Rite-Aid: From Worse to Awful

Speaking of a pharmacy industry shakeout, perpetual also-ran Rite-Aid (RAD) reported another quarter of weak results. See Acquired Stores Weigh on Rite Aid from today’s Wall Street Journal.

Last February, Rite-Aid’s stock had the dubious honor of being named the Worst 10-Year Performer when the stock was still a comparatively lofty $2.79 per share. Industry analyst Larry Abrams calculated at the time that Rite-Aid was worth more closed than as an ongoing concern. (See Rite Aid: Worth More Closed Than Open.)

Rite-Aid’s stock closed at $1.35 yesterday. A Goldman Sachs analyst is quoted in today’s paper as saying “it is hard to find compelling long-term value even at the $2 level.” Ouch.

FYI, McKesson (MCK), Rite-Aid’s primary wholesaler, generated about 15% of its U.S. distribution revenues from Rite-Aid. Their contract runs until April 2010. I presume that McKesson is keeping a tight hand on A/R here.

When Rite-Aid Brooks/Eckerd came together in August 2006, I wrote: “Rite-Aid, Brooks, and Eckerd are notorious underperformers in retail pharmacy. Yes, things have improved, but none of the companies are as well run as CVS or Walgreens. As one industry executive quipped to me this morning: ‘If you tie two rocks together, they still won’t float.’ Nonetheless, the deal makes sense given the marketplace dynamics.”

Thought for the day: In theory, theory and practice are the same. In practice, they are different.

Cardinal Apologizes; NCPA Organizes

More fall-out from the ongoing saga of the DEA’s supply-chain-focused anti-diversion strategy. Meanwhile, I’m getting ready for a trip to HDMA’s meeting in Orlando to hear from the CA Board of Pharmacy and the DEA.

CARDINAL APOLOGIZES

Cardinal Health (CAH) has recently started publicizing An Open Letter to Our Customers from Chairman and CEO Kerry Clark. It appeared on the inside cover of Drug Topics magazine, among other places.

The letter acknowledges an “unintentional” lack of due process that I described in my February interview with Washington pharmacist Richard Molitor. Here’s a key passage:

“In our zeal to do the right thing in addressing the diversion issue, we unintentionally put an undue burden on some of our legitimate and long-standing customers. This is disappointing to all of us, and we apologize to those customers who have been affected.”

George Barrett described the challenges facing Cardinal in refreshingly candid statements last month, which was an important first step. Mr. Clark’s letter is another step on the road to recovery.

Cardinal is still struggling to balance their enforcement responsibilities with the legitimate needs of pharmacies and patients. While Cardinal desperately needs to resolve its DEA issues, I think that the company still has an opportunity to recover from its missteps and regain some lost market share.

NCPA ORGANIZES

The NCPA, which represents independent pharmacies, is also concerned about the DEA’s efforts to make wholesalers responsible for stopping diversion by pharmacies. So, the group is “gathering information that Congress can use to exercise its oversight authority and get involved” according to this item on the NCPA web site.

NCPA is encouraging pharmacies that have had difficulties ordering C-IIs and C-IIIs through a wholesaler to e-mail the NCPA government affairs department. If you are skeptical, just keep in mind that the NCPA has demonstrated an impressive ability to gather affidavits from independent pharmacies, such as the 22 statements compiled for the First DataBank case. Stay tuned for more on this issue.

SEE YOU IN ORLANDO?

I will be at the HDMA’s Distribution Management Conference & Technology Expo in Orlando on Monday and Tuesday. Highlights of Monday’s program include presentations by:

• Virginia Herold, Executive Director, California Board of Pharmacy
• Mark Caverly, Chief Liaison and Policy Section, Office of Diversion Control, DEA

Hmmm, I wonder if I’ll be able to come with any good questions for those two?

I know that some Drug Channels readers will be there, too. Please take the opportunity to critique and/or praise me live and in person. Goofy won't be the only one in Orlando who will be fishing for compliments!

Good Grief! More Trouble for Cardinal

You may find it hard to believe, but a fifth Cardinal Health (CAH) location is now under investigation for allegedly failing to report “suspicious orders” of controlled substances from its Findlay, OH, warehouse. Yet another fine mess for “Iron Man” George Barrett to cleanup.

According to this article in The Columbus Dispatch, the Ohio State Board of Pharmacy is investigating Cardinal’s Findlay, OH, warehouse for allegedly failing to report suspicious drug orders shipped to Caringwell Pharmacy. Per my most recent post, you will not be shocked to know that Caringwell sold more than 600,000 doses to Internet buyers in 49 states. The Ohio Board revoked the pharmacy's license last October.

Cardinal Health has requested a hearing before the pharmacy board, so I presume nothing will happen until then. Penalties could range from a fine (most likely, IMHO) to revocation of its wholesale license (improbable but possible).

Cardinal Health has been dealing with the fallout from controlled substance license suspensions in Washington, Florida, and New Jersey as well as limits on shipments to independent pharmacies from Stafford, Texas. Cardinal seems to have bungled the customer service aspects of these problems (as noted in Cardinal's Customer Problems Deepen). As far as I know, the suspensions are still in place at all four locations. The alleged incidents at Findlay occurred prior to (or at the same time as) the company's DEA issues.

Ironically, pharmaceutical supply chain geeks (ahem) will recall that Findlay was the site used for Cardinal’s first major RFID pilot back in 2006. AAUGH!

Classy Move by McQueary

I wrote about McKesson’s (MCK) acquisition of McQueary Brothers last month in Big Premium in the McKesson–McQueary McDeal. So check out this recent Springfield (MO) Business Journal article in which President David McQueary explains why they sold the company now. There are also some comments from yours truly on the market and historical context.

Mr. McQueary is quite philosophical about the deal, saying:

“It’s not really a celebratory-type situation for us. We’ve been in business for 84 years, and we expected to be in business another 84. It’s kind of a bittersweet thing. It was done with a heavy heart.”

Further demonstrating why these guys will be missed, the owners of McQuery Brothers will be sharing $21 million of the $190 million sale price with long-time employees based on years of service. (See Drug Company Shares in its Sale.) Classy move!

My Op-Ed: Securing the Supply Chain

Pharmalot, the Newark Star-Ledger’s outstanding online pharmaceutical industry news site, has just published my op-ed arguing that America’s approach to tracking finished drugs in the pharmaceutical supply chain needs a radical overhaul. You can read it here:

Securing America's Pharmaceutical Supply Chain

Unlike the blog, this article is written for a general audience. Same great Drug Channels taste, but now with 82 percent less jargon!

I’d love to hear what you think, especially since the style is intentionally more accessible.

Drug Channel Profits in the Fortune 500

Since the Fortune 500 rankings were published last week, I thought it would be fun to look at the revenues and profitability of the ten companies on the list that participate in the pharmacy supply chain. (Hey, everyone needs a hobby!) The financial data also give me an opportunity to address critics who have accused me of being insensitive about the profits of pharmacies and wholesalers. I also look at average investment returns, which have been higher for the channel than for manufacturers.

TEN COMPANIES

Here are the ten wholesalers, pharmacies, and PBMs companies that I found on the Fortune 500 list along with rank and links to the financial data as reported by Fortune:

• McKesson (MCK): 18
• Cardinal Health (CAH): 19
• CVS Caremark (CVS): 24
• AmerisourceBergen (ABC): 28
• Walgreen (WAG): 40
• Medco Health Solutions (MHS): 51
• Express Scripts (ESRX): 135
• Rite Aid (RAD): 142
• Omnicare (OCR): 386
• Longs Drug Stores (LNG): 453

I only include companies that earned a majority of their revenues from pharmaceuticals. This criterion excludes other retail formats with pharmacies (supermarkets and mass merchants). I also do not separate the revenues from each company’s various lines of business. I'd be analyzing the original company data if this were a consulting project, but I'll stick to Fortune's admittedly crude metrics for the blog.

Keep in mind that the Fortune 500 rankings are based on sales revenues, so there is substantial double-counting in this list. For instance, revenue from the same prescription could be counted at least three times by companies on this list if:
(1) the drug is sold by a wholesaler to a pharmacy;
(2) the drug is sold by a pharmacy to a consumer; and
(3) the pharmacy receives reimbursement for from a PBM.

For comparison, there are nine pharmaceutical manufacturers on the Fortune 500 with revenues ranging from $61 billion (Johnson & Johnson) to $12.7 billion (Schering-Plough).

PROFITS

As you can see in the table below, Return on Sales (ROS; profit as percent of revenues) was in the low single digits for all companies in this group, regardless of their position in the supply chain (retail pharmacy, wholesaler, or PBM). The median for my Drug Channels group is 2 percent.

(CLICK TO ENLARGE TABLE)

By contrast, median profit as a percentage of revenues was 16 percent of revenues for the nine drug manufacturers (range: -12% to 21%). Thus, the manufacturer-to-channel ratio is 8X.

However, ROS only tells us part of the profitability story because it ignores the balance sheet assets required to generate an income statement profit. A more meaningful comparison relates ROS to the assets required to generate those operating profits, so the table above includes Profits as a % of Assets, which I will call Return on Assets (ROA).

The profitability of companies in the Drug Channels universe looks much more attractive on this basis, as my friends on Wall Street know. The group median is 5% (Range: 0% to 11%). Again, there is no clear pattern related to supply chain position.

The ROA figures are closer to the pharmaceutical manufacturers, whose median profits as a percent of assets is 9 percent (Range: -5% to 13%). The manufacturer-to-channel ratio is now only 1.8X (versus 8X for ROS) reflecting a risk-return tradeoff. The additional profitability for manufacturers can be considered an innovation/risk premium. Discovering and developing new medicines is expensive, risky, and time consuming. Obviously, the ratio could vary over time, although I just relied on the single year data provided by Fortune.

INVESTMENT RETURNS

Investment returns for the Drug Channels group were higher last year as measured by the average Total Return to Investors for 2007 reported in Fortune’s list:

• 10 Drug Channels companies: 15.2% (Range: -49% to 104%)
• 9 Drug Manufacturers: 3.5% (Range: -32% to 38%)

2007 appears not to be an outlier. The drug channels had a higher average 10 year total return than manufacturers. The channels group has a wider range for both time periods, in part reflecting a greater diversity of business models compared to manufacturers.

SO, WHAT HAVE WE LEARNED?

1) By a conventional metric (revenues), many drug channel participants are substantially larger than the manufacturers.

2) A frequently cited metric of profitability (Profit as % of Revenues) makes drug channels companies look worse than a more appropriate metric such as Profit as % of Assets.

3) Investors earned greater average total returns from the drug channels group last year and over the past 10 years compared to the manufacturers group.

Will these returns hold up in 2008? Well, if I knew the answer to that question with certainty, then I’d be retired on a Caribbean island instead of pecking out another blog post for you!

Stark News from Cardinal and McKesson

Wealthy industrialist Tony Stark's new biopic is not the only thing making financial news today.

Last Thursday, the new CEO of Cardinal Health’s (CAH) distribution division described the company’s market share challenges with independent pharmacies following the disruption of controlled substances distribution at four locations. One day later, McKesson (MCK) announced a settlement with the DEA that temporarily suspends distribution of two controlled substances from two of its distribution centers.

See March’s DEA's Anti-Diversion Strategy blog post for background on the DEA’s strategy for combating diversion of legitimate controlled substances.

STRAIGHT TALK FROM CARDINAL’S GEORGE BARRETT

George Barrett, the new CEO of Cardinal Health’s Healthcare Supply Chain Services division, was refreshingly blunt in describing the need to “turnaround” the drug distribution business on last Thursday’s earning conference call.

Among other issues, Cardinal has been dealing with the fallout from controlled substance license suspensions in Washington, Florida, and New Jersey as well as limits on shipments to independents from Stafford, Texas. Last week, Cardinal disclosed that the disruption due to DEA compliance issues cost $15 million in the first calendar quarter of 2008.

Regular readers know that I’ve been critical of the way in which Cardinal handled this situation, especially the apparent lack of due process accorded to pharmacy customers. (See my exclusive interview with Washington pharmacist Richard Molitor.) I highlighted the marketplace impact in Cardinal's Customer Problems Deepen and have been discussing it privately with my clients for several months.

Here’s Mr. Barrett’s assessment of how Cardinal bungled the customer service aspect of DEA compliance:

“Our early efforts dictated that, at times we use something of a blunt tool to ensure that no diversion was occurring, rather than a precision instrument. We know that this has caused some disruption to our customers, particularly in the retail independent stage. We regret that and truly appreciate their support through a tough time. Having said that, we have lost some independent retail share over this and we’ve certainly made it a challenging environment in which to grow.”

I can’t yet say whether reality will follow the rhetoric. However, it’s encouraging that Mr. Barrett recognizes the challenges of the “enforcement” role that has been thrust upon the company by the DEA. No word from the company yet on whether he plans to fix these problems by flying around in red and gold armor.

MCKESSON SETTLES

McKesson (MCK) resolved its claim with the DEA for $13.25 million, an expected outcome given the company’s previous disclosures (described in New Signs of Rising Compliance Costs.) Florida got $7.5 million of the $13.25 million in civil penalties, ensuring that the state retains its infamous reputation.

A DEA press release describes McKesson’s alleged actions:

“Three McKesson distribution centers received and filled hundreds of suspicious orders placed by pharmacies participating in illicit Internet schemes, but failed to report the orders to DEA. They did so even after a Sept.1, 2005, meeting at which DEA officials met with and warned McKesson officials about excessive sales of their products to pharmacies filling illegal online prescriptions…As a result, millions of dosage units of controlled substances were diverted from legitimate channels of distribution.”

This Reuters story adds that McKesson must also temporarily suspend distribution of two drugs from two of its distribution centers. I presume that McKesson has learned some lessons from Cardinal’s troubles so the marketplace impact should be less severe.

For the record, I will remind you that “the settlement agreement is neither an admission of liability by McKesson nor a concession by the United States that its claims are not well founded.”

For the record, I will also tell you that Iron Man is an awesome movie.

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Check out the new Health Wonk Review, a compendium of health care policy posts from around the web.

National Standards: It’s About Time! !

The movement to make the pharmacy supply chain safer just took a huge step forward with Friday’s introduction of H.R. 5839 Safeguarding America’s Pharmaceuticals Act of 2008. The bill is co-sponsored by Representatives Steve Buyer (R-IN), Gene Green (D-TX), Jim Matheson (D-UT), and Mike Rogers (R-MI).

I enthusiastically support this bill, which finally offers Federal preemption of the multiple disorganized, uncoordinated, and underfunded state-level mandates. Ultimately, patients will be the biggest beneficiaries of a more secure supply chain.

KEY POINTS

Federal Preemption with Uniform National Standards – “no State or political subdivision of a State may establish or continue in effect any requirement with respect to statements of distribution history, manufacturer packing lists, unique standardized numerical identifiers, or drug identification and tracking systems for prescription drugs that is different from, or in addition to, any requirement under this subsection.’’ Got that, States? The bill also establishes new Federal minimum standards for wholesale licensing.

Phased Implementation – The Bill sensibly requires earlier compliance for “High-Risk Drugs.” The precise timing will depend on when the bill becomes law, but it looks like High-Risk Drugs would not have to serialized until mid-2011. (I touted a risk-based approach last July.) There are many places in the bill where the speed of implementation will be based on sensible factors such as “operational and technical feasibility.”

Support for “Independents” – A truly closed-loop, interoperable track-and-trace system based on serialization will require a massive infrastructure upgrade at the 150,000+ points of pharmacy dispensing in the U.S. The bill permits grants for technology upgrades to a “small pharmacy,” which is defined as “a pharmacy which is not owned (or operated) by a publicly traded company.” Of course, some privately-held pharmacies can be quite large (um, Duane Reade?), so this language will need to be cleaned up.

And the pedigree starts with… The bill also clears up a major area of disagreement between various state and federal definitions of pedigree: Where does pedigree begin? According to H.R. 5839, it begins with the Authorized Distributor of Record (ADR) that purchased directly from the manufacturer, a.k.a. “Direct Purchase Pedigree.”

OBSERVATIONS

H.R. 5839 Safeguarding America’s Pharmaceuticals Act of 2008 is only a bill, just sitting there on Capitol Hill. Nonetheless, here are a few implications if this bill becomes a law.

Amateur hour will be officially over. Today’s crazy patchwork of pedigree regulations creates uncertainty for everyone involved in the pharmacy supply chain. These decisions need to be made in a structured, logical, and public manner. Supply chain security regulations are too important to be left to the personal whims of a few volunteers at an underfunded state agency. Yes, I’m thinking about you, California State Board of Pharmacy!

Serialization will not be optional. The momentum for serialization is now inescapable, which is one reason that I joined the Advisory Board of Secure Symbology. Track-and-trace at the unit level only becomes possible with serialization, which is complex and must begin with the manufacturer/packager. At a minimum, serialization with pedigree requires: affixing a unique number during the packaging process; capturing and managing petabytes of data; adding pedigree information as the product moves down the supply chain; and then making these data easily (but securely) accessible. It also requires substantial lead time since serialization must happen during the drug packaging process, which can be months (or longer) from the time that the product is dispensed to a patient.

The pharmacy lobby will oppose national standards. I warned in December that pharmacists do not want pedigree. State Boards of Pharmacy – composed mainly of independent pharmacists – don’t want to lose local control (read: influence, power) and want to avoid any additional burdens on pharmacy operations. In fact, before the text of H.R. 5839 was even posted online, Steve Anderson of NACDS leapt into action with this statement asking Congress to “refrain from mandating serialization, e-pedigrees or track and trace requirements, since they are still experimental and will prove extraordinarily costly for pharmacies and other supply chain operators.” Unfortunately, pharmacies must close the loop if we are all to benefit from complete track-and-trace and ensure that pharmacy purchasing is not the weak link in the supply chain. Plus, wouldn't a single national standard lower compliance costs for NACDS members such as CVS Caremark or Walgreens (WAG)?

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All in all, a very promising start for reducing counterfeits in the legitimate supply chain. Now, we just need to convince consumers to stop buying from shady online pharmacies.

BONUS FUN FACT: Did you know that "PEDIGREE" is a registered trademark of Mars, Inc., the makers of M&Ms? Woof!

Big Premium in the McKesson–McQueary McDeal

Apologies for yet another McKesson (MCK) post, but I certainly can’t ignore this week’s news given that I wrote on Tuesday about the company’s active efforts to alter its business mix.

McKesson (MCK) is acquiring McQueary Brothers Drug Company, one the few remaining regional drug wholesalers in the U.S. (See the official announcement.) McKesson is paying a substantial premium for the McQueary’s business, although the deal could be justified given today’s pharmacy industry dynamics. Will the higher price lure the remaining regional wholesalers to sell out, further concentrating the channel for manufacturers and independent pharmacies?

PAYING A PREMIUM

Here’s my math.

McQueary Brothers is one of the few wholesalers that does not report its sales in HDMA’s Factbook. However, the press release states that McQueary serves “more than 400 independents.” Assuming typical purchase levels by an independent pharmacy ($1.5-2M per year), McQueary’s revenues are probably in the range of $600-$800 million. Let’s say $700 million as a round number.

The purchase price was $190 million, implying a price/revenue ratio of about 0.27X. For those of you keeping score at home, this ratio is more than twice the comparable figures of other recent acquisitions, such as D&K by McKesson or Bellco by AmerisourceBergen (ABC). I presume an EBITDA multiple would reflect a similar 2X+ premium.

At first blush, this premium may seem surprising given the limited number of possible buyers (um, 3?) and the potential risk of a distress sale if independents come under further pressure. As I wrote back in March 2007: “Industries do not consolidate forever (even drug wholesaling). I expect that the remaining regional wholesalers will be looking for a reasonable exit strategy, too.”

BUT STILL A GOOD DEAL

However, McKesson’s desire to win this deal at a higher purchase price makes sense once we consider today’s pharmacy realities:

1) Smaller retail pharmacy customers rely on a wholesaler for many more supply chain services than a self-distributing chain. Thus, the threat of disintermediation is low and the gross margins are generally higher for the wholesaler. (More details: Trouble Ahead for Independent Pharmacies.)

2) Smaller buyers – regional chains, independents, supermarkets, etc. – buy their generic drugs via wholesalers, which also boosts a wholesaler’s gross margins. (More details: CVS' Channel Power.)

3) McKesson has been actively trying to deepen its relationships with customers, either through ownership (such as the OTN acquisition) or through a franchise relationship such as the nearly-2,000 pharmacies participating in HealthMart.

As a bonus, McKesson gets a small top-line boost from an (improbably) growing segment and can easily fund the deal given its extremely low levels of debt.

So what’s next? Will the McQueary buyout premium trigger a final feeding frenzy for the remaining regionals? Will manufacturers take action to address the unsettling levels of concentration in wholesale and pharmacy channels?

Any brave souls care to venture a guess?

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And before you ask, no, that’s not a picture of younger me above. Everyone knows that I don’t wear yellow.

McKesson Gets Out of Pharmacy Outsourcing

McKesson (MCK) is selling its pharmacy outsourcing business to Comprehensive Pharmacy Services (CPS) according to this press release from CPS.

Each of the big 3 wholesalers, which also includes AmerisourceBergen (ABC) and Cardinal Health (CAH), have businesses that operate institutional pharmacies on an outsourced basis. I discussed the controversy around the outsourcing business last month in The Dark Side of Pharmacy Outsourcing. As you may recall from that post, I'm skeptical of the claim that problems at a single hospital indicated systemic flaws in the pharmacy outsourcing business.

You can read more about McKesson’s business at the McKesson Medication Management page. As a guess, Medication Management probably represents less than $1 billion in revenue but has 2 to 3 times better profitability than the core drug distribution business. In the absence of any formal statement from the company, I presume that the risks and controversy did not outweigh these incremental profits.

McKesson has been the most active out of the big 3 in adjusting its health care business portfolio. For example, the company sold its acute care supply business to Owens & Minor last year. Last week, McKesson acquired Rosebud Solutions, a provider of software solutions to track and manage instruments, endoscopes and tissue implants for surgical services. I expect McKesson to continue tweaking its business mix over the coming year.

CA e-pedigree: Going to '11!!

As predicted, the California Board of Pharmacy today announced its decision to extend the deadline for implementation of e-pedigree laws to 2011.

The timing was unexpected but not the outcome. Apparently, my sarcastic mocking on the Drug Channels blog was just too much for them to bear. Plus, the Board now avoids the embarrassment of having a legislative or legal solution imposed on them.

Let's hope that the Board members can put aside their pharma-bashing and get on with the hard work needed over the next 33 months.

ADDENDUM

Here is the official announcement: DECISION OF THE CALIFORNIA STATE BOARD OF PHARMACY PURSUANT TO BUSINESS & PROFESSIONS CODE SECTION 4163.5

Best sentence: “For the moment, the Board concludes that its primary duty to protect the public is better served by a delay permitting a less disruptive implementation, than by a rush to secure industry compliance.”

Nonetheless, I remain surprised at “leading edge” role that California has assigned to itself. As a point of historical fact, Florida’s pedigree laws were prompted in part by a 2003 Grand Jury report that documented widespread problems with the wholesale distribution of pharmaceuticals in the state. Most of these secondary market excesses have been corrected by national, industry-wide efforts such as new data sharing practices and the major wholesalers’ renunciation of secondary trading. I am not aware of a similar grand jury report for the state of California nor have I seen any California-specific research on counterfeiting.

BTW, the Heparin example is completely misleading because the contamination allegedly occurred overseas. Pedigree would have had no value or role in preventing this tragic situation.

WSJ Hypes McKesson Buyout (Again)

John Hammergren, Chairman of the Board, President, Chief Executive Officer of McKesson (MCK), just co-authored a new book called Skin in the Game: How Putting Yourself First Today Will Revolutionize Health Care Tomorrow.

I’ll be reviewing this book in an upcoming post. But in the meantime, I want to check in on the prospects for a buyout of McKesson in advance of Mr. Hammergren’s presumably higher visibility in 2008.

I last speculated about the possibilities for buyout of McKesson in October in Chatter about a McKesson Buyout based in part on a Wall Street Journal article by Greg Zuckerman.

Apparently, Mr. Zuckerman likes to fan these flames periodically because Sunday’s online WSJ featured his article called As the Market Falls, It's Time to Shop. The article states:

“Other stocks that investment pros are keeping their eyes on? One is McKesson (MCK), the largest U.S. drug distributor, which has fallen more than 20% since late November. McKesson's business isn't impacted as much as some others in an economic downturn, and its profit is expected to rise 16% in the next year. When the economy stabilizes, some analysts say McKesson could be an acquisition target.”

McKesson’s closing price was $52.05 yesterday, which is more than double the October 2004 low of about $24 per share but 10% below the closing price on the date that the October WSJ article ran.

So far in 2008, McKesson’s stock price has fared the worst among the big wholesalers – Cardinal Health (CAH) and AmerisourceBergen (ABC). See an interactive chart of Big 3 YTD stock price performance. However, this year’s comparatively weaker performance actually reflects larger relative gains following McKesson’s Halloween rally. See an interactive chart of Big 3 stock price performance since November 1, 2007.

I still view McKesson as the most logical LBO target among the Big 3 wholesalers, especially given its business mix, current operating platform, age (and stability) of its management team, and potential for a value-creating restructuring. However, the turmoil in the credit markets makes a near-term deal seem unlikely as the credit crunch grips private equity.

Luckily, Mr. Hammergren can rely on his book royalties to tide him over until the private equity firms can get back on their feet.

The DEA's Anti-Diversion Strategy

I am getting a lot of questions from Drug Channels readers about the recent uptick in enforcement activities to combat diversion of legitimate controlled substances. As I see it, the increase stems from a combination of changing political priorities, new detection capabilities, and new approaches to the pharmacy supply chain.

Congressional testimony by the DEA on Wednesday shed some light on their strategy behind license suspensions at seven (not four) wholesale distribution centers. Expect more, not less, enforcement action in the future.

As background, you may want to browse the DEA’s list of Drugs and Chemicals of Concern.

POLITICAL FOCUS

There has been growing political pressure to stop the abuse of prescription drugs.

• President Bush recently used his weekly radio address to highlight the “growing availability of highly addictive prescription drugs online.”


• Senator Dianne Feinstein (D-CA) introduced S.980 Online Pharmacy Consumer Protection Act of 2007 in March 2007. The HDMA recently affirmed its support of this bill.


• Similar legislation aimed at rogue pharmacies is also part of S 2237 Crime Control and Prevention Act of 2007. (Look for the section called “Subtitle E--Online Pharmacy Bill” a.k.a. The Ryan Haight Online Pharmacy Consumer Protection Act of 2007).

The President’s National Drug Control Strategy: 2008 Annual Report cites some startling data, such as the fact that abuse of prescription drugs among 12 and 13 year-olds now exceeds marijuana use. (Yikes!)

The DEA also has much-improved abilities to identify diversion of controlled substances. So far, 35 states have enacted legislation requiring Prescription Drug Monitoring Programs (PDMP) to track prescriptions for controlled substances. 26 programs are operating and 9 are in the start-up phase.

THE DEA'S STRATEGY

As I’ve noted on the blog, wholesalers are being “asked” to be “responsible” for stopping diversion by their pharmacy customers.

Michele Leonhart, Acting Administrator of the DEA, testified before Congress on Wednesday. (Read her testimony.) She described the DEA’s strategy for controlling diversion by pursuing actions against wholesalers in the following way:

“As part of our effort to attack rogue Internet pharmacies that are supplying millions of doses of licit drugs, DEA has sought to disrupt the supply chain that makes diversion by these rogue Internet pharmacies possible. To that end, DEA has undertaken an important initiative to educate wholesale distributors, and when necessary, pursue administrative, civil, or other criminal action against wholesalers that distribute excessive amounts of controlled pharmaceuticals. Since beginning the initiative, DEA has suspended the registrations of seven wholesale distributors, four of which were owned by two Fortune 500 companies.”

I presume that four suspensions at Fortune 500 companies include Cardinal Health (CAH) and AmerisourceBergen (ABC). I was not aware of the other three suspensions. Does anyone know which other wholesalers had their licenses suspended? (UPDATED: See comments below.)

Wholesalers are now struggling to balance their enforcement responsibilities with the legitimate needs of pharmacies and patients, as evidenced by Cardinal's customer problems. Perhaps that’s one reason why drug distribution executives there seem to have as much job security as a Spinal Tap drummer. As the DEA has learned, you can't really dust for vomit...

Diversion Risk for ABC?

The DEA’s aggressive enforcement efforts for the diversion of controlled substances and other prescription drugs may mean business disruptions for wholesalers besides Cardinal Health (CAH).

Last week, the DEA and FBI raided drug stores and placed two San Diego pharmacies under immediate suspension. See Feds Raid Drugstores, Mission Hills Home.

Unfortunately, it looks like this pharmacy was being supplied by AmerisourceBergen (ABC). Why do I say this?

• According to the Statement of Facts filed with the Court, the defendant allegedly delivered the diverted drugs in “Good Neighbor Pharmacy” bags.


• Slide 5 of MSNBC’s slideshow from the raids (reproduced above) shows a “Good Neighbor Pharmacy” sign on the pharmacy.


• Good Neighbor Pharmacy is the national cooperative for independent pharmacies that is owned by AmerisourceBergen (ABC).

Of course, thousands of pharmacies participate in ABC’s Good Neighbor program, so finding one bad apple in the bushel is no cause for panic.

However, I wonder if the DEA will use a similar approach with ABC as the Agency is using with Cardinal Health (CAH). If so, then perhaps ABC may be facing the suspension of its license to distribute controlled substances at one of its facilities. Alternatively, ABC may have to limit shipments to independent pharmacists as Cardinal has done in Stafford, TX.

For better (or perhaps worse), the DEA now considers distributors and wholesalers to be responsible for ensuring that a pharmacy is only dispensing prescriptions issued for a legitimate medical purpose by an individual practitioner acting in the usual course of professional practice. (See One Pharmacist’s View of Cardinal’s DEA Issues.) What impact will these new responsibilities have on wholesalers' revenues and customer relationships?

The Dark Side of Pharmacy Outsourcing

I hate to be the bearer of bad news (again), but Katherine Eban, the muckraking author of 2005's Dangerous Doses, is back to take another shot at wholesalers.

Your Hospital's Deadly Secret describes the sad case of Alyssa Shinn, a premature baby who died after being given a fatal overdose of zinc from her intravenous nutrition bag, apparently due to a mistake made in the hospital pharmacy. This story was also featured on Nightline (video).

As it turns out, the hospital pharmacy had been run by outside companies for at least 10 years. Each of the big 3 wholesalers -- AmerisourceBergen (ABC), Cardinal Health (CAH), and McKesson (MCK) -- had taken a turn running the hospital's pharmacy. However, UHS was apparently managing the pharmacy at the time of Alyssa's death. [Please see Correction notice below.] According to Katherine's article, about 440 U.S. hospitals outsource the management of their pharmacies.

But just in case you miss the point, the article's subtitle reads: "Hospital pharmacies across America are being contracted out to companies with little or no medical expertise. Patients are paying the price." Oh well, there goes Katherine's invitation to the next HDMA meeting!

After I read the article, I asked Katherine for her perspective on independent pharmacy managers such as Comprehensive Pharmacy Services versus wholesalers. According to Katherine: "From what my reporting is telling me, I think they probably are better -- in large part because their sole focus is to improve pharmacy performance."

And if Katherine's story is not enough scandal for you, you can also read about Cardinal Health's alleged problems with the management of the hospital pharmacy at DeSoto Regional Health System. (See State, federal agencies probe DeSoto hospital.)

I encourage you to read these articles and make up your own mind. But I'm curious to hear the opinions of my pharmacy or wholesaler readers. Are there systemic flaws in the wholesalers' pharmacy outsourcing business or does this story simply highlight the mistakes of a few individuals at a single facility?

CORRECTION: In a previous version of this post, I had mistakenly written that McKesson was operating the pharmacy at the time of Alyssa's death. In fact, AmerisourceBergen was advising UHS in July, as the article correctly notes. I apologize for the error.

Cardinal's Customer Problems Deepen

As I suspected, Cardinal Health’s (CAH) new role as supply chain enforcer is angering some of the customers who have been tagged as “diverters.”

According to Cardinal Health's Compliance Efforts Rile Some Customers, two pharmacies have so far sued Cardinal over the way in which the company is identifying purported diverters. (Alternate link from the Wall Street Journal site: Cardinal Health's Compliance Efforts Rile Some Customers.) Per the article:

“Community Drugstore, a specialty pharmacy focusing largely on pain management, said in a lawsuit filed in Delaware that Cardinal improperly stopped supply without any evidence that the store had engaged in wrongdoing. A federal judge in December ordered Cardinal to restore Community Drugstore as a customer.”

“In the other lawsuit, an Oklahoma federal judge in December ordered Cardinal to resume supplying controlled substances to Ken's Discount Pharmacy, a longtime Norman, Okla., pharmacy that had said it would go out of business in days without some action. The court said it appeared that Cardinal had stopped supplying the pharmacy and had placed the drugstore on an 'exclusion' list as an arbitrary reaction to compliance issues between Cardinal and the DEA. The plaintiff said the pharmacy, located across the street from a major medical facility, had suffered a hydrocodone shortfall after Cardinal limited its supply.”

You can read Cardinal’s PR spin in the article, but these stories echo the experience of Evergreen Professional Center Pharmacy that I describe in One Pharmacist’s View of Cardinal’s DEA Issues. I also want to give a shout out to regular reader PBMGuru, who was the first to predict legal action in a comment on Cardinal Sins (Again) from last November.

BTW, Dinah Brin of Dow Jones is the only national reporter who has been following Cardinal’s deepening problems with the DEA. Dinah is apparently a fan of my humble ol’ Drug Channels blog because she included a quote from yesterday’s post in her story. Thanks, Dinah!

Cardinal's Latest DEA Deal

Time for another installment in the continuing adventures of Cardinal Health and the Kingdom of the Crystal Meth, now showing in Stafford, TX!

Last Friday, Cardinal Health (CAH) told suppliers that it would discontinue all controlled substance and List 1 Chemical shipments from its Stafford distribution center for retail independent, Medicine Shoppe and Medicap pharmacies only. The move was announced to retail independent customers yesterday. Read Cardinal's letter online here.

As regular Drug Channels readers know, Cardinal had its license to distribute controlled substances suspended by the DEA in Washington, Florida, and New Jersey. While there’s no official DEA suspension, Cardinal has been negotiating with the DEA over the Company’s Stafford, TX distribution center (as I discuss in Fresh DEA News from Cardinal.)

The interesting twist -- and the likely reason that the facility's license was not suspended -- is that Cardinal will be discontinuing shipments only to the retail independent pharmacies from Stafford. The “legitimate controlled substance needs” (their words) of these customers will be serviced from another Texas facility. However, per Cardinal's letter: “We will continue to provide controlled and non-controlled products to acute care, regional chain and national chain customers out of our Stafford (Houston) distribution center.”

Yikes! I can't imagine that this statement will help Cardinal to regain or build market share among independents. Let’s hope that Cardinal’s “contingency plans” have progressed since their Washington license was suspended. (See One Pharmacist’s View of Cardinal’s DEA Issues.)

So what does this move signal about supply chain security? Are retail independent pharmacies now considered to be the weak link in guarding our supply chain against counterfeits and diversion—a demand-side security problem that just won’t go away?

One Pharmacist’s View of Cardinal’s DEA Issues

Drug Topics just published a fascinating Letter to the Editor from Richard Molitor, Manager of the hospital-owned Evergreen Professional Center Pharmacy in Kirkland, WA. His pharmacy was directly affected when the DEA suspended Cardinal Health’s (CAH) license to distribute controlled substances. I contacted Richard directly and he was kind enough to provide me with some additional details (as well as the photo).

In Fresh DEA News from Cardinal, I asked whether an unfair burden is being laid on a corporation that never asked to be a police force. In my opinion, the experience of Evergreen Professional Center Pharmacy illustrates the risks to pharmacies and patients when wholesalers are (explicitly or implicitly) asked to become enforcers without normal due process protections.

THE VOICE OF THE CUSTOMER

You can read Richard’s complete Letter to the Editor online, but here are the key quotes:

• “The week prior to the official DEA shutdown, Cardinal sales reps contacted their accounts (including ours), advising them to increase their on-shelf inventory of controlled substances in order to cope with the pending logistical nightmare.”


• “Cardinal cancelled the ability of several West Coast accounts (including our outpatient pharmacy department) to order controlled substances. This jeopardized our pharmacy's ability to support our hospital's discharging surgical, inpatient, hospice, and oncology patients.”


• “Notification from Cardinal came in the form of a fax sent by the corporate director of quality and regulatory affairs late on a Monday (after the sender, based in Ohio, was no longer available for contact). The fax stated that our account was cancelled in part due to ‘recent excessive quantities ordered’ as well as ‘a risk that diversion will occur if we continue to fill controlled substance orders.’”

OK, we can all see the irony in asking customers to order in advance of the suspension and then penalizing those same customers for actually following their sales rep’s advice! Like many large companies, it sounds like there was poor communication between the head office and the field.

DO (NOT) PROCESS

Apparently, the DEA now considers distributors and wholesalers to be responsible for ensuring that a pharmacy is only dispensing prescriptions issued for a legitimate medical purpose by an individual practitioner acting in the usual course of professional practice.

In a private email to me, Richard told me that Cardinal “didn't seem too willing to allow due process for their customers. Instead, based upon some ill-obtained assessment of 'risk,' they decided to shut us off as well as to restrict (via rationing, once I'd screamed loud enough about being cut off) further ordering (which nearly required our 250-bed hospital to shut down since the Inpatient Pharmacy couldn't get the injectable meds they routinely use).”

While a wholesaler or pharmacist should always “exercise diligence and caution” (as Tom Connelly wrote in his comment last week), I am not aware of formal rules or guidelines to define the precise level of diligence or caution, especially when there is uncertainty about whether an ordering pattern might represent purchases for diversion.

It’s especially tricky for the big 3 wholesalers – AmerisourceBergen (ABC), Cardinal Health (CAH), and McKesson (MCK) – because each co