McKesson 2006 Annual Report Download - page 33

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McKESSON CORPORATION
FINANCIAL REVIEW (Continued)
Gross profit margin in our Medical-Surgical Solutions segment decreased in 2006 primarily reflecting pressure on our supplier and customer
margins and a $15 million asset impairment charge. In 2005, the segment entered into an agreement with a third party vendor to sell the
vendor’s proprietary software and services. The terms of the contract required us to prepay certain royalties. In 2006, we ended the marketing
and sale of the software under the contract. As a result of this decision, we recorded a $15 million charge to cost of sales to write-off the
remaining balance of the prepaid royalties. Gross profit margin for this segment increased in 2005 primarily due to a higher proportion of
alternate site revenues.
Gross profit margins were flat in 2006 and decreased in 2005 in our Provider Technologies segment. The decrease in our 2005 gross profit
margin primarily reflects a greater mix of revenue associated with clinical products which, because of their complexity, have a higher cost of
installation and support than other more established products.
Operating Expenses:
29
– the benefit of higher supplier cash discounts from a change in customer mix and higher sales volume,
– selling margins declined in our U.S. pharmaceutical distribution business in 2005 compared with 2004 due to a higher proportion of
revenues attributable to institutional customers and continued competitive pressures which moderated somewhat in the second half of the
year,
– the benefit of a lower proportion of revenues within the segment attributed to sales to customers’ warehouses, and
– last-in, first-out (“LIFO”) inventory credits of $32 million and $59 million in 2006 and 2005, reflecting a number of generic product
launches in both years and a higher level of branded pharmaceutical price increases in 2006. In 2004, gross profit was impacted by a LIFO
charge of $28 million which was primarily attributable to a small number of pharmaceutical drugs which did not move to the generic
category until 2005.
Our Pharmaceutical 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 Pharmaceutical 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 fiscal years.
Years Ended March 31,
(Dollars in millions) 2006 2005 2004
Operating Expenses
Pharmaceutical Solutions $1,315 $1,141 $1,111
Medical-Surgical Solutions 585 556 501
Provider Technologies 590 514 451
Corporate 213 234 194
Subtotal 2,703 2,445 2,257
Securities Litigation charges, net 45 1,200
—
Total $2,748 $3,645 $2,257
Operating Expenses as a Percentage of Revenues
Pharmaceutical Solutions 1.58% 1.50% 1.70%
Medical-Surgical Solutions 18.88 19.21 17.82
Provider Technologies 38.26 39.48 37.52
Total 3.12 4.55 3.26