McKesson 2014 Annual Report Download - page 36

McKESSON CORPORATION
FINANCIAL REVIEW (Continued)
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Distribution Solutions
Distribution Solutions segment’s gross profit margin increased in 2014 compared to 2013 primarily due to our business
acquisitions, growth in sales of higher margin generic drugs, and an increase in buy margin. Buy margin primarily reflects volume
and timing of compensation we receive from pharmaceutical manufacturers. These increases were partially offset by a decrease
in sell margin and charges related to the LIFO method of accounting for inventories, as further described below. Additionally,
gross profit was impacted by a $50 million charge for the reversal of a fair value step-up of inventory acquired as part of the
Celesio acquisition. Gross profit margin increased in 2013 compared to 2012 primarily due to higher sales of generic drugs,
business acquisitions, an increase in buy margin and antitrust settlement receipts, and a lower proportion of revenues within the
segment attributed to lower-margin sales to customers’ warehouses. These increases were partially offset by a decrease in sell
margin.
Our last-in, first-out (“LIFO”) net inventory expense was $311 million in 2014, $13 million in 2013 and $11 million in 2012.
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 under other accounting methods. The practice in the Distribution Solutions
segment’s 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. A LIFO expense is recognized when the net effect
of price increases on pharmaceutical and non-pharmaceutical products held in inventory exceeds the impact of price declines,
including the effect of branded pharmaceutical products that have lost market exclusivity. A LIFO credit is recognized when the
net effect of price declines exceeds the impact of price increases on pharmaceutical and non-pharmaceutical products held in
inventory.
From 2005 through 2011, we experienced net price deflation and in 2012 and 2013, we began to experience a modest net
inflationary trend in our pharmaceuticals indices, as price increases on branded pharmaceuticals exceeded the impact of price
declines and shifts toward generic pharmaceuticals, including the effect of branded pharmaceutical products that have lost market
exclusivity. As a result of this cumulative net price deflation, at March 31, 2013, pharmaceutical inventories at LIFO were $60
million more than market and, accordingly, a $60 million lower-of-cost or market (“LCM”) reserve reduced inventories to market.
During 2014, we experienced net inflation in our pharmaceutical inventories. As a result, in 2014, we recorded LIFO charges of
$311 million to cost of sales, net of the LCM reserve release. As of March 31, 2014, pharmaceutical inventories at LIFO did not
exceed market. At March 31, 2014 and March 31, 2013, our LIFO reserves, net of LCM adjustments were $431 million and $120
million. Additional information regarding our LIFO accounting is included under the caption “Critical Accounting Policies and
Estimates,” included in this Financial Review.
Technology Solutions
Technology Solutions segment’s gross profit margin increased in 2014 compared to 2013 primarily due to growth in higher-
margin revenues, partially offset by product alignment charges. Technology Solutions segment’s gross profit margin increased in
2013 compared to 2012 primarily due to a change in product and services mix and a decline in product alignment charges partially
offset by a $10 million impairment of capitalized software held for sale.
In 2014, this segment recorded pre-tax charges totaling $57 million. These charges primarily consisted of $35 million of
product alignment charges, $15 million of integration-related expenses and $7 million of reduction-in-workforce severance charges.
Included in the total charge was $35 million for severance for employees primarily in our research and development, customer
services and sales functions, and $15 million for asset impairments which primarily represents the write-off of deferred costs for
a product that will no longer be developed. Charges were recorded in our consolidated statement of operations as follows: $34
million in cost of sales and $23 million in operating expenses.
In 2013, this segment recorded $46 million of non-cash pre-tax impairment charges. These charges were the result of a
significant decrease in estimated revenues for a software product. The charge included a $36 million goodwill impairment to
reduce the carrying value of goodwill within the applicable reporting unit to its implied fair value. In addition, the goodwill had
a nominal tax basis. This impairment charge was recorded in operating expenses within our consolidated statement of operations.
The balance of the charge represents a $10 million impairment to reduce the carrying value of the unamortized capitalized software
held for sale costs for this product to its net realizable value. We concluded that the estimated future undiscounted revenues, net
of estimated related costs, were insufficient to recover its carrying value. This impairment charge was recorded in cost of sales
within our consolidated statement of operations.