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PharMerica Corporation (NYSE:PMC)

March 14, 2013 10:45 am ET

Executives

Michael J. Culotta - Chief Financial Officer and Executive Vice President

Analysts

Brendan Strong - Barclays Capital, Research Division

Brendan Strong - Barclays Capital, Research Division

Through a list of questions, and then we'll have a breakout session after that we can use for other folks to ask questions as well. So with that, I'll just start firing away unless there was anything you want in particular...

Michael J. Culotta

Well, I want to thank you very, very much for having us and all the folks at Barclays also that worked very hard for the conference.

Brendan Strong - Barclays Capital, Research Division

Great. Thank you, Michael, very

[Audio Gap]

Michael J. Culotta

Much.

Question-and-Answer Session

Brendan Strong - Barclays Capital, Research Division

So I wanted to start off just by talking a little bit about the long-term care pharmacy business at a high level, some of the external forces impacting it. At a high level, I get questions on this, too. You think about your primary customer being nursing homes. Right now, the industry isn't growing, and it's a competitive market on top of that within the institutional pharmacies, so it certainly produces challenges when -- as you think about that growth and script growth. And just curious, at what point do you think we -- you guys are able to hit a point where you're delivering organic growth? And what do you think the -- maybe the bigger driver of that's going to be? Is it going to be improved retention? Is it going to be your ability to win some additional customers? Or are customers going to be consuming more drugs? Just take us through that.

Michael J. Culotta

Okay. I think it's a combination of things. I think one-- you've keyed in on a couple of items, is -- but I think we need to really step back and take a look at the industry in and of itself. I think both the largest 2 players have historically had -- maybe 1 quarter or 2 here and there where there's been "natural organic bed growth" in a particular quarter. So some of the outside forces going on that you have is -- let's remember there's quite a number of smaller players that are in the market. And those smaller players predominantly only have 1,000 to 1,500 beds. The other item that you have is the big 3, which are the distributors, are doing quite a number of programs to put people in the business. So it makes it easier for the smaller player to get started and get involved in this space. So from the standpoint, when you take a look at the larger player, the 2 larger players in this industry, it's not predominantly that we're losing it and gaining it so much from each other, but it's predominantly going to either the smaller institutional pharmacy business or somebody is bringing it in-house in terms of that nature, which you see that occasionally take place over a period of time. Usually, they turn around and sell it a few years later, but that's what you normally see. So I think to answer the question, you also have to take a look at other factors within the industry. You're correct, the industry is not growing. When you take a look at skilled nursing facilities, it's not like there's a whole lot of new beds coming into the market. The assisted living facility is -- could be a very good market. The issue has historically been penetration, in that when you're going to a home, you have such -- or to an assisted living facility, you have such a spectrum, a wide spectrum, of a patient. You have -- or a resident, I should say. Not really a patient, but a resident. And you could have a resident that could easily get in their own car and drive to CVS or Walgreens. Then you've got another resident who basically needs a walker and a wheelchair to get around. So I think it's -- that's the hard part, is penetrating, getting the number of scripts running through assisted living facilities. There are 1 or 2 states that they're a little bit more regulated with the assisted living facility, and you see penetration higher in that type of market than you do the other, so I think the concept here is how do we in this space really grow into that bigger market or that big market, the assisted living facility space. So -- because when you take a look at it, I think roughly about 80% to 82% of our beds served are roughly SNFs. I think there's about 8%, 9%, 10%, somewhere in there, assisted living facilities, and then the rest of it is mostly like mental homes, things of that nature, so.

Brendan Strong - Barclays Capital, Research Division

Okay. Just to follow up on that, I mean, what's the -- just going back to the distributors trying to help smaller guys get into the business, why do they want to do that?

Michael J. Culotta

I think for them, it's revenues. And I can understand that. I mean, if I'm working for one of the big 3, I can see it. It's -- basically, they're putting seminars together for the pharmacists and the local pharmacists. And from there, they're able to drive more revenue. And obviously, they're probably -- well, they are, they're a cost to them. They're making more profit off of them on a per drug basis than they would be for one of the -- or ourselves or on me, for example.

Brendan Strong - Barclays Capital, Research Division

Okay, which brings us to the Amerisource contract. You guys had -- I think from an outsider's perspective, I think one of the biggest things you guys have delivered on is a very substantial amount of savings back in 2011 with a new contract then. You've got another new contract with Amerisource now, which is going to produce more savings. Maybe you could just talk to us a little bit about -- just first part of the question and I've got a follow-up on it, is maybe what's different about the savings you're able to generate in 2011, versus the savings you expect in '13, '14 and beyond from the new contract?

Michael J. Culotta

Okay, great question. Let's look back because I think we were pretty vocal about this back in '11. When you take a look at '11, that renegotiated contract at that point in time, remember it was a 5-year contract that went through originally 7/31/2012. We had extended it at the beginning of 1/1/11, and we got a new pricing. And from that, it was extended about 14 months, from what I recall, through September 30, 2013, which would have been this year. And I think we pretty much described it. That increase was about $25 million to $28 million in terms of what occurred there, predominantly around sharing and rebates and pricing around generics, was predominantly what's taking place. This time, we did -- at that time we did not go for a formal bid. It was just strictly negotiations between ourselves and ABC. This time, we did go out formal bid. We spun out an RFP to obviously the big 3. And so we were able to do a lot of comparative pricing between that. Now remember, ABC was still the prime vendor at that point in time. So what we got from the standpoint there was we got a change in pricing on January 1, 2013 of this year, and another pricing change that will take place at the beginning of October 1, 2013. So we originally, when we went out for bid, it was for a 3-year period ending September 30, 2016. So it was for the period October 1, 2013 through September 30, 2016. That was the bid period, but because ABC was already in place, they could make some concessions for us during these first 9-months time frame. So we do have a different pricing schedule that takes place, January 1, and another one that takes place October 1. In addition, as the contract continues, we have more flexibility in buying direct generics, of which we are already starting to look at. So the issue that we have there was that we've really never been able to buy that much. Everything has really gone through that ABC contract. And as you well know is where the savings is, predominantly on cost, is it's going to be in generics. It's not necessarily going to be in the brands. You can't to go direct to the brands. We still have to go through a distributor on brands, but now we're taking a look at going direct to certain manufacturers for generics. We are in the process right now of looking at TPLs. We're getting bids in on third-party logistic companies, TPLs. And, for example, one of the names you would know would be UPS, for example. And so we were looking at that. Now remember, we're going to be doing this just only on generics, and we're only looking at the universe within the top 100 generic drugs. So with anything, it's the old 80-20 rule. When you look at our top 100 brands, when you take a look at our top 100 generics, they probably represent 75% to 80% of the purchases of all of our drugs when you take a look at it that way. But again, this is only generics. And it may not be all 100, it may just be a handful within that 100 that would make the most sense. Again, we would be looking at going to those manufacturers. We'd also be looking to go back to ABC, and which would be the best way to do it. And so, we're not going to split. We'll be buying cases. So let's just say -- make my life simple here, let's say a case has 24 bottles and each bottle has 500 pills in it. We're going to be buying the cases, splitting -- the TPL will be splitting up the case. We're not going to open up those bottles. Then from there is when an order is needed to go to a particular pharmacy, we will send that sealed bottle out. So that's how this whole methodology is going. When we took a look at this, it was more "Let's crawl before we walk, walk before we run. Let's not just jump into this and mess this up. Let's make sure methodically we're going through this and getting the biggest thing from this." So we said the $30 million to $40 million will get you there once we can start buying more and more and more generics. So that number is probably going to be starting sometime more in 2014 as we have more and more flexibility, but we're going to be in line, hopefully, to start with the TPLs sometime late summer or early fall. And we're already -- as some of the folks in Purchasing told me the other day, we've already signed one up already that's going to give us some good savings starting next quarter. So we are starting to see some things starting to develop there.

Brendan Strong - Barclays Capital, Research Division

And just to follow up on that, the $30 million to $40 million, it sounds like most of it comes from generics, being able to buy generics directly. I'm just trying to get a sense for ...

Michael J. Culotta

Most of it is, yes, coming from the generic side of the equation, not necessarily being able to -- not -- I would hate to say that, yes, it's all coming from us being able to go direct out to the manufacturer. We did get some fairly good pricing in terms of what we're doing with ABC. So again -- and we're going to be looking at it. I mean, if there's a drug, ABC, whatever it is, or XYZ, I should say, and it's a generic, we're going to first go to ABC. If they can -- if it's a good price compared to what we can get from another manufacturer, we'll stay with ABC. If it's cheaper, even going through the cost of the TPL, and go direct to that manufacturer, then it'll shift over that way.

Brendan Strong - Barclays Capital, Research Division

I don't know if you've given any details on it, but of the $30 million to $40 million, how do you think about that starting in 2013 versus coming in the later in the year?

Michael J. Culotta

I would say it's -- you're probably going to see more coming later in the year. But don't forget, you've got 3 quarters of really good pricing that's taking place in these first 3 quarters. But your pricing is even better starting in the fourth quarter and beyond, if that make any sense.

Brendan Strong - Barclays Capital, Research Division

Yes, yes. Okay. Yes, so I guess -- and it's -- I know it's difficult to provide any specific details about contracts, but -- and actually, this question isn't specifically about the contract. It's just more about how you go about negotiating a contract with a generic manufacturer when -- because right now, we're in a period where it's a little uncertain what your scripts are going to look like. Now you've got Golden Living saying that they're going to leave, you've got Kindred not having renewed yet. It's a big chunk of your volumes. How do you -- how are you -- how do you have those negotiations with the generic manufacturers? Or does it matter, do you already have enough scale that, that part of it doesn't -- again, that's...

Michael J. Culotta

We really have enough scale. It really doesn't matter. And we have been using consulting firm or firms as we've been going through this whole process, and we're still using one of those firms right now as we're doing those negotiations. So they have the expertise, and so we're still a large purchaser of both brands and generics, a very large purchaser of that. And so that's what they're looking at. What they've told us is if there's only 1 or 2 manufacturers, you're probably going to be better off staying with your distributor, because they're probably going to be aligned with 1 of the big 3. It's when you start getting more than 3 or 4 manufacturers out there that you really can make some very good opportunities to reduce your cost.

Brendan Strong - Barclays Capital, Research Division

Okay, great. Thinking about the Kindred contract, I just -- and again, I -- I'm going to ask you specifically about the contract. I know it's really hard to answer, but, I mean, it's 15% of your business. As I think about it, it just seems to me that it's a contract that it's -- you're the incumbent provider, it's just too big for you to lose. So I think the most likely outcome is you keep the contract, you renew the contract, but there's likely some additional round the price concessions there. And part of that question is I don't really know, when you renegotiated a contract a few years ago, if you guys truly got to a market rate at that time, if the market rates have changed. So is there any color that you can provide around that? Is this the right -- maybe a decent framework at least to think about that Kindred contract?

Michael J. Culotta

Okay, good question. I -- we don't like to get into specifics with contracts, but we will sort of go a little bit here just from the standpoint is -- let's remember, Kindred represents in total 13, roughly, about 13-or-so percent of our business. 3% of that is the hospital side of the business. So roughly about 10% of the business is their skilled nursing facilities that we service through our institutional pharmacy side of our business. That is with all of the homes that were there at 12/31. So don't forget, there's about 5,200 beds, I want to say, from the standpoint that they're giving back or have given back to Ventas. So when you take that into consideration, and we've estimated not keeping all of those, I think you'll see Kindred will be a smaller percentage of the pie. They'll probably be below 10% relating to the institutional pharmacy side of the business. But with that said, they're a very, very important client, very -- to us. We are in early stages with them, and so we'll continue that. And I think, if I'm not mistaken, this is probably our third time of negotiations since we've spun out, if I'm not mistaken. I think we've done this a couple of more times before, 1 year after we spun and then a couple of years after that. So I think this is the third time that we'll be renegotiating that. So I don't want to get into the specifics of the contracts, but obviously, when you've got such a large customer like you have with Kindred and Golden, their pricing is very, very, very competitive is the best way to describe it from that regard. So we want to do everything we can to keep them. And they're a great client, great folks to work with.

Brendan Strong - Barclays Capital, Research Division

Yes. And just one last detail on the contract. It currently expires ...

Michael J. Culotta

12/31.

Brendan Strong - Barclays Capital, Research Division

12/31. You guys are an important part of their operations. So normally, these types of things, you'd want to renew them. I think they'd want to renew them probably a few months in advance. So -- is that the right way to think about it? There's likely -- if there is an announcement probably sometime in September, October. And then just one last thing on that. If there isn't an announcement, just remind us what usually happens. I think what usually happens is you guys are just -- have a short-term contract while -- or the contract gets extended while you still work things out.

Michael J. Culotta

Yes. A lot of the times the way most contracts renew -- again, I don't know the specifics on this particular contract. But usually there's either 60, 90 days before a contract expires that it automatically renews if you're not notified.

Brendan Strong - Barclays Capital, Research Division

Okay.

Michael J. Culotta

That's normal. You just have those evergreens that take place. But obviously, when you've got something like a Kindred, for example, you're still in the negotiations process -- if you're still in that negotiation process, you'll still -- you'll do the extensions for a few months or whatever you need to do, so -- in that regard.

Brendan Strong - Barclays Capital, Research Division

Okay.

Michael J. Culotta

But hopefully, we'll -- we'd love to have something wrapped up sometime summer or early fall, whatever it takes.

Brendan Strong - Barclays Capital, Research Division

Okay, great. I think one of the things that people worry about at times is Medicare pricing for nursing homes.

Michael J. Culotta

Okay.

Brendan Strong - Barclays Capital, Research Division

And, I mean, I don't personally think it's that big of a concern. But I guess question is, if there's another Medicare cut for nursing homes, do you think that you'll experience some of that pain because nursing homes need to pay you less?

Michael J. Culotta

Where you see the pain, and you saw it in 2012, is you will have a handful of nursing home companies that may not have -- have financial difficulties. And that even exasperates that financial difficulty. And so what you saw in late 2011, I think it was like 11.3% reduction that took place. If you noticed, our bad debt expense in 2011 was like 0.88%, and if I'm not mistaken I think it was like 1.7% in 2012. That 1.7%, to a large degree, were 3 customers. That increase was basically 3 customers with financial difficulties. So that's where that bad debt expense came up with that. We're seeing that going the other way now. We're starting to see the bad debt improve even in early 2013. So to really answer your question, where you really see it is, believe it or not, is in the bad debt line.

Brendan Strong - Barclays Capital, Research Division

Right. So -- okay. So if there's some big Medicare cut for nursing homes, you wouldn't expect to take it on price? But there would likely be some impact on bad debt?

Michael J. Culotta

Correct.

Brendan Strong - Barclays Capital, Research Division

Yes. So that means that the thing to watch for is just watching your receivables?

Michael J. Culotta

Watching your receivables.

Brendan Strong - Barclays Capital, Research Division

Okay, great. Let's see. Cash flow. Cash flow, I think, was pretty strong last year. I think it was abnormally strong last year, if I'm not mistaken. So how are you thinking about that in '13, in '14? And how -- what are you thinking about doing with it?

Michael J. Culotta

Well, the main thing in cash flow that we're really taking a look at, what we've historically done, one of the items is, don't forget, we are now a taxpayer. We had not been a taxpayer until the fourth quarter of 2012. We had not even been a taxpayer since our inception because of the net operating losses generated from the transaction that took place. And in addition, there were a number of acquisitions that PharMerica LTC had made that had amortizable goodwill for tax purposes but not for book. And that's pretty much waned at this point in time. So that -- our cash flow will be impacted by being "a taxpayer." But what you're going to be seeing is, is a continuation of acquisitions. The good news is with Amerita, we're looking at, both from the standpoint of home infusion companies, we're also taking a look at institutional pharmacy businesses. The interesting thing is, as you historically know, and we sort of chuckle about this, is it seems the majority, if not all of our acquisitions, come in the fourth quarter, and almost all of them come on December 31. Well, we're starting to see a whole lot more activity earlier on so far. We're working on right now a couple of home infusions. But we've got 3 or 4 very active institutional pharmacy businesses we're looking at right now. So we're starting to see a little bit more things coming in the earlier part of the year. So hopefully we'll have something besides waiting till the fourth quarter to have acquisitions.

Brendan Strong - Barclays Capital, Research Division

Any way to size?

Michael J. Culotta

Most of them are small.

Brendan Strong - Barclays Capital, Research Division

Yes.

Michael J. Culotta

Most of them have been small. From the institutional pharmacy side, it's been mostly under 2,000 beds.

Brendan Strong - Barclays Capital, Research Division

Got it. Okay. And interesting. I actually find it interesting you're already looking at more home infusion. I thought you guys might wait a little while to -- before pursuing more. So it sounds like you've got the right platform, you've got the right management team.

Michael J. Culotta

Yes. Correct.

Brendan Strong - Barclays Capital, Research Division

And so how involved are they in the acquisitions? And how...

Michael J. Culotta

Oh, very heavily. I mean, that came over with that. When we looked to getting in this business, we looked at some smaller players that were for sale. Our problem was we needed a platform. We needed a management team, and that's what we got with Amerita with Jim Glynn, Jim Baker and their team, was we got a solid management team. We did not do this for a synergy play. It was strictly, "Let's get into this business, but let's make sure we have a great team, a great platform that can grow it." So Jim and his team already had the contacts and things in terms of acquisition. So they're the primary party that gets involved in the negotiations of these. We help them from the standpoint of due diligence and the legal ramifications. Everything like that, we help them with. But they pretty much start that whole process off. The other thing is we talked about non-synergy play. And I know this wasn't the question, but I wanted to do it while we still have a little bit of time.

Brendan Strong - Barclays Capital, Research Division

Yes.

Michael J. Culotta

The other thing we looked at when we got with Jim and his team as we were doing the negotiations is all, was how can we with our platform help Amerita grow. It was not about how can Amerita help the institutional pharmacy side of PharMerica grow. So to give you a prime example, they have contacts with people they know. It's very local market-driven also. So, for example, in one particular city, there was a nurse that they wanted to hire. And this particular nurse had been in infusion business 20, 25 years. They've known this person for a large amount of time. But they weren't located there. But because we had a presence there and we were able to, we can dispense the first IV from there. So that local pharmacy, that person now had something local that they can talk about. They hired that person. We can do the first script fill from that -- from our pharmacy, because we have the IV ability to do it. But after that first fill, it's going to be coming from Amerita, being shipped from Amerita after that. So the concept was is we have these 95 institutional pharmacies. How can you, Amerita, be able to hire sales force and other people and be able to use that to the Amerita's advantage to grow that business? And that's what we're looking at pretty heavily. So we have -- the great thing about Amerita is there's 2 ways to look at it: one is the internal growth that it has itself; two, the internal growth it can have by utilizing the platform that we have out there; and three, the ability to go out and acquire. So for us, this was a total win-win and an opportunity to really grow another part of the business.

Brendan Strong - Barclays Capital, Research Division

And it's okay if we run 1 minute or 2 late.

Michael J. Culotta

Okay.

Brendan Strong - Barclays Capital, Research Division

But just to follow up on that, as you think about -- just remind us how much revenue is there at Amerita today and...

Michael J. Culotta

Yes, they're about $90 million.

Brendan Strong - Barclays Capital, Research Division

About $90 million. So what type of growth do you -- I mean, are you optimistic about achieving, once you layer that onto your platform, onto -- being able to use your pharmacies to help grow that business?

Michael J. Culotta

Well, again, you got the law -- in this case, you got the law of smaller numbers. So we're hoping very, very much to easily being in the 10% to 15%, if not more growth going forward in the Amerita business.

Brendan Strong - Barclays Capital, Research Division

Okay. Okay. And then probably just maybe one last question here. If you just -- if you think about the brand-to-generic cycle, just remind us about how much -- how many branded drugs are going generic over the next 3 to 5 years and how you see that playing out over those years.

Michael J. Culotta

Okay, the number of drugs I don't remember off the top of my head, but...

Brendan Strong - Barclays Capital, Research Division

More focused on the [indiscernible]...

Michael J. Culotta

But what we did -- the ones that you'll see is -- that's on the website and that we put in the 10-K, what we did is we went back and looked at those drugs and said, "What was the revenue from those drugs in 2012?" Again, we didn't adjust for any volume changes or anything. And that amounts to about $224 million through 2017. And so in 2013, of that $224 million, $51 million will go generic in 2014, $44 million will go generic, 2015, $112 million will go generic -- and in 2015, it's predominantly through 2 drugs, Namenda and Abilify. And then 2016 and '17 are both $9 million each. So if that gives any flavor. So you can see really 2013 and '14 added together don't even equal 2015. 2015 is the big year, but it's predominately 2 drugs.

Brendan Strong - Barclays Capital, Research Division

And I think the nice part about that is you'll be -- no matter how long it takes you to ramp up buying those generics directly, you'll be fully ready by then?

Michael J. Culotta

Correct.

Brendan Strong - Barclays Capital, Research Division

So being -- that should be another really good year for you.

Michael J. Culotta

Yes, yes.

Brendan Strong - Barclays Capital, Research Division

All right, good. I think we'll leave it there, and we'll move over to the breakout. Thank you.

Michael J. Culotta

Thank you very much.

Brendan Strong - Barclays Capital, Research Division

Thank you, Mike.

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