Cardinal CFO Departs Amid SEC, U.S. Attorney Investigations

Cardinal's interim chief financial officer is J. Michael Losh following the departure of Richard Miller amid Securities & Exchange Commission and U.S. Attorney investigations.

"Certain financial reporting practices and judgments that occurred during my tenure as CFO have come under scrutiny in the ongoing investigations," Miller states in a Cardinal press release July 26. Miller had served as CFO for the wholesaler since 1998.

Cardinal received a subpoena June 21 from the SEC that included a request for documents related to "revenue classification...in the company's pharmaceutical distribution business as either operating revenue or revenues from bulk deliveries to customer warehouses" (¹ (Also see "Cardinal Revenue Classification Is Subject Of SEC/U.S. Attorney Investigation" - Pink Sheet, 5 Jul, 2004.), p. 28).

An initial SEC investigation into Cardinal's accounting of a $22 mil. settlement in litigation over vitamin price fixing was disclosed in October (² 'The Pink Sheet' Oct. 13, 2003, In Brief).

In May, Cardinal revealed that the inquiry had a broader focus when the wholesaler announced that SEC had initiated a formal investigation (³ (Also see "Cardinal Acquisition Of Alaris Shows “Business As Usual” During SEC Probe" - Pink Sheet, 24 May, 2004.), p. 36).

The New York U.S. Attorney's office has since intervened in the ongoing investigation.

Losh is a member of Cardinal's board and served as CFO for General Motors until 2000. While Miller will assist Losh in the transition, he "will not be involved in preparing the company's financial statements or SEC filings," Cardinal said.

The wholesaler postponed the release of its fiscal 2004 (ended June 30) results from July 28 to late August or early September. Cardinal issued an earnings warning in June. The company said the transition to a fee-for-service payment model would result in a $50 mil. to $60 mil. deficit for the fourth quarter.

The two other major wholesalers - AmerisourceBergen and McKesson - also are transitioning from a model that relies on price speculation to fee for service.

AmerisourceBergen is using "hybrid" contracts during the transition. A hybrid inventory management agreement seeks payment from manufacturers for channel services, as well as revenue from wholesaler buying of pharmaceutical inventory in advance of an anticipated price increase.

"We're in discussions at different stages with all of our manufacturers, and we do in fact have some hybrid models out there and it speaks to the fact that this is not a 'flip of the switch' transition," AmerisourceBergen Chief Operating Officer Kurt Hilzinger said on an earnings call July 22.

McKesson's manufacturer agreements establish a payment floor as insurance in case revenue from price speculation falls below the amount anticipated.

"Our compensation from our largest manufacturer partners continues to be tied to some level of pricing activity," McKesson CEO John Hammergren said during an earnings call July 22.

"In these cases, our discussions include securing a floor for our compensation in the event pricing increases are delayed or lower than expected."

Inventory management agreements cover two-thirds of AmerisourceBergen's total business and approximately 80% of the company's brand name pharmaceutical sales.

For McKesson, approximately half of its manufacturing partners - representing two-thirds of the wholesaler's volume - are currently covered by core distribution agreements for basic wholesaler services.

The transition to a fee-for-service model is resulting in lower levels of inventory, AmerisourceBergen and McKesson said. AmerisourceBergen "inventories have been reduced by $1.1 bil. or 14 days since June 30 of last year," CFO Michael Dicandilo told investors.

McKesson's inventory levels declined from over 40 days - the level of several years ago - to 36 days, but are unlikely to drop substantially farther because of the continued use of price speculation.

"I don't think there is a ton of room to move those day levels down," Hammergren said. "You'll see them continue to gradually decrease over time."