<PAGE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
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 quarter ended September 30, 1999
[_] 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)
<TABLE>
<C> <S>
Delaware 94-3207296
(State or other jurisdiction of incorporation (IRS Employer Identification No.)
or organization)
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 the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
<CAPTION>
Class Outstanding at September 30, 1999
----- ---------------------------------
<C> <S>
Common stock, $.01 par value 281,592,000 shares
</TABLE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>
McKESSON HBOC, INC.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Item Page
---- -----
PART I. FINANCIAL INFORMATION
<C> <S> <C>
1. Condensed Financial Statements
Consolidated Balance Sheets
September 30, 1999 and March 31, 1999........................... 3-4
Statements of Consolidated Income
Three and six month periods ended September 30, 1999 and 1998... 5
Statements of Consolidated Cash Flows
Six month periods ended September 30, 1999 and 1998............. 6
Financial Notes.................................................. 7-13
2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Financial Review................................................. 14-25
3. Quantitative and Qualitative Disclosures about Market Risk....... 25
PART II. OTHER INFORMATION
1. Legal Proceedings................................................ 26
4. Submission of Matters to a Vote of Security Holders.............. 26
6. Exhibits and Reports on Form 8-K................................. 26
</TABLE>
2
<PAGE>
PART I. FINANCIAL INFORMATION
McKESSON HBOC, INC.
CONSOLIDATED BALANCE SHEETS
(unaudited)
<TABLE>
<CAPTION>
September 30, March 31,
1999 1999
------------- ---------
(in millions)
<S> <C> <C>
ASSETS
Current Assets
Cash and cash equivalents............................ $ 179.0 $ 240.8
Marketable securities available for sale (Note 2).... 28.1 28.2
Receivables.......................................... 2,743.6 2,583.7
Inventories.......................................... 3,679.8 3,529.0
Prepaid expenses..................................... 167.0 117.8
-------- --------
Total.............................................. 6,797.5 6,499.5
Property, Plant and Equipment
Land................................................. 49.0 50.7
Buildings, machinery and equipment................... 1,396.1 1,324.3
-------- --------
Total.............................................. 1,445.1 1,375.0
Accumulated depreciation............................. (715.2) (681.0)
-------- --------
Net................................................ 729.9 694.0
Capitalized Software................................... 116.0 106.9
Notes Receivable....................................... 108.0 73.4
Goodwill and Other Intangibles......................... 1,224.4 1,228.4
Other Assets (Note 3).................................. 521.6 479.4
-------- --------
Total Assets....................................... $9,497.4 $9,081.6
======== ========
</TABLE>
(Continued)
See Financial Notes.
3
<PAGE>
McKESSON HBOC, INC.
CONSOLIDATED BALANCE SHEETS
(unaudited)
<TABLE>
<CAPTION>
September 30, March 31,
1999 1999
------------- ---------
(in millions, except
par value)
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Drafts payable....................................... $ 361.3 $ 425.5
Accounts payable--trade.............................. 2,965.1 3,154.2
Deferred revenue..................................... 300.4 408.6
Short-term borrowings................................ 662.5 16.7
Current portion of long-term debt.................... 192.4 195.3
Salaries and wages................................... 100.1 101.2
Taxes................................................ 119.8 95.2
Interest and dividends............................... 32.8 34.7
Other................................................ 370.7 368.7
-------- --------
Total.............................................. 5,105.1 4,800.1
-------- --------
Postretirement Obligations and Other Noncurrent
Liabilities........................................... 254.9 258.6
-------- --------
Long-Term Debt (Note 2)................................ 929.8 945.5
-------- --------
McKesson HBOC-obligated mandatorily redeemable
convertible preferred securities of subsidiary grantor
trust whose sole assets are junior subordinated
debentures of McKesson HBOC (Note 4).................. 195.7 195.6
-------- --------
Stockholders' Equity
Common stock (400.0 shares authorized, 282.1 issued
as of September 30, 1999, and 281.1 issued as of
March 31, 1999; par value $0.01).................... 2.8 2.8
Additional paid-in capital........................... 1,747.6 1,725.7
Other capital........................................ (101.7) (107.7)
Retained earnings.................................... 1,561.3 1,465.0
Accumulated other comprehensive loss (Note 7)........ (59.1) (57.7)
ESOP notes and guarantees............................ (107.1) (115.5)
Treasury shares, at cost............................. (31.9) (30.8)
-------- --------
Total Stockholders' Equity......................... 3,011.9 2,881.8
-------- --------
Total Liabilities and Stockholders' Equity......... $9,497.4 $9,081.6
======== ========
</TABLE>
(Concluded)
See Financial Notes.
4
<PAGE>
McKESSON HBOC, INC.
STATEMENTS OF CONSOLIDATED INCOME
(unaudited)
<TABLE>
<CAPTION>
Three Months
Ended Six Months Ended
September 30, September 30,
------------------ --------------------
1999 1998 1999 1998
-------- -------- --------- ---------
(in millions, except per share
amounts)
<S> <C> <C> <C> <C>
REVENUES............................. $9,050.1 $7,337.3 $17,747.5 $13,620.6
-------- -------- --------- ---------
COSTS AND EXPENSES
Cost of sales...................... 8,399.5 6,704.4 16,446.8 12,374.8
Selling, distribution, research and
development and administration
(Note 5).......................... 523.0 555.7 1,024.1 1,020.9
Interest........................... 28.7 29.9 61.3 60.8
-------- -------- --------- ---------
Total............................ 8,951.2 7,290.0 17,532.2 13,456.5
-------- -------- --------- ---------
INCOME BEFORE INCOME TAX EXPENSE AND
DIVIDENDS ON PREFERRED SECURITIES OF
SUBSIDIARY TRUST.................... 98.9 47.3 215.3 164.1
INCOME TAXES......................... (38.0) (19.5) (82.8) (65.6)
DIVIDENDS ON PREFERRED SECURITIES OF
SUBSIDIARY TRUST.................... (1.6) (1.5) (3.1) (3.1)
-------- -------- --------- ---------
NET INCOME........................... $ 59.3 $ 26.3 $ 129.4 $ 95.4
======== ======== ========= =========
EARNINGS PER COMMON SHARE (Note 8)
Diluted............................ $ 0.21 $ 0.10 $ 0.46 $ 0.34
Basic.............................. 0.21 0.10 0.46 0.35
DIVIDENDS PER COMMON SHARE........... $ 0.06 $ 0.125 $ 0.12 $ 0.25
SHARES ON WHICH EARNINGS PER COMMON
SHARE WERE BASED
Diluted............................ 289.4 289.9 290.2 289.2
Basic.............................. 281.1 274.6 280.9 273.5
</TABLE>
See Financial Notes.
5
<PAGE>
McKESSON HBOC, INC.
STATEMENTS OF CONSOLIDATED CASH FLOWS
(unaudited)
<TABLE>
<CAPTION>
Six Months Ended
September 30,
------------------
1999 1998
-------- --------
(in millions)
<S> <C> <C>
Operating Activities
Net income................................................ $ 129.4 $ 95.4
Adjustments to reconcile to net cash used by operating ac-
tivities:
Depreciation............................................. 71.3 63.9
Amortization............................................. 46.3 35.9
Provision for bad debts.................................. 7.6 35.5
Deferred taxes on income................................. (25.5) (7.5)
Other non-cash items..................................... 33.0 16.5
-------- --------
Total................................................... 262.1 239.7
-------- --------
Effects of changes in:
Receivables.............................................. (166.8) (514.6)
Inventories.............................................. (155.2) (624.1)
Accounts and drafts payable.............................. (297.5) 729.6
Taxes.................................................... 36.8 0.3
Deferred revenue......................................... (84.1) (7.4)
Other.................................................... (33.4) 0.7
-------- --------
Total................................................... (700.2) (415.5)
-------- --------
Net cash used by operating activities..................... (438.1) (175.8)
-------- --------
Investing Activities
Purchases of marketable securities........................ (155.5) (25.8)
Maturities of marketable securities....................... 155.0 75.3
Property acquisitions..................................... (111.4) (115.6)
Properties sold........................................... 6.5 18.5
Acquisitions of businesses, less cash and short-term in-
vestments acquired....................................... (22.7) (57.6)
Other..................................................... (112.1) (63.1)
-------- --------
Net cash used by investing activities..................... (240.2) (168.3)
-------- --------
Financing Activities
Proceeds from issuance of debt............................ 667.7 552.1
Repayment of debt......................................... (36.5) (161.9)
Dividends paid on preferred securities of subsidiary
trust.................................................... (5.0) (5.0)
Capital stock transactions
Issuances................................................ 16.6 140.5
ESOP notes and guarantee................................. 8.5 (0.6)
Dividends paid........................................... (33.7) (39.3)
Other.................................................... (1.1) (0.6)
-------- --------
Net cash provided by financing activities............... 616.5 485.2
-------- --------
Net Increase (Decrease) in Cash and Cash Equivalents....... (61.8) 141.1
-------- --------
Cash and Cash Equivalents at beginning of period........... 240.8 566.3
-------- --------
Cash and Cash Equivalents at end of period................. $ 179.0 $ 707.4
======== ========
</TABLE>
See Financial Notes.
6
<PAGE>
McKESSON HBOC, INC.
FINANCIAL NOTES
(unaudited)
1. Interim Financial Statements
In the opinion of McKesson HBOC, Inc. (the "Company"), these unaudited
condensed consolidated financial statements include all adjustments necessary
for a fair presentation of its financial position as of September 30, 1999,
the results of its operations for the three and six months ended September 30,
1999 and 1998 and its cash flows for the six months ended September 30, 1999
and 1998.
The results of operations for the three and six months ended September 30,
1999 and 1998 are not necessarily indicative of the results for the full
years.
These interim financial statements should be read in conjunction with the
annual audited financial statements, accounting policies and financial notes
thereto included in the Company's 1999 Consolidated Financial Statements which
have previously been filed with the Securities and Exchange Commission (the
"SEC").
2. Marketable Securities
The September 30, 1999 marketable securities balance includes $20 million
held in trust as exchange property for the Company's $33.3 million principal
amount of 4.5% exchangeable subordinated debentures which remain outstanding.
3. Investments
Other Assets include the Company's $22.9 million equity investment in WebMD
(an internet-based provider of products and services to physicians, other
healthcare providers and consumers), which has been accounted for under the
cost method. On November 11, 1999, Healtheon Corporation completed a merger
with WebMD, Inc. whereby the Company received 4,518,413 shares of
Healtheon/WebMD common stock in exchange for its shares of WebMD. Based on the
closing price of $42 7/16 on November 11, 1999, the market value of the
Company's investment in Healtheon/WebMD common stock totaled $191.8 million.
Additionally, the Company owns warrants to acquire 8,419,734 shares of
Healtheon/WebMD nonvoting common stock with exercise prices ranging from
$11.14 to $50.86 which expire on September 1, 2004.
4. 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 HBOC 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 in 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
HBOC common stock, subject to adjustment in certain circumstances. If not
converted, 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 on the preferred securities (the "Guarantee"). The
Guarantee, when taken together with the Company's obligations
7
<PAGE>
McKESSON HBOC, INC.
FINANCIAL NOTES--(Continued)
(unaudited)
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.
5. Charges in Continuing Operations
On January 12, 1999, McKesson Corporation ("McKesson") completed the
acquisition of HBO & Company ("HBOC"), a leading health care information
technology company, by exchanging 177 million shares of McKesson common stock
for all of the issued and outstanding common stock of HBOC. The transaction
was accounted for as a pooling of interests. In April 1999, the Company
discovered improper accounting practices at HBOC (see Financial Note 10). In
July, the Audit Committee of the Company's Board of Directors completed an
investigation into such matters (the "Investigation"), which resulted in the
restatement of the Company's historical consolidated financial statements
related to HBOC (pre-merger) in fiscal 1999, 1998, and 1997.
In fiscal 2000, the Company incurred costs in connection with the
Investigation and the resulting restatement of the historical consolidated
financial statements. The Company recorded associated accounting and legal
fees and other pre-tax costs totaling $8.7 million and $15.0 million in the
quarter and six months ended September 30, 1999, respectively. The Company
also incurred $12.1 million and $32.3 million in severance and other costs
associated with former employees, during the quarter and six month periods,
respectively, and during the quarter ended September 30, 1999, recorded $5.0
million of other acquisition-related costs.
During the quarter and six month periods ended September 30, 1998, the
Company incurred pre-tax charges totaling $72.4 million and $82.8 million in
the Health Care Supply Management, Health Care Information Technology and
Water Products segments. These charges included transaction costs, employee
benefit change in control provisions, employee severance, restructuring,
integration and system installation costs associated with acquisition-related
activities. In addition, these charges included amounts for asset impairments
of $9.1 million in the quarter and $10.6 million in the six months. Also, the
Health Care Supply Management segment recorded $4.9 million in the six month
period related to the terminated merger transaction with AmeriSource
Corporation.
6. Restructuring and Asset Impairments
In fiscal 1999, the Company identified six pharmaceutical distribution
centers in the Health Care Supply Management segment for closure, one of which
was shut down by fiscal year end. During the six months ended September 30,
1999, the Company completed the closures of two more of these pharmaceutical
distribution centers, resulting in the termination of approximately 60
employees and the payment of $0.5 million in severance. In addition, the
realignment of the sales organization was completed and certain back office
functions were eliminated resulting in the termination of approximately 70
employees and the payment of $1.3 million in severance. Additionally, the
Company paid $0.4 in severance to approximately 50 employees who were
terminated in fiscal 1999 and 2000 relating to the elimination of duplicate
functions in the medical/surgical distribution business. The Company plans to
continue the closure activities associated with the pharmaceutical
distribution centers, and other medical/surgical distribution centers, all of
which were identified for closure in fiscal 1999, in the second half of fiscal
2000 and first half of fiscal 2001. At September 30, 1999, assets associated
with the restructuring plans, primarily distribution center buildings and
improvements, totaled $7.4 million (net of asset valuation reserves). In the
Health Care Information Technology segment, $8.2 million of severance was paid
in the six month period to approximately 550 employees who were terminated in
fiscal 1999 (under agreements providing for payments over an extended period
of time through fiscal 2002). The Water
8
<PAGE>
McKESSON HBOC, INC.
FINANCIAL NOTES--(Continued)
(unaudited)
Products segment paid $0.7 million in severance to approximately 70 employees
during the six months ended September 30, 1999. In the second half of fiscal
2000, the Company plans to complete the closure of a bottling facility
acquired in fiscal 1999.
A reconciliation of the reserves for the restructuring plans from March 31,
1999 to September 30, 1999, by operating segment, follows (in millions):
<TABLE>
<CAPTION>
Health Care
Information
Health Care Supply Management Technology Water Products
----------------------------- ------------------ ------------------
Other Other Other
Asset Exit- Exit- Exit-
Severance Impairments Related Severance Related Severance Related Total
--------- ----------- ------- --------- -------- --------- -------- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, March 31,
1999................... $10.6 $35.0 $19.0 $12.2 $ 0.6 $ 1.4 $0.4 $ 79.2
Severance amounts paid
during the period...... (2.2) (8.2) (0.7) (11.1)
Asset dispositions (non-
cash).................. (5.5) (5.5)
Other primarily exit-
related costs paid
during the period...... (1.1) (0.3) (1.4)
----- ----- ----- ----- ----- ----- ---- ------
Balance, September 30,
1999................... $ 8.4 $29.5 $17.9 $ 4.0 $ 0.3 $ 0.7 $0.4 $ 61.2
===== ===== ===== ===== ===== ===== ==== ======
</TABLE>
The remaining balances at September 30, 1999 relate primarily to charges
recorded in fiscal 1999, with the exception of $8.7 million of asset
impairment reserves and $1.8 million of exit-related reserves that relate to
the fiscal 1997 plan. The reserves for other exit-related items consist of
costs for preparing facilities for disposal, lease costs and property taxes
required subsequent to termination of operations.
7. Comprehensive Income
Comprehensive income is defined as all changes in stockholders' equity from
non-owner 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 six months ended September 30, 1999 and 1998 is as follows:
<TABLE>
<CAPTION>
Six Months
Three Months Ended Ended
September 30, September 30,
-------------------- ---------------
1999 1998 1999 1998
--------- --------- ------- ------
(in millions)
<S> <C> <C> <C> <C>
Net income.......................... $ 59.3 $ 26.3 $ 129.4 $ 95.4
Unrealized gain on marketable
securities......................... 0.1 0.1 0.1 0.1
Foreign currency translation
adjustments........................ (1.2) (1.2) (1.5) (3.0)
--------- --------- ------- ------
$ 58.2 $ 25.2 $ 128.0 $ 92.5
========= ========= ======= ======
</TABLE>
9
<PAGE>
McKESSON HBOC, INC.
FINANCIAL NOTES--(Continued)
(unaudited)
8. Earnings Per Share
The following is a reconciliation of the numerators and denominators of the
basic and diluted earnings per common share computations:
<TABLE>
<CAPTION>
Three Months Ended
-----------------------------------------------
September 30, 1999 September 30, 1998
----------------------- -----------------------
(in millions, except per share amounts)
Income Shares Per Share Income Shares Per Share
------ ------ --------- ------ ------ ---------
<S> <C> <C> <C> <C> <C> <C>
Basic EPS
Net Income................ $ 59.3 281.1 $0.21 $26.3 274.6 $0.10
===== =====
Effect of Dilutive
Securities
Options to purchase common
stock.................... 2.8 9.5
Trust convertible
preferred securities..... 1.6 5.4 1.5 5.4
Restricted stock.......... 0.1 0.4
------ ----- ----- -----
Diluted EPS
Income available to common
stockholders plus assumed
conversions.............. $ 60.9 289.4 $0.21 $27.8 289.9 $0.10
====== ===== ===== ===== ===== =====
<CAPTION>
Six Months Ended
-----------------------------------------------
September 30, 1999 September 30, 1998
----------------------- -----------------------
(in millions, except per share amounts)
Income Shares Per Share Income Shares Per Share
------ ------ --------- ------ ------ ---------
<S> <C> <C> <C> <C> <C> <C>
Basic EPS
Net Income................ $129.4 280.9 $0.46 $95.4 273.5 $0.35
===== =====
Effect of Dilutive
Securities
Options to purchase common
stock.................... 3.8 9.8
Trust convertible
preferred securities..... 3.1 5.4 3.1 5.4
Restricted stock.......... 0.1 0.5
------ ----- ----- -----
Diluted EPS
Income available to common
stockholders plus assumed
conversions.............. $132.5 290.2 $0.46 $98.5 289.2 $0.34
====== ===== ===== ===== ===== =====
</TABLE>
9. New Accounting Pronouncements
The Company adopted Statement of Position No. 98-1, "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use" as of
April, 1, 1998. The impact of the adoption was not material to the Company's
consolidated financial position, results of operations or cash flows.
In 1998, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which established accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts (collectively referred to as
derivatives) and for hedging activities. It requires that an entity recognize
all derivatives as either assets or liabilities in the statement of financial
position and measure these instruments at fair value. In June 1999, the FASB
issued SFAS No. 137, "Accounting for
10
<PAGE>
McKESSON HBOC, INC.
FINANCIAL NOTES--(Continued)
(unaudited)
Derivative Instruments and Hedging Activities--Deferral of the Effective Date
of FASB Statement No. 133" which defers the effective date of SFAS No. 133
until the Company's fiscal year 2002. The Company is currently evaluating what
impact, if any, SFAS No. 133 may have on its consolidated financial
statements.
10. Litigation
Since the Company's announcement on April 28, 1999 regarding accounting
improprieties at HBOC (the "Announcement"), and as of November 11, 1999,
fifty-eight class action lawsuits, three derivative actions, and four
individual actions have been filed against the Company and certain current or
former officers and directors of the Company.
Fifty-five of the actions were filed in Federal Court (the "Federal
Actions") alleging violations of the federal securities laws and seeking
unspecified damages. Of the fifty-five Federal Actions, fifty-four are class
actions and one is a derivative action. One of the class actions has been
voluntarily dismissed. On November 2, 1999, the United States District Court
for the Northern District of California (the "District Court") issued an Order
consolidating all of the Federal Actions, with the exception of the derivative
action and the class action that has been voluntarily dismissed, into one
action entitled In re McKesson HBOC, Inc. Securities Litigation. The District
Court has reserved decision on the consolidation of the derivative action. The
Company expects the District Court to appoint a Lead Plaintiff who will then
be required to file a Consolidated and Amended Complaint, after which the
Company will be required to respond.
Ten additional actions have been filed in various state courts (the "State
Actions"), including Delaware, California, and Pennsylvania. Of these, two are
derivative actions, one of which is pending in California Superior Court
(Mitchell v. McCall, et al. ("Mitchell")) and the other in the Delaware Court
of Chancery (Fine v. McCall, et al. ("Fine")). Since the filing of the
Company's 1999 Form 10-K in which these actions were originally described, the
Company has moved to dismiss Fine, which motion is pending, and is required to
respond to Mitchell by December 20, 1999. Four individual actions have been
filed, two of which, Yurick v. McKesson HBOC, et al. ("Yurick") and Grant v.
McKesson HBOC, Inc., et al. ("Grant") were originally described in the
Company's 1999 Form 10-K. Since the filing of the 1999 Form 10-K, Yurick has
been stayed pending the commencement of discovery in the consolidated Federal
Actions and the Company is required to respond to Grant by November 24, 1999.
Of the remaining two individual actions, one is pending in Delaware Superior
Court in New Castle County (Kelly v. McKesson HBOC, et al.), to which the
Company must respond by November 17, 1999, and the other has been filed in the
California Superior Court in San Francisco but has not yet been served on the
Company (The State of Oregon v. McKesson HBOC, Inc., et al.), to which the
Company is not currently required to respond. Four purported class actions
have been filed in the courts of Delaware. Two, filed in the Delaware Court of
Chancery, purport to be brought on behalf of holders of McKesson Corporation
stock at the time of the merger with HBOC. The Company has moved to dismiss or
to stay these two actions, and the motions are pending. Of the remaining two
purported class actions, one, brought on behalf of a class of holders of the
shares of Access Health Inc. at the time of its merger with HBOC, was filed in
the Delaware Court of Chancery and was subsequently removed to Federal Court
in the District of Delaware. The Company has moved to dismiss this action, and
the plaintiffs have moved to remand the action back to state court. Both
motions are pending. The last purported class action, brought on behalf of a
class of holders of US Servis Corp. shares at the time of its merger with
HBOC, was filed in the Delaware Superior Court in New Castle County and was
subsequently removed to Federal Court in the District of Delaware. The
plaintiffs have moved to remand this action back to state court, and the
motion is pending. The State Actions allege breaches of fiduciary duty and
other causes of action arising out of the Announcement and seek unspecified
damages.
11
<PAGE>
McKESSON HBOC, INC.
FINANCIAL NOTES--(Continued)
(unaudited)
In addition, the United States Attorney's Office for the Northern District
of California and the San Francisco District Office of the SEC have also
commenced investigations in connection with the matters relating to the
restatement of previously reported amounts for HBOC described in Financial
Note 5. These investigations are ongoing.
The Company does not believe it is feasible to predict or determine the
outcome or resolution of these proceedings, or to estimate the amounts of, or
potential range of loss with respect to these proceedings. In addition, the
timing of the final resolution of these proceedings is uncertain. The range of
possible resolutions of these proceedings could include judgments against the
Company or settlements, that could require substantial payments by the Company
which could have a material adverse impact on the Company's financial
position, results of operations and cash flows.
In October 1999, the Company was named as a defendant in an action entitled
American Healthcare Fund II, L.P., et al. v. HBO & Company and McKesson HBOC,
Inc. filed in the District Court of Colorado, Boulder County (the "Colorado
Action"). The Colorado Action seeks damages for alleged breaches of contracts
and related common law torts, including the alleged wrongful inducement of
such breaches, in connection with HBOC's merger in December 1998 with Access
Health Inc. The Company has not yet responded to the Colorado Action.
In December 1998, Salomon Smith Barney ("SSB") filed an action against
McKesson and HBOC in federal district court in New York City claiming
entitlement to, among other things, $50 million in fees in connection with the
January 12, 1999 merger of the two companies. The Company counter claimed on a
number of grounds. In October 1999, the claims and counter claims were
dismissed prior to trial by mutual agreement, and the resolution had no
material impact on the Company.
In Foxmeyer Health Corporation v. McKesson et al, the renewed summary
judgment motions by the Company and other defendants on the four remaining
counts of the complaint which had been pending were denied by the Delaware
bankruptcy court, and the surviving claims of plaintiff (now known as Avatex
Corporation ) are proceeding in the District Court in Dallas County, Texas.
The Company and other defendants have also dismissed their appeal from the
original Texas bankruptcy court order which denied transfer of the then
removed Texas Action to Delaware.
Except for the matters discussed above, there have not been any significant
changes with respect to the litigation matters described in Financial Note 19
to the Company's Annual Report on Form 10-K/A for the fiscal year ended March
31, 1999.
12
<PAGE>
McKESSON HBOC, INC.
FINANCIAL NOTES--(Concluded)
(unaudited)
11. Segment Information
The Company's chief operating decision makers who determine the allocation
of resources and evaluate the financial performance of the operating segments
are the Co-Chief Executive Officers. In evaluating financial performance,
management focuses on operating profit as a segment's measure of profit or
loss. Operating profit is income before interest expense, corporate interest
income, taxes on income and allocation of certain corporate revenues and
expenses. There have been no changes in the segments reported or the basis of
measurement of segment profit or loss from that which was reported in the
Company's 1999 Annual Report on Form 10-K. Financial information relating to
the Company's reportable segments for the three and six months ended September
30, 1999 and 1998, and as of September 30, 1999 and March 31, 1999, is
presented below:
<TABLE>
<CAPTION>
Three Months
Ended Six Months Ended
September 30, September 30,
------------------ --------------------
1999 1998 1999 1998
-------- -------- --------- ---------
(in millions)
<S> <C> <C> <C> <C>
Revenues
Health Care Supply Management.... $8,624.8 $6,837.8 $16,903.4 $12,657.7
Health Care Information
Technology...................... 311.7 385.2 629.1 754.7
Water Products................... 110.7 105.1 209.3 188.1
Corporate........................ 2.9 9.2 5.7 20.1
-------- -------- --------- ---------
Total........................... $9,050.1 $7,337.3 $17,747.5 $13,620.6
======== ======== ========= =========
Operating profit
Health Care Supply Management.... $ 127.0 $ 37.4 $ 252.4 $ 138.0
Health Care Information
Technology...................... 29.9 22.5 86.0 60.6
Water Products................... 18.9 19.2 33.1 31.8
-------- -------- --------- ---------
Total........................... 175.8 79.1 371.5 230.4
Interest--net.................... (26.4) (21.1) (57.5) (42.9)
Corporate and other.............. (50.5) (10.7) (98.7) (23.4)
-------- -------- --------- ---------
Income from continuing
operations before income taxes
and dividends on preferred
securities of subsidiary
trust.......................... $ 98.9 $ 47.3 $ 215.3 $ 164.1
======== ======== ========= =========
</TABLE>
<TABLE>
<CAPTION>
September 30, March 31,
1999 1999
------------- ---------
(in millions)
<S> <C> <C>
Segment assets
Health Care Supply Management....................... $7,286.2 $6,889.7
Health Care Information Technology.................. 1,264.5 1,357.3
Water Products...................................... 263.4 234.0
Corporate........................................... 683.3 600.6
-------- --------
Total.............................................. $9,497.4 $9,081.6
======== ========
</TABLE>
13
<PAGE>
McKESSON HBOC, INC.
FINANCIAL REVIEW
Segment Results
The revenues and operating profits of the Company by business segment are as
follows:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
September 30, September 30,
-------------------------------- ----------------------------------
1999 1998 % Chg. 1999 1998 % Chg.
-------- -------- ------ --------- --------- ------
REVENUES (in millions)
<S> <C> <C> <C> <C> <C> <C>
Health Care Supply
Management
Pharmaceutical
Distribution &
Services
U.S. Health Care(1)... $7,404.5 $5,842.7 26.7 $14,472.5 $10,652.5 35.9
International......... 547.7 475.7 15.1 1,103.2 994.6 10.9
-------- -------- --------- ---------
Total Pharmaceutical
Distribution &
Services............ 7,952.2 6,318.4 25.9 15,575.7 11,647.1 33.7
Medical/Surgical
Distribution &
Services.............. 672.6 519.4 29.5 1,327.7 1,010.6 31.4
-------- -------- --------- ---------
Total Health Care
Supply Management... 8,624.8 6,837.8 26.1 16,903.4 12,657.7 33.5
-------- -------- --------- ---------
Health Care Information
Technology
Software............... 47.3 82.3 (42.5) 99.8 158.6 (37.1)
Services............... 237.0 245.5 (3.5) 481.6 480.2 0.3
Hardware............... 27.4 57.4 (52.3) 47.7 115.9 (58.8)
-------- -------- --------- ---------
Total Health Care
Information
Technology.......... 311.7 385.2 (19.1) 629.1 754.7 (16.6)
-------- -------- --------- ---------
Water Products.......... 110.7 105.1 5.3 209.3 188.1 11.3
Corporate............... 2.9 9.2 5.7 20.1
-------- -------- --------- ---------
Total................... $9,050.1 $7,337.3 23.3 $17,747.5 $13,620.6 30.3
======== ======== ========= =========
OPERATING PROFIT
Health Care Supply
Management............. $ 127.0 $ 37.4 (5) $ 252.4 $ 138.0 (5)
Health Care Information
Technology............. 29.9 22.5 86.0 60.6 (6)
Water Products.......... 18.9 (3) 19.2 (7) 33.1 (3) 31.8 (7)
-------- -------- --------- ---------
Total................... 175.8 79.1 371.5 230.4
Interest--net(2)........ (26.4) (21.1) (57.5) (42.9)
Corporate and other..... (50.5)(4) (10.7) (98.7)(4) (23.4)
-------- -------- --------- ---------
Income from continuing
operations before
income taxes and
dividends on preferred
securities of
subsidiary trust....... $ 98.9 $ 47.3 $ 215.3 $ 164.1
======== ======== ========= =========
</TABLE>
- -------
(1) Includes sales to customers' warehouses of $2,140.5 million and $1,673.0
million in the quarter and $4,301.1 million and $2,600.9 million in the six
months ended September 30, 1999 and 1998, respectively.
(2) Interest expense is shown net of corporate interest income.
(3) Includes charges of $2.1 million primarily for integration costs incurred
in connection with fiscal 1999 acquisitions.
(4) Includes accounting and legal fees and other costs totaling $8.7 million
and $15.0 million incurred in the quarter and six months ended
September 30, 1999, in connection with the restatement of prior year
financial statements. Also includes $12.1 million and $32.3 million
incurred in the quarter and six months ended September 30, 1999, in
severance and other costs associated with former employees. In addition,
the quarter ended September 30, 1999 includes $2.9 million of acquisition-
related costs.
(5) Includes charges of $70.9 million and $73.7 million in the quarter and six
months ended September 30, 1998, associated with acquisitions including
transaction costs, employee benefit change in control provisions and
restructuring, integration and system installation costs associated with
acquisition-related activities. The six months ended September 30, 1998
also includes charges of $4.9 million for the terminated merger transaction
with AmeriSource Corporation.
(6) Includes charges of $7.6 million primarily for severance associated with
acquisitions.
(7) Includes charges of $1.5 million for transaction costs and restructuring
and integration costs associated with acquisitions.
14
<PAGE>
McKESSON HBOC, INC.
FINANCIAL REVIEW--(Continued)
Factors Affecting Forward Looking Statements
In addition to historical information, management's discussion and analysis
includes certain forward-looking statements within the meaning of Section 27A
of the Securities Act of 1933, as amended (the "Securities Act") and section
21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act").
Some of the forward-looking statements can be identified by the use of forward
looking words such as "believes", "expects", "anticipates", "may", "will",
"should", "seeks", "approximately", "intends", "plans", "estimates", or
"anticipates", or the negative of these words or other comparable technology.
The discussion of financial trends, strategy, plans or intentions may also
include forward-looking statements. Forward-looking statements involve risks
and uncertainties that could cause actual results to differ materially from
those projected. These include, but are not limited to the factors discussed
under "Year 2000" and "Additional Factors That May Affect Future Results" of
this "Financial Review."
These and other risks and uncertainties are described herein or in the
Company's other public documents. Readers are cautioned not to place undue
reliance on these forward-looking statements, which speak only as of the date
hereof. The Company undertakes no obligation to publicly release the result of
any revisions to these forward-looking statements to reflect events or
circumstances after the date hereof or to reflect the occurrence of
unanticipated events.
Overview of Results
Net income for the second quarter increased to $59.3 million, $0.21 per
diluted share, from $26.3 million, $0.10 per share, in the prior year. For the
six month period, net income increased to $129.4 million, $0.46 per diluted
share, compared to $95.4 million, $0.34 per share, in the prior year. Included
in the current year results were $15.9 million in the quarter, and $32.2
million in the half, in after-tax accounting and legal fees and other costs
incurred in connection with the Audit Committee Investigation into improper
accounting practices at HBOC which resulted in the restatement of the Health
Care Information Technology segment's prior year financial statements,
severance and other costs associated with former employees, and other
acquisition-related costs. The prior year's results included $45.7 million in
the quarter and $56.7 million in the half in after-tax charges associated with
completed and terminated acquisition transactions including transaction costs,
employee benefit change in control provisions, employee severance, and
restructuring, integration and system installation costs.
The effective income tax rate applicable to continuing operations for the
six months ended September 30, 1999 differed from the effective income tax
rate for the comparable prior year period primarily due to certain
nondeductible transaction expenses included in the prior year 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 95% of consolidated revenues for the three and six month periods ended
September 30, 1999.
Pharmaceutical Distribution & Services revenues increased by 26% to $8.0
billion in the quarter and 34% to $15.6 billion in the six months, reflecting
growth in the U.S. direct delivery business of 26% in both the quarter and six
months, an increase in U.S. sales to customers' warehouses of 28% and 65%,
respectively, and an increase in international revenues of 15% and 11%,
respectively. Internal growth in the U.S. direct delivery business was 25% in
both the quarter and six month periods.
Medical/Surgical Distribution & Services revenues increased 29% to $672.6
million in the quarter and 31% to $1,327.7 million in the six month period.
Fiscal 2000 results included revenues of $101.3 million in the quarter
15
<PAGE>
McKESSON HBOC, INC.
FINANCIAL REVIEW--(Continued)
and $198.6 million in the six months from Red Line HealthCare which was
acquired in a purchase transaction in the third quarter of fiscal 1999.
Excluding the effect of this acquisition, revenues increased 10% in the
quarter and 12% in the six months.
Health Care Supply Management operating profit increased $89.6 million in
the quarter and $114.4 million in the six months. The prior year's results
included charges of $70.9 million in the quarter and $73.7 in the six month
period, associated with acquisitions including transaction costs, employee
benefit change in control provisions and restructuring, integration and system
installation costs. The six months ended September 30, 1998 also included
charges of $4.9 million for the terminated merger transaction with AmeriSource
Corporation. Excluding the effect of such charges in the prior year periods,
operating profit for the Health Care Supply Management segment increased by
17% in both the second quarter and first half of fiscal 2000. Operating profit
as a percent of revenues (calculated excluding sales to customers' warehouses
and the previously discussed prior year charges) declined 14 basis points to
1.96% in the second quarter and 15 basis points to 2.00% in the six months,
compared to the respective prior year margins. The period-to-period
comparisons were negatively affected by a large number of new and renewal
customer agreements signed in a concentrated period and a delay in timing of
pharmaceutical price increases, partially offset by continuing improvements in
operating expense ratios. In addition, the current year's first half included
a bad debt provision for a long-term care customer.
Health Care Information Technology
The Health Care Information Technology segment includes revenues from
software sales, services business and hardware sales. This segment accounted
for 3% and 4% of consolidated revenues for the quarter and six month periods
ended September 30, 1999, respectively.
Management believes that the overall decline in revenues of 19% in the
quarter and 17% in the six month period reflects the continuing general,
industry-wide slowdown in sales of health care information technology software
and hardware products resulting from delays in purchasing decisions that are
attributed both to Year 2000 issues and general market conditions. Also
contributing to the decline in the first half was the disruption to this
business caused by the completed Audit Committee Investigation (See Financial
Note 5) and Health Care Information Technology senior management changes made
during the first half of this fiscal year.
Operating profit increased by $7.4 million in the quarter and by $25.4
million in the six months. Excluding the impact of charges totaling $7.6
million for severance associated with acquisitions in the prior year's six
month period, operating profit increased by 33% in the quarter and 26% in the
six months. The operating profit margin, excluding the impact of the severance
charges in the prior year, improved to 9.59% and 13.67% in the quarter and
first half, compared to 5.84% and 9.04% in the prior year respective periods.
The improvement reflects a high level of bad debt provisions and other expense
items in the prior year. The favorable year-over-year operating profit margin
comparison is not expected to continue in the second half as strategic product
development and customer service expenditures increase.
Management expects an increased level of contract negotiations and sales
activity as the effects of Year 2000 issues diminish. Revenues may be
augmented by the recognition of certain revenues previously reversed as a
result of the Audit Committee Investigation and resulting restatements.
Water Products
Water Products revenues increased 5% and 11% in the second quarter and
first half, reflecting, in part, dampened demand for products because of an
unusually cool summer in California, the segment's largest market. Operating
profit declined by $0.3 million in the quarter and increased by $1.3 million
in the half. The quarter and six month periods ended September 30, 1999
included $2.1 million in charges primarily for integration costs
16
<PAGE>
McKESSON HBOC, INC.
FINANCIAL REVIEW--(Continued)
incurred in connection with fiscal 1999 acquisitions. The quarter and six
month periods ended September 30, 1998 included $1.5 million in charges for
transaction costs and restructuring and integration costs associated with
acquisitions. Excluding the effect of these charges, Water Products segment
operating profit increased 1% and 6% in the quarter and six month periods.
Operating profit, as a percent of revenues (excluding the previously discussed
charges) declined to 18.97% in the second quarter and to 16.82% in the half
compared to the respective prior year margins of 19.70% and 17.70% reflecting
the increase in the mix of lower-margin packaged water business.
Other
In the second quarter and six months ended September 30, 1999, Corporate
expense included charges of $23.7 million and $50.2 million, respectively,
consisting of professional fees incurred in connection with the previously
discussed Audit Committee Investigation and resulting restatement of prior
year financial statements, severance benefits and other costs associated with
former employees and other acquisition-related costs. Corporate expense also
reflects higher expenses for certain employee benefits (required to maintain a
desired level of benefits to employees despite a decline in the stock price),
affiliation costs incurred in the six months, and transaction costs associated
with the Company's committed receivables sales facility.
Liquidity and Capital Resources
Cash and marketable securities available for sale were $207.1 million at
September 30, 1999 and $269.0 million at March 31, 1999. The September 30,
1999 marketable securities balance included $20.3 million that is currently
restricted and held in trust as exchange property in connection with the
Company's outstanding exchangeable debentures.
The decline in accounts and drafts payable at September 30, 1999 compared
to March 31, 1999 is due to the timing of payments to vendors. At March 31,
1999, vendor payables were unusually high relative to inventory both as a
result of purchases made late in the fiscal year and the timing of certain
supplier payments in the Supply Management Business. The increase in accounts
and drafts payable at September 30, 1998, compared to March 31, 1998 is due to
accelerated payments in the medical/surgical distribution business at March
31, 1998, in order to take advantage of cash discounts with certain vendors,
and the timing of payments in the U.S. pharmaceutical distribution business.
Interest expense, net of interest income, increased to $26.4 million in the
second quarter and to $57.5 million in the six month period compared to $21.1
million and $42.9 million in the prior year periods. The increases from the
prior year reflect increased average working capital to support strong Supply
Management growth, cash paid in the second half of fiscal 1999 for
acquisitions and lower cash flows from the Health Care Information Technology
segment.
Stockholders' equity was $3.0 billion at September 30, 1999, and the net
debt-to-capital ratio was 33%, up from 22% at March 31, 1999. The net debt-to-
capital ratio for both periods was computed by reducing the outstanding debt
amount by the cash and marketable securities balances at the end of the
period. The increase in the ratio is due primarily to funds required for the
previously discussed growth in working capital and prior year acquisitions.
Return on committed capital [earnings before interest expense-net of corporate
interest income, income taxes and amortization of intangibles, divided by
average committed capital (capital employed less cash and cash equivalents,
marketable securities and intangibles)] for the twelve months ended September
30, 1999 declined to 24% from 27% a year ago.
In October 1999, Duff & Phelps, an agency that rates the Company's debt,
lowered the Company's senior debt rating to BBB+ from A-, and reaffirmed the
Company's commercial paper rating of D-2. The Company's ratings from S&P and
Moodys of BBB+ and Baa1, respectively, for senior debt and A-2 and P-2,
respectively,
17
<PAGE>
McKESSON HBOC, INC.
FINANCIAL REVIEW--(Continued)
for commercial paper, remain unchanged from those disclosed in the Company's
1999 Annual Report on Form 10-K. The Company's ratings from all three agencies
remain on negative outlook. Also in October 1999, the Company terminated its
$800 million 364-day revolving credit facility and replaced it with an $850
million 364-day revolving credit facility, provided by substantially the same
group of banks. At the same time, the Company terminated its $575 million
bridge loan facility which it had acquired in May, 1999.
Common shares outstanding increased to 281.6 million at September 30, 1999
from 280.6 million at March 31, 1999 due primarily to shares issued under
employee benefit plans. Average diluted shares declined to 289.4 million in
the second quarter of fiscal 2000 from 289.9 million in the comparable prior
year period due to a lower effect of dilutive securities as a result of the
stock price decline (See Financial Note 8).
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.
18
<PAGE>
McKESSON HBOC, INC.
FINANCIAL REVIEW--(Continued)
Responsibility for implementation of the Project has been divided among
fourteen business units (including the Company's Health Care Information
Technology segment), 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.
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:
<TABLE>
<CAPTION>
Stage One: Stage Two:
---------- ----------
<C> <S>
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)
</TABLE>
Prior to combining with McKesson in January 1999, HBOC had, since 1994,
been pursuing its own Year 2000 compliance project. That compliance project
has now been integrated into the Company's Project. Nevertheless, because the
Health Care Information Technology segment is principally engaged in the sale
and licensing of computer software and systems, the Year 2000 problem raises a
different set of concerns for it from those of the Company's other businesses.
For that reason, the Year 2000 readiness of the Health Care Information
Technology business is discussed separately.
Businesses other than Health Care Information Technology
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) and all phases of the Company's identified Year 2000
projects have been completed in all material respects. During the remainder of
calendar year 1999, the Company will continue to conduct a rigorous final
level of review called systems integration testing under post-Year 2000
conditions.
The Company has conducted and plans to continue to conduct systems testing
with Trading Partners during the remainder of 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 October 31, 1999, all of the computer hardware and purchased software
used for mission critical functions in the Company's Health Care Supply
Management segment was certified by vendors as being compliant. Regardless of
the compliance statements, all third party hardware and software will also be
subjected to testing to reconfirm its Year 2000 readiness.
19
<PAGE>
McKESSON HBOC, INC.
FINANCIAL REVIEW--(Continued)
Health Care Information Technology
The Health Care Information Technology Year 2000 project team is addressing
Year 2000 readiness of (i) the Health Care Information Technology's software
products licensed to customers; (ii) third party software vendor business
partners; and (iii) the segment's internal systems.
The Company's assessment indicates that, with a few exceptions, products
available for licensing and acquisition from the Health Care Information
Technology segment were, as of March 31, 1999, Year 2000 compliant. The
readiness effort has been conducted in the ordinary course of business
regarding the development and enhancement of such software pursuant to
software maintenance and support agreements.
Substantially all of the identified projects involving Health Care
Information Technology software products are at Phase 6 or higher.
The Health Care Information Technology segment continues to monitor
performance of Year 2000 compliant releases of Company software products in
customer environments, and any deployment of maintenance releases to remediate
any Year 2000 issues identified during and after deployment of Year 2000
releases of Company software products will be done in the ordinary course of
business.
The Health Care Information Technology project team is making ongoing
inquiries with respect to the Year 2000 readiness of its hardware and software
vendor business partners. While the Company's current assessment does not
suggest it, 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.
The Health Care Information Technology project team has substantially
completed all project phases for its internal core business systems.
Costs
The Company incurred costs of approximately $9 million in the first half of
fiscal 2000 and $14 million in fiscal 1999, 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 of between $13
million and $17 million in fiscal 2000 for a total project cost of less than
$45 million. Such costs are being expensed as incurred. The costs associated
with creating Year 2000-compliant versions of the Health Care Information
Technology segment's software products have not been separately tracked, as
the underlying activities were performed in the ordinary course of the
segment's business. Year 2000 Project costs are difficult to estimate
accurately and the project 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.
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 Health Care Information Technology segment may experience an increase
in warranty claims relating to (i) malfunctions in Company products which have
not been upgraded, either because the Company has discontinued support for
such products and has therefore not provided the necessary enhancement or
because the
20
<PAGE>
McKESSON HBOC, INC.
FINANCIAL REVIEW--(Continued)
customer has not installed an enhancement made available by the Company or
(ii) malfunctions resulting from Year 2000 problems in third-party hardware or
software used in connection with the operation of Company software products.
Although such warranty claims are generally subject to contractual liability
limitations, the Company is not able to accurately assess or estimate the
possible impact of such claims.
Finally, management believes that the costs of work by customers related to
Year 2000 issues have caused some Health Care Information Technology customers
and prospective customers to defer current projects or prospective decisions
regarding the acquisition of new software.
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.
The Company's contingency planning methodology attempts to identify,
explore, and document every potential failure point, internal and external in
each of the Company's businesses. Failure points are then prioritized based on
likelihood and criticality. Contingency plans are then developed for each of
the potential failure points deemed likely and/or critical. Included in the
Company's contingency plan are preparations that need to be completed
currently (such as printing special forms to be used in the event operations
shift into contingency mode, identifying the triggers for shifting into
contingency mode and appointing and training the resource response teams),
identification of alternate processes to be used in the event of
contingencies, as well as design of the process for exiting contingency mode.
Contingency planning for possible Year 2000 disruptions will continue to be
defined, improved, and implemented.
21
<PAGE>
McKESSON HBOC, INC.
FINANCIAL REVIEW--(Continued)
ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS
In addition to the factors discussed in the "Year 2000" section of this
"Financial Review," the following additional factors may affect the Company's
future results.
Adverse judgments regarding the restatement of the Company's historical
financial statements may cause it to incur material losses.
Subsequent to the Company's April 28, 1999 restatement announcement, and as
of November 11, 1999, fifty-eight class action lawsuits, three derivative
actions, and four individual actions have been filed against the Company, and
certain current or former officers and directors of the Company in federal and
state courts (See Financial Note 10, Litigation). In addition, the United
States Attorney's Office for the Northern District of California and the San
Francisco District Office of the SEC have also commenced investigations in
connection with the matters relating to the restatement of previously reported
amounts.
The Company does not believe it is feasible to predict or determine the
outcome or resolution of these proceedings, or to estimate the amount of, or
potential range of, loss with respect to these proceedings. In addition, the
timing of the final resolution of these proceedings is uncertain. The range of
possible resolutions of these proceedings could include judgments against the
Company or settlements that could require substantial payments by the Company
which could cause it to incur material losses.
The restatement of the Company's earnings may negatively impact the management
of the Company's business.
The effect of the pending litigation and government investigations relating
to the previously announced financial restatement could present challenges in
attracting and retaining quality employees and managers. Such difficulties
could impair the Company's ability to manage the Company's business.
The Company's business could be hindered if it is unable to complete and
integrate acquisitions successfully.
An element of the Company's business is to pursue strategic acquisitions
that either expand or complement its business. The Company routinely reviews
such potential acquisition opportunities and has historically engaged in
numerous acquisitions. Integration of acquisitions, including the merger that
created McKesson HBOC, Inc., involves a number of special risks. Such risks
include:
. the diversion of management's attention to the assimilation of the
operations of businesses the Company has acquired;
. difficulties in the integration of operations and systems and the
realization of potential operating synergies;
. difficulties in the integration of any acquired companies operating in a
different sector of the health care industry;
. delays or difficulties in opening and operating larger distribution
centers in a larger and more complex distribution network;
. the assimilation and retention of the personnel of the acquired
companies;
. challenges in retaining the customers of the combined businesses; and
. potential adverse effects on operating results.
22
<PAGE>
McKESSON HBOC, INC.
FINANCIAL REVIEW--(Continued)
If the Company is unable to successfully complete and integrate strategic
acquisitions in a timely manner, its business and the Company's growth
strategies could be negatively affected.
The Company's issuance of equity to finance acquisitions could have a
potential dilutive effect on its stock.
The Company anticipates that it will finance acquisitions, at least partly
by incurring debt or by the issuance of additional securities. The use of
equity financing, rather than debt, for acquisitions would dilute the
ownership of the Company's then current stockholders.
Changes in the United States healthcare environment could have a material
negative impact on the Company's revenues.
The Company's products and services are intended to function within the
structure of the healthcare financing and reimbursement system currently being
used in the United States. In recent years, the healthcare industry has
changed significantly in an effort to reduce costs. These changes include
increased use of managed care, cuts in Medicare, consolidation of
pharmaceutical and medical/surgical supply distributors, and the development
of large, sophisticated purchasing groups. The Company expects the healthcare
industry to continue to change significantly in the future. Some of these
changes, such as a reduction in governmental support of healthcare services or
adverse changes in legislation or regulations governing the delivery or
pricing of healthcare services or mandated benefits, may cause healthcare
industry participants to greatly reduce the amount of the Company's products
and services they purchase or the price they are willing to pay for the
Company's products and services. Changes in pharmaceutical manufacturers'
pricing or distribution policies could also significantly reduce the Company's
income. Due to the diverse range of health care supply management and health
care information technology products and services the Company offers, such
changes may adversely impact the Company while not affecting some of the
Company's competitors that offer a more narrow range of products and services.
Substantial defaults in payment or a material reduction in purchases of the
Company's products by some large customers could have a significant negative
impact on the Company's financial condition, results of operations and
liquidity.
The Company's recent strategy has been to build relationships with large
customers that are achieving rapid growth. During the fiscal year ended March
31, 1999, sales to the Company's ten largest customers accounted for
approximately 45% of the Company's sales. A growing portion of the Company's
increased sales in fiscal 2000 has been to a limited number of these large
customers. Consequently, the Company's sales and credit concentration have
significantly increased. Accordingly, any defaults in payment or a material
reduction in purchases of the Company's products by these large customers
could have a significant negative impact on the Company's financial condition,
results of operations and liquidity.
The ability of the Health Care Information Technology business to attract and
retain customers due to challenges in integrating software products;
technological advances and Year 2000 concerns may significantly reduce the
Company's revenues.
The Company's Health Care Information Technology business delivers
enterprise-wide patient care, clinical, financial, managed care, payor and
strategic management software solutions, as well as networking technologies,
electronic commerce, outsourcing and other services to health care
organizations throughout the United States and certain foreign countries.
Challenges in integrating software products used by the Health Care
Information Technology business with those of its customers could impair the
Company's ability to attract and retain customers and may reduce its revenues
or increase its expenses.
23
<PAGE>
McKESSON HBOC, INC.
FINANCIAL REVIEW--(Continued)
Future advances in the health care information systems industry could lead
to new technologies, products or services that are competitive with the
products and services offered by the Health Care Information Technology
business. Such technological advances could also lower the cost of such
products and services or otherwise result in competitive pricing pressure. The
success of the Health Care Information Technology business will depend, in
part, on its ability to be responsive to technological developments and
challenges, including pricing pressures and changing business models. In
addition, to remain competitive in the evolving health care information
systems marketplace, the Health Care Information Technology business must
develop new products on a timely basis. The failure to develop competitive
products and to introduce new products on a timely basis could curtail the
ability of the Health Care Information Technology business to attract and
retain customers and thereby significantly reduce the Company's net income.
Finally, management believes that the costs of work by customers related to
Year 2000 Issues have caused some Health Care Information Technology customers
and prospective customers to defer current projects or prospective decisions
regarding the acquisition of new software. These Year 2000 concerns by
existing and potential new customers may adversely affect sales of the
Company's products.
Proprietary technology protections may not be adequate and proprietary rights
may infringe on rights of third parties.
The Company relies on a combination of trade secret, patent, copyright and
trademark laws, nondisclosure and other contractual provisions and technical
measures to protect its proprietary rights in its products. There can be no
assurance that these protections will be adequate or that the Company's
competitors will not independently develop technologies that are substantially
equivalent or superior to the Company's technology. Although the Company
believes that its products and other proprietary rights do not infringe upon
the proprietary rights of third parties, from time to time third parties have
asserted infringement claims against the Company and there can be no assurance
that third parties will not assert infringement claims against the Company in
the future. Additionally, the Company may find it necessary to initiate
litigation to protect the Company's trade secrets, to enforce its patent,
copyright and trademark rights, and to determine the scope and validity of the
proprietary rights of others. These types of litigation can be costly and time
consuming. These litigation expenses or any damage payments resulting from
adverse determinations of third party claims could be significant and could
result in material losses to the Company.
Potential product liability claims arising from Health Care Information
Technology business products could result in material losses to the Company.
Some products of the Health Care Information Technology business provide
information for use by health care providers in providing health care to
patients. Although the Company has not experienced any material claims to
date, any failure of the Company's Health Care Information Technology business
products to provide accurate and timely information could result in claims
against it. The Company maintains insurance to protect against claims
associated with the use of such products, but there can be no assurance that
the Company's insurance coverage would adequately cover any claims asserted
against it. If its insurance coverage is not adequate, the Company may be
required to pay the damages which could result in material losses to it.
System errors and warranties in the Health Care Information Technology
business's products could cause unforeseen liabilities.
The Company's Health Care Information Technology business's systems are
very complex. As with complex systems offered by others, the Company's systems
may contain errors, especially when first introduced. The Health Care
Information Technology business's systems are intended to provide information
for health care
24
<PAGE>
McKESSON HBOC, INC.
FINANCIAL REVIEW--(Concluded)
providers in providing health care to patients. Therefore, users of its
products have a greater sensitivity to system errors than the market for
software products generally. Failure of a client's system to perform in
accordance with its documentation could constitute a breach of warranty and
could require the Company to incur additional expense in order to make the
system comply with the documentation. If such failure is not timely remedied,
it could constitute a material breach under a contract allowing the client to
cancel the contract.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
The Company believes there has been no material change in its exposure to
risks associated with fluctuations in interest and foreign currency exchange
rates discussed in the Company's 1999 Annual Report on Form 10-K.
25
<PAGE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Financial Note 10 to the Company's unaudited condensed consolidated
financial statements contained in Part I of this Quarterly Report on Form 10-Q
is incorporated herein by reference.
Item 4. Submission of Matters to a Vote of Security Holders
On August 25, 1999, the Company held its Annual Meeting of Stockholders.
Three items were considered and the results are as follows:
Proposal 1 to elect four directors to serve a three-year term: 233,185,794
shares voted for Alfred C. Eckert III, and 13,818,642 shares withheld;
233,647,796 shares voted for Gerald E. Mayo and 13,356,640 shares withheld;
238,668,893 shares voted for Alan Seelenfreund and 8,335,543 shares withheld;
and 238,687,148 shares voted for Jane E. Shaw and 8,317,288 shares withheld.
Proposal 2 to approve the McKesson HBOC, Inc. 1998 Employee Stock Purchase
Plan: 222,351,375 shares voted for this proposal, 23,209,309 shares voted
against and 1,443,752 shares abstained.
Proposal 3 to approve an increase in the number of authorized shares for
the McKesson HBOC, Inc. Stock Purchase Plan: 213,965,334 shares voted for this
proposal, 31,622,367 shares voted against and 1,416,735 shares abstained.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
<TABLE>
<C> <S>
3.1 Restated Certificate of Incorporation of the Company (Exhibit 3.2(1))
3.2 Certificate of Amendment to the Restated Certificate of Incorporation
of the Company (Exhibit 4.3(2))
3.3 Amended and Restated By-laws of the Company, as amended through July
15, 1999 (Exhibit 4.5(3))
27 Financial Data Schedule
</TABLE>
--------
(1) Incorporated by reference to the designated exhibit to the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30, 1998.
(2) Incorporated by reference to the designated exhibit to the Company's
Registration Statement on Form S-8 as filed with the Commission on
January 12, 1999.
(3) Incorporated by reference to the designated exhibit to the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30, 1999.
(b) Reports on Form 8-K
There were no reports on Form 8-K filed during the three months ended
September 30, 1999.
26
<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.
Dated: November 15, 1999 By /s/ Heidi E. Yodowitz
-----------------------------------
HEIDI E. YODOWITZ
Senior Vice President and
Controller and Acting Chief
Financial Officer
27
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