Cardinal Health 2008 Annual Report Download - page 67

• Other inventory charges and credits include charges for outdated and returned inventory items and
fluctuation in inventory reserves. The Company estimated the portion of these inventory charges
and credits attributable to each product and then allocated them to bulk and non-bulk customers in
proportion to the sales of these products.
The Company used methods that it believes provide a reasonable correlation to allocate the SG&A expenses
for Distribution between bulk and non-bulk customers as follows:
• Warehouse expense includes labor-related expenses associated with receiving, shipping and handling
the inventory as well as warehouse storage costs including insurance, taxes, supplies and other facility
costs. Warehouse expense was allocated in proportion to the number of invoice line items filled for
each bulk or non-bulk customer because the Company believes that there is a correlation between the
number of different products ordered as reflected in invoice lines and the level of effort associated with
receiving, shipping and handling that order (bulk customers typically order substantially larger
quantities of products and therefore generate substantially fewer invoice lines which results in
substantially less warehouse expense being allocated to bulk customers);
• Delivery expense includes transportation costs associated with physically moving the product from the
warehouse to the customer’s designated location. Delivery expense was allocated in proportion to the
number of invoices generated for each bulk or non-bulk customer on the assumption that each invoice
generates a delivery;
• Sales expense includes personnel-related costs associated with sales and customer service activities
(such activities are the same for both bulk and non-bulk customers). Sales expense was allocated in
proportion to the number of invoices generated for each bulk or non-bulk customer because customer
invoices are a reasonable estimate of the amount of customer service calls and sales effort; and
• General and administrative expenses were allocated in proportion to the units of products sold to bulk
or non-bulk customers. These expenses were allocated on the assumption that general and
administrative expenses increase or decrease in direct relation to the volume of sales.
(2) Amounts exclude last-in, first-out (“LIFO”) credit provisions of $0 million, $0 million and $26 million in
fiscal 2008, 2007 and 2006, respectively.
The internal analysis indicated segment expenses as a percentage of revenue were higher for bulk customers
than for non-bulk customers because of higher segment cost of products sold partially offset by lower segment
SG&A expenses. Bulk customers receive lower pricing on sales of the same products than non-bulk customers
due to volume pricing in a competitive market and the lower costs related to the services provided by the
Company. In addition, sales to bulk customers in aggregate generate higher segment cost of products sold as a
percentage of revenue than sales to non-bulk customers because bulk customers’ orders consist almost entirely of
higher cost branded products. The higher segment cost of products sold as a percentage of revenue for bulk
customers is also driven by lower manufacturer distribution service agreement fees and branded pharmaceutical
price appreciation and lower manufacturer cash discounts. Manufacturer distribution service agreement fees and
manufacturer cash discounts are recognized as a reduction to segment cost of products sold and are lower as a
percentage of revenue due to the mix of products sold. Pharmaceutical price appreciation increases customer
pricing which, in turn, results in higher segment gross margin for sales of inventory that was on-hand at the time
of the manufacturer’s price increase. Since products sold to bulk customers are generally held in inventory for a
shorter time than products sold to non-bulk customers, there is less opportunity to realize the benefit of
pharmaceutical price appreciation. Consequently, segment cost of products sold as a percentage of revenue for
bulk customers is higher than for non-bulk customers and segment gross margin as a percentage of revenue is
substantially lower for bulk customers than for non-bulk customers. Deliveries to bulk customers require
substantially less services by the Company than deliveries to non-bulk customers. As such, the segment SG&A
expenses as a percentage of revenue from bulk customers are substantially lower than from non-bulk customers.
These factors result in segment profit as a percentage of revenue being significantly lower for bulk customers
than for non-bulk customers.
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