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McKesson 10-Q 2013

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32
  5. Ex-32
MCK_10Q_12.31.2012
Table of Contents                                        


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2012
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from             to            
Commission File Number: 1-13252
 
McKESSON CORPORATION
(Exact name of registrant as specified in its charter)
 
Delaware
 
94-3207296
(State or other jurisdiction
of incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
 
One Post Street, San Francisco, California
 
94104
(Address of principal executive offices)
 
(Zip Code)
(415) 983-8300
(Registrant’s telephone number, including area code)
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 
x
  
Accelerated filer
 
¨
 
 
 
 
 
 
 
Non-accelerated filer
 
¨ (Do not check if a smaller reporting company)
  
Smaller reporting company
 
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Class
 
Outstanding as of
December 31, 2012
Common stock, $0.01 par value
 
232,889,372 shares



McKESSON CORPORATION

TABLE OF CONTENTS
 
Item
 
Page
 
 
 
 
 
 
 
 
1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2.
 
 
 
3.
 
 
 
4.
 
 
 
 
 
 
 
 
1.
 
 
 
1A.
 
 
 
2.
 
 
 
3.
 
 
 
4.
Mine Safety Disclosures
 
 
 
5.
 
 
 
6.
 
 
 
 



2

McKESSON CORPORATION

PART I—FINANCIAL INFORMATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In millions, except per share amounts)
(Unaudited)
 
 
Quarter Ended December 31,
 
Nine Months Ended December 31,
 
2012
 
2011
 
2012
 
2011
Revenues
$
31,187

 
$
30,839

 
$
91,835

 
$
91,035

Cost of Sales
(29,519
)
 
(29,273
)
 
(86,847
)
 
(86,313
)
Gross Profit
1,668

 
1,566

 
4,988

 
4,722

Operating Expenses
(1,183
)
 
(1,047
)
 
(3,334
)
 
(3,135
)
Litigation Charges

 
(27
)
 
(60
)
 
(145
)
Gain on Business Combination

 

 
81

 

Total Operating Expenses
(1,183
)
 
(1,074
)
 
(3,313
)
 
(3,280
)
Operating Income
485

 
492

 
1,675

 
1,442

Other Income (Expense), Net
10

 
(2
)
 
28

 
12

Interest Expense
(59
)
 
(64
)
 
(170
)
 
(192
)
Income Before Income Taxes
436

 
426

 
1,533

 
1,262

Income Tax Expense
(138
)
 
(126
)
 
(454
)
 
(380
)
Net Income
$
298

 
$
300

 
$
1,079

 
$
882

 
 
 
 
 
 
 
 
Earnings Per Common Share
 
 
 
 
 
 
 
Diluted
$
1.24

 
$
1.20

 
$
4.49

 
$
3.51

Basic
$
1.27

 
$
1.22

 
$
4.58

 
$
3.57

 
 
 
 
 
 
 
 
Dividends Declared Per Common Share
$
0.20

 
$
0.20

 
$
0.60

 
$
0.60

 
 
 
 
 
 
 
 
Weighted Average Common Shares
 
 
 
 
 
 
 
Diluted
240

 
251

 
240

 
252

Basic
235

 
246

 
236

 
247









See Financial Notes

3

McKESSON CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In millions)
(Unaudited)
 
 
Quarter Ended December 31,
 
Nine Months Ended December 31,
 
2012
 
2011
 
2012
 
2011
Net Income
$
298

 
$
300

 
$
1,079

 
$
882

 
 
 
 
 
 
 
 
Other Comprehensive Income (Loss), Net of Tax
 
 
 
 
 
 
 
Foreign currency translation adjustments, net of income tax expense (benefit) of ($4), ($6), ($2), and $2
(16
)
 
20

 
14

 
(97
)
Other, net of income tax expense of $3, $3, $8, and $7
5

 
3

 
16

 
12

Total Other Comprehensive Income (Loss)
(11
)
 
23

 
30

 
(85
)
Comprehensive Income
$
287

 
$
323

 
$
1,109

 
$
797

























See Financial Notes

4

McKESSON CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS
(In millions, except per share amounts)
(Unaudited)
 
December 31,
2012
 
March 31,
2012
ASSETS
 
 
 
Current Assets
 
 
 
Cash and cash equivalents
$
2,726

 
$
3,149

Receivables, net
9,962

 
9,977

Inventories, net
10,390

 
10,073

Prepaid expenses and other
361

 
404

Total Current Assets
23,439

 
23,603

Property, Plant and Equipment, Net
1,247

 
1,043

Goodwill
5,310

 
5,032

Intangible Assets, Net
1,799

 
1,750

Other Assets
1,638

 
1,665

Total Assets
$
33,433

 
$
33,093

 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current Liabilities
 
 
 
Drafts and accounts payable
$
15,047

 
$
16,114

Short-term borrowings

 
400

Deferred revenue
1,431

 
1,423

Deferred tax liabilities
1,519

 
1,092

Current portion of long-term debt
506

 
508

Other accrued liabilities
1,705

 
2,149

Total Current Liabilities
20,208

 
21,686

Long-Term Debt
3,973

 
3,072

Other Noncurrent Liabilities
1,603

 
1,504

Commitments and Contingent Liabilities (Note 9)

 

Stockholders’ Equity
 
 
 
Preferred stock, $0.01 par value, 100 shares authorized, no shares issued or outstanding

 

Common stock, $0.01 par value, 800 shares authorized at December 31, 2012 and March 31, 2012, 377 and 373 shares issued at December 31, 2012 and March 31, 2012
4

 
4

Additional Paid-in Capital
6,005

 
5,571

Retained Earnings
10,384

 
9,451

Accumulated Other Comprehensive Income
35

 
5

Other
14

 
4

Treasury Shares, at Cost, 144 and 138 at December 31, 2012 and March 31, 2012
(8,793
)
 
(8,204
)
Total Stockholders’ Equity
7,649

 
6,831

Total Liabilities and Stockholders’ Equity
$
33,433

 
$
33,093




See Financial Notes

5

McKESSON CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In millions)
(Unaudited)
 
Nine Months Ended December 31,
 
2012
 
2011
Operating Activities
 
 
 
Net income
$
1,079

 
$
882

Adjustments to reconcile to net cash provided by operating activities:
 
 
 
Depreciation and amortization
428

 
408

Other deferred taxes
499

 
(15
)
Share-based compensation expense
123

 
113

Gain on business combination
(81
)
 

Other non-cash items
53

 
75

Changes in operating assets and liabilities, net of acquisitions:
 
 
 
Receivables
57

 
(575
)
Inventories
(313
)
 
(1,200
)
Drafts and accounts payable
(1,081
)
 
1,636

Deferred revenue
49

 
122

Taxes
(88
)
 
171

Litigation charges
60

 
145

Litigation settlement payments
(470
)
 
(26
)
Other
(39
)
 
(20
)
Net cash provided by operating activities
276

 
1,716

 
 
 
 
Investing Activities
 
 
 
Property acquisitions
(151
)
 
(170
)
Capitalized software expenditures
(117
)
 
(137
)
Acquisitions, less cash and cash equivalents acquired
(577
)
 
(204
)
Other
61

 
81

Net cash used in investing activities
(784
)
 
(430
)
 
 
 
 
Financing Activities
 
 
 
Proceeds from short-term borrowings
1,125

 

Repayments of short-term borrowings
(1,525
)
 

Proceeds from issuances of long-term debt
892

 

Repayments of long-term debt
(4
)
 
(23
)
Common stock transactions:
 
 
 
Issuances
112

 
122

Share repurchases, including shares surrendered for tax withholding
(413
)
 
(672
)
Dividends paid
(147
)
 
(146
)
Other
42

 
22

Net cash provided by (used in) financing activities
82

 
(697
)
Effect of exchange rate changes on cash and cash equivalents
3

 
(10
)
Net increase (decrease) in cash and cash equivalents
(423
)
 
579

Cash and cash equivalents at beginning of period
3,149

 
3,612

Cash and cash equivalents at end of period
$
2,726

 
$
4,191



See Financial Notes

6

McKESSON CORPORATION
FINANCIAL NOTES
(UNAUDITED)


1.
Significant Accounting Policies
Basis of Presentation: The condensed consolidated financial statements of McKesson Corporation (“McKesson,” the “Company,” or “we” and other similar pronouns) include the financial statements of all wholly-owned subsidiaries and majority-owned or controlled companies. We also evaluate our ownership, contractual and other interests in entities to determine if they are variable interest entities (“VIEs”), if we have a variable interest in those entities and the nature and extent of those interests. These evaluations are highly complex and involve judgment and the use of estimates and assumptions based on available historical information and management’s judgment, among other factors. Based on our evaluations, if we determine we are the primary beneficiary of such VIEs, we consolidate such entities into our financial statements. The consolidated VIEs are not material to our condensed consolidated financial statements. Intercompany transactions and balances have been eliminated. The condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial reporting and the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”) and, therefore, do not include all information and footnote disclosures normally included in the annual consolidated financial statements.
To prepare the financial statements in conformity with GAAP, management must make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of these financial statements and income and expenses during the reporting period. Actual amounts may differ from these estimated amounts. In our opinion, the accompanying unaudited condensed consolidated financial statements include all normal recurring adjustments necessary for a fair presentation of our financial position, results of operations and cash flows for the interim periods presented.
The results of operations for the quarter and nine months ended December 31, 2012 are not necessarily indicative of the results that may be expected for the entire year. These interim financial statements should be read in conjunction with the annual audited financial statements, accounting policies and financial notes included in our Annual Report on Form 10-K for the fiscal year ended March 31, 2012 previously filed with the SEC on May 2, 2012 (“2012 Annual Report”). Certain prior period amounts have been reclassified to conform to the current period presentation.
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.
Recently Adopted Accounting Pronouncements
In the first quarter of 2013, we adopted amended guidance on a retrospective basis related to the presentation of other comprehensive income. The amended guidance requires that comprehensive income, the components of net income and the components of other comprehensive income be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. We elected to report other comprehensive income and its components in a separate statement of comprehensive income. While the new guidance changed the presentation of comprehensive income, there were no changes to the components that are recognized in net income or other comprehensive income as determined under previous accounting guidance. The amended guidance did not have a material effect on our condensed consolidated financial statements.
Recently Issued Accounting Pronouncements Not Yet Adopted
In December 2011 and January 2013, disclosure guidance related to the offsetting of assets and liabilities was issued. The guidance requires an entity to disclose information about offsetting assets and liabilities for derivatives, repurchase agreements and reverse purchase agreements, and securities borrowing and securities lending transactions that are either offset in accordance with specific GAAP criteria or subject to a master netting arrangement or similar agreement. The amended guidance is effective for us on a retrospective basis commencing in the first quarter of 2014. We are currently evaluating the impact of this new guidance on our condensed consolidated financial statements.


7

McKESSON CORPORATION
FINANCIAL NOTES (CONTINUED)
(UNAUDITED)


2.
Business Combinations
On October 24, 2012, we entered into a definitive agreement to acquire all outstanding shares of PSS World Medical, Inc. (“PSS World Medical”) of Jacksonville, Florida for $29.00 per share in cash. The total transaction, including the assumption of PSS World Medical’s outstanding debt, is valued at approximately $2.1 billion. PSS World Medical markets and distributes medical products and services throughout the United States. On December 21, 2012, we received notification of early termination of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, in connection with this proposed acquisition.  The acquisition is subject to approval by PSS World Medical shareholders; the shareholder vote has been scheduled for February 19, 2013. After the closing, the operations of PSS World Medical will be included in the results of our Medical-Surgical business, which is part of our Distribution Solutions segment.
On April 6, 2012, we purchased the remaining 50% ownership interest in our corporate headquarters building located in San Francisco, California, for $90 million, which was funded from cash on hand.  We previously held a 50% ownership interest and were the primary tenant in this building.  This transaction was accounted for as a step acquisition, which required that we re-measure our previously held 50% ownership interest to fair value and record the difference between the fair value and carrying value as a gain in the condensed consolidated statements of operations.  The re-measurement to fair value resulted in a non-cash pre-tax gain of $81 million ($51 million after-tax), which was recorded as a gain on business combination within Corporate in the condensed consolidated statements of operations during the first quarter of 2013.
The total fair value of the net assets acquired was $180 million, which was allocated as follows: building and improvements of $113 million and land of $58 million with the remainder allocated for settlement of our pre-existing lease and lease intangible assets. The fair value of the building and improvements was determined based on current market replacement costs less depreciation and unamortized tenant improvement costs, as well as, other relevant market information, and has a weighted average useful life of 30 years. The fair value of the land was determined using comparable sales of land within the surrounding market.
On March 25, 2012, we acquired substantially all of the assets of Drug Trading Company Limited, the independent banner business of the Katz Group Canada Inc. (“Katz Group”), and Medicine Shoppe Canada Inc., the franchise business of the Katz Group (collectively, “Katz Assets”) for $925 million, which was funded from cash on hand. The acquisition of the assets from the Drug Trading Company Limited consists of a marketing and purchasing arm of independently owned pharmacies in Canada. The acquisition of Medicine Shoppe Canada Inc. consists of the franchise business of providing services to independent pharmacies in Canada.
During the second quarter of 2013, the fair value measurements of assets acquired and liabilities assumed of the Katz Assets as of the acquisition date were completed. The following table summarizes the final amounts of the fair values recognized for the assets acquired and liabilities assumed as of the acquisition date, as well as measurement period adjustments made in the first six months of 2013 to the amounts initially recorded in 2012. The measurement period adjustments during the first six months of 2013 did not have a material impact on our consolidated statements of operations, balance sheets or cash flows in any period, and, therefore, we have not retrospectively adjusted our financial statements.
(In millions)
Amounts
Previously
Recognized as of
Acquisition Date
(Provisional)
(1)
 
Measurement
Period
Adjustments
 
Amounts
Recognized as of
Acquisition Date
(Final as Adjusted)
Current assets, net of cash acquired
$
33

 
$
(1
)
 
$
32

Goodwill
506

 
6

 
512

Intangible assets
441

 
1

 
442

Other long-term assets
15

 
(1
)
 
14

Current liabilities
(37
)
 
1

 
(36
)
Long-term deferred tax liabilities
(39
)
 

 
(39
)
Purchase price, less cash and cash equivalents
$
919

 
$
6

 
$
925

(1) 
As previously reported in our Form 10-K for the year ended March 31, 2012.


8

McKESSON CORPORATION
FINANCIAL NOTES (CONTINUED)
(UNAUDITED)


Included in the purchase price allocation are acquired identifiable intangibles of $442 million, the fair values of which were determined by using Level 3 inputs, which are estimated using significant unobservable inputs. Acquired intangibles primarily consist of $318 million of service agreements and $114 million of trademarks and trade names. Service agreements, trademarks and trade names and total acquired intangibles assets each have an estimated weighted average life of 20 years. The excess of the purchase price over the net tangible and intangible assets of $512 million was recorded as goodwill, which primarily reflects the expected future benefits to be realized upon integrating the business. The amount of goodwill expected to be deductible for tax purposes is $290 million.
Financial results for the acquired Katz Assets are included in the results of operations within our Canadian pharmaceutical distribution and services business, which is part of our Distribution Solutions segment, beginning in the first quarter of 2013.
During the last two years, we also completed a number of smaller acquisitions within both 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.
Goodwill recognized for our business acquisitions is generally not expected to be deductible for tax purposes. However, if we acquire the assets of a company, the goodwill may be deductible for tax purposes. The pro forma results of operations for our business acquisitions and the results of operations for these acquisitions since the acquisition date have not been presented because the effects were not material to the consolidated financial statements on either an individual or an aggregate basis.
3.
Product Alignment Charges
During the third quarter of 2012, we approved a plan to align our hospital clinical and revenue cycle healthcare software products within our Technology Solutions segment. As part of this alignment strategy, we began converging our core clinical and revenue cycle Horizon and Paragon product lines onto Paragon’s Microsoft®-based platform. Additionally, we stopped development of our Horizon Enterprise Revenue Management™ (“HzERM”) software product. The plan resulted in a pre-tax charge of $42 million during the third quarter of 2012, of which $26 million was recorded to cost of sales and $16 million was recorded to operating expenses within our Technology Solutions segment. The pre-tax charge included $22 million of non-cash asset impairment charges, primarily for the write-off of prepaid licenses and commissions and capitalized internal use software that were determined to be obsolete as they would not be utilized going forward, $6 million for severance, $6 million for customer allowances and $8 million for other charges.
4.
Income Taxes
As of December 31, 2012, we had $541 million of unrecognized tax benefits, of which $390 million would reduce income tax expense and the effective tax rate, if recognized. During the first nine months of 2013, we recorded an $82 million reduction to our gross unrecognized tax benefits as a result of a change in accounting method for tax purposes, which had no impact to the effective tax rate. During the next twelve months, it is reasonably possible that audit resolutions and the expiration of statutes of limitations could potentially reduce our unrecognized tax benefits by up to $170 million. However, this amount may change because we continue to have ongoing negotiations with various taxing authorities throughout the year.
We have received tax assessments of $98 million from the U.S. Internal Revenue Service (“IRS”) relating to 2003 through 2006. We disagree with a substantial portion of the tax assessments, which primarily relate to transfer pricing. We are pursuing administrative relief through the appeals process. We have also received assessments from the Canada Revenue Agency (“CRA”) for a total of $169 million related to transfer pricing for 2003 through 2007. We have appealed the assessment for 2003 to the Tax Court of Canada and have filed a notice of objection for 2004 through 2007. The trial between McKesson Canada Corporation and the CRA, argued in the Tax Court of Canada, concluded in early February 2012, and we are waiting for the decision. We continue to believe in the merits of our tax positions and that we have adequately provided for any potential adverse results relating to these examinations in our financial statements. However, the final resolution of these issues could result in an increase or decrease to income tax expense.
In November 2011, the IRS began its examination of our 2007 through 2009 federal tax returns. In nearly all jurisdictions, the tax years prior to 2003 are no longer subject to examination. We believe that we have made adequate provision for all income tax uncertainties.


9

McKESSON CORPORATION
FINANCIAL NOTES (CONTINUED)
(UNAUDITED)


We report interest and penalties on tax deficiencies as income tax expense. At December 31, 2012, before any tax benefits, our accrued interest and penalties on unrecognized tax benefits amounted to $131 million. We recognized an income tax expense of $10 million and a reduction in income tax expense of $8 million, before any tax benefit, in our condensed consolidated statements of operations during the third quarter and first nine months of 2013. The income tax benefit recognized during the first nine months of 2013 was primarily due to the reversal of accrued interest resulting from the reduction of our gross unrecognized tax benefits.
5.
Earnings Per Common Share
Basic earnings per common share are computed by dividing net income by the weighted average number of common shares outstanding during the reporting period. Diluted earnings per common share are computed similar to basic earnings per common 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.
The computations for basic and diluted earnings per common share are as follows:
  
Quarter Ended December 31,
 
Nine Months Ended December 31,
(In millions, except per share amounts)
2012
 
2011
 
2012
 
2011
 
 
 
 
 
 
 
 
Net income
$
298

 
$
300

 
$
1,079

 
$
882

 
 
 
 
 
 
 
 
Weighted average common shares outstanding:
 
 
 
 
 
 
 
Basic
235

 
246

 
236

 
247

Effect of dilutive securities:
 
 
 
 
 
 
 
Options to purchase common stock
1

 
2

 
1

 
2

Restricted stock units
4

 
3

 
3

 
3

Diluted
240

 
251

 
240

 
252

 
 
 
 
 
 
 
 
Earnings per common share: (1)
 
 
 
 
 
 
 
Diluted
$
1.24

 
$
1.20

 
$
4.49

 
$
3.51

Basic
$
1.27

 
$
1.22

 
$
4.58

 
$
3.57

 
(1) 
Certain computations may reflect rounding adjustments.
Potentially dilutive securities include outstanding stock options, restricted stock units and performance-based restricted stock units. Approximately 1 million potentially dilutive securities were excluded from the computations of diluted net earnings per common share for the third quarters of 2013 and 2012 and 5 million and 4 million for the first nine months of 2013 and 2012, as they were anti-dilutive.
6.
Goodwill and Intangible Assets, Net
Changes in the carrying amount of goodwill were as follows:
(In millions)
Distribution
Solutions
 
Technology
Solutions
 
Total
Balance, March 31, 2012
$
3,190

 
$
1,842

 
$
5,032

Goodwill acquired
87

 
187

 
274

Foreign currency translation adjustments
3

 
1

 
4

Balance, December 31, 2012
$
3,280

 
$
2,030

 
$
5,310



10

McKESSON CORPORATION
FINANCIAL NOTES (CONTINUED)
(UNAUDITED)


Information regarding intangible assets is as follows:
 
December 31, 2012
 
March 31, 2012
(Dollars in millions)
Weighted
Average
Remaining
Amortization
Period
(years)
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
Carrying
Amount
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
Carrying
Amount
Customer lists
7
 
$
1,250

 
$
(637
)
 
$
613

 
$
1,081

 
$
(554
)
 
$
527

Service agreements
18
 
1,022

 
(98
)
 
924

 
1,022

 
(52
)
 
970

Trademarks and trade names
18
 
199

 
(43
)
 
156

 
192

 
(38
)
 
154

Technology
4
 
265

 
(202
)
 
63

 
244

 
(190
)
 
54

Other
7
 
78

 
(35
)
 
43

 
76

 
(31
)
 
45

Total
 
 
$
2,814


$
(1,015
)
 
$
1,799

 
$
2,615

 
$
(865
)
 
$
1,750

Amortization expense of intangible assets was $53 million and $152 million for the quarter and nine months ended December 31, 2012 and $49 million and $147 million for the quarter and nine months ended December 31, 2011. Estimated annual amortization expense of these assets is as follows: $208 million, $213 million, $192 million, $169 million and $145 million for 2013 through 2017 and $1,024 million thereafter. All intangible assets were subject to amortization as of December 31, 2012 and March 31, 2012.
 
7.
Debt and Financing Activities
Senior Bridge Term Loan
In connection with our execution of an agreement to acquire PSS World Medical, in December 2012 we entered into a $2.1 billion unsecured Senior Bridge Term Loan Agreement (“Bridge Loan”). No amount has been drawn under the Bridge Loan as of December 31, 2012.  The Bridge Loan may be drawn on the closing date of the PSS World Medical acquisition to pay the equity shareholders of PSS World Medical, repay certain indebtedness of PSS World Medical and its subsidiaries and pay transaction costs associated with the acquisition.  The Bridge Loan matures on the first anniversary from the PSS World Medical acquisition date and must be repaid in full at that time, or, in full or in part, upon certain events occurring prior to such time, including specified debt and equity issuances and asset sales. The Bridge Loan bears interest based on the London Interbank Offered Rate plus a margin based on the Company’s credit ratings. Amounts repaid under the Bridge Loan cannot be redrawn by the Company. The Bridge Loan contains terms substantially similar to those in our existing revolving credit facility. We expect that we will refinance all or part of the funds obtained from the draw down of the Bridge Loan with longer-term debt financing prior to the end of the Bridge Loan’s one year term.
Long-Term Debt
On December 4, 2012, we issued 0.95% notes due December 4, 2015 in an aggregate principal amount of $500 million (“Notes due 2015”) and 2.70% notes due December 15, 2022 in an aggregate principal amount of $400 million (“Notes due 2022”). Interest on the Notes due 2015 is payable on June 4 and December 4 of each year beginning on June 4, 2013 and on the Notes due 2022 is payable on June 15 and December 15 of each year beginning on June 15, 2013. We utilized net proceeds, after discounts and offering expenses, of $892 million from the issuance of these notes (each note constitutes a “Series”) for general corporate purposes and replenishing working capital that was used to repay long-term debt that matured in February 2012.
Each Series constitutes an unsecured and unsubordinated obligation of the Company and ranks equally with all of the Company’s existing and future unsecured and unsubordinated indebtedness outstanding from time-to-time. Each Series is governed by materially similar indentures and an officers’ certificate specifying certain terms of each Series.



11

McKESSON CORPORATION
FINANCIAL NOTES (CONTINUED)
(UNAUDITED)


Upon 30 days notice to holders of a Series, we may redeem that Series at any time prior to maturity, in whole or in part, for cash at redemption prices that include accrued and unpaid interest and a make-whole premium, as specified in the indenture and officers’ certificate relating to that Series. In the event of the occurrence of both (1) a change of control of the Company and (2) a downgrade of a Series below an investment grade rating by each of Fitch Ratings, Moody’s Investors Service, Inc. and Standard & Poor’s Ratings Services within a specified period, an offer will be made to purchase that Series from the holders at a price in cash equal to 101% of the then outstanding principal amount of that Series, plus accrued and unpaid interest to, but not including, the date of repurchase. The indenture and the related officers’ certificate for each Series, subject to the exceptions and in compliance with the conditions as applicable, specify that we may not incur liens, enter into sale and leaseback transactions or consolidate, merge or sell all or substantially all of our assets. The indentures also contain customary events of default provisions.

Accounts Receivable Sales Facility
In May 2012, we renewed our existing accounts receivable sales facility (the “Facility”) for a one year period under terms substantially similar to those previously in place. The committed balance of the Facility is $1.35 billion, although from time-to-time, the available amount of the Facility may be less than $1.35 billion based on accounts receivable concentration limits and other eligibility requirements. The renewed Facility will expire in May 2013.
During the nine months ended December 31, 2011, there were no borrowings under the Facility. At March 31, 2012, there were $400 million in secured borrowings and $400 million of related securitized accounts receivable outstanding under the Facility, which are included in short-term borrowings and receivables in the condensed consolidated balance sheets. During the first quarter of 2013, we repaid $400 million of short-term borrowings using cash on hand. During the second quarter of 2013, there were a total of $1,125 million of short-term borrowings under the Facility all of which were repaid in the same quarter using cash on hand. During the third quarter of 2013, there were no borrowings under the Facility. At December 31, 2012, there were no short-term borrowings and related securitized accounts receivable outstanding under the Facility.
The Facility contains requirements relating to the performance of the accounts receivable and covenants relating to the Company. If we do not comply with these covenants, our ability to use the Facility may be suspended and repayment of any outstanding balances under the Facility may be required. At December 31, 2012 and March 31, 2012, we were in compliance with all covenants.
Revolving Credit Facility
We have a syndicated $1.3 billion five-year senior unsecured revolving credit facility, which expires in September 2016. Borrowings under this facility bear interest based upon either the London Interbank Offered Rate or a prime rate. There were no borrowings under this facility during the first nine months of 2013 and 2012. As of December 31, 2012 and March 31, 2012 there were no amounts outstanding under this facility.
8.
Financial Instruments and Hedging Activities
At December 31, 2012 and March 31, 2012, the carrying amounts of cash and cash equivalents, restricted cash, marketable securities, receivables, drafts and accounts payable, short-term borrowings and other current liabilities approximated their estimated fair values because of the short maturity of these financial instruments. All highly liquid debt instruments purchased with original maturity of three months or less at the date of acquisition are included in cash and cash equivalents. Included in cash and cash equivalents at December 31, 2012 and March 31, 2012 were money market fund investments of $1.5 billion and $0.8 billion, which are reported at fair value. The fair value of these investments was determined by using quoted prices for identical investments in active markets, which are considered to be Level 1 inputs under the fair value measurements and disclosure guidance. The carrying value of all other cash equivalents approximates their fair value due to their relatively short-term nature.
The carrying amounts and estimated fair values of our long-term debt and other financing were $4.5 billion and $5.1 billion at December 31, 2012, and $3.6 billion and $4.1 billion at March 31, 2012. The estimated fair values of our long-term debt and other financing was determined using quoted market prices and other inputs that were derived from available market information, which are considered to be Level 2 inputs under the fair value measurements and disclosure guidance, and may not be representative of actual values that could have been realized or that will be realized in the future.


12

McKESSON CORPORATION
FINANCIAL NOTES (CONTINUED)
(UNAUDITED)


In 2012, we entered into a number of forward contracts to hedge Canadian dollar and British pound denominated cash flows with gross notional values of $528 million and $151 million. The contracts to hedge Canadian dollar denominated cash flows mature over a period of eight years and have been designated for hedge accounting. Accordingly, changes in the fair values of these contracts are recorded to accumulated other comprehensive income and reclassified into earnings in the same period in which the hedged transaction affects earnings.  The contracts to hedge British pound denominated cash flows matured and were settled in the first quarter of 2013 and were not designated for hedge accounting. In the third quarter of 2013, we entered into an additional forward contract to hedge a separately identifiable Canadian dollar denominated cash flow with a gross notional value of $177 million. This contract matures in less than one year and also has not been designated for hedge accounting. Accordingly, changes in the fair values of the contracts not designated for hedge accounting are recorded directly in earnings.
At December 31, 2012 and March 31, 2012, the fair values of the outstanding contracts were not material.  Fair values of these derivatives were determined by using Level 2 inputs under the fair value measurements and disclosure guidance and may not be representative of actual values that could have been realized or that will be realized in the future. Amounts recorded to earnings for 2013 and 2012 were also not material.
9.
Commitments and Contingent Liabilities
In addition to commitments and obligations in the ordinary course of business, we are subject to various claims, other pending and potential legal actions for damages, investigations relating to governmental laws and regulations and other matters arising out of the normal conduct of our business. As described below, many of these proceedings are at preliminary stages and many seek an indeterminate amount of damages.
When a loss is considered probable and reasonably estimable, we record a liability in the amount of our best estimate for the ultimate loss. However, the likelihood of a loss with respect to a particular contingency is often difficult to predict and determining a meaningful estimate of the loss or a range of loss may not be practicable based on the information available and the potential effect of future events and decisions by third parties that will determine the ultimate resolution of the contingency. Moreover, it is not uncommon for such matters to be resolved over many years, during which time relevant developments and new information must be reevaluated at least quarterly to determine both the likelihood of potential loss and whether it is possible to reasonably estimate a range of possible loss. When a loss is probable but a reasonable estimate cannot be made, disclosure of the proceeding is provided.
Disclosure also is provided when it is reasonably possible that a loss will be incurred or when it is reasonably possible that the amount of a loss will exceed the recorded provision. We review all contingencies at least quarterly to determine whether the likelihood of loss has changed and to assess whether a reasonable estimate of the loss or range of loss can be made. As discussed above, development of a meaningful estimate of loss or a range of potential loss is complex when the outcome is directly dependent on negotiations with or decisions by third parties, such as regulatory agencies, the court system and other interested parties. Such factors bear directly on whether it is possible to reasonably estimate a range of potential loss and boundaries of high and low estimates.
Significant developments in previously reported proceedings and in other litigation and claims, since the filing of our 2012 Annual Report on Form 10-K and our Quarterly Reports on Form 10-Q for the periods ended June 30, 2012 and September 30, 2012, are set out below. Unless otherwise stated, we are currently unable to estimate a range of reasonably possible losses for the unresolved proceedings described below. Should any one or a combination of more than one of these proceedings be successful, or should we determine to settle any or a combination of these matters, we may be required to pay substantial sums, become subject to the entry of an injunction or be forced to change the manner in which we operate our business, which could have a material adverse impact on our financial position or results of operations.
I. Average Wholesale Price Litigation
The following matters involve a benchmark referred to as Average Wholesale Price (“AWP”), which is utilized by some public and private payers to calculate a portion of the amount that pharmacies and other providers are reimbursed for dispensing certain covered prescription drugs.


13

McKESSON CORPORATION
FINANCIAL NOTES (CONTINUED)
(UNAUDITED)


The Arizona Action
On November 7, 2012, the Company filed a motion to dismiss the previously reported action filed in Arizona state court by the State of Arizona against the Company, State of Arizona ex rel. Thomas Horne v. McKesson Corporation, (No. CV2012-013707). The briefing on the Company’s motion to dismiss is now complete, and a hearing has been set for March 11, 2013.
The Arizona Administrative Proceeding
On November 9, 2012, the Company received a Revised Notice of Proposed Civil Monetary Penalty from the Office of Inspector General for the Arizona Health Care Cost Containment System (“AHCCCS”) purporting to reinitiate an administrative proceeding against the Company, and seeking civil penalties in the amount of $112 million and an assessment in the amount of $102 million for false claims allegedly submitted to the Arizona Medicaid program (No. 2010-1218). This proceeding was previously enjoined by an Arizona state court which injunction was upheld on appeal. The Company intends to challenge the reinitiated proceeding and proposed penalty and assessment by AHCCCS.
The Kentucky Action
On November 26, 2012, the Company entered into an agreement with the Commonwealth of Kentucky in settlement of the previously reported action filed in Kentucky state court by the Commonwealth of Kentucky against the Company and First Databank, Commonwealth of Kentucky ex rel. Jack Conway v. McKesson Corporation, et al., (No. 11-CI-00935). On December 7, 2012, the court entered an order dismissing with prejudice the claims asserted against the Company in the Kentucky Action.
The Hawaii Action
On January 16, 2013, the court entered an order granting the Company’s unopposed motion to continue the April 15, 2013 trial date to February 17, 2014, in the previously reported action filed in Hawaii state court by the State of Hawaii against the Company and First Databank, State of Hawaii v. McKesson Corporation, et al., (No. 10-1-2411-11-GWBC). Discovery is ongoing.
The Kansas Action
On December 4, 2012, the Company entered into an agreement with the State of Kansas in settlement of the previously reported action filed in Kansas state court by the State of Kansas against the Company and First Databank, State of Kansas ex rel. Derek Schmidt v. McKesson Corporation, et al., (No. 10CV1491). On December 7, 2012, the court held a hearing during which it approved the parties’ settlement. On December 18, 2012, the State of Kansas filed a stipulation dismissing with prejudice the claims asserted against the Company in the Kansas Action.
The Virginia Action
On January 2, 2013, the court entered an order moving the July 8, 2013 trial date to October 28, 2013 in the previously reported action filed in the United States District Court for the Northern District of California by the Commonwealth of Virginia against the Company and two of its employees, Commonwealth of Virginia v. McKesson Corporation, et al., (No. C11-02782-SI). Discovery is ongoing.
The Company has a reserve relating to AWP public entity claims, which is reviewed at least quarterly and whenever events or circumstances indicate changes, including consideration of the pace and progress of discussions relating to potentially resolving other public entity claims. Following our most recent review of the reserve for estimated probable losses from current and possible future public entity AWP claims, the Company recorded pre-tax charges of $16 million and $44 million (total of $60 million) during the first and second quarters of 2013. No additional amounts were recorded in the third quarter of 2013. The Company recorded pre-tax charges of $118 million and $27 million (total of $145 million) during the second and third quarters of 2012. Pre-tax charges relating to changes in the Company’s AWP litigation reserve, including accrued interest, are recorded in our Distribution Solutions segment. The Company’s AWP litigation reserve is included in other current liabilities in the condensed consolidated balance sheets. In view of the number of outstanding cases and expected future claims, and the uncertainties of the timing and outcome of this type of litigation, it is possible that the ultimate costs of these matters may exceed or be less than the reserve.


14

McKESSON CORPORATION
FINANCIAL NOTES (CONTINUED)
(UNAUDITED)


The following is the activity related to the AWP litigation reserve for the first nine months of 2013 and 2012:
 
Nine Months Ended December 31,
(In millions)
2012
 
2011
AWP litigation reserve at beginning of period
$
453

 
$
330

Charges incurred
60

 
145

Payments made
(470
)
 
(26
)
AWP litigation reserve at end of period
$
43

 
$
449

II. Other Litigation
As previously reported, on September 28, 2012, the court entered judgment after trial in favor of the Company and its former indirect subsidiary, finding no liability under the False Claims Act in the previously reported action, United States ex rel. Jamison v. McKesson Corporation, et al., (No. 2:08-CV-00214-SA). The time for filing an appeal has expired and no appeal was filed.
In connection with the Company’s execution of an agreement to acquire PSS World Medical, on December 5, 2012, a putative class action complaint was filed in Florida state court, Duval County, by an alleged public shareholder of PSS World Medical against PSS World Medical, members of PSS World Medical’s board of directors, The Goldman Sachs Group, Inc., Goldman, Sachs & Co, and the Company, Baltimore County Employees’ Retirement System v. Gary A. Corless, et al., (No. 16-2012-CA-013015). The suit alleges that PSS World Medical and its board members breached their fiduciary duties by failing to maximize shareholder value and by failing to disclose material information in the preliminary proxy statement, and that the Company and others aided and abetted various fiduciary duty breaches in connection with the proposed merger. In addition to monetary damages in an unspecified amount and other remedies, the suit seeks to enjoin consummation of the merger. The Company has not yet responded to the complaint.
III. Government Investigations
From time-to-time, the Company receives subpoenas or requests for information from various government agencies. The Company generally responds to such subpoenas and requests in a cooperative, thorough and timely manner. These responses sometimes require time and effort and can result in considerable costs being incurred by the Company. Such subpoenas and requests also can lead to the assertion of claims or the commencement of civil or criminal legal proceedings against the Company and other members of the health care industry, as well as to settlements. Examples of such investigations are included in the Company’s 2012 Annual Report on Form 10-K. An example in the third quarter of 2013 is an investigation by the United States Department of Justice through the United States Attorney’s Office for the Middle District of Tennessee. The Company believes that the investigation is focused on distribution procedures with respect to the Vaccine for Children’s Program administered by the Center for Disease Control. In connection with the investigation, the Company has received and has responded to a subpoena seeking information and records from the Company’s Specialty Health business.
In addition, as previously reported, since 2009 the Company has cooperated with and responded to an investigation by the Regie de l'assurance maladie Du Quebec (“RAMQ”), a provincial government agency with administrative authority over the conduct of pharmaceutical businesses in the province of Quebec,  Canada.  The investigation focused on certain discounts and payments offered to pharmacies in Quebec, as well as payments received by the Company from certain manufacturers.  In the third quarter of 2013, the Company engaged in settlement discussions to resolve potential legal claims against the Company and its customers and suppliers arising from the investigation.  In consideration of the pace and progress of settlement discussions, the Company recorded a pre-tax charge of $40 million for estimated probable loss from potential legal claims arising from the investigation.  The charge was recorded to operating expenses within our Distribution Solutions segment. 


15

McKESSON CORPORATION
FINANCIAL NOTES (CONTINUED)
(UNAUDITED)


10.
Stockholders’ Equity
Each share of the Company’s outstanding common stock is permitted one vote on proposals presented to stockholders and is entitled to share equally in any dividends declared by the Company’s Board of Directors (the “Board”).
In March 2012, we entered into an accelerated share repurchase program with a third party financial institution to repurchase $1.2 billion of the Company’s common stock. The program was funded with cash on hand. As of March 31, 2012, we had received 12.0 million shares representing the minimum number of shares due under this program.  This program was completed in multiple tranches, and we received 0.9 million additional shares during the first quarter of 2013. In July 2012, we received 0.6 million additional shares upon completion of this program. The total number of shares repurchased under this program was 13.5 million shares at an average price per share of $89.10.
In the first quarter of 2013, the Board authorized the repurchase of an additional $700 million of the Company’s common stock, bringing the total authorization outstanding to $1.0 billion. During the third quarter of 2013, we repurchased 3.8 million of the Company’s common shares for $360 million through open market transactions at an average price per share of $94.76. The total authorization outstanding for repurchases of the Company’s common stock was $640 million at December 31, 2012.
In January 2013, the Board authorized the repurchase of an additional $500 million of the Company’s common stock bringing the total authorization outstanding to $1.1 billion.


16

McKESSON CORPORATION
FINANCIAL NOTES (CONCLUDED)
(UNAUDITED)

11.
Segment Information
We report our operations in two operating segments: McKesson Distribution Solutions and McKesson Technology Solutions. The factors for determining the reportable segments included the manner in which management evaluates the performance of the Company combined with the nature of the individual business activities. We evaluate the performance of our operating segments on a number of measures, including operating profit before interest expense, income taxes and results from discontinued operations.
Financial information relating to our reportable operating segments and reconciliations to the condensed consolidated totals is as follows:
 
Quarter Ended December 31,
 
Nine Months Ended December 31,
(In millions)
2012
 
2011
 
2012
 
2011
Revenues
 
 
 
 
 
 
 
Distribution Solutions (1)
 
 
 
 
 
 
 
Direct distribution & services
$
22,386

 
$
21,585

 
$
64,625

 
$
63,484

Sales to customers’ warehouses
4,468

 
5,198

 
14,621

 
14,998

Total U.S. pharmaceutical distribution & services
26,854

 
26,783

 
79,246

 
78,482

Canada pharmaceutical distribution & services
2,633

 
2,473

 
7,559

 
7,739

Medical-Surgical distribution & services
874

 
760

 
2,542

 
2,364

Total Distribution Solutions
30,361

 
30,016

 
89,347

 
88,585

Technology Solutions
 
 
 
 
 
 
 
Services
661

 
643

 
1,983

 
1,916

Software & software systems
145

 
152

 
432

 
449

Hardware
20

 
28

 
73

 
85

Total Technology Solutions
826

 
823

 
2,488

 
2,450

Total Revenues
$
31,187

 
$
30,839

 
$
91,835

 
$
91,035

 
 
 
 
 
 
 
 
Operating profit
 
 
 
 
 
 
 
Distribution Solutions (2) (3) (4)
$
525

 
$
510

 
$
1,646

 
$
1,462

Technology Solutions (5)
79

 
69

 
269

 
277

Total
604

 
579

 
1,915

 
1,739

Corporate Expenses, Net (6)
(109
)
 
(89
)
 
(212
)
 
(285
)
Interest Expense
(59
)
 
(64
)
 
(170
)
 
(192
)
Income Before Income Taxes
$
436

 
$
426

 
$
1,533

 
$
1,262

 
(1) 
Revenues derived from services represent less than 2% of this segment’s total revenues.
(2) 
Operating profit for the third quarter and first nine months of 2013 include a $40 million charge for a legal dispute in our Canadian business, which was recorded in operating expenses.
(3) 
For the third quarter of 2012, operating profit includes an AWP litigation charge of $27 million. For the first nine months of 2013 and 2012, operating profit includes AWP litigation charges of $60 million and $145 million. These charges were recorded in operating expenses.
(4) 
Operating profit for the third quarter and first nine months of 2013 includes the receipt of $8 million and $27 million representing our share of settlements of antitrust class action lawsuits brought against drug manufacturers, which were recorded as a reduction to cost of sales.
(5) 
Operating profit for the third quarter and first nine months of 2012 includes product alignment charges of $42 million, of which $26 million was recorded in cost of sales and $16 million was recorded in operating expenses.
(6) 
Corporate expenses for the first nine months of 2013 are net of an $81 million pre-tax gain on business combination related to the acquisition of the remaining 50% ownership interest in our corporate headquarters building.


17

McKESSON CORPORATION
FINANCIAL REVIEW
(UNAUDITED)


Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations.

GENERAL
Management’s discussion and analysis of financial condition and results of operations, referred to as the Financial Review, is intended to assist the reader in the understanding and assessment of significant changes and trends related to the results of operations and financial position of the Company together with its subsidiaries. This discussion and analysis should be read in conjunction with the condensed consolidated financial statements and accompanying financial notes in Item 1 of Part I of this Quarterly Report on Form 10-Q and in Item 8 of Part II of our 2012 Annual Report on Form 10-K.
The Company’s fiscal year begins on April 1 and ends on March 31. Unless otherwise noted, all references to a particular year shall mean the Company’s fiscal year.
Certain statements in this report constitute forward-looking statements. See “Factors Affecting Forward-Looking Statements” included in this Quarterly Report on Form 10-Q.
Results of Operations
Financial Overview:
(In millions, except per share amounts)
Quarter Ended December 31,
 
 
Nine Months Ended December 31,
 
 
2012
 
2011
Change
2012
 
2011
Change
 
 
 
 
 
 
 
 
 
 
 
Revenues
$
31,187

 
$
30,839

1

%
$
91,835

 
$
91,035

1

%
 
 
 
 
 
 
 
 
 
 
 
Litigation Charges
$

 
$
(27
)
NM

 
$
(60
)
 
$
(145
)
(59
)
%
 
 
 
 
 
 
 
 
 
 
 
Gain on Business Combination
$

 
$


%
$
81

 
$

NM

 
 
 
 
 
 
 
 
 
 
 
 
Income Before Income Taxes
$
436

 
$
426

2

%
$
1,533

 
$
1,262

21

%
Income Tax Expense
(138
)
 
(126
)
10

 
(454
)
 
(380
)
19

 
Net Income
$
298

 
$
300

(1
)
 
$
1,079

 
$
882

22

 
 
 
 
 
 
 
 
 
 
 
 
Diluted Earnings Per Common Share
$
1.24

 
$
1.20

3

%
$
4.49

 
$
3.51

28

%
Weighted Average Diluted Common Shares
240

 
251

(4
)
%
240

 
252

(5
)
%
NM – not meaningful 
Revenues for 2013 approximated the same periods a year ago. Revenues were primarily impacted by market growth, which includes growing drug utilization and price increases, and price deflation associated with brand to generic drug conversions.
During the third quarter of 2012, we recorded a pre-tax litigation charge relating to our Average Wholesale Price (“AWP”) litigation of $27 million. For the first nine months of 2013 and 2012, we recorded pre-tax AWP litigation charges of $60 million and $145 million. Adjustments to our AWP litigation reserves reflect our estimated probable losses for these claims.





18

McKESSON CORPORATION
FINANCIAL REVIEW (CONTINUED)
(UNAUDITED)


Since 2009 the Company has cooperated with and responded to an investigation by the Regie de l'assurance maladie Du Quebec (“RAMQ”), a provincial government agency with administrative authority over the conduct of pharmaceutical businesses in the province of Quebec,  Canada.  The investigation focused on certain discounts and payments offered to pharmacies in Quebec, as well as payments received by the Company from certain manufacturers.  In the third quarter of 2013, we engaged in settlement discussions to resolve potential legal claims against the Company and its customers and suppliers arising from the investigation.  In consideration of the pace and progress of settlement discussions, we recorded a pre-tax charge of $40 million for estimated probable loss from potential legal claims arising from the investigation.  The charge was recorded to operating expenses within our Distribution Solutions segment. 
On April 6, 2012, we purchased the remaining 50% ownership interest in our corporate headquarters building located in San Francisco, California for $90 million, which was funded from cash on hand.  We previously held a 50% ownership interest and were the primary tenant in this building.  This transaction was accounted for as a step acquisition, which required that we re‑measure our previously held 50% ownership interest to fair value and record the difference between the fair value and carrying value as a gain in the condensed consolidated statements of operations.  The re-measurement to fair value resulted in a non-cash pre-tax gain of $81 million ($51 million after-tax), which was recorded as a gain on business combination within Corporate in the condensed consolidated statements of operations during the first quarter of 2013.
During the third quarter of 2012, we approved a plan to align our hospital clinical and revenue cycle healthcare software products within our Technology Solutions segment. As part of this alignment strategy, we planned on converging our core clinical and revenue cycle Horizon and Paragon product lines onto Paragon’s Microsoft®-based platform. Additionally, we stopped development of our Horizon Enterprise Revenue Management™ (“HzERM”) software product. The plan resulted in a pre-tax charge of $42 million during the third quarter of 2012, of which $26 million was recorded to cost of sales and $16 million was recorded to operating expenses within our Technology Solutions segment. The pre-tax charge included $22 million of non-cash asset impairment charges, primarily for the write-off of prepaid licenses and commissions and capitalized internal use software that were determined to be obsolete as they would not be utilized going forward, $6 million for severance, $6 million for customer allowances and $8 million for other charges.
Income before income taxes for the third quarter of 2013 increased 2% to $436 million and for the first nine months of 2013 increased 21% to $1,533 million compared to the same periods a year ago. In addition to the items noted above, the increase in income before income taxes was primarily due to growth in our Distribution Solutions segment.
Net income for the third quarter of 2013 decreased 1% to $298 million and for the first nine months of 2013 increased 22% to $1,079 million compared to the same periods a year ago. Diluted earnings per common share for the third quarter of 2013 increased 3% to $1.24 and for the first nine months of 2013 increased 28% to $4.49 compared to the same periods a year ago. Diluted earnings per common share for 2013 also benefited from repurchase of our common stock.


19

McKESSON CORPORATION
FINANCIAL REVIEW (CONTINUED)
(UNAUDITED)


Revenues:
 
Quarter Ended December 31,
 
 
Nine Months Ended December 31,
 
 
(Dollars in millions)
2012
 
2011
Change
2012
 
2011
Change
Distribution Solutions
 
 
 
 
 
 
 
 
 
 
Direct distribution & services
$
22,386

 
$
21,585

4

%
$
64,625

 
$
63,484

2

%
Sales to customers’ warehouses
4,468

 
5,198

(14
)
 
14,621

 
14,998

(3
)
 
Total U.S. pharmaceutical distribution & services
26,854

 
26,783


 
79,246

 
78,482

1

 
Canada pharmaceutical distribution & services
2,633

 
2,473

6

 
7,559

 
7,739

(2
)
 
Medical-Surgical distribution & services
874

 
760

15

 
2,542

 
2,364

8

 
Total Distribution Solutions
30,361

 
30,016

1

 
89,347

 
88,585

1

 
Technology Solutions
 
 
 
 
 
 
 
 
 
 
Services
661

 
643

3

 
1,983

 
1,916

3

 
Software & software systems
145

 
152

(5
)
 
432

 
449

(4
)
 
Hardware
20

 
28

(29
)
 
73

 
85

(14
)
 
Total Technology Solutions
826

 
823


 
2,488

 
2,450

2

 
Total Revenues
$
31,187

 
$
30,839

1

 
$
91,835

 
$
91,035

1

 
Revenues for 2013 approximated the same periods a year ago primarily due to our Distribution Solutions segment, which accounted for approximately 97% of our consolidated revenues.
Direct distribution and services revenues increased primarily due to market growth, which includes growing drug utilization and price increases, and expanded volume with existing customers and new customers, partially offset by price deflation associated with brand to generic drug conversions and the loss of customers.  Revenues for the third quarter of 2013 were also impacted by one additional sales day.
Sales to customers’ warehouses decreased primarily due to price deflation associated with brand to generic drug conversions, net of brand price inflation, partially offset by new and expanded business from existing customers. Revenues for the third quarter of 2013 were also impacted by one additional sales day.
Canadian pharmaceutical distribution and services revenues increased for the third quarter of 2013 and decreased for the first nine months of 2013 compared to the same periods a year ago. Excluding a favorable foreign currency exchange rate fluctuation of 3% during the third quarter of 2013, Canadian revenues increased 3% primarily due to market growth and one additional sales day, partially offset by changes in our customer mix and government imposed price reduction for generic pharmaceuticals in certain provinces. Excluding an unfavorable foreign currency exchange rate fluctuation of 1% during the first nine months of 2013, Canadian revenues decreased 1% for the first nine months of 2013 primarily due to four less sales days, government imposed price reduction for generic pharmaceuticals in certain provinces and changes in our customer mix, partially offset by market growth.
Medical-Surgical distribution and services revenues increased primarily reflecting market growth, new customers and from a small acquisition. These revenues were also impacted by one additional sales day and four less sales days for the third quarter and first nine months of 2013.
Technology Solutions revenues approximated the same period a year ago for the third quarter of 2013 and increased slightly for the first nine months of 2013. These revenues increased primarily due to higher volume of claims processing and an increase in maintenance revenues from new and existing customers. These increases were partially offset by lower revenues associated with the sale and installation of our software products and due to revenue deferral on certain products in our international business.


20

McKESSON CORPORATION
FINANCIAL REVIEW (CONTINUED)
(UNAUDITED)


Gross Profit:
 
Quarter Ended December 31,
 
 
 
Nine Months Ended December 31,
 
 
 
(Dollars in millions)
2012
 
2011
 
Change
2012
 
2011
 
Change
Gross Profit
 
 
 
 
 
 
 
 
 
 
 
 
Distribution Solutions (1)
$
1,287

 
$
1,201

 
7

%
$
3,841

 
$
3,590

 
7

%
Technology Solutions (2)
381

 
365

 
4

 
1,147

 
1,132

 
1

  
Total
$
1,668

 
$
1,566

 
7

  
$
4,988

 
$
4,722

 
6

  
Gross Profit Margin
 
 
 
 
 
 
 
 
 
 
 
 
Distribution Solutions
4.24

%
4.00

%
24

bp 
4.30

%
4.05

%
25

bp 
Technology Solutions
46.13

 
44.35

 
178

 
46.10

 
46.20

 
(10
)
  
Total
5.35

 
5.08

 
27

 
5.43

 
5.19

 
24

  
 
(1) Gross profit for the third quarter and first nine months of 2013 includes the receipt of $8 million and $27 million representing our share of settlements of antitrust class action lawsuits brought against drug manufacturers.
(2) Gross profit for the third quarter and first nine months of 2012 includes product alignment charges of $26 million.
bp - basis points
Gross profit and gross profit margin increased for the third quarter and first nine months of 2013 compared to the same periods a year ago primarily as a result of growth in our Distribution Solutions segment.
Distribution Solutions segment’s gross profit margin increased primarily due to increased sales of higher margin generic drugs, an increase in buy margin, our acquisition of the Katz Assets (as described under the caption “Business Combinations”) and a lower proportion of revenues within the segment attributed to sales to customers’ warehouses. These increases were partially offset by a decrease in sell margin. Buy margin primarily reflects volume and timing of compensation from branded pharmaceutical manufacturers. Our Distribution Solutions segment’s gross profit margin for the third quarter and first nine months of 2013 was also favorably affected by the receipt of $8 million and $27 million representing our share of  settlements of antitrust class action lawsuits brought against drug manufacturers.
Technology Solutions segment's gross profit margin increased for the third quarter of 2013 and decreased for the first nine months of 2013 compared to the same periods a year ago.  The segment's gross profit margin was unfavorably impacted in 2012 by $26 million of product alignment charges.  Additionally, gross profit margin in 2013 was unfavorably impacted by a change in product and services mix. 


21

McKESSON CORPORATION
FINANCIAL REVIEW (CONTINUED)
(UNAUDITED)


Operating Expenses and Other Income (Expense), Net: 
 
Quarter Ended December 31,
 
 
 
Nine Months Ended December 31,
 
 
 
(Dollars in millions)
2012
 
2011
 
Change
2012
 
2011
 
Change
Operating Expenses
 
 
 
 
 
 
 
 
 
 
 
 
Distribution Solutions (1) (2)
$
769

 
$
690

 
11

%
$
2,212

 
$
2,136

 
4

%
Technology Solutions (3)
302

 
297

 
2

  
881

 
857

 
3

 
 Corporate (4)
112

 
87

 
29

  
220

 
287

 
(23
)
 
Total
$
1,183

 
$
1,074

 
10

 
$
3,313

 
$
3,280

 
1

 
Operating Expenses as a Percentage of Revenues
 
 
 
 
 
 
 
 
 
 
 
 
Distribution Solutions
2.53

%
2.30

%
23

bp 
2.48

%
2.41

%
7

bp 
Technology Solutions
36.56

 
36.09

 
47

  
35.41

 
34.98

 
43

 
Total
3.79

 
3.48

 
31

 
3.61

 
3.60

 
1

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other Income (Expense), Net
 
 
 
 
 
 
 
 
 
 
 
 
Distribution Solutions
$
7

 
$
(1
)
 
NM

 
$
17

 
$
8

 
113

%
Technology Solutions

 
1

 
NM

  
3

 
2

 
50

 
Corporate
3

 
(2
)
 
NM

 
8

 
2

 
300

 
Total
$
10

 
$
(2
)
 
NM

 
$
28

 
$
12

 
133

 

(1) 
For the third quarter of 2012, operating expenses include an AWP litigation charge of $27 million. For the first nine months of 2013 and 2012, operating expenses include AWP litigation charges of $60 million and $145 million.
(2) 
Operating expenses for the third quarter and first nine months of 2013 include a $40 million charge for a legal dispute in our Canadian business.
(3) 
Operating expenses for the third quarter and first nine months of 2012 includes product alignment charges of $16 million.
(4)  
Corporate expenses for the first nine months of 2013 are net of an $81 million pre-tax gain on business combination.
Operating expenses and operating expenses as a percentage of revenues increased for the third quarter of 2013 and approximated the same period a year ago for the first nine months of 2013 primarily due to an increase associated with business acquisitions, a $40 million charge for a legal dispute in our Canadian business, higher employee compensation and benefits costs, our continued investments in research and development activities and other corporate initiatives. These expenses were partially offset by lower AWP litigation charges in 2013 and product alignment charges of $16 million incurred in 2012, and for the first nine months of 2013, by the $81 million pre-tax gain on business combination. During the third quarter of 2012, we recorded a pre-tax litigation charge relating to our AWP litigation of $27 million, and for the nine months of 2013 and 2012, we recorded pre-tax AWP litigation charges of $60 million and $145 million.
Within our operating expenses, we recorded a charge of $10 million and a net credit of $66 million for acquisition expenses and related adjustments during the third quarter and first nine months of 2013 compared to charges of $8 million and  $26 million during the third quarter and first nine months of 2012. Expenses in the third quarter and first nine months of 2013 were primarily related to our execution of an agreement to acquire PSS World Medical, Inc. (“PSS World Medical”). The net credit for the first nine months of 2013 was primarily due to the $81 million pre-tax gain on business combination and expenses in 2012 of $26  million were primarily incurred to integrate our acquisition of US Oncology Holdings, Inc.


22

McKESSON CORPORATION
FINANCIAL REVIEW (CONTINUED)
(UNAUDITED)


Acquisition expenses and related adjustments include transaction and integration expenses that are directly related to acquisitions by the Company and gains and losses related to business combinations. These expenses by segment were as follows:
 
Quarter Ended December 31,
 
Nine Months Ended December 31,
(In millions)
2012