McKesson 2008 Annual Report Download - page 38

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McKESSON CORPORATION
FINANCIAL REVIEW (Continued)
31
Our Distribution Solutions segment uses the LIFO method of accounting for the majority of its inventories,
which results in cost of sales that more closely reflects replacement cost than do other accounting methods, thereby
mitigating the effects of inflation and deflation on operating profit. The practice in the Distribution Solutions’
distribution businesses is to pass on to customers published price changes from suppliers. Manufacturers generally
provide us with price protection, which limits price-related inventory losses. Price declines on many generic
pharmaceutical products in this segment over the last few years have moderated the effects of inflation in other
product categories, which resulted in minimal overall price changes in those years. Additional information
regarding our LIFO accounting is included under the caption “Critical Accounting Policies” included in this
Financial Review.
In 2007, our Distribution Solutions segment’ s gross profit margin increased compared to the prior year. Gross
profit margin was impacted by higher buy side margins, the benefit of increased sales of generic drugs with higher
margins and an increase in LIFO inventory credits ($64 million in 2007 compared with $32 million in 2006). In
addition, gross profit margin benefited from a relatively stable sell side margin. Partially offsetting these increases
was a decrease associated with antitrust settlements ($10 million in 2007 compared with $95 million in 2006), $15
million of impairment charges associated with the write-down of certain abandoned assets within our retail
automation group and a decrease associated with a larger proportion of revenues within the segment attributed to
sales to customers’ warehouses.
During the first quarter of 2007, we contributed $36 million in cash and $45 million in net assets primarily from
our Automated Prescription Systems business to Parata Systems, LLC (“Parata”), in exchange for a significant
minority interest in Parata. Parata is a manufacturer of pharmacy robotic equipment. In connection with the
investment, we abandoned certain assets which resulted in a $15 million charge to cost of sales and we incurred $6
million of other expenses related to the transaction which were recorded within operating expenses. We did not
recognize any additional gains or losses as a result of this transaction as we believe the fair value of our investment
in Parata approximates the carrying value of consideration contributed to Parata. Our investment in Parata is
accounted for under the equity method of accounting within our Distribution Solutions segment.
Technology Solutions segment’ s gross profit margin decreased primarily reflecting a change in product mix. In
2008, this segment’ s product mix included a higher proportion of lower margin Per-Se service revenues. Partially
offsetting this decrease, 2008 gross profit margin was positively impacted by the recognition of $21 million of
disease management deferred revenues for a contract for which expenses associated with these revenues were
previously recognized as incurred.
Operating Expenses:
Years Ended March 31,
(Dollars in millions) 2008 2007 2006
Operating Expenses
Distribution Solutions $ 2,138 $ 1,896 $ 1,673
Technology Solutions 1,115 884 720
Corporate 283 294 213
Subtotal 3,536 3,074 2,606
Securities Litigation (credits) charge, net (5) (6) 45
Total $ 3,531 $ 3,068 $ 2,651
Operating Expenses as a Percentage of Revenues
Distribution Solutions 2.17% 2.09% 1.97%
Technology Solutions 37.37 39.48 39.05
Total 3.47 3.30 3.05