1. June 16, 2004
To our Stockholders:
In Fiscal 2004, McKesson delivered its fourth straight year of solid financial
performance. For the year, we achieved revenue growth of 22% and earnings per
share growth of 16%, we generated cash flow from operations of $563 million, made
share repurchases of $157 million and ended the year with a net debt to net capital
ratio of just 13%. Over the past four years, we had compound annual revenue growth
in excess of 17% and compound annual growth of 36% in diluted earnings per share
from continuing operations. During Fiscal 2004, we enhanced our ability to deliver
sustained growth through organizational refinements, operating improvements, a
series of small but strategic acquisitions and continued investments in product
innovation and new initiatives. Our progress, combined with accelerating demand
from consumers, employers, payors and government for more effective and efficient
healthcare, positions your company for continued revenue and earnings growth in
Fiscal 2005.
McKesson Drives Improvements in Healthcare Quality and Cost
Government and consumer pressure is mounting to improve the quality of healthcare
while reducing the cost. Solving this challenge has become a national priority. Aging
Baby Boomers are entering their peak years for healthcare issues. Their informed
medical needs continue to fuel increasing demand for both more and markedly better
care. Meeting these demands strains the financial resources of healthcare payors,
providers and consumers alike. We believe that McKesson solutions can play a pivotal
role in delivering better care to more Americans in the most efficient way possible.
Supply chain integrity delivered by McKesson products and services ensures safe
drugs and medical supplies for patients at the most efficient cost. A recent study by
the Healthcare Distribution Management Association identified the important value
provided by pharmaceutical wholesalers on behalf of both manufacturers and
customers through superb delivery logistics, working capital savings and phenomenal
operating efficiencies combined with innovative valueadding services. For example,
McKesson is a leader in developing and promoting innovations that track the flow of
pharmaceuticals and medical-surgical supplies from the manufacturer's loading dock
to the patient's use. We pioneered technologies that scan bar codes on these products
as they move through the healthcare system on their way to providing beneficial
therapy. We stand ready to provide bar code packaging to our manufacturer and
customer partners as they prepare to meet the government's new mandate for
universal bar coding of pharmaceuticals in hospitals. McKesson is the only company
that provides a comprehensive system of robotics, scanning, dispensing and software
covering both oral and injectable medications to reduce medication errors, which is
2. now used in more than 250 U.S. hospitals. We are currently collaborating closely with
the world's largest retailer, Wal-Mart, to apply nextgeneration RFID technology to
further improve the purchasing, safety and efficient management of pharmaceutical
inventories.
McKesson information technologies and databases of knowledge put best practice
information in the hands of providers when crucial decisions are being made at the
point of care. More than half the nation's largest hospitals currently use McKesson
information technologies to meet their clinical and financial missions. In the past
three years, McKesson has introduced to our customers:
Software and hardware that digitizes, stores and provides access to medical images
such as X-rays, CAT scans and PET scans, speeding viewing while eliminating the
need for film that is expensive and costly to store.
Software and hardware that scans, stores and provides access to written or printed
patient records and notes, improving availability and reducing space used to store
paper for more important clinical use.
An information and ordering system for physicians that integrates technology to order
and view lab tests, schedule clinical events and prescribe drugs with a database that
alerts them to the best practices for more than 1,000 medical encounters.
A web-based portal that securely displays clinical information — and more — on
computer screens, laptop computers, digital assistants and cell-phone screens,
anytime, anywhere.
Increased use of information technology in healthcare received a major boost from
President Bush in early 2004. In his State of the Union address, the President
endorsed computerized healthcare to avoid medical mistakes and improve quality. On
April 27, he announced a new initiative to ensure that all Americans have electronic
medical records within 10 years. The President then directed all federal agencies
involved in healthcare to recommend actions to promote the adoption of healthcare
information technology. We believe that our market momentum, combined with these
favorable influences on our customers, will continue to accelerate revenue
opportunities for information solutions from McKesson.
McKesson disease management programs make it possible for patients with chronic
illnesses to have the best health outcomes at the lowest cost. The Medicare
Modernization Act of 2003 expands access to much-needed drugs for millions of
seniors. Perhaps equally important for the long-term, the Act also provides incentives
and focuses on programs designed to proactively manage the therapies and behaviors
of patients with chronic disease. Millions of Americans suffer from debilitating,
complex and costly conditions such as diabetes, congestive heart failure and asthma.
McKesson now manages the health outcomes for Medicaid patients with these
conditions in seven states, making us the leader in government disease management
programs. These states save on average two dollars for every dollar spent with
McKesson on disease management, saving tens of millions of dollars while improving
health outcomes and the satisfaction of both patients and physicians. We are now
applying for a Medicare Act disease management demonstration project to validate
benefits on an even larger scale. In a related program, the Together Rx drug card
administered by McKesson on behalf of seven pharmaceutical manufacturers has
more than 1.3 million enrollees for whom it has delivered more than $350 million in
cost savings since it was launched two years ago. On June 1, seniors also began
benefiting from the new McKesson Rx Savings Access prescription drug discount card,
3. enabled through cooperation with several of our largest retail chain customers and
accepted at more than 48,000 pharmacies nationwide.
Organizational Changes and Operating Improvements Should Drive Improving
Results
Clearly, McKesson is well-positioned for growth being driven by the many,
intensifying forces for change in healthcare. As Fiscal 2005 began, we implemented a
series of organizational refinements designed to better align and integrate our
product development and selling efforts with the evolving needs of the marketplace.
McKesson Provider Technologies combines McKesson Information Solutions,
McKesson's inpatient automation business and our Corporate Solutions Group, which
quarterbacks complex sales, predominantly to large hospital and health networks. In
Fiscal 2004, Corporate Solutions led 218 large, multi-business strategic agreements,
up from 55 agreements the prior year. We also combined into a single unit the
company's Payor business, which provides medical guidelines and criteria, software,
analytics, patient call services and disease management to more than 600 commercial
and government Payors nationwide. The Payor business is part of McKesson
Pharmaceutical Solutions. And we moved Zee Medical, which provides first aid and
safety products and training services to corporate customers, to McKesson Medical-
Surgical Solutions. These organizational changes should enable us to accelerate
growth through more effective selling efforts while generating internal efficiencies.
In Fiscal 2004, we continued to focus on operational improvements across our
business. These improvements are designed to drive economic efficiencies, increase
operating margins and improve customer satisfaction. Customer satisfaction survey
scores improved in each of our segments, showing that customers recognize the value
we are bringing to their organizations.
We ended the year with strong revenue growth in pharmaceutical distribution in both
the United States and Canada, and have great revenue momentum entering this year.
Over the past 12 months, we signed renewal contracts with six of our ten largest U.S.
customers, in most cases expanding our previous relationship, adding new products or
services. On May 10, we began a major new agreement to supply pharmaceuticals to
the Department of Veterans Affairs, the nation's largest hospital network. While we
continued to leverage our cost structure through expense controls and productivity
programs, Pharmaceutical Solutions operating margin rate and operating profit came
under pressure as a result of reduced product sourcing opportunities and lower
pricing to customers. To stabilize margins, we are executing proactive programs to
address both the profit that we earn from the services we provide to our manufacturer
partners and our pricing to customers. We are making good progress in our
discussions to improve the economics of our relationships with pharmaceutical
manufacturers and believe we have sound strategies to stabilize pricing to customers.
By the second half of Fiscal 2005, we expect to see improvement in our
Pharmaceutical Solutions operating profit.
In Medical-Surgical Solutions, operating profit and operating margin rate improved
steadily throughout the year. Our progress over the past five quarters tracked the
plan we outlined in the fall of 2002. We continue to have strong growth from alternate
site customers. An expanded program to distribute in-office dispensed
pharmaceuticals, such as vaccines, to our more than 50,000 physician office
4. customers, helped drive annual revenue growth of 13% for this sector of the market.
Growth in our alternate site business should continue to be strong in Fiscal 2005,
which together with further progress in our operating plan should produce continued
improvement in operating profit and operating margin.
In Information Solutions, revenue growth was modest. Software revenues for the year
were impacted by slower demand for non-clinical software and the longer installation
periods needed to implement our complex clinical contracts. Operating profit and
operating margin rate improved during the year, reflecting better product mix,
expense controls and the impact of changes to settlement and contract reserves. We
continued to achieve great progress in our program to increase product innovation
and improve customer satisfaction. Seven McKesson software products earned #1 or
#2 rankings in the 2003 Annual Top 20 Year End quot;Best in KLASquot; industry survey. No
other vendor had more. Three years ago, McKesson had no products that ranked #1 or
#2.
With our strong balance sheet, we continued to make strategic investments to
enhance our multifaceted offering to customers. During the year, we acquired Sky
Pharmaceuticals, a leading supplier of unit-dose, bar-coded packaging for hospitals,
having packaged more than 300 million doses in the past 12 months. Sky's
capabilities complement our previously established bulk-tobottle retail repackaging
operation. We now have a comprehensive packaging solution, which is already seeing
increased demand resulting from the FDA's mandate for bar coding of hospital
medications. We also acquired the remaining 50% of our SI Baker joint venture. SI
Baker is the leading provider of end-to-end, high-volume prescription dispensing
technology. It is the cornerstone technology for our automated refill center (ARC)
strategy we provide to large retail chains. On April 1, we completed our acquisition of
Moore Medical, an Internet-enabled, multichannel supplier of medical-surgical
products and pharmaceuticals to non-hospital providers of healthcare. Moore's reach
and technologies for the alternate site market dovetail nicely with our existing
leading position in this segment. We will continue to invest in the future, with $30
million of incremental spending for key initiatives planned in Fiscal 2005, including
our Medication Safety Solution, our Rx Access drug card for seniors and our Payor
business.
Well-Positioned for Continued Growth
As a result of our recent organizational changes, continued focus on operating
efficiencies and expense controls, favorable market conditions, comprehensive
solutions to address healthcare's need to improve quality and reduce cost, product
innovation and strategic initiatives, we believe McKesson is well positioned for
sustained growth. I continue to be especially pleased with the integrity, execution,
accountability and productivity of our dedicated employees. Since 1999, we have
grown our revenues by $39.5 billion, while maintaining our headcount at 24,500
employees — a remarkable 132% increase in revenues per employee in just five years.
McKesson today is an exciting place to be. We sit in the middle of the fastest-growing
and most rewarding segment of the American economy. My thanks to our employees
for their hard work and abiding commitment to our success, to our customers for their
loyalty and cooperative spirit, to our supplier partners for their collaborative approach
to our mutual goals and to our shareholders for their continued support.
5. Despite the near-term challenges in our business, the cost challenges faced by many
companies today and our plan to increase investments in long-term opportunities,
McKesson should deliver growth again in Fiscal 2005. Longer term, the health of the
business and the soundness of our strategies should enable McKesson to grow
revenues in excess of 10% per year and achieve earnings per share growth in the mid-
teens. I'm very pleased with our achievements and look forward to strong
performance in Fiscal 2005.