MCK

McKesson Corporation: Q2 Fiscal 2008 Summary (Period Ended Sept 30, 2007)

Business Context and Reporting Period

This Form 10-Q covers the quarter and six months ended September 30, 2007 (Fiscal Q2 2008). McKesson Corporation operates in two primary segments: Distribution Solutions (pharmaceutical and medical-surgical distribution) and Technology Solutions (healthcare software and services). The company realigned its reporting segments effective April 1, 2007. Significant activity during the period included the acquisition of Per-Se Technologies ($1.8 billion) and the divestiture of the Acute Care medical-surgical business.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Revenues increased 9% in the quarter and 7% for the six months, driven by organic growth in Distribution Solutions and the inclusion of Per-Se Technologies in Technology Solutions.
• Profitability: Net income rose 8% in the quarter and 17% for the six months. This was aided by a $83 million tax credit related to the deductibility of the Securities Litigation settlement and improved operating margins.
• Discontinued Operations: The prior year period included a $58 million after-tax loss from discontinued operations (sale of Acute Care business), whereas the current period had no discontinued operations impact.
• Cash Flow: Operating cash flow for the six months more than doubled to $1.272 billion, reflecting improved inventory management and extended payment terms with vendors.

Guidance, Outlook, and Risks

• Management Commentary: Management highlighted strong performance in both segments. The effective tax rate for the six months was 32.5%, down from 21.5% in the prior year, though the prior year was artificially low due to the $83 million tax credit. The company expects share-based compensation expenses to increase in future periods.
• Capital Allocation: The company repurchased $695 million of stock in the first half of 2008. As of September 30, 2007, $1.316 billion remained available under share repurchase programs.
• Subsequent Event: On October 29, 2007, McKesson acquired Oncology Therapeutics Network (OTN) for approximately $575 million.
• Risks and Contingencies:
  • Securities Litigation: The company reached a settlement with Bear Stearns, the last remaining defendant in the Consolidated Action. Final approval is pending, but the company expects to remove the $962 million liability and corresponding restricted cash from its balance sheet in Q3 2008.
  • Regulatory Environment: Ongoing scrutiny of healthcare industry practices by government agencies poses a risk of future claims, penalties, or settlements.
  • Customer Concentration: The company noted the loss of a large customer in the first half of 2008, impacting pharmaceutical distribution revenues.

Investor Verification Checklist

• Securities Litigation Finality: Verify the final court approval of the Bear Stearns settlement to confirm the release of the $962 million liability and restricted cash.
• Per-Se Integration: Monitor the integration progress and revenue contribution of the $1.8 billion Per-Se Technologies acquisition.
• Tax Rate Volatility: Assess the sustainability of the effective tax rate, noting the one-time $83 million credit in the prior year and the impact of FIN 48 adoption on unrecognized tax benefits ($488 million as of Sept 30, 2007).
• Working Capital Trends: Review the drivers behind the significant increase in operating cash flow, specifically the extension of accounts payable terms and inventory management efficiency.
• OTN Acquisition Impact: Evaluate the financial impact of the subsequent OTN acquisition on the Distribution Solutions segment in upcoming quarters.