SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
(Mark One)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For quarter ended December 31, 1998
[ ]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 HBOC, Inc.
(Exact name of Registrant as specified in its charter)
DELAWARE
(State or other jurisdiction of incorporation or organization)
94-3207296
(IRS Employer Identification No.)
One Post Street, San Francisco, California
(Address of principal executive offices)
94104
(Zip Code)
(415) 983-8300
(Registrant's telephone number, including area code)
McKESSON CORPORATION
(Former name, if changed since last report)
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 the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class
Common stock, $.01 par value
Outstanding at December 31, 1998
99,730,700 shares
<PAGE>
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item Page
1. Financial Statements
Consolidated Balance Sheets
December 31, 1998 and March 31, 1998 3 - 4
Statements of Consolidated Income
Three and nine month periods ended December 31, 5
1998 and 1997
Statements of Consolidated Cash Flows
Nine month periods ended December 31, 1998 and 6 - 7
1997
Financial Notes 8 - 12
2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
Financial Review 13 - 18
3. Quantitative and Qualitative Disclosures about 18
Market Risk
PART II. OTHER INFORMATION
5. Other Information 19
6. Exhibits and Reports on Form 8-K 20
Exhibit Index 22
<PAGE>
PART I. FINANCIAL INFORMATION
The information presented in Part I represents historical information for
McKesson Corporation (the "Company") and does not give effect to the January 12,
1999 merger with HBO & Company ("HBOC") and other acquisitions completed by the
Company and HBOC in fiscal 1999 accounted for under the pooling of interests
method. See Financial Note 8.
McKESSON CORPORATION and SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(unaudited)
<TABLE>
December 31, March 31,
1998 1998
--------------- ---------------
(in millions)
<S> <C> <C>
ASSETS
Current Assets
Cash and cash equivalents $ 124.0 $ 35.7
Marketable securities available for sale
(Note 2) 29.1 77.9
Receivables 2,046.8 1,380.4
Inventories 3,284.7 2,583.5
Prepaid expenses 45.4 28.1
-------- --------
Total 5,530.0 4,105.6
-------- --------
Property, Plant and Equipment
Land 43.1 35.6
Buildings, machinery and equipment 993.0 834.7
-------- --------
Total 1,036.1 870.3
Accumulated depreciation (522.2) (440.0)
-------- --------
Net 513.9 430.3
Goodwill and Other Intangibles 996.9 752.4
Other Assets 398.9 319.2
-------- --------
Total Assets $ 7,439.7 $ 5,607.5
======== ========
</TABLE>
(Continued)
3
<PAGE>
McKESSON CORPORATION and SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(unaudited)
<TABLE>
December 31, March 31,
1998 1998
-------------- --------------
(in millions)
LIABILITIES AND STOCKHOLDERS' EQUITY
<S> <C> <C>
Current Liabilities
Drafts payable $ 532.9 $ 286.2
Accounts payable - trade 2,282.3 1,859.1
Short-term borrowings 841.7 -
Current portion of long-term debt 21.5 10.0
Salaries and wages 46.3 53.9
Taxes 134.6 115.7
Interest and dividends 47.1 29.5
Other 281.6 223.4
-------- --------
Total 4,188.0 2,577.8
-------- --------
Postretirement Obligations and Other Noncurrent
Liabilities 233.4 233.3
-------- --------
Long-Term Debt (Note 2) 1,142.2 1,194.2
-------- --------
McKesson-obligated mandatorily redeemable convertible
preferred securities of subsidiary grantor trust
whose sole assets are junior subordinated debentures
of McKesson (Note 3) 195.4 195.4
-------- -------
Stockholders' Equity
Common stock (400.0 shares authorized, 100.0
issued as of December 31, 1998, 200.0 shares
authorized, 93.4 issued as of March 31, 1998;
par value $0.01) 1.0 0.9
Additional paid-in capital 667.9 440.7
Other capital (54.4) (42.2)
Retained earnings 1,242.8 1,173.2
Accumulated translation adjustment (49.8) (45.4)
ESOP notes and guarantee (115.5) (115.6)
Treasury shares, at cost (11.3) (4.8)
-------- --------
Net 1,680.7 1,406.8
-------- --------
Total Liabilities and Stockholders' Equity $ 7,439.7 $ 5,607.5
======== ========
</TABLE>
See Financial Notes.
(Concluded)
4
<PAGE>
McKESSON CORPORATION and SUBSIDIARIES
STATEMENTS OF CONSOLIDATED INCOME
(unaudited)
<TABLE>
Three Months Ended Nine Months Ended
December 31 December 31
----------------------- -----------------------
1998 1997 1998 1997
---------- ---------- ---------- ----------
(in millions, except per share amounts)
<S> <C> <C> <C> <C>
REVENUES $ 7,978.8 $ 5,373.5 $ 20,791.2 $ 15,496.1
------- -------- --------- ---------
COSTS AND EXPENSES
Cost of sales (Note 4) 7,505.8 4,996.5 19,487.2 14,386.6
Selling, distribution and
administration (Note 4) 371.2 281.6 1,055.3 836.5
Interest 32.4 26.7 89.8 74.8
------- -------- --------- ---------
Total 7,909.4 5,304.8 20,632.3 15,297.9
------- -------- --------- ---------
INCOME BEFORE INCOME TAX EXPENSE
AND DIVIDENDS ON PREFERRED
SECURITIES OF SUBSIDIARY TRUST 69.4 68.7 158.9 198.2
INCOME TAX EXPENSE (25.7) (25.1) (60.6) (74.3)
DIVIDENDS ON PREFERRED
SECURITIES OF SUBSIDIARY TRUST (1.5) (1.6) (4.6) (4.7)
------- -------- --------- ---------
NET INCOME $ 42.2 $ 42.0 $ 93.7 $ 119.2
======= ======== ========= =========
EARNINGS PER COMMON SHARE
Diluted $ 0.40 $ 0.43 $ 0.92 $ 1.23
Basic 0.43 0.45 0.97 1.30
DIVIDENDS PER COMMON SHARE $ 0.125 $ 0.125 $ 0.375 $ 0.375
SHARES ON WHICH EARNINGS PER
COMMON SHARE WERE BASED
Diluted 109.1 101.8 107.1 101.1
Basic 98.6 91.6 96.6 91.3
</TABLE>
See Financial Notes.
5
<PAGE>
McKESSON CORPORATION and SUBSIDIARIES
STATEMENTS OF CONSOLIDATED CASH FLOWS
(unaudited)
<TABLE>
Nine Months Ended
December 31,
1998 1997
-------- --------
(in millions)
<S> <C> <C>
Operating Activities
Net Income $ 93.7 $ 119.2
Adjustments to reconcile to net cash used by
operating activities
Depreciation 56.3 52.3
Amortization 16.3 11.8
Provision for bad debts 11.7 5.8
Deferred taxes on income 5.0 8.4
Other non-cash items 62.8 (0.8)
------ -------
Total 245.8 196.7
------ -------
Effects of changes in
Receivables (640.5) (269.1)
Inventories (669.0) (99.4)
Accounts and drafts payable 646.5 (5.2)
Taxes 44.9 58.6
Other 2.5 (101.5)
------ -------
Total (615.6) (416.6)
------ -------
Net cash used by operating activities (369.8) (219.9)
------ -------
Investing Activities
Purchases of marketable securities (20.4) (1.3)
Maturities of marketable securities 70.9 11.5
Property acquisitions (104.1) (82.5)
Properties sold 20.5 8.0
Acquisitions of businesses, less cash and
short-term investments acquired (303.4) (50.8)
Other (31.3) (42.0)
------ -------
Net cash used by investing activities (367.8) (157.1)
------ -------
</TABLE>
(Continued)
6
<PAGE>
McKESSON CORPORATION and SUBSIDIARIES
STATEMENTS OF CONSOLIDATED CASH FLOWS
(unaudited)
<TABLE>
Nine Months Ended
December 31,
1998 1997
--------- ---------
(in millions)
<S> <C> <C>
Financing Activities
Proceeds from issuance of debt $ 918.9 $ 397.4
Repayment of debt (153.2) (37.9)
Dividends paid on preferred securities of
subsidiary trust (7.5) (7.8)
Capital stock transactions
Issuances 105.5 3.5
ESOP notes and guarantee 0.1 2.6
Dividends paid (37.9) (34.6)
------- -------
Net cash provided by financing activities 825.9 323.2
------- -------
Net Increase (Decrease) in Cash and Cash 88.3 (53.8)
Equivalents
Cash and Cash Equivalents at beginning of
period 35.7 124.8
------- -------
Cash and Cash Equivalents at end of period $ 124.0 $ 71.0
======= =======
</TABLE>
See Financial Notes.
(Concluded)
7
<PAGE>
McKESSON CORPORATION and SUBSIDIARIES
FINANCIAL NOTES
(unaudited)
1. Interim Financial Statements
In the opinion of the Company, these unaudited consolidated financial
statements include all adjustments necessary for a fair presentation of its
financial position as of December 31, 1998, the results of its operations for
the three and nine months ended December 31, 1998 and 1997 and its cash flows
for the nine months ended December 31, 1998 and 1997. Except for certain items
described in Note 4, such adjustments were of a normal recurring nature.
The results of operations for the nine months ended December 31, 1998 and
1997 are not necessarily indicative of the results for the full years.
It is suggested that these interim financial statements be read in
conjunction with the annual audited financial statements and financial notes
thereto included in the Company's 1998 Consolidated Financial Statements which
have previously been filed with the Securities and Exchange Commission.
2. Marketable Securities
The December 31, 1998 marketable securities balance includes $22.8
million held in trust as exchange property for the Company's $37.3 million
principal amount of 4.5% exchangeable subordinated debentures which remain
outstanding.
3. Convertible Preferred Securities
In February 1997, a wholly owned subsidiary trust of the Company issued 4
million shares of preferred securities to the public and 123,720 common
securities to the Company, which are convertible at the holder's option into
McKesson common stock. The proceeds of such issuances were invested by the trust
in $206,186,000 aggregate principal amount of the Company's 5% Convertible
Junior Subordinated Debentures due 2027 (the "Debentures"). The Debentures
represent the sole assets of the trust. The Debentures mature on June 1, 2027,
bear interest at the rate of 5%, payable quarterly, and are redeemable by the
Company beginning in March 2000 at 103.5% of the principal amount thereof.
Holders of the securities are entitled to cumulative cash distributions at
an annual rate of 5% of the liquidation amount of $50 per security. Each
preferred security is convertible at the rate of 1.3418 shares of McKesson
common stock, subject to adjustment in certain circumstances. The preferred
securities will be redeemed upon repayment of the Debentures, and are callable
by the Company at 103.5% of the liquidation amount beginning in March 2000.
The Company has guaranteed, on a subordinated basis, distributions and
other payments due to the preferred securities (the "Guarantee"). The Guarantee,
when taken together with the Company's obligations under the Debentures and in
the indenture pursuant to which the Debentures were issued and the Company's
obligations under the Amended and Restated Declaration of Trust governing the
subsidiary trust, provides a full and unconditional guarantee of amounts due on
the preferred securities.
The Debentures and related trust investment in the Debentures have been
eliminated in consolidation and the preferred securities are reflected as
outstanding in the accompanying consolidated financial statements.
8
<PAGE>
McKESSON CORPORATION and SUBSIDIARIES
FINANCIAL NOTES
(unaudited)
4. Charges in Continuing Operations
The Company continues to pursue its stated objective to become the world
leader in health care supply and information management across the entire
continuum of health care. In line with this goal, during the third quarter, the
Company completed the acquisition of Red Line HealthCare Corporation, which was
accounted for as a purchase. During the nine months, the Company acquired
several other companies, including Hawk Medical Supply, Inc., Automated
Prescription Systems, Inc., Med Management, LLC, and J. Knipper and Company,
Inc. (all accounted for as poolings of interests except Med Management, LLC
which was accounted for as a purchase), and also completed the consolidation of
distribution centers, technologies and back office operations related to the
earlier FoxMeyer Corporation and Drug Trading Company, Limited acquisitions. In
conjunction with the acquisitions and related activities, the Company incurred
transaction costs, charges associated with acquired company employee benefit
change of control provisions, restructuring costs and integration costs
(incurred and recorded in the quarter and nine month periods), and wrote down
certain assets (primarily costs of duplicate systems that will be eliminated).
Also in the nine months, the Company, by mutual agreement, terminated its
pending merger agreement with AmeriSource Health Corporation and incurred
related charges.
Charges for these items were recorded in selling, distribution, and
administrative expenses and are summarized below:
Three Months Nine Months
Ended Ended
December 31, 1998 December 31, 1998
------------------ ------------------
(in millions)
<TABLE>
<S> <C> <C>
Transaction costs $ 0.6 $ 18.0
Costs associated with employee benefit change
of control provisions (including noncash
amounts of $7.4 million) 26.7
Employee severance 0.3 3.7
Write-down of assets and other nonrecurring
costs associated with acquisition
integration activities, facility
consolidations, system implementations and
duplicate assets (including noncash charges
of $23.5 million and $41.7 million in the
three and nine months, respectively) 26.2 58.8
------ ------
Pre-tax charges 27.1 107.2
Tax benefit 9.9 37.7
------ ------
After-tax charges $ 17.2 $ 69.5
====== ======
</TABLE>
The Company's growth strategy is to pursue strategic acquisitions that
either expand or complement its business, and the Company routinely reviews such
potential acquisition opportunities. If additional transactions are entered
into, the Company would incur additional acquisition-related costs.
9
<PAGE>
McKESSON CORPORATION and SUBSIDIARIES
FINANCIAL NOTES
(unaudited)
5. Comprehensive Income
The Company adopted Statement of Financial Accounting Standards ("SFAS")
No. 130 "Reporting Comprehensive Income," in the first quarter of fiscal 1999.
Comprehensive income is defined as all changes in stockholders' equity from
nonowner sources. As such, it includes net income and amounts arising from
foreign currency translations, unrecognized pension costs and unrealized gains
or losses on marketable securities classified as available for sale which are
recorded directly to stockholders' equity. Total comprehensive income for the
three and nine months ended December 31, 1998 and 1997 is as follows:
Three Months Ended Nine Months Ended
December 31, December 31,
------------------- -------------------
1998 1997 1998 1997
-------- -------- -------- --------
(in millions)
<TABLE>
<S> <C> <C> <C> <C>
Net income $ 42.2 $ 42.0 $ 93.7 $ 119.2
Foreign currency translation
adjustments (1.6) (1.0) (4.4) (1.0)
----- ----- ----- -----
Total comprehensive income $ 40.6 $ 41.0 $ 89.3 $ 118.2
===== ===== ===== =====
</TABLE>
6. Earnings Per Share
The following is a reconciliation of the numerators and denominators of
the basic and diluted earnings per common share computations:
Three Months Ended
December 31, 1998 December 31, 1997
----------------------- ---------------------
(in millions, except per share amounts)
<TABLE>
Per Per
Income Shares Share Income Shares Share
-------- ------ ------- -------- ------ -------
<S> <C> <C> <C> <C> <C> <C>
Basic EPS
Net Income $ 42.2 98.6 $ 0.43 $ 42.0 91.6 $ 0.45
===== =====
Effect of Dilutive Securities
Options to purchase common
stock 4.7 4.3
Trust convertible preferred
securities 1.5 5.4 1.6 5.4
Restricted stock 0.4 0.5
----- ----- ----- -----
Diluted EPS
Income available to common
stockholders plus assumed
conversions $ 43.7 109.1 $ 0.40 $ 43.6 101.8 $ 0.43
===== ===== ===== ===== ====== =====
</TABLE>
10
<PAGE>
McKESSON CORPORATION and SUBSIDIARIES
FINANCIAL NOTES
(unaudited)
<TABLE>
Nine Months Ended
December 31, 1998 December 31, 1997
----------------------- ---------------------
(in millions, except per share amounts)
Per Per
Income Shares Share Income Shares Share
------- ------ ------- ------- ------ -------
<S> <C> <C> <C> <C> <C> <C> <C>
Basic EPS
Net Income $ 93.7 96.6 $ 0.97 $ 119.2 91.3 $ 1.30
===== =====
Effect of Dilutive Securities
Options to purchase common 4.7 3.9
stock
Trust convertible preferred 4.6 5.4 4.7 5.4
securities
Restricted stock 0.4 0.5
----- ----- ----- -----
Diluted EPS
Income available to common
stockholders plus assumed
conversions $ 98.3 107.1 $ 0.92 $ 123.9 101.1 $ 1.23
===== ===== ===== ===== ===== =====
</TABLE>
7. New Accounting Pronouncements
In fiscal 1998, the Financial Accounting Standards Board issued SFAS No.
131, "Disclosures about Segments of an Enterprise and Related Information,"
which establishes annual and interim reporting standards for an enterprise's
operating segments and related disclosures about its products, services,
geographic areas, and major customers; and SFAS No. 132, "Employers' Disclosures
about Pension and Other Postretirement Benefits," which standardizes the
disclosure requirements for pensions and other postretirement benefits and
expands disclosures on changes in benefit obligations and fair values of plan
assets. The Company will implement these statements in its fiscal 1999 annual
financial statements. Adoption of these statements will not impact the Company's
consolidated financial position, results of operations or cash flows, and any
effect will be limited to the form and content of its disclosures.
In fiscal 1999, the Financial Accounting Standards Board issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities," which
standardizes the accounting for derivatives, requiring recognition as either
assets or liabilities on the balance sheet and measurement at fair value. The
Company plans to adopt this statement in fiscal 2001. The Company has not yet
determined the effect adoption of this statement will have on the Company's
consolidated financial position, results of operations or cash flows.
8. Acquisition of HBO & Company
On January 12, 1999, the Company completed a merger with HBO & Company
("HBOC"), a leading health care information technology company, by exchanging
177 million shares of Company common stock for all of the common stock of HBOC.
Each share of HBOC was exchanged for .37 of a share of Company common stock. In
addition, outstanding HBOC employee stock options were converted at the same
exchange factor into options to purchase approximately 10 million shares of
Company common stock. The Company was renamed McKesson HBOC, Inc.
("McKessonHBOC"). The merger constituted a tax-free reorganization and will be
accounted for as a pooling of interests.
11
<PAGE>
McKESSON CORPORATION and SUBSIDIARIES
FINANCIAL NOTES
(unaudited)
The following table presents pro forma combined revenues, net income and
earnings per share of McKessonHBOC as if the merger had been consummated at the
beginning of the periods presented. The pro forma combined consolidated
financial data also includes all other acquisitions completed by the Company and
HBOC in fiscal 1999 accounted for under the pooling of interests method.
<TABLE>
Three Months Ended Nine Months Ended
December 31 December 31
------------------ ------------------
1998 1997 1998 1997
-------- -------- -------- --------
(in millions, except per share amount)
<S> <C> <C> <C> <C>
Revenues $ 8,454.6 $ 5,811.6 $ 22,203.7 $ 16,673.6
Net income $ 106.9 $ 77.2 $ 308.3 $ 233.6
Earnings per share
Diluted $ 0.37 $ 0.28 $ 1.08 $ 0.85
Basic 0.39 0.29 1.12 0.88
</TABLE>
Pro forma net income includes special charges of $64.9 million pre-tax
($43.7 million after-tax) and $50.3 million pre-tax ($30.1 million after-tax) in
the three months ended December 31, 1998 and 1997, respectively, and $158.5
million pre-tax ($104.0 million after-tax) and $98.5 million pre-tax ($56.6
million after-tax) in the nine months ended December 31, 1998 and 1997,
respectively, for transaction costs, severance, acquired company employee
benefit change of control provisions, asset write-downs, restructuring,
integration and system implementation costs (incurred and recorded in the
quarter and nine month periods) associated primarily with acquisition-related
activities.
The pro forma combined consolidated financial data does not reflect any
cost savings and other synergies anticipated as a result of the merger or any
merger-related expenses and is not necessarily indicative of the actual results
of the combined entities had the merger and other acquisitions been consummated
at the beginning of the periods presented, nor is it necessarily indicative of
future results of operations.
12
<PAGE>
McKESSON CORPORATION and SUBSIDIARIES
FINANCIAL REVIEW
Segment Results
The revenues and operating profits of the Company by business segment are
as follows:
<TABLE>
Three Months Ended Nine Months Ended
December 31 December 31
------------------------- -------------------------
1998 1997 %chg. 1998 1997 %chg.
-------- -------- ------ -------- -------- ------
(in millions)
<S> <C> <C> <C> <C> <C> <C>
REVENUES
Health Care Supply Management
Pharmaceutical Distribution
& Services
U.S. Health Care(1) $ 6,778.5 $ 4,404.8 53.9 $ 17,418.9 $ 12,697.8 37.2
International 489.1 439.5 11.3 1,483.7 1,204.2 23.2
-------- -------- -------- ---------
Total Pharmaceutical
Distribution & Services 7,267.6 4,844.3 50.0 18,902.6 13,902.0 36.0
Medical/Surgical
Distribution & Services 630.2 461.7 36.5 1,625.2 1,366.9 18.9
-------- -------- -------- ---------
Total Health Care
Supply Management 7,897.8 5,306.0 48.8 20,527.8 15,268.9 34.4
Water Products 79.1 64.8 22.1 256.0 217.5 17.7
Corporate 1.9 2.7 7.4 9.7
-------- -------- -------- ---------
Total $ 7,978.8 $ 5,373.5 48.5 $ 20,791.2 $ 15,496.1 34.2
======== ======== ======== =========
OPERATING PROFIT
Health Care Supply
Management $ 103.8(2) $ 97.0 $ 241.4(3) $ 264.4
Water Products 10.7(4) 10.0 40.7(4) 37.8
------ ------ ------ ------
Total 114.5 107.0 282.1 302.2
Interest-net (5) (31.7) (25.0) (86.4) (70.3)
Corporate and other (13.4) (13.3) (36.8) (33.7)
------ ------ ------ ------
Income before income taxes $ 69.4 $ 68.7 $ 158.9 $ 198.2
====== ====== ====== ======
<FN>
(1) Includes sales to customers' warehouses of $2,206.0 million and $702.7
million in the three months ended December 31, 1998 and 1997, respectively
($4,806.9 million and $2,014.8 million in the nine months, respectively.)
(2) Includes $26.5 million in charges for transaction costs, asset write-downs,
restructuring and integration costs associated with acquisitions.
(3) Includes $105.1 million in charges for transaction costs, acquired company
employee benefit change of control provisions, asset write-downs,
restructuring, integration and system implementation costs associated
primarily with acquisition-related activities.
(4) Includes $0.6 million and $2.1 million in the quarter and nine months,
respectively, for transaction costs and restructuring and integration costs
associated with acquisitions.
(5) Interest expense is shown net of corporate interest income.
</FN>
</TABLE>
13
<PAGE>
McKESSON CORPORATION and SUBSIDIARIES
FINANCIAL REVIEW
Overview of Results
Net income for the third quarter was $42.2 million, $0.40 per diluted
share compared to $42.0 million, $0.43 per share in the prior year. Included in
the current year's third quarter results were $27.1 million in pre-tax charges
($17.2 million after-tax) for transaction costs, asset write-downs (primarily
costs of duplicate systems that will be eliminated), restructuring and
integration costs associated with acquisitions (see Financial Note 4).
For the nine month period, net income was $93.7 million, $0.92 per diluted
share, compared to $119.2 million, $1.23 per share in the prior year. Included
in the current year's results were the $27.1 million in pre-tax charges noted
above, plus $80.1 million in costs incurred in the first and second quarters,
associated with the completion of several acquisitions that were accounted for
as poolings of interests, including Hawk Medical Supply, Inc., J. Knipper and
Company, Inc., and Automated Prescription Systems, Inc., and the terminated
agreement with AmeriSource Health Corporation ("AmeriSource"). The charge also
included amounts for an additional facility closure, non-recurring system
implementation costs and the completion of operational integration activities
associated with earlier acquisitions, which are required to be expensed as
incurred.
The effective income tax rate for the nine months ended December 31, 1998
differed from the effective tax rate for the comparable prior year period
primarily due to certain nondeductible transaction expenses included in the
charges noted above.
Health Care Supply Management
The Health Care Supply Management segment includes the operations of the
Company's U.S. pharmaceutical distribution and services businesses, its
international pharmaceutical operations (Canada and Mexico), and its
medical/surgical distribution and services business. This segment accounted for
99% of consolidated revenues for the three and the nine month periods ended
December 31, 1998.
Pharmaceutical Distribution & Services revenues increased by 50% in the
quarter and 36% in the nine months, reflecting internal growth in the U.S.
direct delivery business of 22% and 17%, increases in U.S. sales to customers'
warehouses of 214% and 139%, and increases in international revenues of 11% and
23%, respectively. Pharmaceutical Distribution & Services revenues, excluding
sales to customers' warehouses, increased 22% and 19% in the three and nine
month periods, respectively. U.S. revenue increases reflect growth in the
existing customer base and the addition of several new major retail chain
customers. International revenue increases reflect the transition of additional
customers of Drug Trading Company, Limited, to Medis Health and Pharmaceutical
Services, Inc., the Company's Canadian health care distribution business.
Medical/Surgical Distribution & Services revenues increased 36% to $630.2
million in the quarter (19% to $1,652.2 million in the nine month period),
including $47.6 million in revenues from Red Line HealthCare, acquired for cash
in a transaction accounted for as a purchase in mid-November. The increase in
revenues reflects several new long-term contracts with major customers.
Operating profit for the Health Care Supply Management segment, excluding
the impact of $26.5 million of previously discussed acquisition-related charges,
increased by 34% in the third quarter (31% for the nine month period, excluding
acquisition-related charges of $105.1 million). Operating profit as a percent of
revenues (calculated excluding acquisition-related charges and sales to
customers' warehouses) increased 18 basis points to 2.29% in the quarter and 21
basis points to 2.20% in the nine months, compared to the respective prior year
periods. The improvement in operating profit margins reflects growth in
procurement profits, operating expense efficiencies and sales of higher-margin
automated drug-dispensing products and manufacturer marketing services.
Including acquisition-related charges, operating profit increased by 7% and
declined by 9% in the quarter and nine month period, respectively.
14
<PAGE>
McKESSON CORPORATION and SUBSIDIARIES
FINANCIAL REVIEW
Water Products
Segment revenues increased by 22% to $79.1 million, and 18% to $256.0
million in the third quarter and the nine month period, respectively (including
internal sales growth of 10% and 11% in the respective periods). Operating
profit increased by 13% to $11.3 million in the quarter and 13% to $42.8 million
in the nine months (before acquisition-related charges of $0.6 million and $2.1
million, respectively), reflecting increased profits in the direct delivery
business and the favorable impact of several small acquisitions during the
current fiscal year. Including the impact of acquisition-related charges,
operating profit increased by 7% and 8% in the quarter and nine month periods,
respectively.
Liquidity and Capital Resources
Cash and marketable securities available for sale were $153.1 million at
December 31, 1998 and $113.6 million at March 31, 1998. The December 31, 1998
marketable securities balance included $22.8 million that is currently
restricted and held in trust as exchange property in connection with the
Company's outstanding exchangeable debentures. Cash and marketable securities
available for sale increased by $39.5 million and total debt increased by $801.2
million during the nine months ended December 31, 1998. The net change of $761.7
million primarily reflects both the increased working capital needs to support
the significant growth in revenue, (48% in the quarter) and cash utilized for
acquisitions.
Interest expense, net of interest income, increased to $31.7 million in
the third quarter and $86.4 million for the nine month period, compared to $25.0
million and $70.3 million, respectively, in the prior year, due to borrowings to
support the increase in working capital and acquisitions.
Stockholders' equity was $1,680.7 million at December 31, 1998, and the
net debt-to-capital ratio was 50% compared with 41% on March 31, 1998. The net
debt-to-capital ratio for both periods was computed by reducing the outstanding
debt amount by the cash and marketable securities at the end of the period.
For the nine month period, average diluted shares increased to 107.1
million from 101.1 million in the prior year due primarily to the issuance of
4.3 million common shares in connection with acquisitions, the sale of 1.3
million shares to the Employee Stock Ownership Plan in the first quarter of
fiscal 1999 and shares issued in connection with other employee benefit plans.
Subsequent Event
On January 12, 1999, the Company completed a merger with HBO & Company, a
leading health care information technology company. The Company was renamed
McKesson HBOC, Inc. The merger constituted a tax-free reorganization and will be
accounted for as a pooling of interests (see Financial Note 8). In connection
with the merger, the Company expects to record charges in the fourth fiscal
quarter for merger (including investment, banking, legal, accounting, and other
related costs), and restructuring costs, and affiliation costs expected to be
incurred in the quarter.
15
<PAGE>
McKESSON CORPORATION and SUBSIDIARIES
FINANCIAL REVIEW
Year 2000
BACKGROUND
The "Year 2000 problem" refers to the fact that some computer hardware,
software and embedded firmware are designed to read and store dates using only
the last two digits of the year. The Company relies heavily on computer
technologies to operate its business. In 1996, the Company conducted an initial
assessment of its information technology to determine which Year 2000 related
problems might cause processing errors or computer system failures. Based on the
results of that initial analysis, the Company's executive management identified
the Year 2000 problem as a top corporate priority and established a central
office to provide enterprise-wide management of its Year 2000 project (the
"Project"), which is currently estimated to have a total project cost of less
than $45 million (see "--Costs").
The following discussion of the implications of the Year 2000 problem for
the Company contains numerous forward-looking statements based on inherently
uncertain information. The cost of the Project and the date on which the Company
plans to complete its internal Year 2000 modifications are based on the
Company's best estimates, which were derived utilizing a number of assumptions
of future events including the continued availability of internal and external
resources, third party modifications and other factors. However, there can be no
guarantee that these estimates will be achieved, and actual results could
differ. Moreover, although the Company believes it will be able to make the
necessary modifications in advance, there can be no guarantee that the failure
to modify the systems would not have a material adverse effect on the Company.
In addition, the Company places a high degree of reliance on computer
systems of third parties, such as customers, trade suppliers and computer
hardware and commercial software suppliers. Although the Company is assessing
the readiness of these third parties and preparing contingency plans, there can
be no guarantee that the failure of these third parties to modify their systems
in advance of December 31, 1999 would not have a material adverse effect on the
Company.
READINESS
The Project is intended to ensure that all critical systems, devices and
applications, as well as data exchanged with customers, trade suppliers, and
other third parties ("Trading Partners") have been evaluated and will be
suitable for continued use into and beyond the year 2000. In addition to areas
normally associated with information technology ("IT"), the project also
includes areas normally considered outside of IT, but which may have embedded
microprocessors with potential Year 2000 problems. Examples of such non-IT areas
include the 30,000 hand-held order entry devices the Company has provided its
customers, and recently implemented bar-code scanning devices used in warehouse
operations.
Responsibility for implementation of the Project has been divided among
thirteen business units, each with its own IT resources. Each business unit
operates under published corporate standards and progress is monitored by the
corporate Year 2000 central office. Responsibilities have been further
subdivided into functional areas. General priorities have been defined,
dependencies identified, preliminary delivery dates assigned, detailed project
plans developed, and internal and external technical resources assigned or
hired. In addition, internal management reporting requirements have been
established. Plans, and progress against those plans, are reviewed by the
Project's central project office and are reported to the Chief Information
Officer, executive steering committee and the Company's Board of Directors.
16
<PAGE>
McKESSON CORPORATION and SUBSIDIARIES
FINANCIAL REVIEW
The Project now consists of hundreds of individual projects, varying in
priority and resource requirements from large undertakings, such as replacing
certain financial and electronic commerce (EDI) systems, to smaller projects,
such as certification of telephony systems. Regardless of its size, each
individual project generally progresses through the following seven phases,
which are divided into two stages:
Stage One: Stage Two:
Awareness (Phase 1) Examination and analysis (Phase 3)
Assessment of risk (Phase 2) Modification and/or renovation (Phase 4)
Data conversion (Phase 5)
Acceptance testing (Phase 6)
Redeployment back into production (Phase 7)
The Company has completed Stage One for all identified projects. Because
of the size of the Project at the Company, and variation in assessed risk, some
individual projects have completed all phases while others are at various phases
within Stage Two. Most of the Company's mission critical projects, (i.e., those
projects whose failure to be completed would create a significant business
disruption) are at Phase 6 or higher, and all of its mission critical projects
will be installed by July 31, 1999. A limited number of systems requiring
extended migration, installation or conversion efforts will require work
extending past July 31, 1999 but, in any case, the Company expects to complete
all phases of all identified projects by September 30, 1999. In calendar year
1999, the Company will be conducting a rigorous final level of review called
systems integrated testing under post-Year 2000 conditions.
The Company has conducted and plans to continue to conduct systems testing
with Trading Partners during calendar year 1999. In addition, to insure Year
2000 readiness with trade suppliers, the Company is participating in an industry
effort organized by the National Wholesale Drug Association with special
attention to critical suppliers such as manufacturers of branded pharmaceutical
products.
Since early 1997, the Company has required Year 2000 compliance statements
from all suppliers of the Company's computer hardware and commercial software.
As of January 1999, approximately 75% of the computer hardware and purchased
software used in the Company's core distribution business was certified by the
vendor as compliant. Regardless of the compliance statements, all third party
hardware and software will also be subjected to testing to reconfirm its Year
2000 readiness.
COSTS
The Company incurred costs of approximately $7 million in fiscal 1998 and
$10 million in the nine months ended December 31, 1998, associated with
modifications to the Company's existing systems to make them Year 2000 ready,
related testing and outside consulting. The Company expects to incur costs
between $10 and $15 million in fiscal 1999 and between $10 million and $20
million in fiscal 2000 for a total project cost of less than $45 million. Such
costs are being expensed as incurred. Year 2000 Project costs are difficult to
estimate accurately and the projects cost could change due to unanticipated
technological difficulties, project vendor delays, project vendor cost overruns
and the degree to which systems of newly acquired businesses are compliant.
17
<PAGE>
McKESSON CORPORATION and SUBSIDIARIES
FINANCIAL REVIEW
RISKS
Because of the range of possible issues and the large number of variables
involved (including the Year 2000 readiness of any entities acquired by the
Company), it is impossible to quantify the potential cost of problems should the
Company's remediation efforts or the efforts of those with whom it does business
not be successful. Such costs and any failure of such remediation efforts could
result in a loss of business, damage to the Company's reputation, and legal
liability. Consequently, any such costs or failures could have a material
adverse effect on the Company. The Company, believes that the most likely risks
of serious Year 2000 business disruptions are external in nature, such as (i)
disruptions in telecommunications, electric, or transportation services, (ii)
failure of third party payors or insurers to provide timely reimbursement to the
Company's customers and (iii) noncompliance of smaller trading partners. Of all
the external risks, the Company believes the most reasonably likely worst case
scenario would be a business disruption resulting from an extended and/or
extensive communications failure. With its extensive use of technology, the
Company is now dependent on data and voice communications to receive, process,
track and bill customers orders, move funds, replenish product and complete
other activities critical to the Company's business. Based on the Company's
information regarding the readiness of its major communications carriers and the
redundancy built into the Company's network architecture, as well as the
Company's developing contingency plans, the Company expects that any such
disruption would be likely to be localized and of short duration, and would
therefore not be likely to have a material adverse effect on the Company.
CONTINGENCY PLANS
Business disruptions in the form of floods, blizzards, hurricanes,
earthquakes, and power failures are a normal part of the Company's contingency
planning. In an effort to reduce the risks associated with the Year 2000
problems the Company has established and is currently continuing to develop Year
2000 contingency plans that build upon existing disaster recovery and
contingency plans. Examples of the Company's existing contingency plans include
alternative electronic and manual means for placing and receiving orders, and
alternative power supplies and communication lines. Contingency planning for
possible Year 2000 disruptions will continue to be defined, improved, and
implemented.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
The Company believes there has been no material change in its exposure to
market risk from that discussed in the Company's 1998 Consolidated Financial
Statements.
18
<PAGE>
PART II. OTHER INFORMATION
Item 5. Other Information
The ratios of earnings to fixed charges and of earnings to combined fixed
charges and preferred stock dividends amounted to 2.31x and 3.00x for the nine
months ended December 31, 1998 and 1997, respectively. There were no preferred
stock dividends in the nine months ended December 31, 1998 and 1997,
respectively.
The ratio of earnings to fixed charges was computed by dividing fixed
charges (interest expense, the portion of rental expense under operating leases
deemed by the Company to be representative of the interest factor and dividends
on preferred securities of a subsidiary grantor trust) into earnings available
for fixed charges (net income plus income tax expense and fixed charges).
19
<PAGE>
Item 6. Exhibits and Reports on Form 8-K
- ------------------------------------------
(a) Exhibits
2.1 Computation of Ratio of Earnings to Fixed Charges and Earnings to
Combined Fixed Charges and Preferred Stock Dividends.
27 Financial Data Schedule
(b) Reports on Form 8-K
The Registrant filed the following reports on Form 8-K during the
three months ended December 31, 1998:
1. Form 8-K
Date of Report: October 19, 1998 Date Filed: October 19, 1998
Item 5. Other Events
--------------------
The Registrant announced a definitive merger agreement had been
signed for McKesson Corporation to acquire HBO & Company
("HBOC").
2. Form 8-K/A (Amendment No. 1)
Date of Report: October 19, 1998 Date Filed: October 30, 1998
Item 7. Financial Statements, Pro Forma Financial Information
---------------------------------------------------------------
and Exhibits
------------
The Registrant filed financial statements and pro forma financial
information related to the merger agreement between McKesson
Corporation and HBOC.
3. Form 8-K/A (Amendment No. 2)
Date of Report: October 19, 1998 Date Filed: November 6, 1998
Item 7. Financial Statements, Pro Forma Financial Information
---------------------------------------------------------------
and Exhibits
------------
The Registrant filed amended pro forma financial information
related to the merger agreement between McKesson Corporation and
HBOC.
4. Form 8-K
Date of Report: December 4, 1998 Date Filed: December 4, 1998
Item 5. Other Events
--------------------
The Registrant filed certain information regarding the Company
and HBOC in connection with the merger agreement between McKesson
Corporation and HBOC.
20
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
McKESSON HBOC, Inc.
(Registrant)
Dated: February 12, 1999 By /s/ Richard H. Hawkins
Richard H. Hawkins
Executive Vice President and
Chief Financial Officer
By /s/ Heidi E. Yodowitz
Heidi E. Yodowitz
Senior Vice President and Controller
21
<PAGE>
EXHIBIT INDEX
Exhibit
Number Description
- -------------- --------------------------------------------------------
12.1 Computation of Ratio of Earnings to Fixed Charges and
Earnings to Combined Fixed Charges and Preferred Stock
Dividends.
27 Financial Data Schedule
22
<PAGE>
EXHIBIT 12.1
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES AND EARNINGS TO COMBINED
FIXED CHARGES AND PREFERRED STOCK DIVIDENDS
(dollars in millions)
<TABLE>
Nine Months Ended
December 31,
----------------------------
1998 1997
---------- ----------
<S> <C> <C>
Net Income $ 93.7 $ 119.2
Taxes on Income and Tax Benefit of Dividends on
Preferred Securities of Subsidiary Grantor Trust
of $3.0 in 1998 and 1997 57.6 71.3
Fixed Charges (1) 115.7 95.4
-------- -------
Earnings Available for Fixed Charges $ 267.0 $ 285.9
======== =======
Fixed Charges (1) $ 115.7 $ 95.4
Preferred Stock Dividends - -
-------- -------
Combined Fixed Charges and Preferred Stock
Dividends $ 115.7 $ 95.4
======== =======
Ratio of Earnings to Fixed Charges 2.31x 3.00x
======== =======
Ratio of Earnings to Combined Fixed Charges and
Preferred Stock Dividends 2.31x 3.00x
======== =======
<FN>
(1) Fixed charges consist of interest expense incurred, the portion of rental
expense under operating leases deemed by the Company to be representative
of the interest factor and dividends on preferred securities of a
subsidiary grantor trust.
</FN>
</TABLE>
<PAGE>
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<NAME> MCKESSON HBOC
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0
0
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</TABLE>
