American pharmaceutical distribution growth, acquisitions and expanded business with existing customers. Gross profit declined 1%, and total gross margin fell 30 basis points. Management cited weaker pharmaceutical manufacturer pricing, competitive selling prices, business mix and reduced compensation from a branded-drug manufacturer. Operating cash flow improved, partly reflecting working-capital movements, including increased payables. Debt-to-capital improved to 39.2% from 43.6%, while cash and working capital declined. The company reported $3.5 billion of available capacity under its revolving credit facility and $183 million of commercial paper outstanding.
Material changes, outlook and risks
- Portfolio and acquisitions: FY2017 acquisitions included Rexall Health for approximately $2.1 billion, Vantage Oncology, Biologics and UDG. The April 3, 2017 CoverMyMeds acquisition cost $1.3 billion, with up to $0.2 billion in contingent consideration. McKesson also sold its Brazilian distribution business.
- Cost alignment: The plan is expected to incur $250–$270 million in pretax charges through implementation, substantially by the end of 2019. McKesson reported $170–$190 million in net pretax savings in FY2017 and expected a further $70–$90 million in FY2018.
- Outlook: The filing refers investors to a May 22, 2017 Form 8-K for FY2018 outlook; it does not state the guidance figures in the provided text. Management expected weaker pharmaceutical manufacturer pricing trends to continue in FY2018.
- Regulatory and legal exposure: In January 2017, McKesson paid $150 million to settle potential DEA/DOJ claims concerning suspicious-order reporting for controlled substances. The DEA imposed staggered, limited suspensions of controlled-substance distribution registrations at four centers. The filing also describes related opioid litigation and other unresolved proceedings; for many, loss ranges could not be estimated.
- Other key risks: High customer concentration (top ten customers represented 54.2% of revenue; CVS alone 20.2%), pricing and reimbursement changes, generic-drug price volatility, acquisition integration, foreign exchange, cybersecurity and privacy, and the performance and governance of the Change Healthcare joint venture. Celesio goodwill was also sensitive to further declines in projected cash flows.
- Unusual financing and capital allocation: FY2017 included $4.24 billion of net acquisition cash payments, $2.25 billion of share repurchases and $253 million of dividends. The company had $2.7 billion remaining under its repurchase authorization at year-end. Its audited financial statements received an unqualified opinion, and management and the auditor concluded internal control over financial reporting was effective; Rexall was excluded from that control assessment as a recently acquired business.
Important facts for investors to verify
- Review the May 22, 2017 Form 8-K for the actual FY2018 guidance and its assumptions.
- Assess earnings and margins excluding the one-time Change Healthcare gain, EIS impairment, acquisition effects, LIFO items and antitrust settlement proceeds.
- Track the Change Healthcare investment’s results, transaction expenses, joint-venture governance and any contemplated IPO or eventual distribution to McKesson shareholders.
- Monitor pharmaceutical pricing and customer concentration, particularly CVS, and the effects of customer consolidation and reimbursement changes.
- Follow the DEA registration suspensions and opioid-related litigation, including any developments that change the company’s ability to estimate potential losses.
- Reconcile post-year-end acquisition funding and cash use with liquidity, debt maturities, buybacks and the reduced year-end cash balance.