UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended March 31, 2017
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the transition period from to
Commission File Number: 1-13252
McKESSON CORPORATION
(Exact name of registrant as specified in its charter)
Delaware | 94-3207296 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
One Post Street, San Francisco, California | 94104 | |
(Address of principal executive offices) | (Zip Code) | |
(415) 983-8300
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
(Title of each class) | (Name of each exchange on which registered) | |
Common stock, $0.01 par value | New York Stock Exchange | |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes ¨ No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer | x | Accelerated filer | ¨ | |||
Non-accelerated filer | ¨ (Do not check if a smaller reporting company) | Smaller reporting company | ¨ | |||
Emerging growth company | ¨ | |||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
Yes ¨ No x
The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant, computed by reference to the closing price as of the last business day of the registrant’s most recently completed second fiscal quarter, September 30, 2016, was approximately $37.6 billion.
Number of shares of common stock outstanding on April 30, 2017: 210,902,490
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s Proxy Statement for its 2017 Annual Meeting of Stockholders are incorporated by reference into Part III of this Annual Report on Form 10-K.
McKESSON CORPORATION
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McKESSON CORPORATION
PART I
Item 1. | Business. |
General
McKesson Corporation (“McKesson,” the “Company,” or “we” and other similar pronouns), currently ranked 5th on the FORTUNE 500, is a global leader in healthcare supply chain management solutions, retail pharmacy, community oncology and specialty care, and healthcare information technology. We partner with pharmaceutical manufacturers, providers, pharmacies, governments and other organizations in healthcare to help provide the right medicines, medical products and healthcare services to the right patients at the right time, safely and cost-effectively.
The Company’s fiscal year begins on April 1 and ends on March 31. Unless otherwise noted, all references in this document to a particular year shall mean the Company’s fiscal year.
Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act,”) are available free of charge on our website (www.mckesson.com under the “Investors — Financial Information — SEC Filings” caption) as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission (“SEC” or the “Commission”). The content on any website referred to in this Annual Report on Form 10-K is not incorporated by reference into this report, unless expressly noted otherwise.
The public may also read or copy any materials that we file with the SEC at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains a website that contains reports, proxy and information statements, and other information regarding issuers, including the Company, that file electronically with the SEC. The address of the website is www.sec.gov.
Business Segments
We operate our business through two segments: McKesson Distribution Solutions and McKesson Technology Solutions.
Our Distribution Solutions segment distributes branded and generic pharmaceutical drugs and other healthcare-related products internationally and provides practice management, technology, clinical support and business solutions to community-based oncology and other specialty practices. This segment also provides specialty pharmaceutical solutions for pharmaceutical manufacturers including offering multiple distribution channels and clinical trial access to our network of oncology physicians. It also provides medical-surgical supply distribution, logistics and other services to healthcare providers within the United States. Additionally, this segment operates retail pharmacy chains in Europe and Canada, and supports independent pharmacy networks within North America and Europe. It also supplies integrated pharmacy management systems, automated dispensing systems and related services to retail, outpatient, central fill, specialty and mail order pharmacies.
Our Technology Solutions segment provides clinical, financial and supply chain management solutions to healthcare organizations and includes our equity method investment in Change Healthcare, LLC (“Change Healthcare”), a Delaware limited liability company, as further described below.
On June 28, 2016, we entered into a contribution agreement (“Contribution Agreement”) with Change Healthcare Holdings, Inc. (“Change”), a Delaware corporation, and others including shareholders of Change to form a joint venture, Change Healthcare. On December 21, 2016, we received notification from the Department of Justice that their review was closed and the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, was terminated. On March 1, 2017, the transaction closed upon satisfaction of all other closing conditions pursuant to the Contribution Agreement. Under the terms of the Contribution Agreement, we contributed the majority of our McKesson Technology Solutions businesses (“Core MTS Business”) to Change Healthcare. We retained our RelayHealth Pharmacy and Enterprise Information Solutions (“EIS”) businesses. Change contributed substantially all of its businesses to the joint venture excluding its pharmacy switch and prescription routing business. In exchange for the contribution, we own 70% of the joint venture with the remaining equity ownership held by Change shareholders. Change Healthcare is a healthcare technology company which provides software and analytics, network solutions and technology-enabled services that will deliver wide-ranging financial, operational and clinical benefits to payers, providers and consumers.
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Net revenues for our segments for the last three years were as follows:
Years Ended March 31, | ||||||||||||||||||
(Dollars in billions) | 2017 | 2016 | 2015 | |||||||||||||||
Distribution Solutions | $ | 195.9 | 99 | % | $ | 188.0 | 98 | % | $ | 176.0 | 98 | % | ||||||
Technology Solutions | 2.6 | 1 | 2.9 | 2 | 3.1 | 2 | ||||||||||||
Total | $ | 198.5 | 100 | % | $ | 190.9 | 100 | % | $ | 179.1 | 100 | % | ||||||
Distribution Solutions Segment
Our Distribution Solutions segment consists of the following businesses: North America pharmaceutical distribution and services, International pharmaceutical distribution and services and Medical-Surgical distribution and services.
North America pharmaceutical distribution and services
Our North America pharmaceutical distribution and services business is the largest pharmaceutical distributor in the United States with more than 40,000 customers and is comprised of the following business units: U.S. Pharmaceutical Distribution, McKesson Specialty Health, McKesson Canada and McKesson Rx Technology Solutions.
U.S. Pharmaceutical Distribution: This business supplies branded, specialty and generic pharmaceuticals and other healthcare-related products to customers throughout the United States in three primary customer channels: (1) retail national accounts (including national and regional chains, food/drug combinations, mail order pharmacies and mass merchandisers); (2) independent retail pharmacies; and (3) institutional healthcare providers such as hospitals, health systems, integrated delivery networks and long-term care providers. This business also provides solutions and services to pharmaceutical manufacturers. This business sources materials and products from a wide array of different suppliers, including certain generic pharmaceutical drugs produced through a contract-manufacturing program and generic pharmaceutical drugs sourced through our sourcing joint venture, ClarusOne Sourcing Services, LLC.
Our U.S. pharmaceutical distribution business operates and serves thousands of customer locations through a network of 27 distribution centers, as well as a primary redistribution center, two strategic redistribution centers and two repackaging facilities, serving all 50 states and Puerto Rico. We invest in technology and other systems at all of our distribution centers to enhance safety and reliability and to provide the best product availability for our customers. For example, in most of our distribution centers we use Acumax® Plus, an award-winning technology that integrates and tracks all internal inventory-related functions such as receiving, put-away and order fulfillment. Acumax® Plus uses bar code technology, wrist-mounted computer hardware and radio frequency signals to provide customers with real-time product availability and industry-leading order quality and fulfillment in excess of 99.9% adjusted accuracy. In addition, we offer Mobile ManagerSM, which integrates portable handheld technology with Acumax® Plus to give customers complete ordering and inventory control. We also offer McKesson ConnectSM, an internet-based ordering system that provides item lookup and real-time inventory availability as well as ordering, purchasing, third-party reconciliation and account management functionality. Together, these features help ensure customers have the right products at the right time for their facilities and patients.
To maximize distribution efficiency and effectiveness, we follow the Six Sigma methodology — an analytical approach that emphasizes setting high-quality objectives, collecting data and analyzing results to a fine degree in order to improve processes, reduce costs, enhance service accuracy and safety. We provide solutions to our customers including supply management technology, world-class marketing programs, managed care, repackaging products and services to help them meet their business and quality goals. We continue to implement information systems to help achieve greater consistency and accuracy both internally and for our customers.
The major customer groups of our U.S. Pharmaceutical Distribution business can be categorized as retail national accounts, independent retail pharmacies and institutional healthcare providers.
Retail National Accounts — Business solutions that help national account customers increase revenues and profitability. Solutions include:
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• | Central FillSM — Prescription refill service that enables pharmacies to more quickly refill prescriptions remotely, more accurately and at a lower cost, while reducing inventory levels and improving customer service. |
• | Redistribution Centers — Two facilities totaling over 750,000 square feet that offer access to inventory for single source warehouse purchasing, including pharmaceuticals and biologics. These distribution centers also provide the foundation for a two-tiered distribution network that supports best-in-class direct store delivery. |
• | McKesson SynerGx® — Generic pharmaceutical purchasing program and inventory management that helps pharmacies maximize their cost savings with a broad selection of generic drugs, competitive pricing and one-stop shopping. |
• | RxPakSM — Bulk-to-bottle repackaging service that leverages our purchasing scale and supplier relationships to provide pharmaceuticals at reduced prices, help increase inventory turns and reduce working capital investment. |
• | Inventory Management — An integrated solution comprising forecasting software and automated replenishment technologies that reduce inventory-carrying costs. |
• | ExpressRx Track™ — Pharmacy automation solution featuring state-of-the-art robotics, upgraded imaging and expanded vial capabilities, and industry-leading speed and accuracy in a radically small footprint. |
Independent Retail Pharmacies — Solutions for managed care contracting, branding and advertising, merchandising, purchasing, operational efficiency and automation that help independent pharmacists focus on patient care while improving profitability. Solutions include:
• | Health Mart® — Health Mart® is a national network of more than 4,800 independently-owned pharmacies and is one of the industry’s most comprehensive pharmacy franchise programs. Health Mart® provides franchisees support for managed care contracting, branding and local marketing solutions, the Health Mart private label line of products, merchandising solutions and programs for enhanced patient support. |
• | AccessHealth® — Comprehensive managed care and reconciliation assistance services that help independent pharmacies save time, access competitive reimbursement rates and improve cash flow. |
• | McKesson Reimbursement AdvantageSM (“MRA”) — MRA is one of the industry’s most comprehensive reimbursement optimization packages, comprising financial services (automated claim resubmission), analytic services and customer care. |
• | McKesson OneStop Generics® — Generic pharmaceutical purchasing program that helps pharmacies maximize their cost savings with a broad selection of generic drugs, competitive pricing and one-stop shopping. |
• | Sunmark® — Complete line of more than 600 products that provide retail independent pharmacies with value-priced alternatives to national brands. |
• | FrontEdge™ — Strategic planning, merchandising and price maintenance program that helps independent pharmacies maximize store profitability. |
• | McKesson Sponsored Clinical Services (SCS) Network — Access to patient-support services that allow pharmacists to earn service fees and to develop stronger patient relationships. |
Institutional Healthcare Providers — Electronic ordering/purchasing and supply chain management systems that help customers improve financial performance, increase operational efficiencies and deliver better patient care. Solutions include:
• | Fulfill-RxSM — Ordering and inventory management system that empowers hospitals to optimize the often complicated and disjointed processes related to unit-based cabinet replenishment and inventory management. |
• | Asset Management — Award-winning inventory optimization and purchasing management program that helps institutional providers lower costs while ensuring product availability. |
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• | SKY Packaging — Blister-format packaging containing the most widely prescribed dosages and strengths in generic oral-solid medications. SKY Packaging enables acute care, long-term care and institutional pharmacies to provide cost-effective, uniform packaging. |
• | McKesson Plasma and BioLogics — A full portfolio of plasma-derivatives and biologic products. |
• | McKesson OneStop Generics® — Described above. |
McKesson Specialty Health (“MSH”): This business provides a range of solutions to oncology and other specialty practices operating in communities across the country, to pharmaceutical and biotechnology suppliers who manufacture specialty drugs and vaccines, and to payers and hospitals. MSH is focused on three core business lines: Manufacturer Solutions, Practice Management and Provider Solutions.
Manufacturer Solutions help manufacturers accelerate the approval and successful commercialization of specialty pharmaceuticals across the product life cycle. MSH’s offerings include supply chain services, including specialty pharmacy services and third party logistics (“3PL”), provider and patient engagement programs, clinical trial support, patient assistance programs, reimbursement services, and analytics. In addition, MSH helps manufacturers minimize reimbursement challenges while offering affordable, safe access to therapies through Risk Evaluation and Mitigation Strategies (“REMS”) programs.
In April 2016, we completed the acquisition of Biologics, Inc (“Biologics”), a Cary, North Carolina-based company that provides oncology pharmacy services to providers and patients as well as solutions for manufacturers and payers. For manufacturers, Biologics helps optimize the speed of therapy to the patient, enhance patient adherence and improve patient access to therapy. In addition, Biologics works with manufacturers to develop custom strategies to enhance the clinical and commercial success of their products at each stage of the life-cycle.
Practice Management provides a variety of solutions, including practice operations, healthcare information technology, revenue cycle management and managed care contracting solutions, evidence-based guidelines and quality measurements to support U.S. Oncology Network, one of the nation’s largest network of physician-led, integrated, community-based oncology practices dedicated to advancing high-quality, evidence-based cancer care. We also support U.S. Oncology Research, one of the nation’s largest research networks, specializing in oncology clinical trials.
In April 2016, we also completed the acquisition of Vantage Oncology Holdings, LLC (“Vantage”), a leading national provider of integrated oncology and radiation services headquartered in Manhattan Beach, California. Vantage’s comprehensive oncology management services model, including its focus on community-based radiation oncology, medical oncology, surgical specialties and other integrated cancer care services, complements and strengthens the existing offerings of McKesson and U.S. Oncology Network, while allowing patients to access the care they need in an efficient, customizable and cost effective way.
Provider Solutions offers community specialists (oncologists, rheumatologists, ophthalmologists, urologists, neurologists, and other specialists) an extensive set of customizable products and services designed to strengthen core practice operations, enhance value-based care delivery, and expand their service offering to patients. Tools and services include specialty drug distribution and group purchasing organization (“GPO”) services, technology solutions, practice consulting services, and vaccine distribution, including our exclusive distributor relationship with the Centers for Disease Control and Prevention’s (“CDC”) Vaccines for Children program. Community-based physicians in this business line have broad flexibility and choice to select the products and commitment levels that best meet their practice needs.
When we classify a pharmaceutical product or service as “specialty,” we consider the following factors: diseases requiring complex treatment regimens such as cancer and rheumatoid arthritis; ongoing clinical monitoring requirements, high-cost, special handling, storage and delivery requirements and, in some cases, exclusive distribution arrangements. Our use of the term “specialty” to define a portion of our distribution business may not be comparable to that used by other industry participants, including our competitors.
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McKesson Canada: McKesson Canada is one of the largest pharmaceutical distributors in Canada. McKesson Canada, through its network of 13 distribution centers, provides logistics and distribution for manufacturers - delivering their products to retail pharmacies, hospitals, long-term care centers, clinics and institutions throughout Canada and through its network of infusion clinics, offers specialty services and adherence programs. Beyond pharmaceutical distribution, logistics and order fulfillment, McKesson Canada provides automation solutions to its retail and hospital customers, dispensing millions of doses each year. McKesson Canada also provides health information exchange solutions that streamline clinical and administrative communication and retail banner services that help independent pharmacists compete and grow through innovative services and operation support. McKesson Canada’s retail banners comprise the largest network of independent pharmacies in Canada. In partnership with other McKesson businesses, McKesson Canada provides a full range of services to Canadian manufacturers and healthcare providers, contributing to the quality and safety of care for patients.
In December 2016, we completed our acquisition of Rexall Health of the Katz Group Canada, Inc. for $2.9 billion Canadian dollars (or, approximately $2.1 billion U.S dollars). Rexall Health, which operates approximately 470 retail pharmacies in Canada, enhances our ability to provide best-in-class pharmacy care through an expanded retail footprint for patients across Canada. Patients in Canada benefits from greater choice and access, integrated pharmacy care and industry-leading service levels. Rexall Health helps us leverage our existing portfolio of assets to drive growth along the entire value chain, particularly in two of Canada’s fastest growing regions, Ontario and Western Canada.
McKesson Rx Technology Solutions (“MRTS”): This business is comprised of McKesson Pharmacy Technology and Services (“MPTS”), RelayHealth Pharmacy (“RHP”) and CoverMyMeds (“CMM”) and drives greater innovation and value for all stakeholders in the pharmaceutical value chain. MRTS focuses on customers across the pharmacy industry, including manufacturers, payers, retail pharmacies, hospital pharmacies and government agencies. This business supports our customers, including physicians, with a comprehensive, expanded portfolio of solutions designed to help them realize greater business efficiencies, deliver high-quality care, enhance medication adherence and safety, and more effectively connect with other players in the pharmaceutical supply chain.
MPTS provides offerings that allow retail chains, hospital outpatient pharmacies, small and independent pharmacies to meet the high demand for prescriptions while maximizing profits, meeting clinical demands and optimizing operations. It supplies integrated pharmacy management systems, automated dispensing systems and related services to retail, outpatient, central fill, specialty and mail order pharmacies. Solutions include:
• | EnterpriseRx® — A Software as a Service (SaaS) pharmacy management system, that allows large retail chain, health system and retail independent pharmacies to meet demand for prescriptions while maximizing profits and optimizing operations. |
• | Pharmaserv® — A fully integrated, server-based pharmacy management system that gives the customer complete control of their pharmacy data. |
• | PharmacyRx — A cost-effective, SaaS-based pharmacy management system that can be installed quickly and makes processing prescriptions fast and easy. |
• | Macro Helix® — Software as a Service (SaaS)-based solutions that help pharmacists manage, track and report on medication replenishment associated with the federal 340B Drug Pricing Program. |
• | Supplylogix® — Develops and delivers practical supply chain intelligence solutions to retail pharmacies to aid in inventory management and control. |
RHP is a leading provider of connectivity to pharmacies, manufacturers and payers. RelayHealth® Pharmacy solutions help our customers accelerate the delivery of high-quality care and improve financial performance through electronic prescribing by physicians and point-of-service resolution of pharmacy claims by payers. This business helps provide efficient delivery of medications and pharmacy services, improved care, faster access, and lower costs. Effective April 1, 2017, RHP is included in MRTS within our Distribution Solutions segment; this business was formerly part of our Technology Solutions segment.
On April 3, 2017, we completed our acquisition of CMM, a privately-owned company headquartered in Columbus, Ohio. CMM provides electronic prior authorization solutions to pharmacies, providers, payers and pharmaceutical manufacturers helping patients get their prescribed drugs more efficiently to live healthy lives.
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International pharmaceutical distribution and services
Our international pharmaceutical distribution and services business provides distribution and services to the pharmaceutical and healthcare sectors in 13 countries within Europe. The pharmaceutical wholesale business supplies pharmaceuticals and other healthcare-related products generally to retail pharmacies and institutional customers. Its wholesale network consists of approximately 110 branches that deliver to over 50,000 pharmacies daily in European countries. This business functions as a vital link between manufacturers and pharmacies in supplying pharmaceuticals to patients, and generally procures the pharmaceuticals approved in each country as well as other products sold in pharmacies directly from the manufacturers. Pharmaceutical and other healthcare-related products are stored at regional wholesale branches with the support of its efficient warehousing management system. The retail pharmacy business serves patients and consumers in European countries directly through over 2,400 of its own pharmacies and over 5,500 participant pharmacies operating under brand partnership arrangements. The retail business provides traditional prescription pharmaceuticals, non-prescription products and medical services and operates under the Lloyds Pharmacy brand in Belgium, Ireland, Italy, Sweden and the United Kingdom (“U.K.”). The latter is the biggest retail business, which accounted for approximately 71% of the total revenue of the retail pharmacy business for the year ended March 31, 2017.
In April 2016, we completed the acquisition of the pharmaceutical distribution business of UDG Healthcare Plc (“UDG”) based in Ireland and the U.K. for $431 million. The acquired UDG business primarily provides pharmaceutical and other healthcare products to retail and hospital pharmacies.
In May 2016, we sold our Brazilian pharmaceutical distribution business, which we acquired through our February 2014 acquisition of Celesio. Refer to Financial Note 5, “Discontinued Operations”, to the consolidated financial statements appearing in this Annual Report on Form 10-K.
Medical-Surgical distribution and services
McKesson Medical-Surgical provides medical-surgical supply distribution, logistics and other services to healthcare providers, including physicians’ offices, surgery centers, extended care facilities, hospital reference labs, and homecare and occupational health sites. Through a network of distribution centers within the U.S., we offer more than 250,000 national brand products plus McKesson’s own line of high-quality medical-surgical products. As a leading distributor of products and solutions to the full range of alternate-site healthcare facilities, we care for our customers so they can care for their patients.
Technology Solutions Segment
Our Technology Solutions segment consists of our EIS business and our equity method investment in Change Healthcare.
Equity method investment in Change Healthcare: We own an approximate 70% equity ownership interest in Change Healthcare. Our investment in Change Healthcare is accounted for using the equity method of accounting. Change Healthcare provides software and analytics, network solutions and technology-enabled services that will deliver wide-ranging financial, operational and clinical benefits to payers, providers and consumers. Refer to Financial Note 2, “Healthcare Technology Net Asset Exchange” to the consolidated financial statements appearing in this Annual Report on Form 10-K.
Enterprise Information Solutions: This business provides clinical and financial information systems for healthcare organizations including professional services, workflow management and supply chain management solutions. We are evaluating strategic options for this business.
Business Combinations, Investments, Discontinued Operations and Other Divestitures
We have undertaken additional strategic initiatives in recent years designed to further focus on our core healthcare businesses and enhance our competitive position. We expect to continue to undertake such strategic initiatives in the future. These initiatives are detailed in Financial Notes 2, 4, 5 and 7, “Healthcare Technology Net Asset Exchange,” “Business Combinations,” “Discontinued Operations” and “Divestiture of Businesses” to the consolidated financial statements appearing in this Annual Report on Form 10-K.
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Competition
Our Distribution Solutions segment faces a highly competitive global environment with strong competition from international, national, regional and local full-line, short-line and specialty distributors, service merchandisers, self-warehousing chain drug stores, manufacturers engaged in direct distribution, third-party logistics companies and large payer organizations. In addition, this segment faces competition from various other service providers and from pharmaceutical and other healthcare manufacturers as well as other potential customers of the segment, which may from time-to-time decide to develop, for their own internal needs, supply management capabilities that would otherwise be provided by the segment. In all areas, key competitive factors include price, quality of service, breadth of product lines, innovation and, in some cases, convenience to the customer.
Our Technology Solutions segment and our technology businesses within our Distribution Solutions segment experience substantial competition from many companies, including other software services firms, consulting firms, shared service vendors, certain hospitals and hospital groups, payers, care management organizations, hardware vendors and internet-based companies with technology applicable to the healthcare industry. Competition varies in size from small to large companies, in geographical coverage and in scope and breadth of products and services offered.
Patents, Trademarks, Copyrights and Licenses
McKesson and its subsidiaries hold patents, copyrights, trademarks and trade secrets related to McKesson products and services. We pursue patent protection for our innovation, and obtain copyrights covering our original works of authorship, when such protection is advantageous. Through these efforts, we have developed a portfolio of patents and copyrights in the U.S. and worldwide. In addition, we have registered or applied to register certain trademarks and service marks in the U.S. and in foreign countries.
We believe that, in the aggregate, McKesson’s confidential information, patents, copyrights, and trademarks are important to its operations and market position, but we do not consider any of our businesses to be dependent upon any one patent, copyright, trademark, or trade secret, or any family or families of the same. We cannot guarantee that our intellectual property portfolio will be sufficient to deter misappropriation, theft, or misuse of our technology, nor that we can successfully enjoin infringers. We periodically receive notices alleging that our products or services infringe on third party patents and other intellectual property rights. These claims may result in McKesson entering settlement agreements, paying damages, discontinuing use or sale of accused products, or ceasing other activities. While the outcome of any litigation or dispute is inherently uncertain, we do not believe that the resolution of any of these infringement notices would have a material adverse impact on our results of operation.
We hold inbound licenses for certain intellectual property that is used internally, and in some cases, utilized in McKesson’s products or services. While it may be necessary in the future to seek or renew licenses relating to various aspects of our products and services, we believe, based upon past experience and industry practice, such licenses generally can be obtained on commercially reasonable terms. We believe our operations and products and services are not materially dependent on any single license or other agreement with any third party.
Other Information about the Business
Customers: During 2017, sales to our ten largest customers, including group purchasing organizations (“GPOs”) accounted for approximately 54.2% of our total consolidated revenues. Sales to our largest customer, CVS Health (“CVS”), accounted for approximately 20.2% of our total consolidated revenues. At March 31, 2017, trade accounts receivable from our ten largest customers were approximately 33.7% of total trade accounts receivable. Accounts receivable from CVS were approximately 17.8% of total trade accounts receivable. We also have agreements with GPOs, each of which functions as a purchasing agent on behalf of member hospitals, pharmacies and other healthcare providers, as well as with government entities and agencies. The accounts receivables balances are with individual members of the GPOs, and therefore no significant concentration of credit risk exists. Substantially all of these revenues and accounts receivable are included in our Distribution Solutions segment.
Suppliers: We obtain pharmaceutical and other products from manufacturers, none of which accounted for more than 5% of our purchases in 2017. The loss of a supplier could adversely affect our business if alternate sources of supply are unavailable. We believe that our relationships with our suppliers are generally good. The ten largest suppliers in 2017 accounted for approximately 40% of our purchases.
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A significant portion of our distribution arrangements with the manufacturers provides us compensation based on a percentage of our purchases. In addition, we have certain distribution arrangements with pharmaceutical manufacturers that include an inflation-based compensation component whereby we benefit when the manufacturers increase their prices as we sell our existing inventory at the new higher prices. For these manufacturers, a reduction in the frequency and magnitude of price increases, as well as restrictions in the amount of inventory available to us, could have a material adverse impact on our gross profit margin.
Research and Development: Research and development costs were $341 million, $392 million and $392 million during 2017, 2016 and 2015. These costs did not include $16 million, $30 million and $34 million of costs capitalized for software held for sale during 2017, 2016 and 2015. Development expenditures were primarily incurred by our Technology Solutions segment. Our Technology Solutions segment’s product development efforts applied computer technology and installation methodologies to specific information processing needs of hospitals and other customers. Additional information regarding our development activities is included in Financial Note 1, “Significant Accounting Policies,” to the consolidated financial statements appearing in this Annual Report on Form 10-K.
Environmental Regulation: Our operations are subject to regulations under various federal, state, local and foreign laws concerning the environment, including laws addressing the discharge of pollutants into the air and water, the management and disposal of hazardous substances and wastes, and the cleanup of contaminated sites. We could incur substantial costs, including cleanup costs, fines and civil or criminal sanctions and third-party damage or personal injury claims, if in the future we were to violate or become liable under environmental laws.
We are committed to maintaining compliance with all environmental laws applicable to our operations, products and services and to reducing our environmental impact across all aspects of our business. We meet this commitment through an environmental strategy and sustainability program.
We sold our chemical distribution operations in 1987 and retained responsibility for certain environmental obligations. Agreements with the Environmental Protection Agency and certain states may require environmental assessments and cleanups at several closed sites. These matters are described further in Financial Note 25, “Commitments and Contingent Liabilities,” to the consolidated financial statements appearing in this Annual Report on Form 10-K.
The liability for environmental remediation and other environmental costs is accrued when the Company considers it probable and can reasonably estimate the costs. Environmental costs and accruals, including that related to our legacy chemical distribution operations, are presently not material to our operations or financial position. Although there is no assurance that existing or future environmental laws applicable to our operations or products will not have a material adverse impact on our operations or financial condition, we do not currently anticipate material capital expenditures for environmental matters. Other than the expected expenditures that may be required in connection with our legacy chemical distribution operations, we do not anticipate making substantial capital expenditures either for environmental issues, or to comply with environmental laws and regulations in the future. The amount of our capital expenditures for environmental compliance was not material in 2017 and is not expected to be material in the next year.
Employees: On March 31, 2017, we employed approximately 78,000 employees, including approximately 27,000 part-time employees.
Financial Information About Foreign and Domestic Operations: Certain financial information relating to foreign and domestic operations is included in Financial Note 29, “Segments of Business,” to the consolidated financial statements appearing in this Annual Report on Form 10-K. See “Risk Factors” in Part I, Item 1A below for information regarding risks associated with our foreign operations.
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McKESSON CORPORATION
Forward-Looking Statements
This Annual Report on Form 10-K, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 of Part II of this report and the “Risk Factors” in Item 1A of Part I of this report, contains forward-looking statements within the meaning of section 27A of the Securities Act of 1933, as amended and section 21E of the Securities Exchange Act of 1934, as amended. Some of these statements can be identified by use of forward-looking words such as “believes,” “expects,” “anticipates,” “may,” “will,” “should,” “seeks,” “approximately,” “intends,” “plans” or “estimates,” or the negative of these words, or other comparable terminology. The discussion of financial trends, strategy, plans or intentions may also include forward-looking statements. Forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those projected, anticipated, or implied. Although it is not possible to predict or identify all such risks and uncertainties, they may include, but are not limited to, the factors discussed in Item 1A of Part I of this report under “Risk Factors.” The reader should not consider the list to be a complete statement of all potential risks and uncertainties.
These and other risks and uncertainties are described herein and in other information contained in our publicly available SEC filings and press releases. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date such statements were first made. Except to the extent required by federal securities laws, we undertake no obligation to publicly release the result of any revisions to these forward-looking statements to reflect events or circumstances after the date hereof, or to reflect the occurrence of unanticipated events.
Item 1A. | Risk Factors |
The risks described below could have a material adverse impact on our financial position, results of operations, liquidity and cash flows. Although it is not possible to predict or identify all such risks and uncertainties, they may include, but are not limited to, the factors discussed below. Our business operations could also be affected by additional factors that are not presently known to us or that we currently consider not to be material. The reader should not consider this list to be a complete statement of all risks and uncertainties.
Changes in the United States healthcare industry and regulatory environment could have a material adverse impact on our results of operations.
Many of our products and services are intended to function within the structure of the healthcare financing and reimbursement system currently being used in the United States. In recent years, the healthcare industry in the United States has changed significantly in an effort to enhance efficiencies, reduce costs and improve patient outcomes. These changes have included cuts in Medicare and Medicaid reimbursement levels, changes in the basis for payments, shifting away from fee-for-service and towards value-based payments and risk-sharing models, increases in the use of managed care, consolidation of pharmaceutical and medical-surgical supply distributors and the development of large, sophisticated purchasing groups. We expect the healthcare industry in the United States to continue to change and for healthcare delivery models to evolve in the future.
Changes in the healthcare industry’s or our pharmaceutical suppliers’ pricing, selling, inventory, distribution or supply policies or practices could significantly reduce our revenues and net income. Due to the diverse range of healthcare supply management and healthcare information technology products and services that we offer, such changes could have a material adverse impact on our results of operations, while not affecting some of our competitors who offer a narrower range of products and services.
The majority of our U.S. pharmaceutical distribution business agreements with manufacturers are structured to ensure that we are appropriately and predictably compensated for the services we provide. However, failure to successfully renew these contracts in a timely and favorable manner could have a material adverse impact on our results of operations. Certain distribution business agreements we entered into with manufacturers continue to have pharmaceutical price inflation as a component of our compensation. Consequently, our results of operations could be adversely affected if the frequency or magnitude of pharmaceutical price increases or decreases, which we do not control. In addition, we distribute generic pharmaceuticals, which can be subject to both price deflation and price inflation. During 2017, our Distribution Solutions segment experienced weaker pharmaceutical pricing trends, which are expected to continue in 2018. Continued volatility in the availability, pricing trends or reimbursement of these generic drugs, or significant fluctuations in the nature, frequency and magnitude of generic pharmaceutical launches, could have a material adverse impact on our results of operations. Additionally, any future changes in branded and generics drug pricing could be significantly different than our projections.
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Generic drug manufacturers are increasingly challenging the validity or enforceability of patents on branded pharmaceutical products. During the pendency of these legal challenges, a generics manufacturer may begin manufacturing and selling a generic version of the branded product prior to the final resolution of its legal challenge over the branded product’s patent. To the extent we source, contract manufacture, and distribute such generic products, the brand-name company could assert infringement claims against us. While we generally obtain indemnification against such claims from generic manufacturers as a condition of distributing their products, there can be no assurances that these rights will be adequate or sufficient to protect us.
The healthcare industry is highly regulated, and further regulation of our distribution businesses and technology products and services could impose increased costs, negatively impact our profit margins and the profit margins of our customers, delay the introduction or implementation of our new products, or otherwise negatively impact our business and expose the Company to litigation and regulatory investigations.
Healthcare Fraud: We are subject to extensive and frequently changing local, state and federal laws and regulations relating to healthcare fraud, waste and abuse. Local, state and federal governments continue to strengthen their position and scrutiny over practices involving fraud, waste and abuse affecting Medicare, Medicaid and other government healthcare programs. Our relationships with pharmaceutical and medical-surgical product manufacturers and healthcare providers, as well as our provision of products and services to government entities, subject our business to laws and regulations on fraud and abuse, which among other things: (1) prohibit persons from soliciting, offering, receiving or paying any remuneration in order to induce the referral of a patient for treatment or to induce the ordering or purchasing of items or services that are in any way paid for by Medicare, Medicaid or other government-sponsored healthcare programs; (2) impose a number of restrictions upon referring physicians and providers of designated health services under Medicare and Medicaid programs; and (3) prohibit the knowing submission of a false or fraudulent claim for payment to, and knowing retention of an overpayment by, a federal healthcare program such as Medicare and Medicaid. Many of the regulations applicable to us, including those relating to marketing incentives, are vague or indefinite and have not been interpreted by the courts. The regulations may be interpreted or applied by a prosecutorial, regulatory, or judicial authority in a manner that could require us to make changes in our operations. If we fail to comply with applicable laws and regulations, we could become liable for damages and suffer civil and criminal penalties, including the loss of licenses or our ability to participate in Medicare, Medicaid and other federal and state healthcare programs.
Reimbursements: Both our profit margins and the profit margins of our customers may be adversely affected by laws and regulations reducing reimbursement rates for pharmaceuticals, medical treatments and related services, or changing the methodology by which reimbursement levels are determined. For example, the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act (collectively the “Affordable Care Act”), signed into law in 2010, revised, subject to rulemaking, the federal upper limits (“FUL”) for Medicaid reimbursement for multiple source generic drugs available for purchase by retail community pharmacies on a nationwide basis. On January 21, 2016, the Centers for Medicare and Medicaid Services (“CMS”) released the Covered Outpatient Drugs final rule with comment. The final rule, with limited exceptions, establishes the FUL to be 175% of the weighted average (determined on the basis of utilization) of the most recently reported monthly average manufacturer price (“AMP”). Additionally, the final rule established actual acquisition cost as the basis by which states should determine their ingredient cost reimbursement, addressed the sufficiency of dispensing fees to reflect the cost of the pharmacist’s professional services and cost to dispense drugs to Medicaid beneficiaries, and clarified that states are required to evaluate the sufficiency of both ingredient cost and professional dispensing fee when proposing changes to either component. Use of the revised AMP-based FUL may result in a reduction in the Medicaid reimbursement rates to our customers for certain pharmaceuticals, which could indirectly impact the prices that we can charge our customers and cause corresponding declines in our profitability.
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The federal government may adopt measures that could reduce Medicare and/or Medicaid spending, or impose additional requirements on healthcare entities. For example, under the terms of the Budget Control Act of 2011, an automatic 2% reduction of Medicare program payments for all healthcare providers became generally effective for services provided on or after April 1, 2013. This automatic reduction is known as “sequestration.” Medicare generally reimburses physicians for Part B drugs at the rate of average sales price (“ASP”) plus 6%. The implementation of sequestration pursuant to the Budget Control Act of 2011 has effectively reduced reimbursement below the ASP plus 6% level for the duration of sequestration (which lasts through fiscal 2024 in the absence of additional legislation). As another example, the Medicare Access and CHIP Reauthorization Act (“MACRA”), signed into law in April 2015, seeks to reform Medicare reimbursement policy for physician fee schedule services and adopts a series of policy changes affecting a wide range of providers and suppliers. Most notably, MACRA repeals the statutory Sustainable Growth Rate formula, which has called for cuts in Medicare rates in recent years, but which Congress routinely stepped in to override the full application of the formula. Instead, after a period of stable payment updates, MACRA links physician payment updates to quality and value measurements and participation in alternative payment models. MACRA also extends certain expiring Medicare and other health policy provisions, including extending the Children’s Health Insurance Program. Additionally, concerns held by federal policymakers about the federal deficit and national debt levels could result in enactment of further federal spending reductions, further entitlement reform legislation affecting the Medicare program, or both. We cannot predict what alternative or additional deficit reduction initiatives or Medicare payment reductions, if any, will ultimately be enacted into law, or the timing or affect any such initiatives or reductions will have on us.
There can be no assurance that the preceding changes would not have a material adverse impact on our results of operations.
Operating, Security and Licensure Standards: We are subject to the operating and security standards of the Drug Enforcement Administration (“DEA”), the U.S. Food and Drug Administration (“FDA”), various state boards of pharmacy, state health departments, the U.S. Department of Health and Human Services (“HHS”), the CMS and other comparable agencies. Certain of our businesses may be required to register for permits and/or licenses with, and comply with operating and security standards of, the DEA, FDA, HHS, CMS, various state boards of pharmacy, state health departments and/or comparable state agencies as well as foreign agencies and certain accrediting bodies, depending upon the type of operations and location of product development, manufacture, distribution, and sale. For example, we are required to hold valid DEA and state-level registrations and licenses, meet various security and operating standards and comply with the Controlled Substances Act and its accompanying regulations governing the sale, marketing, packaging, holding, distribution, and disposal of controlled substances.
As part of these operating, security and licensure standards, we regularly receive requests for information and occasionally subpoenas from government authorities. In some instances, these can lead to monetary penalties and/or license revocation. In January 2017, we reached an agreement with the DEA and Department of Justice pursuant to which we paid the sum of $150 million to settle all potential administrative and civil claims relating to investigations about the Company’s suspicious order reporting practices for controlled substances. The DEA is suspending, on a staggered basis for limited periods of time, McKesson’s DEA registrations to distribute certain controlled substances from four McKesson distribution centers.
Although we have enhanced our procedures to ensure compliance, there can be no assurance that a regulatory agency or tribunal would conclude that our operations are compliant with applicable laws and regulations. In addition, there can be no assurance that we will be able to maintain or renew existing permits, licenses or any other regulatory approvals or obtain without significant delay future permits, licenses or other approvals needed for the operation of our businesses. Any noncompliance by us with applicable laws and regulations or the failure to maintain, renew or obtain necessary permits and licenses could lead to litigation and have a material adverse impact on our results of operations.
Pedigree Tracking: There have been increasing efforts by Congress and state and federal agencies, including state boards of pharmacy and departments of health and the FDA, to regulate the pharmaceutical distribution system in order to prevent the introduction of counterfeit, adulterated and/or mislabeled drugs into the pharmaceutical distribution system, otherwise known as pedigree tracking. In November 2013, Congress passed and the President signed into law the Drug Quality and Security Act (“DQSA”). The DQSA establishes federal standards requiring supply-chain stakeholders to participate in an electronic, interoperable, lot-level prescription drug track and trace system. The law also preempts state drug pedigree requirements. The DSQA also establishes new requirements for drug wholesale distributors and third party logistics providers, including licensing requirements in states that had not previously licensed such entities.
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In addition, the Food and Drug Administration Amendments Act of 2007, which went into effect on October 1, 2007, requires the FDA to establish standards and identify and validate effective technologies for the purpose of securing the pharmaceutical supply chain against counterfeit drugs. These standards may include track-and-trace or authentication technologies, such as radio frequency identification devices and other similar technologies. On March 26, 2010, the FDA released the Serialized Numerical Identifier (“SNI”) guidance for manufacturers who serialize pharmaceutical packaging. We expect to be able to accommodate these SNI regulations in our distribution operations. The DQSA and other pedigree tracking laws and regulations could increase the overall regulatory burden and costs associated with our pharmaceutical distribution business, and could have a material adverse impact on our results of operations.
Privacy: There are numerous federal, state and foreign laws and regulations related to the privacy and security of personal information. In particular, regulations promulgated pursuant to the Health Insurance Portability and Accountability Act of 1996 (“HIPAA”) establish privacy and security standards that limit the use and disclosure of individually identifiable health information (known as “protected health information”) and require the implementation of administrative, physical and technological safeguards to protect the privacy of protected health information and ensure the confidentiality, integrity and availability of electronic protected health information. We are directly subject to certain provisions of the regulations as a “Business Associate” through our relationships with customers. We are also directly subject to the HIPAA privacy and security regulations as a “Covered Entity” with respect to our operations as a healthcare clearinghouse, specialty pharmacy and medical surgical supply business.
The privacy regulations established under HIPAA also provide patients with rights related to understanding and controlling how their protected health information is used and disclosed. To the extent permitted by applicable privacy regulations and our contracts with our customers, we may use and disclose protected health information to perform our services and for other limited purposes, such as creating de-identified information. Other uses and disclosures, such as marketing communications, require written authorization from the individual or must meet an exception specified under the privacy regulations. Determining whether protected health information has been sufficiently de-identified to comply with the HIPAA privacy standards and our contractual obligations may require complex factual and statistical analyses and may be subject to interpretation.
If we are unable to properly protect the privacy and security of protected health information entrusted to us, we could be found to have breached our contracts with our customers. Further, if we fail to comply with applicable HIPAA privacy and security standards, we could face civil and criminal penalties. HHS performs compliance audits of Covered Entities and Business Associates and enforces the HIPAA privacy and security standards. HHS has become an increasingly active regulator and has signaled its intention to continue this trend. HHS has the discretion to impose penalties without being required to attempt to resolve violations through informal means, such as implementing a corrective action plan. HHS enforcement activity can result in financial liability and reputational harm, and responses to such enforcement activity can consume significant internal resources. In addition to enforcement by HHS, state attorneys general are authorized to bring civil actions seeking either injunctions or damages in response to violations that threaten the privacy of state residents. Although we have implemented and maintain policies and processes to assist us in complying with these regulations and our contractual obligations, we cannot provide assurance regarding how these regulations will be interpreted, enforced or applied to our operations. In addition to the risks associated with enforcement activities and potential contractual liabilities, our ongoing efforts to comply with evolving laws and regulations at the federal and state level might also require us to make costly system purchases and/or modifications from time to time.
Healthcare Reform: The Affordable Care Act (“ACA”) significantly expanded health insurance coverage to uninsured Americans and changed the way healthcare is financed by both governmental and private payers. While certain provisions of the ACA took effect immediately, others have delayed effective dates or require further rulemaking action or regulatory guidance by governmental agencies to implement and/or finalize (e.g. nondiscrimination in health programs and activities, excise tax on high-cost employer-sponsored health coverage). Further, as a result of the November 2016 U.S. presidential election, there are uncertainties associated with efforts to change or repeal the ACA or other healthcare reforms, and we cannot predict their full effect on the Company at this time. Two top legislative priorities of the new presidential administration and Congress may be significant reform of the ACA, as discussed above, and reform of the Internal Revenue Code of 1986, as amended (the “Code”), including significant changes to taxation of business entities and the deductibility of interest expense. While there is currently a substantial lack of clarity around the likelihood, timing and details of any such policies and reforms, such policies and reforms may have a material adverse impact on our results of operations.
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FDA Regulation of Medical Software: The FDA has increasingly focused on the regulation of medical software and health information technology products as medical devices under the federal Food, Drug and Cosmetic Act. For example, in February 2015, the FDA issued guidance to inform manufacturers and distributors of medical device data systems that it did not intend to enforce compliance with regulatory controls that apply to medical device data systems, medical image storage devices, and medical image communication devices. If the FDA chooses to regulate more of our products as medical devices, or subsequently changes or reverses its guidance regarding not enforcing regulatory controls for certain medical device products, it can impose extensive requirements upon us. If we fail to comply with the applicable requirements, the FDA could respond by imposing fines, injunctions or civil penalties, requiring recalls or product corrections, suspending production, refusing to grant pre-market clearance of products, withdrawing clearances and initiating criminal prosecution. Any additional FDA regulations governing health information technology products, once issued, may increase the cost and time to market of new or existing products or may prevent us from marketing our products. In December 2016, Congress passed and the President signed into law the 21st Century Cures Act. The 21st Century Cures Act changes the way health IT would be regulated by the FDA. The bill also carves most health IT products out of the FDA’s jurisdiction, but includes a clawback provision that would enable FDA to regulate products on a case-by-case basis if it determined they pose a risk to patient safety.
Medical Billing and Coding: Medical billing, coding and collection activities are governed by numerous federal and state civil and criminal laws. In connection with these laws, we may be subjected to federal or state government investigations and possible penalties may be imposed upon us, false claims actions may have to be defended, private payers may file claims against us and we may be excluded from Medicare, Medicaid or other government-funded healthcare programs. Any such proceeding or investigation could have a material adverse impact on our results of operations.
Our foreign operations subject us to a number of operating, economic, political and regulatory risks that may have a material adverse impact on our financial position and results of operations.
We have operations based in, and we source and contract manufacture pharmaceutical and medical-surgical products in, a number of foreign countries. Moreover, in Europe, Celesio operates as a wholesale and retail company and provider of logistics and services to the pharmaceutical and healthcare sector.
Our foreign operations expose us to a number of risks including changes in trade protection laws, policies and measures and other regulatory requirements affecting trade and investment; changes in licensing regimes for pharmacies; unexpected regulatory, social, political, or economic changes in a specific country or region; changes in intellectual property, privacy and data protection; import/export regulations and trade sanctions in both the United States and foreign countries and difficulties in staffing and managing foreign operations. Political changes, labor strikes, acts of war or terrorism and natural disasters, some of which may be disruptive, can interfere with our supply chain, our customers and all of our activities in a particular location. We may also be affected by potentially adverse tax consequences and difficulties associated with repatriating cash generated or held abroad.
On June 23, 2016, voters in the United Kingdom approved an advisory referendum to withdraw from the European Union, which proposed exit (and the political, economic and other uncertainties it has raised) has exacerbated and may further exacerbate many of the risks and uncertainties described above. Negotiations on withdrawal and post-exit arrangements likely will be complex and protracted, and there can be no assurance regarding the terms, timing or consummation of any such arrangements. The proposed withdrawal could, among other potential outcomes, adversely affect the tax, tax treaty, currency, operational, legal and regulatory regimes to which our businesses in the region are subject. The withdrawal could also, among other potential outcomes, disrupt the free movement of goods, services and people between the United Kingdom and the European Union and significantly disrupt trade between the United Kingdom and the European Union and other parties. Further, uncertainty around these and related issues could lead to adverse effects on the economy of the United Kingdom and the other economies in which we operate. There can be no assurance that any or all of these events will not have a material adverse effect on our results of operations.
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In addition, foreign operations are also subject to risks of violations of laws prohibiting improper payments and bribery, including the U.S. Foreign Corrupt Practices Act, the U.K. Bribery Act and similar regulations in foreign jurisdictions. The U.K. Bribery Act, for example, prohibits both domestic and international bribery, as well as bribery across both private and public sectors. An organization that fails to prevent bribery committed by anyone associated with the organization can be charged under the U.K. Bribery Act unless the organization can establish the defense of having implemented adequate procedures to prevent bribery. Failure to comply with these laws could subject us to civil and criminal penalties that could have a material adverse impact on our financial position and results of operations.
We also may experience difficulties and delays inherent in sourcing products and contract manufacturing from foreign countries, including but not limited to: (1) difficulties in complying with the requirements of applicable federal, state and local governmental authorities in the United States and of foreign regulatory authorities; (2) inability to increase production capacity commensurate with demand or the failure to predict market demand; (3) other manufacturing or distribution problems including changes in types of products produced, limits to manufacturing capacity due to regulatory requirements, physical limitations, or scarce or inadequate resources that could impact continuous supply; and (4) damage to our reputation due to real or perceived quality issues. For example, the FDA has conducted investigations and banned certain generics manufacturers from selling certain raw materials and drug ingredients in the U.S. from overseas plants due to quality issues. Difficulties in manufacturing or access to raw materials could result in production shutdowns, product shortages and other similar delays in product manufacturing that could have a material adverse impact on our financial position and results of operations.
Changes in the Canadian healthcare industry and regulatory environment could have a material adverse impact on our results of operations.
Provincial governments in Canada provide partial funding for the purchase of pharmaceuticals and independently regulate the sale and reimbursement of drugs. Provincial governments in Canada have introduced significant changes in recent years in an effort to reduce the costs of publicly funded health programs. For instance, to reduce the cost for taxpayers, provincial governments have taken steps to reform the rules regarding the sale of generic drugs. These changes include the significant lowering of prices for generic pharmaceuticals and, in some provinces, changes to the allowable amounts of professional allowances paid to pharmacists by generic manufacturers, the tendering of generic molecules on provincial drug formularies as well as the tendering of drug distribution services by provincial governments. These reforms may adversely affect the distribution of drugs as well as the pricing for prescription drugs for the Company’s operations in Canada. Other provinces have implemented or are considering similar changes, which would also lower pharmaceutical pricing and service fees. Individually or in combination, such changes in the Canadian healthcare environment may significantly reduce our Canadian revenue and operating profit.
General European economic conditions, together with austerity measures being taken by certain European governments, could have a material adverse impact on our results of operations.
The Company’s acquisition of Celesio increased our assets and operations within Europe and, accordingly, our exposure to economic conditions in Europe. A slowdown within the European economy could affect our business in Europe by reducing the prices our customers may be able or willing to pay for our products and services. A slowdown may also reduce the demand for our products. Either of these could result in a material adverse impact on our results of operations.
In addition, in many European countries the government provides or subsidizes healthcare to consumers and regulates pharmaceutical prices, patient eligibility, and reimbursement levels to control costs for the government-sponsored healthcare system. In recent years, in response to the recessionary environment and financial crisis in Europe, a number of European governments, including the government in the United Kingdom in the past year, have announced or implemented austerity measures to reduce healthcare spending and constrain overall government expenditures. These measures, which include efforts aimed at reforming healthcare coverage and reducing healthcare costs, continue to exert pressure on the pricing of and reimbursement timelines for pharmaceuticals and may cause our customers to purchase fewer of our products and services and reduce the prices they are willing to pay.
Countries with existing healthcare-related austerity measures may impose additional laws, regulations, or requirements on the healthcare industry. In addition, European governments that have not yet imposed healthcare-related austerity measures may impose them in the future. New austerity measures may be similar to or vary from existing austerity measures and could have a material adverse impact on our results of operations.
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Changes in the European regulatory environment regarding privacy and data protection regulations could have a material adverse impact on our results of operations.
In Europe, we are subject to the 1995 European Union (“EU”) Directive on Data Protection (“1995 Data Protection Directive”), which requires EU member states to impose restrictions on the collection and use of personal data that, in some respects, are more stringent, and impose more significant burdens on subject businesses, than current privacy standards in the United States. We may also face audits or investigations by one or more foreign government agencies relating to our compliance with these regulations that could result in the imposition of penalties or fines. The EU member state regulations establish several obligations that organizations must follow with respect to use of personal data, including a prohibition on the transfer of personal information from the EU to other countries whose laws do not protect personal data to an adequate level of privacy or security. In addition, certain member states have adopted more stringent data protection standards. In May 2018, the General Data Protection Regulation (“GDPR”) will supersede current EU data protection legislation, impose more stringent EU data protection requirements, and provide for greater penalties for noncompliance. The costs of compliance with, and other burdens imposed by, such laws, regulations and policies that are applicable to us may limit the use and adoption of our products and solutions and could have a material adverse impact on our results of operations.
Our results of operations, which are stated in U.S. dollars, could be adversely impacted by fluctuations in foreign currency exchange rates.
We conduct our business worldwide in U.S. dollars and the functional currencies of our foreign subsidiaries, including Euro, British pound sterling and Canadian dollar. Changes in foreign currency exchange rates could have a significant adverse impact on our financial results that are reported in the U.S. dollar. For example, the day after the United Kingdom approved an advisory referendum to withdraw from the European Union in June 2016, the British pound sterling fell by more than 10 percent against the U.S. dollar, to its lowest level in more than 30 years. The fall in the British pound sterling relative to the U.S. dollar and Euro, and the strengthening of the U.S. dollar relative to a number of currencies including the British pound sterling and Euro, could have significant impacts on the business and financial results. We are also exposed to foreign currency exchange rate risk related to our foreign subsidiaries, including intercompany loans denominated in non-functional currencies.
We may from time to time enter into foreign currency contracts or other derivative instruments intended to hedge a portion of our foreign currency exchange rate risks. Additionally, we may use foreign currency borrowings to hedge some of our foreign currency exchange rate risks. These hedging activities may not completely offset the adverse financial effects of unfavorable movements in foreign currency exchange rates during the time the hedges are in place.
Our business could be hindered if we are unable to complete and integrate acquisitions successfully.
An element of our strategy is to identify, pursue and consummate acquisitions that either expand or complement our business. Integration of acquisitions involves a number of significant risks, including the diversion of management’s attention to the assimilation of the operations of businesses we have acquired; difficulties in the integration of operations and systems; the realization of potential operating synergies; the assimilation and retention of the personnel of the acquired companies; accounting, regulatory or compliance issues that could arise, including internal control over financial reporting; and challenges retaining the customers of the combined businesses. Further, acquisitions may have a material adverse impact on our operating results if unanticipated expenses or charges to earnings were to occur, including unanticipated depreciation and amortization expenses over the useful lives of certain assets acquired, as well as costs related to potential impairment charges, assumed litigation and unknown liabilities. In addition, we may potentially require additional financing in order to fund future acquisitions, which may or may not be attainable and is subject to potential volatility in the credit markets. If we are unable to successfully complete and integrate strategic acquisitions in a timely manner, our business and our growth strategies could be negatively affected.
Achieving the anticipated benefits of any acquisition is subject to a number of risks and uncertainties, including foreign exchange fluctuations, challenges of managing new domestic or international operations, and whether we can ensure continued performance or market growth of products and services. The integration process is subject to a number of uncertainties and no assurance can be given that the anticipated benefits of any transaction will be realized or, if realized, the timing of its realization. It is possible that the integration process could take longer than anticipated, and could result in the loss of employees, the disruption of each company’s ongoing businesses, processes and systems, or inconsistencies in standards, controls, procedures, practices, policies and compensation arrangements. Any of these events could adversely affect our ability to achieve the anticipated benefits of an acquisition and which could have a material adverse impact on our results of operations.
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Any significant diversion of management’s attention away from the ongoing businesses, and any difficulties encountered in the acquisition, transition and integration process, could adversely affect our financial results. Moreover, the failure to achieve the anticipated benefits of a transaction could result in increased costs or decreases in the amount of expected revenues, and could adversely affect our future business, financial position and operating results. Events outside of our control, including changes in regulations and laws, as well as economic trends, could also adversely affect our ability to realize the expected benefits from a transaction.
Our results of operations could be impacted if our investment in Change Healthcare fails to perform as expected.
On March 1, 2017, McKesson contributed the majority of its Core MTS Business and Change contributed substantially all of its businesses, excluding its pharmacy switch and prescription routing businesses, to form a joint venture, Change Healthcare. The purpose of the transaction was to create a new healthcare information technology company, bringing together the complementary strengths of the contributed assets to provide software and analytics, network solutions and technology-enabled services that will help customers obtain actionable insights, exchange mission-critical information, control costs, optimize revenue opportunities, increase cash flow and effectively navigate the shift to value-based healthcare. Change Healthcare is jointly governed by McKesson and Change. Operating a business under joint governance of unaffiliated, controlling members could lead to conflicts of interest or deadlocks on important and time-sensitive operational, financial or strategic decisions, and will require additional organizational formalities as well as time-consuming procedures for sharing information and making decisions. If we are unable to manage our joint venture relationship and to realize the strategic and financial benefits that we expect, including an initial private offering of Change Healthcare, such inability to manage the relationship or realize benefits may have a material adverse impact on our results of operations.
Our business and results of operations could be impacted if we fail to manage and complete divestitures.
We regularly evaluate our portfolio in order to determine whether an asset or business may no longer help us meet our objectives. When we decide to sell assets or a business, we may encounter difficulty in finding buyers or alternative exit strategies on acceptable terms in a timely manner, which could delay the achievement of our strategic objectives. We may also experience greater dissynergies than expected, and the impact of the divestiture on our revenue growth may be larger than projected. After reaching an agreement with a buyer, we are subject to satisfaction of pre-closing conditions as well as to necessary regulatory and governmental approvals, which, if not satisfied or obtained, may prevent us from completing the sale. Dispositions may also involve continued financial involvement in the divested business, such as through continuing equity ownership, guarantees, indemnities or other financial obligations. Under these arrangements, performance by the divested businesses or other conditions outside of our control could have a material adverse impact on our results of operations.
We are subject to legal and regulatory proceedings that could have a material adverse impact on our financial position and results of operations.
From time to time and in the ordinary course of our business, we and certain of our subsidiaries may become involved in various legal and regulatory proceedings involving false claims, healthcare fraud and abuse, antitrust, class actions, commercial, employment, environmental, intellectual property, licensing, tort and other various claims. All such legal proceedings are inherently unpredictable, and the outcome can result in excessive verdicts and/or injunctive relief that may affect how we operate our business or we may enter into settlements of claims for monetary payments. In some cases, substantial non-economic remedies or punitive damages may be sought. For some complaints filed against the Company, we are currently unable to estimate the amount of possible losses that might be incurred should these legal proceedings be resolved against the Company.
The outcome of litigation and other legal matters is always uncertain and outcomes that are not justified by the evidence or existing law can occur. The Company believes that it has valid defenses to the legal matters pending against it and is defending itself vigorously. Nevertheless, it is possible that resolution of one or any combination of more than one legal matter could result in a material adverse impact on our financial position or results of operations.
Litigation is costly, time-consuming and disruptive to normal business operations. The defense of these matters could also result in continued diversion of our management’s time and attention away from business operations, which could also harm our business. Even if these matters are not resolved against us, the uncertainty and expense associated with unresolved legal proceedings could harm our business and reputation.
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Competition and industry consolidation may erode our profit.
Our Distribution Solutions segment faces a highly competitive global environment with strong competition from international, national, regional and local full-line, short-line and specialty distributors, service merchandisers, self-warehousing chain drug stores, manufacturers engaged in direct distribution, third-party logistics companies and large payer organizations. In addition, this segment faces competition from various other service providers and from pharmaceutical and other healthcare manufacturers as well as other potential customers of the segment, which may from time-to-time decide to develop, for their own internal needs, supply management capabilities that would otherwise be provided by the segment. In all areas, key competitive factors include price, quality of service, breadth of product lines, innovation and, in some cases, convenience to the customer.
In addition, in recent years, the healthcare industry has been subject to increasing consolidation. As a result, a small number of very large pharmaceutical suppliers could control a significant share of the market. Accordingly, we could depend on fewer suppliers for our products and therefore we may be less able to negotiate price terms with suppliers. Many of our customers, including healthcare organizations that purchase our products and services, have also consolidated to create larger enterprises with greater market power. If this consolidation trend continues among our customers, suppliers and competitors, it could reduce the number of market participants and give the resulting enterprises greater bargaining power, which may lead to erosion of the prices for our products and services. It would also increase counter-party credit risk as the number of market participants decreases. In addition, when our customers combine, they often consolidate infrastructure including IT systems, which in turn may erode the diversity of our customer and revenue base.
Our Technology Solutions segment and McKesson Rx Technology Solutions businesses experience substantial competition from many companies, including other software services firms, consulting firms, shared service vendors, certain hospitals and hospital groups, payers, care management organizations, hardware vendors and internet-based companies with technology applicable to the healthcare industry. Competition varies in size from small to large companies, in geographical coverage and in scope and breadth of products and services offered.
These competitive pressures and industry consolidation could have a material adverse impact on our results of operations.
A material reduction in purchases or the loss of a large customer or group purchasing organization, as well as substantial defaults in payment by a large customer or group purchasing organization, could have a material adverse impact on our financial position and results of operations.
In recent years, a significant portion of our revenue growth has been with a limited number of large customers. During 2017, sales to our ten largest customers, including group purchasing organizations (“GPOs”) accounted for approximately 54.2% of our total consolidated revenues. Sales to our largest customer, CVS Health (“CVS”), accounted for approximately 20.2% of our total consolidated revenues. At March 31, 2017, trade accounts receivable from our ten largest customers were approximately 33.7% of total trade accounts receivable. Accounts receivable from CVS were approximately 17.8% of total trade accounts receivable. As a result, our sales and credit concentration is significant. We also have agreements with GPOs, each of which functions as a purchasing agent on behalf of member hospitals, pharmacies and other healthcare providers, as well as with government entities and agencies. A material default in payment, a material reduction in purchases from these or any other large customers, or the loss of a large customer or GPO could have a material adverse impact on our financial position, results of operations and liquidity.
We generally sell our products and services to customers on credit that is short-term in nature and unsecured. Any adverse change in general economic conditions can adversely reduce sales to our customers, affect consumer buying practices or cause our customers to delay or be unable to pay accounts receivable owed to us, which may in turn materially reduce our revenue growth and cause a material decrease in our profitability and cash flow. Further, interest rate fluctuations and changes in capital market conditions may also affect our customers’ ability to obtain credit to finance their business under acceptable terms, which in turn may materially reduce our revenue growth and cause a decrease in our profitability.
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McKESSON CORPORATION
Contracts with foreign and domestic government entities and their agencies pose additional risks relating to future funding and compliance.
Contracts with foreign and domestic government entities and their agencies are subject to various uncertainties, restrictions and regulations, including oversight audits by various government authorities. Government contracts also are exposed to uncertainties associated with funding. Contracts with the U.S. federal government, for example, are subject to the uncertainties of Congressional funding. Governments are typically under no obligation to maintain funding at any specific level, and funds for government programs may even be eliminated. As a result, our government clients may terminate our contracts for convenience or decide not to renew our contracts with little or no prior notice. The loss of such contracts could have a material adverse impact on our results of operations.
In addition, because government contracts are subject to specific procurement regulations and a variety of other socio-economic requirements, we must comply with such requirements. For example, for contracts with the U.S. federal government, with certain exceptions, we must comply with the Federal Acquisition Regulation, the U.S. False Claims Act, the Procurement Integrity Act, the Buy American Act and the Trade Agreements Act. We must also comply with various other domestic and foreign government regulations and requirements as well as various statutes related to employment practices, environmental protection, recordkeeping and accounting. These regulations and requirements affect how we transact business with our clients and, in some instances, impose additional costs on our business operations. Government contracts also contain terms that expose us to higher levels of risk and potential liability than non-government contracts.
We also are subject to government audits, investigations, and oversight proceedings. For example, government agencies routinely review and audit government contractors to determine whether contractors are complying with specific contractual or legal requirements. If we violate these rules or regulations, fail to comply with a contractual or other requirement, or do not satisfy an audit, a variety of penalties can be imposed by a government including monetary damages and criminal and civil penalties. In addition, any of our government contracts could be terminated or we could be suspended or debarred from all government contract work. The occurrence of any of these actions could harm our reputation and could have a material adverse impact on our results of operations.
Our future results could be materially affected by a number of public health issues whether occurring in the United States or abroad.
Public health issues, whether occurring in the United States or abroad, could disrupt our operations, disrupt the operations of suppliers or customers, or have a broader adverse impact on consumer spending and confidence levels that would negatively affect our suppliers and customers. We have developed contingency plans to address infectious disease scenarios and the potential impact on our operations, and we will continue to update these plans as necessary. However, there can be no assurance that these plans will be effective in eliminating the negative impact of any such diseases on the Company’s operating results. We may be required to suspend operations in some or all of our locations, which could have a material adverse impact on our financial position and results of operations.
We rely on sophisticated computer systems to perform our business operations. Although we and our customers use a variety of security measures to protect our and their computer systems, a failure or compromise of our or our customers’ computer systems from a cyberattack, natural disaster, or malfunction may result in material adverse operational and financial consequences.
Our business relies on the secure electronic transmission, storage, and hosting of sensitive information, including protected health information, financial information and other sensitive information relating to our customers, company and workforce. We routinely process, store and transmit large amounts of data in our operations, including sensitive personal information, protected health information, financial information, and confidential information relating to our business or third parties. Some of the data that we process, store and transmit may travel outside of the United States. Additionally, we outsource some important IT functions to external service providers worldwide.
Despite our implementation of a variety of physical, technical and administrative security measures, our and our customers’ computer systems could be subject to cyberattacks and unauthorized access, such as physical and electronic break-ins or unauthorized tampering. Like other global companies, we and our customers have experienced threats to data and systems, including malware and ransomware attacks, unauthorized access, system failures, and disruptions.
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McKESSON CORPORATION
A failure or compromise of our or our customers’ computer systems may jeopardize the confidential, proprietary, and sensitive information processed, stored, and transmitted through such computer systems. Such an event may result in significant damage to our reputation, financial losses, litigation, increased costs, regulatory penalties, customer attrition, brand impairment, or other business harm. These risks may increase in the future as we continue to expand our internet and mobile strategies and to build an integrated digital enterprise.
We could experience losses or liability not covered by insurance.
In order to provide prompt and complete service to our major Distribution Solutions segment’s customers, we maintain significant product inventory at certain of our distribution centers. While we seek to maintain property insurance coverage in amounts sufficient for our business, there can be no assurance that our property insurance will be adequate or available on acceptable terms. One or more large casualty losses caused by fire, earthquake or other natural disaster in excess of our coverage limits could have a material adverse impact on our results of operations.
Our business exposes us to risks that are inherent in the distribution, manufacturing, dispensing and administration of pharmaceuticals and medical-surgical supplies, the provision of ancillary services, the conduct of our payer businesses and the provision of products that assist clinical decision making and relate to patient medical histories and treatment plans. If customers or individuals assert liability claims against our products and/or services, any ensuing litigation, regardless of outcome, could result in a substantial cost to us, divert management’s attention from operations and decrease market acceptance of our products. We attempt to limit our liability to customers by contract; however, the limitations of liability set forth in the contracts may not be enforceable or may not otherwise protect us from liability for damages. Additionally, we may be subject to claims that are not explicitly covered by contract, such as a claim directly by a patient. We also maintain general liability coverage; however, this coverage may not continue to be available on acceptable terms, may not be available in sufficient amounts to cover one or more large claims against us and may include larger self-insured retentions or exclusions for certain products. In addition, the insurer might disclaim coverage as to any future claim. A successful product or professional liability claim not fully covered by our insurance could have a material adverse impact on our results of operations.
Transactions like our acquisitions of Celesio and Rexall expose us to additional risks related to providing pharmacy services. Pharmacies are exposed to risks inherent in the packaging and distribution of pharmaceuticals and other healthcare products, such as with respect to improper filling of prescriptions, labeling of prescriptions, adequacy of warnings, unintentional distribution of counterfeit drugs and expiration of drugs. Although we maintain liability insurance, the coverage may not be adequate to protect us against future claims. If our insurance coverage proves to be inadequate or unavailable, or we suffer reputational harm as a result of an error or omission, it could have a material adverse impact on our results of operations.
Proprietary protections may not be adequate, and products may be found to infringe the rights of third parties.
We rely on a combination of trade secret, patent, copyright and trademark laws, nondisclosure and other contractual provisions and technical measures to protect our proprietary rights in our products and solutions. There can be no assurance that these protections will be adequate or that our competitors will not independently develop products or services that are equivalent or superior to ours. In addition, despite protective measures, we may be subject to unauthorized use of our technology due to copying, reverse-engineering or other infringement. Although we believe that our products and services do not infringe the proprietary rights of third parties, from time to time third parties have asserted infringement claims against us, and there can be no assurance that third parties will not assert infringement claims against us in the future. If we were found to be infringing others’ rights, we may be required to pay substantial damage awards and forced to develop non-infringing products or services, obtain a license or cease selling or using the products or services that contain the infringing elements. Additionally, we may find it necessary to initiate litigation to protect our trade secrets, to enforce our patent, copyright and trademark rights and to determine the scope and validity of the proprietary rights of others. These types of litigation can be costly and time consuming. These litigation expenses, damage payments or costs of developing replacement products or services could have a material adverse impact on our results of operations.
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McKESSON CORPORATION
System errors or failures of our products or services to conform to specifications could cause unforeseen liabilities or injury, harm our reputation and have a material adverse impact on our results of operations.
The software and technology services that we sell or operate are complex. As with complex systems offered by others, our software and technology services may contain errors, especially when first introduced. For example, our Technology Solutions segment systems are intended to provide information to healthcare professionals in the course of delivering patient care. Therefore, users of our software and technology services have a greater sensitivity to errors than the general market for software products. If clinicians’ use of our software and technology services leads to faulty clinical decisions or injury to patients, we could be subject to claims or litigation by our customers, clinicians or patients. In addition, such failures could damage our reputation and could negatively affect future sales.
Failure of a customer’s system to perform in accordance with our documentation could constitute a breach of warranty and could require us to incur additional expense in order to make the system comply with the documentation. If such failure is not remedied in a timely manner, it could constitute a material breach under a contract, allowing the client to cancel the contract, obtain refunds of amounts previously paid or assert claims for significant damages.
Various risks could interrupt customers’ access to their data residing in our service center, exposing us to significant costs.
We provide remote hosting services that involve operating both our software and the software of third-party vendors for our customers. The ability to access the systems and the data that we host and support on demand is critical to our customers. Our operations and facilities are vulnerable to interruption and/or damage from a number of sources, many of which are beyond our control, including, without limitation: (1) power loss and telecommunications failures; (2) fire, flood, hurricane and other natural disasters; (3) software and hardware errors, failures or crashes; and (4) cyberattacks, computer viruses, hacking and other similar disruptive problems. We attempt to mitigate these risks through various means including disaster recovery plans, separate test systems and change controls, information security procedures, and continued development and enhancement of our cyber security, but our precautions may not protect against all risks. If customers’ access is interrupted because of problems in the operation of our facilities, we could be exposed to significant claims, particularly if the access interruption is associated with problems in the timely delivery of medical care. If customers’ access is interrupted from failure or breach of our operational or information security systems, or those of our contractors or third party service providers, we could suffer reputational harm or be exposed to liabilities arising from the unauthorized and improper use or disclosure of confidential or proprietary information. We must maintain disaster recovery and business continuity plans that rely upon third-party providers of related services and if those vendors fail us at a time that our center is not operating correctly, we could incur a loss of revenue and liability for failure to fulfill our contractual service commitments. Any significant instances of system downtime could negatively affect our reputation and ability to sell our remote hosting services.
We may be required to record a significant charge to earnings if our goodwill, intangible assets, or investments become impaired.
We are required under U.S. generally accepted accounting principles (“GAAP”) to test our goodwill for impairment annually or more frequently if indicators for potential impairment exist. Indicators that are considered include significant changes in performance relative to expected operating results, significant changes in the use of the assets, significant negative industry, or economic trends or a significant decline in the Company’s stock price and/or market capitalization for a sustained period of time. In addition, we periodically review our intangible assets for impairment when events or changes in circumstances, such as a divestiture, indicate the carrying value may not be recoverable. Factors that may be considered a change in circumstances indicating that the carrying value of our intangible assets may not be recoverable include slower growth rates, the loss of a significant customer, or divestiture of a business or asset for less than its carrying value. We may be required to record a significant charge to earnings in our consolidated financial statements during the period in which any impairment of our goodwill or intangible assets is determined. This could have a material adverse impact on our results of operations. There are inherent uncertainties in management’s estimates, judgments and assumptions used in assessing recoverability of goodwill and intangible assets. Any changes in key assumptions, including failure to meet business plans, a further deterioration in the market or other unanticipated events and circumstances, may affect the accuracy or validity of such estimates and could potentially result in an impairment charge.
Our investment in Change Healthcare represents the fair value of our 70% equity interest in Change Healthcare upon closing. We may experience declines in its fair value. A decline in the fair value of our Change Healthcare investment may require that we review the carrying value for potential impairment, and such review could result in impairments and charges to our consolidated statements of operations.
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McKESSON CORPORATION
Tax legislation initiatives or challenges to our tax positions could have a material adverse impact on our results of operations.
We are a large multinational corporation with operations in the United States and international jurisdictions. As such, we are subject to the tax laws and regulations of the United States federal, state and local governments and of many international jurisdictions. From time to time, legislation may be enacted that could adversely affect our tax positions. There can be no assurance that our effective tax rate and the resulting cash flow will not be adversely affected by these changes in legislation. For example, if legislation is passed to repeal the LIFO (last-in, first-out) method of inventory accounting for income tax purposes, it would adversely impact our cash flow. Additionally, if legislation is passed to change the current U.S. taxation treatment of income from foreign operations, or if legislation is passed at the state level to establish or increase taxation on the basis of our gross revenues, it may adversely impact our tax expense. The tax laws and regulations of the various countries where we have major operations are extremely complex and subject to varying interpretations. For example, we operate in various countries that collect value added taxes (“VAT”). The determination of the manner in which a VAT applies to our foreign operations is subject to varying interpretations arising from the complex nature of the tax laws and regulations. Although we believe that our historical tax positions are sound and consistent with applicable laws, regulations and existing precedent, there can be no assurance that these tax positions will not be challenged by relevant tax authorities or that we would be successful in any such challenge. Even if we are successful in maintaining our positions, we may incur significant expense in defending challenges to our tax positions by tax authorities that could have a material impact on our financial position and results of operations.
In addition, as jurisdictions enact legislation to implement the recommendations of the recently concluded base erosion and profit shifting project undertaken by the Organization for Economic Cooperation and Development or as a result of the European Commission’s investigations into illegal state aid, changes to long-standing tax principles may result which could adversely impact our tax expense and cash flows.
Volatility and disruption to the global capital and credit markets may adversely affect our ability to access credit, our cost of credit and the financial soundness of our customers and suppliers.
Volatility and disruption in the global capital and credit markets, including the bankruptcy or restructuring of certain financial institutions, reduced lending activity by other financial institutions, or decreased liquidity and increased costs in the commercial paper market, may adversely affect the availability and cost of credit already arranged and the availability, terms and cost of credit in the future. Although we believe that our operating cash flow, financial assets, current access to capital and credit markets, including our existing credit facilities, will give us the ability to meet our financing needs for the foreseeable future, there can be no assurance that volatility and disruption in the global capital and credit markets will not impair our liquidity or increase our costs of borrowing.
Our business could also be negatively impacted if our customers or suppliers experience disruptions resulting from tighter capital and credit markets or a slowdown in the general economy. As a result, customers may modify, delay or cancel plans to purchase or implement our products or services and suppliers may increase their prices, reduce their output or change their terms of sale. Additionally, if customers’ or suppliers’ operating and financial performance deteriorates or if they are unable to make scheduled payments or obtain credit, customers may not be able to pay, or may delay payment of accounts receivable owed to us and suppliers may restrict credit, impose different payment terms or be unable to make payments due to us for fees, returned products or incentives. Any inability of customers to pay us for our products and services or any demands by suppliers for different payment terms, may have a material adverse impact on our results of operations and cash flow.
Changes in accounting standards issued by the Financial Accounting Standards Board (“FASB”) or other standard-setting bodies may adversely affect our financial statements.
Our financial statements are subject to the application of U.S. GAAP, which is periodically revised and/or expanded. From time to time, we are required to adopt new or revised accounting standards issued by recognized authoritative bodies, including the FASB and the SEC. It is possible that future accounting standards we are required to adopt, such as the amended guidance for revenue recognition and leases, may require changes to the current accounting treatment that we apply to our consolidated financial statements and may require us to make significant changes to our systems. Such changes could result in a material adverse impact on our financial position and results of operations.
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McKESSON CORPORATION
We could face significant liability if we withdraw from participation in one or more multiemployer pension plans in which we participate, or if one or more multiemployer plans in which we participate is reported to have underfunded liabilities.
We participate in various multiemployer pension plans. In the event that we withdraw from participation in one of these plans, then applicable law could require us to make additional cash contributions to the plans in installments. Our withdrawal liability for any multiemployer plan would depend on the extent of the plan’s funding of vested benefits. The multiemployer plans could have significant unfunded vested liabilities. Such underfunding may increase in the event other employers become insolvent or withdraw from the applicable plan or upon the inability or failure of withdrawing employers to pay their withdrawal liability. In addition, such underfunding may increase as a result of lower than expected returns on pension fund assets or other funding deficiencies. The occurrence of any of these events could have a material adverse impact on our consolidated financial position, results of operations or cash flows.
We may not realize the expected benefits from our restructuring and business process initiatives.
On March 14, 2016, the Company committed to a restructuring plan to lower its operating costs (“Cost Alignment Plan”). The Cost Alignment Plan primarily consists of a reduction in workforce and business process initiatives that will be substantially implemented prior to the end of 2019. Expense reduction initiatives could yield unintended consequences such as distraction of our management and employees, business disruption, attrition beyond any planned reduction in workforce, inability to attract or retain key personnel, and reduced employee productivity which could negatively affect our business, sales, financial condition and results of operations. Moreover, our restructuring and business process initiatives result in charges and expenses that impact our operating results. We cannot guarantee that the activities under any restructuring and business initiative will result in the desired efficiencies and estimated cost savings.
We may experience difficulties with outsourcing and similar third party relationships.
Our ability to conduct our business might be negatively impacted if we experience difficulties with outsourcing and managing similar third-party relationships. We outsource certain business and administrative functions and rely on third parties to perform certain services on our behalf. If we fail to develop, implement and monitor our outsourcing strategies, such strategies prove to be ineffective or fail to provide expected cost savings, or our third party providers fail to perform as anticipated, we may experience operational difficulties and increased costs may adversely affect the results of our operations.
Moreover, we utilize contractors and employees located outside of the United States to assist us in performing services or providing support for our customers. Certain of these resources may have access to personal information, including protected health information. Some of our customers have contractually limited or may seek to limit our ability to use our offshore resources which may increase our costs due to concerns regarding potential misuse of this information. Further, Congress and a number of states have considered legislation that would restrict the transmission of personal information of United States residents offshore. Some proposals impose liability on healthcare businesses resulting from misuse or prohibited transmission of personal information to individuals or entities outside the United States and may require the prior consent of the identifiable patient. Congress also has considered establishing a private civil cause of action enabling an individual to recover damages sustained as a result of a violation of these proposed restrictions. If our ability to utilize offshore resources is limited by our customers or legislative action, the work currently being performed offshore may be done at a lower margin or at a loss and we may be subject to sanctions if we are unable to comply with new legislative requirements. Use of offshore resources may increase our risk of violating data security and privacy obligations to our customers, which could adversely affect our results of operations.
We may face risks associated with our retail expansion.
In recent years, we have expanded our retail operations through a number of acquisitions. As we expand our retail footprint, we may face risks that are different from those we currently encounter. Our expansion into additional retail markets, such as those in Europe and Canada, could result in increased competitive, merchandising and distribution challenges. We may encounter difficulties in attracting customers to our retail locations due to a lack of customer familiarity with our brands and our lack of familiarity with local customer preferences and seasonal differences in the market. Our ability to expand successfully will depend on acceptance of our retail store experience by customers, including our ability to design our stores in a manner that resonates locally and to offer the correct product assortment to appeal to consumers. Furthermore, our continued growth in the retail sector may strain relations with certain of our distribution customers who also compete in the retail pharmacy sector. There can be no assurance that our retail locations will be received as well as, or achieve net sales or profitability levels consistent with, our projected targets or be comparable to those of our existing stores in the time periods estimated by us, or at all. If our retail expansion fails to achieve, or unable to sustain, acceptable net sales and profitability levels, our business, results of operations and growth prospects may be materially adversely affected.
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Our retail stores may require additional management time and attention. Failure to properly supervise the operation and maintain the consistency of the customer experience in those retail stores could result in loss of customers and potentially adversely affect our results of operations.
We may be unable to keep existing retail store locations or open new retail locations in desirable places, which could materially adversely affect our results of operations.
We may be unable to keep existing retail locations or open new retail locations in desirable places in the future. We compete with other retailers and businesses for suitable retail locations. Local land use, local zoning issues, environmental regulations and other regulations may affect our ability to find suitable retail locations and also influence the cost of leasing or buying them. We also may have difficulty negotiating real estate leases for new stores, renewing real estate leases for existing stores or negotiating purchase agreements for new sites on acceptable terms. In addition, construction, environmental, zoning and real estate delays may negatively affect retail location openings and increase costs and capital expenditures. If we are unable to keep up our existing retail store locations or open new retail store locations in desirable places and on favorable terms, our results of operations could be materially adversely affected.
Item 1B. | Unresolved Staff Comments. |
None.
Item 2. | Properties. |
Because of the nature of our principal businesses, our plant, warehousing, retail pharmacies, office and other facilities are operated in widely dispersed locations, primarily throughout North America and Europe. The warehouses and retail pharmacies are typically owned or leased on a long-term basis. We consider our operating properties to be in satisfactory condition and adequate to meet our needs for the next several years without making capital expenditures materially higher than historical levels. Information as to material lease commitments is included in Financial Note 23, “Lease Obligations,” to the consolidated financial statements appearing in this Annual Report on Form 10-K.
Item 3. | Legal Proceedings. |
Certain legal proceedings in which we are involved are discussed in Financial Note 25, “Commitments and Contingent Liabilities,” to the consolidated financial statements appearing in this Annual Report on Form 10-K.
Item 4. | Mine Safety Disclosures. |
Not applicable.
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McKESSON CORPORATION
Executive Officers of the Registrant
The following table sets forth information regarding the executive officers of the Company, including their principal occupations during the past five years. The number of years of service with the Company includes service with predecessor companies.
There are no family relationships between any of the executive officers or directors of the Company. The executive officers are elected on an annual basis generally and their term expires at the first meeting of the Board of Directors (“Board”) following the annual meeting of stockholders, or until their successors are elected and have qualified, or until death, resignation or removal, whichever is sooner.
Name | Age | Position with Registrant and Business Experience | ||
John H. Hammergren | 58 | Chairman of the Board since July 2002; President and Chief Executive Officer since April 2001; and a director since July 1999. Service with the Company — 21 years. | ||
James A. Beer | 56 | Executive Vice President and Chief Financial Officer since October 2013; Executive Vice President and Chief Financial Officer, Symantec Corporation from 2006 to October 2013; Senior Vice President and Chief Financial Officer, AMR Corporation and its principal subsidiary, American Airlines, Inc., from 2004 to 2006. Service with the Company — 3 years. | ||
Jorge L. Figueredo | 56 | Executive Vice President, Human Resources since May 2008. Service with the Company — 9 years. | ||
Paul C. Julian | 61 | Executive Vice President and Group President since April 2004. Service with the Company — 21 years. | ||
Kathleen D. McElligott | 61 | Executive Vice President, Chief Information Officer and Chief Technology Officer since July 2015; Chief Information Officer and Vice President, Information Technology, Emerson Electric from 2010 to July 2015. Service with the Company — 1 year, 9 months. | ||
Bansi Nagji | 52 | Executive Vice President, Corporate Strategy and Business Development since February 2015; Principal, Deloitte Consulting, LLP and Global Leader, Monitor Deloitte (which was formed by the global merger of Monitor Group with Deloitte) from January 2013 to February 2015; President, Monitor Group from July 2012 to January 2013; Partner, Monitor Group from 2001 to January 2013. Service with the Company — 2 years. | ||
Lori A. Schechter | 55 | Executive Vice President, General Counsel and Chief Compliance Officer since June 2014; Associate General Counsel from January 2012 to June 2014; Litigation Partner, Morrison & Foerster LLP from January 1995 to December 2011. Service with the Company — 5 years. | ||
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McKESSON CORPORATION
PART II
Item 5. | Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. |
(a) | Market Information: The principal market on which the Company’s common stock is traded is the New York Stock Exchange (“NYSE”). |
The following table sets forth the high and low sales prices for our common stock as reported on NYSE for each quarterly period of the two most recently completed fiscal years:
2017 | 2016 | ||||||||||||
High | Low | High | Low | ||||||||||
First quarter | $ | 188.43 | $ | 154.33 | $ | 243.61 | $ | 219.51 | |||||
Second quarter | $ | 199.43 | $ | 163.57 | $ | 236.86 | $ | 160.10 | |||||
Third quarter | $ | 166.78 | $ | 114.53 | $ | 202.20 | $ | 169.00 | |||||
Fourth quarter | $ | 153.07 | $ | 134.17 | $ | 196.84 | $ | 148.29 | |||||
(b) | Holders: The number of record holders of the Company’s common stock at March 31, 2017 was approximately 5,974. |
(c) | Dividends: In July 2015, the Company’s quarterly dividend was raised from $0.24 to $0.28 per common share for dividends declared after such date, until further action by the Company’s Board of Directors (the “Board”). The Company declared regular cash dividends of $1.12 and $1.08 per share in the years ended March 31, 2017 and 2016. |
The Company anticipates that it will continue to pay quarterly cash dividends in the future. However, the payment and amount of future dividends remain within the discretion of the Board and will depend upon the Company’s future earnings, financial condition, capital requirements and other factors.
(d) | Securities Authorized for Issuance under Equity Compensation Plans: Information relating to this item is provided under Part III, Item 12, to this Annual Report on Form 10-K. |
(e) | Share Repurchase Plans: Stock repurchases may be made from time to time in open market transactions, privately negotiated transactions, through accelerated share repurchase (“ASR”) programs, or by any combination of such methods. The timing of any repurchases and the actual number of shares repurchased will depend on a variety of factors, including our stock price, corporate and regulatory requirements, restrictions under our debt obligations and other market and economic conditions. |
During the last three years, our share repurchases were transacted through both open market transactions and ASR programs with third-party financial institutions.
In May and October 2015, the Board authorized the repurchase of up to $500 million and $2 billion of the Company’s common stock.
In 2016, we repurchased 4.5 million of the Company’s shares for $854 million through open market transactions at an average price per share of $192.27. In February 2016, we entered into an ASR program with a third-party financial institution to repurchase $650 million of the Company’s common stock. This ASR program was completed during the 2016 fourth quarter and we repurchased 4.2 million shares at an average price per share of $154.04. During 2016, we completed the May 2015 share repurchase authorization. At March 31, 2016, $1.0 billion remained available for future authorized repurchases of the Company’s common stock under the October 2015 authorization.
In October 2016, the Board authorized the repurchase of up to $4.0 billion of the Company’s common stock.
In 2017, we repurchased 14.1 million of the Company’s shares for $2 billion through open market transactions at an average price per share of $140.96. In March 2017, we entered into an ASR program with a third-party financial institution to repurchase $250 million of the Company’s common stock. As of March 31, 2017, we had received 1.4 million shares under this program. This ASR program was completed in April 2017 and we received 0.3 million additional shares. The total number of shares repurchased under this ASR program was 1.7 million shares at an average price per share of $143.19. During 2017, we completed the October 2015 share repurchase authorization. The total authorization outstanding for repurchases of the Company’s common stock was $2.7 billion at March 31, 2017.
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In 2016, we retired 115.5 million or $7.8 billion of the Company’s treasury shares previously repurchased. Under the applicable state law, these shares resume the status of authorized and unissued shares upon retirement. In accordance with our accounting policy, we allocate any excess of share repurchase price over par value between additional paid-in capital and retained earnings. Accordingly, our retained earnings and additional paid-in capital were reduced by $6.4 billion and $1.5 billion during 2016.
The following table provides information on the Company’s share repurchases during the fourth quarter of 2017:
Share Repurchases (1) | |||||||||||||
(In millions, except price per share) | Total Number of Shares Purchased | Average Price Paid per Share | Total Number of Shares Purchased as Part of Publicly Announced Programs | Approximate Dollar Value of Shares that May Yet Be Purchased Under the Programs | |||||||||
January 1, 2017 - January 31, 2017 | — | $ | — | — | $ | — | |||||||
February 1, 2017 - February 29, 2017 | — | — | — | — | |||||||||
March 1, 2017 - March 31, 2017 | 1.4 | 143.19 | 1.4 | 2,746 | |||||||||
Total | 1.4 | 1.4 | $ | 2,746 | |||||||||
(1) | This table does not include shares tendered to satisfy the exercise price in connection with cashless exercises of employee stock options or shares tendered to satisfy tax-withholding obligations in connection with employee equity awards. |
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(f) | Stock Price Performance Graph*: The following graph compares the cumulative total stockholder return on the Company’s common stock for the periods indicated with the Standard & Poor’s 500 Index and the S&P 500 Health Care Index. The S&P 500 Health Care Index was selected as a comparator because it is generally available to investors and broadly used by other companies in the same industry. |
March 31, | |||||||||||||||||||||||
2012 | 2013 | 2014 | 2015 | 2016 | 2017 | ||||||||||||||||||
McKesson Corporation | $ | 100.00 | $ | 124.07 | $ | 204.26 | $ | 262.91 | $ | 183.82 | $ | 174.50 | |||||||||||
S&P 500 Index | $ | 100.00 | $ | 113.96 | $ | 138.87 | $ | 156.55 | $ | 159.34 | $ | 186.71 | |||||||||||
S&P 500 Health Care Index | $ | 100.00 | $ | 125.19 | $ | 161.79 | $ | 204.17 | $ | 193.59 | $ | 216.03 | |||||||||||
* Assumes $100 invested in McKesson Common Stock and in each index on March 31, 2012 and that all dividends are reinvested.
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McKESSON CORPORATION
Item 6. | Selected Financial Data. |
FIVE-YEAR HIGHLIGHTS
As of and for the Years Ended March 31, | ||||||||||||||||||||
(In millions, except per share data and ratios) | 2017 | 2016 | 2015 | 2014 | 2013 | |||||||||||||||
Operating Results | ||||||||||||||||||||
Revenues | $ | 198,533 | $ | 190,884 | $ | 179,045 | $ | 137,392 | $ | 122,196 | ||||||||||
Percent change | 4.0 | % | 6.6 | % | 30.3 | % | 12.4 | % | (0.2 | )% | ||||||||||
Gross profit | $ | 11,271 | $ | 11,416 | $ | 11,411 | $ | 8,352 | $ | 6,881 | ||||||||||
Income from continuing operations before income taxes (2) | 6,891 | 3,250 | 2,657 | 2,171 | 1,950 | |||||||||||||||
Income (loss) after income taxes | ||||||||||||||||||||
Continuing operations (2) | 5,277 | 2,342 | 1,842 | 1,414 | 1,363 | |||||||||||||||
Discontinued operations | (124 | ) | (32 | ) | (299 | ) | (156 | ) | (25 | ) | ||||||||||
Net income | 5,153 | 2,310 | 1,543 | 1,258 | 1,338 | |||||||||||||||
Net (income) loss attributable to noncontrolling interests (1) | (83 | ) | (52 | ) | (67 | ) | 5 | — | ||||||||||||
Net income attributable to McKesson Corporation (2) | 5,070 | 2,258 | 1,476 | 1,263 | 1,338 | |||||||||||||||
Financial Position | ||||||||||||||||||||
Working capital | $ | 1,336 | $ | 3,366 | $ | 3,173 | $ | 3,221 | $ | 1,813 | ||||||||||
Days sales outstanding for: (3) | ||||||||||||||||||||
Customer receivables | 27 | 28 | 26 | 29 | 26 | |||||||||||||||
Inventories | 30 | 32 | 31 | 33 | 33 | |||||||||||||||
Drafts and accounts payable | 61 | 59 | 54 | 54 | 51 | |||||||||||||||
Total assets | $ | 60,969 | $ | 56,523 | $ | 53,870 | $ | 51,759 | $ | 34,786 | ||||||||||
Total debt, including capital lease obligations | 8,545 | 8,114 | 9,844 | 10,594 | 4,873 | |||||||||||||||
Total McKesson stockholders’ equity (4) | 11,095 | 8,924 | 8,001 | 8,522 | 7,070 | |||||||||||||||
Payments for property, plant and equipment | 404 | 488 | 376 | 278 | 241 | |||||||||||||||
Acquisitions, net of cash and cash equivalents acquired | 4,237 | 40 | 170 | 4,634 | 1,873 | |||||||||||||||
Common Share Information | ||||||||||||||||||||
Common shares outstanding at year-end | 211 | 225 | 232 | 231 | 227 | |||||||||||||||
Shares on which earnings per common share were based | ||||||||||||||||||||
Diluted | 223 | 233 | 235 | 233 | 239 | |||||||||||||||
Basic | 221 | 230 | 232 | 229 | 235 | |||||||||||||||
Diluted earnings (loss) per common share attributable to McKesson Corporation (5) | ||||||||||||||||||||
Continuing operations | $ | 23.28 | $ | 9.84 | $ | 7.54 | $ | 6.08 | $ | 5.69 | ||||||||||
Discontinued operations | (0.55 | ) | (0.14 | ) | (1.27 | ) | (0.67 | ) | (0.10 | ) | ||||||||||
Total | 22.73 | 9.70 | 6.27 | 5.41 | 5.59 | |||||||||||||||
Cash dividends declared | 249 | 249 | 226 | 214 | 192 | |||||||||||||||
Cash dividends declared per common share | 1.12 | 1.08 | 0.96 | 0.92 | 0.80 | |||||||||||||||
Book value per common share (5) (6) | 52.58 | 39.66 | 34.49 | 36.89 | 31.15 | |||||||||||||||
Market value per common share - year-end | 148.26 | 157.25 | 226.20 | 176.57 | 107.96 | |||||||||||||||
Supplemental Data | ||||||||||||||||||||
Debt to capital ratio (7) | 39.2 | % | 43.6 | % | 50.3 | % | 55.4 | % | 40.6 | % | ||||||||||
Average McKesson stockholders’ equity (8) | $ | 9,282 | $ | 8,688 | $ | 8,703 | $ | 7,803 | $ | 7,294 | ||||||||||
Return on McKesson stockholders’ equity (9) | 54.6 | % | 26.0 | % | 17.0 | % | 16.2 | % | 18.3 | % | ||||||||||
Footnotes to Five-Year Highlights:
(1) | 2016 and 2015 primarily reflect guaranteed dividends and annual recurring compensation that McKesson became obligated to pay to the noncontrolling shareholders of Celesio AG upon the effectiveness of the Domination Agreement in December 2014. 2017 also includes net income attributable to third-party equity interests in our consolidated entities including Vantage and ClarusOne Sourcing Services LLC, which was established between McKesson and Wal-Mart Stores, Inc. |
(2) | 2017 includes a pre-tax gain of $3,947 million ($3,018 million after-tax) from the deconsolidation of our Core MTS Business in connection with Healthcare Technology Net Asset Exchange. |
(3) | Based on year-end balances and sales or cost of sales for the last 90 days of the year. |
(4) | Excludes noncontrolling and redeemable noncontrolling interests. |
(5) | Certain computations may reflect rounding adjustments. |
(6) | Represents McKesson stockholders’ equity divided by year-end common shares outstanding. |
(7) | Ratio is computed as total debt divided by the sum of total debt and McKesson stockholders’ equity excluding accumulated other comprehensive income (loss). |
(8) | Represents a five-quarter average of McKesson stockholders’ equity. |
(9) | Ratio is computed as net income attributable to McKesson Corporation for the last four quarters, divided by a five-quarter average of McKesson stockholders’ equity. |
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Item 7. | Management’s Discussion and Analysis of Financial Condition and Results of Operations. |
GENERAL
Management’s discussion and analysis of financial condition and results of operations, referred to as the Financial Review, is intended to assist the reader in the understanding and assessment of significant changes and trends related to the results of operations and financial position of the Company together with its subsidiaries. This discussion and analysis should be read in conjunction with the consolidated financial statements and accompanying financial notes in Item 8 of Part II of this Annual Report on Form 10-K. The Company’s fiscal year begins on April 1 and ends on March 31. Unless otherwise noted, all references to a particular year shall mean the Company’s fiscal year.
Certain statements in this report constitute forward-looking statements. See Item 1 - Business - Forward-Looking Statements in Part I of this Annual Report on Form 10-K for additional factors relating to these statements; also see Item 1A - Risk Factors in Part I of this Annual Report on Form 10-K for a list of certain risk factors applicable to our business, financial condition and results of operations.
We conduct our business through two operating segments: McKesson Distribution Solutions and McKesson Technology Solutions. Refer to Financial Note 29, “Segments of Business,” to the consolidated financial statements appearing in this Annual Report on Form 10-K for a description of these segments.
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RESULTS OF OPERATIONS
Overview:
(Dollars in millions, except per share data) | Years Ended March 31, | Change | |||||||||||||||||
2017 | 2016 | 2015 | 2017 | 2016 | |||||||||||||||
Revenues | $ | 198,533 | $ | 190,884 | $ | 179,045 | 4 | % | 7 | % | |||||||||
Gross Profit | $ | 11,271 | $ | 11,416 | $ | 11,411 | (1 | ) | % | — | % | ||||||||
Operating Expenses | |||||||||||||||||||
Operating Expenses Excluding Gain on Healthcare Technology Net Asset Exchange, net | $ | (8,109 | ) | $ | (7,871 | ) | $ | (8,443 | ) | 3 | % | (7 | ) | % | |||||
Gain on Healthcare Technology Net Asset Exchange, net | 3,947 | — | — | — | — | ||||||||||||||
Total Operating Expenses | $ | (4,162 | ) | $ | (7,871 | ) | $ | (8,443 | ) | (47 | ) | % | (7 | ) | % | ||||
Income from Continuing Operations Before Income Taxes | $ | 6,891 | $ | 3,250 | $ | 2,657 | 112 | % | 22 | % | |||||||||
Income Tax Expense | (1,614 | ) | (908 | ) | (815 | ) | 78 | 11 | |||||||||||
Income from Continuing Operations | 5,277 | 2,342 | 1,842 | 125 | 27 | ||||||||||||||
Loss from Discontinued Operations, Net of Tax | (124 | ) | (32 | ) | (299 | ) | 288 | (89 | ) | ||||||||||
Net Income | 5,153 | 2,310 | 1,543 | 123 | 50 | ||||||||||||||
Net Income Attributable to Noncontrolling Interests | (83 | ) | (52 | ) | (67 | ) | 60 | (22 | ) | ||||||||||
Net Income Attributable to McKesson Corporation | $ | 5,070 | $ | 2,258 | $ | 1,476 | 125 | % | 53 | % | |||||||||
Diluted Earnings (Loss) Per Common Share Attributable to McKesson Corporation | |||||||||||||||||||
Continuing Operations | $ | 23.28 | $ | 9.84 | $ | 7.54 | 137 | % | 31 | % | |||||||||
Discontinued Operations | (0.55 | ) | (0.14 | ) | (1.27 | ) | 293 | (89 | ) | ||||||||||
Total | $ | 22.73 | $ | 9.70 | $ | 6.27 | 134 | % | 55 | % | |||||||||
Weighted Average Diluted Common Shares | 223 | 233 | 235 | (4 | ) | % | (1 | ) | % | ||||||||||
Revenues for 2017 and 2016 increased 4% and 7% compared to the same periods a year ago primarily due to market growth and expanded business with existing customers within our North America pharmaceutical distribution businesses. Revenues for 2017 also increased due to our 2017 acquisitions including UDG Healthcare Plc (“UDG”), Biologics, Inc. (“Biologics”), Vantage Oncology Holdings, LLC (“Vantage”) and Rexall Health. Market growth includes growing drug utilization, price increases and newly launched products, partially offset by price deflation associated with brand to generic drug conversion.
Gross profit decreased 1% in 2017 and was flat in 2016 compared to the same periods a year ago. Excluding unfavorable foreign currency effects of 1% and 4%, gross profit remained flat in 2017 and increased 4% in 2016. Gross profit margin decreased in 2017 primarily due to weaker pharmaceutical manufacturer pricing trends, the competitive sell-side pricing environment, our mix of business and lower compensation from a branded pharmaceutical manufacturer from our U.S. Pharmaceutical distribution business. These decreases were partially offset by our acquisitions, LIFO inventory credits, higher cash receipts from antitrust legal settlements and benefits from our global procurement arrangements. Gross profit margin decreased in 2016 primarily due to a lower sell margin within our North America distribution business driven by increased customer sales volume with some of our largest customers, partially offset by higher buy margin including benefits from our global procurement arrangements, lower LIFO-related inventory charges and higher cash receipts from antitrust legal settlements. Gross profit included LIFO-related inventory credits of $7 million in 2017 and charges of $244 million and $337 million in 2016 and 2015. LIFO credits were recognized in 2017 primarily due to the impact of lower price increases. Gross profit for 2017 and 2016 also included $144 million and $76 million of cash receipts representing our share of antitrust legal settlements. During 2017 and 2016, our Distribution Solutions segment experienced weaker pharmaceutical manufacturer pricing trends, which are expected to continue in 2018.
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Operating expenses decreased 47% and 7% in 2017 and 2016 compared to the same periods a year ago. Excluding favorable foreign currency effects of 2% and 5%, operating expenses decreased 45% and 2% in 2017 and 2016. Operating expenses decreased in 2017 primarily due to a pre-tax gain of $3,947 million (after-tax gain of $3,018 million) recognized from the deconsolidation of the majority of our Technology Solutions businesses (“Core MTS Business”), as further described below.
On June 28, 2016, we entered into a Contribution Agreement with Change, and others including shareholders of Change to form a joint venture, Change Healthcare. On March 1, 2017, the transaction closed upon satisfaction of all closing conditions pursuant to the Contribution Agreement. Under the terms of the Contribution Agreement, we contributed the majority of our Core MTS Business to the joint venture. We retained our RelayHealth Pharmacy and EIS businesses. We accounted for this transaction as a sale of the Core MTS Business and a subsequent purchase of a 70% interest in the newly formed joint venture. Accordingly, in the fourth quarter of 2017, we deconsolidated the Core MTS Business and recorded a pre-tax gain of $3,947 million (after-tax gain of $3,018 million). The pre-tax gain was calculated based on the difference between the fair value of our 70% equity interest in the joint venture, less the carrying amount of the contributed Core MTS Business’ net assets of $1,132 million and $1,258 million of promissory notes, a $136 million liability associated with a tax receivable agreement and transaction and other related expenses. The $1,258 million of promissory notes were subsequently repaid in cash from proceeds of Change Healthcare’s long term debt issuance. The gain is subject to final net working capital and other adjustments within 90 days from the transaction close date and is recorded in operating expenses within our Technology Solutions segment.
Our investment in Change Healthcare is accounted for using the equity method of accounting on a one-month reporting lag. We disclose intervening events at the joint venture in the lag period that could materially affect our consolidated financial statements, if applicable. In March 2017, our proportionate share of transaction expenses incurred by the joint venture is estimated to be approximately $80 million to $120 million. However, due to the timing of the transaction and the one-month reporting lag, no net income or loss from our investment was recorded in our financial results for 2017. Commencing April 1, 2017, our proportionate share of the net income or loss from the joint venture including these transaction expenses will be recorded in “Other Income, Net” in our consolidated statement of operations.
Refer to Financial Note 2, “Healthcare Technology Net Asset Exchange,” to the consolidated financial statements appearing in this Annual Report on Form 10-K for additional information.
Excluding the gain on Healthcare Technology Net Asset Exchange, 2017 operating expenses increased primarily due to a non-cash pre-tax charge of $290 million ($282 million after-tax) for goodwill impairment related to our EIS business within our Technology Solutions segment and higher expenses due to our 2017 acquisitions. In connection with the Healthcare Technology Net Asset Exchange, we are evaluating strategic options for our EIS business. 2017 operating expenses benefited from lower restructuring charges and cost savings associated with a cost alignment plan implemented in the fourth quarter of 2016 and ongoing expense management efforts. 2016 operating expenses decreased primarily due to pre-tax gains of $103 million from the sale of two businesses and lower acquisition-related expenses, partially offset by pre-tax restructuring charges of $203 million relating to the 2016 cost alignment plan. Additionally, 2015 operating expenses included a pre-tax and after-tax $150 million charge associated with the settlement of controlled substance distribution claims with the Drug Enforcement Administration (“DEA”), Department of Justice (“DOJ”) and various U.S. Attorney’s offices.
Income from continuing operations before income taxes increased in 2017 and 2016 compared with the prior years primarily due to lower operating expenses.
Our reported income tax rates were 23.4%, 27.9% and 30.7% in 2017, 2016 and 2015. Income tax expense for 2017 included discrete income tax benefits of $54 million related to the early adoption of the amended accounting guidance on share-based compensation. In 2017, we sold various software and ancillary intellectual property relating to our Technology Solutions business between wholly owned legal entities within the McKesson group that are based in different tax jurisdictions and recognized a net tax benefit of $137 million prior to the contribution of these assets to Change Healthcare.
Loss from discontinued operations, net of tax, for 2017 includes an after-tax loss from discontinued operations of $113 million resulting from the 2017 first quarter sale of our Brazilian pharmaceutical distribution business and for 2015, included pre-tax non-cash impairment charges of $241 million ($235 million after-tax) associated with the same Brazilian business.
Net income attributable to McKesson Corporation was $5,070 million, $2,258 million and $1,476 million in 2017, 2016 and 2015 and diluted earnings per common share attributable to McKesson Corporation from continuing operations were $23.28, $9.84
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and $7.54. Diluted loss per common share attributable to McKesson Corporation from discontinued operations were $0.55, $0.14 and $1.27 in 2017, 2016 and 2015.
On April 3, 2017, we completed our acquisition of CoverMyMeds LLC (“CMM”) for $1.3 billion and up to an additional $0.2 billion of contingent consideration payable based on CMM’s financial performance through the end of 2019. CMM provides electronic prior authorization solutions and is headquartered in Columbus, Ohio. Refer to Financial Note 4, “Business Combinations” to the consolidated financial statements appearing in this Annual Report on Form 10-K.
Revenues:
Years Ended March 31, | Change | ||||||||||||||||||
(Dollars in millions) | 2017 | 2016 | 2015 | 2017 | 2016 | ||||||||||||||
Distribution Solutions | |||||||||||||||||||
North America pharmaceutical distribution & services | $ | 164,832 | $ | 158,469 | $ | 143,711 | 4 | % | 10 | % | |||||||||
International pharmaceutical distribution & services | 24,847 | 23,497 | 26,358 | 6 | (11 | ) | |||||||||||||
Medical-Surgical distribution & services | 6,244 | 6,033 | 5,907 | 3 | 2 | ||||||||||||||
Total Distribution Solutions | 195,923 | 187,999 | 175,976 | 4 | 7 | ||||||||||||||
Technology Solutions - products and services | 2,610 | 2,885 | 3,069 | (10 | ) | (6 | ) | ||||||||||||
Total Revenues | $ | 198,533 | $ | 190,884 | $ | 179,045 | 4 | % | 7 | % | |||||||||
Revenues increased 4% and 7% in 2017 and 2016 compared to the same periods a year ago primarily driven by our Distribution Solutions segment, which accounted for approximately 99% of our consolidated revenues.
Distribution Solutions
North America pharmaceutical distribution and services revenues increased over the last two years primarily due to market growth, higher revenues associated with our 2017 acquisitions including Biologics, Vantage and Rexall Health, and expanded business with existing customers. These increases were partially offset by customer losses. Market growth includes growing drug utilization, price increases and newly launched products, partially offset by price deflation associated with brand to generic drug conversion.
International pharmaceutical distribution and services revenues increased 6% in 2017 and decreased 11% in 2016. Excluding unfavorable foreign currency effects of 5% and 12%, revenues increased 11% and 1% in 2017 and 2016. Revenues increased in 2017 primarily due to market growth and our acquisition of UDG. Revenue growth for 2016 primarily reflected increased revenues in the United Kingdom due to a new distribution agreement with a manufacturer, which was almost fully offset by lower revenues in Norway associated with the loss of a hospital contract.
Medical-Surgical distribution and services revenues increased over the last two years primarily due to market growth. Revenues for 2017 also benefited from an acquisition and for 2016 were unfavorably affected by the sale of our ZEE Medical business in the second quarter of 2016.
Technology Solutions
Technology Solutions revenues for 2017 decreased primarily due to one less month of revenues from the Core MTS Business, which was contributed to Change Healthcare on March 1, 2017. Revenues decreased over the last two years primarily due to a decline in hospital software revenues, partially offset by higher revenues in our other businesses. Additionally, 2016 revenues decreased as a result of the sale of our nurse triage business and the transition of our workforce business within our International Technology business to a third party during the first quarter of 2016.
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Gross Profit:
Years Ended March 31, | Change | |||||||||||||||||||||
(Dollars in millions) | 2017 | 2016 | 2015 | 2017 | 2016 | |||||||||||||||||
Gross Profit | ||||||||||||||||||||||
Distribution Solutions (1) (2) | $ | 9,856 | $ | 9,948 | $ | 9,937 | (1 | ) | % | — | % | |||||||||||
Technology Solutions (2) | 1,415 | 1,468 | 1,474 | (4 | ) | — | ||||||||||||||||
Total | $ | 11,271 | $ | 11,416 | $ | 11,411 | (1 | ) | % | — | % | |||||||||||
Gross Profit Margin | ||||||||||||||||||||||
Distribution Solutions | 5.03 | % | 5.29 | % | 5.65 | % | (26 | ) | bp | (36 | ) | bp | ||||||||||
Technology Solutions | 54.21 | 50.88 | 48.03 | 333 | 285 | |||||||||||||||||
Total | 5.68 | 5.98 | 6.37 | (30 | ) | (39 | ) | |||||||||||||||
bp - basis points
(1) | Distribution Solutions segment’s gross profit includes LIFO credits of $7 million in 2017 and LIFO charges of $244 million and $337 million in 2016 and 2015. Gross profit for 2017, 2016 and 2015 also includes $144 million, $76 million and $3 million of net cash proceeds representing our share of antitrust legal settlements. |
(2) | Gross profit for 2017 includes pre-tax credits of $4 million from the 2016 cost alignment plan within our Technology Solutions segment, and for 2016 includes pre-tax restructuring charges of $5 million and $21 million related to the 2016 cost alignment plan within our Distribution Solutions segment and Technology Solutions segment. |
Gross profit decreased 1% in 2017 and remained flat in 2016 compared to the same periods a year ago. Excluding unfavorable foreign currency effects of 1% and 4%, gross profit remained flat in 2017 and increased 4% in 2016. Gross profit margin decreased in 2017 and 2016. These changes were primarily due to our Distribution Solutions segment.
Distribution Solutions
Distribution Solutions segment’s gross profit decreased 1% in 2017 and remained flat in 2016. Excluding unfavorable foreign currency effects of 2% and 4%, gross profit increased 1% and 4% in 2017 and 2016.
Gross profit margin for 2017 decreased primarily due to weaker pharmaceutical manufacturer pricing trends, the competitive sell-side pricing environment and lower compensation from a branded pharmaceutical manufacturer from our U.S. Pharmaceutical distribution business, partially offset by LIFO inventory credits, higher cash receipts representing our share of antitrust legal settlements, higher global procurement benefits and our 2017 acquisitions. Gross profit for 2017 also reflects the impact of previously announced customer consolidation activity. Gross profit margin for 2016 decreased primarily due to a lower sell margin within our North America distribution business driven by increased customer sales volume with some of our largest customers, partially offset by lower LIFO inventory charges. Gross profit margin over the last two years was favorably affected by benefits from our global procurement arrangements and higher cash receipts representing our share of antitrust legal settlements. Buy margin primarily reflects volume and timing of compensation we receive from pharmaceutical manufacturers, including the effects of price increases of both branded and generic drugs. During 2017 and 2016, our Distribution Solutions segment experienced weaker pharmaceutical manufacturer pricing trends, which are expected to continue in 2018.
Our LIFO inventory credits were $7 million in 2017 and LIFO charges were $244 million and $337 million in 2016 and 2015. Our North America distribution business uses the LIFO method of accounting for the majority of its inventories, which results in cost of sales that more closely reflects replacement cost than under other accounting methods. The business’ practice is to pass on to customers published price changes from suppliers. Manufacturers generally provide us with price protection, which limits price-related inventory losses. A LIFO charge is recognized when the net effect of price increases on pharmaceutical and non-pharmaceutical products held in inventory exceeds the net impact of price declines, including the effect of branded pharmaceutical products that have lost market exclusivity. A LIFO credit is recognized when the net effect of price declines exceeds the net impact of price increases on pharmaceutical and non-pharmaceutical products held in inventory. Our annual LIFO charge is affected by changes in year-end inventory quantities, product mix and manufacturer pricing practices, which may be influenced by market and other external factors. Changes to any of the above factors could have a material impact to our annual LIFO credits or expense. LIFO credits were recognized in 2017 and LIFO charge decreased in 2016 compared to 2015 primarily due to the impact of lower price increases. As of March 31, 2017 and 2016, pharmaceutical inventories at LIFO did not exceed market.
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Technology Solutions
Technology Solutions segment’s gross profit decreased in 2017 and remained flat in 2016. Gross profit for 2017 decreased due to one less month of gross profit from the Core MTS Business, which was contributed to the joint venture on March 1, 2017. This segment’s gross profit margin increased over the last two years.
Gross profit margin for 2017 increased primarily due to a decline in hospital software revenues, lower severance charges, ongoing cost management efforts and the prior year sales of businesses, partially offset by a lower margin from our hospital software business. Gross profit margin for 2017 also benefited from lower depreciation and amortization expenses related to the Core MTS Business’ assets, which were classified as held for sale since the second quarter of 2017. Depreciation and amortization related to the long-lived assets ceased as of the date they were determined as held for sale.
Gross profit margin for 2016 benefited from the sale of our nurse triage business, transitioning of our workforce business within our International Technology business to a third party, and higher pull-through of deferred revenue. These increases were partially offset by $49 million of pre-tax severance charges including charges associated with the 2016 cost alignment plan. Additionally, in 2015 we recorded a $34 million pre-tax non-cash charge representing a catch-up in depreciation and amortization expenses associated with our workforce business within our International Technology business. This business, which was previously designated as a discontinued operation, was reclassified to a continuing operation in 2015 when we decided to retain the business.
Operating Expenses:
Years Ended March 31, | Change | |||||||||||||||||||
(Dollars in millions) | 2017 | 2016 | 2015 | 2017 | 2016 | |||||||||||||||
Operating Expenses | ||||||||||||||||||||
Distribution Solutions (1) (3) | $ | 6,559 | $ | 6,436 | $ | 6,938 | 2 | % | (7 | ) | % | |||||||||
Technology Solutions (1)(2)(3) | 1,148 | 951 | 1,039 | 21 | (8 | ) | ||||||||||||||
Gain on Healthcare Technology Net Asset Exchange, net | (3,947 | ) | — | — | — | — | ||||||||||||||
Corporate (1) | 402 | 484 | 466 | (17 | ) | 4 | ||||||||||||||
Total | $ | 4,162 | $ | 7,871 | $ | 8,443 | (47 | ) | % | (7 | ) | % | ||||||||
Operating Expenses as a Percentage of Revenues | ||||||||||||||||||||
Distribution Solutions | 3.35 | % | 3.42 | % | 3.94 | % | (7 | ) | bp | (52 | ) | bp | ||||||||
Technology Solutions | (107.24 | ) | 32.96 | 33.85 | (14,020 | ) | (89 | ) | ||||||||||||
Total | 2.10 | 4.12 | 4.72 | (202 | ) | (60 | ) | |||||||||||||
(1) | 2017 includes pre-tax restructuring charges associated with the 2016 cost alignment plan of $19 million and $5 million within our Distribution Solutions segment and Corporate, and credits of $6 million within our Technology Solutions segment. 2016 includes pre-tax restructuring charges of $156 million, $30 million and $17 million within our Distribution Solutions segment, Technology Solutions segment and Corporate. |
(2) | 2017 excludes the pre-tax gain on Healthcare Technology Net Asset Exchange, net, recorded within our Technology Solutions segment. |
(3) | 2017 includes a non-cash pre-tax impairment charge of $290 million related to our EIS business within our Technology Solutions segment. 2015 includes pre-tax claim and litigation charges of $150 million within our Distribution Solutions segment. |
Operating expenses for 2017 and 2016 decreased 47% and 7% compared to the same periods a year ago. Excluding favorable foreign currency effects of 2% and 5%, operating expenses decreased 45% and 2% for 2017 and 2016.
2017 operating expenses benefited from a pre-tax gain of $3,947 million ($3,018 million after-tax) from the deconsolidation of the Core MTS Business within our Technology Solutions segment as previously discussed. 2016 operating expenses were favorably affected by pre-tax gains of $103 million from the sale of two businesses and lower acquisition-related expenses, partially offset by pre-tax restructuring charges of $203 million.
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On March 14, 2016, we committed to a cost alignment plan, which primarily consists of a reduction in workforce and business process initiatives that will be substantially implemented prior to the end of 2019. We expect to incur a total of $250 million to $270 million of pre-tax charges under this plan, of which $243 million primarily representing employee severance costs had been recorded from the inception of the plan through March 31, 2017. Estimated remaining charges primarily consist of exit-related costs and accelerated depreciation and amortization, which are largely attributed to our Distribution Solutions segment. The 2016 cost alignment plan generated approximately $170 million to $190 million of net pre-tax savings during 2017. We anticipate the 2016 cost alignment plan to generate an incremental $70 million to $90 million of net pre-tax savings during the fiscal year ending March 31, 2018. Additional information on our cost alignment plan is included in Financial Note 6, “Restructuring” to the consolidated financial statements appearing in this Annual Report on Form 10-K.
Distribution Solutions
Distribution Solutions segment’s operating expenses increased 2% in 2017 and decreased 7% compared to the same periods a year ago. Excluding favorable foreign currency effects of 3% and 5%, operating expenses increased 5% in 2017 and decreased 2% in 2016.
Operating expenses increased in 2017 primarily due to our acquisitions and higher acquisition-related expenses and intangible amortization, partially offset by lower restructuring charges and cost savings associated with the 2016 cost alignment plan, ongoing expense management efforts, a pre-tax gain from the sale of a business recorded in 2016 and lower bad debt expense.
Operating expense decreased in 2016 compared to the prior year primarily due to lower acquisition-related expenses relating to integration activities for our acquisitions and the sale of our ZEE Medical business, including a pre-tax gain of $52 million. These decreases were partially offset by pre-tax charges of $156 million associated with the 2016 cost alignment plan, higher compensation and benefit costs and bad debt expense. Operating expenses for 2015 included a $150 million charge associated with the settlement of controlled substance distribution claims.
Technology Solutions
Technology Solutions segment’s operating expenses and operating expenses as a percentage of revenues decreased in 2017 primarily due to a pre-tax gain of $3,947 million (after-tax gain of $3,018 million) from the deconsolidation of the Core MTS Business. Excluding the gain on Healthcare Technology Net Asset Exchange, this segment’s operating expenses increased primarily due to a non-cash pre-tax charge of $290 million ($282 million after-tax) for the EIS goodwill impairment charge, partially offset by cost savings from the 2016 cost alignment plan and ongoing cost management efforts and one less month of expenses from the Core MTS Business.
Operating expenses and operating expenses as a percentage of revenues in 2016 decreased compared to the prior year primarily due to the sale of our nurse triage business in the first quarter of 2016, including a pre-tax gain of $51 million, and lower compensation and benefit costs. These decreases were partially offset by pre-tax charges of $30 million for the 2016 cost alignment plan as well as the write-off of internal-use software.
Corporate
Corporate expenses decreased 17% in 2017 compared to the prior year primarily due to lower restructuring charges and cost savings associated with the 2016 cost alignment plan, including lower compensation and benefit costs and outside service fees. Corporate expenses for 2017 also benefited from a pre-tax gain of $15 million from the sale-leaseback transaction of our corporate headquarters building. Corporate expenses increased in 2016 compared to the prior year primarily due to pre-tax charges of $17 million associated with the 2016 cost alignment plan, partially offset by lower acquisition-related expenses and a decrease in compensation and benefit costs.
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Acquisition Expenses and Related Adjustments
Acquisition expenses and related adjustments include transaction, integration and other expenses that are directly related to business acquisitions and Healthcare Technology Net Asset Exchange including gain recognized from the transaction. In addition to a pre-tax gain of $3,947 million from the Healthcare Technology Net Asset Exchange, we recorded acquisition-related expenses of $151 million, $114 million and $224 million in 2017, 2016 and 2015. Expenses in 2017 were higher primarily due to our business acquisitions of UDG, Vantage, Biologics and Rexall Health, partially offset by a decline in expenses associated with our February 2014 acquisition of Celesio and February 2013 acquisition of PSS World Medical, Inc. (“PSSI”). Our integration of PSSI and Celesio were substantially completed in the first quarter of 2017.
Years Ended March 31, | |||||||||||
(Dollars in millions) | 2017 | 2016 | 2015 | ||||||||
Cost of Sales | $ | 1 | $ | — | $ | 1 | |||||
Operating Expenses | |||||||||||
Gain on Change Healthcare Net Asset Exchange, net | (3,947 | ) | — | — | |||||||
Transaction closing expenses | 30 | 10 | 6 | ||||||||
Restructuring, severance and relocation | 25 | — | 57 | ||||||||
Other (1) | 85 | 100 | 160 | ||||||||
Total | (3,807 | ) | 110 | 223 | |||||||
Other Income, Net | 10 | 4 | — | ||||||||
Total Acquisition Expenses and Related Adjustments | $ | (3,796 | ) | $ | 114 | $ | 224 | ||||
(1) | These expenses primarily include outside service fees, costs associated with information technology conversions, closures of duplicative facilities including distribution centers and other integration activities. |
Acquisition expenses and related adjustments by segment were as follows:
Years Ended March 31, | |||||||||||
(Dollars in millions) | 2017 | 2016 | 2015 | ||||||||
Cost of Sales | $ | 1 | $ | — | $ | 1 | |||||
Operating Expenses and Other Income, Net | |||||||||||
Distribution Solutions | 133 | 112 | 211 | ||||||||
Technology Solutions | (3,936 | ) | — | — | |||||||
Corporate | 6 | 2 | 12 | ||||||||
Total | (3,797 | ) | 114 | 223 | |||||||
Total Acquisition Expenses and Related Adjustments | $ | (3,796 | ) | $ | 114 | $ | 224 | ||||
During 2016 and 2015, we incurred $9 million and $109 million of acquisition-related expenses for our acquisition of Celesio and $70 million and $110 million for our acquisition of PSSI. We did not incur any material expenses associated with these two acquisitions in 2017. These expenses primarily include restructuring, severance, employee retention incentives, outside service fees and other costs to integrate the business, and bridge loan fees. Additionally, our acquisition-related expenses for our PSSI acquisition include amounts associated with distribution center rationalization and information technology conversions to common platforms. Integration activities for our PSSI and Celesio acquisitions were substantially completed in 2017.
Amortization Expenses of Acquired Intangible Assets
Amortization expenses of acquired intangible assets in connection with acquisitions recorded in operating expenses were $440 million, $423 million and $483 million in 2017, 2016 and 2015. Amortization expenses increased in 2017 primarily due to our acquisitions of UDG, Biologics, Vantage and Rexall Health, partially offset by lower amortization expense related to Core MTS Business assets which were classified as held for sale since the 2017 second quarter. Amortization expense for 2016 decreased due to foreign currency effects and intangible assets that were fully amortized.
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Amortization expense recorded in operating expenses by segment was as follows:
Years Ended March 31, | |||||||||||
(Dollars in millions) | 2017 | 2016 | 2015 | ||||||||
Distribution Solutions | 418 | $ | 389 | $ | 442 | ||||||
Technology Solutions | 22 | 34 | 40 | ||||||||
Corporate | — | — | 1 | ||||||||
Total | $ | 440 | $ | 423 | $ | 483 | |||||
Other Income, Net:
Years Ended March 31, | Change | ||||||||||||||||||
(Dollars in millions) | 2017 | 2016 | 2015 | 2017 | 2016 | ||||||||||||||
Distribution Solutions | $ | 64 | $ | 41 | $ | 48 | 56 | % | (15 | ) | % | ||||||||
Technology Solutions | 1 | 2 | 3 | (50 | ) | (33 | ) | ||||||||||||
Corporate | 25 | 15 | 12 | 67 | 25 | ||||||||||||||
Total | $ | 90 | $ | 58 | $ | 63 | 55 | % | (8 | ) | % | ||||||||
Other income, net for 2017 increased 55% primarily due to higher equity investment income within our Distribution Solutions segment. Other income, net for 2016 approximated the prior year.
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Segment Operating Profit, Corporate Expenses, Net and Interest Expense:
Years Ended March 31, | Change | |||||||||||||||||||
(Dollars in millions) | 2017 | 2016 | 2015 | 2017 | 2016 | |||||||||||||||
Segment Operating Profit (1) (2) | ||||||||||||||||||||
Distribution Solutions | $ | 3,361 | $ | 3,553 | $ | 3,047 | (5 | ) | % | 17 | % | |||||||||
Technology Solutions (3) | 4,215 | 519 | 438 | 712 | 18 | |||||||||||||||
Subtotal | 7,576 | 4,072 | 3,485 | 86 | 17 | |||||||||||||||
Corporate Expenses, Net (2) | (377 | ) | (469 | ) | (454 | ) | (20 | ) | 3 | |||||||||||
Interest Expense | (308 | ) | (353 | ) | (374 | ) | (13 | ) | (6 | ) | ||||||||||
Income From Continuing Operations Before Income Taxes | $ | 6,891 | $ | 3,250 | $ | 2,657 | 112 | % | 22 | % | ||||||||||
Segment Operating Profit Margin | ||||||||||||||||||||
Distribution Solutions | 1.72 | % | 1.89 | % | 1.73 | % | (17 | ) | bp | 16 | bp | |||||||||
Technology Solutions | 161.49 | 17.99 | 14.27 | 14,350 | 372 | |||||||||||||||
(1) | Segment operating profit includes gross profit, net of operating expenses, plus other income, net, for our two operating segments. |
(2) | In connection with the 2016 cost alignment plan, we recorded pre-tax restructuring charges of $229 million in 2016. 2016 pre-tax charges were recorded as follows: $161 million, $51 million and $17 million within our Distribution Solutions segment, Technology Solutions segment and Corporate expenses, net. Segment operating profit for 2017 includes pre-tax restructuring charges of $19 million and $5 million in our Distribution Solutions segment and Corporate expenses, net, and pre-tax credits of $10 million associated with the 2016 cost alignment plan. |
(3) | Technology Solutions segment’s operating profit for 2017 includes a pre-tax gain of $3,947 million from the deconsolidation of the Core MTS Business and a non-cash pre-tax impairment charge of $290 million related to our EIS business. |
Segment Operating Profit
Distribution Solutions: Operating profit margin decreased for 2017 primarily due to a decline in gross profit margin reflecting weaker pharmaceutical manufacturer pricing trends, the competitive sell-side pricing environment and lower compensation from a branded pharmaceutical manufacturer from our U.S. Pharmaceutical distribution business. Operating profit and operating profit margin in 2017 benefited from LIFO credits, our acquisitions, lower restructuring charges and cost savings associated with the 2016 cost alignment plan and higher cash receipts representing our share of antitrust legal settlements.
Operating profit and operating profit margin for 2016 increased due to lower operating expenses as a percentage of revenues, partially offset by a decline in gross profit margin. Operating profit and operating profit margin in 2016 includes $161 million of pre-tax charges associated with the Cost Alignment Plan, lower LIFO charges, and a $52 million pre-tax gain on the sale of our ZEE Medical business. Operating profit and operating profit margin for 2015 included a $150 million charge related to our controlled substance distribution claims.
Technology Solutions: Operating profit and operating profit margin increased in 2017 primarily due to a $3,947 million pre-tax gain from the deconsolidation of the Core MTS Business in the fourth quarter of 2017, which was partially offset by the non-cash EIS goodwill impairment pre-tax charge of $290 million. 2017 operating profit benefited from lower restructuring charges and cost savings from the 2016 cost alignment plan. Operating profit for 2017 was unfavorably affected by one less month of gross profit from the Core MTS business, which was contributed to Change Healthcare on March 1, 2017. Operating profit margin increased in 2016 primarily due to higher gross profit margin and a decrease in operating expenses as a percentage of revenue. Operating profit and operating profit margin for 2016 included a $51 million pre-tax gain from the sale of our nurse triage business and $51 million of pre-tax charges associated with the 2016 cost alignment plan.
Corporate: Corporate expenses, net, decreased in 2017 primarily due to lower restructuring charges and a pre-tax gain from a sale-leaseback transaction. Corporate expenses, net increased in 2016 compared to 2015 primarily due to higher operating expenses as previously discussed.
Interest Expense: Interest expense decreased in 2017 primarily due to repayments of debt, partially offset by an increase relating to the issuance of commercial paper. Interest expense decreased in 2016 primarily due to repayments of debt and certain foreign currency-denominated credit facilities.
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Interest expense fluctuates based on timing, amounts and interest rates of term debt repaid and new term debt issued, as well as amounts incurred associated with financing fees.
Income Taxes
During 2017, 2016 and 2015, income tax expense related to continuing operations was $1,614 million, $908 million and $815 million, which included net discrete tax benefits of $82 million, $42 million and $33 million. Our discrete tax benefit for 2017 includes a tax benefit of $54 million related to the adoption of the amended accounting guidance on employee share-based compensation. Our reported income tax rates were 23.4%, 27.9% and 30.7% in 2017, 2016 and 2015. Fluctuations in our reported income tax rates are primarily due to changes within our business mix, including varying proportions of income attributable to foreign countries that have lower income tax rates, discrete items and for 2017 also due to the impact of the intercompany sale of software.
The non-cash pre-tax charge of $290 million to impair the carrying value of goodwill related to our EIS business within our Technology Solutions segment, described in Financial Note 3, “Goodwill Impairment,” had an unfavorable impact on our effective tax rate in 2017 given that the majority of this charge was not deductible for tax purposes.
On December 19, 2016, we sold various software and ancillary intellectual property relating to our Technology Solutions business between wholly owned legal entities within the McKesson group that are based in different tax jurisdictions. The transferor entity recognized a gain on the sale of assets that was not subject to income tax in its local jurisdiction; such gain was eliminated upon consolidation. An entity based in the U.S. was the recipient of the software and ancillary intellectual property and is entitled to amortize the fair value of the assets for book and tax purposes. For U.S. GAAP purposes, the tax benefit associated with the amortization of these assets is recognized over the tax lives of the assets. As a result, a net tax benefit of $137 million was recognized prior to the contribution of a portion of these assets to Change Healthcare as described in Financial Note 2, “Healthcare Technology Net Asset Exchange”.
On March 1, 2017, we contributed assets to Change Healthcare as further described in Financial Note 2, “Healthcare Technology Net Asset Exchange”. While this transaction was predominantly structured as a tax free asset contribution for U.S. federal income tax purposes under Section 721(a) of the Internal Revenue Code, we recorded tax expense of $929 million on the gain. The tax expense was primarily driven by the recognition of a deferred tax liability on the excess book over tax basis in our equity investment in Change Healthcare.
Significant judgments and estimates are required in determining the consolidated income tax provision and evaluating income tax uncertainties. Although our major taxing jurisdictions include the U.S., Canada and the United Kingdom, we are subject to income taxes in numerous foreign jurisdictions. Our income tax expense, deferred tax assets and liabilities and uncertain tax liabilities reflect management’s best assessment of estimated current and future taxes to be paid. We believe that we have made adequate provision for all income tax uncertainties.
We file income tax returns in the U.S. federal jurisdiction, various U.S. state jurisdictions and various foreign jurisdictions. During the first quarter of 2017, we reached an agreement with the Internal Revenue Service to settle all outstanding issues relating to the fiscal years 2007 through 2009. This settlement did not have a material impact on our provision for income taxes.
We received reassessments from the Canada Revenue Agency related to a transfer pricing matter impacting years 2003 through 2013. During 2016, we reached an agreement to settle the transfer pricing matter for years 2003 through 2013 and recorded a net discrete tax benefit of $8 million.
Loss from Discontinued Operations, Net of Tax
Losses from discontinued operations, net of tax, were $124 million, $32 million and $299 million in 2017, 2016 and 2015.
Loss from discontinued operations, net for 2017 includes an after-tax loss of $113 million related to the sale of our Brazilian pharmaceutical distribution business within our Distribution Solutions segment, which we acquired through our February 2014 acquisition of Celesio. In 2015, we committed to a plan to sell this business and the results of operations and cash flows for this business had been classified as discontinued operations since 2015. On May 31, 2016, we completed the sale of this business and recognized the loss primarily for the settlement of certain indemnification matters as well as the release of the cumulative translation losses. We made a payment of approximately $100 million related to the sale.
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Loss from discontinued operations, net for 2015 included pre-tax non-cash impairment charges of $241 million ($235 million after-tax), which were recorded to reduce the carrying value of our Brazilian pharmaceutical distribution business to its estimated fair value, less costs to sell. Loss from discontinued operations, net for 2015 also included a pre-tax and after-tax loss of $6 million from the sale of a software business within our International Technology business.
Refer to Financial Note 5, “Discontinued Operations,” to the consolidated financial statements appearing in this Annual Report on Form 10-K for additional information.
Net Income (Loss) Attributable to Noncontrolling Interests: Net income attributable to noncontrolling interests for all periods presented includes the guaranteed dividend or annual recurring compensation that we are obligated to pay to the noncontrolling shareholders of Celesio AG under the profit and loss transfer agreement (the “Domination Agreement”). In 2017, net income attributable to noncontrolling interests also includes third-party equity interests in our consolidated entities including Vantage and ClarusOne Sourcing Services LLC, which was established between McKesson and Wal-Mart Stores, Inc. Noncontrolling interests with redemption features, such as put rights, that are not solely within the Company’s control are considered redeemable noncontrolling interests. Redeemable noncontrolling interests are presented outside of Stockholders’ Equity on our consolidated balance sheet. Refer to Financial Note 11, “Redeemable Noncontrolling Interests and Noncontrolling Interests,” to the consolidated financial statements appearing in this Annual Report on Form 10-K for additional information.
Net Income Attributable to McKesson Corporation: Net income attributable to McKesson Corporation was $5,070 million, $2,258 million and $1,476 million in 2017, 2016 and 2015 and diluted earnings per common share were $22.73, $9.70 and $6.27.
Weighted Average Diluted Common Shares Outstanding: Diluted earnings per common share was calculated based on a weighted average number of shares outstanding of 223 million, 233 million and 235 million for 2017, 2016 and 2015. Weighted average diluted common shares outstanding is affected by the exercise and settlement of share-based awards and in 2017 and 2016, the cumulative effect of share repurchases.
Foreign Operations
Our foreign operations represented approximately 17%, 17% and 20% of our consolidated revenues in 2017, 2016 and 2015. Foreign operations are subject to certain risks, including currency fluctuations. We monitor our operations and adopt strategies responsive to changes in the economic and political environment in each of the countries in which we operate. We conduct our business worldwide in local currencies including Euro, British pound sterling and Canadian dollar. As a result, the comparability of our results reported in U.S. dollars can be affected by changes in foreign currency exchange rates. In discussing our operating results, we may use the term “foreign currency effect”, which refers to the effect of changes in foreign currency exchange rates used to convert the local currency results of foreign countries where the functional currency is not the U.S. dollar. We present this information to provide a framework for assessing how our business performed excluding the effect of foreign currency rate fluctuations. In computing foreign currency effect, we translate our current year results in local currencies into U.S dollars by applying average foreign exchange rates of the corresponding prior year periods, and we subsequently compare those results to the previously reported results of the comparable prior year periods in U.S. dollars. Additional information regarding our foreign operations is included in Financial Note 29, “Segments of Business,” to the consolidated financial statements appearing in this Annual Report on Form 10-K.
Business Combinations
Refer to Financial Notes 4 and 17, “Business Combinations” and “Debt and Financing Activities,” to the consolidated financial statements appearing in this Annual Report on Form 10-K for additional information.
2018 Outlook
Information regarding the Company’s 2018 outlook is contained in our Form 8-K dated May 22, 2017. This Form 8-K should be read in conjunction with the sections Item 1 - Business - Forward-Looking Statements and Item 1A - Risk Factors in Part I of this Annual Report on Form 10-K.
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CRITICAL ACCOUNTING POLICIES AND ESTIMATES
We consider an accounting estimate to be critical if the estimate requires us to make assumptions about matters that were uncertain at the time the accounting estimate was made and if different estimates that we reasonably could have used in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, could have a material impact on our financial condition or results from operations. Below are the estimates that we believe are critical to the understanding of our operating results and financial condition. Other accounting policies are described in Financial Note 1, “Significant Accounting Policies,” to the consolidated financial statements appearing in this Annual Report on Form 10-K. Because of the uncertainty inherent in such estimates, actual results may differ from these estimates.
Allowance for Doubtful Accounts: We provide short-term credit and other customer financing arrangements to customers who purchase our products and services. Other customer financing primarily relates to guarantees provided to our customers, or their creditors, regarding the repurchase of inventories. We also provide financing to certain customers related to the purchase of pharmacies, which serve as collateral for the loans. We estimate the receivables for which we do not expect full collection based on historical collection rates and specific knowledge regarding the current creditworthiness of our customers and record an allowance in our consolidated financial statements for these amounts.
In determining the appropriate allowance for doubtful accounts, which includes general and specific reserves, the Company reviews accounts receivable aging, industry trends, customer financial strength, credit standing, historical write-off trends and payment history to assess the probability of collection. If the frequency and severity of customer defaults due to our customers’ financial condition or general economic conditions change, our allowance for uncollectible accounts may require adjustment. As a result, we continuously monitor outstanding receivables and other customer financing and adjust allowances for accounts where collection may be in doubt. During 2017, sales to our ten largest customers, including group purchasing organizations (“GPOs”) accounted for approximately 54.2% of our total consolidated revenues. Sales to our largest customer, CVS Health (“CVS”), accounted for approximately 20.2% of our total consolidated revenues. At March 31, 2017, trade accounts receivable from our ten largest customers were approximately 33.7% of total trade accounts receivable. Accounts receivable from CVS were approximately 17.8% of total trade accounts receivable. As a result, our sales and credit concentration is significant. We also have agreements with GPOs, each of which functions as a purchasing agent on behalf of member hospitals, pharmacies and other healthcare providers, as well as with government entities and agencies. The accounts receivables balances are with individual members of the GPOs, and therefore no significant concentration of credit risk exists. A material default in payment, a material reduction in purchases from these or any other large customers, or the loss of a large customer or GPO could have a material adverse impact on our financial position, results of operations and liquidity.
Reserve methodologies are assessed annually based on historical losses and economic, business and market trends. In addition, reserves are reviewed quarterly and updated if unusual circumstances or trends are present. We believe the reserves maintained and expenses recorded in 2017 are appropriate and consistent with historical methodologies employed. At this time, we are not aware of any internal process or customer issues that might lead to a significant increase in our allowance for doubtful accounts as a percentage of net revenue in the foreseeable future.
At March 31, 2017, trade and notes receivables were $14,717 million prior to allowances of $243 million. In 2017, 2016 and 2015, our provision for bad debts was $93 million, $113 million and $67 million. At March 31, 2017 and 2016, the allowance as a percentage of trade and notes receivables was 1.7% and 1.4%. An increase or decrease of a hypothetical 0.1% in the 2017 allowance as a percentage of trade and notes receivables would result in an increase or decrease in the provision for bad debts of approximately $15 million. The selected 0.1% hypothetical change does not reflect what could be considered the best or worst case scenarios. Additional information concerning our allowance for doubtful accounts may be found in Schedule II included in this Annual Report on Form 10-K.
Inventories: We report inventories at the lower of cost or market (“LCM”). Inventories for our Distribution Solutions segment consist of merchandise held for resale. For our Distribution Solutions segment, the majority of the cost of domestic inventories is determined using the LIFO method. The majority of the cost of inventories held in foreign locations is based on weighted average purchase price using the first-in, first-out method (“FIFO”). Technology Solutions segment inventories consist of computer hardware with cost generally determined by the standard cost method, which approximates average cost. Rebates, cash discounts and other incentives received from vendors relating to the purchase or distribution of inventory are considered as product discounts and are accounted for as a reduction in the cost of inventory and are recognized when the inventory is sold. Total inventories were $15.3 billion at March 31, 2017 and 2016.
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The LIFO method was used to value approximately 70% and 74% of our inventories at March 31, 2017 and 2016. If we had used the FIFO method of inventory valuation, which approximates current replacement costs, inventories would have been approximately $1,005 million and $1,012 million higher than the amounts reported at March 31, 2017 and 2016. These amounts are equivalent to our LIFO reserves. Our LIFO valuation amount includes both pharmaceutical and non-pharmaceutical products. We recognized net LIFO credits of $7 million in 2017 and net LIFO charges of $244 million and $337 million in 2016 and 2015 within our consolidated statements of operations. A LIFO charge is recognized when the net effect of price increases on pharmaceutical and non-pharmaceutical products held in inventory exceeds the impact of price declines including the effect of branded pharmaceutical products that have lost market exclusivity. A LIFO credit is recognized when the net effect of price declines exceeds the impact of price increases on pharmaceutical and non-pharmaceutical products held in inventory.
We believe that the average inventory costing method provides a reasonable estimation of the current cost of replacing inventory (i.e., “market”). As such, our LIFO inventory is valued at the lower of LIFO or market. As of March 31, 2017 and 2016, inventories at LIFO did not exceed market.
In determining whether inventory valuation issues exist, we consider various factors including estimated quantities of slow-moving inventory by reviewing on-hand quantities, outstanding purchase obligations and forecasted sales. Shifts in market trends and conditions, changes in customer preferences due to the introduction of generic drugs or new pharmaceutical products or the loss of one or more significant customers are factors that could affect the value of our inventories. We write down inventories which are considered excess and obsolete as a result of these reviews. These factors could make our estimates of inventory valuation differ from actual results.
Business Combinations: We account for acquired businesses using the acquisition method of accounting, which requires that once control of a business is obtained, 100% of the assets acquired and liabilities assumed, including amounts attributed to noncontrolling interests, be recorded at the date of acquisition at their respective fair values. Any excess of the purchase price over the estimated fair values of the net assets acquired is recorded as goodwill. Acquisition-related expenses and related restructuring costs are expensed as incurred.
Several valuation methods may be used to determine the fair value of assets acquired and liabilities assumed. For intangible assets, we typically use the income method. This method starts with a forecast of all of the expected future net cash flows associated with each asset. These cash flows are then adjusted to present value by applying an appropriate discount rate that reflects the risk factors associated with the cash flow streams. Some of the more significant estimates and assumptions inherent in the income method or other methods include the amount and timing of projected future cash flows, the discount rate selected to measure the risks inherent in the future cash flows and the assessment of the asset’s life cycle and the competitive trends impacting the asset, including consideration of any technical, legal, regulatory, or economic barriers to entry. Determining the useful life of an intangible asset also requires judgment as different types of intangible assets will have different useful lives. Refer to Financial Note 4, “Business Combinations,” to the consolidated financial statements appearing in this Annual Report on Form 10-K for additional information regarding our acquisitions.
Goodwill and Intangible Assets: As a result of acquiring businesses, we have $10,586 million and $9,786 million of goodwill at March 31, 2017 and 2016 and $3,665 million and $3,021 million of intangible assets, net at March 31, 2017 and 2016. We maintain goodwill assets on our books unless the assets are considered to be impaired. We perform an impairment test on goodwill balances annually in the fourth quarter or more frequently if indicators for potential impairment exist. Indicators that are considered include significant changes in performance relative to expected operating results, significant changes in the use of the assets, significant negative industry or economic trends, or a significant decline in the Company’s stock price and/or market capitalization for a sustained period of time.
Goodwill impairment testing is conducted at the reporting unit level, which is generally defined as a component — one level below our Distribution Solutions and Technology Solutions operating segments, for which discrete financial information is available and segment management regularly reviews the operating results of that reporting unit.
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The first step in goodwill testing requires us to compare the estimated fair value of a reporting unit to its carrying value. This step may be performed utilizing either a qualitative or quantitative assessment. If the carrying value of the reporting unit is lower than its estimated fair value, no further evaluation is necessary. If the carrying value of the reporting unit is higher than its estimated fair value, the second step must be performed to measure the amount of impairment loss. Under the second step, the implied fair value of goodwill is calculated in a hypothetical analysis by subtracting the fair value of all assets and liabilities of the reporting unit, including any unrecognized intangibles assets, from the fair value of the reporting unit calculated in the first step of the impairment test. If the carrying value of goodwill for the reporting unit exceeds the implied fair value of goodwill, an impairment charge is recorded for that excess.
To estimate the fair value of our reporting units, we use a combination of the market approach and the income approach. Under the market approach, we estimate fair value by comparing the business to similar businesses, or guideline companies whose securities are actively traded in public markets. Under the income approach, we use a discounted cash flow model in which cash flows anticipated over several periods, plus a terminal value at the end of that time horizon, are discounted to their present value using an appropriate expected rate of return. In addition, we compare the aggregate of the reporting units’ fair values to our market capitalization as further corroboration of the fair values.
Some of the more significant estimates and assumptions inherent in the goodwill impairment estimation process using the market approach include the selection of appropriate guideline companies, the determination of market value multiples for both the guideline companies and the reporting unit, the determination of applicable premiums and discounts based on any differences in marketability between the business and the guideline companies and for the income approach, the required rate of return used in the discounted cash flow method, which reflects capital market conditions and the specific risks associated with the business. Under the income approach, the fair value estimates in the goodwill impairment analysis are highly sensitive to the discount rates used in the discounting of expected cash flows attributable to the reporting units. The discount rates are the weighted average cost of capital measuring the reporting units’ cost of debt and equity financing weighted by the percentage of debt and percentage of equity in a company’s target capital. Other estimates inherent in both the market and income approaches include long-term growth rates, projected revenues, earnings and cash flow forecasts for the reporting units.
In 2016 and 2015, we concluded that there were no impairments of goodwill as the fair value of each reporting unit exceeded its carrying value. In 2017, we recorded a non-cash pre-tax charge of $290 million ($282 million after-tax) to impair the carrying value of our EIS business. Estimates of fair value result from a complex series of judgments about future events and uncertainties and rely heavily on estimates and assumptions at a point in time. Judgments made in determining an estimate of fair value may materially impact our results of operations. The valuations are based on information available as of the impairment review date and are based on expectations and assumptions that have been deemed reasonable by management. Any material changes in key assumptions, including failure to meet business plans, negative changes in government reimbursement rates, deterioration in the U.S. and global financial markets, an increase in interest rate or an increase in the cost of equity financing by market participants within the industry or other unanticipated events and circumstances, may decrease the projected cash flows or increase the discount rates and could potentially result in an impairment charge. Our Celesio reporting unit within our Distribution Solutions segment experienced a decline in its estimated future cash flows primarily driven by government reimbursement reductions in our U.K. retail business. The decline in estimated future cash flows resulted in the estimated fair value of this reporting unit exceeding the carrying value of the reporting unit by 13%. The goodwill balance of this reporting unit was $2,790 million at March 31, 2017 or approximately 26% of the total distribution segment’s goodwill balance. A further decrease in the estimated future cash flows, an increase in the discount rate and/ or a decrease in the terminal growth rate, could result in a goodwill impairment for this reporting unit. The discount rate and terminal growth rate used in our 2017 annual impairment testing for this reporting unit were 7% and 1.5%.
Currently, all of our intangible assets are subject to amortization and are amortized based on the pattern of their economic consumption or on a straight-line basis over their estimated useful lives, ranging from one to 38 years. We review intangible assets for impairment whenever events or changes in circumstances indicate that the carrying value of the assets may not be recoverable. Determination of recoverability is based on the lowest level of identifiable estimated future undiscounted cash flows resulting from use of the asset and its eventual disposition. Measurement of any impairment loss is based on the excess of the carrying value of the asset over its fair value. Assumptions and estimates about future values and remaining useful lives of our purchased intangible assets are complex and subjective. They can be affected by a variety of factors, including external factors such as industry and economic trends, and internal factors such as changes in our business strategy and our internal forecasts. There were no material impairments of intangibles in 2017, 2016 or 2015 within our continuing operations. Our ongoing consideration of all the factors described previously could result in impairment charges in the future, which could adversely affect our net income.
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Supplier Reserves: We establish reserves against amounts due from suppliers relating to various price and rebate incentives, including deductions or billings taken against payments otherwise due to them. These reserve estimates are established based on judgment after considering the status of current outstanding claims, historical experience with the suppliers, the specific incentive programs and any other pertinent information available. We evaluate the amounts due from suppliers on a continual basis and adjust the reserve estimates when appropriate based on changes in factual circumstances. As of March 31, 2017 and 2016, supplier reserves were $201 million and $144 million. The final outcome of any outstanding claims may differ from our estimate. All of the supplier reserves at March 31, 2017 and 2016 pertain to our Distribution Solutions segment. An increase or decrease in the supplier reserve as a hypothetical 0.1% of trade payables at March 31, 2017 would result in an increase or decrease in the cost of sales of approximately $31 million in 2017. The selected 0.1% hypothetical change does not reflect what could be considered the best or worst case scenarios.
Income Taxes: Our income tax expense and deferred tax assets and liabilities reflect management’s best assessment of estimated current and future taxes to be paid. We are subject to income taxes in the U.S. and numerous foreign jurisdictions. Significant judgments and estimates are required in determining the consolidated income tax provision and in evaluating income tax uncertainties. We review our tax positions at the end of each quarter and adjust the balances as new information becomes available.
Deferred income taxes arise from temporary differences between the tax and financial statement recognition of revenue and expense. In evaluating our ability to recover our deferred tax assets, we consider all available positive and negative evidence including our past operating results, the existence of cumulative net operating losses in the most recent years and our forecast of future taxable income. In estimating future taxable income, we develop assumptions including the amount of future federal, state and foreign pre-tax operating income, the reversal of temporary differences and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment about the forecasts of future taxable income and are consistent with the plans and estimates we use to manage the underlying businesses. We had deferred income tax assets (net of valuation allowances) of $1,156 million and $1,272 million and deferred tax liabilities of $4,806 million and $3,947 million at March 31, 2017 and 2016. Deferred tax assets primarily consist of timing differences relating to our compensation and benefit related accruals and for net operating loss and tax credit carryforwards. Deferred tax liabilities have been established primarily due to excess book over tax basis in inventory valuation (including inventory valued at LIFO), intangible assets and our investment in Change Healthcare. Valuation allowances of $503 million and $267 million exist at March 31, 2017 and 2016 against certain deferred tax assets, which primarily relate to state and foreign net operating loss carryforwards for which the ultimate realization of future benefits is uncertain. Changes in tax laws and rates could also affect recorded deferred tax assets and liabilities in the future. Should tax laws change, including those laws pertaining to LIFO, our tax expense and cash flows could be materially impacted.
In addition, the calculation of our tax liabilities includes estimates for uncertainties in the application of complex tax regulations across multiple global jurisdictions where we conduct our operations. We recognize liabilities for tax and related interest for issues in the U.S. and other tax jurisdictions based on our estimate of whether, and the extent to which, additional taxes and related interest will be due. If our current estimate of tax and interest liabilities is less than the ultimate settlement, an additional charge to income tax expense may result. If our current estimate of tax and interest liabilities is more than the ultimate settlement, a reduction to income tax expense may be recognized.
An increase or decrease of a hypothetical 1% in our 2017 effective tax rate as applied to income from continuing operations would result in an increase or decrease in the provision for income taxes of approximately $69 million for 2017.
Loss Contingencies: We are subject to various claims, including claims with customers and vendors, pending and potential legal actions for damages, investigations relating to governmental laws and regulations and other matters arising out of the normal conduct of our business. When a loss is considered probable and reasonably estimable, we record a liability in the amount of our best estimate for the ultimate loss. However, the likelihood of a loss with respect to a particular contingency is often difficult to predict and determining a meaningful estimate of the loss or a range of loss may not be practicable based on the information available and the potential effect of future events and decisions by third parties that will determine the ultimate resolution of the contingency. Moreover, it is not uncommon for such matters to be resolved over many years, during which time relevant developments and new information must be reevaluated at least quarterly to determine both the likelihood of potential loss and whether it is possible to reasonably estimate a range of possible loss. When a loss is probable but a reasonable estimate cannot be made, disclosure of the proceeding is provided.
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Disclosure is also provided when it is reasonably possible that a loss will be incurred or when it is reasonably possible that the amount of a loss will exceed the recorded provision. We review all contingencies at least quarterly to determine whether the likelihood of loss has changed and to assess whether a reasonable estimate of the loss or range of the loss can be made. As discussed above, development of a meaningful estimate of loss or a range of potential loss is complex when the outcome is directly dependent on negotiations with or decisions by third parties, such as regulatory agencies, the court system and other interested parties. Such factors bear directly on whether it is possible to reasonably estimate a range of potential loss and boundaries of high and low estimate.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
We expect our available cash generated from operations and our short-term investment portfolio, together with our existing sources of liquidity from our revolving credit facilities and commercial paper issuance, will be sufficient to fund our long-term and short-term capital expenditures, working capital and other cash requirements. In addition, we may access the long-term debt capital markets from time to time. We are in the process of acquiring certain businesses, and the cost of these acquisitions may be partially funded through the issuance of debt.
Net cash flow from operating activities was $4,744 million in 2017 compared to $3,672 million in 2016 and $3,112 million in 2015. Operating activities over the last three years were primarily affected by an increase in drafts and accounts payable reflecting longer payment terms for certain purchases and increases in receivables primarily associated with our revenue growth. Cash flows from operations can be significantly impacted by factors such as the timing of receipts from customers and payments to vendors. Additionally, working capital is primarily a function of sales and purchase volumes, inventory requirements and vendor payment terms. Operating activities for 2017 were also affected by $150 million of litigation settlement payment.
Net cash used in investing activities was $3,796 million in 2017 compared to $1,557 million in 2016 and $677 million in 2015. Investing activities for 2017 include $4,237 million of net cash payments for acquisitions including $2.1 billion for our acquisition of Rexall, $1,228 million of net payments received on Healthcare Technology Net Asset Exchange, $404 million and $158 million in capital expenditures for property, plant and equipment, and capitalized software, and $206 million of net cash proceeds from sales of businesses and other assets. Additionally, we prepaid $1.4 billion for acquisitions that closed subsequent to year end.
Investing activities for 2016 included $40 million of net cash payments for acquisitions, $488 million and $189 million in capital expenditures for property, plant and equipment, and capitalized software, and $210 million of cash proceeds from sales of our automation business and an equity investment. Investing activities for 2015 included $170 million of net cash payments for acquisitions, including $4,497 million for our acquisition of Celesio. Investing activities in 2015 also included $376 million and $169 million in capital expenditures for property, plant and equipment, and capitalized software, and $15 million of cash proceeds from sales of our automation business and equity investment.
Financing activities utilized $2,069 million, $3,453 million and $968 million of cash in 2017, 2016 and 2015. Financing activities for 2017 include cash receipts of $8,294 million and payments of $8,124 million from short-term borrowings. We received cash from long-term debt issuances of $1,824 million and made repayments on long-term debt of $1,601 million in 2017. Financing activities in 2017 also include $2,250 million of cash paid for stock repurchases and $253 million of dividends paid.
Financing activities for 2016 include cash receipts of $1,561 million and payments of $1,688 million from short-term borrowings. We made repayments on long-term debt of $1,598 million in 2016. Financing activities in 2016 also include $1,504 million of cash paid for stock repurchases and $244 million of dividends paid.
Financing activities for 2015 include cash receipts of $3,100 million and cash paid of $3,152 million from short-term borrowings. Long-term debt repayments in 2015 were primarily cash paid on promissory notes. Financing activities in 2015 also reflect a cash payment of $32 million to acquire approximately 1 million additional common shares of Celesio through the tender offers we completed in 2015. Additionally, financing activities for 2015 include $340 million of cash paid for stock repurchases and $227 million of dividends paid.
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The Company’s Board has authorized the repurchase of McKesson’s common stock from time-to-time in open market transactions, privately negotiated transactions, accelerated share repurchase (“ASR”) programs, or by any combination of such methods. The timing of any repurchases and the actual number of shares repurchased will depend on a variety of factors, including our stock price, corporate and regulatory requirements, restrictions under our debt obligations and other market and economic conditions.
The Board authorized the repurchase of the Company’s common stock up to $4 billion in October 2016. In 2017, we repurchased 14.1 million of our shares through open market transactions and 1.4 million of our shares through an ASR program. In 2016, we repurchased 8.7 million of our shares through both an ASR program and open market transactions.
Years Ended March 31, | |||||||||||
(In millions, except per share data) | 2017 | 2016 | 2015 | ||||||||
Number of shares repurchased (1) | 15.5 | 8.7 | 1.5 | ||||||||
Average price paid per share | $ | 141.16 | $ | 173.64 | $ | 226.55 | |||||
Total value of shares repurchased (1) | $ | 2,250 | $ | 1,504 | $ | 340 | |||||
(1) | Excludes shares surrendered for tax withholding. |
At March 31, 2017, the total authorization outstanding was $2.7 billion available under the October 2016 share repurchase plan for future repurchases of the Company’s common stock.
We believe that our operating cash flow, financial assets and current access to capital and credit markets, including our existing credit facilities, will give us the ability to meet our financing needs for the foreseeable future. However, there can be no assurance that continued or increased volatility and disruption in the global capital and credit markets will not impair our liquidity or increase our costs of borrowing.
Selected Measures of Liquidity and Capital Resources:
March 31, | ||||||||||||||
(Dollars in millions) | 2017 | 2016 | 2015 | |||||||||||
Cash and cash equivalents | $ | 2,783 | $ | 4,048 | $ | 5,341 | ||||||||
Working capital | 1,336 | 3,366 | 3,173 | |||||||||||
Debt to capital ratio (1) | 39.2 | % | 43.6 | % | 50.3 | % | ||||||||
Return on McKesson stockholders’ equity (2) | 54.6 | 26.0 | 17.0 | |||||||||||
(1) | Ratio is computed as total debt divided by the sum of total debt and McKesson stockholders’ equity, which excludes noncontrolling and redeemable noncontrolling interests and accumulated other comprehensive income (loss). |
(2) | Ratio is computed as net income attributable to McKesson Corporation for the last four quarters, divided by a five-quarter average of McKesson stockholders’ equity, which excludes noncontrolling and redeemable noncontrolling interests. |
Cash equivalents, which are available-for-sale, are carried at fair value. Cash equivalents are primarily invested in AAA rated prime, AAA rated prime money market funds denominated in Euros, AAA rated prime money market fund denominated in British pound sterling, U.S. government money market funds denominated in U.S. dollars, overnight repurchase agreements collateralized by U.S. government securities, Canadian government securities and/or securities that are guaranteed or sponsored by the U.S. government.
The remaining cash and cash equivalents are deposited with several financial institutions. We mitigate the risk of our short-term investment portfolio by depositing funds with reputable financial institutions and monitoring risk profiles and investment strategies of money market funds.
Our cash and cash equivalents balance as of March 31, 2017 included approximately $2.3 billion of cash held by our subsidiaries outside of the United States. Our primary intent is to utilize this cash in foreign operations and acquisitions. Although the vast majority of cash held outside the United States is available for repatriation, doing so could subject us to U.S. federal, state and local income tax.
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Working capital primarily includes cash and cash equivalents, receivables and inventories net of drafts and accounts payable, short-term borrowings, current portion of long-term debt, deferred revenue and other current liabilities. Our Distribution Solutions segment requires a substantial investment in working capital that is susceptible to large variations during the year as a result of inventory purchase patterns and seasonal demands. Inventory purchase activity is a function of sales activity and other requirements.
Consolidated working capital decreased at March 31, 2017 compared to March 31, 2016 primarily due to a decrease in the cash and cash equivalents balance and an increase in drafts and accounts payable and deferred tax liabilities, partially offset by increases in receivables. Consolidated work