How did McKesson's core earnings perform excluding litigation effects?

Excluding Securities Litigation charges and credits, net income was $826 million in fiscal 2007 versus $781 million in fiscal 2006, and diluted EPS was $2.71 versus $2.48. The $83 million tax reserve reversal tied to the Securities Litigation is also excluded from this measure, so the reported and underlying figures differ meaningfully.

What was the purpose of the Per-Se acquisition and how is it reflected in results?

Per-Se Technologies, a provider of financial and administrative healthcare solutions, was acquired for about $1.8 billion including debt. Its results are included in the Provider Technologies segment since January 26, 2007. Per-Se represents about 8% of total assets and less than 1% of revenue and net income, and it was excluded from management's internal control assessment for fiscal 2007.

What are the main risks to McKesson's distribution margins?

A large share of distribution compensation from branded drug manufacturers was once tied to inflation-based price increases. Most arrangements have shifted to percentage-of-purchase models, but some contracts still depend on inflation. Slower branded price increases or faster generic price declines could hurt gross margin. Shifts in customer mix, such as growth in lower-margin sales to customer warehouses, also weigh on margin.

What remains outstanding in the Securities Litigation?

The company paid about $960 million into escrow for the Consolidated Action settlement, and total estimated Securities Litigation accruals were $983 million at March 31, 2007. Management believes the accrual is adequate, but notes timing and outcomes are uncertain. Remaining matters include a Bear Stearns appeal, pending actions against Andersen, and several Georgia state court cases.

What changes are coming to McKesson's reporting structure?

Beginning in fiscal 2008, McKesson will report two segments instead of three: McKesson Distribution Solutions, which combines Pharmaceutical Solutions and Medical-Surgical Solutions, and McKesson Technology Solutions, which is the former Provider Technologies segment plus the Payor group. Prior periods will be recast to conform to the new presentation.

MCK 10-K FY2007 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed May 9, 2007. Cited figures are marked; the original filing is the authoritative source.

McKesson Corporation's fiscal 2007 10-K (fiscal year ended March 31, 2007) shows a company growing revenue and earnings while leaning heavily on its core pharmaceutical distribution business.

Revenues rose 7% to $93.0 billion^a, driven by Pharmaceutical Solutions, which accounted for over 95% of revenue. Diluted EPS was $2.99 versus $2.38 in fiscal 2006, and net income reached $913 million. Excluding Securities Litigation charges and credits, diluted EPS was $2.71, up from $2.48, so the underlying improvement is real but smaller than the headline figure.

Gross margin improved 32 basis points to 4.66%, helped by better U.S. pharmaceutical distribution margins and generic drug sales, while operating expense growth outpaced revenue growth, partly from acquisitions and share-based compensation. The balance sheet and capital allocation changed meaningfully during the year. McKesson spent about $1.9 billion^b on acquisitions, most notably Per-Se Technologies for roughly $1.8 billion including assumed debt, which expanded the Provider Technologies segment.

It funded this with $1 billion^c of new notes and an interim credit facility. Total debt rose to $1.96 billion, the debt-to-capital ratio climbed to 23.8% from 14.4%, and net debt to net capital employed was essentially flat near 0.1%. The company repurchased $1.0 billion of stock during the year and authorized another $1.0 billion repurchase plan in April 2007.

Management also disclosed that the Securities Litigation accrual stood at $983 million^d, with some matters still pending. A notable tax benefit of $83 million came from an IRS private letter ruling confirming the deductibility of the $960 million settlement. Investors should note the concentration risk.

The ten largest customers represented about 51% of revenue, and the largest customer, Caremark RX, accounted for about 11%. Margins in the distribution business also depend on manufacturer compensation arrangements that have shifted away from inflation-based models, and the company has exposure to pending litigation including Vioxx, fen-phen, asbestos, and antitrust matters. The 2008 reorganization into two new segments, McKesson Distribution Solutions and McKesson Technology Solutions, will change how future results are reported.

02—Key points

Key Highlights

Revenue grew 7% to $92.98 billion in fiscal 2007, with Pharmaceutical Solutions contributing over 95% of the total.
Diluted EPS rose to $2.99 from $2.38; excluding Securities Litigation items, diluted EPS was $2.71 versus $2.48, a 9% increase.
Gross profit increased 15% to $4.33 billion, and gross margin improved 32 basis points to 4.66%, driven mainly by U.S. pharmaceutical distribution.
Per-Se Technologies was acquired in January 2007 for about $1.8 billion including assumed debt, funded by $1 billion of new notes and an interim facility.
Total debt increased to $1.96 billion and the debt-to-capital ratio rose to 23.8% from 14.4%, still well below the 56.5% covenant limit.
McKESSON repurchased $1.0 billion of common stock during fiscal 2007 and approved a new $1.0 billion repurchase plan in April 2007.
Customer concentration remains high: the ten largest customers were about 51% of revenue and Caremark RX alone was about 11%.

03—Questions

Frequently Asked Questions

How did McKesson's core earnings perform excluding litigation effects?
Excluding Securities Litigation charges and credits, net income was $826 million in fiscal 2007 versus $781 million in fiscal 2006, and diluted EPS was $2.71 versus $2.48. The $83 million tax reserve reversal tied to the Securities Litigation is also excluded from this measure, so the reported and underlying figures differ meaningfully.
What was the purpose of the Per-Se acquisition and how is it reflected in results?
Per-Se Technologies, a provider of financial and administrative healthcare solutions, was acquired for about $1.8 billion including debt. Its results are included in the Provider Technologies segment since January 26, 2007. Per-Se represents about 8% of total assets and less than 1% of revenue and net income, and it was excluded from management's internal control assessment for fiscal 2007.
What are the main risks to McKesson's distribution margins?
A large share of distribution compensation from branded drug manufacturers was once tied to inflation-based price increases. Most arrangements have shifted to percentage-of-purchase models, but some contracts still depend on inflation. Slower branded price increases or faster generic price declines could hurt gross margin. Shifts in customer mix, such as growth in lower-margin sales to customer warehouses, also weigh on margin.
What remains outstanding in the Securities Litigation?
The company paid about $960 million into escrow for the Consolidated Action settlement, and total estimated Securities Litigation accruals were $983 million at March 31, 2007. Management believes the accrual is adequate, but notes timing and outcomes are uncertain. Remaining matters include a Bear Stearns appeal, pending actions against Andersen, and several Georgia state court cases.
What changes are coming to McKesson's reporting structure?
Beginning in fiscal 2008, McKesson will report two segments instead of three: McKesson Distribution Solutions, which combines Pharmaceutical Solutions and Medical-Surgical Solutions, and McKesson Technology Solutions, which is the former Provider Technologies segment plus the Payor group. Prior periods will be recast to conform to the new presentation.

04—Continue

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