Drugstore.com is considering establishing its own distribution centers to fill orders made through its pharmacy web site, according to a prospectus for an initial public offering filed May 19.

The online pharmacy currently purchases all of its pharmaceutical products from RxAmerica, the pharmacy benefit management and mail-order pharmacy joint venture between American Stores and Longs Drug Stores. American Stores was recently acquired by Albertson's. Drugstore.com buys most of its non-pharmaceutical products from Walsh Distribution.

"We carry minimal inventory and rely to a large extent on rapid fulfillment from RxAmerica, Walsh Distribution and other vendors," the document states. It adds that American Stores and Longs are both "potential competitors of drugstore.com" and that "our agreement with RxAmerica only has a one-year term (ending in February 2000)," although it may be renewed. McKesson is RxAmerica's sole-source wholesaler.

The company may have to use some of the funds from its proposed stock sale to build infrastructure. "We are in the process of evaluating our long-term distribution strategy," the prospectus says. "At some point, it is possible that we may need to establish our own distribution centers either to achieve greater control over the distribution process or to ensure adequate supplies of products to our customers."

Direct manufacturer relationships are also under consideration, "to ensure the availability of adequate volumes of products ordered by our customers," drugstore.com said.

Drugstore.com is moving quickly to get its bid in for a share of the burgeoning internet drug market. CVS recently announced it will buy internet pharmacy Soma.com; the chain drug store mentioned Soma's fully automated fulfillment center as one of the reasons it chose to partner with Soma ("The Pink Sheet" May 24, p. 8).

The CVS deal values Soma at less than half the amount drugstore.com expects to raise through the IPO. CVS will pay $30 mil. in stock for Soma; drugstore.com's prospectus estimates the total value of the offering at $67.5 mil., although the company has not revealed the number or price of the shares to be offered. Morgan Stanley Dean Witter, Donaldson, Lufkin & Jenrette and Thomas Weisel Partners are managing the offering.

One advantage Soma cited in the CVS deal is the access it will gain to third-party contracts. The drugstore.com prospectus suggests that the company's lack of a full range of third-party contracts may be limiting Rx sales. The prospectus notes that "to date, a substantial majority of our prescriptions have been submitted by cash paying customers."

Drugstore.com said it has "a number" of third-party contracts, but indicated that it may take some time for it to offer a greater number of reimbursement options to its customers.

Insurers and PBMs in many cases may "delay their decisions to contract with online pharmacies or may decide to develop their own internet capabilities that may compete with us," the prospectus notes. Express Scripts and Coram Healthcare have both announced plans to open full-service online pharmacies.

"In addition, many insurance companies have existing contracts with chain drugstores and PBMs that have announced their intentions to establish online pharmacies," the prospectus continues. "It is likely that some insurance companies and PBMs will contract with only one or a limited number of online pharmacies."

A potential strategic advantage is drugstore.com's relationship with Amazon.com, its largest shareholder. Amazon.com promotes the new firm's web site, and its president, Jeff Bezos, sits on drugstore.com's board.

From Feb. 24, when drugstore.com launched sales, to the end of the quarter on April 4, the firm had $652,000 in revenues. Because of "promotional sales discounts" associated with the launch of the site, the company had negative gross margins for a loss of $20,000 on sales. The company's operating loss for the quarter was $10.2 mil.

Drugstore.com noted that it and other online pharmacies will be closely watched by lawmakers. Members of the House Commerce Committee have requested General Accounting Office reports on the industry and intend to hold hearings on the subject ("The Pink Sheet" April 5, p. 14).

Drugstore.com May Build Distribution Centers; Plans $67.5 Mil. Stock Sale

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