McKesson 2016 Annual Report Download - page 46

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McKESSON CORPORATION
FINANCIAL REVIEW (Continued)
Gross profit was flat in 2016 and increased 37% in 2015 compared to the same periods a year ago.
Excluding unfavorable foreign currency effects of 4%, gross profit increased 4% in 2016. Gross profit margin
decreased in 2016 and increased in 2015. These changes were primarily due to our Distribution Solutions
segment.
Distribution Solutions
Distribution Solutions segment’s gross profit was flat in 2016 and increased in 2015. Excluding unfavorable
foreign currency effects of 4%, gross profit increased 4% in 2016. Gross profit margin decreased in 2016
primarily due to a lower sell margin within our North America distribution business driven by increased
customer sales volume with some of our largest customers, partially offset by higher buy margin including
benefits from our global procurement arrangements, lower LIFO-related inventory charges and $76 million in
cash receipts representing our share of antitrust legal settlements. Additionally, this business has been
experiencing weaker generic pharmaceutical pricing trends, which are expected to continue in 2017. Buy margin
primarily reflects volume and timing of compensation we receive from pharmaceutical manufacturers, including
the effects of price increases of both branded and generic drugs.
Gross profit margin increased in 2015 primarily due to our Celesio acquisition, higher buy margin including
the effects of generic price increases and our mix of business, partially offset by lower sell profit. Gross profit
margin for 2015 was unfavorably affected by the increased sales associated with newly launched drugs for the
treatment of Hepatitis C. Additionally, gross profit margin for 2014 included a $50 million charge for the
reversal of a fair value step-up of inventory acquired through our Celesio acquisition and $37 million of cash
receipts representing our share of antitrust settlements.
Our LIFO-related inventory expenses were $244 million, $337 million and $311 million in 2016, 2015 and
2014. Our North America distribution business 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 business’ practice 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 net 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 net impact of price increases on pharmaceutical and non-pharmaceutical products held in inventory.
Our annual LIFO expense is affected by changes in year-end inventory quantities, product mix and manufacturer
pricing practices, which may be influenced by market and other external influences. Changes to any of the above
factors could have a material impact to our annual LIFO expense. LIFO expense decreased in 2016 primarily due
to the impact of lower price increases.
As a result of cumulative net price deflation, at March 31, 2013, pharmaceutical inventories at LIFO were
more than market and accordingly, a $60 million lower-of-cost or market (“LCM”) reserve reduced inventories
to market. Starting in 2014, we have experienced net inflation in our pharmaceutical inventories and LIFO-
related charges were incurred, and accordingly, the $60 million LCM reserve was fully released resulting in an
increase in gross profit. As of March 31, 2016 and 2015, pharmaceutical inventories at LIFO did not exceed
market.
Technology Solutions
Technology Solutions segment’s gross profit decreased over the last two years. Gross profit margin
increased in 2016 and decreased in 2015. In addition to changes in our mix of business, gross profit margin was
impacted by:
40