McKesson 2006 Annual Report Download - page 36

McKESSON CORPORATION
FINANCIAL REVIEW (Continued)
Medical-Surgical Solutions segment’s operating profit as a percentage of revenues declined over the past two years. The decline in the
segment’s 2006 operating profit as a percentage of revenues primarily reflects lower gross profit margins, including a $15 million asset
impairment charge, as well as an increase in bad debt expense. The decline in the segment’s 2005 operating profit as a percentage of revenues
primarily reflects an increase in gross profit margins which were more than offset by a higher proportion of operating expenses. Operating
expenses increased in 2005, in both dollars and as a percentage of revenues, primarily due to the acquisition of MMC and a higher proportion
of costs incurred to serve the segment’s alternate site customers, which have a higher cost-to-serve ratio than the segment’s other customers.
Operating profit for 2005 was also impacted by the lack of flu vaccine supply as well as an $7 million charge to operating expenses due to an
increase in litigation reserves. The Company has decided to explore its strategic options with regard to the acute care portion of this segment’s
business.
Provider Technologies segment’s operating profit as a percentage of revenues increased in 2006 primarily reflecting favorable operating
expenses as a percentage of revenues. Operating expenses for this segment increased primarily due to investments in research and development
activities and sales functions to support the segment’s revenue growth and to a lesser extent, due to the acquisition of Medcon, Ltd.
(“Medcon”). Partially offsetting these increases, operating profit benefited from a reduction in bad debt expense. Operating profit as a
percentage of revenues for this segment declined in 2005 primarily reflecting a decrease in gross profit margin as well as an increase in
operating expenses to support the segment’s revenue growth and a decrease in customer settlement reserve reversals. In 2004, the segment
recorded $66 million of reversals of customer settlement reserves.
During the first quarter of 2007, the segment anticipates incurring restructuring charges of approximately $6 million to $8 million as a result
of a reorganization announced early in the quarter designed to reallocate product development and marketing resources.
Corporate expenses, net of other income, decreased in 2006 primarily reflecting an increase in interest income and a decrease in legal costs
associated with our Securities Litigation. These favorable variances were partially offset by additional costs incurred to support various
initiatives. Corporate expenses, net of other income increased in 2005 primarily reflecting incremental legal costs due to the acceleration of
activity in our Securities Litigation, settlement charges pertaining to lump-sum cash payments from an unfunded U.S. pension plan, a decrease
in gains on sales of surplus properties and additional administrative expenses incurred to support various initiatives. These unfavorable
variances were partially offset by higher interest income and a decrease in expenses associated with charges for loans made to former
employees. In 2004, expenses reflect a $21 million charge for uncollected balances on loans made to former employees for the purchase of
McKesson common stock primarily in February 1999. Legal costs associated with our Securities Litigation were $27 million, $43 million and
$18 million in 2006, 2005 and 2004.
Securities Litigation Charges, Net: As discussed in Financial Note 18, “Other Commitments and Contingent Liabilities,” to the
accompanying consolidated financial statements, in the third quarter of 2005, we announced that we had reached an agreement to settle the
action captioned In re McKesson HBOC, Inc. Securities Litigation (the “Consolidated Action”). In general, under the agreement to settle the
Consolidated Action, we agreed to pay the settlement class a total of $960 million in cash. The settlement agreement was subject to various
conditions, including, but not limited to, preliminary approval by the court, notice to the Class, and final approval by the court after a hearing.
Other than the Consolidated Action, none of the previously reported Securities Litigation was resolved by the settlement date. As a result,
during the third quarter of 2005, we recorded a $1,200 million pre-tax ($810 million after-tax) charge with respect to the Company’s Securities
Litigation. The charge consisted of $960 million for the Consolidated Action and $240 million for other Securities Litigation proceedings.
During 2006, we settled many of the other Securities Litigation proceedings and paid $243 million pursuant to those settlements. Based on
the payments made in the Consolidated Action and the other Securities Litigation proceedings, settlements reached in certain of the other
Securities Litigation proceedings and our assessment of the remaining cases, the estimated reserves were increased by $52 million and
$1 million in pre-tax charges during the first and third quarters of 2006 and decreased by an $8 million pre-tax credit during the fourth quarter
of 2006, for a total net pre-tax charge of $45 million for 2006. As of March 31, 2006 and 2005, the Securities Litigation accrual was
$1,014 million and $1,214 million. Additionally, on February 24, 2006, the court gave final approval to the settlement of the Consolidated
Action, and as a result, we paid approximately $960 million into an escrow account established by the lead plaintiff in connection with the
settlement of the Consolidated Action.
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