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Executive Summary

Alco's drug distribution business to hospitals passed the $1 bil. milestone in fiscal 1991. With a gain of $157 mil. in additional sales in fiscal 1990, the hospital business generated nearly 60% of the wholesaler's total sales gain of $263 mil. in the last full-year reporting period ended Sept. 30, 1991. The hospital drug business has been the fastest-growing segment of Alco for at least the last six consecutive fiscal years. As recently as fiscal 1985, the hospital business accounted for less than a quarter of Alco's total sales mix. At just over $1 bil., the hospital distribution business accounted for well over a third of 1991 sales (see customer profile box, p. 18). "The contribution to overall sales from the hospital segment increased from 31% in fiscal 1988 to 35% in fiscal 1991," Alco observes in a prospectus for a public offering. The hospital business grew at a "compounded rate of 15.2% over the period." Alco's cultivation of hospitals has made that part of the business particularly important to the wholesaler. The firm notes that "hospitals and institutions account for a slightly larger share of the company's customer mix than the industry average." The most recent annual operating survey figures from the National Wholesale Druggists' Association indicate that Alco's hospital business accounts for 12 percentage points more of its corporate sales mix than the industry average of about 23%. The hospital business remains a target for further growth at Alco. The wholesaler says that it "intends to expand in the markets it currently serves by focusing on customer segments, such as hospitals, not fully serviced in the area." The wholesaler reports that the hospital business got a boost in the middle of fiscal 1991 by "new supply agreements with several major hospital groups." Alco has had a less steady growth pattern with chain drugstores. The company dropped several "low-margin" chain and mass merchandiser accounts in fiscal 1991. Those customer discontinuations cut sales growth to that class to 2% in 1991. Alco said the discontinuations reflected in part a "decision to decrease bulk or dock-to-dock sales to chain warehouses due to minimal profit contribution." Chains re-emerged as a growth segment in the first quarter of the current fiscal year. Sales to that category advanced 25%. Alco says it intends to focus on small chain drug companies where it "can provide higher margin value-added services." Alco maintains that its business is more balanced among major customers than its three largest wholesale competitors. Despite the large contracts with hospital groups, Alco reports that no single customer accounts for more than 5% of Alco's business. As Alco's hospital business has increased, so has its generic drug distribution. Generic drugs have grown to represent almost 15% of the company's total pharmaceutical sales, up from about 5% of sales in the mid-1980s. With total pharmaceutical sales in fiscal 1991 of about $2.5 bil., Alco handled roughly $380 mil. in generic/multi-source products. Price increases in the drug business have played a significant role in the growth of Alco's business during the last several years. According to figures in the recent filing with SEC, price increases have contributed $175 mil. in added sales volume in fiscal 1991 and $178 mil. in 1990. In both years, price increases represented almost two-thirds of Alco's revenue increase for the year. In another sign of the slowing pace of industry price increases, Alco reports that price hikes played a smaller precentage role in the growth of revenues in the three months ended Dec. 31, 1991. Price increases added about $34 mil. to the company's $135 mil. revenue growth in the first quarter of the current fiscal year. While Alco rode the price increase curve to higher sales during recent years, the firm said that it did not attempt to take full advantage of the profit opportunities from purchasing inventory ahead of manufacturer increases. "The company believes that it has not invested to the same extent as many of its competitors in inventory purchased in advance of manufacturer price increases," Alco said. The wholesaler added that it believes that the opportunity still exists "to enhance profitability through such inventory investment techniques." One of the major reasons Alco has been restricted in its ability to participate in the investment-buying approach stems from a heavy debt load assumed in 1989. The continued growth of the wholesaler during the last two- and-a-half years has occurred under the strictures of the leveraged buyout burden. The added sales volume, in fact, has been generated simultaneously with a sharp reduction in the number of separate distribution facilities at Alco. The wholesaler has eliminated 13 facilities over the last four years. Alco boasts that "despite the net reduction of facilities, the company continued to increase its gross revenue in each fiscal year since 1989." The firm says that its average revenue per facility was approximately $148.8 mil. compared to the industry average of $114.8 mil. The consolidation of facilities was undertaken as a belt- tightening move after the leveraged buyout of Alco in October 1989 ("The Pink Sheet" May 1, 1989, p. 17). That buyout saddled Alco with a heavy debt load: from $67 mil. on Sept. 30, 1988 to $499 mil. on Sept. 30, 1989 and $540 mil. a year later. While gross profits rose during the period Sept. 30, 1988 to Sept. 30, 1991, net earnings were erased by the interest load of the buyout. Alco showed a net loss of almost $30 mil. in fiscal 1990 and $23 mil. in fiscal 1991. The company has loss carry forwards of $17.1 mil. available and expects to add $15.6 mil. after the offering. The company's plan to go public again as Alco Health Distribution Corp. is designed to raise over $100 mil. for the company. Most of the proceeds are earmarked to reduce the debt incurred in the buyout. Almost half of the funds raised from the offering of 7.5 mil. shares of common stock (at a projected price of $14.50 per share) will be used to retire about $44 mil. in merger debentures issued as part of the 1989 buyout. The other $56 mil. in proceeds to the company will be used to reduce a large revolving credit facility initiated at the time of the buyout. Alco borrowings against that credit line were $308 mil. at the end of calendar 1991. The company could cut that figure to about $250 mil. if it uses the funds from the offering. The wholesaler says that it may also use the new funds available from the offering to try to get back into the acquisition race. Alco was just concluding an active acquisition period in the late 1980s when it took on the leveraged buyout debt. Two recent acquisitions on the periphery of existing markets (Bindley Western's purchase of Goold and Dohmen's purchase agreement with Northwestern) indicate the type of opportunities that Alco may have been denied because of its debt load. As part of the reissue of public shares, Alco Chairman John McNamara will record a large paper profit. From options received at the time of the buyout and from a subsequent option plan, he has rights to purchase about 238,000 shares of common stock for $1 per share. That stock will be worth $3.45 mil. after the offering. Those shares are apparently restricted (by agreement with the underwriters) from a secondary offering for at least a half-year after the upcoming public offering.

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