McKesson 2005 Annual Report Download - page 38

McKESSON CORPORATION
FINANCIAL REVIEW (Continued)
We predominately use a discounted cash flow model derived from internal budgets in assessing fair values for our goodwill impairment
testing. Factors that could change the result of our goodwill impairment test include, but are not limited to, different assumptions used to
forecast future revenues, expenses, capital expenditures and working capital requirements used in our cash flow models. In addition, selection
of a risk-adjusted discount rate on the estimated undiscounted cash flows is susceptible to future changes in market conditions, and when
unfavorable, can adversely affect our original estimates of fair values. At March 31, 2005, we concluded that there was no impairment in our
goodwill.
Contract Accounting: We use the percentage of completion method of accounting to recognize certain revenues and costs, primarily for
long-term software contracts within our Provider Technologies segment. This method of accounting requires us to estimate the timing and
amounts of total revenue to be earned and total costs to be incurred over the life of a contract. Revenue estimates are derived primarily from
negotiated contract prices modified by assumptions regarding change orders, contract arrangements and assumptions regarding penalty
provisions associated with technical performance. Revenues are recorded based on the percentage of costs incurred to date compared to the
most recent estimate of total costs to complete each contract. Cost estimates are based primarily on the expected amount of resources required
to complete the contract.
The estimated revenue to be earned and costs to complete a project can change significantly throughout the period of a contract. Factors that
could change estimates include, but are not limited to, the ability to successfully complete milestones, the timing of milestones, and
modifications in the amount of resources or other costs required to complete the project. Changes in estimates to complete, and revisions in
overall profit estimates on percentage of completion contracts, are recognized in the period in which they are determined. We accrue for
contract losses if and when the current estimate of total contract costs exceeds total contract revenue. Such a provision is subject to change as
additional information is obtained and as contracts progress towards completion.
In 2002, we entered into a $500 million, ten year contract with the National Health Services Information Authority (“NHS”), an
organization of the British government charged with the responsibility of delivering healthcare in England and Wales. The contract engages the
Company to develop, implement and operate a human resources and payroll system at more than 600 NHS locations.
As previously reported, there have been contract delays to date which have increased costs and decreased the amount of time in which we
can earn revenues. These delays have adversely impacted the contract’s projected profitability and no material revenue has yet been recognized
on this contract. As of March 31, 2005, our consolidated balance sheet includes an investment of approximately $114 million in net assets,
consisting of prepaid expenses, software and capital assets, net of cash received, related to this contract. Due to the delays and other desired
modifications to the original contract, we have negotiated a tentative agreement with the NHS on changes to certain key terms and conditions
in the contract including a term extension and updated implementation plan. We expect this contract amendment to be signed in the first
quarter of the 2006 fiscal year. While we believe it is likely that we can deliver and operate a satisfactory system and recover our investment in
this contract, failure to sign the tentative agreement in its current form and/ or further implementation delays may result in significant losses
that could be material. Additionally, if there is further modification to the tentative amended contract terms and conditions and implementation
plan, it is possible that the terms of that agreement may result in significant losses, that could be material.
Stock Options: We account for employee stock-based compensation in accordance with Accounting Principles Board Opinion (“APB”)
No. 25, “Accounting for Stock Issued to Employees.” In accordance with APB No. 25, compensation expense is recorded based on a stock
option’s intrinsic value, which is the difference between the market value of a company’s stock and the exercise price at the date of grant. As
we generally grant stock options to employees at market value at the date of grant, compensation expense as a result of option grants has been
nominal.
Effective April 1, 2006, we anticipate recording stock-based compensation expense in accordance with SFAS No. 123(R), “Share-Based
Payment.” SFAS No. 123(R) requires the recognition of cost resulting from all share-based payments, including grants of employee stock
options, in the financial statements based on the grant-date fair values. We intend to adopt this standard using the modified prospective method
of transition, whereby compensation cost will be recognized for new awards granted and awards modified, repurchased and cancelled after
April 1, 2006 and for the unvested portion of all awards issued prior to and outstanding at April 1, 2006 at their respective grant date fair value
as the remaining requisite service is rendered.
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