mckesson_healthcare%20war%20game%20briefing%20book%202009

The Battle for Healthcare Information

© Fuld & Company 2009 Healthcare War Game Briefing Book 48

2008 Annual Report Extending our record of

superior stockholder returns

Fiscal year 2008 was a year of milestones for McKesson. In January, we marked our 175th anniversary, a distinction rarely achieved in American business. Our revenues grew 9% to reach $101.7 billion, exceeding $100 billion for the first time. Perhaps most gratifying, we received numerous awards and significant recognition from our customers and industry groups for our superior service and solutions. Our progress in fiscal year 2008 continued our track record of superior financial performance and stockholder returns. During the five-year period ending March 31, 2008, both our revenues and earnings per share grew at a compound annual growth rate exceeding 8%.

– John H. Hammergren Chairman and Chief Executive Officer

6. McKesson Corporation

6.1 Company Overview

McKesson, the largest health care company in the world, reported revenue of $101.7 billion in 2008 from the sale of health care systems, medical supplies, and pharmaceutical products. It was the first time the company reported revenue in excess of $100B. Marking its 175th year in January 2008, McKesson is one of the oldest continually operating businesses in the U.S. According to some reports, the company processes 80% of all prescriptions written in the U.S.

McKesson has offices throughout North America, plus international offices in Ireland, France, the Netherlands, the U.K., and Australia. The company operates in two business segments: Distribution Solutions and Technology Solutions. In 2008, McKesson derived 97% of its revenue from its distribution business segment.

Distribution Solutions – This business segment distributes prescription drugs, medical-surgical supplies and equipment, and health and beauty care products throughout North America. The company has distribution agreements with CVS Caremark, Kinney Drugs, Rite Aid, Safeway, Cigna, Humana, Costco, and Wal-Mart. This segment also provides specialty pharmaceutical solutions for biotech and pharmaceutical manufacturers, sells pharmacy software, and provides consulting, outsourcing and other services. Also included here is the company’s 49% interest in Nadro, the leading pharmaceutical distributor in Mexico, and its 39% interest in Parata Systems, which sells automated pharmacy and supply management systems and services to retail and institutional outpatient pharmacies.

Technology Solutions – This segment delivers enterprise-wide clinical, patient care, financial, supply chain, and strategic management software solutions, pharmacy automation for hospitals, as well as connectivity, outsourcing, and other services. Also included here is McKesson’s clinical auditing, compliance, and medical management software businesses and care management programs. Customers include hospitals, physicians, homecare providers, retail pharmacies, and payors in North America, Europe, and Asia Pacific.

NYSE MCK

Founded 1833

Headquarters San Francisco

Total Revenue (2008) $101.7B

Revenue Growth (YoY) 9.4%

Net Profit (2008) $990M

Profit Growth (YoY) 8.4%

Employees (2008): 33,000

Fortune 500 #18



McKesson at a glance

• Delivers more than $1 billion in medi-cines to pharmacies, hospitals, physi-cian offices, and other healthcare sites every week — one-third of the medi-cines used each day in North America.

• Distributes more than 150,000 medical-surgical products — ranging from gloves and bandages, to surgical las-ers, to flu vaccines — to more than 300,000 physician offices and other customers.

• Provides bar-code scanning solutions in hospitals that prevent 700,000 medi-cation errors every week.

• Helps insurers, including the top 25 managed care organizations, pay claims for more than 160 million plan members.

• Provides physician portal for secure access to patients’ records, with current usage of 3.7 million visits per month.

Source: McKesson 2008 Annual Report

Since 1950s, McKesson has derived a growing proportion of its income from medical technology rather than pharmaceuticals. This culminated in its purchase of medical information systems firm HBO & Company (HBOC) in 1999. Irregularities in accounting at HBOC produced a one-day, $8.6 billion plunge in McKesson’s stock on April 28, 1999. Shareholders lost nearly half of the value of their holdings. Several McKesson and HBOC executives were dismissed and prosecuted by the New York State comptroller, who was the lead plaintiff among thousands of others. Current chairman and CEO John Hammergren, who led McKesson’s wholesale drug unit at the time, was promoted to head the company. McKesson Technology Solutions has continued to increase its market share through acquisitions, notably Per Se Technologies, RelayHealth, and Practice Partner. Today, McKesson is one of the leading healthcare IT companies in the U.S., with software and hardware in more than 70% of hospitals with more than 200 beds. KLAS Enterprises, an independent monitor of healthcare IT vendors, rated 18 McKesson products in the top three in their categories in its 2007 report.

6.2 Recent Acquisitions

From fiscal year 2006 through 2008, McKesson spent $3.1 billion on strategic acquisitions. Many of these were smaller investments that improved the company’s value proposition to customers in both distribution and information technology. In his 2008 letter to shareholders, Hammergren noted three major investments the company made in the past three years that, as he said, “create opportunities to increase stockholder value.”

In October 2007, McKesson acquired Oncology Therapeutics Network (OTN) of San Francisco for $531 million. OTN is a leading distributor of specialty pharmaceuticals, McKesson believes this purchase “significantly enhanced” its presence in what the “fastest-growing sector of the pharmaceutical market.” In January 2007, McKesson acquired Per-Se Technologies of Alpharetta for $1.8 billion, the company’s largest IT acquisition since 1999. Per Se is a leading provider of financial and administrative solutions for hospitals, physicians and retail pharmacies. In 2006, McKesson acquired D&K Healthcare of St. Louis, expanding its footprint among independent pharmacies in the Midwest.

In February 2007, McKesson acquired Physician Micro Systems, known as Practice Partner, a provider of integrated software for electronic health records, medical billing and appointment scheduling for independent physician practices. Terms of the agreement were not disclosed. The McKesson press release said that this acquisition, along with Per-Se Technologies, demonstrates the company’s “commitment to provide a complete solution – including software, billing and collection services, supplies and connectivity – to physician practices regardless of size, specialty or geographic location.” Pamela Pure, president of McKesson Technology Solutions, said the company had established “a technology footprint” with 20% of U.S. physicians.

In his 2008 letter to shareholders, CEO Hammergren cited two other acquisitions that “advance our long-term strategy,” one in distribution and the other in information technology. McKesson increased the size of its Midwest distribution footprint even further by acquiring McQueary Brothers Drug Company, a Springfield, Missouri-based distributor to more than 400 independent and regional chain pharmacies. This move also expands McKesson’s distribution profile in the independent pharmacy segment, opening up new opportunities for building out McKesson’s Health Mart franchise and OneStop Generics program. In its technology business, the company acquired



McKesson and Microsoft

“Until now, the ability for consumers to access and share appropriate health information online has not been possible. As a result, personal health records (PHRs) have not been broadly adopted or consistently used. Our relationship with Microsoft can change that. HealthVault offers consumers a convenient and accessible way to store and manage their healthcare and wellness data in one central place. The RelayHealth network then connects the consumer’s portfolio of information with the care provider and unifies the management of the personal health record.”

– Pamela Pure, President McKesson Technology Solutions August 2008

Rosebud Solutions of Ann Arbor, a provider of software that tracks and manages instruments, endoscopes, tissue implants for surgical services, as well as medical crash carts and mobile equipment. McKesson believes Rosebud Solutions will help hospitals create efficient workflow processes that improve patient safety and reduce surgical delays and costs. Rosebud offerings complement McKesson’s existing materials management and surgical services solutions.

The company’s 2008 annual report presents a bold summary of McKesson’s position: “Drawing on our formidable array of assets, we are serving customers in ways that truly set McKesson apart in the marketplace. We are the healthcare industry’s most complete solution provider, with the ability to deliver distribution and supply chain services, software solutions, claims processing capabilities, consulting services, pharmacy management systems, hospital automation, and disease management programs.... We are combining our capabilities in bold new ways to create unique, innovative solutions that expand and redefine the segments in which we compete and drive improvements across the entire healthcare spectrum.”

6.3 Strategic Partnerships and Agreements

McKesson continues to enter into new partnerships with leading healthcare and technology companies to reinforce and extend its market position.

Distribution Agreements – During 2008, McKesson renewed pharmaceutical distribution agreements with these key partners: CVS Caremark, Rite Aid, Safeway, Cigna, Humana and Costco. McKesson has a long-standing supply agreement with Wal-Mart Stores, the world’s largest retailer. It also is a supplier to Target.

Microsoft Corp. – In August 2008, Microsoft announced a strategic collaboration between its HealthVault service and McKesson’s RelayHealth connectivity business. RelayHealth’s core services enable patients to schedule appointments online, request prescription refills, pay bills, obtain results, and consult with their doctors online for non-urgent care. With this new combined solution, physicians will be able to use RelayHealth through a Web browser as the initial step toward clinical automation of their practice. The service is designed to integrate with EMR systems already in use. For patients, the combined solution will provide access to their personal health information and online communications with their physicians.

St. Luke’s Episcopal Healthcare System – McKesson promotes its relationship with St. Luke’s in Houston as an example of its growing number of “One McKesson” customers who use a combination of McKesson-provided information technology, automation and pharmaceutical distribution solutions. St. Luke’s recently added extensive clinical IT capabilities to its three hospitals and 18 clinics: more than 300 McKesson AcuDose-Rx® medication dispensing cabinets, a software and hardware solution that drives patient safety and process efficiency. This was the largest contract ever signed in McKesson’s automation business. St. Luke’s is also a McKesson pharmaceutical distribution customer.

ProMedica – In March 2008, McKesson signed a contract with this Ohio-based network of ten hospitals to provide an array of clinical solutions, pharmacy automation and medication distribution services.



McKesson portal handles $2 billion in drug orders

every month

For larger pharmacies and chains, McKesson invests in strategic programs like central fill, bulk repackaging and pharmacy management systems to help our customers maximize their operational and financial success. The acquisition of Per-Se significantly enhanced our pharmacy systems offering by providing a new, contemporary software platform for retail chain and mail order customers. We support all pharmacy customers with a robust infrastructure that includes Supply Management Online, our customer Internet portal that accounts for more than $2 billion in pharmaceutical orders each month.

– McKesson 2008 Annual Report

Blue Cross and Blue Shield of Massachusetts – In February 2008, BCBSMA, an independent not-for-profit health care benefits company, licensed McKesson’s InterQual suite of products.

Proventys – In February 2008, McKesson entered into a relationship with Proventys, a personalized medicine knowledge service provider, under which McKesson will incorporate Proventys’ risk prediction capabilities into its core clinical decision support solutions.

Community Health Systems (CHS) – In January 2008, McKesson signed a national agreement with CHS, one of the largest operators of general acute care hospitals in non-urban and mid-size markets in the US. McKesson will deploy clinical information systems in over 40 of its larger hospitals.

Aetna – In January 2008, McKesson announced a five-year agreement with Aetna, a leading health care benefits company, under which Aetna will add McKesson’s ClaimsXten software to its claims management capabilities.

Amerinet – In October 2007, the company signed an agreement with this national healthcare purchasing organization to provide central pharmacy automated distribution systems. The agreement gives Amerinet members access to McKesson’s barcode-based medication packaging solutions.

6.4 Distribution Products and Services

In the U.S., McKesson’s has a network of 29 pharmaceutical distribution centers, as well as a master redistribution center, a strategic redistribution center, and two repackaging facilities. McKesson Canada, the largest pharmaceutical distributor in Canada, has a network of 17 distribution centers, providing logistics and distribution to more than 800 manufacturers. The company has a 49% share of Nadro, Mexico’s leading pharmaceutical distributor. McKesson tailors its distribution solutions for retail national accounts, independent retail pharmacies, and institutional healthcare providers.

Retail National Accounts

• Central Fill – Prescription refill service that enables pharmacies to refill prescriptions remotely, reducing inventory levels and improving customer service.

• Redistribution Centers – Two facilities totalling 420,000 square feet offers access to inventory for single-source warehouse purchasing, including pharmaceuticals and biologicals. These centers also provide the foundation for a two-tiered distribution network that supports “best-in-class” direct store delivery.

• RxPakSM – Bulk repackaging service that leverages McKesson’s purchasing power and supplier relationships to provide pharmaceuticals at reduced prices, help increase inventory turns, and reduce working capital investment.

• EnterpriseRx™ – Launched in July 2008, this is a complete pharmacy management system that provides control over the entire prescription filling process while supporting administration and management functions.



Independent Retail Pharmacies

• Health Mart® –McKesson’s franchise program helps independent pharmacies attract new business, maximize the value of existing customer relationships and enhance operational efficiency. In FY 2008, Health Mart grew by more than 600 new stores, bringing the total to more than 1,850. McKesson credits Health Mart for contributing to its 11%YoY growth in sales for generics, significantly above overall market growth for generics, according to McKesson.

• AccessHealth® – These comprehensive managed care and reconciliation assistance services are designed to help independent pharmacies save time, access competitive reimbursement rates, and improve cash flow.

• OneStop Generics® – Pharmaceutical purchasing program helps pharmacies maximize their cost savings with a broad selection of generic drugs and lower up-front pricing.

• Prefer Rx – Through this discount program, McKesson offers aggressive prices on more than 100 branded drugs, helping retail independent pharmacies increase margins and eliminate rebate paperwork.

Institutional Healthcare Providers

• Fulfill-Rx™ – Ordering and inventory management system that integrates McKesson pharmaceutical distribution services with its automation solutions, helping hospitals optimize the processes supporting unit-based cabinet replenishment and inventory management.

• McKesson Patient Relationship Solutions (MPRS), introduced in FY2008, helps pharmacists counsel patients to stay on their prescribed medications. MPRS provides 225 adherence programs that are supported by more than 50 pharmaceutical manufacturers. The program’s LoyaltyScript® card is used by 11,000 patients each day. McKesson is piloting a Medication Therapy Management program to improve communications among pharmacists, physicians and payors to improve patient outcomes by helping patients increase medication adherence and reduce adverse drug events.

6.5 Technology Products and Services

The portfolio in McKesson’s Technology Solutions segment addresses a wide array of healthcare, clinical, and business performance needs ranging from medication safety and information access to revenue cycle management, resource utilization, and physician adoption of electronic health records. For physicians, McKesson promotes its practice management and EHR solutions as “complete solutions for physician practices of every size, specialty, or geographic location.”

• Practice Partner® – This integrated software solution, marketed to independent physician practices, provides electronic health records, medical billing, and appointment scheduling. Practice Partner’s EHR system is certified by the Certification Commission for Healthcare Information Technology (CCHIT). The solution includes a sophisticated multi-clinic scheduler and a comprehensive practice management system that provides billing and collection services, supplies, and connectivity services. According to McKesson, more than 1,500 practices representing approximately 6,000 physicians, are using Practice Partner. McKesson acquired Practice Partner from Physician Micro Systems in February 2007. Terms of the agreement were not disclosed.



McKesson’s Momentum

“We’ve built strong momentum with our Connecting PhysiciansSM strategy, which is focused on helping hospitals to reduce traditional EHR adoption barriers by collaborating with local practices to provide a single record for inpatient and ambulatory care. With Practice Partner, McKesson is now positioned to automate independent physician offices and to deploy EHR technology to help drive safer, more efficient care.”

– Pamela Pure, President McKesson Technology Solutions February 2007

• Horizon Clinicals® – This comprehensive clinical management solution includes a clinical data repository, decision support, physician order entry, point-of-care documentation with bar-coded medication administration, enterprise laboratory, radiology, pharmacy, surgical management, an emergency department solution, and an ambulatory EHR system. Horizon Clinicals also includes solutions to simplify physician access to patient information such as a Web-based physician portal and wireless devices that draw on information from the hospital’s information systems. The Horizon Clinicals suite is also marketed to homecare providers, including telehealth and hospice.

• RelayHealth® – This is McKesson’s network-based solution for streamlining clinical, financial and administrative communication between patients, providers, payors, pharmacies, and financial institutions. RelayHealth operates as a neutral partner in an open network environment, according to McKesson, offering interoperability among all organizations, systems, and solutions to improve clinical communication, care delivery, and cash collection. RelayHealth enables online consultation between physicians by patients, electronic prescribing by physicians, point-of-service resolution of pharmacy claims by payors, pre-visit financial clearance of patients by providers, and post-visit settlement of provider bills by payors and patients. RelayHealth processes more than 12 billion financial and clinical transactions annually and 70% of all retail pharmacy claims nationwide. McKesson acquired this technology in 2007 and combined it with some of the assets acquired from Per-Se to form its current RelayHealth offering. McKesson promotes RelayHealth connectivity solutions in all of its customer segments. In the physician segment, the company promotes two “innovations that provide cost and efficiency benefits to physicians and improve patient care”: e-prescribing and online patient-doctor consultations, branded by McKesson as WebVisits®.

6.6 Key Executives

John H. Hammergren, 49, chairman, president, and CEO, McKesson

Hammergren has been the chairman of McKesson since 2002, president and CEO since 2001. He was co-president/CEO of the company from 1999 to 2001. Previously, he was the executive vice president of the company and president/CEO of the Supply Management Business from January 1999 to July 1999, group president of McKesson Health Systems from 1997 to 1999, and vice president of the company since 1996. He also is a director of Nadro and Verispan entities in which McKesson holds interests, and serves on Hewlett-Packard’s board of directors.

"McKesson is helping transform the health care industry into a modern, efficient, and quality-driven system."

– John H. Hammergren



Paul C. Julian, 52, executive vice president, group president, McKesson Distribution Solutions

Julian has served in this role since 2004. Previously, he was senior vice president since 1999 and president of the Supply Solutions Business since 2000. Prior to joining McKesson, Julian held a variety of senior management positions in healthcare companies, including Owens and Minor and Stuart Medical, where he served in several where he served in several roles including group vice president and chief operating officer.

Pamela Pure, 47, executive vice president, president, McKesson Technology Solutions

Pure has served in this role since 2004. She joined McKesson in 2001 as group president, Product Development and Support. She has more than 20 years of operating and executive experience in the health care information technology industry. Before joining McKesson, Pure was the chief operating officer for the Channel Health subsidiary of IDX Systems. Previously, she held a series of management, product development and marketing positions at Shared Medical Systems.

Randall N. Spratt, 56, executive vice president, chief information officer, McKesson

Spratt has been with McKesson for more than 18 years, most recently as chief process officer for McKesson Technology Solutions managing business development, information technology, and strategic planning officers, as well as the technology services business. Prior to joining McKesson, Spratt held executive positions of increasing responsibility at the start-up Advanced Laboratory Systems, where he ultimately became the chief operations officer. After the acquisition of ALS in 1999, Spratt took on responsibility for HBOC’s laboratory systems business. After the acquisition of HBOC by McKesson in 1999, he became part of the reconstructed management team.

Marc E. Owen, 48, executive vice president, Corporate Strategy and Business Development

Owen has served in this role since 2004. Prior to joining McKesson, he was a senior partner at McKinsey. He was also a founding partner responsible for establishing McKinsey’s presence in Silicon Valley and a leader of McKinsey's Business Technology office globally. He was also CEO of MindCrossing. Owen is currently a director of Nadro, Verispan, Proventys, and MedVantx.

McKesson’s non-executive board of directors has nine members, including David M. Lawrence, 66. Dr. Lawrence has been a director of McKesson since 2004. He served as chairman of the board of Kaiser Foundation Health Plan and Kaiser Foundation Hospitals from 1992 to 2002, when he retired as chairman emeritus. He served as CEO of Kaiser Foundation Health Plan and Kaiser Foundation Hospitals from 1991 to 2002. Dr. Lawrence held a number of positions with these organizations, including vice chairman of the board and chief operating officer. Dr. Lawrence is also a director of Agilent Technologies, Dynavax Technologies, and Raffles Medical Group.



6.7 Selected Financial Statements

Source: McKesson 2008 Annual Report and 10-K

Stock Repurchase Plan and Doubled Dividends: Over the past three years, McKesson has repurchased $3.7 billion of outstanding McKesson common stock. The company is also committed to returning capital to stockholders, and earlier this year, doubled the quarterly dividend from 6 cents to 12 cents per share.

Ten Customers Account for 53% of Total Revenue: In recent years, a significant portion of McKesson’s revenue growth has been with a limited number of large customers. In 2008, sales to its ten largest customers accounted for approximately 53% of total consolidated revenues. Sales to the two largest customers, CVS Caremark Corp. and Rite Aid Corp., accounted for 14% and 13% of total consolidated revenues.

Ten Suppliers Account of 48% of Purchases: McKesson obtains pharmaceutical and other products from various manufacturers, none of which accounted for more than approximately 9% of its purchases in 2008. The company’s ten largest suppliers in 2008 accounted for approximately 48% of its purchases.

Three-Year Summary of Revenues

Revenues increased 9% to $101.7 billion in 2008 and 7% to $93.0 billion in 2007. The growth in revenues was primarily driven by the Distribution Solutions segment, which accounted for 97% of revenues.



Five-Year Revenue Highlights

Source: McKesson 2008 Annual Report and 10-K

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