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Business Observer Friday, Dec. 12, 2003 15 years ago

DrugMax Goes for the Max

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The stock of Clearwater-based DrugMax lnc. languishes outside of Wall Street's radar. COO William LaGamba says becoming a $1 billion company should take care of that.

DrugMax Goes for the Max

The stock of Clearwater-based DrugMax lnc. languishes outside of Wall Street's radar. COO William LaGamba says becoming a $1 billion company should take care of that.

By Dee Gill

Contributing Writer

It's hard to find anything in wholesaler DrugMax Inc.'s second quarter earnings report that would warrant a big sell-off of the Clearwater company's shares.

Even though the company broke even on earnings and revenues declined 18% to $60.2 million, the story behind the results was generally positive. After all, profit margins increased, thanks to a decision to focus on generic drugs. New products are on their way. The adjustment to a recent acquisition was coming along nicely, with the expectation that it would contribute to profits next quarter.

Nevertheless, in four days after DrugMax's Nov. 14 earnings announcement, investors pushed down DrugMax shares 21%. On Nov. 20, shares of the company closed at $1.85, down from $2.35 the week earlier. On Dec. 9, it closed at $2.15.

Most likely, the fall was more a reflection of lack of interest in the company than disappointment with its results. It's near impossible to get attention on Wall Street when you're a nano-cap company like DrugMax. It's even harder when, like DrugMax, you're an ex dot-commer. Your share price yo-yos, often at the mercy of investors looking at technical factors rather than performance or strategy. What's more, industry analysts who could spread your good news to institutional investors simply ignore you.

William LaGamba, DrugMax president and chief operating officer, 44, understands the market obscurity his company is operating in now, and he doesn't like it. In fact, he doesn't plan to remain in it long. "We don't want to be a microcap," he says. "Our goal is $1 billion in revenues. In five years."

DrugMax revenue for fiscal year ended March 30, totaled $291.8 million. That's up 64% from the $177.7 million in revenues generated two years ago, but it would still take a big leap to get to $1 billion.

But with a $40 million line of credit, LaGamba points out that DrugMax has money and shares for acquisitions. He's convinced DrugMax can grow in big jumps while most of his competitors can't.

If his plan works, DrugMax could be one of the biggest generic drug wholesalers in the country by the end of the decade.

Closed club

Drug wholesalers store product from pharmaceutical companies in warehouses and sell them to businesses pharmacies, hospitals and nursing homes. DrugMax also sells over-the-counter medicines and health and beauty products to the same customers.

While many wholesalers buy pharmaceuticals from other wholesalers, LaGamba says only 38 national companies, including DrugMax, can buy product directly from the major pharmaceutical companies. Three of these authorized distributors - Amerisource-Bergen, Cardinal Health and McKesson - are giants selling double-digit billion dollars worth of product annually and taking the vast majority of the wholesale market. But after those three, the size of companies on the list drops dramatically.

New competition from start-ups is rare. The population of authorized distributors has dropped from about 120 in the mid-1980s, he says, and the pharmaceutical companies seem to like it that way. "It's kind of a club from years ago," says LaGamba. "They just aren't taking new members."

It's also not a terribly attractive industry for newcomers. Average net profit margins for the industry are a bare 0.73%, according to the Healthcare Distribution Management Association. DrugMax has been able to raise its gross profit margin to 3.5%, largely by cutting back on branded drug sales in favor of selling more profitable generics.

And while Wall Street may not be paying much attention to DrugMax, it loves this industry. Everyone is getting older and taking more medicine. Sales of pharmaceutical and health care products have more than quadrupled since 1991 to $139.2 billion in 2002. Health care is one of the few sectors of the economy begging for workers. Industry analysts have buy recommendations on many of the companies' shares.

LaGamba's background has driven DrugMax's growth. He grew up in the industry, spending 14 years at McKesson, moving up the management ladder, largely on the sales side. He always had a plan to start his own wholesale business. As McKesson's minimum order size kept rising, he knew there would be an opportunity for a connected wholesaler willing to fill small orders.

In January 1997, LaGamba started Becan Distributors Inc. in Pittsburgh, selling pharmaceuticals to independent pharmacies and picking up secondary orders from the bigger chains. Because of his history in the industry, including work with its trade associations, he was welcomed into the club.

Unlike most entrepreneurs, LaGamba didn't have to wait long for proof that his concept worked. He broke even in March, three months into the business. He turned a profit in April. He says he sweated every minute anyway: "I didn't sleep for three months."

He hooked up with venture capitalist Jugal Taneja in 1999. Taneja was looking for a way to put several ventures together.

Taneja started with a spin-off called NuMed, which lost money and he essentially liquidated. He then merged NuMed with Nutriceuticals.com, a company that sold natural products over the Internet. Nutriceuticals.com bought Becan, as well as a publicly-traded software company. They quickly changed the name from Nutriceuticals "which no one could spell, including us," says LaGamba, to DrugMax.com. In turn, DrugMax.com bought Valley Drug Co., a full line drug wholesaler, just in time to avoid the dot-com implosion. They dropped the ".com" in 2001.

DrugMax maintains a thriving Internet store, but LaGamba is quick to explain that the company's sales force generates the vast majority of revenues. The advantage of selling through people versus clicks shows up in the size of the orders, he says. Sales people talking to clients can tout products tailored for those buyers. "We have a clientele that will take product that we steer them toward," he says.

DrugMax sells pharmaceuticals, over-the-counter drugs, health and beauty aids and nutritional supplements mainly to independent pharmacies in the U.S. It also sells these products to small- and mid-sized pharmacy chains, alternative care facilities like nursing homes, and other wholesalers. More than 9,000 of these customers are registered to purchase DrugMax products through its Web site.

Finally, large pharmacy chains, which are usually supplied mainly by one of the three largest wholesale companies, sometimes place secondary orders with DrugMax.

Looking for a roll-up

LaGamba believes that many of his small competitors are ripe for acquisition. The thin margins make wholesaling a tough business, and critical mass is hard to achieve. Some of them are regional suppliers, or specialty distributors selling a limited product line. "There are opportunities for roll-ups of some of these small wholesalers," he says.

Many of these companies are too small to interest the big three wholesalers, he says. He points out that only five companies on that list of 38 have publicly traded shares to offer sellers. DrugMax also secured a three-year, $40 million line of credit in April that includes $5 million for acquisitions.

In May, DrugMax made a small acquisition of Avery Pharmaceuticals Inc., a Fort Worth, Texas company that makes respiratory therapy products.

When the company is ready to make a major acquisition, LaGamba says, paying for it with paper rather than cash will be a big advantage.

But it's an advantage that comes with a steep price. DrugMax's status as a public company sometimes seems more painful than useful. Money that would have looked good on the bottom line at earnings time was instead eaten up by the various legal and accounting costs necessitated by selling shares on the open market. "A substantial percentage of earnings now," LaGamba admits, "goes to just being public."

If LaGamba can really do what he plans - build a profitable, billion-dollar wholesaler - the cost of being public will pale in comparison to the rewards. And getting attention from Wall Street won't be a problem.

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