A financial mushroom cloud rose over McKesson HBOC last week as the company slashed revenue figures by $327.4 million and operating profits by $191.5 million for the past three fiscal years because of irregularities uncovered at HBO & Co., the software specialist it acquired in January.
"We profoundly regret the series of events that has led us to what we are announcing tonight," David Mahoney, co-chief executive officer of McKesson, told investors and analysts assembled July 14 at the Waldorf Astoria Hotel in New York. "The effect on our employees and our company's reputation has been truly regrettable," he said.
The stakes are high for McKesson's hospital customers as well. Some analysts said McKesson's preoccupation with internal problems could sap the vitality of the HBO business lines.
About 5,000 hospitals are McKesson customers, John Hammergren, the company's other co-CEO, told analysts. "There is no place in healthcare where our corporation doesn't touch," he said, trying to reassure investors of the company's fundamental strength. But he also underscored the gravity of McKesson's woes for the thousands of hospitals that rely on the San Francisco-based company for the delivery of supplies and information services.
The massive revisions stemmed from rampant manipulation of contracts at HBO, including backdating sales agreements and booking sales before contingencies such as board approval were obtained. Audits of HBO uncovered the improprieties, and all the financial restatements were limited to operations in that division, McKesson said last week.
The restatements effectively wiped out half the information technology division's profits during the past fiscal year and left many analysts and investors reeling.
In January, McKesson paid big bucks-$12.4 billion-for HBO based on the company's torrid sales of software and services. But HBO's outward success was buoyed by scores of phantom sales, McKesson has since learned.
McKesson executives said they expect to record many of those deals in the future, although they acknowledge that about $50 million will probably never materialize.
"We clearly have overpaid for HBO & Co.," Mahoney said. "We would put our credibility at risk if we said anything other than that. Whether we substantially overpaid for it will be determined over time."
Wall Street was braced for bad news. Based on preliminary estimates, McKesson warned on April 28 that revenues would be reduced by about $42 million. A month later, McKesson officials said the situation was much worse than expected.
On June 21, former HBO executives Charles McCall and Albert Bergonzi were dismissed, and McKesson's CEO Mark Pulido and Chief Financial Officer Richard Hawkins resigned (June 28, p. 22).
Even after all the foreshadowing, the whopping cuts were shocking.
"We were pretty surprised by the absolute size and depth of them," said Chris McFadden, an analyst at First Union Capital Markets, Richmond, Va.
McKesson said for fiscal 1999 ended March 31, it earned $84.9 million, or 31 cents per share, on revised revenues of $30.4 billion, compared with earnings of $304.6 million, or $1.10 per share, on revenues of $22.4 billion in 1998.
The financial irregularities are being investigated by the U.S. attorney's office for the Northern District of California and the San Francisco District Office of the Securities and Exchange Commission, McKesson said.
McKesson added insult to some investors' financial injuries by rewarding Pulido, who engineered the disastrous HBO deal.
In a proxy statement filed with the SEC last week, McKesson said it would pay Pulido at least $850,000 per year through 2004, under the employment agreement in effect before he resigned. Pulido also received $6 million in incentive payments in fiscal 1999, triggered by the HBO deal, according to the proxy.
The price of McKesson shares slid $31.25 per share, or 48%, on April 28, after the company disclosed that irregularities at HBO would require financial revisions. On July 15, the first day of trading after the restatement was released, McKesson shares closed up 37 cents at $31.37 on the New York Stock Exchange.
"I'm absolutely appalled at how richly Mark Pulido is being rewarded for destroying $10 billion in shareholder value," fumed Michael Krensavage, an analyst at Brown Brother Harriman, New York. "It's disgusting."
Others expressed hope that McKesson is on the road to recovery. "I'm encouraged by the speed at which they've made changes and the strategic steps they're taking," said Larry Marsh, an analyst at Lehman Brothers. Nevertheless, McKesson "is going to be a transition story for the next year," he said.