Industry Insight

Date February 2017

By the numbers


Current trends

  • The Affordable Care Act boosted drug spending, benefitting wholesalers; however, efforts to repeal and replace it may put some reimbursements at risk
  • The industry, along with its investors, continues to anticipate what changes, if any, may come from the federal government to regulate prices
  • Increasing levels of chargebacks have dampened recovery values in recent years


 Projected Values


Revenue Growth - U.S. Brand Name Pharmaceutical Manufacturing 


Revenue Growth - U.S. Generic Pharmaceutical Manufacturers 


Pharmaceutical chargebacks discounted in liquidation: Large hospital buying groups and retail pharmacies typically negotiate purchase prices for pharmaceutical drugs directly with manufacturers based on volume. Pharmaceutical chargebacks help to remedy differences in purchase prices charged to various types of buyers, typically, as follows: a wholesaler will sell a product to customers at a price lower than the price charged to the wholesaler by the manufacturer. The wholesaler is then allowed to contractually charge back the manufacturer for the difference and normal margin. Drug manufacturers often do not reimburse this chargeback in cash; instead, drug manufacturers issue a credit to be applied against future purchases. Thus, at any point in time, there are payables due to the wholesaler for chargebacks as well as payables due to the manufacturer for the original inventory purchase. Gordon Brothers typically assumes that a wholesaler (and in turn the secured party) won’t receive the chargebacks in a liquidation, as they would be offset against other accounts payables owed; in essence, this means that, in a liquidation scenario, the company wouldn’t realize the full contracted margins they usually generate.

Fifteen years ago, chargebacks fell in the range of 5 percent to 6 percent of total sales; now it is not uncommon for chargebacks to be as high as 30 percent to 40 percent of total sales. Previously, chargebacks were not tracked at the lot level, and competitors would buy pharmaceuticals in a liquidation below cost and recover the chargebacks when they sold the product, minimizing the impact of chargebacks in a liquidation. Now, primarily due to gray market pharmaceutical concerns and cross-border sales issues, chargebacks are tracked at the specific lot level and can only be recovered by the parties involved in the original purchase. Competitors that buy pharmaceuticals in a liquidation will not consider the benefit of a chargeback into what they pay for the product.

Government contracts pose risk: Some wholesalers sell a significant portion of their inventory under government contracts, which are negotiated between the manufacturer and the contracting agency. These contracts enable government bodies to purchase products at typically significantly discounted rates. In a liquidation, it is unlikely that inventory would continue to be sold to the government at those prices, which could pose a problem if the government is a significant buyer. In this scenario, liquidators would likely need to find alternate buyers; depending on the volume, that could be challenging. Lenders should be aware of how much inventory is typically sold under government contracts and the impact it could have on recovery values.

Limited distribution increases desirability of some inventory in liquidation: The Drug Quality and Security Act, signed into law in 2013, aims to improve identification and traceability of all prescription drugs distributed in the U.S. To control distribution, manufacturers often strictly limit the number of wholesalers authorized to sell particular products, meaning that no one other than a potentially short list of wholesalers is authorized to buy that product from the manufacturer. If one of those authorized wholesalers were to go into liquidation, some wholesalers that were previously unable to acquire the product directly from the manufacturer may be willing to pay a premium for it. Thus, lenders may wish to consider how exclusive their wholesalers’ contracts are.

Gray market pharmaceutical issues: These new regulatory constraints have also evolved in order to limit the secondary sale of pharmaceuticals from wholesaler to wholesaler and shrink the so called “gray market” for these products. As a result, the secondary market for pharmaceuticals is not what it once was. Historically, a significant variation has existed in the price charged for what is ostensibly the same product in various countries and regions of the world. With the advent of the internet as a major retail sales channel, online pharmacies started filling pharmaceutical sales across government borders. In order to protect regional and national margins (as well as protect against burgeoning counterfeit operations), pharmaceutical manufacturers and governments began to crack down on pharmaceuticals being sold out of the intended national sales channel. This stifling of the gray market and the control of out-of-channel purchases has also had a negative effect on the secondary market for pharmaceuticals in a liquidation as there are fewer entities willing to purchase pharmaceuticals out of channel.

Aging an important consideration: All pharmaceuticals have expiration dates. Many retailers will not accept inventory that is a year or closer to its expiration date. Thus, lenders should inquire about the aging of inventory and beware of lending against any product that has a shelf life of less than one year. Often wholesalers will return inventory with a shelf life of less than six months because of this concern. Lenders should inquire about inventory management procedures and stock rotation programs in place.

Exit strategies must be coordinated with government agencies: The U.S. Food and Drug Administration (“FDA”) is the primary agency responsible for the regulation of pharmaceutical manufacturers and distributors. Manufacturers and distributors are required to register for permits and licenses and comply with certain regulatory controls of the FDA, the U.S. Drug Enforcement Administration, and various state boards of pharmacy or comparable agencies. Additionally, pharmaceutical manufacturers and distributors are subject to the requirements of the Controlled Substances Act and the Prescription Drug Marketing Act of 1987, an amendment to the Food, Drug, and Cosmetic Act, which requires each state to regulate the purchase and distribution of prescription drugs under prescribed minimum standards. These laws regulate the manufacture, shipping, storage, sale, and use of such products and product samples. The FDA, Federal Trade Commission, and state authorities (regulations vary by state) regulate the advertising of prescription and over-the-counter products as well as rules and licenses regarding filling, compounding, and dispensing prescription products.

Gordon Brothers has discussed hypothetical exit strategies with the FDA and has been advised that the agency would work with a responsible party in a liquidation event, assuming the party was acting in good faith, with transparency, and expressed an interest in protecting the public health. The FDA has advised that any such action in relation to a company’s inventory would best be taken under the direction of the existing company that would likely be currently licensed to distribute the regulated products. This being said, for distribution entities, there is no FDA license or FDA authority required for a liquidation; however, there are state distribution licenses typically regulated and administered by a state pharmacology board. If the liquidation were to involve any dispensing of prescription products, a licensed pharmacist would not be engaged to handle and oversee these activities. In all cases, the selling entity would need to be licensed by the appropriate federal and state authorities as applicable under the situation. Lenders should be aware of these complexities in taking possession of pharmaceutical inventory and the proper and legal process for liquidating it.