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modified after May 31, 2003 and for all other matters, at the beginning of our second quarter 2004. The adoption of this standard did not have a material impact on our consolidated financial statements.

     In December 2003, the Staff of the SEC issued Staff Accounting Bulletin (“SAB”) No. 104, “Revenue Recognition,” which supersedes SAB No. 101, “Revenue Recognition in Financial Statements.” SAB No. 104’s primary purpose is to rescind the accounting guidance contained in SAB No. 101 related to multiple-element revenue arrangements that was superseded as a result of the issuance of Emerging Issues Task Force (“EITF”) Issue No. 00-21. Additionally, SAB No. 104 rescinds the SEC’s related Revenue Recognition in Financial Statements Frequently Asked Questions and Answers issued with SAB No. 101 that had previously been codified by the SEC. While the wording of SAB No. 104 reflects the issuance of EITF Issue No. 00-21, the revenue recognition principles of SAB No. 101 remain largely unchanged by the issuance of SAB No. 104, which was effective upon issuance. The adoption of SAB No. 104 did not have a material effect on our consolidated financial position or results of operations.

     In January 2004, the FASB issued Financial Staff Position (“FSP”) No. FAS 106-1, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003.” The Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the “Act”) allows employers that sponsor a postretirement plan providing a qualifying or eligible prescription drug benefit to receive a federal subsidy. As permitted by FSP No. 106-1, we elected to defer recognizing the effects of the Act until authoritative guidance on accounting for the new subsidy was issued. In May 2004, the FASB issued FSP No. FAS 106-2 which provides accounting guidance for this new subsidy. Management has concluded that the prescription drug benefits provided to our Medicare-eligible retirees are actuarially equivalent based on the current interpretation of the guidance included in the Act and accordingly, the Company adopted the provisions of FSP No. 106-2 in the second quarter of 2005. The expected subsidy had the effect of reducing the Company’s accumulated postretirement benefit obligation by approximately $19 million. This reduction is recognized as an actuarial gain and will be amortized over three years. The expected subsidy will result in a reduction in interest cost of approximately $1 million in 2005. As required by the FSP, the Company recognized reductions in postretirement benefit expense of $3.7 million in the second quarter, including amounts attributable to the first quarter, and $1.8 million in the third quarter of 2005.

     In November 2004, the FASB issued SFAS No. 151, “Inventory Costs — an amendment of ARB No. 43, Chapter 4.” SFAS No. 151 clarifies the accounting guidance included in Accounting Research Bulletin (“ARB”) No. 43, Chapter 4, “Inventory Pricing” related to abnormal amounts of idle facility expense, freight, handling and spoilage costs. SFAS No. 151 is effective for inventory costs incurred during 2007. We are currently assessing the impact of SFAS No. 151 on our consolidated financial statements; however, we do not believe the adoption of this standardSFAS No. 154 will have a material effect on our consolidated financial statements.

     In December 2004, the FASB issued SFAS No. 123(R), “Share-Based Compensation,” which requires the recognition of cost resulting from transactions in which the Company acquires goods and services by issuing its shares, share options, or other equity instruments. This standard requires a fair value-based measurement method in accounting for share-based payment transactions with both employees and nonemployees. This standard replaces SFAS No. 123, “Accounting for Stock-Based Compensation,” and supersedes Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees.” Accordingly, the use of the intrinsic value method as provided under APB Opinion No. 25 will be eliminated. SFAS No. 123(R) is effective for all awards of share-based payments granted, modified, or cancelled after June 15, 2005. In addition, compensation cost for the unvested portion of awards issued prior to and outstanding as of June 15, 2005 would continue to be recognized at the grant-date fair value as the remaining requisite service is rendered. We are currently assessing the impact of SFAS No. 123(R) on our consolidated financial statements.

     In December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets — an amendment of APB Opinion No. 29,” which eliminates the exception from fair value measurement for nonmonetary exchanges of similar productive assets that do not culminate an earning process under APB Opinion No. 29, “Accounting for Nonmonetary Transactions.” SFAS No. 153 requires the measurement based on the recorded amount of the assets relinquished for nonmonetary exchanges that do not have commercial substance. A nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the

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before March 31, 2005 and have2005. Prior to 2004, stock options typically vested over a sevenfour year term. Historically, options grantedperiod. These actions were approved by the Company generally vest over four years and have a term of ten years.

     The Compensation Committee of the Company’s Board of Directors (the “Board”) approved the accelerated vesting in 2004 and the shorter vesting period for certain 2005 stock option grants for employee retention purposes and in anticipation of the requirements of SFAS No. 123(R)., "Share–Based Payment." As discloseda result of the 2004 accelerated vesting and 2005 shorter vesting periods, compensation expense, as indicated in Note 1,the above table, was nominal.

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contract loss provision by $15.2 million primarily to reflect the final terms and conditions of our termination agreement with this customer.

4. Restructuring Activities

     We recorded net reductions in restructuring reserves of $0.7 million and net charges from restructuring activities of $0.4 million for the quarter and the nine months ended December 31, 2004. The net reductions primarily related to adjustments for prior years’ restructuring plans due to changes in estimated costs to complete these activities.

     The following table summarizes restructuring activities for the nine months ended December 31, 2004:

     Accrued restructuring liabilities are included in other liabilities in the accompanying condensed consolidated balance sheets. In connection with the April 2004 acquisition of MMC, we recorded $4.0 million of liabilities for employee severance costs. These costs have been recognized as liabilities assumed in the purchase price of MMC.

     In addition to the above restructuring activities, we are still managing a 2001/2000 restructuring plan associated with customer settlements for the discontinuance of overlapping and nonstrategic products and other product development projects within our Provider Technologies segment. Customer settlement allowances, which are included as a reduction of accounts receivable in the accompanying condensed consolidated balance sheets, were reduced by $1.0 million in non-cash settlements during the first nine months of 2005 to $5.2 million at December 31, 2004 from $6.2 million at March 31, 2004. Total cash and non-cash settlements of $45.3 million and $96.0 million have been incurred since the inception of this restructuring plan. Non-cash settlements represent write-offs of customer receivables. There have been no significant offsetting changes in estimates that increased the provision for customer settlements. During the nine months ended December 31, 2003, $19.7 million of the allowance was reversed into operating expenses due to favorable settlements and continued negotiations with affected customers. At March 31, 2004, we substantially completed our negotiations with the affected customers. As a result, we do not anticipate additional significant increases to the allowance for customer settlements. However, as settlement negotiations with the remaining customers are finalized, additional adjustments to the reserve may be necessary.

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5. Pension and Other Postretirement Benefit Plans

     The following table provides the components of the net periodic expense for the Company’s defined benefit pension and postretirement plans:

     As described in Note 1, we adopted the provisions of FSP No. FAS 106-2 in the second quarter of 2005. The expected Medicare subsidy had the effect of reducing the Company’s accumulated postretirement benefit obligation by approximately $19 million. This reduction is recognized as an actuarial gain and amortized over three years. The expected subsidy results in a reduction in interest cost of approximately $1 million in 2005. As required by the FSP, the Company recognized reductions in postretirement benefit expense of $3.7 million in the second quarter, including amounts attributable to the first quarter, and $1.8 million in the third quarter of 2005.

     During the first quarter of 2005, we made several lump sum payments totaling approximately $42 million from an unfunded U.S. pension plan. In accordance with SFAS No. 88, “Employers’ Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits,” approximately $12 million in settlement charges associated with these payments were expensed in the first quarter of 2005. Substantially all of this expense was recorded in the Corporate segment.

6. Income Taxes

     During the third quarter of 2005, we recorded an income tax benefit of $390 million for the Securities Litigation described in more detail in Note 12. We believe the settlement of the consolidated securities class action and the ultimate resolution of the lawsuits brought independently by other shareholders will be tax deductible. However, the tax attributes of the litigation are complex and the Company expects challenges from the appropriate taxing authorities, and accordingly such deductions will not be finalized until all the lawsuits are concluded and an examination of the Company’s tax returns is completed. Accordingly, we have provided a reserve of $85 million for future resolution of these uncertain tax matters. While we believe the tax reserve is adequate, the ultimate resolution of these tax matters may exceed or be below the reserve. During the third quarter of 2005, we also recorded a $4.9 million income tax expense arising primarily from settlements and adjustments with various taxing authorities.

     During the nine months ended December 31, 2004, a $6.4 million income tax benefit was recorded primarily due to a reduction of a portion of a valuation allowance related to state income tax net operating loss carryforwards. We believe that the income tax benefit from a portion of these state net operating loss carryforwards will now be realized. In addition, we sold a business for net cash proceeds of $12.3 million. The disposition resulted in a pre-tax loss of $1.1 million and an after-tax loss of $4.6 million. The after-tax loss on the disposition was the result of a lower tax adjusted cost basis for the business. Financial results for this business were included in our Pharmaceutical Solutions segment and were not material to our condensed consolidated financial statements. Partially offsetting the tax impact of this disposition, a net income tax benefit of $2.2 million relating to favorable tax settlements and adjustments was recorded.

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the principal amount.$206 million. The Debentures were purchased by theMcKesson Financing Trust which is wholly owned by the Company,(the “Trust”) with proceeds from its issuance of four million shares of preferred securities to the public and 123,720 common securities to us. These preferred securities are convertible at the holder’s option into the Company’s common stock. The Debentures representrepresented the sole assets of the Trust.

Trust and bore interest at an annual rate of 5%, payable quarterly. These preferred securities of the Trust were convertible into our common stock at the holder’s option.

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recorded as liabilities. Because the amounts of these indemnification obligations often are not explicitly stated, the overall maximum amount of these commitments cannot be reasonably estimated. Other than obligations recorded as liabilities at the time of divestiture, we have historically not made significant payments as a result of these indemnification provisions.

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monetary judgment in this action. Also as previously reported,or settlements that could require payments by the Company and other defendants moved to dismiss all of the claims on various grounds. The Delaware Court dismissed all claims against all defendants, except that the Delaware Court stayed (in favor of the Consolidated Action) the claim against the pre-merger McKesson directors based on alleged breaches of fiduciary duty arising out of the allegedly material false proxy statement issued in connection with the merger, and the Delaware Court denied the defendants’ motion to dismiss the claim against certain post-merger directors of McKesson for alleged failures to exercise oversight of the Company’s accounting practices from January 12, 1999 through April 28, 1999, leaving a single claim to be litigated in the Delaware Court. Pursuant to a stipulation and order entered by the court on January 10, 2005, the defendants must file an answeraddition to the fourth amended complaint by January 31, 2005. No trial date has been set.

II. Contingency

     As discussed in our annual report on Form 10-K for the year ended March 31, 2004, 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.

     To date, there have been delays to this contract which have caused increased costs and a decrease in 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 December 31, 2004, our consolidated balance sheet includes an investment of approximately $94 million in net assets, consisting of prepaid expenses, software and capital assets, net of cash received, related to this contract. While we believe it is likely that we can deliver and operate an acceptable system and recover our investment in this contract, we are currently negotiating with the NHS to amend certain key terms and conditions in the contract, and there is no certainty we will agree on an updated implementation plan. Our goal is to complete this negotiation by the end of fiscal 2005. However, the timing and the outcome of these negotiations is uncertain and failure to reach agreement on an updated implementation plan and amend certain key contract terms and conditions, and/or further delays in the implementation may result in losses that could be material. Even if we agree on amended contract terms and conditions and an updated implementation plan, it is possible that the terms of that agreement may result in the impairment of our net assets related to the contract as well as substantial penalties and charges,reserve, which could have a material adverse impact on our consolidatedMcKesson’s financial statements.

13. Stockholders’ Equity

     Comprehensive income is as follows:position, results of operations and cash flows.