McKesson 2008 Annual Report Download - page 51

McKESSON CORPORATION
FINANCIAL REVIEW (Continued)
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We estimate the grant-date fair value of employee stock options using the Black-Scholes option-pricing model.
We believe that it is difficult to accurately measure the value of an employee stock option. Our estimates of
employee stock option values rely on estimates of factors we input into the model. The key factors involve an
estimate of future uncertain events. The key factors influencing the estimation process, among others, are the
expected term of the option, the expected stock price volatility factor and the expected dividend yield. We continue
to use historical exercise patterns as our best estimate of future exercise patterns in determining our expected term of
the option. We use a combination of historical and quoted implied volatility to determine the expected stock price
volatility factor. We believe that this market-based input provides a better estimate of our future stock price
movements and is consistent with emerging employee stock option valuation considerations. Through 2008, our
expected stock price volatility assumption reflected a constant dividend yield during the expected term of the option.
Once the fair values of employee stock options are determined, current accounting practices do not permit them to
be changed, even if the estimates used are different from actual.
In addition, we develop an estimate of the number of share-based awards which will ultimately vest primarily
based on historical experience. Changes in the estimated forfeiture rate can have a material effect on share-based
compensation expense. If the actual forfeiture rate is higher than the estimated forfeiture rate, then an adjustment is
made to increase the estimated forfeiture rate, which will result in a decrease to the expense recognized in the
financial statements. If the actual forfeiture rate is lower than the estimated forfeiture rate, then an adjustment is
made to decrease the estimated forfeiture rate, which will result in an increase to the expense recognized in the
financial statements. We re-assess the estimated forfeiture rate established upon grant periodically throughout the
required service period. Such estimates are revised if they differ materially from actual forfeitures. As required, the
forfeiture estimates will be adjusted to reflect actual forfeitures when an award vests. The actual forfeitures in the
future reporting periods could be materially higher or lower than our current estimates.
Our assessments of estimated share-based compensation charges are affected by our stock price as well as
assumptions regarding a number of complex and subjective variables and the related tax impact. These variables
include, but are not limited to, the volatility of our stock price, employee stock option exercise behaviors, timing,
level and types of our grants of annual share-based awards and the attainment of performance goals. As a result, the
future share-based compensation expense may differ from the Company’ s historical amounts. In 2008, 2007 and
2006, share-based compensation expense was $0.20, $0.13 and $0.03 per diluted share.
Loss Contingencies: We are subject to various claims, pending and potential legal actions for product liability
and other damages, investigations relating to governmental laws and regulations and other matters arising out of the
normal conduct of business. Each significant matter is regularly reviewed and assessed for potential financial
exposure. If a potential loss is considered probable and can be reasonably estimated, we accrue a liability in the
consolidated financial statements. The assessment of probability and estimation of amount is highly subjective and
requires significant judgment due to uncertainties related to these matters and is based on the best information
available at the time. The accruals are adjusted, as appropriate, as additional information becomes available. We
regularly review contingencies to determine the adequacy of the accruals and related disclosures. The amount of
actual loss may differ significantly from these estimates.
FINANCIAL CONDITION, LIQUIDITY, AND CAPITAL RESOURCES
Net cash flow from operating activities was $869 million in 2008, compared with $1,539 million in 2007 and
$2,738 million in 2006. Operating activities for 2008 were impacted by a use of cash of $962 million due to the
release of restricted cash for our Consolidated Securities Litigation Action. Excluding this $962 million use of cash,
cash flow provided from operations was $1,831 million. In addition, operating activities in 2008 reflect changes in
our working capital accounts due to revenue growth. Cash flows from operations can also be significantly impacted
by factors such as the timing of receipts from customers and payments to vendors.
Operating activities for 2007 benefited from improved accounts receivable management, reflecting changes in
our customer mix, our termination of a customer contract and an increase in accounts payable associated with
improved payment terms. These benefits were partially offset by increases in inventory needed to support our
growth and timing of inventory receipts. Operating activities for 2007 also include payments of $25 million for the
settlements of Securities Litigation cases.