McKesson 2006 Annual Report Download - page 48

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McKESSON CORPORATION
FINANCIAL REVIEW (Continued)
Funds necessary for future debt maturities and our other cash requirements are expected to be met by existing cash balances, cash flows
from operations, existing credit sources and other capital market transactions.
MARKET RISKS
Interest rate risk: Our long-term debt bears interest predominately at fixed rates, whereas our short-term borrowings are at variable interest
rates. If the underlying weighted average interest rate on our variable rate debt were to have changed by 50 bp in 2006 and 2005, interest
expense would not have been materially different from that reported.
As of March 31, 2006 and 2005, the net fair value liability of financial instruments with exposure to interest rate risk was approximately
$1,082 and $1,335 million. Fair value was estimated on the basis of quoted market prices, although trading in these debt securities is limited
and may not reflect fair value. Fair value is subject to fluctuations based on our performance, our credit ratings, changes in the value of our
stock and changes in interest rates for debt securities with similar terms.
Foreign exchange risk: We derive revenues and earnings from Canada, the United Kingdom, Ireland, France, the Netherlands, Israel,
Australia, New Zealand and Mexico, which exposes us to changes in foreign exchange rates. We seek to manage our foreign exchange risk in
part through operational means, including managing same currency revenues in relation to same currency costs, and same currency assets in
relation to same currency liabilities. Foreign exchange risk is also managed through the use of foreign currency forward-exchange contracts.
These contracts are used to offset the potential earnings effects from mostly intercompany foreign currency investments and loans. As of
March 31, 2006 and 2005, an adverse 10% change in quoted foreign currency exchange rates would not have had a material impact on our net
fair value of financial instruments that have exposure to foreign currency risk.
RELATED PARTY BALANCES AND TRANSACTIONS
Information regarding our related party balances and transactions is included in “Critical Accounting Policies” appearing within this
Financial Review and Financial Note 20, “Related Party Balances and Transactions,” to the accompanying consolidated financial statements.
NEW ACCOUNTING PRONOUNCEMENTS
In December 2004, the Financial Accounting Standards Board issued SFAS No. 123(R), “Share-Based Payment.” SFAS No. 123(R)
replaces SFAS No. 123, “Stock-Based Compensation” issued in 1995. SFAS No. 123(R) requires that the fair value of the grant of employee
stock options be reported as an expense. Historically, we have disclosed in our footnotes the pro forma expense effect of the grants (see
Financial Note 1 to the accompanying consolidated financial statements under the caption “Share-Based Payment.”)
In 2006, 2005 and 2004, we accelerated the vesting of substantially all of the then outstanding stock options. As a result of this acceleration,
approximately $132 million of pro forma SFAS No. 123 compensation expense would not be recognized in earnings in accordance with SFAS
No. 123(R) post April 1, 2006. Total compensation expense related to unvested stock options not yet recognized at March 31, 2006 was
approximately $11 million, which is expected to be recognized on a pro rata basis over the next four years.
As a result of the provisions of SFAS No. 123(R), in 2007, we expect share-based compensation charges to approximate $0.08 to $0.10 per
diluted share, or approximately $0.05 to $0.07 per diluted share more than the share-based compensation expense recognized in our net income
in 2006. 2006 net income includes $0.03 per diluted share of compensation expense associated with restricted stock whose intrinsic value as of
the grant date is being amortized over the vesting period. Looking beyond 2007 through to 2010, we anticipate the impact of SFAS No. 123(R)
to continue to impact net income as future awards of share-based compensation are granted and amortized over the expected vesting period of
four years. Our assessments of estimated 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.
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