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BINDLEY WESTERN DIVERSION INVESTIGATIONS COST WHSLR. $900,000 OR ALMOST 10% OF 1985 OPERATING INCOME: NET PROFITS INCREASE NONETHELESS BY 11%

Executive Summary

Bindley Western's 1985 operating earnings were reduced roughly 10% by expenses incurred in relation to two grand jury investigations and legal proceedings stemming from them. According to the firm's recent 10K, annual report with the Securities & Exchange Commission, the legal fees appear as an "unusual item" cost of $905,000 on the whslr.'s operating statement. Over half of the expense, or $550,000, was incurred in the fourth quarter, Bindley noted. The primary catalyst in Bindley's legal entanglements is the grand jury investigation of drug diversion in the Atlanta, Georgia area. Code named "Pharmoney," the investigation resulted in guilty pleadings by four former Bindley Western employees, including Exec VP Jack Laughner and Purchasing VP Steven Asher ("The Pink Sheet" Nov. 11, p. 6). As a result of the Atlanta investigation, a complaint was filed Nov. 1 in Philadelphia federal court against the whslr. and some of its officers by shareholder Bernard Lowe. The suit alleges fraud and securities violations in connection ith the firm's $55 mil. convertible debenture public offering in April 1985, and seeks compensatory, punitive and treble damages. Additionally, a federal grand jury in Indianapolis is currently investigating the company, its president, William Bindley, and Senior VP-Treasurer David Swaim. That second grand jury's probe is the result of testimony by Laughner and Asher. A search warrant was executed by federal agents at the company's Indianapolis headquarters last November. Whslr.'s Purchases From Secondary Sources Never "As Much As 4%" Of Total Purchases Precipitating the search, Bindley indicated, were allegations of controlled substances recordkeeping, control and reporting violations; tax reporting and recordkeeping violations; currency reporting violations and falsification of the company's internal books. The controlled substances violations include an allegation that "Mr. Bindley, occasionally obtained non-narcotic prescription pills from the company's inventory for personal use," the SEC filing states. Potential tax offenses include allegations of personal use of corporate assets as well as an allegation that Laughner and Asher "were discovered in possession of a kickback of approximately $40,000 in cash which was recovered from them and subsequently used to pay cash bonuses to employees, but not reflected on the company's books and records or tax returns." While most of the $905,000 diversion investigation expenses for Bindley were associated with legal fees in the court actions, the firm noted that some of the costs were also related to the decision in June to stop purchasing from secondary sources. Bindley pointed out that "inventory losses" from that decision contributed to the $905,000 charge. An increase in doubtful account allowances in Atlanta and the cost of the special outside board cmte. to review the diversion allegations also contributed to the one-time charge. Dropping secondary suppliers at mid-year cost Bindley about $1.7 mil. in gross profits for the full year, the firm indicated. Bindley attributed a drop in gross profit margins from 2.34% in 1984 to 2.07% in 1985 to the decision to forego secondary sources of supply and to realignment of personnel. In his letter to shareholders, Chairman Bindley noted that "at no time" did the purchases of products from secondary sources "ever amount to as much as 4% of our total purchases in a year." He noted that Bindley viewed the purchases as legal until an opinion was given by the U.S. Attorney's office in Atlanta in relation to the Pharmoney investigation In response to the allegations of inadequate recordkeeping for controlled substances, Bindley reported that "the company has recently retained a former senior official of the Federal Drug Enforcement Administration to review the company's controlled substance record-keeping and reporting procedures and to make recommendations for improvement, if needed." Despite the adverse effect of the diversion related expenses on operating earnings, Bindley nevertheless reported an 11% net earnings gain in 1985. Profits were $5.2 mil., compared to $4.7 mil. in 1984. Revenues increased at the same rate, from $567 mil. in 1984 to $627 mil. in 1985. Roughly 82% f the whslr.'s sales, or $514 mil., were attributable to business with five drug chains -- Jack Eckerd, Revco, Rite-Aid, Thrifty and Kroger. Eckerd, Revco and Rite-Aid each accounted "for more than 10%" of the firm's 1985 sales. Combined the three chains accounted for about $400 mil. in business for Bindley. Bindley's reliance on chains as its primary customers reflects the company's operating strategy of specializing in the distribution of Rx pharmaceuticals to firms maintaining their own warehouses. In doing so Bindley Western "has differentiated itself from full-line drug whslrs. which also carry a broad range of non-pharmaceutical products." The company does, however, act as a primary distributor to hospitals, clinics and drugstores carrying only pharmaceutical products. Between 1984 and 1985, sales to nonwarehouse customers increased from roughly 9.7% of sales to 10.8%. Boosted by the proceeds from a $55 mil. debenture offering, the whslr.'s cash position strengthened considerably by the end of 1985, increasing almost two and one-half times during the year, from $32.1 mil. to $77.1 mil. The cash influx helped bolster the firm's working capital, which jumped almost 300%, from $32.4 mil. to $91.2 mil. "The company continues to believe that internally generated funds and its bank lines of credit, increased to $31 mil. during March 1985, should be sufficient to satisfy its current working capital requirements, including forward purchasing opportunities," Bindley stated. With its spartan approach to bricks-and-mortar, and employment costs, Bindley claims to have some of the "industry leading measurements of productivity", such as inventory turns of 32 times in 1985, $4.2 mil. in sales per employee, and $6,300 of sales per square foot of warehouse. In 1985, the company had about $2 mil. in buildings, leases and equipment and over $4.6 mil. in transportation and other equipment. BINDLEY EXPLAINS DECISION TO HALT PURCHASES FROM SECONDARY SOURCES Taken from Bindley-Western Chairman William Bindley's letter to shareholders in the 1985 annual report. Paragraphing by "The Pink Sheet". "As reported in both our June and September quarterly reports in 1985, the company had, until June of 1985, purchased pharmaceuticals from licensed secondary wholesale distributors (sometimes referred to as 'diverters') in addition to purchasing from the manufacturers. Management of the company believes that these purchases were legal. In fact, in 1983 the company was given a legal opinion that such purchases were not, on their own, illegal. Our understanding of the legality of these types of purchases was shared by many in the industry as evidenced by the fact that many of our competitors, as well as some major drug chains, routinely purchase from secondary wholesalers. However, last June we were informed by the United States Attorney's office in Atlanta that it viewed all purchases of pharmaceuticals from secondary wholesalers to be illegal and to constitute a fraud upon the manufacturer and the drug consuming public. When advised of this, management immediately stopped all purchasing from secondary wholesalers. However, at no time did these purchases ever amount to as much as four percent of our total purchases in any year."
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