AmerisourceBergen Expects Fee-For-Service Transition To Last Two Years

AmerisourceBergen expects the transition to a fee-for-service model to last one to two years.

"We expect the evolution of inventory management agreements to a fee-for-service model to be a one- to two-year migration, as our manufacturer agreements, which are usually one to two years in length, renew," CEO David Yost told investors during an earnings call April 26. "Discussions regarding fee-for-service are occurring daily."

Wholesalers have been moving toward a fee-for-service model since Bristol-Myers Squibb announced in March 2003 that it would no longer allow forward buying. Since then, most large manufacturers have implemented inventory management agreements to prevent speculative buying (¹ (Also see "McKesson Sees Cash Flow Upside To Slow Growth, Inventory Management" - Pink Sheet, 15 Sep, 2003.), p. 35).

Two-thirds of ABC's operating revenue is now covered under inventory management agreements, Yost explained.

"To put this in perspective, this quarter versus last year, we generated $1.1 bil. more in revenue with $1.3 bil. less in inventory. Operating revenues were up 10% and inventory was down almost 19%."

To smooth the transition to a fee-for-service model, Amerisource has added former Roche executive Leonardo DeCandia as senior VP-supply chain management.

In the newly created position, DeCandia will focus on the "delivery of value-added services," ABC said.

"I think he's going to bring a very nice perspective to our organization and allow us to connect more readily with our manufacturers over some of the challenges we're working through right now," ABC Chief Operating Officer Kurt Hilzinger said.

DeCandia's experience in large pharma will allow him to more effectively negotiate with manufacturers, Hilzinger added. DeCandia, who joined the wholesaler April 26, "can be a very effective spokesperson for us with them. He knows their world."

"These are large complicated organizations and I think [DeCandia] will help us navigate some of those organizations, particularly the large of the pharmas."

Hilzinger described the kind of fee-for-service contracts ABC is seeking. "First, agreements should be tailored to the unique and specific needs of each manufacturer. Second, compensation to the distributor should reflect fair value for the services provided relative to the closest alternative."

Payments under a fee-for-service agreement should be periodic, as opposed to corresponding with drug price increases, he added.

"Performance goals for the distributor should be integral to the arrangements," Hilzinger continued. "Material improvements to the supply chain cannot occur without improved transparency. We feel strongly that agreements should allow greater data sharing for greater visibility."

"Lastly, incentives should be built in to drive proactive, collaborative management of shared supply channel challenges, such as counterfeiting, supply shortages, and the like," Hilzinger stated.

ABC will benefit from FDA actions to secure the supply chain, Hilzinger added. "We continue to expect that new regulatory initiatives regarding bar coding and anti-counterfeiting will drive significant growth opportunities for the packaging group."

Also, Amerisource is confident that changes to Medicare will drive revenue in the coming quarters. "We look for the Medicare card programs that will be operational in June to be a very positive driver on revenues for this segment," Yost said.

The rollout of new distribution centers, "in combination with the continued expected strong demand in the pharmaceutical channel, the additional volume expected from the Medicare drug benefit, and the opportunity to align our capacity with long-term geographic growth trends, gives us great confidence that we will see substantial future benefit from the follow through of our plans," Hilzinger explained.

Amerisource will open six new distribution center facilities, beginning with one in Sacramento, Calif. this summer. After that, a new distribution center will come on line every six months.

"We built these 300,000-square-foot distribution centers with the ability to expand by double," Yost described. "We've designed our distribution network to carry us easily seven to 10 years past where we think the business will be when the network is completed."

While Amerisource expects a continued shift among pharmaceutical distributors toward pricing discipline, the company will remain aggressive in retaining its current customers, Yost said.

"Though we have had to aggressively maintain our customer base - and will continue to do so - we would hope the sell side margin will stabilize as we move forward," Yost stated.

CFO Michael DiCandilo agreed, adding that although ABC would be aggressive in retaining customers, it will seek a profitable return on its current contracts.

"We will preserve the business that we have today," DiCandilo declared. "Having said that, the guiding principles we have for our organization are we want to drive returns on committed capital on those contracts north of 20% so this is a cash generative business over the long term."

ABC likely feels an increased pressure to retain its customers going forward due in part to the forthcoming loss of two major accounts: the Department of Veterans Affairs and AdvancePCS.

The prime vendor contract for the Department of Veterans Affairs will switch over to McKesson May 10 following a March 25 federal claims court ruling that the VA appropriately considered both ABC's and McKesson's bids (² (Also see "McKesson Takes Over VA Contract From AmerisourceBergen May 10" - Pink Sheet, 29 Mar, 2004.), p. 32).

AdvancePCS, which recently completed its merger with Caremark, temporarily extended its contract with ABC until September. Amerisource remains pessimistic about the possibility of continuing the contract beyond then (³ (Also see "AmerisourceBergen Expects Veterans Affairs Contract Loss To Save $40 Mil." - Pink Sheet, 2 Feb, 2004.), p. 14).

AdvancePCS has the option to terminate the contract extension with 90 days notice.