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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 June 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
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McKESSON HBOC, INC.
(Exact name of Registrant as specified in its charter)
Delaware 94-3207296
(State or other jurisdiction of incorporation or
organization) (IRS Employer Identification No.)
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.
Class Outstanding at June 30, 1999
--------------- ----------------------------
Common stock, $.01 par value 281,277,000 shares
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TABLE OF CONTENTS
Item Page
---- ----
PART I. FINANCIAL INFORMATION
1. Condensed Financial Statements
Consolidated Balance Sheets
June 30, 1999 and March 31, 1999............................. 3
Statements of Consolidated Income
Three month periods ended June 30, 1999 and 1998............. 4
Statements of Consolidated Cash Flows
Three month periods ended June 30, 1999 and 1998............. 5
Financial Notes............................................... 6
Management's Discussion and Analysis of Financial Condition
2. and Results of Operations
Financial Review.............................................. 10
3. Quantitative and Qualitative Disclosures about Market Risk ... 17
PART II. OTHER INFORMATION
6. Exhibits and Reports on Form 8-K.............................. 18
Exhibit Index................................................. 20
2
PART I. FINANCIAL INFORMATION
McKESSON HBOC, INC.
CONSOLIDATED BALANCE SHEETS
(unaudited)
June 30, March 31,
1999 1999
-------- ---------
(in millions,
ASSETS except par value)
Current Assets
Cash and cash equivalents................................ $ 178.8 $ 240.8
Marketable securities available for sale (Note 2)........ 182.0 28.2
Receivables.............................................. 2,532.4 2,583.7
Inventories.............................................. 3,665.8 3,529.0
Prepaid expenses......................................... 137.4 117.8
-------- --------
Total................................................... 6,696.4 6,499.5
Property, Plant and Equipment
Land..................................................... 49.2 50.7
Buildings, machinery and equipment....................... 1,370.4 1,324.3
-------- --------
Total................................................... 1,419.6 1,375.0
Accumulated depreciation................................. (701.3) (681.0)
-------- --------
Net..................................................... 718.3 694.0
Capitalized software...................................... 108.4 106.9
Notes receivable.......................................... 84.1 73.4
Goodwill and Other Intangibles............................ 1,223.3 1,228.4
Other Assets.............................................. 494.4 479.4
-------- --------
Total Assets............................................ $9,324.9 $9,081.6
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Drafts payable........................................... $ 263.2 $ 425.5
Accounts payable--trade.................................. 3,008.8 3,154.2
Deferred revenue......................................... 310.8 408.6
Short-term borrowings.................................... 596.2 16.7
Current portion of long-term debt........................ 192.7 195.3
Salaries and wages....................................... 95.9 101.2
Taxes.................................................... 118.1 95.2
Interest and dividends................................... 46.2 34.7
Other.................................................... 348.6 368.7
-------- --------
Total................................................... 4,980.5 4,800.1
-------- --------
Postretirement Obligations and Other Noncurrent
Liabilities.............................................. 253.1 258.6
-------- --------
Long-Term Debt (Note 2)................................... 937.6 945.5
-------- --------
McKesson HBOC-obligated mandatorily redeemable convertible
preferred securities of subsidiary grantor trust whose
sole assets are junior subordinated debentures of
McKesson HBOC (Note 3)................................... 195.6 195.6
-------- --------
Stockholders' Equity
Common stock (400.0 shares authorized, 281.8 issued as of
June 30, 1999, and 281.1 issued as of March 31, 1999;
par value $0.01)........................................ 2.8 2.8
Additional paid-in capital............................... 1,742.9 1,725.7
Other capital............................................ (108.6) (107.7)
Retained earnings........................................ 1,518.5 1,465.0
Accumulated other comprehensive loss..................... (58.0) (57.7)
ESOP notes and guarantees................................ (108.3) (115.5)
Treasury shares, at cost................................. (31.2) (30.8)
-------- --------
Total Stockholders' Equity.............................. 2,958.1 2,881.8
-------- --------
Total Liabilities and Stockholders' Equity.............. $9,324.9 $9,081.6
======== ========
See Financial Notes.
3
McKESSON HBOC, INC.
STATEMENTS OF CONSOLIDATED INCOME
(unaudited)
Three Months
Ended
June 30,
------------------
1999 1998
-------- --------
(in millions,
except
per share
amounts)
REVENUES.................................................. $8,697.4 $6,283.3
-------- --------
COSTS AND EXPENSES
Cost of sales............................................ 8,047.3 5,670.4
Selling, distribution and administration (Note 4)........ 501.1 465.2
Interest................................................. 32.6 30.9
-------- --------
Total.................................................. 8,581.0 6,166.5
-------- --------
INCOME BEFORE INCOME TAX EXPENSE AND DIVIDENDS ON
PREFERRED SECURITIES OF SUBSIDIARY TRUST................. 116.4 116.8
INCOME TAXES.............................................. (44.8) (46.1)
DIVIDENDS ON PREFERRED SECURITIES OF SUBSIDIARY TRUST..... (1.5) (1.6)
-------- --------
NET INCOME................................................ $ 70.1 $ 69.1
======== ========
EARNINGS PER COMMON SHARE
Diluted.................................................. $ 0.25 $ 0.25
Basic.................................................... 0.25 0.25
DIVIDENDS PER COMMON SHARE................................ $ 0.06 $ 0.125
SHARES ON WHICH EARNINGS PER COMMON SHARE WERE BASED
Diluted.................................................. 290.2 288.4
Basic.................................................... 280.6 272.4
See Financial Notes.
4
McKESSON HBOC, INC.
STATEMENTS OF CONSOLIDATED CASH FLOWS
(unaudited)
Three Months Ended
June 30,
--------------------
1999 1998
--------- ---------
(in millions)
Operating Activities
Net income.............................................. $ 70.1 $ 69.1
Adjustments to reconcile to net cash provided (used) by
operating activities
Depreciation........................................... 34.4 31.7
Amortization........................................... 22.4 16.2
Provision for bad debts................................ 7.5 3.4
Deferred taxes on income............................... (2.4) (13.9)
Other non-cash items................................... 2.1 3.5
--------- ---------
Total................................................. 134.1 110.0
--------- ---------
Effects of changes in
Receivables............................................ 44.5 (258.8)
Inventories............................................ (131.5) (198.5)
Accounts and drafts payable............................ (315.1) 487.7
Taxes.................................................. 32.1 40.2
Other.................................................. (132.2) 6.2
--------- ---------
Total................................................. (502.2) 76.8
--------- ---------
Net cash provided (used) by operating activities........ (368.1) 186.8
--------- ---------
Investing Activities
Purchases of marketable securities...................... (155.0) (6.8)
Maturities of marketable securities..................... -- 42.5
Property acquisitions................................... (59.7) (54.5)
Properties sold......................................... 2.7 8.4
Acquisitions of businesses, less cash and short-term
investments acquired................................... (7.4) (3.9)
Other................................................... (43.3) (46.0)
--------- ---------
Net cash used by investing activities................... (262.7) (60.3)
--------- ---------
Financing Activities
Proceeds from issuance of debt.......................... 595.7 77.2
Repayment of debt....................................... (27.4) (143.8)
Dividends paid on preferred securities of subsidiary
trust.................................................. (2.5) (2.5)
Capital stock transactions
Issuances.............................................. 13.1 133.6
ESOP notes and guarantee............................... 7.2 --
Dividends paid......................................... (16.9) (16.9)
Other.................................................. (0.4) (0.5)
--------- ---------
Net cash provided by financing activities............. 568.8 47.1
--------- ---------
Net Increase (Decrease) in Cash and Cash Equivalents..... (62.0) 173.6
--------- ---------
Cash and Cash Equivalents at beginning of period......... 240.8 566.3
--------- ---------
Cash and Cash Equivalents at end of period............... $ 178.8 $ 739.9
========= =========
See Financial Notes.
5
McKESSON HBOC, INC.
FINANCIAL NOTES
(unaudited)
1. Interim Financial Statements
In the opinion of the Company, these unaudited condensed consolidated
financial statements include all adjustments necessary for a fair presentation
of its financial position as of June 30, 1999 and the results of its
operations and its cash flows for the three months ended June 30, 1999 and
1998.
The results of operations for the three months ended June 30, 1999 and 1998
are not necessarily indicative of the results for the full years.
It is suggested that these interim financial statements be read in
conjunction with the annual audited financial statements, 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.
2. Marketable Securities
The June 30, 1999 marketable securities balance includes $23 million held in
trust as exchange property for the Company's $37.3 million principal amount of
4.5% exchangeable subordinated debentures which remain outstanding.
3. Convertible Preferred Securities
In February 1997, a wholly owned subsidiary trust of the Company issued 4
million shares of preferred securities to the public and 123,720 common
securities to the Company, which are convertible at the holder's option into
McKesson 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 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. 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 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.
4. 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
6
McKESSON HBOC, INC.
FINANCIAL NOTES--(Continued)
(unaudited)
accounted for as a pooling of interests. In April 1999, the Company discovered
improper accounting practices at HBOC (see Financial Note 8). 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.
During the quarter ended June 30, 1999, 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 costs totaling $6.3 million. The Company
also incurred $18.5 million in severance and benefit costs resulting from the
change in executive management announced June 21, 1999, and $1.7 million in
retention benefits. For segment reporting purposes (see Financial Note 9),
these charges are included in the Corporate segment.
During the quarter ended June 30, 1998, the Company incurred charges
totaling $7.7 million in the Health Care Supply Management segment and $7.6
million in the Health Care Information Technology segment. The Health Care
Supply Management segment's charge consisted of $4.9 million for the
terminated merger transaction with AmeriSource Health Corporation
("AmeriSource") and $2.8 million in integration costs incurred in connection
with recent acquisitions. The Health Care Information Technology segment's
charge consisted primarily of acquisition-related employee severance.
5. 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 months ended June 30, 1999 and 1998 is as follows:
Three
Months
Ended June
30,
------------
1999 1998
----- -----
(in
millions)
Net income..................................................... $70.1 $69.1
Foreign currency translation adjustments....................... (0.3) (1.8)
----- -----
$69.8 $67.3
===== =====
7
McKESSON HBOC, INC.
FINANCIAL NOTES--(Continued)
(unaudited)
6. Earnings Per Share
The following is a reconciliation of the numerators and denominators of the
basic and diluted earnings per common share computations:
Three Months Ended
---------------------------------------
June 30, 1999 June 30, 1998
------------------- -------------------
(in millions, except per share amounts)
Per Per
Income Shares Share Income Shares Share
------ ------ ----- ------ ------ -----
Basic EPS
Net Income........................ $70.1 280.6 $0.25 $69.1 272.4 $0.25
===== =====
Effect of Dilutive Securities
Options to purchase common stock.. 4.1 10.2
Trust convertible preferred
securities....................... 1.5 5.4 1.6 5.4
Restricted stock.................. 0.1 0.4
----- ----- ----- -----
Diluted EPS
Income available to common
stockholders plus assumed
conversions...................... $71.6 290.2 $0.25 $70.7 288.4 $0.25
===== ===== ===== ===== ===== =====
7. New Accounting Pronouncement
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 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.
8. HBOC Litigation
Since the Company's April 28, 1999 announcement regarding accounting
improprieties at HBOC, and as of August 6, 1999, fifty-five class action
lawsuits, three derivative actions, and two individual actions have been filed
against the Company, and certain current or former officers and directors of
the Company. In addition, the United States Attorney's Office for the Northern
District of California and the San Francisco District Office of the United
States Securities and Exchange Commission ("SEC") have also commenced
investigations in connection with the matters relating to the restatement of
previously reported amounts for HBOC described above. The SEC has advised the
Company that its inquiry should not be construed as an indication by the SEC
or its staff that any violations of law have occurred.
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.
8
McKESSON HBOC, INC.
FINANCIAL NOTES--(Concluded)
(unaudited)
9. 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 quarters ended June 30, 1999 and
1998 and as of June 30, 1999 and March 31, 1999, is presented below (in
millions):
Three Months Ended
June 30,
-------------------
1999 1998
-------- ---------
Revenues
Health Care Supply Management.......................... $8,278.6 $5,819.9
Health Care Information Technology..................... 317.4 369.5
Water Products......................................... 98.6 83.0
Corporate.............................................. 2.8 10.9
-------- --------
Total................................................ $8,697.4 $6,283.3
======== ========
Operating profit
Health Care Supply Management.......................... $ 125.4 $ 100.6
Health Care Information Technology..................... 56.1 38.1
Water Products......................................... 14.2 12.6
-------- --------
Total................................................ 195.7 151.3
Interest--net.......................................... (31.1) (21.8)
Corporate and other.................................... (48.2) (12.7)
-------- --------
Income from continuing operations before income taxes
and dividends on preferred securities of subsidiary
trust............................................... $ 116.4 $ 116.8
======== ========
June 30, March 31,
1999 1999
-------- ---------
Segment Assets
Health Care Supply Management.......................... $6,973.8 $6,889.7
Health Care Information Technology..................... 1,295.1 1,357.3
Water Products......................................... 250.4 234.0
Corporate.............................................. 805.6 600.6
-------- --------
Total................................................ $9,324.9 $9,081.6
======== ========
9
McKESSON HBOC, INC.
FINANCIAL REVIEW
Segment Results
The revenues and operating profits of the Company by business segment are as
follows:
Three Months Ended
June 30,
-------------------------------
1999 1998 % Chg.
-------- -------- ------
(in millions)
REVENUES
Health Care Supply Management Pharmaceutical
Distribution & Services
U.S. Health Care(1).......................... $7,068.0 $4,809.8 47.0
International................................ 555.5 518.9 7.1
-------- --------
Total Pharmaceutical Distribution &
Services.................................. 7,623.5 5,328.7 43.1
Medical/Surgical Distribution & Services..... 655.1 491.2 33.4
-------- --------
Total Health Care Supply Management........ 8,278.6 5,819.9 42.2
-------- --------
Health Care Information Technology
Software..................................... 52.5 76.3 (31.2)
Services..................................... 244.6 234.7 4.2
Hardware..................................... 20.3 58.5 (65.3)
-------- --------
Total Health Care Information Technology... 317.4 369.5 (14.1)
-------- --------
Water Products................................ 98.6 83.0 18.8
Corporate..................................... 2.8 10.9
-------- --------
Total......................................... $8,697.4 $6,283.3 38.4
======== ========
OPERATING PROFIT
Health Care Supply Management................. $ 125.4 $ 100.6(4)
Health Care Information Technology............ 56.1 38.1(5)
Water Products................................ 14.2 12.6 12.7
-------- --------
Total......................................... 195.7 151.3
Interest--net(2).............................. (31.1) (21.8)
Corporate and other........................... (48.2)(3) (12.7)
-------- --------
Income before income taxes.................... $ 116.4 $ 116.8
======== ========
- --------
(1) Includes sales to customers' warehouses of $2,160.6 million and $927.9
million in the quarters ended June 30, 1999 and 1998, respectively.
(2) Interest expense is shown net of corporate interest income.
(3) Includes accounting and legal fees and other costs totaling $6.3 million
incurred in the quarter in connection with the restatement of prior year
financial statements. Also includes $18.5 million of severance and benefit
costs resulting from the change in executive management announced June 21,
1999 and $1.7 million in retention benefits incurred in the quarter.
(4) Includes $4.9 million in charges for the terminated merger transaction
with AmeriSource Health Corporation and $2.8 million in acquisition-
related integration costs incurred.
(5) Includes $7.6 million in charges associated with acquisitions, primarily
employee severance.
10
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 regarding events and financial
trends which may affect the Company's future operating results and financial
position. Such statements are subject to risks and uncertainties that could
cause the Company's actual results and financial position to differ
materially. Also, words such as "estimates", "expects", "anticipates",
"plans", "believes" and similar expressions identify forward-looking
statements involving risks and uncertainties. These include, but are not
limited to: the resolution or outcome of the pending litigation and government
investigations relating to the previously announced financial restatement (the
"Pending Proceedings"--see Financial Notes 4 and 8); the Company's ability to
successfully integrate and operate acquired businesses and the risks
associated with such businesses, including the merger that created
McKessonHBOC; the changing U.S. health care environment, including potential
changes in private and governmental reimbursement for health care services,
the method by which such services are delivered, legislation or regulations
governing such services or mandated benefits, and changes in manufacturers'
pricing or distribution policies; the ability of the Company's Health Care
Information Technology business to retain existing customers and to attract
new customers in light of rapid technological advances and changing business
models, slowing of demand for software products because of Year 2000 concerns,
and challenges in integrating the Company's software products; the effect of
the Pending Proceedings on the Company's ability to manage its businesses and
to attract and retain employees and management; and the Company's ability and
the ability of the Company's vendors and customers to complete the necessary
actions to achieve a Year 2000 conversion for computer systems and
applications.
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 first quarter increased to $70.1 million, $0.25 per
diluted share, from $69.1 million, $0.25 per share, in the prior year.
Included in the current year first quarter results were $16.3 million in
after-tax accounting, legal and other associated fees incurred in connection
with the restatement of the Health Care Information Technology segment's
financial statements, severance and benefit costs resulting from the change in
executive management announced June 21, 1999 and retention benefits incurred
in the quarter. The prior year's first quarter results included $11.0 million
in after-tax charges associated with terminated and completed acquisition
transactions.
The effective income tax rate applicable to continuing operations for the
quarter ended June 30, 1999 differed from the effective income tax rate for
the comparable prior year period primarily due to the write-off of
nondeductible costs associated with the AmeriSource transaction in the quarter
ended June 30, 1998. In the second quarter of fiscal 1999, the termination of
the merger with AmeriSource was announced and the tax benefit on such costs
was recognized.
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 month period ended June 30,
1999.
11
McKESSON HBOC, INC.
FINANCIAL REVIEW--(Continued)
Pharmaceutical Distribution & Services revenues increased by 43% to $7.6
billion in the quarter reflecting growth in the U.S. direct delivery business
of 26%, an increase in U.S. sales to customers' warehouses of 133% and an
increase in international revenues of 7%. Internal growth in the U.S. direct
delivery business was 25%.
Medical/Surgical Distribution & Services revenues increased 33% to $655.1
million in the quarter. Fiscal 2000 revenues included $97.3 million in
revenues 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 14%.
Health Care Supply Management's operating profit increased $24.8 million or
25% in the quarter. Excluding the effect of unusual charges of $7.7 million in
the prior year, operating profit for the Health Care Supply Management segment
increased by 16% in the first quarter. Operating profit as a percent of
revenues (calculated excluding sales to customers' warehouses) declined 16
basis points to 2.05% in the quarter compared to the respective prior year
period. The quarter-over-quarter comparison in the operating profit margin was
negatively affected by exceptionally strong pharmaceutical procurement profits
achieved in the first quarter a year ago, and by a bad debt provision for a
long-term care customer in this year's first quarter. The prior year's charges
included $4.9 million for the terminated merger transaction with AmeriSource
and $2.8 million in acquisition-related integration costs incurred.
Health Care Information Technology
The Health Care Information Technology segment includes revenues from
software sales, services business and hardware sales. This segment accounted
for 4% of consolidated revenues for the three month period ended June 30,
1999.
The overall decline in revenues of 14% in the quarter reflects a 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 was the temporary disruption to this business
caused by the recently completed Audit Committee Investigation (See Financial
Note 4) and Health Care Information Technology senior management changes made
during the quarter.
Operating profit, excluding charges of $7.6 million (for acquisition-related
employee severance in the prior year), increased 23% in the quarter. The
operating profit margin improved to 17.7% compared to 12.4% in the prior
fiscal year's first quarter, reflecting a lower operating expense ratio.
Management expects an increased level of contract negotiations and sales
activity as the effects of Year 2000 issues diminish. Revenues should be
augmented by the recognition of certain revenues previously reversed in
connection with the Audit Committee investigation and restatements. However,
management plans to increase investments in research and development, product
integration and customer support activities. Management expects that these
investments will negatively affect the segment's margins for the remainder of
fiscal 2000.
Water Products
Segment revenues increased by 19% for the quarter compared with the prior
year, reflecting modest growth in the direct-delivery business and significant
increases in packaged water sales to the retail trade. Water Products segment
operating profit increased 13% in the quarter to $14.2 million from $12.6
million in the prior year. Operating profit as a percent of revenues declined
to 14.4% from 15.2% in the prior year, reflecting the increase in the mix of
lower margin packaged water business.
12
McKESSON HBOC, INC.
FINANCIAL REVIEW--(Continued)
Other
First quarter fiscal 2000 Corporate expense included $26.5 million in
special charges consisting of professional fees incurred in connection with
the previously discussed restatement of prior year financial statements,
executive severance benefits and retention benefits incurred in the quarter.
Corporate expense also reflects higher expenses for the Employee Stock
Ownership Plan (required to maintain a desired level of benefits provided to
employees despite a decline in the stock price), affiliation costs incurred in
the quarter and transaction costs associated with the Company's committed
receivables sales facility.
Liquidity and Capital Resources
Cash and marketable securities available for sale were $360.8 million at
June 30, 1999 and $269.0 million at March 31, 1999. The June 30, 1999
marketable securities balance included $23 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 June 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 payments.
Interest expense, net of interest income, increased to $31.1 million in the
first quarter compared to $21.8 million in the prior year, and $28.1 million
in the prior quarter. The increase from the prior quarter is due to borrowings
to support the increase in average working capital levels during the quarter
resulting from the build-up of inventories in advance of the start of new
contracts with retail and institutional customers.
Stockholders' equity was approximately $3.0 billion at June 30, 1999, and
the net debt-to-capital ratio was 30%, 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 in the current quarter is due
primarily to the previously discussed decline in vendor payables.
Average diluted shares increased to 290.2 million from 288.4 million in the
prior year due primarily to shares issued under employee benefits plans.
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
13
McKESSON HBOC, INC.
FINANCIAL REVIEW--(Continued)
availability of internal and external resources, third party modifications and
other factors. However, there can be no guarantee that these estimates will be
achieved, and actual results could differ. Moreover, although the Company
believes it will be able to make the necessary modifications in advance, there
can be no guarantee that the failure to modify the systems would not have a
material adverse effect on the Company.
In addition, the Company places a high degree of reliance on computer
systems of third parties, such as customers, trade suppliers and computer
hardware and commercial software suppliers. Although the Company is assessing
the readiness of these third parties and preparing contingency plans, there
can be no guarantee that the failure of these third parties to modify their
systems in advance of December 31, 1999 would not have a material adverse
effect on the Company.
Readiness
The Project is intended to ensure that all critical systems, devices and
applications, as well as data exchanged with customers, trade suppliers, and
other third parties ("Trading Partners") have been evaluated and will be
suitable for continued use into and beyond the year 2000. In addition to areas
normally associated with information technology ("IT"), the project also
includes areas normally considered outside of IT, but which may have embedded
microprocessors with potential Year 2000 problems. Examples of such non-IT
areas include the 30,000 hand-held order entry devices the Company has
provided its customers, and recently implemented bar-code scanning devices
used in warehouse operations.
Responsibility for implementation of the Project has been divided among
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:
Stage One: Stage Two:
---------- ----------
Awareness (Phase 1) Examination and analysis (Phase 3)
Assessment of risk
(Phase 2) Modification and/or renovation (Phase 4)
Data conversion (Phase 5)
Acceptance testing (Phase 6)
Redeployment back into production (Phase 7)
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.
14
McKESSON HBOC, INC.
FINANCIAL REVIEW--(Continued)
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) have been installed as of July 31, 1999. A limited number
of systems requiring extended migration, installation or conversion efforts
will require additional work, but in any case, the Company expects to complete
all phases of all identified projects by September 30, 1999. In the third
quarter of calendar year 1999, the Company will be conducting 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 July 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.
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 its assessment efforts with respect to internal systems except for
certain remote locations. The Company expects that remediation efforts with
respect to all of the Health Care Information Technology's material internal
systems will be completed by September 30, 1999, with the exception of the
foregoing remote locations, as to which the assessment is ongoing.
15
McKESSON HBOC, INC.
FINANCIAL REVIEW--(Continued)
Costs
The Company incurred costs of approximately $3 million in the first quarter
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
$10 million and $20 million in fiscal 2000 for a total project cost of less
than $45 million. Such costs are being expensed as incurred. 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 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.
16
McKESSON HBOC, INC.
FINANCIAL REVIEW--(Concluded)
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.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
The Company believes there has been no material change in its exposure to
market risk from that discussed in the Company's 1999 Annual Report.
17
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
4.5 Amended and Restated By-Laws of the Company, dated July 15, 1999
4.7 Rights Agreement, dated as of October 21, 1994, by and between the
Company and First Chicago Trust Company of New York as Rights Agent
27 Financial Data Schedule
(b) Reports on Form 8-K
The Registrant filed the following report on Form 8-K during the three
months ended June 30, 1999:
Form 8-K
Date of Report: April 28, 1999Date Filed: May 3, 1999
Item 5. Other Events
The Registrant announced it would be restating revenues and earnings due to
the discovery of improper accounting practices at its recently acquired
subsidiary, HBO & Company.
18
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: August 12, 1999 /s/ Heidi E. Yodowitz
By __________________________________
Heidi E. Yodowitz
Senior Vice President and
Controller
and Acting Chief Financial
Officer
19
EXHIBIT INDEX
Exhibit
Number Description
------- -----------
4.5 Amended and Restated By-Laws of the Company, dated July 15, 1999..
4.7 Rights Agreement, dated as of October 21, 1994, by and between the
Company and First Chicago Trust Company of New York as Rights
Agent............................................................
27 Financial Data Schedule...........................................
20