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McKesson 10-K 2007 Documents found in this filing:Table of Contents
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
For the fiscal year ended March 31, 2007
OR
Commission File Number 1-13252
McKESSON CORPORATION
A Delaware Corporation
I.R.S. Employer Identification Number
94-3207296 McKesson Plaza
One Post Street, San Francisco, CA 94104 Telephone (415) 983-8300 Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act: None.
Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act. Yes þ No o
Indicate by check mark whether the registrant is not required to file reports pursuant to
Section 13 or 15(d) of the Act. Yes o No þ
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the Registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation
S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in
definitive proxy or information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. þ
Indicate by check mark whether the registrant is a shell company as defined in Rule 12b-2 of
the Exchange Act. Yes o No þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated
filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated
filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer þ Accelerated filer o Non-accelerated filer o
The aggregate market value of the voting stock held by non-affiliates of the registrant,
computed by reference to the closing price as of the last business day of the registrant’s most
recently completed second fiscal quarter, September 2006, was approximately $15.5 billion.
Number of shares of common stock outstanding on April 30, 2007: 297,204,662
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant’s Proxy Statement for its 2007 Annual Meeting of Stockholders are
incorporated by reference into Part III of this Annual Report on Form 10-K.
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PART I
Item 1. Business
General
McKesson Corporation (“McKesson,” the “Company,” the “Registrant,” or “we” and other similar
pronouns), is a Fortune 18 corporation providing supply, information and care management products
and services designed to reduce costs and improve quality across the healthcare industry.
The Company’s fiscal year begins on April 1 and ends on March 31. Unless otherwise noted, all
references in this document to a particular year shall mean the Company’s fiscal year.
Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K
and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the
Securities Exchange Act of 1934 (the “Exchange Act”), as amended, are available free of charge on
our Web site (www.mckesson.com under the “Investors – SEC Filings” caption) as soon as
reasonably practicable after we electronically file such material with, or furnish it to, the
Securities and Exchange Commission (“SEC” or the “Commission”). The content on any Web site
referred to in this Annual Report on Form 10-K is not incorporated by reference into this report,
unless expressly noted otherwise.
Business Segments
We conduct our business through three segments. Through our Pharmaceutical Solutions segment,
we are a leading distributor of ethical and proprietary drugs, and health and beauty care products
throughout North America. This segment also provides medical management and specialty
pharmaceutical solutions for biotech and pharmaceutical manufacturers, patient and other services
for payors, software and consulting and outsourcing services to pharmacies and, through its
investment in Parata Systems, LLC (“Parata”), sells automated pharmaceutical dispensing systems for
retail pharmacies. Our Medical-Surgical Solutions segment distributes medical-surgical supplies,
first-aid products and equipment, and provides logistics and other services within the United
States and Canada. Our Provider Technologies segment delivers enterprise-wide patient care,
clinical, financial, supply chain, and strategic management software solutions, pharmacy automation
for hospitals, as well as connectivity, outsourcing and other services, to healthcare organizations
throughout North America, the United Kingdom and other European countries. Its customers include
hospitals, physicians, homecare providers, retail pharmacies and payors. The Company’s strategy is
to create strong, value-based relationships with customers, enabling us to sell additional products
and services to these customers over time.
Net revenues for our segments for the last three years were as follows:
Pharmaceutical Solutions
McKesson Pharmaceutical Solutions consists of the following businesses: McKesson U.S.
Pharmaceutical, McKesson Canada, McKesson Health Solutions, McKesson Pharmacy Systems, McKesson
Medication Management and McKesson Specialty Distribution. We also own an approximate 49% interest
in Nadro, S.A. de C.V. (“Nadro”) and an approximate 39% interest in Parata.
U.S. Pharmaceutical Distribution: This business supplies pharmaceuticals and other healthcare
related products to customers in three primary customer segments: 1) retail national accounts
(including national and regional chains, food/drug combinations, mail order pharmacies and mass
merchandisers); 2) independent retail pharmacies, and; 3) institutional healthcare providers
(including hospitals, health systems, integrated delivery networks, clinics and other acute-care
facilities and long-term care providers).
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Our U.S. Pharmaceutical business operates and serves thousands of customer locations through a
network of 30 distribution centers, as well as a master redistribution center, a strategic
redistribution center and a repackaging facility, serving all 50 states and Puerto Rico. We invest
in technology and other systems at all of our distribution centers to enhance safety, reliability
and the best product availability for our customers. For example, in all of our distribution
centers we use Acumax® Plus, a Smithsonian award-winning technology, which integrates and tracks
all internal functions, such as receiving, put-away and order fulfillment. Acumax® Plus uses bar
code technology, wrist-mounted computer hardware, and radio frequency signals to provide our
customers with real-time product availability and industry-leading order quality and fulfillment at
up to 99.9% accuracy. In addition, we offer Mobile ManagerSM, which integrates portable
handheld technology with Acumax® Plus to give customers complete ordering and inventory control.
We also offer Supply Management OnlineSM, an Internet-based tool that provides item
look-up and real-time inventory availability as well as ordering, purchasing, third-party
reconciliation and account management functionality. Together, these features help ensure that our
customers have the right products at the right time for their facilities and patients.
To maximize distribution efficiency and effectiveness, we follow the Six Sigma methodology —
an analytical approach that emphasizes setting high quality objectives, collecting data and
analyzing results to a fine degree in order to improve processes, reduce costs and errors.
Furthermore, we continue to implement information systems to help achieve greater consistency and
accuracy both internally and for our customers.
Our U.S. Pharmaceutical Distribution business’ major value-added offerings, by customer group,
include the following:
Retail National Accounts — Business solutions that help national accounts increase revenues
and profitability:
Independent Retail Pharmacies — Solutions for managed care contracting, branding and
advertising, merchandising and purchasing that help independent pharmacists focus on patient care
while improving profitability:
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Institutional Healthcare Providers — Electronic
ordering/purchasing and supply chain management systems that help improve efficiencies, save labor
and improve asset utilization:
International Pharmaceutical Distribution: McKesson Canada Corporation, a wholly-owned
subsidiary, is the largest pharmaceutical distributor in Canada. We also own an approximate 49%
interest in Nadro, the leading pharmaceutical distributor in Mexico.
Investment in Parata: We own an approximate 39% interest in Parata which sells automated
pharmacy and supply management systems and services to retail and
institutional outpatient pharmacies.
Payor Group: The following suite of services and software products is marketed to payors,
employers and government organizations to help manage the cost and quality of care:
McKesson Specialty Distribution: This business’ product-specific solutions are directed
towards manufacturers, payors and physicians to enable delivery and administration of high-cost,
often injectable, bio-pharmaceutical drugs used to treat patients with chronic disease. The
business facilitates patient and provider access to specialty pharmaceuticals across multiple
delivery channels (direct-to-physician wholesale, patient-direct specialty pharmacy dispensing and
access to retail pharmacy), provides clinical support and treatment compliance programs that help
patients stay on complex therapies and offers reimbursement, data collection and analysis services.
Medical–Surgical Solutions
Our Medical-Surgical Solutions segment provides medical-surgical supply distribution,
equipment, logistics and other services to healthcare providers that include physicians’ offices,
surgery centers, extended care facilities, homecare and occupational health sites through a network
of 29 distribution centers within the U.S. This segment is the leading provider of supplies to the
full range of alternate-site healthcare facilities, including physicians’ offices, clinics and
surgery centers (primary care), long-term care, occupational health facilities and homecare sites
(extended care). Through a variety of technology products and services geared towards the supply
chain, Medical-Surgical Solutions is focused on helping its customers operate more efficiently
while providing the industry’s most extensive product offering, including its own private label
line. This segment also includes ZEE® Medical, North America’s leading provider of first aid,
safety and training solutions, providing services to industrial and commercial customers. This
business offers an extensive line of products and services aimed at maximizing productivity and
minimizing the liability and cost associated with workplace illnesses and injuries.
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Provider Technologies
Our Provider Technologies segment provides a comprehensive portfolio of software, automation,
support and services to help healthcare organizations improve quality and patient safety, reduce
the cost and variability of care and better manage their resources and revenue stream. This
segment markets its products and services to integrated delivery networks, hospitals, physician practices, home health providers, retail pharmacies and payors. The segment also sells its
solutions internationally through subsidiaries and/or distribution agreements in Canada, the United
Kingdom, Ireland, France, the Netherlands, Australia, New Zealand and Israel.
The product portfolio for the Provider Technologies segment is designed to address a wide
array of healthcare clinical and business performance needs ranging from medication safety and
information access to revenue cycle management, resource utilization and physician adoption of
electronic health records (“EHR”). Analytics software enables organizations to measure progress as
they automate care processes for optimal clinical outcomes, business and operating results, and
regulatory compliance. To ensure that organizations achieve the maximum value for their
information technology investment, the Provider Technologies segment also offers a wide range of
services to support the implementation and use of solutions as well as assist with business and
clinical redesign, process re-engineering and staffing (both information technology and
back-office).
Key solution areas are as follows:
Clinical management: Horizon Clinicals® is built with architecture to facilitate
integration
and enable modular system deployment. It includes a clinical data repository, clinical decision
support/physician order entry, point-of-care documentation with bar-coded medication
administration, enterprise laboratory, radiology, pharmacy, surgical management, an emergency
department solution and an ambulatory EHR system. Horizon Clinicals® also includes solutions to
facilitate physician access to patient information such as a Web-based physician portal and
wireless devices that draw on information from the hospital’s information systems. In addition,
the Horizon Clinicals® suite includes a comprehensive solution for homecare, including telehealth
and hospice.
Enterprise imaging: In addition to document imaging to facilitate maintenance and access to
complete medical records, the segment provides a suite of enterprise medical imaging and
information management systems, including a picture archiving communications system and a
comprehensive cardiovascular information system. The segment’s enterprise-wide approach to medical
imaging enables organizations to take advantage of specialty-specific workstations while building
an integrated image repository that manages all of the images and information captured throughout
the care continuum.
Revenue cycle management: The segment’s revenue cycle solutions are designed to reduce days
in accounts receivable, prevent insurance claim denials, reduce costs and improve productivity.
Examples of solutions include online patient billing, contract management, electronic claims
processing and coding compliance checking. The segment’s hospital information systems play a key
role in managing the revenue cycle by automating the operation of individual departments and their
respective functions within the inpatient environment.
Resource management: Resource management solutions consist of an integrated suite of
applications that enhance an organization’s ability to forecast and optimize enterprise-wide use of
resources (labor, supplies, equipment and facilities) associated with the delivery of care. These
solutions help automate and link resource requirements to care protocols designed to increase
profitability, enhance decision-making and improve business processes.
Automation: Automation solutions include technologies that help hospitals to re-engineer and
improve their medication use and supply management processes. Examples include centralized
pharmacy automation for unit-dose medications, unit-based cabinet technologies for secure
medication storage and rapid retrieval, point-of-use supply automation systems for inventory
management and revenue capture, and an automated medication administration system for ensuring
accuracy at the point of care. Based on a foundation of bar-code scanning technology, these
integrated solutions are designed to reduce errors and bring new levels of safety to patients.
Physician practice solutions: The segment provides a complete solution for physician
practices of all sizes that includes software, revenue cycle outsourcing and connectivity services.
Software solutions include practice management and EHR software for physicians of every size,
specialty or geographic location. The segment’s physician practice offering also includes
outsourced billing and collection services as well as services that connect physicians with their
patients, hospitals, retail pharmacies and payors. Revenue cycle outsourcing enables physician
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groups to avoid the infrastructure investment and administrative costs of their own in-house
billing office. Services include clinical data collection, data input, medical coding, billing,
contract management, cash collections, accounts receivable management and extensive reporting of
metrics related to the physician practice.
Connectivity: Following the acquisition of Per-Se Technologies, Inc., in January 2007, we
announced a vendor-neutral connectivity business known as RelayHealth®. The RelayHealth®
“intelligent” network includes interactive connectivity solutions that streamline clinical,
financial and administrative communication between patients, providers, payors, pharmacies and
financial institutions. RelayHealth helps to accelerate the delivery of high-quality care and
improve financial performance through solutions such as those for online consultation of physicians
by patients, electronic prescribing by physicians, point-of-service resolution of pharmacy claims
by payors, pre-visit financial clearance of patients by providers and post-visit settlement of
provider bills by payors and patients.
In addition to the product offerings described above, the Provider Technologies segment offers
a comprehensive range of services to help organizations derive greater value, enhance satisfaction
and return on investment throughout the life of the solutions implemented. The range of services
includes:
Technology Services: The segment has worked with numerous healthcare organizations to support
the smooth operation of their information systems by providing the technical infrastructure
designed to maximize application accessibility, availability, security and performance.
Professional Services: Professional services help customers achieve business results from
their software or automation investment. The segment offers a wide array of quality service
options, including consulting for business and/or clinical process improvement and re-design as
well as implementation, project management, technical and education services relating to all
products in the Provider Technologies segment.
Outsourcing Services: The segment helps organizations focus their resources on healthcare
while the segment manages their information technology or revenue cycle operations through
outsourcing. Outsourcing service options include managing hospital data processing operations, as
well as strategic information systems planning and management, revenue cycle processes, payroll
processing, business office administration and major system conversions.
Acquisitions, Investments and Discontinued Operations
We have undertaken strategic initiatives in recent years designed to further focus on our core
healthcare businesses and enhance our competitive position. We expect
to continue to undertake such strategic initiatives in the future. These initiatives are detailed in
Financial Notes 2 and 3 to the consolidated financial statements, “Acquisitions and Investments”
and “Discontinued Operations,” appearing in this Annual Report on Form 10-K.
Competition
In every area of healthcare distribution operations, our Pharmaceutical Solutions and
Medical-Surgical Solutions segments face strong competition, both in price and service, from
national, regional and local full-line, short-line and specialty wholesalers, service
merchandisers, self-warehousing chains, manufacturers engaged in direct distribution and large
payor organizations. In addition, these segments face competition from various other service
providers and from pharmaceutical and other healthcare manufacturers (as well as other potential
customers of the segments) which may from time to time decide to develop, for their own internal
needs, supply management capabilities provided by the segments. Price, quality of service and, in
some cases, convenience to the customer are generally the principal competitive elements in these
segments.
Our Provider Technologies segment experiences substantial competition from many firms,
including other computer services firms, consulting firms, shared service vendors, certain
hospitals and hospital groups, hardware vendors and Internet-based companies with technology
applicable to the healthcare industry. Competition varies in size from small to large companies,
in geographical coverage, and in scope and breadth of products and services offered.
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Intellectual Property
The principal trademarks and service marks of the Pharmaceutical Solutions and
Medical-Surgical Solutions segments include: AccessHealth®, Acumax®,
Ask-A-Nurse®, CareEnhance®,
Closed Loop DistributionSM, Comets®, ConsumerScriptSM, CRMS®, .com Pharmacy
Solutions®, Econolink®, Empowering Healthcare®,
EnterpriseRx™, Episode Profiler®, Expect More From
MooreSM, FrontEdge™, Fulfill-Rx™, Health Mart®, High Performance
PharmacySM,
InterQual®, LoyaltyScriptSM, Max ImpactSM, McKesson®, McKesson Advantage®,
McKesson Empowering Healthcare®, McKesson Max Rewards®, McKesson OneStop
Generics®, McKesson
Priority Express®, McKesson Supply ManagerSM,
MediNet™, Medi-Pak®, Mobile
ManagerSM, Moore Medical®, MoorebrandSM,
NOA®, Patterns Profiler™,
Pharma360®, PharmacyRx™, Pharmaserv®, PharmAssureSM,
ProIntercept®, ProMed®, ProPBM®, RX
PakSM, RX Savings Access®, ServiceFirst®,
Staydry®, Sunmark®, Supply Management
OnlineSM, TrialScript®, Valu-Rite®, XVIII B Medi
Mart® and ZEE®.
The substantial majority of technical concepts and codes embodied in our Provider Technologies
segment’s computer programs and program documentation are principally protected as trade secrets.
The principal trademarks and service marks for this segment are: Care Fully Connected™,
HealthQuest®, Paragon®, Pathways 2000®, TRENDSTAR®, Horizon Clinicals®, HorizonWP®, Series 2000™,
STAR 2000™, PracticePoint®, ROBOT-Rx®,
MedCarousel®, PACMED™, AcuDose-Rx®, CarePoint-RN™,
Connect-Rx®, Connect-RN™, Horizon Admin-Rx™, Pak Plus-Rx®,
SelfPace®, Fulfill-RxSM and
SupplyScan™, Per-Se Technologies® (and logo), Per-Se®,
PerYourHealth.com®, ORSOS®, One-Call®,
One-Staff®, ANSOS®, Premis®, DataStat®, Medisoft™, ePremis®, Lytec®, E-Script™,
WebVisit™,
RelayHealth®, Practice Partner® and Physician Micro
Systems®.
We also own other registered and unregistered trademarks and service marks and similar rights
used by our business segments. All of the principal trademarks and service marks are registered in
the United States, or registrations have been applied for with respect to such marks, in addition
to certain other jurisdictions. The United States federal registrations of these trademarks have
terms of ten or twenty years, depending on date of registration, and are subject to unlimited
renewals. We believe we have taken all necessary steps to preserve the registration and duration
of our trademarks and service marks, although no assurance can be given that we will be able to
successfully enforce or protect our rights thereunder in the event that they are subject to
third-party infringement claims. We do not consider any particular patent, license, franchise or
concession to be material to our business. We also hold copyrights
in, and patents related to, many of our products.
Other Information About the Business
Customers: In recent years, a significant portion of our revenue growth has been with a
limited number of large customers. During 2007, sales to our largest customer, Caremark RX, Inc.,
and ten largest customers accounted for approximately 11% and 51% of our total consolidated
revenues. At March 31, 2007, accounts receivable from Caremark RX, Inc. and our ten largest
customers were approximately 12% and 48% of total accounts receivable. The majority of these
revenues and accounts receivable are included in our Pharmaceutical Solutions segment.
Suppliers: We obtain pharmaceutical and other products from manufacturers, none of which
accounted for more than approximately 10% of our purchases in 2007. The loss of a supplier could
adversely affect our business if alternate sources of supply are unavailable. We believe that our
relationships with our suppliers on the whole are good. The ten largest suppliers in 2007 accounted for
approximately 55% of our purchases.
Over the past few years, our U.S. pharmaceutical distribution business has changed how it is
compensated for the logistical, capital and administrative services that it provides to branded
pharmaceutical manufacturers. Historically, a significant portion of compensation from the
manufacturers was inflation-based. We purchased and held pharmaceutical inventory in anticipation
of manufacturers increasing their prices. We benefited when the manufacturers increased their
prices as we sold the inventory being held at the new higher prices. Commencing in 2003, branded
pharmaceutical manufacturers implemented a number of changes such as restricting the volume of
product available for purchase by pharmaceutical wholesalers. These changes limited our ability to
purchase inventory in advance of price increases and led to volatility in our gross profit. In
2005, manufacturers also reduced the number and average magnitude of price increases.
By early 2006, we had revised most of our distribution arrangements with the manufacturers.
Under these new arrangements, a significant portion of our compensation from the manufacturers is
generated based on a percentage of purchases and, as a result, we are no longer as dependent upon
pharmaceutical price increases. We continue to have certain distribution arrangements with
manufacturers that include an inflation-based compensation component while other arrangements
remain structured under the historical inflation-based compensation model.
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For these manufacturers, a reduction in the frequency and magnitude of price increases as well
as restrictions in the amount of inventory available to us could adversely impact our gross profit
margin. In 2007, we benefited from certain branded manufacturers’ price increases on selected
drugs.
In addition, with the transition to these new arrangements, purchases from certain
manufacturers are better aligned with customer demand and as a result, net financial inventory
(inventory, net of accounts payable) decreased in 2006. This decrease had a positive impact on our
cash flow from operations. These new arrangements also have somewhat diminished the seasonality of
gross profit margin which has historically reflected the pattern of manufacturers’ price increases.
Research and Development: Our research and development (“R&D”) expenditures primarily consist
of our investment in software development held for sale. We expended $359 million, $285 million
and $232 million for R&D activities in 2007, 2006 and 2005, and of these amounts, we capitalized
21%, 22% and 21%. R&D expenditures are primarily incurred by our Provider Technologies segment and
Payor Group. Our Provider Technologies segment’s product development efforts apply computer
technology and installation methodologies to specific information processing needs of hospitals.
We believe a substantial and sustained commitment to such expenditures is important to the
long-term success of this business. Additional information regarding our R&D activities is
included in Financial Note 1 to the consolidated financial statements, “Significant Accounting
Policies,” appearing in this Annual Report on Form 10-K.
Environmental Legislation: We sold our chemical distribution operations in 1987 and retained
responsibility for certain environmental obligations. Agreements with the Environmental Protection
Agency and certain states may require environmental assessments and cleanups at several closed
sites. These matters are described further in Financial Note 17, “Other Commitments and Contingent
Liabilities,” appearing in this Annual Report on Form
10-K. Other than any expenditures that may be required in connection with those legal
matters, we do not anticipate making substantial capital expenditures either for environmental
issues, or to comply with environmental laws and regulations in the future. The amount of our
capital expenditures for environmental compliance was not material in 2007 and is not expected to
be material in the next year.
Employees: On March 31, 2007, we employed approximately 31,800 persons compared to 26,400 in
2006 and 25,200 in 2005.
Financial Information About Foreign and Domestic Operations: Information as to foreign and
domestic operations is included in Financial Notes 1 and 21 to the consolidated financial
statements, “Significant Accounting Policies” and “Segments of Business,” appearing in this Annual
Report on Form 10-K.
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Item 1A. Risk Factors
Information regarding our risk factors is included in the Financial Review under the captions
“Factors Affecting Forward-Looking Statements” and “Additional Factors That May Affect Future
Results,” beginning on page 48 of this Annual Report on Form 10-K.
Item 1B. Unresolved Staff Comments
Not applicable.
Item 2. Properties
Because of the nature of our principal businesses, plant, warehousing, office and other
facilities are operated in widely dispersed locations. The warehouses are typically owned or
leased on a long-term basis. We consider our operating properties to be in satisfactory condition
and adequate to meet our needs for the next several years without making capital expenditures
materially higher than historical levels. Information as to material lease commitments is included
in Financial Note 12 to the consolidated financial statements, “Lease Obligations,” appearing in
this Annual Report on Form 10-K.
Item 3. Legal Proceedings
Certain legal proceedings in which we are involved are discussed in Financial Note 17 to our
consolidated financial statements, “Other Commitments and Contingent Liabilities,” appearing in
this Annual Report on Form 10-K.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders, through the solicitation of proxies
or otherwise, during the three months ended March 31, 2007.
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Executive Officers of the Registrant
The following table sets forth information regarding the executive officers of the Company,
including their principal occupations during the past five years. The number of years of service
with the Company includes service with predecessor companies.
There are no family relationships between any of the executive officers or directors of the
Company. The executive officers are chosen annually to serve until the first meeting of the Board
of Directors following the next annual meeting of stockholders and until their successors are
elected and have qualified, or until death, resignation or removal, whichever is sooner.
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PART II
Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters, Issuer Purchases of Equity Securities and Stock
Price Performance Graph
On April 25, 2007, the Board approved an additional share repurchase plan of up to $1.0
billion of the Company’s common stock.
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Item 6. Selected Financial Data
Selected financial data is presented in the Five-Year Highlights section of this Annual Report on Form 10-K.
Item 7. Management’s Discussion and Analysis of Results of Operations and Financial Condition
Management’s discussion and analysis of the Company’s results of operations and financial
condition are presented in the Financial Review section of this Annual Report on Form 10-K.
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Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Information required by this item is included in the Financial Review section of this Annual Report on
Form 10-K.
Item 8. Financial Statements and Supplementary Data
Financial Statements and Supplementary Data are included as separate sections of this Annual Report on
Form 10-K. See Item 15.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Not applicable.
Item 9A. Controls and Procedures
Disclosure Controls and Procedures
Our Chief Executive Officer and our Chief Financial Officer, with the participation of other
members of the Company’s management, have evaluated the effectiveness of the Company’s “disclosure
controls and procedures” (as defined in the Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the
end of the period covered by this report, and have concluded that our disclosure controls and
procedures are effective based on their evaluation of these controls and procedures as required by
paragraph (b) of Exchange Act Rules 13a-15 or 15d-15.
Internal Control over Financial Reporting
Management’s report on the Company’s internal control over financial reporting (as such term
is defined in Rules 13a-15(f) and 15d-15(f) in the Exchange Act), and the related report of our
independent registered public accounting firm, are included on page 56 and page 57 of this Annual
Report on Form 10-K, under the headings, “Management’s Annual Report on Internal Control Over
Financial Reporting” and “Report of Independent Registered Public Accounting Firm,” and are
incorporated herein by reference.
Changes in Internal Controls
There were no changes in our internal control over financial reporting identified in
connection with the evaluation required by paragraph (d) of Exchange Act Rules 13a-15 or 15d-15
that occurred during our most recent fiscal quarter that have materially affected, or are
reasonably likely to materially affect, our internal control over financial reporting.
Item 9B. Other Information
Not applicable.
PART III
Item 10. Directors, Executive Officers and Corporate Governance
Information about our Directors is incorporated by reference from the discussion under Item 1
of our proxy statement for the 2007 Annual Meeting of Stockholders (the “Proxy Statement”) under
the heading “Election of Directors.” Information about compliance with Section 16(a) of the
Exchange Act is incorporated by reference from the discussion under the heading “10-K Section 16(a)
Beneficial Ownership Compliance” in our Proxy Statement. Information about our Audit Committee,
including the members of the committee, and our Audit Committee
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financial expert is incorporated by reference from the discussion under the headings “Audit
Committee Report” and “Audit Committee Financial Expert” in our Proxy Statement. The balance of
the information required by this item is contained in the discussion entitled “Executive Officers
of the Registrant” in Item 4 of Part I of this Annual Report on Form 10-K.
Pursuant to Section 303A.12 (a) of the NYSE Listed Company Manual, the Company’s Chief
Executive Officer submitted a certification, dated August 21, 2006, stating that, as of such date,
he was not aware of any violation by the Company of any NYSE corporate governance listing
standards.
Information about the Code of Ethics governing our Chief Executive Officer, Chief Financial
Officer, Controller and Financial Managers can be found on our Web site, www.mckesson.com,
under the Governance tab. The Company’s Corporate Governance Guidelines and Charters for the Audit
and Compensation Committees and the Committee on Directors and Corporate Governance can also be
found on our Web site under the Governance tab.
Copies of these documents may be obtained from:
Corporate Secretary
McKesson Corporation One Post Street, 33rd Floor San Francisco, CA 94104 (800) 826-9360 The
Company intends to disclose required information regarding any
amendment to or waiver under the Code of Ethics referred to above by
posting such information on our Web site within four business days
after any such amendment or waiver.
Item 11. Executive Compensation
Information with respect to this item is incorporated by reference from the Proxy Statement.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters
Information about security ownership of certain beneficial owners and management is
incorporated by reference from the Proxy Statement.
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The following table sets forth information as of March 31, 2007 with respect to the plans
under which the Company’s common stock is authorized for issuance:
The following are descriptions of equity plans that have been approved by the Company’s
stockholders. The plans are administered by the Compensation Committee of the Board of Directors,
except for the portion of the 2005 Stock Plan related to Non-Employee Directors which is
administered by the Committee on Directors and Corporate Governance.
2005 Stock Plan (the “2005 Stock Plan”): The 2005 Stock Plan was adopted by the Board of
Directors on May 25, 2005 and approved by the Company’s stockholders on July 27, 2005. The 2005
Stock Plan provides for the grant of up to 13 million shares, in the form of nonqualified stock
options, incentive stock options, stock appreciation rights, restricted stock awards, restricted
stock unit awards, performance shares and other share-based awards. For any one share of common
stock issued in connection with a stock-settled stock appreciation right, restricted stock award,
restricted stock unit award, performance share or other share-based award, two shares shall be
deducted from the shares available for future grants. Shares of common stock not issued or
delivered as a result of the net exercise of a stock appreciation right or option, shares used to
pay the withholding taxes related to a stock award, or shares repurchased on the open market with
proceeds from the exercise of options shall not be returned to the reserve of shares available for
issuance under the 2005 Stock Plan.
Options are granted at not less than fair market value and have a term of seven years.
Options generally become exercisable in four equal annual installments beginning one year after the
grant date, or after four years from the date of grant. The award or vesting of restricted stock,
restricted stock units (“RSUs”) or performance based RSUs may be conditioned upon the attainment of
one or more performance objectives. Vesting of such awards is generally a three year cliff.
Non-employee directors receive an annual grant of up to 5,000 RSUs, currently set at 2,500
RSUs, which vest immediately, however payment of any shares is delayed until the director is no
longer performing services for the Company. The 2005 Stock Plan replaced the 1997 Non-Employee
Directors Equity Compensation and Deferral Plan.
1973 Stock Purchase Plan (the “SPP”): The SPP was adopted by the stockholders of the Company’s
predecessor in 1973. The Company’s stockholders approved an additional 2.5 million shares to be
issued under the SPP in 1999, which remain available for issuance. Rights to purchase shares are
granted under the SPP to key employees of the Company as determined by the Compensation Committee
of the Board. The purchase price, to be paid in cash or using promissory notes of the Company’s
common stock, subject to rights granted under the SPP, is the fair market value of such stock on
the date the right is exercised.
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2000 Employee Stock Purchase Plan (the “ESPP”): The ESPP is intended to qualify as an
“employee stock purchase plan” within the meaning of Section 423 of the Internal Revenue Code. In
March 2002, the Board amended the ESPP to allow for participation in the plan by employees of
certain of the Company’s international and other subsidiaries. As to those employees, the ESPP
does not so qualify. Currently, 11 million shares have been authorized for issuance under the
ESPP.
The ESPP is implemented through a continuous series of three-month purchase periods (“Purchase
Periods”) during which contributions can be made toward the purchase of common stock under the
plan.
Each eligible employee may elect to authorize regular payroll deductions during the next
succeeding Purchase Period, the amount of which may not exceed 15% of a participant’s compensation.
At the end of each Purchase Period, the funds withheld by each participant will be used to
purchase shares of the Company’s common stock. The purchase price of each share of the Company’s
common stock is based on 85% of the fair market value of each share on the last day of the
applicable Purchase Period. In general, the maximum number of shares of common stock that may be
purchased by a participant for each calendar year is determined by dividing $25,000 by the fair
market value of one share of common stock on the offering date.
The following are descriptions of equity plans that have not been submitted for approval by
the Company’s stockholders:
On July 27, 2005, the Company’s stockholders approved the 2005 Stock Plan which had the effect
of terminating the 1999 Stock Option and Restricted Stock Plan, the 1998 Canadian Stock Incentive
Plan, the Stock Option Plans adopted in January 1999 and August 1999, which plans had not been
submitted for approval by the Company’s stockholders, and the 1997 Non-Employee Directors’ Equity
Compensation and Deferral Plan, which had previously been approved by the Company’s stockholders.
Prior grants under these plans include stock options, restricted stock and RSUs. Stock options
under the terminated plans generally have a ten-year life and vest over four years. Restricted
stock contains certain restrictions on transferability and may not be transferred until such
restrictions lapse. Each of these plans has outstanding equity grants, which are subject to the
terms and conditions of their respective plans, but no new grants will be made under these
terminated plans.
1999 Executive Stock Purchase Plan (the “1999 SPP”): The 1999 SPP was adopted by the Board of
Directors in February 1999. The 1999 SPP provided for the grant of rights to purchase a maximum of
0.7 million shares of common stock subject to the NYSE limits. No further grants will be made from
the 1999 SPP. Rights to purchase shares were granted under the 1999 SPP to eligible employees of
the Company. The purchase price, to be paid in cash or using promissory notes, for the Company’s
common stock subject to rights granted under the 1999 SPP was equal to the fair market value of the
Company’s common stock on the date the right was exercised (which was the closing price of the
Company’s common stock on the NYSE). Purchases were evidenced by written stock purchase agreements
which provide for the payment of the purchase price by (i) payment in cash, or (ii) a promissory
note payable on a repayment schedule determined by the Compensation Committee of the Board, or
(iii) a combination of (i) and (ii).
HBOC 1994 UK Sharesave Scheme (the “1994 Scheme”): In connection with the acquisition by the
Company of HBO & Company (“HBOC”), we assumed the HBOC 1994 Scheme, which is similar to the ESPP,
under which approximately 0.2 million shares remain available for issuance. Employees and previous
directors of HBOC and its subsidiaries, who are residents of the United Kingdom, are eligible to
receive options under the 1994 Scheme. The exercise price of the stock covered by each option
shall not be less than 85% of the fair market value of the Company’s common stock on the date the
option is granted. Participants under the 1994 Scheme pay for options through monthly
contributions, subject to minimum and maximum monthly limits. We no longer offer any new options
under the 1994 Scheme.
Item 13.
Certain Relationships and Related Transactions and Director
Independence
Information with respect to certain transactions with management is incorporated by reference
from the Proxy Statement under the heading “Certain Relationships and Related Transactions.”
Additional information regarding related party transactions is included in the Financial Review
section of this Annual Report on Form 10-K and Financial Note 20, “Related Party Balances and
Transactions,” to the consolidated financial statements.
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McKESSON CORPORATION
Item 14.
Principal Accounting Fees and Services
Information
regarding principal accounting fees and services is set forth under the heading
“Ratification of Appointment of Deloitte & Touche LLP as the Company’s Independent Registered
Public Accounting Firm for 2008” in our Proxy Statement and all such information is incorporated
herein by reference.
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PART IV
Item 15. Exhibits and Financial Statement Schedule
(a) Financial Statements, Financial Statement Schedule and Exhibits
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
On behalf of the Registrant and pursuant to the requirements of the Securities Exchange
Act of 1934, this report has been signed below by the following persons in the capacities and on
the date indicated:
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McKESSON CORPORATION
SCHEDULE II
SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENT SCHEDULE
VALUATION AND QUALIFYING ACCOUNTS For the Years Ended March 31, 2007, 2006 and 2005
(In millions)
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EXHIBIT INDEX
Exhibits identified in parentheses below are on file with the Commission and are incorporated
by reference as exhibits hereto.
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* Management
contract or compensation plan or arrangement in which directors
and/or executive officers are eligible to participate.
Registrant agrees to furnish to the Commission upon request a copy of each instrument defining
the rights of security holders with respect to issues of long-term debt of the Registrant, the
authorized principal amount of which does not exceed 10% of the total assets of the Registrant.
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McKESSON CORPORATION
INDEX TO CONSOLIDATED FINANCIAL INFORMATION
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McKESSON CORPORATION
FIVE-YEAR HIGHLIGHTS
Footnotes to Five-Year Highlights:
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FINANCIAL REVIEW
Item 7. Management’s Discussion and Analysis of Results of Operations and Financial
Condition
GENERAL
Management’s discussion and analysis of results of operations and financial condition,
referred to as the Financial Review, is intended to assist the reader in the understanding and
assessment of significant changes and trends related to the results of operations and financial
position of the Company together with its subsidiaries. This discussion and analysis should be
read in conjunction with the consolidated financial statements and accompanying financial notes.
The Company’s fiscal year begins on April 1 and ends on March 31. Unless otherwise noted, all
references in this document to a particular year shall mean the Company’s fiscal year.
We conduct our business through three operating segments: Pharmaceutical Solutions,
Medical-Surgical Solutions and Provider Technologies. See Financial Note 1 to the accompanying
consolidated financial statements, “Significant Accounting Policies,” for a description of these
segments.
RESULTS OF OPERATIONS
Overview:
Revenues increased 7% to $93.0 billion and 10% to $87.0 billion in 2007 and 2006. The
increase in revenues primarily reflects growth in our Pharmaceutical Solutions segment, which
accounted for over 95% of our consolidated revenues. Increases in revenue for this segment were
primarily due to market growth rates and due to our acquisition of D&K Healthcare Resources, Inc.
(“D&K”) during the second quarter of 2006.
Gross profit increased 15% to $4.3 billion and 13% to $3.8 billion in 2007 and 2006. As a
percentage of revenues, gross profit increased 32 basis points (“bp”) to 4.66% in 2007 and 11 bp to
4.34% in 2006. Our 2007, 2006 and 2005 gross profit includes the receipt of $10 million, $95
million and $41 million of cash proceeds representing our share of settlements of antitrust class
action lawsuits. Excluding these settlements, gross profit margin increased by 42 bp and 6 bp in
2007 and 2006. The increase in our 2007 gross profit margin primarily reflects improvement in
margins in our U.S. pharmaceutical distribution business.
Operating expenses were $3.1 billion, $2.7 billion and $3.6 billion in 2007, 2006 and 2005.
Operating expenses for 2007, 2006 and 2005 includes a pre-tax credit of $6 million and pre-tax
charges of $45 million and $1.2 billion for our Securities Litigation. Excluding the Securities
Litigation charges or credit, operating expenses increased 18% in 2007 and 11% in 2006 primarily
reflecting additional operating expenses incurred to support our sales growth and higher
compensation expenses including expenses associated with our implementation of Statement of
Financial Accounting Standards (“SFAS”) No. 123(R), “Share-based Compensation”. SFAS No. 123(R)
was implemented on April 1, 2006 and requires us to expense all share-based compensation.
Operating expenses were also impacted by our business acquisitions, including our acquisition of
D&K.
Other income, net in 2007 approximated that of 2006. Other income, net increased 104% to $139
million in 2006 primarily reflecting increases in our interest income due to our favorable cash
balances.
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FINANCIAL REVIEW (Continued)
Interest expense increased 5% to $99 million in 2007 and decreased 20% to $94 million in 2006.
Interest expense increased in 2007 primarily reflecting the issuance of $1.0 billion of debt as
part of our $1.8 billion acquisition of Per-Se Technologies, Inc. (“Per-Se”). Interest expense
decreased in 2006 primarily reflecting the repayment of $250 million of term debt in the fourth
quarter of 2005.
Income (loss) from continuing operations before income taxes was $1,297 million, $1,171
million and ($266) million in 2007, 2006 and 2005, reflecting the above noted factors.
Our reported income tax rates were 25.4%, 36.4% and 35.0% in 2007, 2006 and 2005.
Fluctuations in our reported income tax rates are primarily due to changes in income within states
and foreign countries that have lower tax rates. Additionally, in 2007, we recorded an $83 million
credit to our income tax provision relating to the reversal of income tax reserves for our
Securities Litigation. The tax reserves were initially established in 2005 for future resolution
of uncertain tax matters related to our Securities Litigation, which were favorably resolved in
2007.
Results from discontinued operations include an after-tax loss of $55 million and after tax
gains of $6 million and $16 million, or ($0.18), $0.02 and $0.06 per diluted share in 2007, 2006
and 2005. During the second quarter of 2007, we sold our Medical-Surgical Solutions segment’s
Acute Care business for net cash proceeds of $160 million. Financial results for this business for
2007 reflect an after-tax loss of $66 million, which includes a $79 million non-tax deductible
write-off of goodwill. Financial results for the Acute Care business have been reclassified as a
discontinued operation for all periods presented.
Net income (loss) was $913 million, $751 million and ($157) million in 2007, 2006 and 2005 and
diluted earnings (loss) per share was $2.99, $2.38 and ($0.53). Excluding the Securities
Litigation charges or credit, net income would have been $826 million, $781 million and $653
million in 2007, 2006 and 2005 and diluted earnings per share would have been $2.71, $2.48 and
$2.19.
Revenues:
Revenues increased 7% to $93.0 billion in 2007 and 10% to $87.0 billion in 2006. The growth
in revenues was primarily driven by our Pharmaceutical Solutions segment, which accounted for over
95% of revenues.
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McKESSON CORPORATION
FINANCIAL REVIEW (Continued)
The customer mix of our U.S. pharmaceutical distribution revenues was as follows:
U.S. Healthcare pharmaceutical direct distribution and service revenues increased in 2007
primarily reflecting market growth rates, partially offset by the loss of a large customer.
Revenues for 2007 were also impacted by our acquisition of D&K during the second quarter of 2006
and by expanded agreements with customers. Revenues for this segment increased in 2006 primarily
due to our acquisition of D&K and growth among existing customers which includes market growth
rates. Market growth rates reflect growing drug utilization and price increases, which are offset
in part by the increased use of lower priced generics.
U.S. Healthcare sales to customers’ warehouses increased over the last two years primarily as
a result of new and expanded agreements with customers. Partially offsetting these increases was a
decrease in volume from a large customer commencing in 2006. Sales to customers’ warehouses
represent large volume sales of pharmaceuticals primarily to a limited number of large
self-warehousing customers whereby we order bulk product from the manufacturer, receive and process
the product through our central distribution facility and subsequently deliver the bulk product
(generally in the same form as received from the manufacturer) directly to our customers’
warehouses. These sales provide a benefit to our customers in that they can use one source for
both their direct store-to-store business and their warehouse business. We have significantly
lower gross profit margin on these sales as we pass much of the
efficiency of this low
cost-to-serve model onto the customer. These sales do, however, contribute to our gross profit
dollars.
Canadian pharmaceutical distribution revenues increased over the last two years
primarily reflecting
market growth rates and favorable exchange rates. Canadian revenues benefited from a 5%, 7% and 7%
foreign currency impact in 2007, 2006 and 2005.
Medical-Surgical Solutions segment distribution revenues increased in 2007 primarily
reflecting stronger than average market growth rates and due to the acquisition of Sterling Medical
Services LLC (“Sterling”) during the first quarter of 2007. Sterling is based in Moorestown, New
Jersey, and is a national provider and distributor of disposable medical supplies, health
management services and quality management programs to the home care market. This segment’s
revenues also increased in 2006 primarily due to market growth rates.
Provider Technologies revenues increased over the last two years primarily reflecting greater
domestic implementations of clinical, imaging, revenue cycle and resource management software
solutions. In 2007, revenues for this segment also benefited from increased software solution
implementations, and to a lesser extent, due to our acquisition of Per-Se during the fourth quarter
of 2007.
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McKESSON CORPORATION
FINANCIAL REVIEW (Continued)
Gross Profit:
Gross profit increased 15% to $4.3 billion in 2007 and 13% to $3.8 billion in 2006. As a
percentage of revenues, gross profit increased 32 bp in 2007 and 11 bp in 2006. All three of our
operating segments contributed to the increase in our gross profit dollars and gross profit margin
in 2007. Increases in our gross profit dollars in 2006 were primarily due to our Pharmaceutical
Solutions segment and to a lesser extent, due to our Provider Technologies segment. Gross profit
margins increased in 2006 primarily due to an increase in our Pharmaceutical Solutions segment’s
gross profit margin.
Our Pharmaceutical Solutions segment’s gross profit margin improved over the past two years.
This segment’s gross profit margin was impacted by a number of changes, including:
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FINANCIAL REVIEW (Continued)
In addition, gross profit margin for our U.S. pharmaceutical distribution business benefited
from a relatively stable sell side margin over the last two years.
Medical-Surgical Solutions segment’s gross profit margin increased in 2007 primarily
reflecting favorable product mix and buy and sell side margins. This segment’s gross profit margin
decreased in 2006 primarily reflecting pressure on our buy and sell margins. Provider Technologies
segment’s gross profit margin increased in 2007 primarily due to a change in product mix. This
segment’s gross profit margin in 2006 approximated that of 2005.
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McKESSON CORPORATION
FINANCIAL REVIEW (Continued)
Operating Expenses:
Operating expenses increased 16% to $3.1 billion in 2007 and decreased 25% to $2.7 billion in
2006. Operating expenses for 2007, 2006 and 2005 include a pre-tax credit of $6 million and
pre-tax charges of $45 million and $1.2 billion for our Securities Litigation. Excluding the
impact of our Securities Litigation, operating expenses increased 18% and 11% in 2007 and 2006.
Operating expenses as a percentage of revenues increased 25 bp to 3.30% in 2007 and decreased 145
bp to 3.05% in 2006 (or 31 bp and 2 bp in 2007 and 2006, excluding the impact of our Securities
Litigation). Excluding the Securities Litigation charges and credit, increases in operating
expenses in 2007 compared with 2006 were primarily due to additional costs to support our sales
volume growth, our business acquisitions, employee compensation costs including the requirement to
expense all share-based compensation, and research and development expenditures. Increases in
operating expenses for 2006 compared with 2005, excluding the Securities Litigation charges, were
primarily due to additional expenses incurred to support our sales volume growth, including
distribution expenses and higher foreign currency exchange rates for our Canadian operations and
increased research and development expenditures. Operating expenses in 2006 were also impacted by
our acquisition of D&K.
Operating expenses included the following significant items:
2007
2006
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McKESSON CORPORATION
FINANCIAL REVIEW (Continued)
2005
Other Income, net:
Other income, net decreased in 2007 and increased in 2006 primarily reflecting changes in our
interest income associated with the Company’s cash balances and, to a lesser extent for 2006, due
to an increase in our equity in earnings of Nadro, S.A. de C.V. (“Nadro”). Interest income, which
is primarily recorded in Corporate expenses, was $103 million, $105 million and $41 million in
2007, 2006 and 2005.
Segment Operating Profit and Corporate Expenses:
Segment operating profit includes gross margin, net of operating expenses, and other income
for our three business segments. In addition to the significant items previously discussed,
operating profit increased in 2007 and 2006 primarily reflecting revenue growth and an increase in
gross profit margin in our Pharmaceutical Solutions segment and for 2006, improved operating profit
in our Provider Technologies segment.
Operating profit as a percentage of revenues increased in 2007 and 2006 in our Pharmaceutical
Solutions segment primarily reflecting an increase in gross profit margins, offset in part by an
increase in operating expenses as a percentage of revenues. Operating expenses increased in both
dollars and as a percentage of revenues primarily due to additional costs incurred to support our
revenue growth, additional compensation expense and for 2006, the addition of D&K’s operating and
integration expenses. In 2007, operating profit for this segment also benefited from an $11
million credit to operating expense due to an adjustment to a legal reserve and in 2006, the
segment
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McKESSON CORPORATION
FINANCIAL REVIEW (Continued)
benefited from a $15 million credit to bad debt expense due to a recovery on a previously
reserved customer account. Operating profit in 2006 also benefited from an increase in equity
earnings from our investment in Nadro.
Medical-Surgical Solutions segment’s operating profit as a percentage of revenues declined in
2007 primarily reflecting an increase in operating expenses as a percentage of revenues, partially
offset by a small improvement in the segment’s gross profit margin. The segment’s operating profit
as a percentage of revenues also declined in 2006 primarily reflecting lower gross profit margin,
partially offset by a decrease in operating expenses as a percentage of revenues. Over the past
two years, operating expenses as a percentage of revenue have been impacted by a higher amount of
operating costs associated with a greater proportion of costs incurred to serve the segment’s
alternate site customers, which have a higher cost-to-serve ratio than the segment’s other
customers. Additionally, operating expenses in 2007 include increases in compensation expense and
in 2007 and 2006, an increase in bad debt expense. Operating expenses in 2006 also benefited from
a receipt of a vendor credit and a decrease in legal expenses.
Provider Technologies segment’s operating profit as a percentage of revenues decreased in 2007
primarily reflecting an increase in operating expenses as a percentage of revenues, partially
offset by an increase in gross profit margin. Operating expenses increased in both dollars and as
a percentage of revenues in 2007 primarily reflecting additional compensation expense and
restructuring charges incurred to reallocate product development and marketing resources and to
realign one of the segment’s international businesses. This segment’s operating profit as a
percentage of revenues increased in 2006 primarily reflecting favorable operating expenses as a
percentage of revenues. In addition to the factors previously noted, operating expense dollars for
this segment increased over the past two years reflecting investments in research and development
activities and sales functions to support the segment’s revenue growth and business acquisitions.
Additionally, operating expenses in 2006 benefited from a reduction in bad debt expense.
This
segment is in the process of completing the business integration
plans for the
acquisition of Per-Se. In accordance with accounting standards, certain costs that will be
incurred to integrate acquired businesses will be treated as part of the cost of the acquisition
whereas other related costs will be expensed.
Corporate expenses, net of other income, increased in 2007 primarily reflecting additional
costs incurred to support various initiatives and revenue growth, an increase in compensation
expense and a decrease in interest income. Legal costs associated with our Securities Litigation
declined in 2007; however, other legal costs offset this benefit. Corporate expenses, net of other
income, decreased in 2006 primarily reflecting an increase in interest income, a decrease in legal
costs associated with our Securities Litigation and a decrease in pension settlement charges.
These favorable variances were partially offset by additional costs incurred to support various
initiatives and revenue growth. Legal costs associated with our Securities Litigation were $19
million, $27 million and $43 million in 2007, 2006 and 2005.
Securities Litigation Charges, Net: As discussed in Financial Note 17, “Other Commitments and
Contingent Liabilities,” to the accompanying consolidated financial statements, in the third
quarter of 2005, we announced that we had reached an agreement to settle the action captioned In re
McKesson HBOC, Inc. Securities Litigation (No. C-99-20743-RMW) (the “Consolidated Action”). In
general, we agreed to pay the settlement class a total of $960 million in cash. During the third
quarter of 2005, we recorded a $1,200 million pre-tax ($810 million after-tax) charge with respect
to the Company’s Securities Litigation. The charge consisted of $960 million for the Consolidated
Action and $240 million for other Securities Litigation proceedings.
During 2006, we settled many of the other Securities Litigation proceedings and paid $243
million pursuant to those settlements. Based on the payments made in the Consolidated Action and
the other Securities Litigation proceedings, settlements reached in certain of the other Securities
Litigation proceedings and our assessment of the remaining cases, the estimated reserves were
increased by $52 million and $1 million in pre-tax charges during the first and third quarters of
2006 and decreased by an $8 million pre-tax credit during the fourth quarter of 2006, for a total
net pre-tax charge of $45 million for 2006. On February 24, 2006, the Court gave final approval to
the settlement of the Consolidated Action and as a result, we paid approximately $960 million into
an escrow account established by the lead plaintiff in connection with the settlement.
During 2007, the Securities Litigation accrual decreased $31 million primarily reflecting a
net pre-tax credit of $6 million representing a settlement and a reassessment of another case in
the second quarter of 2007, and $25 million of cash payments made in connection with these
settlements. Based on the payments made in the
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FINANCIAL REVIEW (Continued)
Consolidated Action and payments made to settle
other previously reported Securities Litigation proceedings, and
based on our assessment of the remaining cases, the estimated Securities Litigation accruals
as of March 31, 2007 and 2006 were $983 million and $1,014 million. We believe this accrual is
adequate to address our remaining potential exposure with respect to all of the Securities
Litigation matters. However, in view of the number and uncertainties of the timing and outcome of
this type of litigation, and the substantial amounts involved, it is possible that the ultimate
costs of these matters could impact our earnings, either negatively or positively, in the quarter
of their resolution. We do not believe that the resolution of these matters will have a material
adverse effect on our results of operations, liquidity or financial position taken as a whole.
Interest Expense: Interest expense increased in 2007 compared to 2006 primarily due to $1.0
billion of additional financing required to fund our acquisition of Per-Se. Refer to our
discussion under the caption “Credit Resources” within this Financial Review for additional
information regarding our financing for the Per-Se acquisition. Interest expense decreased in 2006
compared to 2005 primarily reflecting the repayment of $250 million of term debt during the fourth
quarter of 2005.
Income Taxes: Our reported tax rates were 25.4%, 36.4% and 35.0% in 2007, 2006 and 2005. In
addition to the items noted below, fluctuations in our reported tax rate are primarily due to
changes within state and foreign tax rates resulting from our business mix, including varying
proportions of income attributable to foreign countries that have lower income tax rates.
Securities Litigation — As discussed in Financial Note 15, “Income Taxes,” we recorded an
income tax benefit of $390 million relating to the Securities Litigation in the third quarter of
2005. We believed the pending settlement of the Consolidated Action and the ultimate resolution of
the lawsuits brought independently by other shareholders would be tax deductible. However, the tax
attributes of the litigation were complex and the Company expected challenges from the taxing
authorities, and accordingly such deductions could not be finalized until the lawsuits were
concluded and the tax authorities reviewed the deductions. As of March 31, 2005, we provided tax
reserves for future resolution of these uncertain tax matters.
In the second quarter of 2007, we recorded a credit to income tax expense of $83 million which
primarily pertains to our receipt of a private letter ruling from the U.S. Internal Revenue Service
holding that our payment of approximately $960 million to settle our Securities Litigation
Consolidated Action is fully tax-deductible. As discussed in the preceding paragraph, we
previously established tax reserves to reflect the lack of certainty regarding the tax
deductibility of settlement amounts paid in the Consolidated Action and related litigation.
Other Income Tax Adjustments — In 2007, we recorded $24 million in income tax benefits
arising primarily from settlements and adjustments with various taxing authorities and research and
development investment tax credits generated by our Canadian operations.
In 2006, we recorded a $14 million income tax expense which primarily relates to a basis
adjustment in an investment and adjustments with various taxing authorities.
In 2005, we recorded a $10 million income tax benefit arising primarily from settlements and
adjustments with various taxing authorities and a $3 million income tax benefit primarily due to a
reduction of a valuation allowance related to state income tax net operating loss carryforwards.
We believe that the income tax benefit from a portion of these state net operating loss
carryforwards will now be realized.
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McKESSON CORPORATION
FINANCIAL REVIEW (Continued)
Discontinued Operations:
Results from discontinued operations were as follows:
In the second quarter of 2007, we sold our Medical-Surgical Solutions segment’s Acute Care
supply business to Owens & Minor, Inc. (“OMI”) for net cash proceeds of approximately $160 million.
In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,”
the financial results of this business are classified as a discontinued operation for all periods
presented in the accompanying consolidated financial statements. Revenues associated with the
Acute Care business prior to its disposition were $1,062 million and $1,025 million for 2006 and
2005 and $597 million for the first half of 2007.
Financial results for 2007 for this discontinued operation include an after-tax loss of $66
million, which primarily consists of an after-tax loss of $61 million for the business’ disposition
and $5 million of after-tax losses associated with operations, other asset impairment charges and
employee severance costs. The after-tax loss of $61 million for the business’ disposition includes
a $79 million non-tax deductible write-off of goodwill, as further described below.
In connection with the divestiture of our Acute Care business, we allocated a portion of our
Medical-Surgical Solutions segment’s goodwill to the Acute Care business as required by SFAS No.
142, “Goodwill and Other Intangible Assets.” The allocation was based on the relative fair values
of the Acute Care business and the continuing businesses that are being retained by the Company.
The fair value of the Acute Care business was determined based on the net cash proceeds resulting
from the divestiture and the fair value of the continuing businesses was determined by a
third-party valuation. As a result, we allocated $79 million of the segment’s goodwill to the
Acute Care business.
Additionally, as part of the divestiture, we entered into a transition services agreement
(“TSA”) with OMI under which we provided certain services to the Acute Care business during a
transition period of approximately six months. Financial results from the TSA, as well as employee
severance charges over the transition period, were recorded as part of discontinued operations.
The continuing cash flows generated from the TSA were not material to our consolidated financial
statements and the TSA was completed as of March 31, 2007.
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McKESSON CORPORATION
FINANCIAL REVIEW (Continued)
In 2005, our Acute Care business entered into an agreement with a third party vendor to sell
the vendor’s proprietary software and services. The terms of the contract required us to prepay
certain royalties. During the third quarter of 2006, we ended marketing and sale of the software
under the contract. As a result of this decision, we recorded a $15 million pre-tax charge in the
third quarter of 2006 to write-off the remaining balance of the prepaid royalties.
In the second quarter of 2007, we also sold a wholly-owned subsidiary, Pharmaceutical Buyers
Inc., for net cash proceeds of $10 million. The divestiture resulted in an after-tax gain of $5
million resulting from the tax basis of the subsidiary exceeding its carrying value. The gain on
disposition was also recorded in the second quarter of 2007. Financial results for this business,
which were previously included in our Pharmaceutical Solutions segment, were not material to our
consolidated financial statements.
The results for discontinued operations for 2007 also include an after-tax gain of $6 million
associated with the collection of a note receivable from a business sold in 2003 and the sale of a
small business.
In the second quarter of 2006, we sold our wholly-owned subsidiary, McKesson BioServices
Corporation (BioServices”), for net cash proceeds of $63 million. The divestiture resulted in an
after-tax gain of $13 million. Financial results for this business, which were previously included
in our Pharmaceutical Solutions segment, were not material to our consolidated financial
statements.
In accordance with SFAS No. 144, financial results for these businesses are classified as
discontinued operations for all periods presented.
Net Income: Net income (loss) was $913 million, $751 million and ($157) million in 2007, 2006
and 2005 and diluted earnings (loss) per share was $2.99, $2.38 and ($0.53). Excluding the
Securities Litigation charges, 2007 net income and net income per diluted share would have been
$826 million and $2.71, for 2006, $781 million and $2.48, and for 2005, $653 million and $2.19.
A reconciliation between our net income (loss) per share reported under accounting standards
generally accepted (“GAAP”) in the United States and our earnings per diluted share, excluding
charges for the Securities Litigation is as follows:
These pro forma amounts are non-GAAP financial measures. We use these measures
internally and consider these results to be useful to investors as they provide relevant benchmarks
of core operating performance.
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McKESSON CORPORATION
FINANCIAL REVIEW (Continued)
Weighted Average Diluted Shares Outstanding: Diluted earnings (loss) per share was calculated
based on a weighted average number of shares outstanding of 305 million, 316 million and 294
million for 2007, 2006 and 2005. Weighted average shares outstanding for 2007 decreased from 2006
primarily reflecting common stock repurchased during the year, net of stock option exercises.
Weighted average diluted shares outstanding for 2006 primarily reflect an increase in the number of
common shares outstanding as a result of exercised stock options, net of common stock repurchased,
as well as an increase in the common stock equivalents from stock options due to the increase in
the Company’s common stock price. For 2005, potentially dilutive securities were excluded from the
per share computations due to their antidilutive effect.
International Operations
International operations accounted for 7.5%, 7.0% and 6.8% of 2007, 2006 and 2005 consolidated
revenues. International operations are subject to certain risks, including currency fluctuations.
We monitor our operations and adopt strategies responsive to changes in the economic and political
environment in each of the countries in which we operate. Additional information regarding our
international operations is also included in Financial Note 21, “Segments of Business” to the
accompanying consolidated financial statements.
Acquisitions and Investments
In 2007, we made the following acquisitions and investment:
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McKESSON CORPORATION
FINANCIAL REVIEW (Continued)
During the last three years we also completed a number of other smaller acquisitions and
investments within all three of our operating segments. Financial results for our business
acquisitions have been included in our consolidated financial statements since their respective
acquisition dates. Purchase prices for our business acquisitions have been allocated based on
estimated fair values at the date of acquisition and, for certain recent acquisitions, may be
subject to change. Goodwill recognized for our business acquisitions is not expected to be
deductible for tax purposes. Pro forma results of operations for our business acquisitions have
not been presented because the effects were not material to the consolidated financial statements
on either an individual or an aggregate basis. Refer to Financial Note 2, “Acquisitions and
Investments,” to the accompanying consolidated financial statements for further discussions
regarding our acquisitions and investing activities.
2008 Outlook
Information regarding the Company’s 2008 outlook is contained in our Form 8-K dated May 7,
2007. This Form 8-K should be read in conjunction with the sections “Factors Affecting
Forward-looking Statements” and “Additional Factors That May Affect Future Results” included in
this Financial Review.
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McKESSON CORPORATION
FINANCIAL REVIEW (Continued)
2008 Operating Segments
Beginning
with the first quarter of 2008, we will report our operations in two
segments: McKesson
Distribution Solutions and McKesson Technology Solutions. This change resulted from a realignment of our
businesses to better correlate our operations with the needs of our customers. The factors for
determining the reportable segments included the manner in which management evaluated the
performance of the Company combined with the nature of the individual business activities. In
accordance with SFAS 131, “Disclosures about Segments of an Enterprise and Related Information”,
all prior period segment information will be reclassified to conform to this new financial
reporting presentation commencing in 2008. Additional information regarding our new segments is as
follows:
We have combined our Pharmaceutical Solutions and Medical-Surgical Solutions segments into a
new segment, McKesson Distribution Solutions. This segment distributes ethical and proprietary
drugs, medical-surgical supplies and equipment, and health and beauty care products throughout
North America. This segment also provides specialty pharmaceutical solutions for biotech and
pharmaceutical manufacturers, software, consulting, outsourcing and other services and, through its
investment in Parata, sells automated pharmaceutical dispensing systems for retail pharmacies.
The McKesson Technology Solutions segment (currently known as our Provider Technologies
segment) delivers enterprise-wide patient care, clinical, financial, supply chain, and strategic
management software solutions, pharmacy automation for hospitals, as well as connectivity,
outsourcing and other services, to healthcare organizations throughout North America, the United
Kingdom and other European countries. The segment also provides disease management programs to
payors primarily in the United States. The segment’s customers include hospitals, physicians,
homecare providers, retail pharmacies and payors. We have added our Payor group of businesses,
which includes our clinical auditing and compliance, disease management, medical management and
InterQual businesses, to this segment. The Payor group was previously included in our
Pharmaceutical Solutions segment.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
We consider an accounting estimate to be critical if the estimate requires us to make
assumptions about matters that were uncertain at the time the accounting estimate was made and if
different estimates that we reasonably could have used in the current period, or changes in the
accounting estimate that are reasonably likely to occur from period to period, would have a
material impact on our financial condition or results from operations. Below are the estimates
that we believe are critical to the understanding of our operating results and financial condition.
Other accounting policies are described in Financial Note 1, “Significant Accounting Policies,” to
the accompanying consolidated financial statements. Because of the uncertainty inherent in such
estimates, actual results may differ from these estimates.
Receivables: We provide short-term credit and other customer financing arrangements to
customers who purchase our products and services. Other customer financing relates to guarantees
provided to our customers, or their creditors, regarding the repurchase of inventories and lease
and credit financing. We estimate the receivables for which we do not expect full collection based
on historical collection rates and specific knowledge regarding the current creditworthiness of our
customers. An allowance is recorded in our consolidated financial statements for these amounts.
If the frequency and severity of customer defaults due to our customers’ financial condition
or general economic conditions change, our allowance for uncollectible accounts may require
adjustment. As a result, we continuously monitor outstanding receivables and other customer
financing and adjust allowances for accounts where collection may be in doubt. In addition, in
2007, sales to our ten largest customers accounted for approximately 51% of our total consolidated
revenues. Sales to our largest customer, Caremark RX, Inc., represented approximately 11% of our
2007 total consolidated revenues. At March 31, 2007, accounts receivable from our ten largest
customers and Caremark RX, Inc. were approximately 48% and 12% of total accounts receivable. As a
result, our sales and credit concentration is significant. Any defaults in payment or a material
reduction in purchases from this or any other large customer could have a significant negative
impact on our financial condition, results of operations and liquidity.
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McKESSON CORPORATION
FINANCIAL REVIEW (Continued)
At March 31, 2007, trade and notes receivables were $5,896 million, and other customer
financing was $100 million, prior to allowances of $150 million. In 2007, 2006 and 2005 our
provision for bad debts was $24 million,
$26 million, and $16 million. At March 31, 2007 and 2006, the allowance as a percentage of
trade and notes receivables was 2.6% and 2.3%. Additional information concerning our allowance for
doubtful accounts may be found in Schedule II included this Annual Report on Form 10-K.
Inventories: We state inventories at the lower of cost or market. Inventories for our
Pharmaceutical Solutions and Medical-Surgical Solutions segments consist of merchandise held for
resale. For our Pharmaceutical Solutions segment, the majority of the cost of domestic inventories
was determined on the LIFO method and international inventories are stated using the first-in,
first-out (“FIFO”) method. Cost of inventories for our Medical-Surgical Solutions segment was
primarily determined on the FIFO method. Provider Technologies’ inventories consist of computer
hardware with cost determined by the standard cost method. Total
inventories were $8.2 billion and $7.1 billion at March 31, 2007 and 2006.
The LIFO method was used to value approximately 87% of our inventories at March 31, 2007 and
2006. If the FIFO method, which approximates replacement cost, had been applied, total inventories
would have increased $92 million and $156 million at March 31, 2007 and 2006. In addition, we
recorded LIFO benefit reserve adjustments of $64 million, $32 million and $59 million in 2007, 2006
and 2005. LIFO adjustments generally represent the net effect of the amount of price increases on
branded pharmaceutical products held in inventory offset by price declines on generic
pharmaceutical products, including the price decrease effect of branded pharmaceutical products
that have lost patent protection. A LIFO benefit implies that the price declines on generic
pharmaceutical products, including the effect of branded pharmaceuticals that have lost patent
protection, exceeded the effect of price increases on branded pharmaceutical products held in
inventory. Our remaining pharmaceutical LIFO
reserve of approximately $18 million is expected to be used in
2008.
In determining whether inventory valuation issues exist, we consider various factors including
estimated quantities of slow-moving inventory by reviewing on-hand quantities, outstanding purchase
obligations and forecasted sales. Shifts in market trends and conditions, changes in customer
preferences due to the introduction of generic drugs or new pharmaceutical products, or the loss of
one or more significant customers are factors that could affect the value of our inventories.
These factors could make our estimates of inventory valuation differ from actual results.
Acquisitions: We account for acquired businesses using the purchase method of accounting
which requires that the assets acquired and liabilities assumed be recorded at the date of
acquisition at their respective fair values. Any excess of the purchase price over the estimated
fair values of the net assets acquired is recorded as goodwill. Amounts allocated to acquired
in-process research and development are expensed at the date of acquisition. The judgments made in
determining the estimated fair value assigned to each class of assets acquired and liabilities
assumed, as well as asset lives, can materially impact our results of operations. Accordingly, for
significant items, we typically obtain assistance from third party valuation specialists. The
valuations are based on information available near the acquisition date and are based on
expectations and assumptions that have been deemed reasonable by management.
There are several methods that can be used to determine the fair value of assets acquired and
liabilities assumed. For intangible assets we typically use the income method. This method starts
with a forecast of all of the expected future net cash flows. These cash flows are then adjusted
to present value by applying an appropriate discount rate that reflects the risk factors associated
with the cash flow streams. Some of the more significant estimates and assumptions inherent in the
income method or other methods include the amount and timing of projected future cash flows; the
discount rate selected to measure the risks inherent in the future cash flows; and the assessment
of the asset’s life cycle and the competitive trends impacting the asset, including consideration
of any technical, legal, regulatory, or economic barriers to entry. Determining the useful life of
an intangible asset also requires judgment as different types of intangible assets will have
different useful lives and certain assets may even be considered to have indefinite useful lives.
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McKESSON CORPORATION
FINANCIAL REVIEW (Continued)
Goodwill: We have significant goodwill assets as a result of acquiring businesses. We
maintain goodwill assets on our books unless the assets are deemed to be impaired. We perform an
impairment test on goodwill balances annually or when indicators of impairment exist. Such
impairment tests require that we first compare the carrying value of net assets to the estimated
fair value of net assets for the operations in which goodwill is assigned. If carrying value
exceeds fair value, a second step would be performed to calculate the amount of impairment. Fair
values can be determined using market, income or cost approaches. To estimate the fair value of a
business using the market approach, we compare the business to similar businesses or guideline
companies whose securities are actively traded in public markets or the income approach, where we
use a discounted cash flow model in which cash flows anticipated over several periods, plus a
terminal value at the end of that time horizon, are discounted to their present value using an
appropriate rate of return.
Some of the more significant estimates and assumptions inherent in the goodwill impairment
estimation process using the market approach include the selection of appropriate guideline
companies, the determination of market value multiples for the guideline companies, the subsequent
selection of an appropriate market value multiple for the business based on a comparison of the
business to the guideline companies, the determination of applicable premiums and discounts based
on any differences in marketability between the business and the guideline companies and when
considering the income approach, include the required rate of return used in the discounted cash
flow method, which reflects capital market conditions and the specific risks associated with the
business. Other estimates inherent in the income approach include long-term growth rates and cash
flow forecasts for the business.
Estimates of fair value result from a complex series of judgments about future events and
uncertainties and rely heavily on estimates and assumptions at a point in time. The judgments made
in determining an estimate of fair value can materially impact our results of operations. The
valuations are based on information available as of the impairment review date and are based on
expectations and assumptions that have been deemed reasonable by management. Any changes in key
assumptions, including unanticipated events and circumstances, may affect the accuracy or validity
of such estimates and could potentially result in an impairment charge.
In September 2006, we sold our Medical-Surgical Solutions segment’s Acute Care supply business
and allocated $79 million of the segment’s goodwill to the divested business. The allocation was
based on the relative fair values of the Acute Care business and continuing businesses that were
retained by the Company, as determined by a third-party valuation. Goodwill at March 31, 2007 and
2006 was $2,975 million and $1,637 million and we concluded that there was no impairment of our
goodwill.
Supplier Reserves: We establish reserves against amounts due from our suppliers relating to
various price and rebate incentives, including deductions or billings taken against payments
otherwise due to them from us. These reserve estimates are established based on our best judgment
after carefully considering the status of current outstanding claims, historical experience with
the suppliers, the specific incentive programs and any other pertinent information available to us.
We evaluate amounts due from our suppliers on a continual basis and adjust the reserve estimates
when appropriate based on changes in factual circumstances. As of March 31, 2007 and 2006,
supplier reserves were $100 million and $97 million.
Approximately 80% of the supplier reserves at
March 31, 2007 and 2006 pertains to our Pharmaceutical Solutions segment. A hypothetical 0.1%
percentage increase or decrease in the supplier reserve as a percentage of trade payables would
have resulted in an increase or decrease in the cost of sales of approximately $11 million in 2007.
The ultimate outcome of any amounts due from our suppliers may be different than our estimate.
Income Taxes: Our income tax expense, deferred tax assets and liabilities reflect
management’s best assessment of estimated future taxes to be paid. We are subject to income taxes
in both the U.S. and numerous foreign jurisdictions. Significant judgments and estimates are
required in determining the consolidated income tax provision.
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McKESSON CORPORATION
FINANCIAL REVIEW (Continued)
Deferred income taxes arise from temporary differences between the tax and financial statement
recognition of revenue and expense. In evaluating our ability to recover our deferred tax assets
we consider all available positive and negative evidence including our past operating results, the
existence of cumulative net operating losses in the most recent years and our forecast of future
taxable income. In estimating future taxable income, we develop assumptions including the amount
of future state, federal and foreign pretax operating income, the reversal of temporary differences
and the implementation of feasible and prudent tax planning strategies. These assumptions require
significant judgment about the forecasts of future taxable income and are consistent with the plans
and estimates we are using to manage the underlying businesses.
Changes in tax laws and rates could also affect recorded deferred tax assets and liabilities
in the future. Management is not aware of any such changes that would have a material effect on
the Company’s results of operations, cash flows or financial position.
The calculation of our tax liabilities involves dealing with uncertainties in the application
of complex tax regulations in a multitude of jurisdictions across our global operations. We
recognize liabilities based on our estimate of whether additional taxes will be due. These
liabilities are recorded when, despite our belief that our tax return positions are supportable, we
believe that certain positions are likely to be challenged and may not be fully sustained upon
audit by tax authorities in the U.S and other countries. These tax liabilities are reflected net
of related tax loss carryforwards. We adjust these liabilities in light of changing facts and
circumstances; however, due to the complexity of some of these uncertainties, the ultimate
resolution may result in a payment that is materially different from our current estimate of the
tax liabilities. These differences will be reflected as increases or decreases to income tax
expense as discrete items in the period in which they are determined. If the tax liabilities
relate to tax uncertainties existing at the date of the acquisition of a business, the adjustment
of such tax liabilities will result in an adjustment to the goodwill recorded at the date of
acquisition.
If our assumptions and estimates described above were to change, an increase/decrease of 1% in
our effective tax rate as applied to income from continuing operations would have
increased/decreased tax expense by approximately $13 million for 2007.
As discussed in Financial Note 1, “Significant Accounting Policies” under the caption “New
Accounting Pronouncements,” in the first quarter of 2008, we are required to adopt the provisions
of Financial Interpretation (“FIN”) No. 48, “Accounting for Uncertainty in Income Taxes”. FIN No.
48 clarifies the accounting for uncertainty in income taxes recognized in the financial statements
in accordance with SFAS No. 109, “Accounting for Income Taxes.” This standard also provides that a
tax benefit from an uncertain tax position may be recognized when it is more likely than not that
the position will be sustained upon examination, including resolutions of any related appeals or
litigation processes, based on the technical merits. The amount recognized is measured as the
largest amount of tax benefit that is greater than 50 percent likely of being realized upon
ultimate settlements. This interpretation also provides guidance on measurement, derecognition,
classification, interest and penalties, accounting in interim periods, disclosure and transition.
While we are assessing the impact of FIN No. 48 on our consolidated financial statements, we
currently estimate the cumulative effect upon adoption of FIN No. 48 may result in a decrease to
shareholders’ equity of up to $100 million. The estimated impact is subject to revision as we
complete the analysis. We will continue to classify interest and penalties to be paid on an
underpayment of income taxes as income taxes in our consolidated statements of operations.
Share-Based Payment: Our compensation programs include share-based payments. Beginning in
2007, we account for all share-based payment transactions using a fair-value based measurement
method required by SFAS No. 123(R), “Share-Based Payment.” We adopted SFAS No. 123(R) using the
modified prospective method of transition. The share-based compensation expense is recognized for
the portion of the awards that is ultimately expected to vest on a straight-line basis over the
requisite service period for those awards with graded vesting and service conditions. For the
awards with performance conditions, we recognize the expense on a straight-line basis, treating
each vesting tranche as a separate award. Upon adoption of SFAS No. 123(R), in the first quarter
of 2007, we elected the “short-cut” method for calculating the beginning balance of the additional
paid-in capital pool related to the tax effects of share-based compensation.
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McKESSON CORPORATION
FINANCIAL REVIEW (Continued)
We estimate the grant-date fair value of employee stock options using the Black-Scholes
option-pricing model. We believe that it is difficult to accurately measure the value of an
employee stock option. Our estimates of employee stock option values rely on estimates of factors
we input into the model. The key factors involve an estimate of future uncertain events. The key
factors influencing the estimation process, among others, are the expected term of the option, the
expected stock price volatility factor and the expected dividend yield. We continue to use
historical exercise patterns as our best estimate of future exercise patterns in determining our
expected term of the option. We use a combination of historical and quoted implied volatility to
determine the expected stock price volatility factor. We believe that this market-based input
provides a better estimate of our future stock price movements and is consistent with emerging
employee stock option valuation considerations. Our expected stock price volatility assumption
continues to reflect a constant dividend yield during the expected term of the option. Once the
fair values of employee stock options are determined, current accounting practices do not permit
them to be changed, even if the estimates used are different from actual.
In addition, we develop an estimate of the number of share-based awards which will ultimately
vest primarily based on historical experiences. Changes in the estimated forfeiture rate can have
a material effect on share-based compensation expense. If the actual forfeiture rate is higher
than the estimated forfeiture rate, then an adjustment is made to increase the estimated forfeiture
rate, which will result in a decrease to the expense recognized in the financial statements. If
the actual forfeiture rate is lower than the estimated forfeiture rate, then an adjustment is made
to decrease the estimated forfeiture rate, which will result in an increase to the expense
recognized in the financial statements. We re-assess the estimated forfeiture rate established
upon grant periodically throughout the required service period. Such estimates are revised if they
differ materially from actual forfeitures. As required, the forfeiture estimates will be adjusted
to reflect actual forfeitures when an award vests. The actual forfeitures in the future reporting
periods could be materially higher or lower than our current estimates.
Our assessments of estimated share-based compensation charges are affected by our stock price
as well as assumptions regarding a number of complex and subjective variables and the related tax
impact. These variables include, but are not limited to, the volatility of our stock price,
employee stock option exercise behaviors, timing, level and types of our grants of annual
share-based awards and the attainment of performance goals. As a result, the future share-based
compensation expense may differ from the Company’s historical amounts. In 2007, share-based
compensation charges amounted to $0.13 per diluted share, or approximately $0.10 per diluted share
more than the share-based compensation expense recognized in our net income in 2006.
Prior to the adoption of SFAS No. 123(R), we accounted for our employee stock-based
compensation plans using the intrinsic value method under Accounting Principles Board (“APB”)
Opinion No. 25, “Accounting for Stock Issued to Employees.” Under this policy, since the exercise
price of stock options we granted was generally set equal to the market price on the date of the
grant, we did not record any expense to the income statement related to the grants of stock
options, unless certain original grant-date terms were subsequently modified. The pro forma effect
on net income (loss) and diluted earnings (loss) per common share required under the disclosure
provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” as amended by SFAS No. 148,
“Accounting for Stock-Based Compensation — Transition and Disclosure,” for the years ended March
31, 2006 and 2005 is set forth in Financial Note 19, “Share-Based Payment.”
Loss Contingencies: We are subject to various claims, 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 business. Each significant matter is
regularly reviewed and assessed for potential financial exposure. If a potential loss is
considered probable and can be reasonably estimated, we accrue a liability in the consolidated
financial statements. The assessment of probability and estimation of amount is highly subjective
and requires significant judgment due to uncertainties related to these matters and is based on the
best information available at the time. The accruals are adjusted, as appropriate as additional
information becomes available. The amount of actual loss may differ significantly from these
estimates.
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McKESSON CORPORATION
FINANCIAL REVIEW (Continued)
FINANCIAL CONDITION, LIQUIDITY, AND CAPITAL RESOURCES
Net cash flow from operating activities was $1,539 million in 2007, compared with $2,738
million in 2006 and $1,543 million in 2005. Operating activities for 2007 benefited from improved
accounts receivable management, reflecting changes in our customer mix, our termination of a
customer contract and an increase in accounts payable associated with improved payment terms.
These benefits were partially offset by increases in inventory needed to support our growth and
timing of inventory receipts. Cash flows from operations can be significantly impacted by factors
such as the timing of receipts from customers and payments to vendors. Operating activities for
2007 also reflect payments of $25 million for the settlements of Securities Litigation cases.
Net cash flow from operations in 2006 increased primarily reflecting improved working capital
balances for our U.S. pharmaceutical distribution business as purchases from certain of our
suppliers became better aligned with customer demand and as a result, net financial inventory
(inventory, net of accounts payable) decreased. Operating activities for 2006 also benefited from
better inventory management. Operating activities for 2006 include a $143 million cash receipt in
connection with an amended agreement entered into with a customer and cash settlement payments of
$243 million for the Securities Litigation. Additionally, cash flows from operations for 2006
include a reduction in current income taxes payable and a reduction in our deferred tax assets
which largely pertain to our Securities Litigation cash settlement
payments (including the $962
million placed in escrow), which was deducted in our 2006 income tax return. Net cash flow from
operating activities in 2005 includes a $1,200 million non-cash ($810 million after-tax) charge for
the Securities Litigation.
Net cash used in investing activities was $2,103 million in 2007, compared with $1,816 million
in 2006 and $360 million in 2005. Investing activities for 2007 reflect payments of $1,938 million
for our business acquisitions (including $1.8 billion for Per-Se) and $36 million for our
investment in Parata. Investing activities for 2007 also reflect $179 million of cash proceeds
from the sale of our businesses, including $164 million for the sale of our Acute Care business.
Investing activities for 2006 include increases in property acquisitions and capitalized software
expenditures which primarily reflect our investment in our U.S. pharmaceutical distribution center
network and our Provider Technologies segment’s investment in software for a contract with the
British government’s National Health Services Information Authority organization. Investing
activities for 2006 also include $589 million of expenditures for our business acquisitions,
including D&K, and a use of cash of $962 million due to a transfer of cash to an escrow account for
future payment of our Securities Litigation. Partially offsetting these increases were cash
proceeds of $63 million pertaining to the sale of BioServices. Investing activities for 2005
include $76 million of business acquisition primarily for MMC and
$33 million for
the increased investment in Nadro.
Financing activities provided cash of $379 million in 2007 and utilized cash of $583 million
and $91 million in 2006 and 2005. On March 5, 2007, we issued $500 million of 5.25% notes due 2013
and $500 million of 5.70% notes due 2017. Net proceeds from the issuance after offering expenses
of the notes of $990 million were used, together with cash on hand, to repay $1.0 billion of
short-term borrowings then outstanding under the interim facility we entered into in connection
with the acquisition of Per-Se. Financing activities for 2007 also include $1.0 billion of cash
paid for stock repurchases, partially offset by $399 million of cash receipts from common stock
issuances. Cash received from common stock issuances primarily represent employees’ exercises of
stock options. Financing activities for 2006 include $958 million of cash paid for stock
repurchases and $102 million of cash paid for the repayment of life insurance policy loans, which
was partially offset by $568 million of cash receipts from common stock issuances. Financing
activities for 2005 include repayment of $268 million of long-term debt partially offset by $223
million of cash receipts from common stock issuances. Cash dividends paid in 2007, 2006 and 2005
were $72 million, $73 million and $70 million.
The Company’s Board of Directors (the “Board”) approved share repurchase plans in October
2003, August 2005, December 2005 and January 2006 which permitted the Company to repurchase up to a
total of $1 billion ($250 million per plan) of the Company’s common stock. Under these plans, we
repurchased 19 million shares for $958 million during 2006 and made no repurchases in 2005. As of
March 31, 2006, less than $1 million remained available for future repurchases under the January
2006 plan and all of these other plans were completed.
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McKESSON CORPORATION
FINANCIAL REVIEW (Continued)
In April and July 2006, the Board approved two new share repurchase plans which permitted the
Company to repurchase up to an additional $1 billion ($500 million per plan) of the Company’s
common stock. During 2007, we repurchased a total of 20 million shares for $1.0 billion. As a
result of these repurchases, we effectively completed all of the 2007 share repurchase plans.
On April 25, 2007, the Board approved an additional share repurchase plan of up to $1.0
billion of the Company’s common stock. Repurchased shares are used to support our stock-based employee compensation plans and for other
general corporate purposes. Stock repurchases may be made from time to time in open market or
private transactions.
Selected Measures of Liquidity and Capital Resources:
Working capital primarily includes cash, receivables and inventories, net of drafts and
accounts payable and other liabilities. Our Pharmaceutical Solutions segment requires a
substantial investment in working capital that is susceptible to large variations during the year
as a result of inventory purchase patterns and seasonal demands. Inventory purchase activity is a
function of sales activity, new customer build-up requirements and for 2006, the number and timing
of fee-based arrangements with pharmaceutical manufacturers. In 2007, our working capital
decreased primarily as a result of increases in other liabilities and deferred revenue. Net
financial inventory (inventory, net of drafts and accounts payable) resulted in a small increase to
working capital in 2007. Working capital in 2006 also decreased primarily due to a decrease in our
net financial inventory, partially offset by improvements in our cash, cash equivalent and
restricted cash balances and an increase in our accounts receivable. Improvements in our net
financial inventory primarily reflect a better alignment of our purchases with customer demand for
our U.S. pharmaceutical distribution business.
Our ratio of net debt to net capital employed decreased in 2007 primarily due to our issuance
of $1.0 billion of long-term debt in relation with the Per-Se acquisition. Our ratio of net debt
to net capital employed declined in 2006 as growth in our operating profit was in excess of the
growth in working capital and other investments needed to fund increases in revenue.
The Company has paid quarterly cash dividends at the rate of $0.06 per share on its common
stock since the fourth quarter of 1999. A dividend of $0.06 per share was declared by the Board on
January 24, 2007, and was paid on April 2, 2007 to stockholders of record at the close of business
on March 1, 2007. The Company anticipates that it will continue to pay quarterly cash dividends in
the future. However, the payment and amount of future dividends remain within the discretion of
the Board and will depend upon the Company’s future earnings, financial condition, capital
requirements and other factors.
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McKESSON CORPORATION
FINANCIAL REVIEW (Continued)
Financial Obligations and Commitments:
The table below presents our significant financial obligations and commitments at March 31,
2007:
We define a purchase obligation as an arrangement to purchase goods or services that is
enforceable and legally binding on the Company. These obligations primarily relate to inventory
purchases, capital commitments and service agreements.
We have agreements with certain of our customers’ financial institutions (primarily for our
Canadian business) under which we have guaranteed the repurchase of inventory at a discount in the
event these customers are unable to meet certain obligations to those financial institutions.
Among other limitations, these inventories must be in resalable condition. We have also guaranteed
loans and credit facilities for some customers and we are a secured lender for substantially all of
these guarantees. Customer guarantees range from one to seven years and were primarily provided to
facilitate financing for certain strategic customers. At March 31, 2007, the maximum amounts of
inventory repurchase guarantees and other customer guarantees were $96 million and $4 million. We
consider it unlikely that we would make significant payments under these guarantees, and
accordingly, amounts accrued for these guarantees were nominal.
In addition, our banks and insurance companies have issued $99 million of standby letters of
credit and surety bonds on our behalf in order to meet the security requirements for statutory
licenses and permits, court and fiduciary obligations, and our workers’ compensation and automotive
liability programs.
Credit Resources:
We fund our working capital requirements primarily with cash, short-term borrowings and our
receivables sale facility. We have a $1.3 billion five-year, senior unsecured revolving credit
facility that expires in September 2009. Borrowings under this credit facility bear interest based
upon either a Prime rate or the London Interbank Offering Rate (“LIBOR”). In June 2006, we renewed
our committed accounts receivable sales facility. The facility was renewed under substantially
similar terms to those previously in place with the exception that the facility was reduced to $700
million from $1.4 billion. The renewed facility expires in June 2007. At March 31, 2007 and March
31, 2006, no amounts were outstanding under any of these facilities.
In connection with our purchase of Per-Se in January 2007, we entered into a single-draw $1.8
billion interim credit facility. The interim credit facility was a 364-day unsecured facility
which had terms substantially similar to those contained in the Company’s existing revolving credit
facility. On January 26, 2007, we borrowed $1.0 billion under the interim credit facility to
partially fund the Per-Se acquisition. On March 5, 2007, we issued $500 million of 5.25% notes due
2013 and $500 million of 5.70% notes due 2017. The notes are redeemable at any time, in whole or
in part, at our option. In addition, upon occurrence of both a change of control and a ratings
downgrade of the notes to non-investment-grade levels, we are required to make an offer to redeem
the notes at a price equal to 101% of the principal amount plus accrued interest. We utilized net
proceeds after offering expenses from the
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issuance of the notes of $990 million, together with cash on hand, to repay the $1 billion
short-term credit facility borrowings.
Our senior debt credit ratings from S&P, Fitch, and Moody’s are currently BBB, BBB+ and Baa3,
and our commercial paper ratings are currently A-2, F-2 and P-3. Our ratings outlook is positive
with S&P and stable with Fitch and Moody’s. Our various borrowing facilities and certain long-term
debt instruments are subject to covenants. Our principal debt covenant is our debt to capital
ratio, which cannot exceed 56.5%. If we exceed this ratio, repayment of debt outstanding under the
revolving credit facility and $215 million of term debt could be accelerated. At March 31, 2007,
this ratio was 23.8% and we were in compliance with all other covenants. A reduction in our credit
ratings or the lack of compliance with our covenants could result in a negative impact on our
ability to finance our operations.
Funds necessary for the resolution of future debt maturities and our other cash requirements
are expected to be met by existing cash balances, cash flows from operations, existing credit
sources and other capital market transactions.
MARKET RISKS
Interest rate risk: Our long-term debt bears interest predominately at fixed rates, whereas
our short-term borrowings are at variable interest rates. If the underlying weighted average
interest rate on our variable rate debt were to have changed by 50 bp in 2007 and 2006, interest
expense would not have been materially different from that reported.
As of March 31, 2007 and 2006, the net fair value liability of financial instruments with
exposure to interest rate risk was approximately $2,036 million and $1,082 million. Fair value was
estimated on the basis of quoted market prices, although trading in these debt securities is
limited and may not reflect fair value. Fair value is subject to fluctuations based on our
performance, our credit ratings, changes in the value of our stock and changes in interest rates
for debt securities with similar terms.
Foreign exchange risk: We derive revenues and earnings from Canada, the United Kingdom,
Ireland, France, the Netherlands, Israel, Australia, New Zealand and Mexico, which expose us to
changes in foreign exchange rates. We seek to manage our foreign exchange risk in part through
operational means, including managing same currency revenues in relation to same currency costs,
and same currency assets in relation to same currency liabilities. Foreign exchange risk is also
managed through the use of foreign currency forward-exchange contracts. These contracts are used
to offset the potential earnings effects from mostly intercompany foreign currency investments and
loans. As of March 31, 2007 and 2006, an adverse 10% change in quoted foreign currency exchange
rates would not have had a material impact on our net fair value of financial instruments that have
exposure to foreign currency risk.
RELATED PARTY BALANCES AND TRANSACTIONS
Information regarding our related party balances and transactions is included in “Critical
Accounting Policies and Estimates” appearing within this Financial Review and Financial Note 20,
“Related Party Balances and Transactions,” to the accompanying consolidated financial statements.
NEW ACCOUNTING PRONOUNCEMENTS
New accounting pronouncements that impact the Company are included in Financial Note 1,
“Significant Accounting Policies”, to our consolidated financial statements, under the captions
“Share-Based Payment” and “New Accounting Pronouncements”.
FACTORS AFFECTING FORWARD-LOOKING STATEMENTS
In addition to historical information, management’s discussion and analysis includes certain
forward-looking statements within the meaning of section 27A of the Securities Act of 1933, as
amended and section 21E of the Securities Exchange Act of 1934, as amended. Some of the
forward-looking statements can be identified by use of forward-looking words such as “believes,”
“expects,” “anticipates,” “may,” “should,” “seeks,” “approximately,”
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“intends,” “plans,” or
“estimates,” or the negative of these words, or other comparable terminology. The discussion
of financial trends, strategy, plans or intentions may also include forward-looking
statements. Forward-looking statements involve risks and uncertainties that could cause actual
results to differ materially from those projected anticipated or implied. Although it is not
possible to predict or identify all such risks and uncertainties, they may include, but are not
limited to, the factors discussed under “Additional Factors That May Affect Future Results.” The
reader should not consider this list to be a complete statement of all potential risks and
uncertainties.
These and other risks and uncertainties are described herein or in our other public documents.
Readers are cautioned not to place undue reliance on these forward-looking statements, which speak
only as of the date hereof. We undertake no obligation to publicly release the result of any
revisions to these forward-looking statements to reflect events or circumstances after the date
hereof, or to reflect the occurrence of unanticipated events.
ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS
The following additional factors may affect our future results:
Adverse resolution of pending Securities Litigation regarding the restatement of our historical
financial statements may cause us to incur material losses.
As discussed in Financial Note 17, “Other Commitments and Contingent Liabilities,” to the
accompanying consolidated financial statements, in the third quarter of 2005, we announced that we
had reached an agreement to settle the action captioned In re McKesson HBOC, Inc. Securities
Litigation (No. C-99-20743-RMW) (the “Consolidated Action”). In general, we agreed to pay the
settlement class a total of $960 million in cash. During the third quarter of 2005, we recorded a
$1,200 million pre-tax ($810 million after-tax) charge with respect to the Company’s Securities
Litigation. The charge consisted of $960 million for the Consolidated Action and $240 million for
other Securities Litigation proceedings.
On February 24, 2006, the court gave final approval to the settlement of the Consolidated
Action, and as a result, we paid approximately $960 million into an escrow account established by
the lead plaintiff in connection with the settlement. Based on the payments made in the
Consolidated Action and payments made to settle other previously reported Securities Litigation
proceedings, and based on our assessment of the remaining cases, the estimated Securities
Litigation accruals as of March 31, 2007 and 2006 were $983 million and $1,014 million. We believe
this accrual is adequate to address our remaining potential exposure with respect to all of the
Securities Litigation matters. However, in view of the number and uncertainties of the timing and
outcome of this type of litigation, and the substantial amounts involved, it is possible that the
ultimate costs of these matters could impact our earnings, either negatively or positively, in the
quarter of their resolution. We do not believe that the resolution of these matters will have a
material adverse effect on our results of operations, liquidity or financial position taken as a
whole.
Changes in the United States healthcare environment could have a material negative impact on our
revenues and net income.
Our products and services are primarily intended to function within the structure of the
healthcare financing and reimbursement system currently being used in the United States. In recent
years, the healthcare industry has changed significantly in an effort to reduce costs. These
changes include increased use of managed care, cuts in Medicare and Medicaid reimbursement levels,
consolidation of pharmaceutical and medical-surgical supply distributors, and the development of
large, sophisticated purchasing groups.
We expect the healthcare industry to continue to change significantly in the future. Some of
these changes, such as adverse changes in government funding of healthcare services, legislation or
regulations governing the privacy of patient information, or the delivery or pricing of
pharmaceuticals and healthcare services or mandated benefits, may cause healthcare industry
participants to greatly reduce the amount of our products and services they purchase or the price
they are willing to pay for our products and services.
Changes in the healthcare industry’s, or any of our individual or collective group of
pharmaceutical suppliers’, pricing, selling, inventory, distribution or supply policies or
practices, or changes in our customer mix could also significantly reduce our revenues and net
income. Due to the diverse range of healthcare supply management and
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healthcare information
technology products and services that we offer, such changes could have an adverse impact
on our results of operations, while not affecting some of our competitors who offer a narrower
range of products and services.
The majority of our U.S. pharmaceutical distribution business’ agreements with manufacturers
are structured to ensure that we are appropriately and predictably compensated for the services we
provide; however, failure to successfully renew these contracts in a timely and favorable manner
could have an adverse impact on our results of operations.
Healthcare and public policy trends indicate that the number of generic drugs will increase
over the next few years as a result of the expiration of certain drug patents. In recent years,
our revenues and gross margins have increased from our generic drug offering programs. An increase
or a decrease in the availability or changes in pricing or reimbursement of these generic drugs
could have an adverse impact on our results of operations.
There have been increasing efforts by various levels of government including state boards of
pharmacy and comparable agencies to regulate the pharmaceutical distribution system in order to
prevent the introduction of counterfeit, adulterated, and/or mislabeled drugs into the
pharmaceutical distribution system (“pedigree tracking”). Certain states have adopted or are
considering laws and regulations that are intended to protect the integrity of the pharmaceutical
distribution system while other government agencies are currently evaluating their recommendations.
Florida has adopted pedigree-tracking requirements and California has enacted a law requiring
chain of custody technology using radio frequency tagging and electronic pedigrees. Final
regulations under the federal Prescription Drug Marketing Act requiring pedigree and chain of
custody tracking in certain circumstances became effective December 1, 2006. This latter
regulation has been challenged in a case brought by secondary distributors. A preliminary
injunction was issued by the federal District Court for the Eastern District of New York that
temporarily enjoined implementation of this regulation. These pedigree tracking laws and
regulations could increase the overall regulatory burden and costs associated with our
pharmaceutical distribution business, and could have an adverse impact on our results of
operations.
We are subject to extensive and frequently changing local, state and federal laws and
regulations relating to healthcare fraud. The federal government continues to strengthen its
position and scrutiny over practices involving healthcare fraud affecting Medicare, Medicaid and
other government healthcare programs. Furthermore, our relationships with pharmaceutical and
medical-surgical product manufacturers and healthcare providers subject our business to laws and
regulations on fraud and abuse. Many of the regulations applicable to us, including those relating
to marketing incentives offered by pharmaceutical or medical-surgical suppliers, are vague or
indefinite and have not been interpreted by the courts. They may be interpreted or applied by a
prosecutorial, regulatory or judicial authority in a manner that could require us to make changes
in our operations. If we fail to comply with applicable laws and regulations, we could suffer
civil and criminal penalties, including the loss of licenses or our ability to participate in
Medicare, Medicaid and other federal and state healthcare programs.
Medical billing and collection activities are governed by numerous federal and state civil and
criminal laws that pertain to companies that provide billing and collection services, or that
provide consulting services in connection with billing and collection activities. In connection
with these laws, we may be subjected to federal or state government investigations and possible
penalties may be imposed upon us, false claims actions may have to be defended, private payers may
file claims against us, and we may be excluded from Medicare, Medicaid or other government-funded
healthcare programs. Any such proceeding or investigation could have an adverse impact on our
results of operations.
Competition
may erode our profit.
In every area of healthcare distribution operations, our Pharmaceutical Solutions and
Medical-Surgical Solutions segments face strong competition, both in price and service, from
national, regional and local full-line, short-line and specialty wholesalers, service
merchandisers, self-warehousing chains, manufacturers engaged in direct distribution and large
payor organizations. In addition, these segments face competition from various other service
providers and from pharmaceutical and other healthcare manufacturers (as well as other potential
customers of the segments) which may from time to time decide to develop, for their own internal
needs, supply management capabilities which are provided by the segments and other competing
service providers. Price, quality of service, and, in some cases, convenience to the customer are
generally the principal competitive elements in these segments.
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Our Provider Technologies segment
experiences substantial competition from many firms, including other computer services firms,
consulting firms, shared service vendors, certain hospitals and hospital groups, hardware vendors
and
Internet-based companies with technology applicable to the healthcare industry. Competition
varies in size from small to large companies, in geographical coverage, and in scope and breadth of
products and services offered. These competitive pressures could have an adverse impact on our
results of operations.
Our Pharmaceutical Solutions segment is subject to inflation in branded pharmaceutical prices and
deflation in generic pharmaceutical prices, which subjects us to risks and uncertainties.
Certain of our U.S. pharmaceutical distribution business’ agreements entered into with branded
pharmaceutical manufacturers are partially inflation-based. A slowing in the frequency or rate of
branded price increases could have an adverse impact on our results of operations. In addition, we
also distribute generic pharmaceuticals, which are subject to price deflation. An acceleration of
the frequency or rate of generic price decreases could also have an adverse impact on our results
of operations.
Substantial defaults in payment or a material reduction in purchases of our products by large
customers could have a significant negative impact on our financial condition and results of
operations and liquidity.
In recent years, a significant portion of our revenue growth has been with a limited number of
large customers. During the year ended March 31, 2007, sales to our ten largest customers
accounted for approximately 51% of our total consolidated revenues. Sales to our largest customer,
Caremark RX, Inc., represented approximately 11% of our 2007 total consolidated revenues. At March
31, 2007, accounts receivable from our ten largest customers and Caremark RX, Inc. were
approximately 48% and 12% of total accounts receivable. As a result, our sales and credit
concentration is significant. Any defaults in payment or a material reduction in purchases from
this or any other large customer could have an adverse impact on our results of operations.
Our Pharmaceutical Solutions and Medical-Surgical Solutions segments are dependent upon
sophisticated information systems. The implementation delay, malfunction or failure of these
systems for any extended period of time could adversely affect our business.
We rely on sophisticated information systems in our business to obtain, rapidly process,
analyze and manage data to: facilitate the purchase and distribution of thousands of inventory
items from numerous distribution centers, receive, process and ship orders on a timely basis,
manage the accurate billing and collections for thousands of customers and process payments to
suppliers. If these systems are interrupted, damaged by unforeseen events, or fail for any
extended period of time, we could have an adverse impact on our results of operations.
We could become subject to liability claims that are not adequately covered by our insurance, and
may have to pay damages and other expenses which could have an adverse impact on our results of
operations.
Our business exposes us to risks that are inherent in the distribution, manufacturing,
dispensing of pharmaceuticals and medical-surgical supplies, the provision of ancillary services,
the conduct of our payor businesses (which include disease management programs and our nurse triage
services) and the provision of products that assist clinical decision-making and relate to patient
medical histories and treatment plans. If customers assert liability claims against our products
and/or services, any ensuing litigation, regardless of outcome, could result in a substantial cost
to us, divert management’s attention from operations and decrease market acceptance of our
products. We attempt to limit, by contract, our liability to customers; however, the limitations
of liability set forth in the contracts may not be enforceable or may not otherwise protect us from
liability for damages. We also maintain general liability coverage; however, this coverage may not
continue to be available on acceptable terms or may not be available in sufficient amounts to cover
one or more large claims against us. In addition, the insurer might disclaim coverage as to any
future claim. A successful product or professional liability claim not fully covered by our
insurance could have an adverse impact on our results of operations.
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The failure of our Provider Technologies business to attract and retain customers due to challenges
in software product integration or to keep pace with technological advances may significantly
reduce our revenues or increase our expenses.
Our Provider Technologies business delivers enterprise-wide patient care, clinical, financial,
supply chain, strategic management software solutions and pharmacy automation to hospitals,
physicians, homecare providers, retail and mail order pharmacies and payors. Challenges in
integrating Provider Technologies software products could impair our ability to attract and retain
customers and could have an adverse impact on our results of operations.
Future advances in the healthcare information systems industry could lead to new technologies,
products or services that are competitive with the products and services offered by our Provider
Technologies business. Such technological advances could also lower the cost of such products and
services or otherwise result in competitive pricing pressure. The success of our Provider
Technologies business will depend, in part, on its ability to be responsive to technological
developments, pricing pressures and changing business models. To remain competitive in the
evolving healthcare information systems marketplace, our Provider Technologies business must
develop new products on a timely basis. The failure to develop competitive products and to
introduce new products on a timely basis could curtail the ability of our Provider Technologies
business to attract and retain customers and thereby could have an adverse impact on our results of
operations.
The loss of third party licenses utilized by our Provider Technologies segment may adversely impact
our operating results.
We license the rights to use certain technologies from third-party vendors to incorporate in
or complement our Provider Technologies segment’s products and solutions. These licenses are
generally nonexclusive, must be renewed periodically by mutual consent, and may be terminated if we
breach the terms of the license. As a result, we may have to discontinue, delay or reduce product
shipments until we obtain equivalent technology, which could hurt our business. Our competitors
may obtain the right to use any of the technology covered by these licenses and use the technology
to compete directly with us. In addition, if our vendors choose to discontinue support of the
licensed technology in the future, we may not be able to modify or adapt our own products.
Proprietary technology protections may not be adequate, and products may be found to infringe the
rights of third parties.
We rely on a combination of trade secret, patent, copyright and trademark laws, nondisclosure
and other contractual provisions and technical measures to protect our proprietary rights in our
products. There can be no assurance that these protections will be adequate or that our
competitors will not independently develop technologies that are substantially equivalent or
superior to our technology. Although we believe that our products do not infringe the proprietary
rights of third parties, from time to time third parties have asserted infringement claims against
us and there can be no assurance that third parties will not assert infringement claims against us
in the future. If we were found to be infringing others’ rights, we may be required to pay
substantial damage awards and forced to develop non-infringing technology, obtain a license or
cease selling the products that contain the infringing technology. Additionally, we may find it
necessary to initiate litigation to protect our trade secrets, to enforce our patent, copyright and
trademark rights, and to determine the scope and validity of the proprietary rights of others.
These types of litigation can be costly and time consuming. These litigation expenses, damage
payments, or costs of developing replacement technology could have an adverse impact on our results
of operations.
System errors or failures of our products to conform to specifications could cause unforeseen
liabilities.
The software and software systems (“systems”) that we sell or operate are very complex. As
with complex systems offered by others, our systems may contain errors, especially when first
introduced. For example, our Provider Technologies’ business systems are intended to provide
information for healthcare providers in providing patient care. Therefore, users of our systems
have a greater sensitivity to errors than the general market for software products. Failure of a
client’s system to perform in accordance with our documentation could constitute a breach of
warranty and could require us to incur additional expense in order to make the system comply with
the documentation. If such failure is not remedied in a timely manner, it could constitute a
material breach under a
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contract, allowing the client to cancel the contract, obtain refunds of
amounts previously paid, or assert claims for significant damages.
Regulation of our distribution businesses and regulation of our computer-related products could
impose increased costs, delay the introduction of new products and negatively impact our business.
The healthcare industry is highly regulated. We are subject to various local, state, federal,
foreign and transnational laws and regulations, which include the operating and security standards
of the Drug Enforcement Administration (the “DEA”), the Food and Drug Administration (the “FDA”),
various state boards of pharmacy, state health departments, the Department of Health and Human
Services (the “DHHS”), and other comparable agencies. Certain of our subsidiaries may be required
to register for permits and/or licenses with, and comply with operating and security standards of,
the DEA, the FDA, DHHS and various state boards of pharmacy, state health departments and/or
comparable state agencies as well as foreign agencies and certain accrediting bodies depending upon
the type of operations and location of product distribution, manufacturing and sale.
In
addition, the FDA has increasingly focused on the regulation of computer products and
computer-assisted products as medical devices under the Federal Food, Drug and Cosmetic Act. If
the FDA chooses to regulate any of our products as medical devices, it can impose extensive
requirements upon us. If we fail to comply with the applicable requirements, the FDA could respond
by imposing fines, injunctions or civil penalties, requiring recalls or product corrections,
suspending production, refusing to grant pre-market clearance of products, withdrawing clearances
and initiating criminal prosecution. Any final FDA policy governing computer products, once
issued, may increase the cost and time to market new or existing products or may prevent us from
marketing our products.
We
regularly receive requests for information and occasionally
subpoenas from governmental authorities. Although we believe that we are in compliance, in all material respects, with applicable laws
and regulations, there can be no assurance that a regulatory agency or tribunal would not reach a
different conclusion concerning the compliance of our operations with applicable laws and
regulations. In addition, there can be no assurance that we will be able to maintain or renew
existing permits, licenses or any other regulatory approvals or obtain without significant delay
future permits, licenses or other approvals needed for the operation of our businesses. Any
noncompliance by us with applicable laws and regulations or the failure to maintain, renew or
obtain necessary permits and licenses could have an adverse impact on our results of operations.
New and potential federal regulations relating to patient confidentiality and format and data
content standards could depress the demand for our products and impose significant product redesign
costs and unforeseen liabilities on us.
State and federal laws regulate the confidentiality of patient records and the circumstances
under which those records may be released. These regulations govern both the disclosure and use of
confidential patient medical record information and will require the users of such information to
implement specified security measures. Regulations currently in place governing electronic health
data transmissions continue to evolve and are often unclear and difficult to apply.
The Health Insurance Portability and Accountability Act of 1996 (“HIPAA”) requires national
standards for some types of electronic health information transactions and the data elements used
in those transactions, security standards to ensure the integrity and confidentiality of health
information and standards to protect the privacy of individually
identifiable health information.
Although our systems have been updated and modified to comply with the current requirements of
HIPAA, evolving HIPAA-related laws or regulations, such as the claims attachment rule, could
restrict the ability of our customers to obtain, use or disseminate patient information. This
could adversely affect demand for our products if they are not re-designed in a timely manner in
order to meet the requirements of any new regulations that seek to protect the privacy and security
of patient data or enable our customers to execute new or modified healthcare transactions. We may
need to expend additional capital, research and development and other resources to modify our
products to address evolving data security and privacy issues.
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The length of our sales and implementation cycles for our Provider Technologies segment could have
an adverse impact on our future operating results.
Many of the solutions offered by our Provider Technologies segment have long sales and
implementation cycles, which could range from several months to over two years or more from initial
contact with the customer to completion of implementation. How and when to implement, replace, or
expand an information system, or modify or add business processes, are major decisions for
healthcare organizations. Many of the solutions we provide typically require significant capital
expenditures and time commitments by the customer. Any decision by our customers to delay
implementation could have an adverse impact on our results of operations. Furthermore, delays or
failures to meet milestones established in our agreements may result in a breach of contract,
termination of the agreement, damages and/or penalties as well as a reduction in our margins or a
delay in our ability to recognize revenue.
Our inability to perform well under chronic disease or impact condition programs could have an
adverse effect on our business and results of operations.
Part of our growth strategy focuses on developing health and care support programs to address
chronic diseases and medical conditions as well as the overall health of all enrollees of a health
plan. Our success in this area, including our ability to recognize revenue, is highly dependent
upon the timely receipt of accurate data from health plan customers and our accurate analysis of
such data. Data acquisition, data quality control and data analysis are complex processes that
carry a risk of untimely, incomplete or inaccurate data from health plan customers or flawed
analysis of such data. If we do not receive timely and accurate data from health plan customers or
our analyses are flawed, or if we fail to execute on new or modified programs, it could have an
adverse impact on our results of operations.
Reduced capacity in the commercial property insurance market exposes us to potential loss.
In order to provide prompt and complete service to our major Pharmaceutical Solutions and
Medical-Surgical Solutions customers, we maintain significant product inventory at certain of our
distribution centers. While we seek to maintain property insurance coverage in amounts sufficient
for our business, there can be no assurance that our property insurance will be adequate or
available on acceptable terms. One or more large casualty losses caused by fire, earthquake or
other natural disaster in excess of our coverage limits could have an adverse impact on our results
of operations.
We may be required to record a significant charge to earnings if our goodwill or amortizable
intangible assets become impaired.
We are required under generally accepted accounting principles to test our goodwill for
impairment at least annually as well as review our amortizable intangible assets for impairment
when events or changes in circumstances indicate the carrying value may not be recoverable.
Factors that may be considered a change in circumstances indicating that the carrying value of our
intangible assets may not be recoverable include slower growth rates and the loss of a significant
customer. We may be required to record a significant charge to earnings in our consolidated
financial statements during the period in which any impairment of our goodwill or amortizable
intangible assets is determined. This could have an adverse impact on our results of operations.
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Our operating results and our financial condition may be adversely affected by foreign operations.
We have operations based in foreign countries, including Canada, the United Kingdom, Europe
and other foreign countries, and we have a large investment in Mexico. In the future we look to
continue to grow our foreign operations both organically and through acquisitions and investments;
however, increasing our foreign operations carries additional risks. Operations outside of the
United States may be affected by changes in trade protection laws, policies, measures and other
regulatory requirements affecting trade and investment; unexpected changes in regulatory
requirements for software, social, political, labor or economic conditions in a specific country or
region; import/export regulations in both the United States and foreign countries, and difficulties
in staffing and managing foreign operations. Political changes and natural disasters, some of
which may be disruptive, can interfere with our supply chain, our customers and all of our
activities in a particular location. Additionally, foreign operations expose us to foreign
currency fluctuations that could adversely impact our results of operations based on the movements
of the applicable foreign currency exchange rates in relation to the U.S. Dollar.
Tax legislation initiatives could adversely affect our net earnings.
We are a large multinational corporation with operations in the United States and
international jurisdictions. As such, we are subject to the tax laws and regulations of the United
States federal, state and local governments and of many international jurisdictions. From time to
time, various legislative initiatives may be proposed that could adversely affect our tax
positions. There can be no assurance that our effective tax rate will not be adversely affected by
these initiatives. In addition, United States federal, state and local, as well as international,
tax laws and regulations are extremely complex and subject to varying interpretations. Although we
believe that our historical tax positions are sound and consistent with applicable laws,
regulations and existing precedent, there can be no assurance that these tax positions will not be
challenged by relevant tax authorities or that we would be successful in any such challenge.
Our business could be hindered if we are unable to complete and integrate acquisitions
successfully.
An element of our strategy is to identify, pursue and consummate acquisitions that either
expand or complement our business. Integration of acquisitions involves a number of risks
including the diversion of management’s attention to the assimilation of the operations of
businesses we have acquired, difficulties in the integration of operations and systems and the
realization of potential operating synergies, the assimilation and retention of the personnel of
the acquired companies, challenges in retaining the customers of the combined businesses, and
potential adverse effects on operating results. In addition, we may potentially require additional
financing in order to fund future acquisitions, which may or may not be attainable. If we are
unable to successfully complete and integrate strategic acquisitions in a timely manner, our
business and our growth strategies could be negatively affected.
In addition to the above, changes in generally accepted accounting principles and general
economic and market conditions could affect future results.
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MANAGEMENT’S ANNUAL REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The management of McKesson Corporation is responsible for establishing and maintaining
adequate internal control over financial reporting for the Company. With the participation of the
Chief Executive Officer and the Chief Financial Officer, our management conducted an evaluation of
the effectiveness of our internal control over financial reporting based on the framework and
criteria established in Internal Control—Integrated Framework, issued by the Committee of
Sponsoring Organizations of the Treadway Commission. Based on this evaluation, our management has
concluded that our internal control over financial reporting was effective as of March 31, 2007.
Deloitte & Touche LLP, an independent registered public accounting firm, has issued an audit
report on our management’s assessment of our internal control over financial reporting. This audit
report appears on page 57 of this Annual Report on Form 10-K.
The scope of management’s assessment of the effectiveness of internal control over financial
reporting excludes the acquired operations of Per-Se Technologies, Inc., (“Per-Se”) because it was
acquired on January 26, 2007. Per-Se represents
approximately 8% of our total assets
at March 31, 2007, and less than 1% of our revenues and
net income for the year ended March 31, 2007.
May 9, 2007
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Stockholders and Board of Directors of McKesson Corporation:
We have audited the accompanying consolidated balance sheets of McKesson Corporation and
subsidiaries (the “Company”) as of March 31, 2007 and 2006, and the related consolidated statements
of operations, stockholders’ equity and cash flows for each of the three fiscal years in the period
ended March 31, 2007. Our audits also included the financial statement schedule listed in the
Index at Item 15(a). We also have audited management’s assessment, included in the accompanying
Management’s Annual Report on Internal Control Over Financial Reporting, that the Company
maintained effective internal control over financial reporting as of March 31, 2007 based on
criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. As described in Management’s Annual Report on Internal
Control Over Financial Reporting, management excluded from its assessment the internal control over
financial reporting at Per-Se Technologies, Inc. (“Per-Se”)
which was acquired on January 26, 2007 and whose financial
statements constitute approximately 8% of total
assets and less than 1% of revenues and net income as of and for the year ended March 31, 2007. Accordingly, our audit did not include the
internal control over financial reporting at Per-Se. The Company’s management is responsible for
these financial statements and financial statement schedule, for maintaining effective internal
control over financial reporting, and for its assessment of the effectiveness of internal control
over financial reporting. Our responsibility is to express an opinion on these financial
statements and financial statement schedule, an opinion on management’s assessment, and an opinion
on the effectiveness of the Company’s internal control over financial reporting based on our
audits.
We conducted our audits in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of material
misstatement and whether effective internal control over financial reporting was maintained in all
material respects. Our audit of financial statements included examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing the accounting
principles used and significant estimates made by management, and evaluating the overall financial
statement presentation. Our audit of internal control over financial reporting included obtaining
an understanding of internal control over financial reporting, evaluating management’s assessment,
testing and evaluating the design and operating effectiveness of internal control, and performing
such other procedures as we considered necessary in the circumstances. We believe that our audits
provide a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed by, or under the
supervision of, the company’s principal executive and principal financial officers, or persons
performing similar functions, and effected by the company’s board of directors, management, and
other personnel to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance with generally
accepted accounting principles. A company’s internal control over financial reporting includes
those policies and procedures that (1) pertain to the maintenance of records that, in reasonable
detail, accurately and fairly reflect the transactions and dispositions of the assets of the
company; (2) provide reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted accounting principles and
that receipts and expenditures of the company are being made only in accordance with authorizations
of management and directors of the company; and (3) provide reasonable assurance regarding
prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s
assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial reporting, including
the possibility of collusion or improper management override of controls, material misstatements
due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any
evaluation of the effectiveness of the internal control over financial reporting to future periods
are subject to the risk that the controls may become inadequate because of changes in conditions,
or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the consolidated financial statements referred to above present fairly, in all
material respects, the financial position of McKesson Corporation and subsidiaries as of March 31, 2007 and 2006, and the
results of their operations and their cash flows for each of the three fiscal years in the period ended
March 31, 2007, in conformity with accounting principles generally accepted in the United States of
America. Also, in our opinion, such financial statement schedule, when considered in relation to
the basic consolidated financial statements taken as a whole, presents fairly, in all material
respects, the information set forth therein. Also in our opinion, management’s assessment that the
Company maintained effective internal control over financial reporting as of March 31, 2007, is
fairly stated, in all material respects, based on the criteria established in Internal
Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission. Furthermore, in our opinion, the Company maintained, in all material respects,
effective internal control over financial reporting as of March 31, 2007, based on the criteria
established in Internal Control—Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission.
As discussed in Note 1
to the consolidated financial statements, on April 1, 2006, the Company
changed its method of accounting for share-based payment arrangements to conform to Statement
of Financial Accounting Standards (“SFAS”) No. 123(R),
“Share-Based Payment.” As also discussed in Note 1 to the
consolidated financial statements, on March 31, 2007, the Company
adopted SFAS No. 158, “Employers’ Accounting for Defined Benefit
Pension and Other Postretirement Plans.”
Deloitte & Touche LLP
San Francisco, California May 9, 2007 57
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McKESSON CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(In millions, except per share amounts)
See Financial Notes
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McKESSON CORPORATION
CONSOLIDATED BALANCE SHEETS
(In millions, except per share amounts)
See Financial Notes
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CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
Years Ended March 31, 2007, 2006 and 2005
(In millions except per share amounts)
See Financial Notes
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CONSOLIDATED STATEMENTS OF CASH FLOWS
(In millions)
See Financial Notes
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FINANCIAL NOTES
1. Significant Accounting Policies
Nature of Operations: The consolidated financial statements of McKesson Corporation
(“McKesson,” the “Company,” or “we” and other similar pronouns) include the financial statements of
all majority-owned or controlled companies. Significant intercompany transactions and balances
have been eliminated. The Company’s fiscal year begins on April 1 and ends on March 31. Unless
otherwise noted, all references to a particular year shall mean the Company’s fiscal year.
We conduct our business through three segments. Through our Pharmaceutical Solutions segment,
we are a leading distributor of ethical and proprietary drugs, and health and beauty care products
throughout North America. This segment also provides medical management and specialty
pharmaceutical solutions for biotech and pharmaceutical manufacturers, patient and other services
for payors, software and consulting and outsourcing services to pharmacies and, through its
investment in Parata Systems, LLC (“Parata”), sells automated pharmaceutical dispensing systems for
retail pharmacies. Our Medical-Surgical Solutions segment distributes medical-surgical supplies,
first-aid products and equipment, and provides logistics and other services within the United
States and Canada. Our Provider Technologies segment delivers enterprise-wide patient care,
clinical, financial, supply chain, and strategic management software solutions, pharmacy automation
for hospitals, as well as connectivity, outsourcing and other services, to healthcare organizations
throughout North America, the United Kingdom and other European countries. Its customers include
hospitals, physicians, homecare providers, retail pharmacies and payors.
Reclassifications: Certain prior year amounts have been reclassified to conform to the
current year presentation. The reclassifications are primarily related to discontinued operations
(see Financial Note 3, “Discontinued Operations”) and had no impact on net income.
Use of Estimates: The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires that we 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: All highly liquid debt instruments purchased with a maturity of
three months or less at the date of acquisition are included in cash and cash equivalents.
Restricted Cash: Cash that is subject to legal restrictions or is unavailable for general
operating purposes is classified as restricted cash. At March 31, 2007 and 2006 restricted cash
included $962 million paid into an escrow account for future distribution to class members of our
Securities Litigation settlement. The corresponding liability is in current liabilities under the
caption “Securities Litigation.” The liability will be discharged at such time as the settlement
is declared effective by the court. Refer to Financial Note 17, “Other Commitments and Contingent
Liabilities.”
Marketable Securities Available for Sale: We carry our marketable securities which are
available for sale at fair value and the net unrealized gains and losses, net of the related tax
effect, computed in marking these securities to market have been reported within stockholders’
equity.
Inventories: We state inventories at the lower of cost or market. Inventories for the
Pharmaceutical Solutions and Medical-Surgical Solutions segments consist of merchandise held for
resale. For our Pharmaceutical Solutions segment, the majority of the cost of domestic inventories
is determined on the last-in, first-out (“LIFO”) method and Canadian inventories are stated using
the first-in, first-out (“FIFO”) method. Cost of inventories for our Medical-Surgical Solutions
segment is primarily determined on the FIFO method. Provider Technologies segment inventories
consist of computer hardware with cost determined by the standard cost method. The LIFO method is
used to value approximately 87% of our inventories at March 31, 2007 and 2006. Total inventories
before the LIFO cost adjustment, which approximates replacement cost, were $8,244 million and
$7,283 million at March 31, 2007 and 2006. Vendor rebates, cash discounts, allowances and
chargebacks received from vendors are generally accounted for as a reduction in the cost of
inventory and are recognized when the inventory is sold.
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Property, Plant and Equipment: We state our property, plant and equipment at cost and
depreciate them on the straight-line method at rates designed to distribute the cost of properties
over estimated service lives ranging from one to 30 years.
Capitalized Software Held for Sale: Development costs for software held for sale, which
primarily pertain to our Provider Technologies segment, are capitalized once a project has reached
the point of technological feasibility. Completed projects are amortized after reaching the point
of general availability using the straight-line method based on an estimated useful life of
approximately three years. We monitor the net realizable value of capitalized software held for
sale to ensure that the investment will be recovered through future sales.
Additional information regarding our capitalized software expenditures is as follows:
Long-lived Assets: We assess the recoverability of goodwill and indefinite-lived purchased
intangible assets on at least an annual basis and other long-lived assets when events or changes in
circumstances indicate that the carrying amount of an asset may not be recoverable. Measurement of
impairment losses for long-lived assets, including goodwill, which we expect to hold and use, is
based on estimated fair values of the assets. Estimates of fair values are based on quoted market
prices, when available, the results of valuation techniques utilizing discounted cash flows (using
the lowest level of identifiable cash flows) or fundamental analysis. Long-lived assets to be
disposed of, either by sale or abandonment, are reported at the lower of carrying amount or fair
value less costs to sell. Intangible assets with finite lives
(customer lists, technology, trademarks and other) are amortized on a
straight-line basis over the estimated useful lives ranging from one
to twenty years.
Capitalized Software Held for Internal Use: We amortize capitalized software held for
internal use over the assets’ estimated useful lives ranging from one to ten years. As of March
31, 2007 and 2006, capitalized software held for internal use was $465 million and $435 million,
net of accumulated amortization of $391 million and
$315 million and was included in Other Assets
in the consolidated balance sheets.
Insurance Programs: Under our insurance programs, we seek to obtain coverage for catastrophic
exposures as well as those risks required to be insured by law or contract. It is our policy to
retain a significant portion of certain losses primarily related to workers’ compensation and
comprehensive general, product, and vehicle liability. Provisions for losses expected under these
programs are recorded based upon our estimate of the aggregate liability for claims incurred as
well as for claims incurred but not yet reported. Such estimates utilize certain actuarial
assumptions followed in the insurance industry.
Revenue Recognition: Revenues for our Pharmaceutical Solutions and Medical-Surgical Solutions
segments are recognized when we deliver product and title passes to the customer or when services
have been rendered and there are no further obligations to customers.
Revenues are recorded net of sales returns, allowances and rebates. We accrue sales returns
based on estimates at the time of sale to the customer. Sales returns from customers were
approximately $1,113 million, $933 million and $845 million in 2007, 2006 and 2005. Taxes
collected from customers and remitted to governmental authorities are presented on a net basis;
that is, they are excluded from revenues.
The revenues for the Pharmaceutical Solutions segment include large volume sales of
pharmaceuticals to a limited number of large customers who warehouse their own product. We order
bulk product from the manufacturer, receive and process the product through our central
distribution facility and deliver the bulk product (generally in the same form as received from the
manufacturer) directly to our customers’ warehouses. We also record revenues for direct store
deliveries from most of these same customers. Sales to customer warehouses amounted to $27.6
billion in 2007, $25.5 billion in 2006 and $23.8 billion in 2005. Direct store deliveries are
shipments from the manufacturer to our customers of a limited category of products that require
special handling. We assume the primary liability to the manufacturer for these products.
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FINANCIAL NOTES (Continued)
Based on the criteria of Emerging Issues Task Force (“EITF”) Issue No. 99-19, “Reporting
Revenue Gross as a Principal Versus Net as an Agent,” our revenues are recorded gross when we are
the primary party obligated in the
transaction, take title to and possession of the inventory, are subject to inventory risk,
have latitude in establishing prices, assume the risk of loss for collection from customers as well
as delivery or return of the product, are responsible for fulfillment and other customer service
requirements, or the transactions have several but not all of the these indicators.
Our Pharmaceutical Solutions segment also includes revenues from disease management programs
provided to various states’ Medicaid programs. These service contracts include provisions for
achieving certain cost-savings and clinical targets. If the targets are not met, a portion, or
all, of the revenue must be refunded to the customer. We recognize revenue during the term of the
contract by assessing our actual performance compared to targets and then determining the amount
the customer would be legally obligated to pay if the contract terminated at that point. These
assessments include estimates of medical claims and other data, which could require future
adjustment because there is generally a significant time delay between recording the accrual and
the final settlement of the contract. If data is insufficient to assess performance or we have not
met the targets, we defer recognition of the revenue. As of March 31, 2007 and 2006, we had
deferred $104 million and $96 million related to these contracts, which was included in
current deferred revenue in the consolidated balance sheets. We generally have been successful in
achieving performance goals under these contracts.
Revenues for our Provider Technologies segment are generated primarily by licensing software
systems (consisting of software, hardware and maintenance support), and providing outsourcing and
professional services. Revenue for this segment is recognized as follows:
Software systems are marketed under information systems agreements as well as service
agreements. Perpetual software arrangements are recognized at the time of delivery or under the
percentage-of-completion method based on the terms and conditions in the contract. Contracts
accounted for under the percentage-of-completion method are generally measured based on the ratio
of labor costs incurred to date to total estimated labor costs to be incurred. Changes in
estimates to complete and revisions in overall profit estimates on these contracts are charged to
earnings in the period in which they are determined. We accrue for contract losses if and when the
current estimate of total contract costs exceeds total contract revenue.
Hardware revenues are generally recognized upon delivery. Revenue from multi-year software
license agreements is recognized ratably over the term of the agreement. Software implementation
fees are recognized as the work is performed or under the percentage-of-completion contract method.
Maintenance and support agreements are marketed under annual or multi-year agreements and are
recognized ratably over the period covered by the agreements. Remote processing service fees are
recognized monthly as the service is performed. Outsourcing service revenues are recognized as the
service is performed.
We also offer our products on an application service provider (“ASP”) basis, making available
our software functionality on a remote hosting basis from our data centers. The data centers
provide system and administrative support as well as hosting services. Revenue on products sold on
an ASP basis is recognized on a monthly basis over the term of the contract starting when the
hosting services begin.
This segment also engages in multiple-element arrangements, which may contain any combination
of software, hardware, implementation or consulting services, or maintenance services. When some
elements are delivered prior to others in an arrangement and vendor-specific objective evidence of
fair value (“VSOE”) exists for the undelivered elements, revenue for the delivered elements is
recognized upon delivery of such items. The segment establishes VSOE for hardware and
implementation and consulting services based on the price charged when sold separately, and for
maintenance services, based on renewal rates offered to customers. Revenue for the software
element is recognized under the residual method only when fair value has been established for all
of the undelivered elements in an arrangement. If fair value cannot be established for any
undelivered element, all of the arrangement’s revenue is deferred until the delivery of the last
element or until the fair value of the undelivered element is determinable.
Supplier Incentives: We generally account for fees for service and other incentives received
from our suppliers, relating to the purchase or distribution of inventory, as a reduction to cost
of goods sold. We consider these fees to represent product discounts, and as a result, the fees
are recorded as a reduction of product cost and recognized through cost of goods sold upon the sale
of the related inventory.
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FINANCIAL NOTES (Continued)
Supplier Reserves: We establish reserves against amounts due from our suppliers relating to
various price and rebate incentives, including deductions or billings taken against payments
otherwise due to them. These reserve estimates are established based on our judgment after
carefully considering the status of current outstanding claims, historical experience with the
suppliers, the specific incentive programs and any other pertinent information
available to us. We evaluate the amounts due from our suppliers on a continual basis and
adjust the reserve estimates when appropriate based on changes in factual circumstances. The
ultimate outcome of any outstanding claim may be different than our estimate. As of March 31, 2007
and 2006, supplier reserves were $100 million and $97 million.
Shipping and Handling Costs: We include all costs to warehouse, pick, pack and deliver
inventory to our customers in distribution expenses.
Income Taxes: We account for income taxes under the asset and liability method, which
requires the recognition of deferred tax assets and liabilities for the expected future tax
consequences of events that have been included in the financial statements. Under this method,
deferred tax assets and liabilities are determined based on the difference between the financial
statements and tax basis of assets and liabilities using enacted tax rates in effect for the year
in which the differences are expected to reverse.
Foreign Currency Translation: Assets and liabilities of international subsidiaries are
translated into U.S. dollars at year-end exchange rates, and revenues and expenses are translated
at average exchange rates during the year. Cumulative currency translation adjustments are
included in accumulated other comprehensive income or losses in the stockholders’ equity section of the
consolidated balance sheets. Realized gains and losses from currency exchange transactions are
recorded in operating expenses in the consolidated statements of operations and were not material
to our consolidated results of operations in 2007, 2006 or 2005.
Derivative Financial Instruments: Derivative financial instruments are used principally in
the management of our foreign currency and interest rate exposures and are recorded on the balance
sheet at fair value. If the derivative is designated as a fair value hedge, the changes in the
fair value of the derivative and of the hedged item attributable to the hedged risk are recognized
as a charge or credit to earnings. If the derivative is designated as a cash flow hedge, the
effective portions of changes in the fair value of the derivative are recorded in accumulated other
comprehensive losses and are recognized in the consolidated statement of earnings when the hedged
item affects earnings. Ineffective portions of changes in the fair value of cash flow hedges are
recognized as a charge or credit to earnings. Derivative instruments not designated as hedges are
marked-to-market at the end of each accounting period with the results included in earnings.
Concentrations of Credit Risk: Trade receivables subject us to a concentration of credit risk
with customers primarily in our Pharmaceutical Solutions segment. A significant proportion of our
revenue growth has been with a limited number of large customers and as a result, our credit
concentration has increased. Accordingly, any defaults in payment by or a reduction in purchases
from these large customers could have a significant negative impact on our financial condition,
results of operations and liquidity. At March 31, 2007, revenues and accounts receivable from our
ten largest customers accounted for approximately 51% of consolidated revenues and approximately
48% of accounts receivable. 2007 revenues and March 31, 2007 receivables from our largest
customer, Caremark RX, Inc., represented approximately 11% of total consolidated revenues and 12%
of accounts receivable. We have also provided financing arrangements to certain of our customers
within our Pharmaceutical Solutions segment, some of which are on a revolving basis. At March 31,
2007, these customer financing arrangements totaled approximately $122 million.
Accounts Receivable Sales: At March 31, 2007, we had a $700 million revolving receivables
sales facility, which was fully available. The program qualifies for sale treatment under
Statement of Financial Accounting Standards (“SFAS”) No. 140, “Accounting For Transfers and
Servicing Financial Assets and Extinguishments of Liabilities.” Sales are recorded at the
estimated fair values of the receivables sold, reflecting discounts for the time value of money
based on U.S. commercial paper rates and estimated loss provisions. Discounts are recorded in
administrative expenses in the consolidated statements of operations.
Share-Based Payment: Beginning in 2007, we account for all share-based payment transactions
using a fair-value based measurement method required by SFAS No. 123(R), “Share-Based Payment.”
The share-based compensation expense is recognized for the portion of the awards that is ultimately
expected to vest on a straight-
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FINANCIAL NOTES (Continued)
line basis over the requisite service period for those awards with
graded vesting and service conditions. For the awards with performance conditions, we recognize
the expense on a straight-line basis, treating each vesting tranche as a separate award.
Prior to the adoption of SFAS No. 123(R), we accounted for our employee stock-based
compensation plans using the intrinsic value method under Accounting Principles Board (“APB”)
Opinion No. 25, “Accounting for Stock Issued to Employees.” Under this policy, since the exercise
price of stock options we granted was generally
set equal to the market price on the date of the grant, we did not record any expense to the
income statement related to the grants of stock options, unless certain original grant-date terms
were subsequently modified. See Financial Note 19, “Share-Based Payment,” for the pro forma effect
on net income (loss) and diluted earnings (loss) per common share required under the disclosure
provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” as amended by SFAS No. 148,
“Accounting for Stock-Based Compensation – Transition and Disclosure,” for the years ended March
31, 2006 and 2005.
New Accounting Pronouncements: In November 2004, the Financial Accounting Standards Board
(“FASB”) issued SFAS No. 151, “Inventory Costs — an amendment of Accounting Research Bulletin
(“ARB”) No. 43, Chapter 4.” SFAS No. 151 clarifies the accounting guidance included in ARB No. 43,
Chapter 4, “Inventory Pricing” related to abnormal amounts of idle facility expense, freight,
handling and spoilage costs. SFAS No. 151 became effective for inventory costs incurred during
2007. The adoption of this standard did not have a material effect on our consolidated financial
statements.
On April 1, 2006, we adopted SFAS No. 123(R), “Share-Based Payment,” which requires the
recognition of expense resulting from transactions in which we acquire goods and services by
issuing our shares, share options, or other equity instruments. This standard requires a
fair-value based measurement method in accounting for share-based payment transactions. The
share-based compensation expense is recognized for the portion of the awards that is ultimately
expected to vest. This standard replaced SFAS No. 123 and superseded APB Opinion No. 25.
Accordingly, the use of the intrinsic value method as provided under APB Opinion No. 25, which was
utilized by the Company, was eliminated. We adopted SFAS No. 123(R) using the modified prospective
method of transition. See Financial Note 19, “Share-Based Payment,” for further details.
In March 2005, the Securities and Exchange Commission (“SEC”) staff issued Staff Accounting
Bulletin (“SAB”) No. 107, “Share-Based Payment”, which provides guidance on the interaction between
SFAS No. 123(R) and certain SEC rules and regulations, as well as on the valuation of share-based
payments. SAB No. 107 did not modify any of the requirements under SFAS No. 123(R). SAB No. 107
provides interpretive guidance related to valuation methods (including assumptions such as expected
volatility and expected term), first-time adoption of SFAS No. 123(R) in an interim period, the
classification of compensation expense and disclosures subsequent to adoption of SFAS No. 123(R).
Operating income in 2007 and
2006 included $60 million and $16 million of share-based compensation
expense. 2006 expense is associated with restricted stock whose intrinsic value as of the grant
date is being amortized over the remaining requisite service period. We anticipate the impact of
SFAS No. 123(R) to continue to impact net income as future awards of share-based compensation are
granted and amortized over the requisite service period of four years. Share-based compensation
charges are affected by our stock price as well as assumptions regarding a number of complex and
subjective variables and the related tax impact. These variables include, but are not limited to,
the volatility of our stock price, employee stock option exercise behaviors, timing, level and
types of our grants of annual share-based awards, and the attainment of performance goals. As a
result, the actual future share-based compensation expense may differ from historical levels of
expense.
In December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets — an
amendment of APB Opinion No. 29,” which eliminates the exception from fair value measurement for
nonmonetary exchanges of similar productive assets that do not culminate an earning process under
APB Opinion No. 29, “Accounting for Nonmonetary Transactions.” SFAS No. 153 requires that that
measurement be based on the recorded amount of the assets relinquished for nonmonetary exchanges
that do not have commercial substance. A nonmonetary exchange has commercial substance if the
future cash flows of the entity are expected to change significantly as a result of the exchange.
This standard became effective for nonmonetary asset exchanges in 2007. The adoption of this
standard did not have a material impact on our consolidated financial statements.
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In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial
Instruments, an amendment of FASB Statements No. 133 and 140.” SFAS No. 155 clarifies certain
issues relating to embedded derivatives and beneficial interests in securitized financial assets,
including permitting fair value measurement for any hybrid financial instrument that contains an
embedded derivative, eliminating the prohibition on a qualifying special-purpose entity from
holding certain derivative instruments, and providing clarification that concentrations of credit
risk in the form of subordination are not embedded derivatives. This standard is effective for us
for all financial instruments acquired or issued after 2008. We do not believe the adoption of
this standard will have a material impact on our consolidated financial statements.
In July 2006, the FASB issued Financial Interpretation (“FIN”) No. 48, “Accounting for
Uncertainty in Income Taxes,” which clarifies the accounting for uncertainty in income taxes
recognized in the financial statements in accordance with SFAS No. 109, “Accounting for Income
Taxes.” FIN No. 48 provides that a tax benefit from an uncertain tax position may be recognized
when it is more likely than not that the position will be sustained upon examination, including
resolutions of any related appeals or litigation processes, based on the technical merits. The
amount recognized is measured as the largest amount of tax benefit that is greater than 50 percent
likely of being realized upon ultimate settlements. This interpretation also provides guidance on
measurement, derecognition, classification, interest and penalties, accounting in interim periods,
disclosure and transition. We are required to adopt the provisions of FIN No. 48 in the first
quarter of 2008. While we are assessing the impact of FIN No. 48 on our consolidated financial
statements, we currently estimate the cumulative effect upon adoption of FIN No. 48 may result in a
decrease to shareholders’ equity of up to $100 million. The estimated impact is subject to revision
as we complete the analysis. We will continue to classify interest and penalties to be paid on an
underpayment of income taxes as income taxes in our consolidated statements of operations.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” which defines fair
value, establishes a framework for measuring fair value, and expands disclosures about fair value
measurements. This standard applies under other accounting pronouncements that require or permit
fair value measurements, but does not require any new fair value measurements. SFAS No. 157 will
become effective for us in 2009. We are currently assessing the impact of SFAS No. 157.
In September 2006, the SEC staff issued SAB No. 108, “Considering the Effects of Prior Year
Misstatements when Quantifying Misstatements in Current Year Financial Statements.” This guidance
indicates that the materiality of a misstatement must be evaluated using both the rollover and iron
curtain approaches. The iron curtain approach quantifies a misstatement based on the effects of
correcting the misstatement existing in the balance sheet at the end of the current year, while the
rollover approach quantifies a misstatement based on the amount of the error originating in the
current year income statement. SAB No. 108 is effective for our 2007 annual consolidated financial
statements. The adoption of SAB No. 108 did not have a material effect on our consolidated
financial statements.
In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit
Pension and Other Postretirement Plans,” which requires us to recognize the funded status of our
defined benefit plans in the consolidated balance sheets and changes in the funded status in
comprehensive income. This standard also requires us to recognize the gains/losses, prior year
service costs/credits and transition assets/obligations as a component of other comprehensive
income upon adoption, and provide additional annual disclosure. SFAS No. 158 does not affect the
computation of benefit expense recognized in our consolidated statements of operations. In
addition, SFAS No. 158 requires us to measure plan assets and benefit obligations as of the
year-end balance sheet date effective in 2009. We adopted the recognition and disclosure
provisions of this standard, as required, prospectively in 2007.
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The following table sets forth the incremental effect of applying SFAS No. 158 on individual
line items in our consolidated balance sheet at March 31, 2007:
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial
Assets and Financial Liabilities, including an amendment of FASB Statement No. 115.” SFAS No. 159
permits us to elect fair value as the initial and subsequent measurement attribute for certain
financial assets and liabilities that are not otherwise required to be measured at fair value, on
an instrument-by-instrument basis. If we elect the fair value option, we would be required to
recognize changes in fair value in our earnings. This standard also establishes presentation and
disclosure requirements designed to improve comparisons between entities that choose different
measurement attributed for similar types of assets and liabilities. SFAS No. 159 is effective for
2009 although early adoption is permitted. We are currently assessing the impact of SFAS No. 159
on our consolidated financial statements.
The following table summarizes the preliminary estimated fair values of the assets acquired and
liabilities assumed in the acquisition as of March 31, 2007:
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During the last three years we also completed a number of other smaller acquisitions and
investments within all three of our operating segments. Financial results for our business
acquisitions have been included in our consolidated financial statements since their respective
acquisition dates. Purchase prices for our business acquisitions have been allocated based on
estimated fair values at the date of acquisition and, for certain recent acquisitions, may be
subject to change. Goodwill recognized for our business acquisitions is not expected to be
deductible for tax purposes. Pro forma results of operations for our business acquisitions have
not been presented because the effects were not material to the consolidated financial statements
on either an individual or an aggregate basis.
3. Discontinued Operations
Results from discontinued operations were as follows:
In the second quarter of 2007, we sold our Medical-Surgical Solutions segment’s Acute Care
supply business to Owens & Minor, Inc. (“OMI”) for net cash proceeds of approximately $160 million.
In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,”
the financial results of this business are classified as a discontinued operation for all periods
presented in the accompanying consolidated financial
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statements. Such presentation includes the
classification of all applicable assets of the disposed business under the caption “Prepaid
expenses and other” and all applicable liabilities under the caption “Other” under “Current
Liabilities” within our consolidated balance sheets for all periods presented. Revenues associated
with the Acute Care business prior to its disposition were $1,062 million and $1,025 million for
2006 and 2005 and $597 million for the first half of 2007.
Financial results for 2007 for this discontinued operation include an after-tax loss of $66
million, which primarily consists of an after-tax loss of $61 million for the business’ disposition
and $5 million of after-tax losses associated with operations, other asset impairment charges and
employee severance costs. The after-tax loss of $61
million for the business’ disposition includes a $79 million non-tax deductible write-off of
goodwill, as further described below.
In connection with this divestiture, we allocated a portion of our Medical-Surgical Solutions
segment’s goodwill to the Acute Care business as required by SFAS No. 142, “Goodwill and Other
Intangible Assets.” The allocation was based on the relative fair values of the Acute Care
business and the continuing businesses that are being retained by the Company. The fair value of
the Acute Care business was determined based on the net cash proceeds resulting from the
divestiture and the fair value of the continuing businesses was determined by a third-party
valuation. As a result, we allocated $79 million of the segment’s goodwill to the Acute Care
business.
Additionally, as part of the divestiture, we entered into a transition services agreement
(“TSA”) with OMI under which we provided certain services to the Acute Care business during a
transition period of approximately six months. Financial results from the TSA, as well as employee
severance charges over the transition period, were recorded as part of discontinued operations.
The continuing cash flows generated from the TSA were not material to our consolidated financial
statements and the TSA was completed as of March 31, 2007.
In 2005, our Acute Care business entered into an agreement with a third party vendor to sell
the vendor’s proprietary software and services. The terms of the contract required us to prepay
certain royalties. During the third quarter of 2006, we ended marketing and sale of the software
under the contract. As a result of this decision, we recorded a $15 million pre-tax charge in the
third quarter of 2006 to write-off the remaining balance of the prepaid royalties.
In the second quarter of 2007, we also sold a wholly-owned subsidiary, Pharmaceutical Buyers
Inc. (“PBI”), for net cash proceeds of $10 million. The divestiture resulted in an after-tax gain
of $5 million resulting from the tax basis of the subsidiary exceeding its carrying value.
Financial results of this business, which were previously included in our Pharmaceutical Solutions
segment, have been presented as a discontinued operation for all periods presented in the
accompanying consolidated financial statements. These results were not material to our
consolidated financial statements.
The results for discontinued operations for 2007 also include an after-tax gain of $6 million
associated with the collection of a note receivable from a business sold in 2003 and the sale of a
small business.
In the second quarter of 2006, we sold our wholly-owned subsidiary, McKesson BioServices
Corporation (“BioServices”), for net cash proceeds of $63 million. The divestiture resulted in an
after-tax gain of $13 million. Financial results for this business, which were previously included
in our Pharmaceutical Solutions segment, have been presented as a discontinued operation for all
periods presented in the accompanying consolidated financial statements. These results were not
material to our consolidated financial statements.
In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived
Assets,” financial results for these businesses are classified as discontinued operations for all
periods presented.
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4. Restructuring Activities
The following table summarizes the activity related to our restructuring liabilities,
excluding customer settlement reserves, for the three years ended March 31, 2007:
During 2007, we recorded pre-tax restructuring expense of $15 million, which primarily
reflected employee severance costs within our Pharmaceutical Solutions and Provider
Technologies segments. There were no material restructuring expenses for 2006 and 2005. Accrued
restructuring liabilities are included in other liabilities in the consolidated balance sheet.
In connection with the D&K acquisition, in 2006 we recorded $10 million of liabilities
relating to employee severance costs and $28 million for facility exit and contract termination
costs. Approximately 260 employees, consisting primarily of distribution, general and
administrative staff, were terminated as part of this restructuring plan. To date, $9 million of
severance and $9 million of exit costs have been paid. In connection with the Company’s investment
in Parata, $13 million of contract termination costs that were initially estimated as part of the
D&K acquisition were extinguished and, as a result, the Company decreased goodwill and its
restructuring liability in 2007. At March 31, 2007, the remaining severance liability for this
plan was $1 million, and the remaining facility exit liability was $5 million, which is anticipated
to be paid at various dates through 2015. Also, in connection with the Per-Se acquisition in 2007,
we recorded an $8 million employee severance liability and a $4 million facility exit liability.
5. Other Income, Net
6. Earnings (Loss) Per Share
Basic earnings per share is computed by dividing net income (loss) by the weighted average
number of common shares outstanding during the reporting period. Diluted earnings (loss) per share
is computed similar to basic earnings per share except that it reflects the potential dilution that
could occur if dilutive securities or other obligations to issue common stock were exercised or
converted into common stock. For 2005, because of our
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reported net loss, potentially dilutive
securities were excluded from the per share computations due to their antidilutive effect.
The computations for basic and diluted earnings (loss) per share from continuing and
discontinued operations are as follows:
Approximately 11 million stock options were excluded from the computations of diluted net
earnings per share in 2007 and 2006 as their exercise price was higher than the Company’s average
stock price.
7. Receivables, net
The allowances are primarily for uncollectible accounts and sales returns.
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8. Property, Plant and Equipment, net
9. Goodwill and Intangible Assets, net
Changes in the carrying amount of goodwill were as follows:
Information regarding intangible assets is as follows:
Amortization expense of intangible assets was $53 million, $28 million and $24 million for
2007, 2006 and 2005. The weighted average remaining amortization period for customer lists,
technology, trademarks and other intangible assets at March 31, 2007 was: 9 years, 4 years and 5
years. Estimated future annual amortization expense of these assets is as follows: $98 million,
$89 million, $76 million, $69 million and $64 million for 2008 through 2012, and $200 million
thereafter. At March 31, 2007, there were $17 million of intangible assets not subject to
amortization.
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10. Long-Term Debt and Other Financing
Convertible Junior Subordinated Debentures
In February 1997, we issued 5% Convertible Junior Subordinated Debentures (the “Debentures”)
in an aggregate principal amount of $206 million. The Debentures were purchased by McKesson
Financing Trust (the “Trust”) with proceeds from its issuance of four million shares of preferred
securities to the public and 123,720 common securities to us. The Debentures represented the sole
assets of the Trust and bore interest at an annual rate of 5%, payable quarterly. These preferred
securities of the Trust were convertible into our common stock at the holder’s option.
Holders of the preferred securities were entitled to cumulative cash distributions at an
annual rate of 5% of the liquidation amount of $50 per security. Each preferred security was
convertible at the rate of 1.3418 shares of our common stock, subject to adjustment in certain
circumstances. The preferred securities were to be redeemed upon repayment of the Debentures and
were callable by us on or after March 4, 2000, in whole or in part, initially at 103.5% of the
liquidation preference per share, and thereafter at prices declining at 0.5% per annum to 100% of
the liquidation preference on and after March 4, 2007 plus, in each case, accumulated, accrued and
unpaid distributions, if any, to the redemption date.
During the first quarter of 2006, we called for the redemption of the Debentures, which
resulted in the exchange of the preferred securities for 5 million shares of our newly issued
common stock.
Other Financing
In January 2007, we entered into a $1.8 billion interim credit facility. The interim credit
facility was a single-draw 364-day unsecured facility which had terms substantially similar to
those contained in the Company’s existing revolving credit facility. We utilized $1.0 billion of
this facility to fund a portion of our purchase of Per-Se.
On March 5, 2007, we issued $500 million of 5.25% notes due 2013 and $500 million of 5.70%
notes due 2017. The notes are unsecured and interest is paid semi-annually on March 1 and
September 1. The notes are redeemable at any time, in whole or in part, at our option. In
addition, upon occurrence of both a change of control and a ratings downgrade of the notes to
non-investment-grade levels, we are required to make an offer to redeem the notes at a price equal
to 101% of the principal amount plus accrued interest. We utilized net proceeds after offering
expenses of $990 million from the issuance of the notes, together with cash on hand, to repay all
amounts outstanding under the interim credit facility plus accrued interest.
We have a $1.3 billion five-year, senior unsecured revolving credit facility that expires in
September 2009. Borrowings under this credit facility bear interest based upon either a Prime rate
or the London Interbank Offering Rate (“LIBOR”). We also have a $700 million accounts receivable
sales facility, which was renewed in June 2006,
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with terms substantially similar to those
previously in place. This renewed facility is currently scheduled to expire in June 2007. No
amounts were outstanding under any of these facilities at March 31, 2007 and 2006.
In 2007, 2006 and 2005, we sold customer lease portfolio receivables for cash proceeds of $5
million, $60 million and $59 million.
The employee stock ownership program (“ESOP”) debt bears interest at rates ranging from 8.6%
fixed rate to approximately 93% of the LIBOR and is due in semi-annual and annual installments
through 2009.
Our various borrowing facilities and certain long-term debt instruments are subject to
covenants. Our principal debt covenant is our debt to capital ratio, which cannot exceed 56.5%.
If we exceed this ratio, repayment of debt outstanding under the revolving credit facility and $215
million of term debt could be accelerated. At March 31, 2007, this ratio was 23.8% and we were in
compliance with all other covenants.
11. Financial Instruments and Hedging Activities
At March 31, 2007 and 2006, the carrying amounts of cash and cash equivalents, restricted
cash, marketable securities, receivables, drafts and accounts payable, and other liabilities
approximated their estimated fair values because of the short maturity of these financial
instruments. The carrying amounts and estimated fair values of our long-term debt were $1,958
million and $2,036 million at March 31, 2007 and $991 million and $1,082 million at March 31, 2006.
The estimated fair value of our long-term debt was determined based on quoted market prices and
may not be representative of actual values that could have been realized or that will be realized
in the future.
In the normal course of business, we are exposed to interest rate changes and foreign currency
fluctuations. We limit these risks through the use of derivatives such as interest rate swaps and
forward contracts. In accordance with our policy, derivatives are only used for hedging purposes.
We do not use derivatives for trading or speculative purposes.
12. Lease Obligations
We lease facilities and equipment under both capital and operating leases. Net assets held
under capital leases included in property, plant and equipment were $2 million and $3 million at
March 31, 2007 and 2006. Rental expense under operating leases was $117 million, $106 million and
$106 million in 2007, 2006 and 2005. We recognize rent expense on a straight-line basis over the
term of the lease, taking into account, when applicable, lessor incentives for tenant improvements,
periods where no rent payment is required and escalations in rent payments over the term of the
lease. Deferred rent is recognized for the difference between the rent expense recognized on a
straight-line basis and the payments made per the terms of the lease. Most real property leases
contain renewal options and provisions requiring us to pay property taxes and operating expenses in
excess of base period amounts.
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FINANCIAL NOTES (Continued)
At March 31, 2007, future minimum lease payments and sublease rental income for years ending
March 31 are:
13. Pension Benefits
We maintain a number of qualified and nonqualified defined benefit pension plans and defined
contribution plans for eligible employees.
As discussed in Financial Note 1, we adopted the recognition and disclosure provisions of SFAS
No. 158, as required, prospectively in 2007.
Defined Pension Benefit Plans
Eligible U.S. employees who were employed by the Company prior to December 31, 1996 are
covered under the Company-sponsored defined benefit retirement plan. In 1997, we amended this plan
to freeze all plan benefits based on each employee’s plan compensation and creditable service
accrued to that date. The Company has made no annual contributions since this plan was frozen.
The benefits for this defined benefit retirement plan are based primarily on age of employees at
date of retirement, years of service and employees’ pay during the five years prior to retirement.
We also have defined benefit pension plans for eligible Canadian and United Kingdom employees as
well as nonqualified supplemental defined benefit plans for certain U.S. executives, which are
non-funded. We also assumed a frozen qualified defined benefit plan through our acquisition of
Per-Se in 2007. The measurement date for all of our pension plans is December 31.
The net periodic expense for our pension plans is as follows:
The projected unit credit method is utilized for measuring net periodic pension expense
over the employees’ service life for the U.S. pension plans. Unrecognized actuarial losses
exceeding 10% of the greater of the projected
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benefit obligation and the market value of assets are amortized straight-line over the average
remaining future service periods.
Information regarding the changes in benefit obligations and plan assets for our pension plans
is as follows:
The accumulated benefit obligations for our pension plans were $525 million at March 31, 2007
and $462 million at March 31, 2006.
A reconciliation of the pension plans’ funded status to the net asset recognized is as
follows:
NA — Not applicable in 2007 due to the application of SFAS No. 158.
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Amounts recognized in the consolidated balance sheet at March 31, are as follows:
The components of the amount recognized in accumulated other comprehensive income are as
follows:
The amounts in accumulated other comprehensive income expected to be amortized into 2008 net
periodic pension expense are:
Prior to the adoption of SFAS No. 158, additional minimum liabilities were established to
increase accrued benefit cost for our plans, totaling $35 million and $48 million at March 31, 2007
and 2006, which were partially offset by intangible assets of $12 million and $14 million. The
additional minimum liabilities were charged to other comprehensive income included in the
consolidated stockholders’ equity, net of tax, before the SFAS No. 158 adjustments were recorded.
See Financial Note 1, “Significant Accounting Policies,” for the incremental effect of applying
SFAS No. 158.
Projected benefit obligations relating to our unfunded U.S. plans were $92 million and $87
million at March 31, 2007 and 2006. Pension costs are funded based on the recommendations of
independent actuaries. We expect contributions for our pension plans in 2008 to be approximately
$30 million.
Expected benefit payments for our pension plans are as follows:
Expected benefit payments are based on the same assumptions used to measure the benefit
obligations and include estimated future employee service.
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Weighted average asset allocations of the investment portfolio for our pension plans at
December 31 and target allocations are as follows:
We develop our expected long-term rate of return assumption based on the historical experience
of our portfolio and the review of projected returns by asset class on broad, publicly traded
equity and fixed-income indices. Our target asset allocation was determined based on the risk
tolerance characteristics of the plan and, at times, may be adjusted to achieve our overall
investment objective.
Weighted-average assumptions used to estimate the net periodic pension expense and the
actuarial present value of benefit obligations were as follows:
Other Defined Benefit Plans
Under various U.S. bargaining unit labor contracts, we make payments into multi-employer
pension plans established for union employees. We are liable for a proportionate part of the
plans’ unfunded vested benefits liabilities upon our withdrawal from the plan, however information
regarding the relative position of each employer with respect to the actuarial present value of
accumulated benefits and net assets available for benefits is not available. Contributions to the
plans and amounts accrued were not material for the years ended March 31, 2007, 2006 and 2005.
Defined Contribution Plans
We have a contributory profit sharing investment plan (“PSIP”) for U.S. employees not covered
by collective bargaining arrangements. Eligible employees may contribute up to 20% of their
compensation to an individual retirement savings account. Effective April 1, 2005, the Company
makes matching contributions in an amount equal to 100% of the employee’s first 3% of pay deferred,
and 50% of the employee’s deferral for the next 2% of pay deferred. The Company provides for the
PSIP contributions primarily with its common shares through its leveraged ESOP or cash payments.
The ESOP has purchased an aggregate of 24 million shares of the Company’s common stock since its
inception. These purchases were financed by 10 to 20 year loans from or guaranteed by us. The
ESOP’s outstanding borrowings are reported as long-term debt of the Company and the related
receivables from the ESOP are shown as a reduction of stockholders’ equity. The loans are repaid
by the ESOP from interest earnings on cash balances and common dividends on shares not yet
allocated to participants, common dividends on certain allocated shares and
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Company cash contributions. The ESOP loan maturities and rates are identical to the terms of
related Company borrowings. Stock is made available from the ESOP based on debt service payments
on ESOP borrowings.
Contribution expense for the PSIP in 2007, 2006 and 2005 was primarily ESOP related.
After-tax ESOP expense and other contribution expense, including interest expense on ESOP debt, was
$8 million, $7 million and $9 million in 2007, 2006 and 2005. Approximately 1 million shares of
common stock were allocated to plan participants in each of the years 2007, 2006 and 2005. Through
March 31, 2007, 23 million common shares have been allocated to plan participants, resulting in a
balance of 1 million common shares in the ESOP, which have not yet been allocated to plan
participants.
14. Postretirement Benefits
We maintain a number of postretirement benefits, primarily consisting of healthcare and life
insurance (“welfare”) benefits, for certain eligible U.S. employees. Eligible employees consist of
those who retired before March 31, 1999 and those who retire after March 31, 1999, but were an
active employee as of that date, after meeting other age-related criteria. We also provide
postretirement benefits for certain U.S. executives. The measurement date for our postretirement
welfare plan is December 31.
As discussed in Financial Note 1, “Significant Accounting Policies”, we adopted the
recognition and disclosure provisions of SFAS No. 158, as required, prospectively in 2007.
The net periodic expense for our postretirement welfare benefits is as follows:
Information regarding the changes in benefit obligations for our postretirement welfare plans
is as follows:
Amounts recognized in the consolidated balance sheet at March 31, are as follows:
NA — Not applicable in 2007 due to the application of SFAS No. 158.
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The components of the amount recognized in accumulated other comprehensive income are as
follows:
The amount in accumulated other comprehensive income expected to be amortized into 2008 net
periodic post-retirement expense is approximately $5 million representing the net actuarial loss.
Other postretirement benefits are funded as claims are paid. Expected benefit payments for
our postretirement welfare benefit plans, net of expected Medicare subsidy receipts of $21 million,
are as follows:
Expected benefit payments are based on the same assumptions used to measure the benefit
obligations and include estimated future employee service.
Weighted-average assumptions used to estimate postretirement welfare benefit expenses and the
actuarial present value of benefit obligations were as follows:
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