Cardinal Fee-For-Service Distribution Margins Lower Than Anticipated
This article was originally published in The Pink Sheet Daily
Executive Summary
Wholesaler remains optimistic that manufacturers' distribution fees will rise over time due to "built-in escalators" in existing contracts and potential to increase fees during contract renewal.
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Cardinal's distribution fees collected from brand-name pharmaceutical manufacturers came in 10 basis points lower than anticipated in fiscal 2005 (ended June 30) as a result of the transition to fee-for-service (FFS) agreements, the wholesaler reported Aug. 5. The distributor remains optimistic that pharma vendor margins will rise over time, Cardinal CEO Robert Walter stated during a conference call. "We intend to continue to work with our branded manufacturers to realize higher margins as we fully achieve the performance incentives in some of our manufacturer contracts and demonstrate more value to other manufacturers," the exec said. Some of the contracts have "built-in escalators" in the fees, and in other cases, Cardinal will work to convince manufacturers who signed short-term agreements to pay more during contract renewals, Walter explained. "We do not expect to negotiate lower fees for any manufacturer as we renew annual agreements," he stated. "Our price is based on the value we know we provide relative to the next best alternative." The switch to FFS has provided validation that the wholesale distribution model is the most efficient way to get pharmaceuticals to market, he added. "If that were not the case, some method or alternative would certainly have come forth during the past year as a better alternative," he said. The announcement that Cardinal's vendor margins were lower than anticipated comes as the wholesaler cycled the first year of the transition to FFS. New distribution agreements signed in the fourth quarter brought Cardinal's annual number of new contracts signed with manufacturers to 100, the firm reported. Wholesale distributors have maintained that the switch to FFS from a buy-and-hold distribution model will allow them to better predict sell side margins and reduce earnings volatility in the segment (1 (Also see "Wholesalers Forecast More Accurate Sell-Side Margins From Fee-For-Service Contracts" - Pink Sheet, 16 Jun, 2005.)). Annual revenues in Cardinal's Pharmaceutical Distribution and Provider Services segment increased 16% to $60.8 bil., while operating earnings declined 1% to $1 bil. The distribution fee transition, the recovery of Cardinal's Pyxis automated pharmacy business and sterile manufacturing problems at the company's manufacturing plants were three issues that negatively impacted growth and contributed to earnings volatility during the year. Cardinal said it made progress in all three areas, with the impact beginning to show in the financial results for FFS and Pyxis. Operational problems within sterile manufacturing, however, continued, with the operation performing as "a high margin business with great demand and an inability to execute," Walter said. Turnaround progress in sterile manufacturing is taking longer than anticipated, leading Cardinal to lower its expectations for the business in fiscal 2006. The company is now forecasting that the sterile business will contribute less than 10% to the budget for Pharmaceutical Technologies and Services (PTS), down from the 20% predicted in fiscal 2005. Sterile manufacturing will represent less than 2% of Cardinal's consolidated operating earnings. Last year, the company had anticipated that its sterile manufacturing capabilities would be a significant driver of growth and a contributor to restructuring (2 (Also see "Cardinal Sees Sterile Manufacturing As Key Component Of Revenue Growth" - Pink Sheet, 13 Dec, 2004.)). PTS earnings during the fourth quarter were affected by an $8 mil. write-down of sterile inventory and nearly $7 mil. in expenses to operate a sterile manufacturing facility in Humacao, Puerto Rico, which the company plans to close later this year. Cardinal had trouble securing FDA approval for the Puerto Rico facility, as well as for a facility in New Mexico. The company reported a 15.2% increase in sales for the year to $74.9 bil., while net earnings fell 26.7% to $1.08 bil. - Jessica Merrill |