Summary of MCKESSON CORP - Yahoo! Finance

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

of Operations
Financial Overview

                                                          Quarter Ended                                    Nine Months Ended
                                                          December 31,                                       December 31,
(In millions, except per share data)          2007              2006           Change            2007              2006           Change

Revenues                                   $ 26,494          $ 23,111             15 %        $ 75,472          $ 68,812             10 %
Securities Litigation pre-tax
credits, net                                      -                 -              -                 5                 6            (17 )
Income from Continuing Operations
Before Income Taxes                             277               334            (17 )             993               934              6
Income Tax Provision                            (76 )             (94 )          (19 )            (309 )            (223 )           39
Discontinued Operations, net                      -                 3            NM                 (1 )             (55 )          (98 )

Net Income                                 $    201          $    243            (17 )        $    683          $    656              4


Diluted Earnings Per Share:
Continuing Operations                      $   0.68          $   0.79            (14 )%       $   2.28          $   2.33             (2 )%
Discontinued Operations                           -              0.01            NM                  -             (0.18 )          NM

Total                                      $   0.68          $   0.80            (15 )        $   2.28          $   2.15              6

NM - not meaningful
Revenues for the quarter ended December 31, 2007 grew 15% to $26.5 billion, net income decreased 17% to $201 million and diluted earnings per share decreased 15% to $0.68 compared to the same period a year ago. The decreases in net income and diluted earnings per share for the quarter primarily reflect $41 million of pre-tax charges ($32 million after-tax) recorded during the quarter relating to increases in legal reserves and a settlement, severance expenses associated with a reduction in workforce, asset impairments and restructuring activities. These charges are discussed in further detail under the caption "Operating Expenses." The decrease in net income and diluted earnings per share for the quarter also reflect an increase in share-based compensation, a decrease in last-in-first-out ("LIFO") inventory credits and a net dilutive impact of our acquisitions.
For the nine months ended December 31, 2007, revenues increased 10% to $75.5 billion, net income increased 4% to $683 million and diluted earnings per share increased 6% to $2.28 compared to the same period a year ago. Increases in net income and diluted earnings per share reflect higher operating profit in our Distribution Solutions and Technology Solutions segments, including our fourth quarter 2007 acquisition of Per-Se Technologies, Inc. ("Per-Se") and a decrease in our effective tax rate. Additionally, net income and diluted earnings per share for 2007 were impacted by an $83 million credit to our income tax provision relating to the reversal of income tax reserves for our Securities Litigation. This credit was partially offset by $55 million of after-tax losses associated with our discontinued operations, primarily due to the divestiture of our Acute Care medical-surgical supply business. On September 30, 2006, we sold this business for net cash proceeds of $160 million. The first nine months of 2007 financial results for the Acute Care business were an after-tax loss of $64 million, which includes a $79 million non-tax deductible write-off of goodwill.

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                              McKESSON CORPORATION
                          FINANCIAL REVIEW (CONTINUED)
                                  (UNAUDITED)
Results of Operations
   Revenues:

                                            Quarter Ended                                    Nine Months Ended
                                            December 31,                                       December 31,
(In millions)                   2007              2006           Change            2007              2006           Change

Distribution Solutions
U.S. pharmaceutical
direct distribution &
services                     $ 15,703          $ 13,414             17 %        $ 44,273          $ 39,964             11 %
U.S. pharmaceutical
sales to customers'
warehouses                      7,183             6,836              5            21,251            20,413              4

Subtotal                       22,886            20,250             13            65,524            60,377              9
Canada pharmaceutical
distribution &
services                        2,224             1,685             32             5,886             5,086             16
Medical-Surgical
distribution &
services                          648               632              3             1,884             1,789              5

Total Distribution
Solutions                      25,758            22,567             14            73,294            67,252              9

Technology Solutions
Services                          553               374             48             1,644             1,060             55
Software & software
systems                           150               132             14               427               385             11
Hardware                           33                38            (13 )             107               115             (7 )

Total Technology
Solutions                         736               544             35             2,178             1,560             40

Total Revenues               $ 26,494          $ 23,111             15          $ 75,472          $ 68,812             10

Revenues increased by 15% and 10% to $26.5 billion and $75.5 billion during the quarter and nine months ended December 31, 2007 compared to the same periods a year ago. The increase primarily reflects growth in our Distribution Solutions segment, which accounted for 97% of consolidated revenues.
U.S. pharmaceutical direct distribution and services revenues increased primarily reflecting market growth rates, new business and the acquisition of Oncology Therapeutics Network ("OTN"). In addition, these revenues benefited from one additional day of sales in 2008 compared to the same period a year ago. On October 29, 2007, we acquired all of the outstanding shares of OTN of San Francisco, California for approximately $531 million, including the assumption of debt. OTN is a U.S. distributor of specialty pharmaceuticals.
U.S. pharmaceutical sales to customers' warehouses increased primarily as a result of expanded agreements with customers. In addition, these revenues benefited from one additional day of sales in 2008 compared to the same period a year ago. For the nine months ended December 31, 2007, these revenues were also impacted by a decrease in volume from a large customer.
Canadian pharmaceutical distribution and services revenues increased primarily reflecting favorable foreign exchange rates, market growth rates and new and expanded business. Canadian revenues benefited in the third quarter and the nine months ended December 31, 2007 from an 18% and a 9% foreign currency increase compared to the same periods a year ago. In addition, these revenues benefited from one additional day of sales during the third quarter of 2008 compared to the same period a year ago. For the first nine months of 2008, these revenues were also impacted by four fewer days of sales compared to the same period a year ago.

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McKESSON CORPORATION FINANCIAL REVIEW (CONTINUED) (UNAUDITED)
Medical-Surgical distribution and services revenues increased for the quarter primarily reflecting market growth rates and an acquisition partially offset by a decrease in sales of flu vaccines due to earlier market availability and the discontinuance of the distribution of a product line. Revenues associated with this product line are now recorded by our U.S. distribution business. For the first nine months of 2008, Medical-Surgical distribution and services revenues increased primarily reflecting market growth rates and an acquisition partially offset by one less week of sales.
Technology Solutions segment revenues increased primarily due to the acquisition of Per-Se, increased services revenues, primarily reflecting the segment's expanded customer bases, and clinical software implementations. On January 26, 2007, we acquired Per-Se of Alpharetta, Georgia for approximately $1.8 billion. Per-Se is a leading provider of financial and administrative healthcare solutions for hospitals, physicians and retail pharmacies. For the nine months ended December 31, 2007, these revenues also benefited from the recognition of $21 million of disease management deferred revenues. Expenses associated with these revenues were previously recognized as incurred.
Gross Profit:

                                       Quarter Ended                      Nine Months Ended
                                        December 31,                        December 31,
    (Dollars in millions)      2007        2006        Change       2007        2006       Change

    Gross Profit
    Distribution Solutions   $   859     $   790          9 %     $ 2,529     $ 2,329         9 %
    Technology Solutions         345         271         27         1,033         752        37

    Total                    $ 1,204     $ 1,061         13       $ 3,562     $ 3,081        16


    Gross Profit Margin
    Distribution Solutions      3.33 %      3.50 %      (17 )bp      3.45 %      3.46 %      (1 )bp
    Technology Solutions       46.88       49.82       (294 )       47.43       48.21       (78 )
    Total                       4.54        4.59         (5 )        4.72        4.48        24

Gross profit for the third quarter of 2008 increased 13% to $1.2 billion compared to the same period a year ago. As a percentage of revenues, gross profit margin for the third quarter of 2008 decreased slightly primarily reflecting a decrease in both of our segments' gross profit margins, which was partially offset by a greater proportion of higher margin Technology Solutions products.
For the third quarter of 2008, gross profit margin for our Distribution Solutions segment was impacted from a prior year benefit associated with the launch of three generic drugs. In addition, the segment's gross profit margin declined due to a decrease in our sell margin and a decrease in LIFO credits, partially offset by the benefit from a lower proportion of revenues within the segment attributed to sales to customers' warehouses, which have lower gross profit margins relative to other revenues within the segment. During the third quarter of 2008, we recorded $10 million of LIFO inventory credits compared with $18 million for the same period a year ago. LIFO inventory credits reflected a number of generic product launches partially offset by a higher level of branded pharmaceutical price increases.
Technology Solutions segment's gross profit margin decreased during the third quarter of 2008 compared to the same period a year ago primarily reflecting a change in product mix, including a higher proportion of Per-Se service revenues. Gross profit margin for the third quarter of 2008 was also impacted by $3 million of pre-tax charges as discussed under the caption "Operating Expenses and Other Income, Net."
Gross profit for the nine months ended December 31, 2007 increased 16% to $3.6 billion compared to the same period a year ago. As a percentage of revenues, gross profit margin for the nine months ended December 31, 2007 increased 24 basis points to 4.72% primarily reflecting a greater proportion of higher margin Technology Solutions products partially offset by a decrease in gross profit margin in our Technology Solutions segment.

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McKESSON CORPORATION FINANCIAL REVIEW (CONTINUED) (UNAUDITED)
For the nine months ended December 31, 2007, gross profit margin for our Distribution Solutions segment approximated that for the prior comparable period. Gross profit margin for this segment was impacted by higher buy side margin, the benefit of increased sales of generic drugs with higher margins, a benefit associated with a lower proportion of revenues within the segment attributed to sales to customers' warehouses and a decrease in asset impairment charges. These gross profit margin benefits were fully offset by a decrease in sell margin, a decrease in LIFO inventory credits and our acquisition of OTN. During the nine months ended December 31, 2007, there were $9 million of LIFO inventory credits compared with $38 million for the same period a year ago. During the first nine months of 2007, we recorded a $15 million charge pertaining to the write-down of certain abandoned assets within our retail automation group.
Technology Solutions segment's gross profit margin decreased during the nine months ended December 31, 2007 compared to the same period a year ago primarily reflecting a change in product mix, including a higher proportion of Per-Se service revenues. Partially offsetting this decrease, the segment's 2008 gross profit margin was positively impacted by the recognition of $21 million of disease management deferred revenues for which expenses associated with these revenues were previously recognized as incurred.
Operating Expenses and Other Income, Net:

                                           Quarter Ended                                  Nine Months Ended
                                           December 31,                                      December 31,
(Dollars in millions)          2007             2006           Change           2007             2006            Change

Operating Expenses
Distribution Solutions       $   554          $   462             20 %        $ 1,541          $ 1,380              12 %
Technology Solutions             300              210             43              827              608              36
Corporate                         68               71             (4 )            202              203               -
Securities Litigation
credits, net                       -                -              -               (5 )             (6 )           (17 )

Total                        $   922          $   743             24          $ 2,565          $ 2,185              17

Operating Expenses as
a Percentage of
Revenues
Distribution Solutions          2.15 %           2.05 %           10 bp          2.10 %           2.05 %             5 bp
Technology Solutions           40.76            38.60            216            37.97            38.97            (100 )
Total                           3.48             3.21             27             3.40             3.18              22

Other Income, Net
Distribution Solutions       $     7          $    12            (42 )%       $    30          $    32              (6 )%
Technology Solutions               4                2            100                9                7              29
Corporate                         20               25            (20 )             65               67              (3 )

Total                        $    31          $    39            (21 )        $   104          $   106              (2 )

Operating expenses for the third quarter and first nine months of 2008 increased 24% to $922 million and 17% to $2.6 billion. As a percentage of revenues, operating expenses for the third quarter and first nine months of 2008 increased 27 and 22 basis points to 3.48% and 3.40%. The increase in our operating expenses as a percentage of revenues primarily reflects $38 million of pre-tax charges recorded during the third quarter of 2008 which are further described below, and our acquisitions of Per-Se and OTN. Operating expense dollars increased primarily due to our business acquisitions, including Per-Se and OTN, additional costs incurred to support our sales volume growth, $38 million of pre-tax charges recorded in the third quarter of 2008, and to a lesser extent, due to employee compensation costs associated with the requirement to expense share-based compensation and foreign currency fluctuations. Pre-tax share-based compensation for the third quarters of 2008 and 2007 was $26 million and $15 million and $73 million and $39 million for the first nine months of 2008 and 2007.

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                              McKESSON CORPORATION
                          FINANCIAL REVIEW (CONTINUED)
                                  (UNAUDITED)
   During the third quarter of 2008, we incurred $41 million of pre-tax charges
($32 million after-tax) as follows:

                                                          Distribution        Technology
(In millions)                                              Solutions           Solutions         Total

Increase in legal reserves and a settlement (1)            $     13            $     4           $ 17
Restructuring charges - facility closures (2)                     3                  -              3
Restructuring charges & related asset impairment
charge - termination of a software project (3)                    -                  8              8
Severance expense (non-restructuring) (4)                         -                  9              9
Other asset impairment charge (5)                                 -                  4              4

Total pre-tax charges                                      $     16            $    25           $ 41

(1) During the third quarter of 2008, we engaged in discussions with a governmental agency to settle claims arising out of an inquiry. As a result of these settlement discussions, we recorded an increase in a legal reserve of $13 million during the quarter within our Distributions Solutions segment. This reserve is not tax deductible.

(2) Consists of severance costs for two facility closures.

(3) Represents $4 million of severance and exit-related costs and a $4 million asset impairment charge for the write-off of capitalized software costs associated with the termination of a software project.

(4) Severance expense associated with the realignment of our workforce. Although such actions do not constitute a restructuring plan, they represent independent actions taken from time to time, as appropriate. In addition, during the first nine months of 2007, our Technology Solutions segment incurred $6 million of severance charges associated with the reallocation of product development and marketing resources and the realignment of one of the segment's international businesses.

(5) Asset impairment charge associated with the write-down to fair value for a property as assessed by market prices.

These expenses were recorded in our condensed consolidated statements of operations as follows:

                                       Distribution     Technology
              (In millions)             Solutions        Solutions      Total

              Cost of sales             $      -         $     3        $  3
              Operating expenses              16              22          38

              Total pre-tax charges     $     16         $    25        $ 41

Due to the accelerated vesting of share-based awards prior to 2007, we anticipate the impact of Statement of Financial Accounting Standards ("SFAS") No. 123(R), "Share-Based Payment," to increase in significance as future awards of share-based compensation are granted and amortized over the requisite service period. 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 behavior, timing, level and types of our grants of annual share-based awards, the attainment of performance goals and actual forfeiture rates. As a result, the actual future share-based compensation expense may differ from historical levels of expense. Refer to Financial Note 4, "Share-Based Payment," to the accompanying condensed consolidated financial statements for further information on our share-based compensation.
Other income, net decreased in the third quarter of 2008 compared to the same period a year ago primarily reflecting a decrease in interest income. For the nine months ended December 31, 2007, other income, net approximated that of the comparable prior year period.

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                              McKESSON CORPORATION
                          FINANCIAL REVIEW (CONTINUED)
                                  (UNAUDITED)
   Segment Operating Profit and Corporate Expenses:

                                            Quarter Ended                                     Nine Months Ended
                                             December 31,                                        December 31,
(Dollars in millions)          2007            2006             Change             2007             2006             Change

Segment Operating
Profit (1)Distribution
Solutions                    $  312          $   340              (8 )%          $ 1,018          $   981              4 %
Technology Solutions             49               63             (22 )               215              151             42

Subtotal                        361              403             (10 )             1,233            1,132              9
Corporate Expenses,
net                             (48 )            (46 )             4                (137 )           (136 )            1
Securities Litigation
credits, net                      -                -                                   5                6            (17 )
Interest Expense                (36 )            (23 )            57                (108 )            (68 )           59

Income from Continuing
Operations, Before
Income Taxes                 $  277          $   334             (17 )           $   993          $   934              6

Segment Operating
Profit Margin
Distribution Solutions         1.21 %           1.51 %           (30 ) bp           1.39 %           1.46 %           (7 ) bp
Technology Solutions           6.66            11.58            (492 )              9.87             9.68             19

(1) Segment operating profit includes gross profit, net of operating expenses, plus other income for our two operating segments.

Operating profit as a percentage of revenues in our Distribution Solutions segment decreased primarily reflecting lower gross profit margin and higher operating expenses as a percentage of revenues. Operating expenses as a percentage of revenues increased primarily due to the $16 million of pre-tax charges incurred during the third quarter of 2008, our investments in our Retail Automation group and due to our acquisition of OTN, which has a higher ratio of operating expenses as a percentage of revenues. Operating expenses increased primarily due to additional costs incurred to support our sales volume growth, business acquisitions, including OTN and Per-Se, and $16 million of pre-tax charges incurred during the quarter. Share-based compensation expense for this segment was $8 million and $4 million for the third quarters of 2008 and 2007 and $21 million and $11 million for the nine months ended December 31, 2007 and 2006.
Operating profit as a percentage of revenues in our Technology Solutions segment decreased during the third quarter of 2008 compared to the same period a year ago reflecting a decrease in gross profit margin and an increase in operating expenses as a percentage of revenues. Operating expenses as a percentage of revenues increased primarily due to $22 million of pre-tax charges incurred during the third quarter of 2008 partially offset by the acquisition of Per-Se which has a lower ratio of operating expenses as a percentage of revenues. Operating expenses increased primarily due to business acquisitions, including Per-Se, $22 million of pre-tax charges incurred during the quarter, investments in research and development activities, additional share-based compensation and higher bad debt expense. Share-based compensation expense for this segment was $10 million and $3 million for the third quarters of 2008 and 2007.
Operating profit as a percentage of revenues in our Technology Solutions segment increased during the first nine months of 2008 compared to the same period a year ago. The increase is primarily attributable to a decrease in operating expenses as a percentage of revenues partially offset by a decrease in gross profit margin. Operating expenses as a percentage of revenues were favorably impacted by the acquisition of Per-Se partially offset by $22 million of pre-tax charges incurred during the quarter. Operating expenses increased primarily due to business acquisitions, including Per-Se, $22 million of pre-tax charges incurred during the quarter, investments in research and development activities and additional share-based compensation. Share-based compensation expense for this segment was $28 million and $11 million for the first nine months of 2008 and 2007. In addition, operating expenses for the first nine months of 2007 include $6 million of restructuring charges incurred to reallocate product development and marketing resources and to realign one of the segment's international businesses.

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McKESSON CORPORATION FINANCIAL REVIEW (CONTINUED) (UNAUDITED)
Corporate expenses, net of other income, increased primarily reflecting a decrease in interest income and additional costs incurred to support our revenue growth partially offset by a decrease in legal expenses associated with our Securities Litigation. For the nine months ended December 31, 2007, Corporate expenses, net of other income, was also impacted by an increase in share-based compensation. Share-based compensation expense for this segment was $8 million for both the third quarters of 2008 and 2007 and $24 million and $17 million for the nine months ended December 31, 2007 and 2006.
Securities Litigation: During the nine months ended December 31, 2007 and 2006, we recorded net credits of $5 million and $6 million relating to various settlements for our Securities Litigation. Recent developments pertaining to our Securities Litigation are described in Financial Note 12, "Other Commitments and Contingent Liabilities," to the accompanying condensed consolidated financial statements.
Interest Expense: Interest expense for the third quarter and first nine months of 2008 increased compared to the same periods a year ago primarily due . . .