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Executive Summary

McKesson's Pharmaceutical Card System (PCS) handled approximately $740 mil. in Rx drug reimbursement claims for health plan sponsors in fiscal 1986, the company disclosed in a recent prospectus detailing its first public offering. The company reported processing 43 mil. claims at an average Rx price of $17.25. Those claims generated $31 mil. for PCS, or an average of 71› per claim. The company explained that its client base currently includes 180 insurance carriers, 28 Blue Cross/Blue Shield organizations, over 350 self-insured Rx drug plans, approximately 40 HMOs and seven PPOs covering 100,000 health and welfare funds. The company is going public of the basis of a five-year, 18.4% compound annual growth rate in number of claims processed. PCS, however, believes the market for processing has barely been touched. The firm says it "serves fewer than 10% of the more than 170 mil. individuals in the U.S. covered by major medical insurance plans, the majority of which . . . include some form of Rx drug reimbursement program." In addition, the company sees an opportunity to expand on existing relationships with plan sponsors to increase the percentage of individuals covered by an Rx program. The Scottsdale, Arizona-based company estimates this its current computer hardware is capable of processing 70% more claims without significant modification. However, the company said it plans to upgrade its two central processing units in the first quarter of fiscal 1988, thereby increasing processing capacity by an additional 27%. In addition, the company said it plans to add "two or three" sales reps per year over the next five years. Currently, the PCS marketing staff includes 18 reps working out of 13 sales offices in the U.S. and Canada. PCS markets its drug Rx programs to health plan sponsors on the basis of low-cost claims processing, expertise in pharmacy audit and claims verifications, and monthly reports containing information on Rx claim activity. Plan participants, 5.1 mil. cardholders covering roughly 11.8 mil. individuals, benefit from lower out-of-pocket expenses as well as access to any of more than 59,000 pharmacies that comprise the PCS network, according to the company. While pharmacies must accept lower profit margins resulting from sponsor-imposed drug prices and dispensing fees, PCS maintains that they benefit from the program through access to the large PCS cardholder base and an accurate and timely payment system which reduces losses from bad debts and eliminates service charges associated with credit purchases. PCS will become the second McKesson subsidiary to be spun off in the last six months. In July, after reporting strong first quarter results and declaring a two-for-one stock split, the wholesaler announced plans to take its Armor All unit public ("The Pink Sheet" July 26, p.2). McKesson also recently completed the sale of its chemical business. PCS' total revenues in fiscal 1986 were $39.4 mil., up 24% over the previous year. Of this total, 22% or $8.7 mil. came from subsidiary Pharmaceutical Data Services (PDS), which collects and analyzes data on prescribing patterns, sales and use of Rx drugs for the pharmaceutical industry. PCS had operating profits of $11.9 mil.; PDS operating profits were $1.8 mil. First quarter 1987 results indicate continued growth in both revenue and profit. For three months ended June 30, PCS reported revenues up more than 28% to $11.8 mil. and net earnings of $1.6 mil., an increase of roughly 60% "McKesson believes that a partial separation from McKesson of the company's share ownership and operational management will reinforce the company's ability to pursue its business and marketing strategy of emphasizing cost containment services," the wholesaler explained. "In addition, McKesson believes that obtaining an independent reflection of the company's value in financial markets may furnish additional information to such markets in valuing McKesson's capital stock." McKesson is timing the PCS spinoff with a planned buyback of up to 640,000 shares, or 1.5% of its 42.8 mil. outstanding common shares. The buyback announcement was made Oct. 24, less than two weeks after the PCS announcement. A total 2.3 mil. shares of PCS have been registered for the public offering, which is being jointly managed by Morgan Stanley and Goldman Sachs. Based on a proposed offering price of $11-13 a share, the deal should fetch between $25-30 mil. The prospectus notes that all proceeds will go to McKesson, whose stock price closed at 33-5/8 on Oct. 31. McKesson's ownership in PCS will remain between 84.1% and 86.2% depending on whether the underwriters exercise their over-allotment option in full. After the offering, McKesson will privide certain services to PCS under the terms of an agreement, which initially expires March 31, 1988 and is renewable for one-year terms thereafter. "It is anticipated that such services will include treasury and financial, real estate management, legal, corporate secretary, investor relations, tax, accounting and financial reporting, audit, personnel, planning and procurement services and data processing services related to financial and personnel matters," the prospectus states. Top management of PCS includes President and CEO Donald Dahlin, Robert Field, exec VP and general manager of PCS and Sheldon Silverberg, exec VP and general manager of PDS. All three hold seats on the PCS board. Chart omitted.

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