1. June 16, 2003
To our Stockholders:
In 1999 and early 2000, faced with a number of financial, operating and competitive
challenges, McKesson implemented a series of organizational and process
improvements. Since then, the company has outperformed our competitors on the key
measures of stockholder value creation: internally-generated revenue growth,
operating margin improvement and earnings per share gains. Here are the highlights
of our performance over the past year and the past three years. These are results from
continuing operations, using GAAP (Generally Accepted Accounting Principles)
measures, which we elected to adopt as our sole reporting method during Fiscal 2003:
Growth Rates
FY03 FY03 vs. FY00
Revenues excluding sales to customers' warehouses +15% + 51%
Total revenues +14% + 56%
Operating income +33% +769%
Net income +33% +207%
Earnings per fully diluted share +32% +192%
Return on equity + 13.3% +740 bp
In Fiscal 2003, cash flow from operations more than doubled, to a record $696 million.
We made significant investments in the future growth of our business and still ended
the year with an extremely strong balance sheet. Our net debt to net capital ratio is
14%, its lowest level ever. This excellent performance in Fiscal 2003 and over the past
three years demonstrates the value of our diversified business model, our integrated
selling strategy and our disciplined focus on return on capital. More than anything,
our results are an indication of the quality of our people and our focus on execution.
We believe that the processes we have put in place, the investments we have made in
our business, the strength of our markets and the needs of our customers for
McKesson solutions provide a solid foundation for continued revenue and profit
growth in Fiscal 2004.
Healthcare Market Opportunities
The quality and affordability of healthcare is a concern for employers as well as
employees and has become a major priority for both the President and Congress.
Nearly every day, some aspect of healthcare is the featured story on the front page of
the newspaper or on the evening news. More often than not, the point of the story is
that healthcare is out of control or becoming less affordable or, even worse, is hurting
people when it intends to help. Amidst this turmoil, McKesson sits at the center of the
action. We are uniquely positioned to help both our customers and our elected officials
2. solve the problems and right the ship by helping to deliver higher quality care to more
people at an affordable cost.
Let's look at two specific healthcare problems and how McKesson has played a role in
their solution. First, quality of care. Three years ago, the Institute of Medicine
estimated that up to 100,000 Americans die each year from preventable medical
errors. Many of these deaths come as a result of the patient receiving the wrong
medication or the wrong dose. Preventing these mistakes is a key objective for
hospital administrators today. In the mid-1990s, McKesson pioneered the use of
robotic dispensing and bedside scanning of bar-coded medications in hospitals. Our
technology helps ensure that the right patient is receiving the right drug in the right
dose at the right time.
On March 13 of this year, Health and Human Services Secretary Tommy Thompson
announced that the FDA will require bar coding on all hospital medications and will
enhance reporting requirements for safety problems involving medicines. FDA
Commissioner Mark McClellan described the actions as quot;quot;the start of a comprehensive
strategy to build a medical patient protection system for the 21st Century.'' McKesson
is the only company that provides a comprehensive system of robotics, scanning,
dispensing and software covering both oral and injectable medications to reduce
medication errors in the hospital. We call our approach Closed Loop Patient Safety.
To date, more than 250 hospitals are in various stages of adopting our technologies to
improve the quality of care at their institutions.
Second, affordability of care. Congress is actively considering new, bi-partisan
legislation to add a drug benefit to Medicare coverage for seniors, which is a positive
for both seniors and McKesson. Such coverage is not currently available, forcing many
seniors to make difficult and financially stressful decisions about their therapy. While
support has been gathering for this benefit for several years, McKesson took action.
Using our relationships with pharmaceutical manufacturers and drug retailers, along
with our capabilities for patient support services, McKesson helped create the
Together Rx card. This card provides discounts on medicines from seven
manufacturers for qualifying seniors. It was launched in June 2002 and is
administered by McKesson. Today, more than 750,000 seniors carry the Together Rx
card. Using the card, they have obtained more than $80 million in prescription
savings.
The signs of meaningful healthcare reform are encouraging and not a moment too
soon. Each year, millions of Baby Boomers are entering their senior years, a time
when consumption of medical care and medicines increases significantly. Most of
these individuals have enjoyed highquality healthcare benefits provided by their
employers and have participated actively in their own care. Their demand for
healthcare will be high. More importantly, their expectations for the affordability and
quality of that care are equally high. As a result, we expect a strong and sustained
market for the products and services that McKesson provides. According to industry
analysts, U.S. market growth for pharmaceuticals and healthcare information
technology should both be at least 10% in the coming year.
Unique Solutions for Customers
Our goal is to grow at, or above, market rates in each of our segments. To reach our
objective, we differentiate McKesson from our competition by offering our customers
3. more than simply basic distribution or information technology services. Our solutions
provide the additional benefits of sustainable high quality, workflow enhancements
and working capital improvements. We are transforming to a unified company selling
integrated, customer-oriented solutions. We provide a full range of solutions that
address the most critical issues of cost and quality for retail pharmacies, hospitals,
physician offices, nursing homes and payers. Our customers are looking for complete
solutions and McKesson has them. It's a strategy we call quot;One McKesson.quot;
We call the team that leads our One McKesson strategy McKesson Corporate
Solutions. During the past year, McKesson Corporate Solutions quarterbacked 55
large, multi-year agreements that will deliver annual revenues of more than $1.5
billion and total revenues over the life of the contracts of about $4.5 billion. The vast
majority of these agreements were with hospitals and health systems where the
contract included a McKesson solution that combined software, services, automation,
distribution and consulting. As a result, our growth in these product lines has been
exceptional. We had another fine year for new software orders, up 27%. During the
past year, our hospital pharmaceutical distribution revenue growth exceeded 20%,
well above the growth rate of the market. Our hospital automation business grew 25%
for the year, faster than the growth of our key competitors.
Continued Operating Improvements Drive Margin Expansion
We will continue to look for opportunities to bring the power of One McKesson to our
customers, extending to the retail segment the same kind of multi-business solutions
that we have brought so successfully to the institutional segment. However, we are
also focused on operational improvements across our business. These improvements
are designed to drive economic efficiencies, increase operating margins and improve
customer satisfaction. Customer satisfaction survey scores improved in each of our
segments in Fiscal 2003, showing that customers recognize the value we are bringing
to their organizations.
We have been heavily focused on improving the processes in our pharmaceutical
distribution operations. Over the past three years, our Pharmaceutical Solutions
operating margin has continued to expand. Increasing sales of higher margin generics
and close management of operating expenses have been significant contributors to our
margin expansion. For example, three years ago, our average pharmaceutical
distribution center revenue was less than $800 million annually and the ratio of
operating expenses to direct revenues was 3.77%. Last year, the average distribution
center revenue was almost $1.4 billion and our expense ratio was down to 2.88%. We
have used an approach called Six Sigma to analyze and improve our processes and
quality. Over the past three years, Six Sigma has achieved $40 million in net
operating savings in our Pharmaceutical Solutions segment. We are now expanding
its application broadly across McKesson.
The financial performance of our Medical-Surgical Solutions business has stabilized
and we are making good progress with our operating upgrades. We completed our
distribution center consolidation program and continued on schedule with conversions
to our new enterprise reporting system. These operating improvements should help
deliver better financial results for this business as the year progresses.
Over the past three years, we have made tremendous strides at McKesson
Information Solutions. Our large installed base of information systems customers is a
4. valuable asset to McKesson. Recognizing that, we have focused on improving
customer service, support and satisfaction, and on the development and successful
implementation of innovative new products designed to address specific needs. Our
software bookings, revenue growth and gains in customer satisfaction survey scores
demonstrate that customers appreciate the progress we have made on their behalf,
and are rewarding us with their loyalty. In Fiscal 2003, we made almost 1,900
individual software product sales, a significant increase from the prior year. These
agreements add to revenues, drive margin expansion and, most importantly,
strengthen our relationships with our installed base of customers. This provides a
great foundation for future purchases of software from McKesson. Over the past three
years, this business has improved its operating profit from essentially break-even to
almost $100 million. We expect continued improvement this year.
Well-Positioned for Continued Growth
Our progress across McKesson the past three years has been the result of favorable
market conditions, a well-developed strategy to differentiate our company and
improve its performance and great execution by our 24,500 employees. I am very
pleased with the integrity, dedication and accountability of our employees. We are
proud to be celebrating our 170th year of service in support of the American
healthcare industry this year.
McKesson is extremely well-positioned with a broad offering of timely and innovative
products and services that improve quality and reduce costs. Our people are the best
in the industry. We have a healthy and growing customer base. Our relationships
with customers and manufacturing partners are based on mutual value creation. Over
the long term, our objective is to build stockholder value by growing revenues at least
at market growth rates, gaining operating margin improvements through value-added
services and realizing cost efficiencies. This leverage should enable McKesson's
earnings to grow significantly faster than revenues over the long term. Our results
this year, and the past three years, underscore the value of this strategy and the
precision of our execution. I'm very pleased with our achievements and look forward
to strong performance again in Fiscal 2004.