MCKESSON CORPORATION
CONSOLIDATED FINANCIAL STATEMENTS
1998
CONSOLIDATED FINANCIAL STATEMENTS
CONTENTS
PAGE
----
Six-Year Highlights....................................................... 2
Financial Review.......................................................... 8
Statement of Management's Responsibility.................................. 21
Independent Auditors' Report.............................................. 23
Consolidated Financial Statements
Statements of Consolidated Income for the years ended March 31, 1998,
1997 and 1996.......................................................... 24
Consolidated Balance Sheets, March 31, 1998, 1997 and 1996.............. 25
Statements of Consolidated Stockholders' Equity for the years ended
March 31, 1998, 1997 and 1996.......................................... 26
Statements of Consolidated Cash Flows for the years ended March 31,
1998, 1997 and 1996.................................................... 28
Financial Notes......................................................... 29
1
SIX-YEAR HIGHLIGHTS
CONSOLIDATED OPERATIONS
YEARS ENDED MARCH 31
------------------------------------------------------------------------------------------------
1998 1997(1) 1996 1995 1994 1993
--------- --------- --------- --------- --------- ----------
(DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)
Revenues.................. $20,857.3 $15,710.8 $12,964.8 $12,324.1 $11,321.5 $10,598.9
Percent change........... 32.8% 21.2% 5.2% 8.9% 6.8% 14.2%
Gross profit(2)........... 1,521.3 1,037.3 915.5 808.2(2) 783.6 777.2
Percent of revenues...... 7.3% 6.6% 7.1% 6.6% 6.9% 7.3%
Operating profit.......... 403.9(3) 127.4(4) 245.7 90.6(5) 202.6 200.3
Percent of revenues...... 1.9% 0.8% 1.9% 0.7% 1.8% 1.9%
Operating profit before
unusual items(6)......... 434.5 274.4 245.7 215.2 202.6 200.3
Percent of revenues...... 2.1% 1.7% 1.9% 1.7% 1.8% 1.9%
Operating margin
(deficit)(7)............. 362.2(3) 92.8(4) 241.3 (9.0)(8) 153.6(9) 156.5
Percent of revenues...... 1.7% 0.6% 1.9% (0.1)% 1.4% 1.5%
Operating margin before
unusual items(6)......... 392.8 239.8 241.3 189.9 167.0 156.5
Percent of revenues...... 1.9% 1.5% 1.9% 1.5% 1.5% 1.5%
Interest expense.......... 102.5 55.7 44.4 44.5 39.3 47.5
Income (loss) before taxes
on income................ 259.7(3) 37.1(4) 196.9 (53.5)(8) 114.3(9) 109.0
Taxes on income........... 98.6(10) 31.3 76.2 96.6 (11) 45.0 42.2
Effective tax rate....... 38.0% 84.4% 38.7% -- 39.4% 38.7%
Dividends on preferred
securities of subsidiary
trust, net of tax
benefit.................. 6.2 0.7 -- -- -- --
Income (loss) after taxes
Continuing operations.... 154.9(3, 10) 5.1(4) 120.7 (150.1)(8, 11) 69.3(9) 66.8
Discontinued operations.. -- 128.8(12) 14.7 554.6 (13) 87.8(14) 47.9
Extraordinary item....... -- -- -- -- (4.2) --
Cumulative effect of
accounting change....... -- -- -- -- (16.7) --
Net income................ 154.9 133.9 135.4 404.5 136.2 114.7
Percent change........... 15.7% (1.1)% (66.5)% 197.0% 18.7% --
Average stockholders'
equity................... 1,322.6 990.6 1,043.3 808.3 623.1 581.5
Return on equity(15). 11.7% 13.5% 13.0% 50.0% 21.9% 19.7%
Depreciation and
amortization............. 87.2 71.8 64.2 59.1 54.5 53.0
EBITA(16)................. 373.1 91.0 217.2 (14.9) 159.5 157.0
Average committed
capital(17).............. 1,869.5 1,299.0 754.1 900.4 839.5 606.5
Return on committed
capital(18).............. 20.0% 7.0% 28.8% (1.7)% 19.0% 25.9%
Return on committed
capital(18) before
unusual items(6)......... 21.6% 18.3% 28.8% 20.4% 20.6% 25.9%
Common dividends declared. 46.3 43.3 44.7 56.5 66.9 64.0
Diluted earnings (loss)
per common share(19)
Continuing operations.... $ 1.59 $ 0.06 $ 1.29 $ (1.83) $ 0.75 $ 0.72
Discontinued operations.. -- 1.45 0.16 6.61 1.00 0.53
Extraordinary item....... -- -- -- -- (0.05) --
Cumulative effect of
accounting change....... -- -- -- -- (0.19) --
Total................... 1.59 1.51 1.45 4.78 1.51 1.25
2
- --------
(1) Includes the results of the FoxMeyer business from the acquisition date of
November 8, 1996 and of McKesson General Medical Corp. from the
acquisition date of February 21, 1997.
(2) Revenues less cost of sales, in fiscal 1995 includes $35.9 million of
charges for restructuring, asset impairment and other operating items,
0.3% of revenues.
(3) Includes $16.7 million in charges for the proposed merger with AmeriSource
and $13.9 million in costs associated primarily with the integration and
rationalization of recent acquisitions, 0.1% or revenues in the aggregate,
$25.4 million after-tax.
(4) Includes $98.8 million in charges for restructuring, asset impairment and
other operating items and $48.2 million for the write-off of in-process
technology related to the acquisition of Automated Healthcare, Inc., 0.9%
of revenues in the aggregate, $109.5 million after tax.
(5) Includes $124.6 million in charges for restructuring, asset impairment and
other operating items, 1.0% of revenues.
(6) Unusual items include those which management believes are either one-time
occurrences and/or events which are not related to normal, ongoing
operations or represent charges that are in excess of normal/historical
amounts. See notes 2, 3, 4, 5, 8 and 9.
(7) Income (loss) from continuing operations before interest expense, taxes on
income and dividends on preferred securities of subsidiary trust.
(8) Includes $59.4 million of compensation costs related to the sale of the
PCS business and $139.5 million of charges for restructuring, asset
impairment and other operating items, representing 1.6% of revenues in the
aggregate, $130.6 million after-tax.
(9) Includes a loss on the termination of interest rate swap arrangements of
$13.4 million, $8.2 million after-tax.
(10) Includes a $4.6 million favorable tax adjustment.
(11) Includes $107.0 million of income tax expense related to the sale of PCS.
(12) Includes gain on sale of Armor All of $120.2 million after-tax.
(13) Includes gain on sale of PCS of $576.7 million after-tax, write-down of
the Company's investment in Millbrook of $72.8 million after-tax, and
$1.0 million of income after-tax from a donation of Armor All stock to
the McKesson Foundation.
(14) Includes $32.7 million after-tax relating to a gain on the sale and
donation of Armor All stock.
(15) Based on net income.
(16) Earnings (loss) before interest-net, amortization and taxes on income.
(17) Capital employed less cash and cash equivalents, marketable securities
and intangibles.
(18) EBITA divided by average committed capital (capital employed less cash
and cash equivalents, marketable securities and intangibles).
(19) Restated in accordance with Statement of Financial Accounting Standards
No. 128 "Earnings per Share" and to reflect the two-for-one stock split
declared October 29, 1997, distributed January 2, 1998 to stockholders of
record on December 1, 1997.
3
SIX-YEAR HIGHLIGHTS
CONSOLIDATED FINANCIAL POSITION
YEARS ENDED MARCH 31
--------------------------------------------------------------------------------
1998 1997(/1/) 1996 1995 1994 1993
-------- --------- -------- -------- -------- --------
(DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)
Customer receivables..... $1,249.4 $1,180.4 $ 631.7 $ 635.6 $ 615.3 $ 605.3
Days of sales(2)........ 21.6 22.0 17.5 18.6 19.6 20.6
Inventories.............. 2,583.5 2,259.5 1,317.0 1,081.9 900.5 777.1
Days of sales(2)........ 48.1 45.5 39.3 33.8 30.7 28.5
Drafts and accounts
payable................. 2,145.3 2,065.4 1,343.2 1,229.8 1,061.5 999.9
Days of sales(2)........ 39.9 41.6 40.1 38.4 36.2 36.6
Current assets........... 4,105.6 3,761.1 2,463.0 2,464.2 1,627.9 1,490.0
Current liabilities...... 2,577.8 2,637.2 1,642.5 1,585.2 1,326.5 1,298.6
Working capital.......... 1,527.8 1,123.9 820.5 879.0 301.4 191.4
Percent of
revenues(2)............ 7.3% 5.8% 6.3% 7.1% 2.7% 1.8%
Property, plant and
equipment--net.......... 430.3 373.6 356.0 341.6 345.7 334.2
Percent of
revenues(2)............ 2.1% 1.9% 2.7% 2.8% 3.1% 3.2%
Capital expenditures..... 130.0 76.9 73.6 76.4 68.1 49.0
Total assets............. 5,607.5 5,172.8 3,360.2 3,260.2 2,676.6 2,458.4
Total debt(3)............ 1,204.2 985.2 398.3 425.1 499.0 397.6
Convertible preferred
securities.............. 195.4 194.8 -- -- -- --
Stockholders' equity..... 1,406.8 1,260.8 1,064.6 1,013.5 678.6 619.4
Capital employed(4)...... 2,806.4 2,440.8 1,462.9 1,438.6 1,177.6 1,017.0
Ratio of net debt to
capital employed(5).... 40.5% 34.2% -- -- 39.1% 34.1%
Diluted shares(6, 7)..... 101.2 89.4 93.2 83.9 87.8 89.5
Common shares outstanding
at March 31(7).......... 93.2 91.6 89.7 88.7 81.2 81.1
Dividends per common
share(7)................ 0.50 0.50 0.50 0.67 0.83 0.80
Cash distribution from
the sale of PCS per
common share............ -- -- -- 38.00(7, 8) -- --
Book value per common
share(7, 9)............. 15.09 13.76 11.87 11.43 8.19 7.50
Market price(7)
High.................... 61 5/8 34 1/8 27 13/16 54 5/8 34 1/4 23 9/16
Low..................... 31 1/2 20 9/16 18 5/8 15 1/16 19 5/16 15 1/8
At year end............. 57 3/4 32 25 5/8 20 3/16 29 3/4 22 3/8
- -------
(1) Includes the results of the FoxMeyer business from the acquisition date of
November 8, 1996 and of McKesson General Medical Corp. from the
acquisition date of February 21, 1997.
(2) Based on year-end balances and sales or cost of sales assuming major
acquisitions occurred at beginning of year.
(3) Total debt includes all interest-bearing debt and capitalized lease
obligations.
(4) Capital employed consists of total debt, convertible preferred securities
of subsidiary trust and stockholders' equity.
(5) Ratio computed as net debt (total debt less cash and cash equivalents and
marketable securities) to net capital employed (capital employed less cash
and cash equivalents and marketable securities).
(6) Restated in accordance with Statement of Financial Accounting Standards
No. 128 "Earnings per Share."
(7) Restated to reflect the two-for-one stock split declared October 29, 1997,
distributed January 2, 1998 to stockholders of record on December 1, 1997.
(8) Received by shareholders directly from Eli Lilly and Company.
(9) Stockholders' equity less preferred stock plus portion of ESOP notes and
guarantee related to the Series B ESOP preferred stock divided by year-end
common shares outstanding.
4
SIX-YEAR HIGHLIGHTS
REPORTING SEGMENTS
YEARS ENDED MARCH 31
-------------------------------------------------------------------------------
1998 1997(/1/) 1996 1995 1994 1993
--------- --------- --------- --------- --------- ---------
(DOLLARS IN MILLIONS)
HEALTH CARE SERVICES
Revenues................. $20,563.0 $15,415.9 $12,667.8 $12,063.1 $11,075.4 $10,360.5
Percent change.......... 33.4% 21.7% 5.0% 8.9% 6.9% 14.6%
Sales to customers'
warehouses.............. 2,703.9 2,824.1 3,011.1 2,888.1 2,800.7 2,607.2
Revenue excluding sales
to customers'
warehouses.............. 17,859.1 12,591.8 9,656.7 9,175.0 8,274.7 7,753.3
Percent change.......... 41.8% 30.4% 5.3% 10.9% 6.7% 11.1%
Operating profit......... 354.7(2) 92.8(3) 206.1 76.1(4) 165.6 169.9
Percent of revenues
excluding sales to
customers' warehouses.. 2.0% 0.7% 2.1% 0.8% 2.0% 2.2%
Operating profit
excluding unusual
items(5)................ 385.3 232.8 206.1 183.4 165.6 169.9
Percent of revenues
excluding sales to
customers' warehouses.. 2.2% 1.8% 2.1% 2.0% 2.0% 2.2%
EBITA(6)................. 371.5 99.1 213.0 83.1 172.5 176.0
EBITA(6) excluding
unusual items(5)........ 402.1 239.1 213.0 190.4 172.5 176.0
Average committed
capital(7).............. 1,985.4 1,309.9 833.7 794.0 634.0 448.8
Return(8)............... 18.7% 7.6% 25.5% 10.5% 27.2% 39.2%
Return(8) excluding
unusual items(5)....... 20.3% 18.3% 25.5% 24.0% 27.2% 39.2%
Segment assets........... 5,166.4 4,648.2 2,525.3 2,148.6 1,951.6 1,759.5
Capital expenditures..... 75.2 41.9 43.5 44.4 34.4 24.5
Depreciation............. 45.9 40.3 33.9 30.2 23.1 20.2
Amortization of
intangibles............. 16.8 6.3 6.9 7.0 6.9 6.1
WATER PRODUCTS
Revenues................. $ 282.9 $ 275.1 $ 259.3 $ 246.0 $ 240.3 $ 229.6
Percent change.......... 2.8% 6.1% 5.4% 2.4% 4.7% (1.4)%
Operating profit......... 49.2 34.6(9) 39.6 14.5(10) 37.0 30.4
Percent of revenues..... 17.4% 12.6% 15.3% 5.9% 15.4% 13.2%
Operating profit
excluding unusual
items(5)................ 49.2 41.6 39.6 31.8 37.0 30.4
Percent of revenues..... 17.4% 15.1% 15.3% 12.9% 15.4% 13.2%
EBITA(6)................. 49.3 34.7 39.7 14.7 37.0 30.4
EBITA(6) excluding
unusual items(5)........ 49.3 41.7 39.7 32.0 37.0 30.4
Average committed
capital(7).............. 118.1 113.9 111.1 119.5 117.9 106.9
Return(8)............... 41.7% 30.5% 35.7% 12.3% 31.4% 28.4%
Return(8) excluding
unusual items(5)....... 41.7% 36.6% 35.7% 26.8% 31.4% 28.4%
Segment assets........... 166.5 144.6 142.0 142.3 150.4 135.7
Capital expenditures..... 47.4 32.3 24.8 26.3 28.7 20.6
Depreciation............. 22.1 22.7 21.4 20.3 18.3 16.8
Amortization of
intangibles............. 0.1 0.1 0.1 0.2 -- --
5
- --------
(1) Includes the results of the FoxMeyer business from the acquisition date
of November 8, 1996 and of McKesson General Medical Corp. from the
acquisition date of February 21, 1997.
(2) Includes $16.7 million in charges for the proposed merger with
AmeriSource and $13.9 million in costs primarily associated with the
integration and rationalization of recent acquisitions, 0.1% of revenues
in the aggregate.
(3) Includes $91.8 million in charges for restructuring, asset impairment and
other operating items and $48.2 million for the write-off of in-process
technology related to the acquisition of Automated Healthcare, Inc., 0.9%
of revenues in the aggregate.
(4) Includes $107.3 million of charges for restructuring, asset impairment
and other operating items, 0.9% of revenues.
(5) Unusual items include those which management believes are either one-time
occurrences and/or events which are not related to normal, ongoing
operations or represent charges that are in excess of normal/historical
amounts. See notes 2, 3, 4, 9 and 10.
(6) Earnings before interest, amortization and taxes on income.
(7) Net assets of the segment less cash and cash equivalents and marketable
securities and intangibles.
(8) EBITA divided by average committed capital.
(9) Includes $7.0 million of charges for asset impairment, 2.5% of revenues.
(10) Includes $17.3 million of charges for restructuring, asset impairment and
other operating items, 7.0% of revenues.
6
SIX-YEAR HIGHLIGHTS
REPORTING SEGMENTS
YEARS ENDED MARCH 31
--------------------------------------------------------------------
1998 1997 1996 1995 1994 1993
------- ------- ------- ------- ------ ------
(DOLLARS IN MILLIONS)
CORPORATE
Revenues.............. $ 11.4 $ 19.8 $ 37.7 $ 15.0 $ 5.8 $ 8.8
Expenses.............. (47.7) (42.8) (35.5) (112.7)(1) (50.0)(2) (49.4)
Average committed
capital(3)........... (234.0) (124.8) (190.7) (13.1) 87.6 50.8
Total assets*......... 274.6 380.0 692.9 969.3 574.6 563.2
Capital expenditures.. 7.4 2.7 5.3 5.7 5.0 3.9
Depreciation.......... 2.3 2.4 1.9 1.4 6.2 9.9
*Total assets include:
Cash and cash
equivalents and
marketable
securities.......... 113.6(4) 229.8(4) 456.2 670.4 62.7 77.5
Net assets of
discontinued
operations in other
assets(5)......... -- -- 125.7 88.2 353.9 333.3
- --------
(1) Includes $74.3 million of expense related to compensation costs associated
with the sale of PCS and charges for restructuring, asset impairment and
other operating items.
(2) Includes a loss on the termination of interest rate swap arrangements of
$13.4 million.
(3) Net assets (liabilities) of the segment less cash and cash equivalents and
marketable securities and intangibles.
(4) Includes $76.7 million at March 31, 1998 and $109.8 million at March 31,
1997 which were restricted and held in trust as exchange property in
connection with the Company's outstanding exchangeable debentures.
(5) Includes the net assets of the Armor All, Millbrook, and PCS businesses
prior to their respective disposition dates.
7
FINANCIAL REVIEW
GENERAL
Management's discussion and analysis is intended to assist in the
understanding and assessment of significant changes and trends related to the
results of operations and financial condition of McKesson Corporation,
together with its subsidiaries (the "Company"). This discussion and analysis
should be read in conjunction with the Company's Consolidated Financial
Statements and accompanying notes.
PRIVATE SECURITIES LITIGATION REFORM SAFE HARBOR STATEMENT
In addition to historical information, management's discussion and analysis
and the accompanying letter to shareholders includes certain forward-looking
statements regarding events and financial trends which may affect the
Company's future operating results and financial position. Such statements are
subject to risks and uncertainties that could cause the Company's actual
results and financial position to differ materially. Also, words such as
"estimates", "expects", "anticipates", "plans", "believes" and similar
expressions identify forward-looking statements involving risks and
uncertainties. These include, but are not limited to: the speed of integration
of acquired businesses, the impact of continued intense competition, success
of strategic initiatives, implementation of new technologies, continued
industry consolidation, changes in customer mix, and changes in pharmaceutical
manufacturers' pricing or distribution policies. These and other risks and
uncertainties are described in the Company's 1998 Annual Report on Form 10K
and other public documents. Readers are cautioned not to place undue reliance
on these forward-looking statements, which speak only as of the date hereof.
The Company undertakes 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.
FISCAL 1998 OVERVIEW
McKesson Corporation (the "Company") is the leading health care supply
management company in North America. The Company also develops and manages
marketing programs for pharmaceutical manufacturers and, through McKesson
Water Products Company ("Water Products"), processes and markets pure drinking
water.
The Company's focus on health care and long-standing commitment to
technological innovation and new programs produced strong financial results in
fiscal 1998. Specific accomplishments included:
. 16% internal revenue growth (excluding the acquired FoxMeyer Corporation's
pharmaceutical distribution business ("FoxMeyer")) in the U.S.
pharmaceutical distribution business from expanded existing customer
relationships and new distribution agreements.
. 31 basis point improvement in the Health Care Services operating profit
margin before unusual items reflecting margin expansion in the base U.S.
pharmaceutical distribution business, the rapid integration of the acquired
FoxMeyer business and the favorable impact of the McKesson General Medical
Corp. ("MGM") acquisition. Both of these acquisitions were made during the
latter part of fiscal 1997.
. Significant progress in strategic initiatives launched in the prior year,
including:
- A substantial increase in the installed base of ROBOT-Rx/TM/ systems by
McKesson Automated Healthcare, Inc. ("MAH") in the current year.
- 70% growth in sales of McKesson Select Generics/SM/ in fiscal 1998 versus
the prior year.
- An increase of 88% in prescriptions processed through OmniLink/SM/ compared
to the prior year. OmniLink facilitates pharmacy compliance with managed
care requirements by providing on-line, real-time reimbursement
information and records at the point of dispensing.
8
FINANCIAL REVIEW--(CONTINUED)
RESULTS OF OPERATIONS
Fiscal 1998 net income was $154.9 million or $1.59 per diluted share. Fiscal
1998 results included $20.8 million of after-tax charges primarily for
acquisition-related activities and costs associated with the continued
integration and rationalization of fiscal 1998 and 1997 acquisitions into the
Company's operations and other workforce reductions designed to reduce the
Company's cost structure.
Fiscal 1997 net income was $133.9 million or $1.51 per diluted share. Income
from continuing operations was $5.1 million, which included $109.5 million of
after-tax charges associated with the integration and rationalization of the
FoxMeyer and McKesson distribution operations, systems, program offerings and
administrative functions, the write-off of purchased in-process technology and
other operating items. Income from discontinued operations was $128.8 million,
including a $120.2 million after-tax gain on the sale of the Company's
remaining interest in Armor All Products Corporation ("Armor All").
Fiscal 1996 net income was $135.4 million, or $1.45 per diluted share, which
included earnings from continuing operations of $120.7 million and earnings
from discontinued operations of $14.7 million.
The results of continuing operations include the following:
YEARS ENDED MARCH 31
----------------------------------------------------
1998 1997 1996
----------------- ----------------- ----------------
PRE- PRE- PRE-
TAX AFTER-TAX TAX AFTER-TAX TAX AFTER-TAX
------ --------- ------ --------- ------ ---------
(IN MILLIONS)
Income from Continuing
Operations
Before unusual items and
dividends on
convertible preferred
securities of
subsidiary trust....... $290.3 $181.9 $184.1 $115.3 $196.9 $120.7
Dividends on convertible
preferred securities of
subsidiary trust....... (6.2) (0.7)
------ ------ ------ ------ ------ ------
Before unusual items.... 290.3 175.7 184.1 114.6 196.9 120.7
Unusual Items(1)
Acquisition-related
costs and other costs,
primarily severance,
associated with the
integration
and rationalization of
recent acquisitions... (30.6) (25.4)
Charges for
restructuring, asset
impairment, purchased
in-process technology
and other operating
items................. (147.0) (109.5)
Favorable tax
adjustment............ 4.6
------ ------ ------ ------ ------ ------
Income from Continuing
Operations............... $259.7 $154.9 $ 37.1 $ 5.1 $196.9 $120.7
====== ====== ====== ====== ====== ======
- --------
(1) For the purposes of discussing the results of operations, these items are
referred to as "unusual items" in the Financial Review as management
believes that these items either represent one-time occurrences and/or
events which are not related to normal, ongoing operations or represent
charges that are in excess of normal/historical operating amounts.
9
FINANCIAL REVIEW--(CONTINUED)
Fiscal 1998
Fiscal 1998 income from continuing operations before unusual items was
$175.7 million, a 53% increase over the prior year's income from continuing
operations before unusual items of $114.6 million. Fiscal 1998 results reflect
internal growth, operating margin expansion and the full-year effect of
acquisitions made late in the prior fiscal year.
Unusual Items
In the fourth quarter of fiscal 1998, the Company took a pre-tax charge of
$30.6 million primarily for acquisition-related activities, including $16.7
million for transaction costs incurred during the year in connection with a
pending merger with AmeriSource Health Corporation ("AmeriSource"), a leading
U.S. wholesale distributor of pharmaceutical and related healthcare products
and services. On September 23, 1997, the Company and AmeriSource jointly
announced that they had signed a definitive merger agreement providing for the
acquisition of AmeriSource by the Company. On March 9, 1998, the Federal Trade
Commission ("FTC") filed a complaint seeking a preliminary injunction to halt
the merger. The Company and AmeriSource have each announced they will oppose
the FTC's motion for preliminary injunction. A hearing on the FTC's motion is
expected to begin June 9, 1998. Although the merger and transactions
contemplated thereby have been approved by stockholders of both companies,
there can be no assurance that the companies will prevail in their opposition
to the FTC's complaint, that the merger will be completed, that it will be
completed as contemplated or what the results of the merger might be. In light
of this uncertainty, management deemed it appropriate to write off transaction
costs incurred to date.
In addition, the Company took a pre-tax charge of $13.9 million primarily
for severance costs associated with the integration and rationalization of the
FoxMeyer, MGM and Drug Trading Company, Limited ("Drug Trading") businesses
into the Company's operations, including workforce reductions designed to
reduce cost structure. Partially offsetting the impact of the aforementioned
charges was the recognition of a favorable $4.6 million tax adjustment
resulting from the completion of tax audits for certain prior years.
Acquisitions
In fiscal 1998, the Company's Canadian health care distribution business,
Medis Health and Pharmaceutical Services Inc. ("Medis") announced an agreement
with Drug Trading to acquire Drug Trading's retail customers over a transition
period. This transition began in August 1997 and was substantially completed
by the end of the fiscal year. The acquisition was funded with proceeds from
operations and short-term borrowings. In fiscal 1998 the Company also made
several smaller acquisitions in the core healthcare business.
Fiscal 1997
Fiscal 1997 income from continuing operations, before unusual items, was
$114.6 million, a 5% decrease from the prior year's income from continuing
operations of $120.7 million. Fiscal 1997 results were negatively impacted by
the temporary dilutive effect of acquisitions discussed below and investments
in strategic initiatives geared toward enhancing the Company's competitive
position in the institutional and retail markets and to improving productivity
through automated logistics.
Unusual Items
Included in the $147 million of unusual items in fiscal 1997 are $67.4
million of charges associated primarily with the acquisition of FoxMeyer. The
acquisition of the assets and operations of FoxMeyer resulted in a significant
increase in sales volume, a substantial change in the customer mix (primarily
10
FINANCIAL REVIEW--(CONTINUED)
a large increase in institutional customers), and overlapping, duplicate and
"similar purpose" assets. In fiscal 1997, management assessed the Company's
operations, distribution center network and business strategies, including
program offerings in light of the FoxMeyer acquisition. A plan was developed
and executed during the latter part of fiscal 1997 and fiscal 1998 to optimize
the network configuration from the combined distribution centers of the
Company and those acquired in the transaction which has resulted in the
consolidation and closure of 15 distribution centers, workforce reductions,
and disposal of excess, duplicate assets. Management also reassessed
strategies and program offerings for expanding certain customer segments in
light of the larger and more diverse customer base and identified certain
programs and investments that would no longer be pursued as originally
contemplated. Other duplicate, common purpose assets including administrative
facilities, software and other equipment were reviewed to identify the optimum
mix for the combined companies. This resulted in the impairment in the value
of certain assets which were not retained or utilized as originally intended.
The foregoing was reflected in the valuation of the FoxMeyer assets acquired
and liabilities assumed, and resulted in a $67.4 million pre-tax charge with
respect to the affected assets of the Company.
Also included in the fiscal 1997 unusual items was a $48.2 million charge to
write off the portion of the purchase price of MAH allocated to purchased in-
process technology for which feasibility had not been established as of the
acquisition date, and charges of $15.1 million and $16.3 million for
receivable reserves and other operating items, respectively.
Acquisitions
In April 1996, the Company acquired MAH for $61.4 million in cash and the
assumption of $3.2 million of employee stock incentives. MAH designs,
manufactures, sells, and installs automated pharmaceutical dispensing
equipment for use by health care institutions. The acquisition was accounted
for under the purchase method. Goodwill relating to the acquisition of
approximately $13.4 million is being amortized on a straight-line basis over
ten years. A $48.2 million charge was recorded to write off the portion of the
purchase price allocated to technology for which technological feasibility had
not been established as of the acquisition date. Existing technology was
valued at $0.4 million and is being amortized on a straight-line basis over
three years.
In November 1996, the Company acquired FoxMeyer for approximately $598
million, pursuant to an expedited auction process in the FoxMeyer Corporation
bankruptcy proceeding in Wilmington, Delaware. The Company paid approximately
$23 million in cash to the debtors, paid off approximately $500 million in
secured debt, and assumed an additional $75 million in other liabilities. The
Company utilized proceeds from commercial paper issuances and a note payable
to a bank to fund the transaction. The note payable was repaid prior to March
31, 1997, with cash flow from operations and proceeds from divestitures (see
"Divestitures" section on the following page). The Company acquired assets
consisting primarily of accounts receivable and inventories of $650 million,
customer contracts, and fixed assets. This acquisition was accounted for under
the purchase method. At the time of the acquisition, FoxMeyer was receiving
very little trade credit from suppliers. Normal trade credit was restored
subsequent to the acquisition, resulting in a reduction in the investment
associated with the retained FoxMeyer customer base to approximately $400
million at March 31, 1997. The excess of the fair value of the net assets
acquired over the purchase price, after reducing to zero the carrying value of
long-term assets which were expected to be retained for use by the Company,
was approximately $30 million (negative goodwill). Negative goodwill is being
amortized on a straight-line basis over a five-year period.
In February 1997, the Company acquired MGM for approximately $775 million,
including the issuance of 5.6 million shares of the Company's common stock and
the assumption of approximately
11
FINANCIAL REVIEW--(CONTINUED)
$428 million in debt. MGM is the nation's leading supplier of medical-surgical
supplies to the full range of alternate-site health care facilities, including
physicians and clinics, long-term care and home-care sites, and is the third
largest distributor of medical-surgical supplies to hospitals. The acquisition
was accounted for under the purchase method. The excess of the purchase price
over the fair value of the net assets acquired was approximately $600 million
and is being amortized on a straight-line basis over 40 years.
Divestitures
In December 1996, the Company sold its 55% equity interest in Armor All
Products Corporation ("Armor All") to The Clorox Company for $221.9 million
and recognized an after-tax gain of $120.2 million.
In March 1997, the Company sold its service merchandising unit, Millbrook
Distribution Services, Inc. ("Millbrook") to R.A.B. Holdings, Inc. The after-
tax proceeds on the sale approximated Millbrook's book value.
The Armor All and Millbrook segments have been classified as discontinued
operations for all periods presented.
In March 1997, the Company sold its Aqua-Vend vended water business ("Aqua-
Vend"), a unit of the Water Products segment. The after-tax proceeds on the
sale approximated its book value, after giving effect to the $7.0 million pre-
tax provision for the impairment of certain Aqua-Vend assets recorded in the
third quarter of fiscal 1997.
Fiscal 1996
Fiscal 1996 income from continuing operations was $120.7 million, an
increase of 38% over the prior year's income from continuing operations
(before unusual items) of $87.5 million, reflecting increased profits in
Health Care Services and Water Products, as well as additional interest
income.
BUSINESS SEGMENTS
Health Care Services is the Company's primary business and includes the U.S.
pharmaceutical, health care products, and medical-surgical supplies
distribution businesses. U.S. Health Care Services operations also include
marketing and other support services to drug manufacturers, a manufacturer of
automated pharmaceutical-dispensing systems for hospitals and a distributor of
first-aid products and supplies to industrial and commercial customers. Health
Care Services also includes the Company's international pharmaceutical
distribution business (consisting of the Company's Canadian operations and an
equity interest in a Mexican distribution business).
Water Products is engaged in the processing, delivery and sale of bottled
drinking water to homes and businesses in California, Arizona, Nevada,
Oklahoma, Washington, New Mexico and Texas. It also sells packaged water
through retail stores.
REVENUE GROWTH
Fiscal 1998 revenues, including sales to customers' warehouses, increased
$5.1 billion, or 33% to $20.9 billion. Revenues increased 21% to $15.7 billion
in fiscal 1997 from fiscal 1996. Reported revenues include large volume sales
of pharmaceuticals to major self-warehousing drug chain stores, whereby the
Company acts as an intermediary in the order and subsequent delivery of
products directly from the manufacturer to the customers' warehouses. Revenues
excluding such sales to
12
FINANCIAL REVIEW--(CONTINUED)
customers' warehouses increased 41% to $18.2 billion in fiscal 1998 and 29% to
$12.9 billion in fiscal 1997. The following table identifies the components of
revenue growth (excluding sales to customers' warehouses) over the past three
fiscal years:
YEARS ENDED
MARCH 31
----------------
1998 1997 1996
---- ---- ----
Existing business............................................. 13% 14% 5%
Growth from acquired businesses............................... 28 15 --
--- --- ---
Total revenue growth........................................ 41% 29% 5%
=== === ===
Revenue from existing business, excluding sales to customers' warehouses and
the effects of fiscal 1998 and 1997 acquisitions, in the Health Care Services
segment increased by $1.5 billion or 13% in fiscal 1998 compared with
increases of 14% and 5% in fiscal 1997 and 1996, respectively. Internal growth
in U.S. Health Care Services was 16% in fiscal 1998 reflecting institutional
growth of 27%, retail chain growth of 19% and increased sales to independent
pharmacies of 5%. The fiscal 1998 growth was primarily volume related,
reflecting growth from existing customers and new distribution agreements.
International revenues, excluding the effect of the Drug Trading acquisition,
declined modestly reflecting the completion of the phased transition of a
major customer to self-warehousing early in the year. Revenues from acquired
businesses were $5.3 billion and relate primarily to the FoxMeyer, MGM and
Drug Trading acquisitions.
Fiscal 1997 internal growth in U.S. Health Care Services was 17% reflecting
growth in all customer segments (independent, retail chain and institutional)
and was volume related. International revenues were flat reflecting the phased
transition of a major customer at Medis to self-warehousing. Fiscal 1997
revenues from acquired businesses were $1.5 billion and relate primarily to
the FoxMeyer and MGM acquisitions.
The practice in the Health Care Services distribution business is to pass on
to customers published price changes from suppliers. In each of fiscal 1998,
1997, and 1996, prices declined on many generic pharmaceutical products sold
by the Health Care Services business. These price declines were offset, in
part, by moderate inflation on other product lines, which resulted in almost
no net price changes in each year.
Water Products revenues increased 3% in fiscal 1998 to $282.9 million and 6%
to $275.1 million in fiscal 1997. The increases in both years resulted
primarily from higher packaged water sales to the grocery trade and moderate
growth in the direct-delivery business. Fiscal 1997 revenues included $16.0
million from the Aqua-Vend vended water business that was sold in March 1997.
Factoring out the Aqua-Vend business, revenues increased 9% in fiscal 1998.
Corporate revenues declined by $8.4 million to $11.4 million in fiscal 1998
and by $17.9 million to $19.8 million in fiscal 1997 primarily due to
decreased interest income as a result of lower balances in cash and marketable
securities available for sale.
OPERATING PROFIT
Operating profit before unusual items for the Company increased 58% to
$434.5 million in fiscal 1998 and increased 12% to $274.4 million in fiscal
1997 due primarily to increases in the Health Care Services segment.
Health Care Services operating profit before unusual items rose 66% to
$385.3 million in fiscal 1998, primarily reflecting internal growth and margin
expansion in the base U.S. pharmaceutical
13
FINANCIAL REVIEW--(CONTINUED)
distribution business, the rapid integration of FoxMeyer, the impact of the
February 1997 MGM acquisition and growth in higher margin product offerings.
Operating profit for Health Care Services included charges of $30.6 million
for unusual items in fiscal 1998.
Health Care Services operating profit before unusual items rose 13% to
$232.8 million in fiscal 1997, reflecting the increase in revenues and margin
improvement in the base U.S. Health Care Services business. Continued
reductions in selling margins in U.S. Health Care were more than offset by
product management efforts under the Company's proprietary generic
pharmaceutical program and other inventory programs, as well as operating
expense efficiencies. The rate of growth was moderated by the effects of the
acquisitions and dilution from internal strategic initiatives. In addition,
international operating profits were lower due to the previously discussed
loss of a major customer by Medis and lower margins on the replacement
business and costs associated with consolidations of distribution centers and
administrative functions. Operating profit for Health Care Services included
charges of $140.0 million for unusual items in fiscal 1997.
The Company uses the last-in, first-out (LIFO) method of accounting for the
majority of its inventories which results in cost of sales that more closely
reflect replacement cost than other accounting methods, thereby mitigating the
effects of inflation and deflation on operating profit. The practice in the
Health Care Services distribution businesses is to pass published price
changes from suppliers on to customers. Manufacturers generally provide the
Company with price protection, which prevents inventory losses from
manufacturer price decreases. As previously discussed, price declines on many
generic pharmaceutical products in the Health Care Services segment in each of
the fiscal years ending March 31, 1998, 1997, and 1996 moderated the effects
of inflation in other product categories, which resulted in minimal overall
price changes in those fiscal years.
Water Products operating profit before unusual items increased 18% to $49.2
million in fiscal 1998 reflecting strong growth in grocery sales and
productivity improvements.
Water Products operating profit before unusual items increased 5% to $41.6
million in fiscal 1997 reflecting the 6% sales increase offset, in part, by
expenses associated with the continuing geographic expansion into Texas and
the Pacific Northwest. Operating profit for Water included $7.0 million of
unusual items in fiscal 1997 related to a write-down of assets of its Aqua-
Vend unit.
The following table summarizes operating profit as a percent of revenues by
segment:
AS A PERCENT OF REVENUE(1)
-----------------------------------------
1998 1997 1996
--------- --------- ---------
Health Care Services.............. 2.0%(2) 0.7%(3) 2.1%
Water Products.................... 17.4 12.6 (4) 15.3
- --------
(1) Excluding sales to customers' warehouses.
(2) Excluding fiscal 1998 unusual items, the percentage is 2.2%.
(3) Excluding fiscal 1997 unusual items, the percentage is 1.8%.
(4) Excluding fiscal 1997 unusual items, the percentage is 15.1%.
The improvement in the Health Care Services operating profit margin before
unusual items in fiscal 1998 reflects the accretive impact of fiscal 1997
acquisitions, productivity improvements in the base business and growth in
higher margin product offerings. The improvement in the Water Products
operating profit margin is primarily the result of operating efficiencies.
The decline in the Health Care Services operating profit margin before
unusual items in fiscal 1997 reflects the previously discussed effects of the
acquisitions, internal strategic initiatives and lower
14
FINANCIAL REVIEW--(CONTINUED)
international margins due to a change in customer mix and costs associated
with distribution center and administrative consolidations. These declines
were offset, in part, by a six basis point improvement in operating profit
margins in the U.S. Health Care Services base business reflecting productivity
improvements. Absent the effects of the acquisitions and strategic
initiatives, the Health Care Services operating profit before unusual items
was 2.1% in fiscal 1997, unchanged from the prior year.
The following table identifies the operating margin (income before interest
expense, taxes on income and dividends on preferred securities of subsidiary
trust as a percent of revenues) components for the past three years.
AS A PERCENT OF REVENUE(1)
-------------------------------------------
1998 1997 1996
--------- --------- ---------
Gross profit margin.............. 8.4% 8.0% 9.2%
Operating expenses............... 6.4 (2) 7.3 (3) 6.8
--------- --------- ---------
Operating margin................. 2.0%(2) 0.7%(3) 2.4%
========= ========= =========
- --------
(1) Excluding sales to customers' warehouses.
(2) Excluding fiscal 1998 unusual items, operating expenses are 6.2% and the
operating margin is 2.2%.
(3) Excluding fiscal 1997 unusual items, operating expenses are 6.2% and the
operating margin is 1.8%.
The increase in the operating margin in fiscal 1998 reflects the full-year
impact of the higher-margin medical-surgical distribution business, the
elimination of duplicate costs associated with the FoxMeyer acquisition,
volume increases in higher-margin products and operating profit margin
expansion in the base U.S. pharmaceutical distribution business. The increase
in the gross profit ratio in the current year primarily reflects the greater
mix of medical-surgical distribution business.
The decline in the operating margin in fiscal 1997 (excluding unusual items)
reflects duplicate costs associated with the FoxMeyer acquisition that were
eliminated by the end of fiscal 1998 through the consolidation of distribution
centers and administrative functions. In addition, the margin was negatively
impacted by the previously discussed internal strategic initiatives and lower
international margins.
INTERNATIONAL OPERATIONS
International operations accounted for 8%, 12% and 16% of fiscal 1998, 1997
and 1996 consolidated operating profits before unusual items, and 7%, 5% and
7% of consolidated assets at March 31, 1998, 1997 and 1996, respectively.
International operations are subject to certain opportunities and risks,
including currency fluctuations. The Company monitors its operations and
adopts strategies responsive to changes in the economic and political
environment in each of the countries in which it operates.
WORKING CAPITAL
Operating working capital (receivables and FIFO inventories net of related
payables) as a percent of revenues was 9.9%, 8.8%, and 7.2% at March 31, 1998,
1997 and 1996, respectively. The calculation is based on year-end balances and
assumes major acquisitions occurred at the beginning of the year. The increase
in the operating working capital ratio in fiscal 1998 primarily reflects
revised payment terms with certain vendors in the medical-surgical
distribution business and the timing of vendor payments in the U.S.
pharmaceutical distribution business.
15
FINANCIAL REVIEW--(CONTINUED)
CASH FLOW AND LIQUIDITY
Cash and cash equivalents and marketable securities (primarily U.S. Treasury
securities with maturities of one year or less) were $114 million, $230
million, and $456 million at March 31, 1998, 1997 and 1996, respectively. The
March 31, 1998 and 1997 balances include $77 million and $110 million,
respectively, from the sale of Armor All, which is restricted and held in
trust as exchange property in connection with the Company's exchangeable
debentures.
Cash Flow from Operations for Capital Expenditures
The following table summarizes the excess (deficit) of cash flow from
operations over capital expenditures:
YEARS ENDED
MARCH 31
------------------
1998 1997 1996
----- ---- -----
(IN MILLIONS)
Net cash provided (used) by continuing operations
Income from continuing operations...................... $ 155 $ 5 $ 121
Depreciation........................................... 70 65 57
Amortization of intangibles............................ 17 6 7
Gain on sale of subsidiary............................. -- -- (11)
Other noncash charges.................................. 96 148 49
Working capital changes................................ (333) 3 (212)
----- ---- -----
Total................................................. 5 227 11
Capital expenditures................................... (130) (77) (74)
----- ---- -----
Excess (deficit)...................................... $(125) $150 $ (63)
===== ==== =====
Cash flow from continuing operations reflects the cash earnings of the
Company's continuing businesses and the effects of the changes in working
capital. The working capital increase in fiscal 1998 primarily reflects the
13% internal growth in the business, revised payment terms with certain
vendors in the medical-surgical distribution business and the timing of vendor
payments in the U.S. pharmaceutical distribution business. Working capital
changes in fiscal 1997 were favorably impacted by the previously discussed
restoration of trade credit from suppliers of FoxMeyer related to purchases
following the acquisition. The Company expects to generate funds in excess of
capital expenditure requirements over the next three years as current working
capital initiatives are fully implemented.
Capital expenditures for the fiscal years ended March 31, 1998, 1997 and
1996 for the Health Care Services segment were $75 million, $42 million, and
$44 million, respectively, and for the Water Products segment were $47
million, $32 million, and $25 million, respectively. The growth in fiscal 1998
capital expenditures for the Health Care Services segment reflects expansion
of certain facilities in conjunction with the integration and rationalization
of the FoxMeyer, MGM and Drug Trading businesses. The increase in capital
expenditures for the Water Products segment reflects expenditures for
processing plants to support the expansion into Texas and the Pacific
Northwest.
Other Financing Activities
In October 1997, a subsidiary of the Company issued $125 million of fixed-
rate debt which matures on November 1, 2002. Proceeds were used to pay down
short-term borrowings of the Company's Canadian subsidiary, Medis.
In February 1998, the Company issued fixed-rate unsubordinated debt totaling
$300 million to finance internal growth. $150 million matures on March 1, 2005
and the remaining $150 million matures on March 1, 2008.
16
FINANCIAL REVIEW--(CONTINUED)
During fiscal 1997 and 1996, the Company repurchased 6.8 million and 2.7
million of its common shares for $156 million and $63 million, respectively,
as part of a share repurchase program that was placed on hold in January 1997.
In February, 1997, the Company issued approximately 5.6 million common shares
in conjunction with the MGM acquisition.
In fiscal 1997, the Company, through a wholly-owned subsidiary trust, issued
$200 million of trust convertible preferred securities to fund internal
growth. These securities are convertible into approximately 5.4 million common
shares, yield a 5% dividend and are callable by the Company beginning in March
2000 at 103.5% of par.
Also in fiscal 1997, the Company issued $525 million of fixed rate debt to
term out the financing of the MGM transaction including the refinancing of
higher cost debt assumed in the acquisition.
The Company has $750 million of available credit under committed revolving
credit lines. As a result of the Company's investment grade credit rating (S&P
A-, Duff & Phelps A and Moody's A3), management believes the Company has
access to additional private credit sources and to public capital markets at
favorable terms. Funds necessary for future debt maturities and other cash
requirements of the Company are expected to be met by existing cash balances,
cash flow from operations, existing credit sources or other capital market
transactions.
MARKET RISK
The Company's major risk exposure is changing interest rates, primarily in
the United States. The Company manages interest rates through the use of a
combination of fixed and floating rate debt. Interest rate swaps may be used
to adjust interest rate exposures when appropriate, based upon market
conditions. These contracts are entered into with major financial institutions
thereby minimizing the risk of credit loss.
If interest rates on existing variable-rate debt rose 65 basis points, the
Company's results from operations and cash flows would not be materially
affected.
The Company conducts business in Canada and Mexico and is subject to foreign
currency exchange risk on cash flows related to sales, expenses, financing and
investment transactions. Aggregate foreign exchange translation gains and
losses included in net income and in equity are discussed in Note 1 on pages
29 to 31 of the accompanying financial statements.
17
FINANCIAL REVIEW--(CONTINUED)
CAPITALIZATION
The Company's capitalization was as follows:
MARCH 31
----------------------
1998 1997 1996
------ ------ ------
(IN MILLIONS)
Short-term borrowings............................... $ -- $ 100 $ 7
Term debt........................................... 1,091 725 211
Exchangeable debt................................... 113 160 180
------ ------ ------
Total debt......................................... 1,204 985 398
Convertible preferred securities of subsidiary
trust.............................................. 195 195 --
Stockholders' equity................................ 1,407 1,261 1,065
------ ------ ------
Total capitalization............................... $2,806 $2,441 $1,463
====== ====== ======
Debt-to-capital ratio at March 31................... 42.9% 40.4% 27.2%
Net debt-to-capital ratio at March 31(1)............ 40.5% 34.2% --
Average interest rate during year
Total debt......................................... 6.5% 5.9% 6.2%
Short-term borrowings.............................. 5.6 5.7 7.3
Other debt......................................... 7.0 6.1 6.0
- --------
(1) Ratio computed as net debt (total debt less cash and cash equivalents and
marketable securities) to net capital employed (capital employed less cash
and cash equivalents and marketable securities).
Increases in the debt-to-capital ratio primarily reflect the increase in
debt to fund internal growth and acquisitions in fiscal 1998 and 1997, and
share repurchases in fiscal 1997.
On a post-split basis, average diluted shares were 101.2 million in fiscal
1998, 89.4 million in fiscal 1997 and 93.2 million in fiscal 1996. Common
shares outstanding increased to 93.2 million at March 31, 1998 from 91.6
million at March 31, 1997 due primarily to issuance of shares under employee
plans. Common shares outstanding increased to 91.6 million at March 31, 1997
from 89.7 million at March 31, 1996 due primarily to shares issued in
connection with the acquisition of MGM and issuance of shares under employee
plans, in excess of the shares repurchased during the year.
18
FINANCIAL REVIEW--(CONTINUED)
CAPITAL EMPLOYED
Capital employed (net assets) by segment was:
MARCH 31
----------------------------------------------
1998 1997 1996
------ ------ ------
(IN MILLIONS)
Health Care Services
Intangibles................ $ 764 $ 748 $ 195
Committed capital(1)....... 2,105 1,691 954
------ ------ ------
Total Health Care
Services................. 2,869 2,439 1,149
Water Products.............. 133 108 110
------ ------ ------
Total Operations.......... 3,002 2,547 1,259
Corporate
Cash and cash equivalents
and marketable securities. 114 230 456
Discontinued operations.... -- -- 126
Other...................... (310) (336) (378)
------ ------ ------
Total capital employed.... $2,806 $2,441 $1,463
====== ====== ======
Returns
Health Care Services
Committed capital(2)...... 18.7%(3) 7.6%(3) 25.5%
Total capital
employed(4).............. 12.6 (5) 6.1 (5) 19.8
Water Products
Total capital
employed(4).............. 39.2 29.1 (6) 34.7
Total Consolidated
Operations
Committed capital(2)....... 20.0%(7) 7.0%(7) 28.8%
Total capital
employed(8)............... 12.8 (9) 5.4 (9) 15.8
Return on average stockhold-
ers' equity................ 11.7%(10) 13.5%(10, 11) 13.0%
- --------
(1) Capital employed less cash and cash equivalents, marketable securities
and intangibles.
(2) Earnings before interest, amortization and taxes on income divided by
average committed capital.
(3) Excluding unusual items, Health Care Services return on committed capital
is 20.3% and 18.3% in fiscal 1998 and 1997.
(4) Operating profit divided by average capital employed.
(5) Excluding unusual items, Health Care Services return on total capital is
employed is 13.7% and 15.2% in fiscal 1998 and 1997.
(6) Excluding unusual items, Water Products return on total capital employed
is 35.0% in fiscal 1997.
(7) Excluding unusual items, consolidated return on committed capital is
21.6% and 18.3% in fiscal 1998 and 1997.
(8) Income from continuing operations before taxes, interest expense and
dividends on convertible preferred securities of subsidiary trust divided
by average capital employed.
(9) Excluding unusual items, consolidated return on total capital employed is
13.9% in fiscal 1998 and 1997.
(10) Excluding unusual items and gain on sale of Armor All, return on
stockholders' equity is 13.3% and 12.4% in fiscal 1998 and 1997.
(11) Net income includes a $120.2 million gain on the sale of Armor All in
fiscal 1997.
The increase in capital employed in Health Care Services in fiscal 1998
reflects the Drug Trading acquisition, capital spending relating to the
integration and rationalization of the FoxMeyer, MGM and Drug Trading
businesses and growth in working capital to support the 13% revenue growth
from existing businesses. The increase in capital employed in Health Care
Services in fiscal 1997 is due to the acquisitions and the increased
investment spending for retail and institutional strategic initiatives.
19
FINANCIAL REVIEW--(CONCLUDED)
The returns on average total capital employed before unusual items in the
Health Care Services segment and for the Company as a whole in fiscal 1998
were impacted by the full year effect of the goodwill from the acquired
medical-surgical distribution business. The returns on average total capital
employed before unusual items in the Health Care Services segment and for
total consolidated operations declined in fiscal 1997 from fiscal 1996 due
primarily to the previously discussed effects of the acquisitions and
strategic initiatives.
ENVIRONMENTAL MATTERS
The Company's continuing operations do not require ongoing material
expenditures to comply with federal, state and local environmental laws and
regulations. However, in connection with the disposition of its chemical
operations in fiscal 1987, the Company retained responsibility for certain
environmental obligations. In addition, the Company is a party to a number of
proceedings brought under the Comprehensive Environmental Response,
Compensation and Liability Act, (commonly known as "Superfund"), and other
federal and state environmental statutes primarily involving sites associated
with the operation of the Company's former chemical distribution businesses. A
$1.5 million reduction to the reserves for these environmental matters was
recorded within discontinued operations in fiscal 1996. There were no
adjustments made to the reserves in fiscal 1998 and 1997. Management does not
believe that changes in the remediation cost estimates in future periods, or
the ultimate resolution of the Company's environmental matters, will have a
material impact on the Company's consolidated financial position or results of
operations. See Note 16, "Other Commitments and Contingent Liabilities" on
pages 50 to 53 of the accompanying financial statements.
INCOME TAXES
The tax rate on income from continuing operations (excluding fiscal 1998 and
1997 unusual items) was 37.3% in fiscal 1998, 37.4% in fiscal 1997 and 38.7%
in fiscal 1996. The decline in the effective tax rate in fiscal 1998 reflects
the positive effect of a refinancing of Canadian debt in a more tax-efficient
manner. The decline in the effective tax rate in fiscal 1997 is due primarily
to the inclusion of a higher amount of non-taxable income, primarily life
insurance gains, in fiscal 1997's results.
YEAR 2000 PROJECT
The Company relies heavily on computer technologies to operate its business.
The Company has conducted an assessment of its computer systems and has begun
to make the changes necessary to make these systems Year 2000 compliant. The
Company believes that with modifications to or replacements of its existing
computer-based systems, it will be Year 2000 compliant by March 31, 1999,
although the Company cannot provide any assurance in this regard. Company
systems rely in part on the computer-based systems of its trading partners. As
part of the Company's assessment, an overview of certain of its trading
partners' Year 2000 compliance strategies is being performed and the Company
plans to conduct extensive systems testing with such trading partners during
calendar year 1999. Nevertheless, if any trading partner or other entity upon
which they rely failed to become Year 2000 compliant, McKesson could be
adversely affected. The Company incurred approximately $7 million in fiscal
1998 and expects to incur between $10 and $15 million in each of the next two
fiscal years in costs associated with modifications to the Company's existing
systems to make them Year 2000 compliant and related testing, including
planned testing with trading partners. Such costs are being expensed as
incurred. Year 2000 project costs are difficult to estimate accurately and the
projected cost could change due to unanticipated technological difficulties,
project vendor delays and project vendor cost overruns.
NEW ACCOUNTING PRONOUNCEMENTS
See Note 1 "Significant Accounting Policies" on pages 29 to 31 of the
accompanying financial statements.
20
STATEMENT OF MANAGEMENT'S RESPONSIBILITY
Management is responsible for the preparation and accuracy of the
consolidated financial statements and other information included in this
report. The financial statements have been prepared in conformity with
generally accepted accounting principles using, where appropriate,
management's best estimates and judgments.
In meeting its responsibility for the reliability of the financial
statements, management has developed and relies on the Company's system of
internal accounting control. The system is designed to provide reasonable
assurance that assets are safeguarded and that transactions are executed as
authorized and are properly recorded. The system is augmented by written
policies and procedures and an internal audit department.
The Board of Directors reviews the financial statements and reporting
practices of the Company through its Audit Committee, which is composed
entirely of directors who are not officers or employees of the Company. The
committee meets regularly with the independent auditors, internal auditors and
management to discuss audit scope and results and to consider internal control
and financial reporting matters. Both the independent and internal auditors
have direct unrestricted access to the Audit Committee. The entire Board of
Directors reviews the Company's financial performance and financial plan.
/s/ Mark A. Pulido /s/ Richard H. Hawkins
- ------------------ ----------------------
Mark A. Pulido Richard H. Hawkins
President and Chief Executive Officer Vice President and Chief Financial
Officer
21
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INDEPENDENT AUDITORS' REPORT
The Stockholders and Board of Directors of McKesson Corporation:
We have audited the accompanying consolidated balance sheets of McKesson
Corporation and subsidiaries as of March 31, 1998, 1997, and 1996, and the
related statements of consolidated income, consolidated stockholders' equity
and consolidated cash flows for the years then ended. These financial
statements are the responsibility of the Corporation's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of McKesson Corporation and
subsidiaries at March 31, 1998, 1997, and 1996, and the results of their
operations and their cash flows for the years then ended in conformity with
generally accepted accounting principles.
/s/ DELOITTE & TOUCHE LLP
- -------------------------
DELOITTE & TOUCHE LLP
San Francisco, California
May 18, 1998
23
MCKESSON CORPORATION
STATEMENTS OF CONSOLIDATED INCOME
YEARS ENDED MARCH 31
-------------------------------
1998 1997 1996
--------- --------- ---------
(IN MILLIONS EXCEPT PER SHARE
AMOUNTS)
REVENUES (Note 1).............................. $20,857.3 $15,710.8 $12,964.8
--------- --------- ---------
COSTS AND EXPENSES (Note 3)
Cost of sales.................................. 19,336.0 14,673.5 12,049.3
Selling........................................ 240.6 139.8 114.0
Distribution................................... 477.0 354.7 327.4
Administrative................................. 441.5 450.0 232.8
Interest....................................... 102.5 55.7 44.4
--------- --------- ---------
Total...................................... 20,597.6 15,673.7 12,767.9
--------- --------- ---------
INCOME BEFORE TAXES ON INCOME AND DIVIDENDS
ON PREFERRED SECURITIES OF SUBSIDIARY TRUST... 259.7 37.1 196.9
Taxes on income (Note 13)...................... 98.6 31.3 76.2
--------- --------- ---------
INCOME BEFORE DIVIDENDS ON PREFERRED SECURITIES
OF SUBSIDIARY TRUST........................... 161.1 5.8 120.7
Dividends on preferred securities of subsidiary
trust,
net of $4.0 and $0.4 tax benefit (Note 9)..... (6.2) (0.7) --
--------- --------- ---------
INCOME AFTER TAXES
Continuing operations.......................... 154.9 5.1 120.7
Discontinued operations (Notes 2 and 7)........ -- 8.6 14.7
Discontinued operations--Gain on sale of
Armor All stock (Notes 2 and 7) .............. -- 120.2 --
--------- --------- ---------
NET INCOME..................................... $ 154.9 $ 133.9 $ 135.4
========= ========= =========
EARNINGS PER COMMON SHARE
Diluted
Continuing operations........................ $ 1.59 $ 0.06 $ 1.29
Discontinued operations...................... -- 0.10 0.16
Discontinued operations--Gain on sale of
Armor All stock............................. -- 1.35 --
--------- --------- ---------
Total...................................... $ 1.59 $ 1.51 $ 1.45
========= ========= =========
Basic
Continuing operations........................ 1.69 $ 0.06 $ 1.36
Discontinued operations...................... -- 0.10 0.17
Discontinued operations--Gain on sale of
Armor All stock............................. -- 1.41 --
--------- --------- ---------
Total...................................... $ 1.69 $ 1.57 $ 1.53
========= ========= =========
SHARES ON WHICH EARNINGS
PER COMMON SHARE WERE BASED
Diluted........................................ 101.2 89.4 93.2
Basic.......................................... 91.5 85.5 88.8
See Financial Notes.
24
MCKESSON CORPORATION
CONSOLIDATED BALANCE SHEETS
MARCH 31
----------------------------
1998 1997 1996
-------- -------- --------
(IN MILLIONS, EXCEPT PAR
VALUE)
ASSETS
Cash and cash equivalents........................ $ 35.7 $ 124.8 $ 260.8
Marketable securities available for sale (Note
1).............................................. 77.9 105.0 195.4
Receivables (Note 5)............................. 1,380.4 1,224.5 672.8
Inventories (Note 6)............................. 2,583.5 2,259.5 1,317.0
Prepaid expenses (Note 13)....................... 28.1 47.3 17.0
-------- -------- --------
Total current assets........................... 4,105.6 3,761.1 2,463.0
-------- -------- --------
Land............................................. 35.6 38.0 36.1
Buildings........................................ 225.9 208.5 205.8
Machinery and equipment.......................... 608.8 532.8 471.8
-------- -------- --------
Total property, plant and equipment............ 870.3 779.3 713.7
Accumulated depreciation......................... (440.0) (405.7) (357.7)
-------- -------- --------
Net property, plant and equipment.............. 430.3 373.6 356.0
Goodwill and other intangibles................... 752.4 736.2 183.7
Net assets of discontinued operations (Notes 2
and 7).......................................... -- -- 125.7
Other assets (Notes 13 and 14)................... 319.2 301.9 231.8
-------- -------- --------
Total assets................................... $5,607.5 $5,172.8 $3,360.2
======== ======== ========
LIABILITIES
Drafts payable................................... $ 286.2 $ 210.7 $ 194.0
Accounts payable--trade.......................... 1,859.1 1,854.7 1,149.2
Short-term borrowings............................ -- 100.0 6.6
Current portion of long-term debt (Note 8)....... 10.0 60.3 21.1
Salaries and wages............................... 53.9 52.9 26.3
Taxes (Note 13).................................. 115.7 80.0 92.2
Interest and dividends........................... 29.5 21.3 19.0
Other............................................ 223.4 257.3 134.1
-------- -------- --------
Total current liabilities...................... 2,577.8 2,637.2 1,642.5
-------- -------- --------
Postretirement obligations and other noncurrent
liabilities (Note 14)........................... 233.3 255.1 282.5
-------- -------- --------
Long-term debt (Note 8).......................... 1,194.2 824.9 370.6
-------- -------- --------
McKesson-obligated mandatorily redeemable
preferred securities of subsidiary grantor trust
whose sole assets are junior subordinated
debentures of McKesson (Note 9)................. 195.4 194.8 --
-------- -------- --------
STOCKHOLDERS' EQUITY
Common stock (200.0 shares authorized, 93.4, 92.8
and 90.9 issued as of March 31, 1998, 1997 and
1996, respectively; par value of $.01) (Note
12)............................................. 0.9 0.8 0.8
Additional paid-in capital....................... 440.7 408.2 332.0
Other capital.................................... (42.2) (19.2) (36.2)
Retained earnings................................ 1,173.2 1,062.2 968.5
Accumulated translation adjustment............... (45.4) (44.6) (49.7)
ESOP notes and guarantee (Note 14)............... (115.6) (118.3) (122.5)
Treasury shares, at cost (Note 12)............... (4.8) (28.3) (28.3)
-------- -------- --------
Stockholders' equity........................... 1,406.8 1,260.8 1,064.6
-------- -------- --------
Total liabilities and stockholders' equity..... $5,607.5 $5,172.8 $3,360.2
======== ======== ========
See Financial Notes.
25
MCKESSON CORPORATION
STATEMENTS OF CONSOLIDATED STOCKHOLDERS' EQUITY
YEARS ENDED MARCH 31, 1998, 1997 AND 1996
(SHARES IN THOUSANDS, DOLLARS IN MILLIONS)
COMMON STOCK ADDITIONAL
------------- PAID-IN
SHARES AMOUNT CAPITAL
------ ------ ----------
BALANCES, MARCH 31, 1995 (RESTATED FOR THE
TWO-FOR-ONE SPLIT--NOTE 12)........................... 88,776 $0.8 $319.8
Issuance of shares under employee plans (Note 12)...... 2,124 (10.6)
Purchase of shares ....................................
ESOP note payments.....................................
Translation adjustment.................................
Unrealized gain on marketable securities...............
Net income.............................................
Other (Note 14)........................................ 22.8
Cash dividends declared
Common, $0.50 per share..............................
------ ---- ------
BALANCES, MARCH 31, 1996 (RESTATED FOR THE
TWO-FOR-ONE SPLIT--NOTE 12)........................... 90,900 0.8 332.0
Issuance of shares under employee plans (Note 12)...... 204 (25.2)
Purchase of shares.....................................
ESOP note payments.....................................
Translation adjustment.................................
Unrealized gain on marketable securities...............
Net income.............................................
Acquisition of MGM..................................... 1,690 83.0
Other (Note 14)........................................ 18.4
Cash dividends declared
Common, $0.50 per share..............................
------ ---- ------
BALANCES, MARCH 31, 1997 (RESTATED FOR THE
TWO-FOR-ONE SPLIT--NOTE 12)........................... 92,794 0.8 408.2
Issuance of shares under employee plans (Note 12)...... 605 0.1 16.2
ESOP note payments.....................................
Translation adjustment.................................
Net income.............................................
Other (Note 14)........................................ 16.3
Cash dividends declared
Common, $0.50 per share..............................
------ ---- ------
BALANCES, MARCH 31, 1998............................... 93,399 $0.9 $440.7
====== ==== ======
See Financial Notes.
26
TREASURY
--------------
ACCUMULATED ESOP
OTHER RETAINED TRANSLATION NOTES AND COMMON STOCKHOLDERS'
CAPITAL EARNINGS ADJUSTMENT GUARANTEE SHARES AMOUNT EQUITY
- ------- -------- ----------- --------- ------ ------ -------------
$ (4.1) $ 875.5 $(51.6) $(126.4) (28) $ (0.5) $1,013.5
(4.0) 1,522 34.9 20.3
(2,698) (62.7) (62.7)
3.9 3.9
1.9 1.9
(0.8) (0.8)
135.4 135.4
(27.3) 2.3 (2.2)
(44.7) (44.7)
- ------ -------- ------ ------- ------ ------ --------
(36.2) 968.5 (49.7) (122.5) (1,204) (28.3) 1,064.6
(7.5) 2,868 66.0 33.3
(6,780) (155.7) (155.7)
4.2 4.2
5.1 5.1
(1.1) (1.1)
133.9 133.9
3,892 89.7 172.7
25.6 3.1 47.1
(43.3) (43.3)
- ------ -------- ------ ------- ------ ------ --------
(19.2) 1,062.2 (44.6) (118.3) (1,224) (28.3) 1,260.8
(19.7) 1,045 23.5 20.1
2.7 2.7
(0.8) (0.8)
154.9 154.9
(3.3) 2.4 15.4
(46.3) (46.3)
- ------ -------- ------ ------- ------ ------ --------
$(42.2) $1,173.2 $(45.4) $(115.6) (179) $ (4.8) $1,406.8
====== ======== ====== ======= ====== ====== ========
27
MCKESSON CORPORATION
STATEMENTS OF CONSOLIDATED CASH FLOWS
YEARS ENDED MARCH 31
---------------------------
1998 1997 1996
------- --------- -------
(IN MILLIONS)
OPERATING ACTIVITIES
Income from continuing operations................. $ 154.9 $ 5.1 $ 120.7
Adjustments to reconcile to net cash provided by
operating activities:
Depreciation..................................... 70.3 65.4 57.2
Amortization of intangibles...................... 16.9 6.4 7.0
Provision for bad debts.......................... 10.2 23.0 13.7
Deferred taxes on income......................... 66.4 (1.6) 42.9
Gain on sale of subsidiary....................... -- -- (11.2)
Other noncash (Note 3)........................... 18.8 125.0 (7.4)
------- --------- -------
Total......................................... 337.5 223.3 222.9
------- --------- -------
Effects of changes in:
Receivables..................................... (124.0) (129.5) --
Inventories..................................... (292.2) (332.6) (239.6)
Accounts and drafts payable..................... 84.4 521.0 103.9
Taxes........................................... 75.5 (39.0) (13.1)
Other........................................... (76.6) (16.6) (62.9)
------- --------- -------
Total......................................... (332.9) 3.3 (211.7)
------- --------- -------
NET CASH PROVIDED BY CONTINUING OPERATIONS.... 4.6 226.6 11.2
Discontinued operations (Notes 2 and 7)........... (2.4) 11.5 (7.4)
------- --------- -------
NET CASH PROVIDED BY OPERATING ACTIVITIES..... 2.2 238.1 3.8
------- --------- -------
INVESTING ACTIVITIES
Purchases of marketable securities................ (1.3) (103.1) (130.6)
Maturities of marketable securities............... 32.7 198.2 244.8
Property acquisitions............................. (130.0) (76.9) (73.6)
Properties sold................................... 8.4 3.6 6.7
Proceeds from sales of subsidiaries and
investments (Note 2)............................. 1.8 300.7 36.1
Acquisitions of businesses, less cash and short-
term investments acquired (Note 2)............... (102.4) (1,209.5) (33.5)
Investing activities of discontinued operations... -- (4.2) (4.4)
Other............................................. (94.4) (73.0) (49.5)
------- --------- -------
NET CASH USED BY INVESTING ACTIVITIES......... (285.2) (964.2) (4.0)
------- --------- -------
FINANCING ACTIVITIES (Notes 8, 9 and 12)
Proceeds from issuance of debt.................... 445.8 1,118.2 0.6
Proceeds from issuance of trust convertible
preferred securities, net of issuance costs...... -- 195.1 --
Repayment of debt................................. (211.7) (551.9) (19.1)
Capital stock transactions........................
Issuances........................................ 11.3 27.4 19.2
Share repurchases................................ -- (155.7) (62.7)
ESOP note payments............................... 2.7 4.2 3.9
Dividends paid................................... (46.3) (43.3) (44.2)
Other............................................. (7.9) (3.9) 0.2
------- --------- -------
NET CASH PROVIDED (USED) BY FINANCING
ACTIVITIES................................... 193.9 590.1 (102.1)
------- --------- -------
NET DECREASE IN CASH AND CASH EQUIVALENTS......... (89.1) (136.0) (102.3)
Cash and Cash Equivalents at beginning of year.... 124.8 260.8 363.1
------- --------- -------
CASH AND CASH EQUIVALENTS AT END OF YEAR.......... $ 35.7 $ 124.8 $ 260.8
======= ========= =======
See Financial Notes.
28
FINANCIAL NOTES
1. SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements of McKesson Corporation (the "Company"
or "McKesson") include the financial statements of all majority-owned
companies, except those classified as discontinued operations. All significant
intercorporate amounts have been eliminated. Certain prior year amounts have
been reclassified to conform to the current year presentation.
Within the United States and Canada, McKesson is the largest wholesale
distributor of ethical and proprietary drugs, medical-surgical supplies and
health and beauty care products. The Company is also engaged in the processing
and sale of bottled drinking water to homes and businesses and packaged water
through retail stores. The principal markets for the drug, medical-surgical
supplies and health and beauty care distribution businesses are chain and
independent drug stores, hospitals, alternate care sites, food stores and mass
merchandisers.
The preparation of financial statements in conformity with generally
accepted accounting principles requires that management make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities as of the date of the
financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents include all highly liquid debt instruments
purchased with a maturity of three months or less at the date of acquisition.
Marketable Securities Available for Sale are carried at fair value and the
net unrealized gains and losses computed in marking these securities to market
have been reported within stockholders' equity. At March 31, 1998, the fair
value approximated the amortized cost of these securities. The investments
mature on various dates through fiscal 1999.
Inventories consist of merchandise held for resale and are stated at the
lower of cost or market. The majority of the cost of domestic inventories is
determined on the last-in, first-out (LIFO) method. International inventories
are stated at average cost.
Property, Plant and Equipment is stated at cost and depreciated on the
straight-line method at rates designed to distribute the cost of properties
over estimated service lives ranging from one to 45 years.
Capitalized Software included in other assets reflects costs related to
internally developed or purchased software for projects in excess of $1
million that are capitalized and amortized on a straight-line basis over
periods not exceeding seven years.
Goodwill and Other Intangibles are amortized on a straight-line basis over
periods estimated to be benefited, generally 3 to 40 years. Negative goodwill
arising from the acquisition of the FoxMeyer business is being amortized over
a five year period (see Note 2). Accumulated amortization balances netted
against goodwill and other intangibles were $78.1 million, $61.2 million, and
$54.8 million at March 31, 1998, 1997 and 1996, respectively.
Long-lived Assets. The Company periodically assesses the recoverability of
the cost of its long-lived assets, including goodwill, based on a review of
projected undiscounted cash flows associated with these assets. These cash
flows are prepared and reviewed by management in connection with the Company's
annual long range planning process. See Note 3 for charges the Company
recorded in fiscal 1997 related to impairment of assets.
29
FINANCIAL NOTES--(CONTINUED)
Insurance Programs. Under the Company's insurance programs, coverage is
obtained for catastrophic exposures as well as those risks required to be
insured by law or contract. It is the policy of the Company to retain a
significant portion of certain losses related primarily to workers'
compensation, physical loss to property, business interruption resulting from
such loss, and comprehensive general, product, and vehicle liability.
Provisions for losses expected under these programs are recorded based upon
the Company's estimates of the aggregate liability for claims incurred. Such
estimates utilize certain actuarial assumptions followed in the insurance
industry.
Revenue Recognition. Revenue is recognized when products are shipped or
services are provided to customers. Included in revenues are large volume
sales of pharmaceuticals to major self-warehousing drugstore chains whereby
the Company acts as an intermediary in the order and subsequent delivery of
products to the customers' warehouses. These sales totaled $2.7 billion in
1998, $2.8 billion in 1997 and $3.0 billion in 1996. Previously only the gross
margin from such sales had been classified in revenues. Such sales have been
reclassified into revenues and cost of sales for all periods presented. Also
included in revenues is interest income of $12.9 million, $14.5 million, and
$37.8 million in fiscal 1998, 1997 and 1996, respectively.
Income Taxes. The Company accounts for income taxes under the liability
method in accordance with Statement of Financial Accounting Standards ("SFAS")
No. 109, "Accounting for Income Taxes", see Note 13.
Foreign Currency Translation. Assets and liabilities of the Company's
foreign affiliates are translated at current exchange rates, while revenue and
expenses are translated at average rates prevailing during the year.
Translation adjustments related to the Company's Canadian operation are
reported as a component of stockholders' equity.
The Company has a 23% equity interest in a pharmaceutical distributor in
Mexico, which has been designated a "highly inflationary economy" effective
January 1, 1997. Accordingly, adjustments associated with the translation of
this entity's financial statements have been reflected in the Company's
consolidated statement of income since that date. Prior to January 1, 1997,
translation adjustments associated with this entity were reported as a
component of stockholders' equity.
Derivative Financial Instruments. The Company has entered into interest rate
and currency swap agreements to hedge certain interest and currency rate risks
which are accounted for using the settlement basis of accounting. As such, no
gains or losses are recorded for movements in the swaps' values during the
terms of the respective agreements.
Employee Stock Options. The Company uses the intrinsic value method to
account for stock-based compensations in accordance with Accounting Principles
Board Opinion No. 25, "Accounting for Stock Issued to Employees." See Note 12
for the disclosures of pro forma earnings and earnings per share had the fair
value method been used to account for stock-based employee compensation plans
in accordance with SFAS No. 123, "Accounting for Stock-Based Compensation."
Accounting Change. In fiscal 1998, the Company adopted SFAS No. 128
"Earnings per Share" which requires a dual presentation of basic and diluted
earnings per share ("EPS"). Basic EPS excludes dilution and is computed by
dividing net income available to common stockholders by the weighted average
number of common shares outstanding for the period. Diluted EPS reflects the
potential dilution that would occur if securities or other contracts to issue
common stock were exercised or converted into common stock. All share and per
share amounts have been restated in accordance with the provisions of SFAS No.
128. See Note 12.
30
FINANCIAL NOTES--(CONTINUED)
New Accounting Pronouncements. In fiscal 1998, the Financial Accounting
Standards Board issued SFAS No. 130 "Reporting Comprehensive Income," which
requires that an enterprise report, by major component and as a single total,
the change in its net assets during the period from nonowner sources; SFAS No.
131 "Disclosures about Segments of an Enterprise and Related Information, "
which establishes annual and interim reporting standards for an enterprise's
operating segments and related disclosures about its products, services,
geographic areas, and major customers; and SFAS No. 132 "Employers'
Disclosures about Pension and Other Postretirement Benefits," which
standardizes the disclosure requirements for pensions and other postretirement
benefits and expands disclosures on changes in benefit obligations and fair
values of plan assets. The Company plans to implement these statements in
fiscal 1999. Adoption of these statements will not impact the Company's
consolidated financial position, results of operations or cash flows, and any
effect will be limited to the form and content of its disclosures.
2. ACQUISITIONS, INVESTMENTS AND DIVESTITURES
In August 1997, the Company's Canadian health care distribution business,
Medis Health and Pharmaceutical Services Inc. ("Medis") announced an agreement
with Drug Trading Company, Limited ("Drug Trading") to transition Drug
Trading's retail customers to Medis over a transition period. The Company
acquired assets consisting primarily of accounts receivable, inventories and
customer contracts, for approximately $83 million in cash. The transaction was
funded with proceeds from operations and short-term borrowings. This
acquisition was accounted for under the purchase accounting method and the
excess of the purchase price over the fair value of the net assets acquired of
$9.2 million is being amortized on a straight-line basis over 40 years. The
purchase price allocation is based on preliminary estimates and may be subject
to revision.
In fiscal 1998, the Company also made a number of smaller acquisitions
including six distributors of first-aid products, two distributors of medical-
surgical supplies, and a pharmaceuticals distributor. The aggregate cost of
these acquisitions, accounted for as purchases, amounted to approximately
$20 million.
On February 21, 1997, the Company acquired General Medical Inc. ("MGM") for
approximately $775 million including the issuance of approximately 5.6 million
shares of the Company's common stock and the assumption of approximately $428
million in debt. Payment of $30 million of the purchase price has been
withheld pending the outcome of a contingency. MGM is a multi-market
distributor of medical-surgical supplies to acute-care, physician-care, and
extended-care markets. This acquisition was accounted for under the purchase
method and the results of operations of MGM have been included in the
consolidated financial statements since the date of acquisition. The valuation
of the MGM net assets acquired included the recognition of liabilities
totaling $7.9 million related to closures of duplicate facilities and
involuntary termination and relocation benefits, of which $1.0 million and
$7.3 million remained outstanding as of March 31, 1998 and 1997, respectively.
Changes to the reserve in fiscal 1998 consisted primarily of cash payments for
severance benefits and costs to close down duplicate facilities. The excess of
the purchase price over the fair value of the net assets acquired of
approximately $600 million is being amortized on a straight-line basis over 40
years.
On November 8, 1996, the Company acquired FoxMeyer Corporation's
pharmaceutical distribution business ("FoxMeyer"), pursuant to an expedited
auction process in the FoxMeyer Corporation bankruptcy proceeding in
Wilmington, Delaware. Through an amended sale agreement, the Company paid
approximately $23 million in cash to the debtors, paid off approximately $500
million in secured debt, and assumed an additional $75 million in other
liabilities. The Company utilized proceeds from commercial paper issuances and
a note payable to a bank to fund the transaction. The note payable
31
FINANCIAL NOTES--(CONTINUED)
to a bank was repaid prior to March 31, 1997, with cash flow from operations
and proceeds from divestitures. The Company acquired assets consisting
primarily of accounts receivable and inventories of approximately $650
million, customer contracts and fixed assets. This acquisition was accounted
for under the purchase method.
As further discussed in Note 3, as a result of the FoxMeyer acquisition,
management assessed strategies and program offerings and initiated a plan to
optimize the network configuration from the combined distribution centers of
the Company and those acquired. This plan was reflected in the valuation of
the FoxMeyer net assets acquired. The plan to consolidate the FoxMeyer
business was developed and executed during the latter part of fiscal 1997 and
1998. Liabilities of $37.6 million were recognized for costs associated with
closures of duplicate distribution centers and workforce reductions of which
$3.0 million and $21.9 million remained outstanding as of March 31, 1998 and
1997, respectively. Reductions in the reserves in fiscal 1998 consisted
primarily of cash payments for severance benefits and costs related to
FoxMeyer facility closures. The excess of the fair value of net assets
acquired over the purchase price, after reducing to zero the carrying value of
long-term assets expected to be retained for use by the Company, was initially
estimated at $50 million (negative goodwill). In fiscal 1998, the estimates
were finalized resulting in a $22 million increase in goodwill (reduction in
negative goodwill) primarily for reserves for out of date and slow-moving
inventory at the acquisition date and additional liabilities assumed in the
transaction. The negative goodwill is being amortized over 5 years.
The following unaudited pro forma information has been prepared assuming
FoxMeyer and MGM had been acquired as of the beginning of fiscal 1996:
MARCH 31
--------------------
1997 1996
--------- ---------
(IN MILLIONS EXCEPT
PER SHARE AMOUNTS)
Revenues................................................ $17,398.8 $16,992.8
Net income (loss)....................................... (269.3) 79.3
Earnings (loss) per share
Diluted............................................... (3.15) 0.85
Basic................................................. (3.15) 0.89
The unaudited pro forma information above is not indicative of the
consolidated financial position or results of operations of the Company as
they may be in the future or as they might have been had the MGM and FoxMeyer
acquisitions been effected on the assumed dates. For instance, due to
FoxMeyer's bankruptcy filing on August 27, 1996, and the resulting
deterioration in its operations through November 8, 1996, FoxMeyer experienced
a decline in its sales base, wrote off its goodwill and other intangibles
totaling $207.9 million, and established substantial accounts receivable and
inventory reserves and an additional valuation allowance for deferred tax
assets aggregating $153.4 million during the period from April 1, 1996 to
November 8, 1996.
In April 1996, the Company acquired Automated Healthcare, Inc. ("MAH") for
$61.4 million in cash and the assumption of $3.2 million of employee stock
incentives. MAH designs, manufactures, sells, and installs automated
pharmaceutical dispensing equipment for use by health care institutions. The
acquisition was accounted for as a purchase and accordingly, MAH's results are
included in the consolidated financial statements since the date of
acquisition. The results of operations of MAH were not material in relation to
the Company's consolidated results of operations. The goodwill related to the
acquisition of approximately $13.4 million is being amortized on a straight-
line basis over a ten-year period. A $48.2 million charge was recorded to
write off the portion of the purchase price of MAH allocated to technology for
which technological feasibility had not been established as of the acquisition
32
FINANCIAL NOTES--(CONTINUED)
date and for which there were no alternative uses. Existing technology was
valued at $0.4 million and is being amortized on a straight-line basis over a
three-year period. The Company utilized a discounted cash flow methodology by
product line to value in-process and existing technologies as of the
acquisition date.
In fiscal 1996, the Company acquired McKesson BioServices, a provider of
support services to commercial, non-profit and governmental organizations
engaged in drug and biomedical development for $20 million. The Company also
acquired interests in two companies engaged in the development of new
technology-based initiatives to enhance the Health Care Services segment's
competitive position.
On March 31, 1997, the Company sold its service merchandising unit,
Millbrook Distribution Services, Inc. ("Millbrook"), to R.A.B. Holdings, Inc.
The after-tax proceeds on the sale approximated Millbrook's book value.
In March 1997, the Company sold its Aqua-Vend vended water business ("Aqua-
Vend"), a unit of the Water Products segment. The after-tax proceeds on the
sale approximated Aqua-Vend's book value, after giving effect to the $7.0
million pre-tax provision for impairment of certain assets recorded in the
third quarter of fiscal 1997; see Note 3.
On December 31, 1996, the Company sold its 55% equity interest in Armor All
Products Corporation ("Armor All") to The Clorox Company for $221.9 million
and recognized an after-tax gain of $120.2 million. At closing, after-tax
proceeds of $109.8 million replaced the 6.9 million Armor All shares held in
trust as exchange property for the Company's $180 million exchangeable
subordinated debentures; see Note 8.
All of the net assets and results of operations of both Armor All and
Millbrook have been reclassified as discontinued operations. Prior year
amounts have been restated.
In fiscal 1996, the Company sold its interest in a Central American
pharmaceutical manufacturer for $36.1 million, resulting in a gain of $11.2
million.
3. CHARGES AND GAINS IN CONTINUING OPERATIONS
Fiscal 1998
On September 23, 1997, the Company and AmeriSource Health Corporation
("AmeriSource"), a leading U.S. wholesale distributor of pharmaceutical and
related health care products and services, jointly announced the execution of
a definitive Merger Agreement providing for the Company to acquire
AmeriSource. On March 3, 1998, the Federal Trade Commission voted to block the
proposed merger. On March 9, 1998, the FTC filed a complaint with the United
States District Court of the District of Columbia seeking a preliminary
injunction to halt the merger. On March 18, 1998, the Company and AmeriSource
each announced that they will oppose the FTC's motion for preliminary
injunction. A full hearing on the FTC's motion is expected to begin June 9,
1998. Although the merger and transactions contemplated thereby have been
approved by stockholders of both companies, there can be no assurance that
McKesson and AmeriSource will prevail in their opposition of the FTC's request
for a preliminary injunction, that the merger will be completed, or that it
will be completed as contemplated or what the results of the merger might be.
In light of this uncertainty, management deemed it appropriate to write off
transaction costs incurred to date of $16.7 million.
In addition, the Company took a pre-tax charge of $10.5 million for costs
associated with the integration and rationalization of recent acquisitions
into the Company's operations including workforce
33
FINANCIAL NOTES--(CONTINUED)
reductions designed to reduce cost structure. Approximately $9.4 million of
the $10.5 million charge is for severance and related benefits.
The Company also incurred a charge of $3.4 million pre-tax in the Health
Care Services segment related primarily to the sale of an investment.
The above discussed charges totaling $30.6 million, $25.4 million after-tax,
have been recorded in selling, distribution and administrative expenses. In
addition, the Company recognized a favorable one-time tax adjustment of $4.6
million associated with the completion of tax audits for certain prior years.
The favorable tax adjustment was a non-cash transaction. There were no
significant changes in estimates or recharacterization of other amounts from
prior restructuring reserves in fiscal 1998.
Fiscal 1997
The acquisition of the assets and operations of FoxMeyer (see Note 2)
resulted in a significant increase in sales volume, a substantial change in
the customer mix (primarily a large increase in institutional customers), and
overlapping, duplicate, and "similar purpose" assets. In fiscal 1997,
management reassessed the Company's operations, distribution center network
and business strategies, including program offerings in light of the FoxMeyer
acquisition. A plan was developed and executed during the latter part of
fiscal 1997 and fiscal 1998 to optimize the network configuration from the
combined distribution centers of the Company and those acquired in the
transaction which has resulted in the consolidation and closure of 15
distribution centers, workforce reductions, and disposal of excess, duplicate
assets. Management also reassessed strategies and program offerings for
expanding certain customer segments in light of the larger and more diverse
customer base and identified certain programs and investments, that would no
longer be pursued as originally contemplated. Other duplicate, common purpose
assets including administrative facilities, software, and other equipment were
reviewed to identify the optimum mix for the combined companies. This resulted
in the impairment in the value of certain assets which were not retained or
utilized as originally intended. The foregoing was reflected in the valuation
of the FoxMeyer assets acquired and liabilities assumed, and in the charges
discussed below with respect to the affected assets of the Company.
The charges resulting from the impairment of assets of the Company as a
result of the integration and rationalization of the Company's distribution
operations, systems, strategies, and program offerings and administrative
functions, and for certain operating items were recorded in selling,
distribution, and administrative expenses and are summarized below:
Development costs and investments associated with program offerings
that are no longer being pursued as originally contemplated.......... $28.0
Computer software which will no longer be utilized or for which the
development program has ceased....................................... 29.3
Cost of facilities closures--primarily write-down of assets which are
to be disposed of.................................................... 10.1
Receivable reserves................................................... 15.1
Other operating items................................................. 16.3
-----
$98.8
=====
The write-downs associated with assets to be disposed of and asset
impairments due to changed business conditions were based primarily on
independent appraisals. Substantially all of the charges represented the
write-down of existing balances and were, accordingly, noncash. Balances
remaining
34
FINANCIAL NOTES--(CONTINUED)
from a prior restructuring in fiscal 1995 for facilities closures were
considered in connection with the revised facilities plan after the FoxMeyer
transaction, resulting in an additional provision of $2.9 million. There were
no other significant changes in estimates or recharacterization of other
amounts from the prior restructuring reserves. Also included in the charge for
facilities closures was $7.2 million for Medis which had restructured its
distribution operations and network following a significant change in its
customer mix.
The charge related to receivable reserves resulted from management's
reevaluation of the U.S. Health Care business' estimated exposures for bad
debts, disputed amounts, customer allowances, and rebates.
Other operating items included a provision by the Water Products business of
$7.0 million for the impairment of assets in its vended water business. Other
operating items of the U.S. Health Care Services business consisted of $2.8
million of incremental costs incurred during a strike at a distribution
center, $1.5 million for the termination of a marketing program and certain
distributor relationships, and $5.0 million of other charges.
Summary of Reserve Balances
The remaining balances outstanding for the combined reserves at March 31,
1998 and 1997 are as follows:
MARCH 31
-----------
1998 1997
----- -----
Costs of facilities closure and surplus properties, primarily
write-down of assets which will no longer be utilized and will
be disposed of................................................. $17.4 $27.8
Severance costs for announced workforce reductions.............. 6.6 --
----- -----
$24.0 $27.8
===== =====
The disposition of properties in connection with facilities closures is
expected to be completed over the next one to two years. Charges to the
restructuring reserve in fiscal 1998, 1997 and 1996 consisted primarily of
asset write-offs (substantially all of which are non-cash) and cash payments
for severance of $1.7 million and asset holding costs of $1.9 million in
fiscal 1998, and for severance of $2.0 million and $5.2 million in fiscal 1997
and 1996, respectively.
4. OFF-BALANCE SHEET RISK AND CONCENTRATIONS OF CREDIT RISK
Trade receivables subject the Company to a concentration of credit risk with
customers in the retail and institutional sectors. This risk is spread over a
large number of geographically dispersed customers.
The Company sold $299.9 million and $147.4 million at March 31, 1998 and
1997, respectively, of trade receivables at amounts approximating their fair
value to a bank.
Proceeds received by the Company on sales of accounts receivable with
recourse to the Company for certain uncollectible amounts totaled $105 million
in 1996.
The Company's Canadian subsidiary, Medis, has agreements with certain of its
customers' financial institutions to repurchase inventory in the event the
customers are unable to meet certain obligations to the financial
institutions. Medis has also agreed to guarantee the payment of a major
customer's leases. The amounts related to these guarantees were approximately
$55.7 million for the inventory and $12 million for the lease obligations at
March 31, 1998.
35
FINANCIAL NOTES--(CONTINUED)
5. RECEIVABLES
MARCH 31
--------------------------
1998 1997 1996
-------- -------- ------
(IN MILLIONS)
Customer accounts................................ $1,249.4 $1,180.4 $631.7
Other............................................ 189.0 88.0 79.2
-------- -------- ------
Total.......................................... 1,438.4 1,268.4 710.9
Allowances....................................... (58.0) (43.9) (38.1)
-------- -------- ------
Net............................................ $1,380.4 $1,224.5 $672.8
======== ======== ======
The allowances are for uncollectible accounts, discounts, returns and other
adjustments.
6. INVENTORIES
The LIFO method was used to value approximately 83%, 84% and 90% of the
inventories at March 31, 1998, 1997, and 1996, respectively. Inventories
before the LIFO cost adjustment, which approximates replacement cost, were
$2,825.3, $2,538.6 and $1,602.5 million at March 31, 1998, 1997 and 1996,
respectively.
7. DISCONTINUED OPERATIONS
The net assets (liabilities) of discontinued operations at March 31 were as
follows:
1998 1997 1996
----- ----- -------
(IN MILLIONS)
Total assets.......................................... $ 1.9 $ 2.5 $ 275.5
Total liabilities..................................... (2.8) (5.8) (149.8)
----- ----- -------
Net assets (liabilities)............................ $(0.9) $(3.3) $ 125.7
===== ===== =======
At March 31, 1998 and 1997, net liabilities of discontinued operations are
included in other current liabilities. Assets consist primarily of land held
for sale and investments in affiliates. Liabilities consist primarily of other
accrued liabilities.
At March 31, 1996, assets of discontinued operations consisted primarily of
cash, receivables, inventory, property, plant and equipment and goodwill of
Armor All and Millbrook. Liabilities of discontinued operations consist
primarily of accounts payable and other accrued liabilities of Armor All and
Millbrook.
Results of discontinued operations were as follows:
1998 1997 1996
----- ------ ------
(IN MILLIONS)
Revenues............................................. $ 0.2 $592.1 $749.6
===== ====== ======
Discontinued operations before taxes................. $ 0.1 $ 17.2 $ 31.7
Provision for taxes on income........................ (0.1) (5.6) (13.7)
Minority interest in Armor All....................... -- (3.0) (3.3)
----- ------ ------
Discontinued operations............................ -- 8.6 14.7
----- ------ ------
Gain on sale of Armor All stock...................... -- 154.5 --
Tax expense.......................................... -- (34.3) --
----- ------ ------
Discontinued operations--gain on sale of Armor All
stock............................................. -- 120.2 --
----- ------ ------
Total............................................ $ -- $128.8 $ 14.7
===== ====== ======
36
FINANCIAL NOTES--(CONTINUED)
Discontinued operations in fiscal 1997 of $8.6 million after-tax includes
$3.7 million and $4.9 million after-tax from the operations of Armor All and
Millbrook, respectively.
Discontinued operations in fiscal 1996 of $14.7 million after-tax includes
$4.3 million and $10.4 million after-tax from the operations of Armor All and
Millbrook, respectively.
8. LONG-TERM DEBT
MARCH 31
----------------------
1998 1997 1996
-------- ------ ------
(IN MILLIONS)
ESOP related debt..................................... $ 115.6 $118.3 $122.5
4.50% exchangeable subordinated debentures due 2004... 113.3 160.4 180.0
8.625% Notes due 1998................................. -- 49.0 49.0
8.75% Notes due 1997.................................. -- -- 10.0
6.60% Notes due 2000.................................. 175.0 175.0 --
6.875% Notes due 2002................................. 175.0 175.0 --
6.55% Notes due 2002.................................. 125.0 --
6.30% Notes due 2005.................................. 150.0 -- --
6.40% Notes due 2008.................................. 150.0 -- --
7.65% Debentures due 2027............................. 175.0 175.0 --
3.65% to 5.70% IDRBs due through 2026................. 17.8 21.4 20.0
Capital lease obligations (averaging 8.5%)............ 3.9 4.2 4.4
Other, 6.0% to 12.125%, due through 2021.............. 3.6 6.9 5.8
-------- ------ ------
Total............................................. 1,204.2 885.2 391.7
Less current portion.................................. 10.0 60.3 21.1
-------- ------ ------
Total............................................. $1,194.2 $824.9 $370.6
======== ====== ======
The Company has a revolving credit agreement with certain U.S. and Canadian
banks whereby the banks commit $250 million borrowing availability at the
reference rate (8.50% at March 31, 1998) or money market-based rates. The
agreement expires in fiscal 2002. The agreement permits the Company's wholly-
owned Canadian subsidiary, Medis, to borrow the Canadian dollar equivalent of
up to $75 million (as part of the $250 million arrangement) at the Canadian
prime rate or Canadian money market-based rates. The agreement contains
limitations on additional indebtedness. Compensating balances are not
required. The Company has additional available liquidity of $500 million for
general working capital purposes in the form of two facilities with a duration
of 364 days or less. At March 31, 1998, the Company had $750 million of unused
borrowing capacity under these agreements.
Total interest payments were $94.4 million, $53.6 million, and $47.5 million
in fiscal 1998, 1997 and 1996, respectively.
ESOP related debt (see Note 14) is payable to banks and insurance companies,
bears interest at rates ranging from 8.6% fixed rate to approximately 80% of
the prime or LIBOR +0.4% and is due in installments through 2009.
In connection with the 4.5% exchangeable subordinated debentures, the March
31, 1998 marketable securities balance includes $76.7 million held in trust as
exchange property for the exchangeable subordinated debentures. The March 31,
1997 cash and cash equivalents and marketable securities balances include
$13.2 million and $96.6 million, respectively, held in trust as exchange
property for the exchangeable subordinated debentures. Through March 31, 1998,
the Company repurchased $66.7 million of the exchangeable subordinated
debentures.
37
FINANCIAL NOTES--(CONTINUED)
In fiscal 1998, the Company issued fixed rate, unsecured unsubordinated debt
totaling $300 million. The 6.3% notes mature on March 1, 2005 and the 6.4%
notes mature on March 1, 2008. In addition, a wholly-owned subsidiary of the
Company issued $125 million of 6.55% senior notes due November 1, 2002 which
are guaranteed by the Company.
Certain debt agreements require that the Company's total debt not exceed
56.5% of total capitalization (total debt plus equity). At March 31, 1998, the
Company was in compliance with its debt covenants.
In fiscal 1998, the Company entered into two interest rate swap agreements,
each with a notional principal amount of $150 million. The swaps mature in
2005 and 2008 and swap fixed interest payments of 6.30% and 6.40%,
respectively, for floating interest payments based on a LIBOR index; the
floating rates at March 31, 1998 were 4.92% and 4.82%, respectively. These
swaps have an imbedded interest rate cap of 7%.
Also in fiscal 1998, a subsidiary of the Company entered into a currency
swap agreement to convert the $125 million proceeds from the issuance of
senior notes to $173 million Canadian currency, which was used to pay down
short-term borrowings of the Company's Canadian subsidiary, Medis. This swap
matures on November 1, 2002.
Aggregate annual payments on long-term debt and capitalized lease
obligations (see Note 10) for the years ending March 31 are:
LONG-TERM CAPITAL
DEBT LEASES TOTAL
--------- ------- --------
(IN MILLIONS)
1999.............................................. $ 9.7 $0.3 $ 10.0
2000.............................................. 185.5 0.3 185.8
2001.............................................. 11.3 0.4 11.7
2002.............................................. 187.1 0.4 187.5
2003.............................................. 138.2 0.4 138.6
Later years....................................... 668.5 2.1 670.6
-------- ---- --------
Total........................................... $1,200.3 $3.9 $1,204.2
======== ==== ========
9. CONVERTIBLE PREFERRED SECURITIES
In February 1997, a wholly-owned subsidiary trust of the Company issued 4
million shares of preferred securities to the public and 123,720 common
securities to the Company, which are convertible at the holder's option into
McKesson common stock. The proceeds of such issuances were invested by the
trust in $206,186,000 aggregate principal amount of the Company's 5%
Convertible Junior Subordinated Debentures due 2027 (the "Debentures"). The
Debentures represent the sole assets of the trust. The Debentures mature on
June 1, 2027, bear interest at the rate of 5%, payable quarterly and are
redeemable by the Company beginning in March 2000 at 103.5% of the principal
amount thereof.
Holders of the securities are entitled to cumulative cash distributions at
an annual rate of 5% of the liquidation amount of $50 per security. Each
preferred security is convertible at the rate of 1.3418 shares of McKesson
common stock, subject to adjustment in certain circumstances. The preferred
securities will be redeemed upon repayment of the Debentures and are callable
by the Company at 103.5% of the liquidation amount beginning in March 2000.
The Debentures and related trust investment in the Debentures have been
eliminated in consolidation and the preferred securities reflected as
outstanding in the accompanying consolidated financial statements.
38
FINANCIAL NOTES--(CONTINUED)
10. LEASE OBLIGATIONS
The Company leases facilities and equipment under both capital and operating
leases. Net assets held under capital leases included in property, plant and
equipment were $2.9 million, $3.0 million, and $3.3 million at March 31, 1998,
1997 and 1996, respectively. Amortization of capital leases is included in
depreciation expense.
As of March 31, 1998, future minimum lease payments and sublease rentals in
years ending March 31 are:
NON- NON-
CANCELABLE CANCELABLE
OPERATING SUBLEASE CAPITAL
LEASES RENTALS LEASES
---------- ---------- -------
(IN MILLIONS)
1999........................................... $ 42.0 $ 3.9 $0.7
2000........................................... 36.3 3.3 0.7
2001........................................... 31.6 2.8 0.6
2002........................................... 26.1 2.6 0.6
2003........................................... 21.8 2.2 0.6
Later years.................................... 64.4 4.6 2.8
------ ----- ----
Total minimum lease payments................... $222.2 $19.4 6.0
====== =====
Less amounts representing interest............. 2.1
----
Present value of minimum lease payments........ $3.9
====
Rental expense was $52.9 million, $33.7 million, and $26.1 million in fiscal
1998, 1997 and 1996, respectively.
Most real property leases contain renewal options and provisions requiring
the Company to pay property taxes and operating expenses in excess of base
period amounts.
11. FAIR VALUE OF FINANCIAL INSTRUMENTS
At March 31, 1998, the carrying amounts and estimated fair values of the
Company's financial instruments, as determined under SFAS No. 107,
"Disclosures about Fair Value of Financial Instruments", were as follows:
CARRYING ESTIMATED
AMOUNT FAIR VALUE
-------- ----------
(IN MILLIONS)
Cash and cash equivalents................................ $ 35.7 $ 35.7
Marketable securities.................................... 77.9 77.9
Long-term debt, including current portion................ 1,204.2 1,177.3
Interest rate swaps...................................... -- (5.1)
Foreign currency rate swap............................... -- 4.0
The estimated fair values were determined as follows:
Cash and cash equivalents: carrying amounts approximate fair value.
Marketable securities and long-term debt: quoted market prices or market
comparables.
Interest and foreign currency rate swaps: quoted market prices or market
comparables.
39
FINANCIAL NOTES--(CONTINUED)
12. STOCKHOLDERS' EQUITY
On October 29, 1997, the Company's board of directors declared a two-for-one
split of the Company's common stock. The split was effective January 2, 1998
for shareholders of record on December 1, 1997. All share and per share
amounts have been restated for the split.
At March 31, 1998, 1997, and 1996, the Company was authorized to issue
100,000,000 shares of series preferred stock ($.01 par value) of which none
were outstanding and 200,000,000 shares of common stock ($.01 par value) of
which approximately 93,220,000 shares, 91,570,000 shares and 89,696,000 shares
were outstanding net of treasury stock, respectively.
In October 1994, the Company's Board of Directors declared a dividend
distribution of one right (a "Right") for each then outstanding share of
common stock and authorized the issuance of one Right for each share
subsequently issued to purchase, upon the occurrence of certain specified
triggering events, a unit consisting of one one hundredth of a share of Series
A Junior Participating Preferred Stock. Triggering events include, without
limitation, the acquisition by another entity of 15% or more of the Company's
common stock without the prior approval of the Company's Board. The Rights
have certain anti-takeover effects and will cause substantial dilution to the
ownership interest of a person or group that attempts to acquire the Company
on terms not approved by the Board. The rights expire in 2004 unless redeemed
earlier by the Board. As a result of the two-for-one stock split described
above, each share of common stock now has attached to it one-half of a Right.
The Company adopted SFAS No. 128, "Earnings per Share," in the third quarter
of the current fiscal year. All earnings and share amounts have been restated
in accordance with the provisions of SFAS No. 128.
40
FINANCIAL NOTES--(CONTINUED)
The following is a reconciliation of the numerators and denominators of the
basic and diluted per-share computations for income from continuing
operations:
1998
------------------------------------------
INCOME SHARES PER SHARE
------------- ------------ --------------
(IN MILLIONS EXCEPT PER SHARE AMOUNTS)
Basic EPS
Income from continuing
operations...................... $ 154.9 91.5 $ 1.69
============
Effect of Dilutive Securities
Options to purchase common stock. -- 3.9
Trust convertible preferred
securities...................... 6.2 5.4
Restricted stock................. -- 0.4
------------- ------------
Diluted EPS
Income available to common
stockholders plus assumed
conversions..................... $ 161.1 101.2 $ 1.59
============= ============ ============
1997
------------------------------------------
INCOME SHARES PER SHARE
------------- ------------ --------------
(IN MILLIONS EXCEPT PER SHARE AMOUNTS)
Basic EPS
Income from continuing
operations...................... $ 5.1 85.5 $ 0.06
============
Effect of Dilutive Securities
Options to purchase common stock. -- 3.2
Trust convertible preferred
securities...................... 0.7 0.6
Restricted stock................. -- 0.1
------------- ------------
Diluted EPS
Income available to common
stockholders plus assumed
conversions..................... $ 5.8 89.4 $ 0.06
============= ============ ============
1996
------------------------------------------
INCOME SHARES PER SHARE
------------- ------------ --------------
(IN MILLIONS EXCEPT PER SHARE AMOUNTS)
Basic EPS
Income from continuing
operations...................... $ 120.7 88.8 $ 1.36
============
Effect of Dilutive Securities
Options to purchase common stock. -- 4.3
Restricted stock................. -- 0.1
------------- ------------
Diluted EPS
Income available to common
stockholders plus assumed
conversions..................... $ 120.7 93.2 $ 1.29
============= ============ ============
The Company's stock-based compensation plan, the 1994 Stock Option and
Restricted Stock Plan provides grants of nonqualified stock options to
employees of the Company, and, until January 1, 1997 to non-employee
directors. After January 1, 1997, all non-employee directors receive grants
under the 1997 Director's Equity Compensation and Deferral Plan. Most grants
under the Director's Equity Compensation and Deferral Plan vest immediately on
grant date. Most other options generally vest over four years and all options
expire ten years after the grant date. Under the plans, the Company is
authorized to grant up to 30 million shares, including 25.6 million for
options as of March 31, 1998.
41
FINANCIAL NOTES--(CONTINUED)
The following is a summary of options outstanding at March 31, 1998:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------- ---------------------
WEIGHTED-
NUMBER OF AVERAGE WEIGHTED- NUMBER OF WEIGHTED-
OPTIONS REMAINING AVERAGE OPTIONS AVERAGE
RANGE OF OUTSTANDING CONTRACTUAL EXERCISE EXERCISABLE EXERCISE
EXERCISE PRICES AT YEAR END LIFE PRICE AT YEAR END PRICE
- --------------- ----------- ----------- --------- ----------- ---------
(IN YEARS)
$0.01 to $10.56......... 3,965,846 5.01 $6.79 3,895,723 $ 6.87
$11.61 to $20.13........ 997,067 6.77 17.28 684,650 17.37
$21.38 to $27.88........ 4,332,118 8.41 26.39 1,117,370 25.64
$31.94 to $44.75........ 1,033,650 9.12 40.97 74,100 36.34
$50.38 to $59.06........ 1,703,847 9.82 50.78 -- --
---------- ---------
12,032,528 7.41 23.88 5,771,843 12.13
========== =========
Expiration dates range from July 28, 1998 to March 25, 2008.
The following is a summary of changes in the options for the stock option
plans:
1998 1997 1996
--------------------- --------------------- ---------------------
WEIGHTED- WEIGHTED- WEIGHTED-
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
---------- --------- ---------- --------- ---------- ---------
Outstanding at beginning
of year................ 10,861,116 $17.00 9,940,806 $11.31 12,254,322 $ 7.98
Assumed through
acquisition............ -- -- 125,098 1.08 -- --
Granted................. 2,555,747 48.04 3,465,948 27.36 1,768,400 24.76
Exercised............... (1,127,316) 12.05 (2,319,292) 7.49 (3,524,894) 6.34
Canceled................ (257,019) 25.28 (351,444) 15.26 (557,022) 11.65
---------- ---------- ----------
Outstanding at year end. 12,032,528 23.88 10,861,116 17.00 9,940,806 11.31
========== ========== ==========
Exercisable at year end. 5,771,843 12.13 4,880,080 9.24 4,418,920 7.28
========== ========== ==========
42
FINANCIAL NOTES--(CONTINUED)
Pursuant to SFAS No. 123, the Company has elected to account for its stock-
based compensation plans under Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees." Accordingly, no compensation cost
has been recognized in the consolidated financial statements for the stock
option plans. Had compensation cost for the stock option plan been recognized
based on the fair value at the grant dates for awards under those plans,
consistent with the provision of SFAS No. 123, net income and earnings per
share would have been as indicated in the table below. Since pro forma
compensation cost relates to all periods over which the awards vest, the
initial impact on pro forma net income may not be representative of
compensation cost in subsequent years, when the effect of amortization of
multiple awards would be reflected.
YEARS ENDED MARCH 31
--------------------
1998 1997 1996
------ ------ ------
(IN MILLIONS, EXCEPT
PER SHARE AMOUNTS)
Net income
As reported........................................... $154.9 $133.9 $135.4
Pro forma............................................. 144.7 130.0 134.9
Earnings per common share--diluted
As reported........................................... $ 1.59 $ 1.51 $ 1.45
Pro forma............................................. 1.49 1.46 1.45
Earnings per common share--basic
As reported........................................... $ 1.69 $ 1.57 $ 1.53
Pro forma............................................. 1.58 1.52 1.52
Fair values of the options were estimated at the date of grant using the
Black-Scholes option pricing model with the following weighted-average
assumptions:
YEARS ENDED
MARCH 31
----------------
1998 1997 1996
---- ---- ----
Expected stock price volatility............................ 23.8% 25.6% 25.6%
Expected dividend yield.................................... 1.5% 1.5% 1.5%
Risk-free interest rate.................................... 5.6% 6.2% 5.2%
Expected life (in years)................................... 5 5 5
The weighted average grant date fair values of the options granted during
1998, 1997 and 1996 were $16.06, $7.06 and $5.66 per share, respectively.
43
FINANCIAL NOTES--(CONTINUED)
13. TAXES ON INCOME
The provision for income taxes related to continuing operations consists of
the following:
1998 1997 1996
----- ----- -----
(IN MILLIONS)
CURRENT
Federal................................................... $13.2 $26.6 $23.3
State and local........................................... 9.5 2.9 5.0
Foreign................................................... 9.5 3.4 5.0
----- ----- -----
Total current........................................... 32.2 32.9 33.3
----- ----- -----
DEFERRED
Federal................................................... 58.2 (3.2) 27.2
State..................................................... 8.2 2.2 7.5
Foreign................................................... -- (0.6) 8.2
----- ----- -----
Total deferred.......................................... 66.4 (1.6) 42.9
----- ----- -----
Total provision......................................... $98.6 $31.3 $76.2
===== ===== =====
Deferred income taxes arise from temporary differences between the tax basis
of assets and liabilities and their reported amounts in the financial
statements. Foreign pre-tax earnings were $21.4 million, $12.1 million, and
$26.2 million in fiscal 1998, 1997 and 1996, respectively.
The reconciliation between the Company's effective tax rate on income from
continuing operations and the statutory Federal income tax rate follows:
1998 1997 1996
---- ---- ----
Statutory federal income tax rate......................... 35.0% 35.0% 35.0%
State and local income taxes net of federal tax benefit... 4.5 9.1 4.1
Nondeductible charge for the write-off of in-process
technology............................................... -- 45.5 --
AmeriSource merger costs.................................. 2.2 -- --
Nondeductible amortization................................ 2.2 5.3 1.1
Nontaxable income--life insurance......................... (1.6) (7.0) (0.9)
Favorable tax adjustment.................................. (1.8) -- --
Dividends paid deduction--ESOP allocated shares........... (0.4) (2.5) (0.5)
Tax-advantaged debt issuance.............................. (0.4) -- --
Other--net................................................ (1.7) (1.0) (0.1)
---- ---- ----
Effective tax rate........................................ 38.0% 84.4% 38.7%
==== ==== ====
Income tax payments were $34 million, $76 million, and $97 million in fiscal
1998, 1997 and 1996, respectively.
44
FINANCIAL NOTES--(CONTINUED)
As of March 31, the deferred tax balances consisted of the following:
1998 1997 1996
------- ------- -------
(IN MILLIONS)
ASSETS
Nondeductible accruals for environmental obliga-
tions.............................................. $ 8.9 $ 10.6 $ 11.9
Receivable reserves................................. 24.2 17.6 13.8
Compensation and benefit-related accruals........... 19.4 16.5 16.1
Loss and credit carryforwards....................... 39.3 9.4 --
Costs associated with duplicate facility closures
and workforce reductions related to acquired
businesses......................................... 2.4 11.7 --
Other............................................... 18.2 17.6 5.8
------- ------- -------
Current............................................. 112.4 83.4 47.6
------- ------- -------
Nondeductible accruals for:
Postretirement and postemployment plans........... 68.8 76.2 76.6
Deferred compensation............................. 30.9 33.0 29.0
Costs associated with facility closures and
surplus properties and asset write-downs......... 7.0 11.1 10.4
Retirement plan..................................... -- -- 6.0
Systems development costs........................... -- 11.8 --
Loss and credit carryforwards....................... 10.1 1.7 9.7
Other............................................... 14.3 15.3 17.0
------- ------- -------
Noncurrent.......................................... 131.1 149.1 148.7
------- ------- -------
Total............................................. $ 243.5 $ 232.5 $ 196.3
======= ======= =======
LIABILITIES
Basis differences for inventory valuation........... $(139.1) $ (70.1) $ (38.8)
Other............................................... (4.1) (5.2) (5.9)
------- ------- -------
Current............................................. (143.2) (75.3) (44.7)
------- ------- -------
Accelerated depreciation............................ (38.0) (38.2) (43.6)
Systems development costs........................... (35.2) -- (14.5)
Retirement plan..................................... (13.5) (8.5) --
Other............................................... (4.8) (10.7) (9.9)
------- ------- -------
Noncurrent.......................................... (91.5) (57.4) (68.0)
------- ------- -------
Total............................................. $(234.7) $(132.7) $(112.7)
======= ======= =======
Total net current--included in (taxes payable) pre-
paid expenses...................................... $ (30.8) $ 8.1 $ 2.9
======= ======= =======
Total net noncurrent (included in other assets)..... $ 39.6 $ 91.7 $ 80.7
======= ======= =======
14. POSTRETIREMENT AND POSTEMPLOYMENT BENEFITS
Pension Plans
On December 31, 1996, substantially all full-time employees of the Company
were covered under either the Company-sponsored defined benefit retirement
plan or by bargaining unit sponsored multi-employer plans. On that date, the
Company amended the Company-sponsored defined benefit plan to freeze all plan
benefits based on each employee's plan compensation and creditable service
accrued to that date. The benefits for such Company-sponsored plans are based
primarily on age of employees at date of retirement, years of service and
employees' pay during the five years prior to employment.
45
FINANCIAL NOTES--(CONTINUED)
On January 1, 1997, the Company amended the ESOP to provide future additional
benefits in place of a portion of those benefits previously provided by the
pension plan.
Net pension expense (income) for the Company-sponsored defined benefit
retirement plan and executive supplemental retirement plan consisted of the
following:
1998 1997 1996
------ ------ ------
(IN MILLIONS)
Service cost--benefits earned during the year...... $ 0.7 $ 5.4 $ 5.3
Interest cost on projected benefit obligation...... 22.6 23.6 23.7
Return on assets
--actual income................................... (55.4) (35.5) (51.6)
--deferred gain................................... 30.6 12.1 31.2
Amortization of unrecognized loss and prior service
costs............................................. 0.8 5.9 4.5
Amortization of unrecognized net transition asset.. (2.5) (2.5) (2.5)
Curtailment loss recognized in connection with the
December 31, 1996 plan amendment.................. -- 0.4 --
------ ------ ------
Net pension expense (income)...................... $ (3.2) $ 9.4 $ 10.6
====== ====== ======
Assets of the plans are measured on a calendar year basis. The funded
status of the Company-sponsored defined benefit retirement plan at December 31
was as follows:
1997 1996 1995
------ ------ -------
(IN MILLIONS)
Actuarial present value of benefit obligations
Vested benefits.................................. $266.0 $246.0 $ 249.8
Nonvested benefits............................... 9.8 13.9 14.1
------ ------ -------
Accumulated benefit obligation................... 275.8 259.9 263.9
Effect of assumed increase in future compensation
levels.......................................... -- -- 20.7
------ ------ -------
Projected benefit obligation for services
rendered to date................................ 275.8 259.9 284.6
Assets of plan at fair value....................... 294.0 262.3 248.9
------ ------ -------
Excess (shortfall) of assets over projected benefit
obligation........................................ 18.2 2.4 (35.7)
Unrecognized prior service cost and net loss from
experience different from that assumed............ 11.7 22.1 67.1
Unrecognized net transition asset, recognized
straight-line through 1998........................ (0.3) (3.1) (6.0)
Adjustment required to recognize minimum liability. -- -- (40.4)
------ ------ -------
Pension asset (liability) included in other assets
(noncurrent liabilities).......................... $ 29.6 $ 21.4 $ (15.0)
====== ====== =======
The projected unit credit method is utilized for measuring net periodic
pension cost over the employees' service life. Costs are funded based on the
recommendations of independent actuaries. The projected benefit obligations
for Company-sponsored plans were determined using a discount rate of 7.25% at
December 31, 1997, 7.75% at December 31, 1996 and 7.25% at December 31, 1995
and an assumed increase in future compensation levels of 4.0% at December 31,
1995. The expected long-term rate of return on assets used to determine
pension expense was 9.75% for all periods. The adjustment required to
recognize the minimum liability at December 31, 1995 was charged to other
equity, net of tax, and was reversed at December 31, 1996.
The assets of the plan consist primarily of listed common stocks and bonds
for which fair value is determined based on quoted market prices.
46
FINANCIAL NOTES--(CONTINUED)
The projected benefit obligation for the Company's executive supplemental
retirement plan at December 31, 1997 was $35.6 million of which $33.8 million
(the accumulated benefit obligation) is recognized as a liability on the
consolidated balance sheet.
Profit-Sharing Investment Plan
Retirement benefits for employees not covered by collective bargaining
arrangements include a supplementary contributory profit sharing investment
plan ("PSIP"). The leveraged ESOP portion of the PSIP has purchased an
aggregate of 24.3 million shares of common stock since inception. These
purchases have been financed by 10 to 20-year loans from or guaranteed by the
Company. The Company's related receivables from the ESOP have been classified
as a reduction of stockholders' equity. The loans will be repaid by the ESOP
from common dividends on shares not yet allocated to participants, interest
earnings on cash balances not yet allocated to participants, common dividends
on certain allocated shares and future Company cash contributions. The ESOP
loan maturities and rates are identical to the terms of related Company
borrowings (see Note 8).
After-tax ESOP expense (income), including interest expense on ESOP debt,
was $(0.1) million, $2.3 million, and $(0.2) million in fiscal 1998, 1997 and
1996, respectively. Additional tax benefits received on dividends paid on
unallocated shares of $2.4 million, $3.1 million, and $2.2 million in fiscal
1998, 1997 and 1996, respectively, have been credited directly to retained
earnings in accordance with SFAS No. 109.
Contribution expense for the PSIP in fiscal 1997, 1996 and 1995 was all ESOP
related and is reflected in the amounts above. In fiscal 1998, 1997 and 1996
approximately 694,000, 907,000 and 915,000 shares, respectively, were
allocated to plan participants.
Through March 31, 1998, 11.3 million common shares have been allocated to
plan participants. At March 31, 1998, 13.0 million common shares in the ESOP
Trust had not been allocated to plan participants.
Health Care and Life Insurance
In addition to providing pension benefits, the Company provides health care
and life insurance benefits for certain retired employees. The Company's
policy is to fund these benefits as claims are paid. The benefits have been
reduced significantly for those employees retiring after December 31, 1990. In
1989, the Company implemented an ESOP to provide funds at retirement that
could be used for medical costs or health care coverage.
Expenses for postretirement health care and life insurance benefits
consisted of the following:
1998 1997 1996
----- ----- -----
(IN MILLIONS)
Service cost--benefits earned during the period........ $ 0.7 $ 1.1 $ 1.1
Interest cost on projected benefit obligation.......... 9.1 9.4 11.4
Amortization of unrecognized gain and prior service
costs................................................. (8.9) (5.5) (9.3)
----- ----- -----
Total................................................ $ 0.9 $ 5.0 $ 3.2
===== ===== =====
Payments for postretirement health care and life insurance benefits amounted
to $11.8 million, $13.3 million, and $10.9 million in fiscal 1998, 1997 and
1996, respectively.
47
FINANCIAL NOTES--(CONTINUED)
The funded status and amounts recognized in the consolidated balance sheet
for postretirement health care and life insurance benefits at March 31, were
as follows:
1998 1997 1996
------ ------ ------
(IN MILLIONS)
Accumulated postretirement benefit obligations:
Retirees............................................. $111.6 $110.6 $122.2
Active plan participants............................. 13.4 12.3 17.9
------ ------ ------
Total.............................................. 125.0 122.9 140.1
Unrecognized prior service cost and accumulated
net gain............................................ 11.3 24.2 14.8
------ ------ ------
Accrued postretirement benefit obligation............ $136.3 $147.1 $154.9
====== ====== ======
The assumed health care cost trend rate used in measuring the accumulated
postretirement benefit obligation is 6.0% for 1998, decreasing to 5.33% in
1999 and to an ultimate rate of 5.0% thereafter. The health care cost trend
rate assumption has a significant effect on the amounts reported. Increasing
the trend rate by one percentage point would increase the accumulated
postretirement health care and life insurance obligation as of March 31, 1998
by $7.2 million and the related fiscal 1998 aggregate service and interest
costs by $0.7 million. The discount rate used in determining the accumulated
postretirement benefit obligation was 7.25% at March 31, 1998, 7.75% at March
31, 1997 and 7.25% at March 31, 1996.
48
FINANCIAL NOTES--(CONTINUED)
15. SEGMENTS OF BUSINESS
1998 1997 1996
--------- --------- ---------
(IN MILLIONS)
REVENUES
Health Care Services.................. $20,563.0 $15,415.9 $12,667.8
Water Products........................ 282.9 275.1 259.3
Corporate............................. 11.4 19.8 37.7
--------- --------- ---------
Total............................... $20,857.3 $15,710.8 $12,964.8
========= ========= =========
OPERATING PROFIT
Health Care Services(1)............... $ 354.7(2) $ 92.8(3) $ 206.1
Water Products........................ 49.2 34.6(3) 39.6
--------- --------- ---------
Total............................... 403.9 127.4 245.7
Interest--net(4)...................... (96.5) (47.5) (13.3)
Corporate............................. (47.7) (42.8) (35.5)
--------- --------- ---------
Income before taxes on income....... $ 259.7 $ 37.1 $ 196.9
========= ========= =========
SEGMENT ASSETS--AT YEAR END
Health Care Services.................. $ 5,166.4 $ 4,648.2 $ 2,525.3
Water Products........................ 166.5 144.6 142.0
--------- --------- ---------
Total............................... 5,332.9 4,792.8 2,667.3
Corporate
Cash, cash equivalents and marketable
securities.......................... 113.6 229.8 456.2
Net assets of discontinued
operations.......................... -- -- 125.7
Other................................ 161.0 150.2 111.0
--------- --------- ---------
Total............................... $ 5,607.5 $ 5,172.8 $ 3,360.2
========= ========= =========
DEPRECIATION AND AMORTIZATION
Health Care Services.................. $ 62.7 $ 46.6 $ 40.8
Water Products........................ 22.2 22.8 21.5
Corporate............................. 2.3 2.4 1.9
--------- --------- ---------
Total............................... $ 87.2 $ 71.8 $ 64.2
========= ========= =========
CAPITAL EXPENDITURES
Health Care Services.................. $ 75.2 $ 41.9 $ 43.5
Water Products........................ 47.4 32.3 24.8
Corporate............................. 7.4 2.7 5.3
--------- --------- ---------
Total............................... $ 130.0 $ 76.9 $ 73.6
========= ========= =========
- --------
(1) Includes $12.0 million, $11.4 million and $12.2 million of pre-tax
earnings from an equity investment in fiscal 1998, 1997 and 1996,
respectively.
(2) Includes $16.7 million in charges for the proposed merger with AmeriSource
and $13.9 million in costs associated primarily with the integration and
rationalization of recent acquisitions.
(3) Health Care Services and Water Products amounts include charges for
restructuring, asset impairment, write-off of in-process purchased
technology and other operating items of $140.0 million and $7.0 million,
respectively.
(4) Interest expense is shown net of corporate interest income.
49
FINANCIAL NOTES--(CONTINUED)
The Health Care Services segment includes the Company's U.S. pharmaceutical,
health care products and medical-surgical supplies distribution businesses.
U.S. Health Care operations also include marketing and other support services
to pharmaceutical manufacturers, a manufacturer of automated pharmaceutical
dispensing systems for hospitals and a distributor of first-aid products to
industrial and commercial customers. Health Care Services also includes the
Company's international distribution operations (including Canada and an
equity interest in a Mexican distribution business).
The Water Products segment is engaged in the processing, delivery and sale
of bottled drinking water to homes and businesses and the sale of packaged
water to retail stores.
Information as to the Company's foreign operations is as follows:
1998 1997 1996
--------- --------- ---------
(IN MILLIONS)
REVENUES
United States......................... $19,218.1 $14,198.3 $11,440.6
International......................... 1,639.2 1,512.5 1,524.2
--------- --------- ---------
Total............................... $20,857.3 $15,710.8 $12,964.8
========= ========= =========
OPERATING PROFIT
United States......................... $ 370.3(1) $ 94.1(2) $ 207.5
International......................... 33.6(3) 33.3(4) 38.2
--------- --------- ---------
Total............................... $ 403.9 $ 127.4 $ 245.7
========= ========= =========
ASSETS, AT YEAR END
United States......................... $ 5,194.8 $ 4,935.4 $ 3,130.9
International......................... 412.7 237.4 229.3
--------- --------- ---------
Total............................... $ 5,607.5 $ 5,172.8 $ 3,360.2
========= ========= =========
- --------
(1) Includes $16.7 million in charges for the proposed merger with AmeriSource
and $13.1 million in costs associated primarily with the integration and
rationalization of recent acquisitions.
(2) Includes $90.6 million in charges for restructuring, asset impairment and
other operating items and $48.2 million for the write-off of in-process
purchased technology.
(3) Includes $0.8 million in costs associated with the integration and
rationalization of recent acquisitions.
(4) Includes $8.2 million in charges for restructuring, asset impairment and
other operating items.
16. OTHER COMMITMENTS AND CONTINGENT LIABILITIES
In addition to commitments and obligations in the ordinary course of
business, the Company is subject to various claims, other pending and
potential legal actions for product liability and other damages,
investigations relating to governmental laws and regulations, and other
matters arising out of the normal conduct of the Company's business.
The Company currently is a defendant in numerous civil antitrust actions
filed since 1993 in federal and state courts by retail pharmacies. The federal
cases have been coordinated for pretrial purposes in the United States
District Court in the Northern District of Illinois and are known as MDL 997.
MDL 997 consists of a consolidated class action (the "Federal Class Action")
as well as approximately 109 additional actions brought by approximately 3,500
individual retail, chain and supermarket pharmacies (the "Individual
Actions"). There are numerous other defendants in these actions including
several pharmaceutical manufacturers and several other wholesale distributors.
These cases allege, in essence, that the defendants have violated the Sherman
Act by conspiring to fix the prices of brand name pharmaceuticals sold to
plaintiffs at artificially high, and non-competitive levels, especially as
50
FINANCIAL NOTES--(CONTINUED)
compared with the prices charged to mail order pharmacies, managed care
organizations and other institutional buyers. A class has been certified in
the Federal Class Action. The Seventh Circuit Court of Appeals reversed the
District Court's grant of summary judgment in favor of the Company and the
other wholesale distributors in the Federal Class Action. Trial of the Federal
Class Action is currently scheduled to begin on September 14, 1998. The
Individual Actions will remain in the Northern District of Illinois for pre-
trial purposes, but will be remanded to their original transferor
jurisdictions for trial.
The currently pending state court antitrust cases against the Company are in
California, Alabama and Mississippi. The Company has been dismissed pursuant
to a settlement in cases which were pending in Wisconsin (K-S Pharmacy, et al.
v. Abbott Laboratories, et al.) and Minnesota (Salk Drug v. Abbott
Laboratories, et al.). The state cases are based essentially on the same facts
alleged in the Federal Class Action and Individual Actions and assert
violations of state antitrust and/or unfair competition laws. The case in
California (referred to as Coordinated Special Proceeding, Pharmaceutical
Cases I, II & III) is pending in Superior Court for the State of California
(San Francisco County). A class of retail pharmacies has been certified and
the case is trailing MDL 997. The case in Alabama (Durrett, et al. v. The
Upjohn Co. et al.) is venued in the Circuit Court for Greene County, Alabama.
A class has not yet been certified, and the case is currently before the
Alabama Supreme Court on an appeal from the denial of defendants' motion to
dismiss. The case in Mississippi (Montgomery Drug Co. et al. v. The Upjohn Co.
et al.) is pending in the Chancery Court of Prentiss County, Mississippi. The
Chancery Court has held that the case may not be maintained as a class action.
In each of the cases, plaintiffs seek remedies in the form of injunctive
relief and unquantified monetary damages, and attorneys fees and costs.
Plaintiffs in the California cases also seek restitution. In addition, trebled
damages are sought in the Federal Class Action, the Individual Actions and the
California case and statutory penalties of $500 per violation are sought in
the Mississippi and Alabama cases. The Company believes it has meritorious
defenses to the allegations made against it and intends to vigorously defend
itself in all of these actions. In addition, the Company has entered into a
judgment sharing agreement with certain pharmaceutical manufacturer
defendants, which provides generally that the Company (together with the other
wholesale distributor defendants) will be held harmless by such pharmaceutical
manufacturer defendants and will be indemnified against the costs of adverse
judgments, if any, against the wholesaler and manufacturers in these or
similar actions, in excess of $1 million in the aggregate per wholesale
distributor defendant.
In January 1997, the Company and twelve pharmaceutical manufacturers (the
"Manufacturer Defendants") were named as defendants in the matter of FoxMeyer
Health Corporation vs. McKesson Corporation, et. al. filed in the District
Court in Dallas County, Texas. In its complaint, Plaintiff (the parent
corporation of FoxMeyer Drug Company and FoxMeyer Corporation collectively,
"FoxMeyer Corporation") alleges that, among other things, the Company (i)
defrauded Plaintiff, (ii) competed unfairly and tortiously interfered with
FoxMeyer Corporation's business operations, and (iii) conspired with the
Manufacturer Defendants, all in order to destroy FoxMeyer Corporation's
business, restrain trade and monopolize the marketplace, and allow the Company
to purchase that business at a distressed price. Plaintiff seeks relief
against all defendants in the form of compensatory damages of at least $400
million, punitive damages, attorneys fees and costs. The Company answered the
complaint, denying the allegations, and removed the case to federal bankruptcy
court in Dallas (the "Texas Action").
In March 1997, the Company and the Manufacturer Defendants filed a complaint
in intervention against Plaintiff (now known as Avatex Corporation) in the
action filed against Avatex by the FoxMeyer Unsecured Creditors Committee in
the United States Bankruptcy Court for the District of Delaware. The complaint
in intervention seeks declaratory relief and an order enjoining Avatex from
pursuing the
51
FINANCIAL NOTES--(CONTINUED)
Texas Action. Motions for summary judgment filed by the Company, the
Manufacturer Defendants and the Chapter 7 trustee in the Delaware action are
pending, as is a motion by Avatex to transfer the complaint in intervention to
the Texas Bankruptcy Court. In August 1997, the Texas Bankruptcy Court entered
an order denying the defendants' motion to transfer the case to the District
of Delaware and deferred ruling on the plaintiff's motion to demand the case
to the Texas State Court until the bankruptcy court in Delaware has ruled on
the motions for the summary judgment. The Company believes it has meritorious
defenses to the allegations made against it and intends to vigorously defend
this litigation.
In July 1995, a purported class action was filed in the Supreme Court of the
State of New York against General Medical Corp., Inc. (also known as McKesson
General Medical) and several other defendants by Richard A. Bernstein,
Chairman and President of Rabco Health Services, Inc. and Chairman of General
Medical at the time of its leveraged buyout in 1993. Plaintiff alleges a
conspiracy to orchestrate the buyout of plaintiff's interest in Rabco at an
unfairly low price. Plaintiff alleges common law fraud, breach of fiduciary
duty and inducing breach of fiduciary duty. Plaintiff seeks rescissionary
damages of $50 million, compensatory damages of $25 million, and punitive
damages of $25 million. The complaint was initially dismissed with prejudice
by the Court but that order was reversed by the Court's Appellate Division.
Defendants thereupon filed their answers to the complaint together with a
motion for leave to appeal to the Court of Appeals, which motion was denied. A
renewed motion by defendants General Medical and GM Holdings to dismiss and/or
for summary judgment is pending. The Company believes it has meritorious
defenses to the allegations made against it and intends to vigorously defend
the action.
The Company has been named along with several other defendants in two
lawsuits in California, Royer v. Wyeth-Ayerst Laboratories, et al. and
Valentine v. Wyeth-Ayerst Laboratories, et al., alleging that the plaintiffs
have been injured because they took the drugs fenfluramine or dexfenfluramine
with phentermine, commonly known as dexfen-phen or fen-phen. The Company has
tendered the cases to manufacturers of the drugs and has filed an answer in
one of the cases pending a reply. In addition, a third fen-phen case, Galvan
v. American Home Products, et al., filed in New York state court against a
customer of the Company, has been tendered to the Company by the customer.
This case is being defended by counsel retained by the Company to protect the
customer's interest pending the determination of tender to the manufacturers.
Primarily as a result of the operation of its former chemical businesses,
which were divested in fiscal 1987, the Company is involved in various matters
pursuant to environmental laws and regulations:
The Company has received claims and demands from governmental agencies
relating to investigative and remedial action purportedly required to address
environmental conditions alleged to exist at five sites where the Company (or
entities acquired by the Company) formerly conducted operations; and the
Company, by administrative order or otherwise, has agreed to take certain
actions at those sites, including soil and groundwater remediation.
The current estimate (determined by the Company's environmental staff, in
consultation with outside environmental specialists and counsel) of the upper
limit of the Company's range of reasonably possible remediation costs for
these five sites is approximately $19 million, net of approximately $4 million
which third parties have agreed to pay in settlement or which the Company
expects, based on either on agreements or nonrefundable contributions which
are ongoing, to be contributed by third parties. The $19 million is expected
to be paid out between April 1998 and March 2028 and is included in the
Company's recorded environmental reserves at March 31, 1998.
52
FINANCIAL NOTES--(CONTINUED)
In addition, the Company has been designated as a potentially responsible
party (PRP) by the U.S. Environmental Protection Agency under the
Comprehensive Environmental Response Compensation and Liability Act of 1980,
as amended (the "Superfund" law), for environmental assessment and cleanup
costs as the result of the Company's alleged disposal of hazardous substances
at 18 Superfund sites. With respect to each of these Superfund sites, numerous
other PRP's have similarly been designated and, while the current state of the
law potentially imposes joint and several liability upon PRPs, as a practical
matter costs of these sites are typically shared with other PRPs. The
Company's estimated liability at those 18 Superfund sites is approximately $1
million, net of $2 million which insurance companies, and $2 million which
another PRP, are expected or have agreed to contribute to the Company's
allocated share. The aggregate settlements and costs paid by the Company in
Superfund matters to date has not been significant. The $1 million is included
in the Company's recorded environmental reserves at March 31, 1998.
The potential costs to the Company related to environmental matters is
uncertain due to such factors as: the unknown magnitude of possible pollution
and cleanup costs; the complexity and evolving nature of governmental laws and
regulations and their interpretations; the timing, varying costs and
effectiveness of alternate cleanup technologies; the determination of the
Company's liability of proportion to other PRPs; and the extent, if any, to
which such costs are recoverable from insurance or other parties.
Management believes, based on current knowledge and the advice of the
Company's counsel, that the outcome of the litigation and governmental
proceedings discussed in this note will not have a material adverse effect on
the Company's financial position or results of operations.
17. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
FIRST SECOND THIRD FOURTH FISCAL
QUARTER QUARTER QUARTER QUARTER YEAR
-------- -------- -------- -------- ---------
(IN MILLIONS EXCEPT PER SHARE AMOUNTS)
FISCAL 1998
Revenues................... $4,975.5 $5,147.1 $5,373.5 $5,361.2 $20,857.3
Gross profit............... 364.8 367.7 377.0 411.8 1,521.3
Net income................. 37.6 39.6 42.0 35.7(1) 154.9
Earnings per common
share(2, 3)
Diluted................... $ 0.39 $ 0.41 $ 0.43 $ 0.36 $ 1.59
Basic..................... 0.41 0.44 0.45 0.39 1.69
Cash dividends per common
share(3).................. $ 0.125 $ 0.125 $ 0.125 $ 0.125 $ 0.50
Market prices per common
share(3)
High...................... $40 1/16 $ 53 1/8 $ 56 7/8 $ 61 3/4 $ 61 3/4
Low....................... 31 1/2 38 1/4 48 11/16 47 7/8 31 1/2
- --------
(1) Includes $16.7 million in after-tax charges for the proposed merger with
AmeriSource, $8.7 million in after-tax costs associated primarily with the
integration and rationalization of recent acquisitions and a $4.6 million
favorable tax adjustment.
(2) Restated in accordance with Statement of Financial Accounting Standards
No. 128 "Earnings per Share."
(3) Restated to reflect the two-for-one stock split declared October 29, 1997,
distributed January 2, 1998 to stockholders of record December 1, 1997.
53
FINANCIAL NOTES--(CONCLUDED)
FIRST SECOND THIRD FOURTH FISCAL
QUARTER QUARTER QUARTER QUARTER YEAR
-------- -------- -------- -------- ---------
(IN MILLIONS EXCEPT PER SHARE AMOUNTS)
FISCAL 1997
Revenues............... $3,326.7 $3,410.6 $4,211.5 $4,762.0 $15,710.8
Gross profit........... 231.9 231.0 243.8 330.6 1,037.3
Income (loss) after
taxes.................
Continuing operations. (21.4)(1) 25.8 (36.1)(2) 36.8 5.1
Discontinued
operations........... 3.3 2.3 2.1 0.9 8.6
Discontinued
operations--Gain on
sale of Armor All.... -- -- 120.2 -- 120.2
-------- -------- -------- -------- ---------
Total................ $ (18.1) $ 28.1 $ 86.2 $ 37.7 $ 133.9
======== ======== ======== ======== =========
Earnings (loss) per
common share(3, 4)
Diluted
Continuing operations. $ (0.25) $ 0.29 $ (0.43) $ 0.41 $ 0.06
Discontinued
operations........... 0.04 0.03 0.02 0.01 0.10
Discontinued
operations--Gain on
sale of Armor All.... -- -- 1.44 -- 1.35
-------- -------- -------- -------- ---------
Total................ $ (0.21) $ 0.32 $ 1.03 $ 0.42 $ 1.51
======== ======== ======== ======== =========
Basic
Continuing operations. $ (0.25) $ 0.30 $ (0.43) $ 0.42 $ 0.06
Discontinued
operations........... 0.04 0.03 0.02 0.01 0.10
Discontinued
operations--Gain on
sale of Armor All.... -- -- 1.44 -- 1.41
-------- -------- -------- -------- ---------
Total................ $ (0.21) $ 0.33 $ 1.03 $ 0.43 $ 1.57
======== ======== ======== ======== =========
Cash dividends per
share(4)............... $ 0.125 $ 0.125 $ 0.125 $ 0.125 $ 0.50
Market prices per common
share(4)
High................... $ 25 5/8 $24 1/16 $ 28 3/8 $ 34 1/8 $ 34 1/8
Low.................... 22 1/16 20 9/16 22 7/8 26 1/16 20 9/16
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(1) Includes $48.2 million for the write-off of purchased in-process
technology.
(2) Includes $61.3 million in after-tax charges for restructuring, asset
impairment and other operating items.
(3) Restated in accordance with Statement of Financial Accounting Standards No.
128 "Earnings per Share."
(4) Restated to reflect the two-for-one stock split declared October 29, 1997,
distributed January 2, 1998 to stockholders of record December 1, 1997.
54