Pharmaceutical price increases remain a critical component of manufacturers' commercial strategies, McKesson CEO John Hammergren assured analysts during the Thomas Weisel Partners Healthcare Conference in Boston Sept. 9.

"We believe that the pharmaceutical industry is continuing to use price as a vehicle to offset the significant challenges that they have with generics and other kinds of things," Hammergren said. "It would be an important vehicle going forward."

"We would anticipate that the level of price increase will remain about where it has been, and the frequency will remain about where it has been, and the items affected on a full-year basis will remain the same," he said.

Hammergren appeared at the conference two days after McKesson issued an earnings warning for its upcoming second quarter report, saying that pharmaceutical price increases are not occurring at the rate the company projected.

"The number of U.S. pharmaceutical price increases in the September quarter to date was at the lowest level since the September quarter of 2000," McKesson said in a Sept. 7 press release.

Although "the magnitude of price increases that have been realized thus far this fiscal year is comparable to those of the recent past," the actual number of increases is much lower, McKesson said.

As a result, the company is reducing its projected earnings per share forecast for the first half of fiscal 2005 (ending Sept. 30) to $0.75-$0.80; McKesson had previously said that it expected earnings per share to be "modestly lower" than the $1.05 recorded during the first half of fiscal 2004.

"Price increases through June had happened at about the same level" as McKesson has seen in recent years, Hammergren explained during the analysts conference.

"Beginning in July and continuing through August and into September...the numbers of price increases have diminished rather significantly, and certainly the big items that we had expected inflation on have not occurred."

Hammergren stressed that McKesson sees the issue simply as a change in timing - not in strategy - by manufacturers. Price increases will come, he said, "just a little later than we had originally anticipated."

The wholesaler still expects to meet full year EPS guidance ($2.20-$2.35) based on the "assumption that the majority of the anticipated price increases will be realized before fiscal year end," the Sept. 7 press release states.

Hammergren cited the experience four years ago as a model for how McKesson sees the current pricing environment.

"We haven't seen a phenomenon like this, a significant shift, since the year 2000," Hammergren noted. "The price increases that we had anticipated in 2000 in the first half did in fact get skipped in the first half, some of them, and they were taken in the second half of the year."

The year 2000 disruption in the pricing increase pattern was attributed to a desire by manufacturers to avoid contributing to any Y2K-related supply problems (¹ Also see "Rx Year 2000 Preparations Register In Wholesaler Earnings Reports" - Pink Sheet, 1 November, 1999., p. 22).

McKesson is the second of the "big three" wholesalers to issue an earnings warning in the last two months. Cardinal announced in early July that the transition to a "fee-for-service" distribution model is holding back performance.

Cardinal issued its earnings warning at the same time it disclosed an expanded investigation into accounting practices. The company has since changed its CFO and delayed its fiscal year-end report (² Also see "Cardinal CFO Departs Amid SEC, U.S. Attorney Investigations" - Pink Sheet, 2 August, 2004., p. 9).

McKesson maintains that its efforts to convert to fee-for-service contracting is proceeding well - but, like Cardinal, the company is attempting to accelerate that process by issuing an ultimatum to manufacturers (see ³ Also see "Cardinal, McKesson Issue Ultimatum: March 31 Deadline For Manufacturers" - Pink Sheet, 13 September, 2004.).

McKesson underscored its continuing dependence on price increases to drive profitability, despite the conversion to inventory management agreements.

The profit impact from changes in the timing of price increases "is probably amplified in our current business structure because we make a lot more of our money on drug price inflation today than we did in the year 2000," Hammergren added. "We're more dependent on it."

Hammergren acknowledged that McKesson's continued dependence on price increases "probably wasn't clearly understood" on Wall Street, given the discussions over the past two years about the implementation of IMAs that limit forward buying by wholesalers.

"In fact, those IMA agreements are still price sensitive," Hammergren noted.

When manufacturers do not increase prices, wholesalers miss out on the potential profit they would realize from "normal" inventory levels - and any enhanced payment they would receive under the IMA.

"In the world where price increases are happening normally, IMAs will perform normally," Hammergren said. "In the world where price increases are delayed or are taken at a lower level, IMAs are directly affected in terms of their financial delivery to a wholesaler."

A move to fee-for-service contracts with manufacturers would essentially eliminate the price increase component of earnings, he added.

Hammergren stressed that he considers the timing of the price increase issue to be coincidental, not an offshoot of the negotiations over the wholesaling model.

"It had nothing to do with 'let's get the wholesalers,'" Hammergren said.

"Big pharma doesn't really care about what happens to us," Hammergren declared. "We are a by-product of what they decide is their strategy. Their pricing activity is focused on what they want to do in the marketplace for their own reasons."

"I would consider us to be collateral damage as a result of that policy change," Hammergren said."

Hammergren did not offer an opinion on the reasons for the shift in timing by manufacturers.

"If anything, over the past three years, they have been moving price increases forward into the first half as opposed to shifting it to the back half," he said. "You'll have to draw your own conclusions" about why the timing may have changed.

One new element in the pricing calculus is the visibility on manufacturer prices under the Medicare-endorsed discount card program.

AARP and other groups criticized manufacturers for raising prices headed into the discount card program, and pledged to monitor carefully for signs that companies may be undoing the savings from the cards (⁴ Also see "Rx Price Increases After Medicare Passage Undermine Law's Intent – AARP" - Pink Sheet, 5 July, 2004., p. 14).

Rx Price Restraint Hits McKesson; Wholesaler Sees Delay, Not Policy Change

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