Medco Health Solutions, Inc. Q4 2008 Earnings Call Transcript

Feb.24.09 | About: Medco Health (MHS)

Medco Health Solutions, Inc. (NYSE:MHS)

Q4 2008 Earnings Call

February 24, 2009 8:00 am ET

Executives

Valerie Haertel – Vice President of Investor Relations

Dave Snow - Chairman and Chief Executive Officer

Rich Rubino – Chief Financial Officer

Kenny Klepper - President and Chief Operating Officer

Tom Moriarty - General Counsel, Secretary, and SVP of Pharmaceutical Strategies and Solution

Steve Fitzpatrick – President of Accredo Health Group

Analysts

Lisa Gill – J.P. Morgan

Garen Sarafian – Citigroup

Ricky Goldwasser – UBS

Glen Garmont – Thinkequity

Alex Beckler – Goldman Sachs

Ross Muken – Deutsche Bank Securities

Larry Marsh – Barclays Capital

Helene Wolk – Sanford Bernstein

Robert Willoughby – Banc of America-Merrill Lynch

John Kreger – William Blair & Company, L.L.C.

Operator

At this time, I would like to welcome everyone to the Medco Health Solutions fourth quarter 2008 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer session. (Operator Instructions). I would now like to turn the call over to Valerie Haertel, Vice President of Investor Relations. Please go ahead.

Valerie Haertel

Good morning everyone, and thank you for joining us on Medco’s fourth quarter and full year 2008 earnings conference call. With me today as speakers are Chairman and Chief Executive Officer, David Snow and Chief Financial Officer, Rich Rubino. Also joining us for our question-and-answer session are our General Counsel Secretary and Senior Vice President of Pharmaceutical Strategies and Solutions, Tom Moriarty, our President and Chief Operating Officer, Kenny Klepper, and the President of Accredo Health Group, Steve Fitzpatrick, will be joining us by phone.

During the course of this call, we will make forward-looking statements as the term is defined in the Private Securities Litigation Reform Act of 1995. No forward-looking statements can be guaranteed, and actual results may differ materially from those projected. We undertake no obligation to publicly update any forward-looking statements whether as the result of new information, future events, or otherwise. Forward-looking statements made on this call should be evaluated together with the risks and uncertainties that affect our business, particularly those disclosed in our SEC filings.

Copies of Medco’s filings are available from the SEC, the Medco website or from the Medco Investor Relations department. The copyrights for the contents of this discussion and the written materials used on this earnings call are owned by Medco Health Solutions, Inc., 2009. Slides to accompany our presentation which detail our financial and operating results and the guidance discussed on this call can be found in the Events section of the Investor Relations site on medcohealth.com. Additionally, please note that our 10-K will be filed after the close of the market today.

At this time, I would like to turn the call over to Dave Snow.

Dave Snow

Thanks to all of you for joining us this morning. Today, we are reporting exceptionally strong 2008 full year performance across the board. Our full year GAAP diluted earnings per share reached a record $2.13 representing 30.7% growth year over year. Our diluted earnings per share excluding the intangible amortization from our 2003 spin-off reached a record $2.33, representing 28% growth year over year. Both are at the top of our 2008 guidance range.

Our mail order prescription volumes for the year increased to 11.6% and reached a new record of nearly 106 million scripts, exceeding the 105 million we projected. This is primarily due to a fourth quarter volume increase likely driven by the pressures of a weakening economy on consumers who are seeking best value. The continued strength in mail order volume and relative weakness in retail volume brought our adjusted mail order penetration rate to 40.3% in the fourth quarter and to a record 39.7% for full year 2008, 1.8 percentage points higher than the 37.9% in 2007.

For the full year, our generic dispensing rate increased 4.4 points to a record 54.1% compared to 59.7% for full year 2007. Year over year improvements in our generic dispensing rates drove incremental 2008 savings to our client and members of $2.7 billion, a new savings milestone for clients at a time when they need it most.

EBITDA for adjusted script climbed 15.7% to a new record of $3.09 for the full year compared to $2.67 for full year 2007. We exited the year with a fourth year EBITDA per adjusted script of $3.18, a 25.2% increase over fourth quarter 2007. Medco’s record setting level of new client wins of 7.2 billion for 2008 and strong retention rate of 98% drove our net revenues to a record $51.3 billion for the year reflecting growth of 15.2% over the $44.5 billion in 2007.

Our sales momentum continues. Our 2009 year-to-date annualized new name sales climbed to a record of over $8 billion from the $6.4 billion we last reported. Net new sales for 2009 rose to a record of $6.1 billion from the previously reported $4.9 billion. Medco’s 2008 and 2009 selling seasons to date have yielded over $15 billion in annualized new name sales and over $11.5 billion on net new sales. I would like to remind you of what we mean when we discussed annualized new name and net new sales. New name sales cover all of our sales wins from competitor incumbent and are accounted for on an annualized basis. Net new sales reflect these brand new external business wins minus any internal account losses and are accounted for on a fiscal year basis. Net new sales also include growth and erosion from our existing internal accounts to provide you with a true depiction of the net growth of our business and importantly our success in the competitive market place. Our 2009 client retention rate stands at a strong 96.4%. We are now over 96% complete with our 2009 scheduled and early elective renewals, which now total approximately $20 billion.

As we reported last quarter, we have completed all 2009 scheduled renewals for clients exceeding $500 million in drug spend. It is important to know that we continue to price contracts with the same discipline that we had consistently demonstrated in the past. Our Accredo Specialty Pharmacy segment demonstrated strong continued growth in 2008 with record net revenues reaching $8 billion, representing 32% growth over the $6 billion in net revenues they earned in 2007. Accredo’s operating income grew by 33.8% in 2008 over 2007, delivering record full year operating year of $281.2 million.

The success we achieved in 2008 demonstrates that our clinically driven business model provides winning solutions to our clients, especially in a weak economic environment. We are delivering clearly differentiated therapy management solutions that drive better outcomes and lower total healthcare costs. I am delighted with our record-breaking 2009 sales results to date, and I am equally pleased to report that our January 1, 2009, new client installations were virtually flawless. To give you a sense of the magnitude of the effort, we logged over 180,000 programming hours to customize the benefit and eligibility software necessary to install our January 1, 2009, new name business wins and implement plan design changes for our existing clients.

I am deeply indebted to the thousands of Medco employees who worked tirelessly in 2008 and throughout the holiday season to make sure that our new and existing customers received the highest quality installation and ongoing service that are part of Medco’s brandable difference. With our strong 2008 performance as a backdrop, we are reaffirming our 2009 diluted GAAP earnings per share guidance of $2.45 and $2.55, which based on our 2008 actual earnings performance, represents growth of 15-20% over 2008. Excluding the amortization of intangible assets, we expect diluted earnings per share to be in the range of $2.67 and $2.77, a 15-19% growth rate.

We believe that the range of earnings per share guidance we are reaffirming today takes into account both the opportunities and the challenges posed by the current recessionary environment including rising unemployment rates. This represents strong continuing growth especially given that the 2009 pipeline of new generic introductions is heavily weighted toward the back half of the year. The diversity of our client base, the strength of our business model, and the success of our strategic growth drivers allowed us to deliver strong fourth quarter and full year 2008 results and support the confidence that is reflected in guidance we have set for 2009.

In summary, our highly scalable clinically driven model is proving to be a strong brandable difference in the marketplace. Our portfolio of solutions provides the right answers to help our client and members during this time of economic uncertainty. Our strong sales and financial results would not have been possible without our key brandable differences enabling us to advance the practice of pharmacy, our therapeutic resource center model, our personalized medicine initiatives, and our evidence-based protocol-driven approach to pharmacy, which improves clinical outcome and financial results for our clients and members.

With that, I will turn a call over to our CFO, Rich Rubino, who will discuss additional details behind our 2008 financial performance and our 2009 guidance.

Rich Rubino

We are pleased to deliver another quarter and full year of strong financial and operating performance. I will begin my discussion with a report on our balance sheet followed by a review of additional income statement highlights and some points to consider as you look ahead to the first quarter and full year 2009.

As we previously stated, our key 2009 financial strategies include driving operational efficiencies, increasing cash generation, and improving our return on invested capital. We have already created significant incremental internally generated liquidity and are optimistic about our ability to exceed the cash generation goals we discussed in our third quarter 2008 call. We closed the four quarter with $938.4 million of cash on our balance sheet, up 21% over the $774.1 million at the end of 2007 and up $440.8 million at the close of the third quarter. Our previously stated goal was to double the third quarter balance by the end of 2009. The cash balance in fact doubled by the end 2008.

There is always an element of timing in cash balances in quarter to quarter, and we expect our cash balance to grow even further in the course of 2009. Our cash flow from operations for full year 2008 was $1635 million compared to $1367 million in full year 2007. The 2008 full year performance represents a record, and we still expect to increase cash flows by 50% in 2009, as we further strengthen our balance sheet through working capital management. Hence, we expect to achieve cash flow from operations of well over $2 billion dollars in 2009.

Our total debt remained at $4.6 billion, and we expect to hold that level of debt through the end of 2009, effectively lowering our debt to EBITDA ratio as our EBITDA grows. Our inventory levels declined from September 2008 by over $90 million to $1857 million. That operational focus along with the similar optimization we achieved in the third quarter means that we have now been able to successfully reduce our inventory level by more than 10% since the end of the second quarter of 2008. To provide another point of reference, our year-end 2008 inventory balance is the lowest it has been since the third quarter of 2007 despite the growth of our quarterly mail order volumes by almost 14% since that point in time.

As a result of our working capital management progress to date and our plans for the remainder of 2009, we now expect more than a 2 percentage point increase in our return on invested capital for 2009. One last comment on the balance sheet; our capital expenditure for full year 2008 totaled $286.9 million, in line with our guidance of approximately $285 million reflecting investments across the business including our new automated back-end pharmacy in Indiana. We still expect capital expenditures to decline to approximately $225 million for full year 2009, as we complete construction of the Indiana Pharmacy later in 2009.

With regard to our income statement performance, I will refrain from repeating the highlights they have already provided. Instead, I will focus more on the quarter and also point you to the detailed slides we have made available on our website. Unless otherwise stated, comparisons are to the equivalent period of 2007.

Our fourth quarter EPS results were very strong. Fourth quarter 2008 GAAP diluted EPS of $0.54 exceeded 2007 performance by 42.1%. Diluted EPS excluding the amortization of intangibles from the 2003 spin-off of $0.59 was higher by 37.2%. Fourth quarter revenue is $13 billion, representing a growth of 13.9%. Product revenue grew 13.6% while service revenue grew 37%. Product revenue growth reflects significant new business and price inflation on brand name drugs, partially offset by a higher representation of lower cost generics. Service revenue growth reflects the expansion of our overall client base and includes client clinical program revenue for a multitude of programs we offer that generates substantial savings to our client and Medicare part D service fees.

Our 2008 product revenue growth was fuelled by significant expansion of mail order volumes including strong growth of our specialty pharmacy, the Accredo Health Group, and price inflation on brand name drugs. For the fourth quarter, our mail order revenue grew by 23.9% while retail revenue increased 6.6%. For the full year, the mail order revenue growth rate was 25.2% with retail growth at 8.3%.

In terms of volumes, our mail order prescriptions in the fourth quarter of 2008 reached $26.7 million scripts, a new quarterly record for Medco. This represents growth of 9.4% over 2007 and more than 2% growth compared to the third quarter of 2008. Total fourth quarter prescriptions adjusted for the difference in base supply between retail and mail amounted to 198.1 million, or an increase of 4.3% of the fourth quarter of 2007. For the year, total adjusted prescriptions amounted to 795.9 million scripts, an increase of 6.4% over 2007.

Retail volume growth slowed to a 1% rate from the fourth quarter below the 3.3% rate experience for the full year. The resultant adjusted mail order penetration rate of 40.3% for the fourth quarter 2008 was almost 2 percentage points higher than the 38.4% achieved in fourth quarter of 2007. The full year 2008 adjusted mail order penetration rate increased 1.8 percentage points to 39.7% from 37.9% in 2007. Our other mail order volumes not counted as prescriptions, which include OTC items and diabetes supplies totaled 1.7 million units for the fourth quarter 2008 and 6.0 million units for full year 2008 reflecting contributions from PolyMedica and Europa Apotheek Venlo.

Our overall generic dispensing rates for fourth quarter 2008 reached a new record of 64.9%, comprising of 67% retail generic dispensing rate, which is mainly the result of the higher number of generic acute prescriptions primarily dispensed in retail, largely generic antibiotics and narcotic analgesics, and a 55.9% mail order generic dispensing rate comprised primarily of chronic prescriptions. The key consideration here is the savings we generate for our clients and members. For the fourth quarter of 2008, these higher generic dispensing rates yielded incremental savings of approximately $570 million for clients and members and as Dave mentioned saved almost $2.7 dollars on a full year basis.

Turning to rebates, we earned about $1.2 billion in the fourth quarter and well over $4.4 billion for full year 2008, both records. This represents 38.9% growth for the quarter and 24.9% growth for the year attributable to new client wins and improved formulary contracting. Our fourth quarter 2008 rebate retention rate was 15.9% compared to 14.5% in fourth quarter of 2007, and for full year 2008 our rebate retention rate of 18.1% exceeded the 15.4% for full year 2007. Fluctuations are largely the result of client mix and client preferences regarding the rebate sharing aspects of their overall pricing structure.

Turning to gross margins, the strength of Medco across our portfolio drove a new record for Medco gross margin in the fourth quarter including contributions from PolyMedica, Europa Apotheek Venlo, and Accredo, which I will summarize later. Our consolidated gross margin read 7.5% for fourth quarter 2008 compared to 6.7% for the same period in 2007. Recall that in the fourth quarter of 2007 Medco incurred startup costs included in gross margin of $31 million for the installation of significant new business. In the fourth quarter of 2008, gross margin included new client startup costs of $19 million. Full year 2008 gross margin was also a record at 7.3% compared to 6.6% in 2007.

Selling general and administrative expenses amounted to $381.0 million for the quarter and $1425 million for the year, in line with our guidance of approximately $1.4 billion. The fourth quarter growth of 15.9% equates to 8.9% when excluding the incremental impact of the PolyMedica and TCS acquisitions in mid fourth quarter in 2007 and the Europa Apotheek Venlo majority stake acquisition in April 2008. For the full year, expenses grew 27.9% or 9.2% when excluding the effects of these acquisitions.

Acquisitions aside, Medco’s core SG&A expenses reflect expansion of our clinical initiatives along with addition of the resources necessary to support our expensive new client win. Even in light of the record selling season results for 2009 to date, we continue to target zero SG&A growth for 2009 over 2008, a testament to the focus and discipline throughout the Medco organization.

Our total EBITDA for fourth quarter 2008 reached a new record $629 million, a growth of 13.5%. Full year EBITDA of $2461 million set yet another record with year over year growth of 23.0%. Dave already walked you through the EBITDA per adjusted script highlights where we achieved over 25% growth to the quarter and almost 16% growth for the year.

Our intangible amortization totaled $73.9 million in the fourth quarter of 2008, up from $64.2 million in the fourth quarter of 2007 as a result of the acquisitions I mentioned earlier, mainly driven by PolyMedica amortization. The full year amortization of $285.1 million exceeded the 2007 amount of $228.1 million because of the acquisition and was in the center of the guidance range of $280 to $290 million.

Total net interest expense of $57.6 million for the quarter increased from $37.4 million last year reflecting the higher debt levels from our March 2008 senior notes issuance. These debt levels, which have remained consistent in the second half of 2008, generated $227.5 million of net interest expense for full year 2008, compared to $99.8 million in 2007. The $227.5 million expense for 2008 is consistent with our previous guidance of approximately $230 million.

The full year 2008 effective tax rate was 38.4% compared to 39.3% in 2007 and was also in line with our guidance. For the fourth quarter of 2008 our effective tax rate was 40% compared to 34% in the third quarter, which includes the previously reported third quarter 2008 nonrecurring state income tax benefit.

Net income for the year increased 20.9% to $1103 million from the $912 million reported for 2007. For the quarter, net income increased to 32.2% to $274.4 million from the $207.6 million reported for the fourth quarter of 2007.

During the third quarter 2008 earnings call, we announced the completion of our $5.5 billion share re-purchase program in October 2008 as well as the authorization of a new $3 billion program effective through November 2010. From the inception of the $5.5 billion share re-purchase program in 2005 to its completion, we acquired 173.8 million shares at an average per share cost of $35.75. For the fourth quarter of 2008, we repurchased a total 5.8 million shares, which included shares repurchased to complete the $5.5 billion program and shares repurchased under the new $3 billion program. Fourth quarter 2008 share repurchases totaled $230 million at an average per share cost of $39.60 and were entirely funded from free cash flow.

For 2009 to date we have repurchased 228 million shares for a total cost of $116.7 million at an average per share cost of $41.86. Our weighted average fully diluted share count for 2008 decreased by 42.3 million shares to 518.6 million from 560.9 million in 2007; slightly below our guidance range of 520 to 522 million shares reflecting a higher number of shares repurchased at a lower cost per share and a lower than anticipated dilutive effect of employee stock options. Our weighted average fully diluted share count of 505.3 million shares for the fourth quarter decreased 41 million shares compared to 546.3 million for the fourth quarter of 2007 reflecting share repurchases made throughout the year partially offset by employee stock options. We finished the fourth quarter of 2008 with 493.3 million basic shares outstanding plus a dilutive equivalent of approximately 9.4 million additional shares bringing the total fully diluted share count to approximately 502.7 million shares on December 27, 2008. This fully diluted share count becomes the entry point for fiscal 2009.

Dave already provided full year highlights for Accredo. The specialty business delivered over $0.05 in incremental earnings contribution to Medco, slightly ahead of the high end of our expectations reflecting the continued positive response to Medco’s robust offerings. Accredo’s revenue growth to the fourth quarter of full year was 30.6% and 32% respectively and operating income growth for the quarter and year was 44.2% and 33.8% respectively.

You may recall that in the fourth quarter of 2007, Accredo incurred high startup expenses for the installation of significant new business. Accredo’s gross margin percentages remain stable across the fourth quarter and full year period in the 7.9% to 8.0% range. We continue to experience profitable success in the Medicare marketplace as a direct provider through our own PDP, as a partner with health plans, and in collaboration with our employer clients. For full year 2008, Medco’s PDP revenues increased 27.8% to $618.6 million. For the fourth quarter, these revenues increased 25.9% to $145.8 million. For full year 2008, generic dispensing rates for our PDP grew to 69.3% with adjusted mail order penetration of 26.9%. Our unique capabilities and proven operational excellence in the Medicare market has enabled us to provide highly customized solutions and unmatched service levels to our clients. As we reported previously, in 2009, we increased three-fold the number of Medicare lives administered under a Medco pharmacy benefit.

Moving on to guidance, as Dave discussed, we are reaffirming our guidance for GAAP diluted earnings per share in the range of $2.45 to $2.55, representing growth 15-20% over 2008. Excluding the amortization of intangibles from the 2003 spin-off, our diluted EPS guidance is expected to be in the range of $2.67 to $2.77 representing growth of 15-19% over 2008. We believe that the balance sheet strengths highlighted earlier will serve us well in the market where tight liquidity remains a reality. Our strong 2009 earnings projection reflects our confidence that our business model provides an important solution especially in a weak economy.

The 2009 key guidance assumptions that we reviewed with you last quarter at our analysts day can be found on the slides on our website that accompany this call. There have been no changes to the detailed full year 2009 income statement guidance that we provided last quarter. As you model the first quarter of 2009 and the remainder of the year, it is important to consider the following: We previously reported that new generic introductions are expected to benefit Medco’s 2009 earnings per share by $0.11. These introductions are skewed toward the second half of the year and will contribute $0.01 in the first quarter, $0.03 in the second quarter, $0.03 in the third quarter, and $0.04 in the fourth quarter. This quarterly spread is unchanged from what we presented on analysts day last November.

Our 2009 scheduled and early elective renewals amounting to approximately $20 billion are over 96% complete. About 95% of the renewal pricing is in effect at the beginning of the year with the remainder primarily in the third quarter. Mail order volume guidance continues in the range of 105 to 107 million scripts with first quarter estimated in the 25.5 to 26.0 million script range. Volumes are expected to expand toward the end of 2009 as our mail programs gain even further traction. Retail volumes from new clients are coming in stronger than expected thus far in 2009. We will see how this affects our adjusted mail order penetration rate as the year progresses. Most importantly, as I just mentioned, our mail volumes are on target and the higher retail volumes create additional opportunity for new mail order scripts in the future.

My final guidance point is on our effective tax rate. Our full year 2009 guidance continues to be in the range of 38.5% to 39.5%. The effective tax rate for the first three quarters of the year is expected to approximate the rate experience in the fourth quarter of 2008, which was 40%. We currently expect a tax rate improvement in the fourth quarter of 2009 that will bring us into the full year guidance range.

As you can see, we have delivered strong 2008 results. During these difficult economic times, we clearly see Medco as part of the solution. We clearly see Medco as part of the solution. That is why we remain confident in our prospects of 2009. We continue to deliver valuable savings and world class service to our clients and members while at the same time driving shareholder value. Now, Dave and I would like open the lines for questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Lisa Gill with J.P. Morgan.

Lisa Gill – J.P. Morgan

Dave, just a couple of quick questions around what we see for plan design. First, can you talk about for 2009, any kind of performance guarantees that you are giving, things you’re doing around gaps in care, adherence to pharmaceuticals? What’re your clients saying about that and how you are potentially sharing in the savings, and then secondly, are you seeing opportunities around plan design changes? I think that Rich made a comment that we could potentially see greater mail penetration in the back half of the year, so should we expect that we will see some plan design changes that will go into effect mid year to drive some of that activity, and then just lastly, I know there’s been lots of talk about some of your larger customers and layoffs. Do they come and talk to you prior to the layoff? Do you get any kind of heads-up around this or are you watching all the same kind of data that we are?

David Snow

On the plan design question, a lot of clients put in effective change benefit design to favor mail even more strongly. That doesn’t mean that the male volume picks up day one. Once the plan design has changed, there is work Medco needs to do with the client, with mailings to the members, etc., and so forth, and you see that volume build over time which is why Rich reflected in his comments that we will see this grow over time as these new benefit designs get fully understood by the employees of the customers that we serve, and by the way I would tell you that relative to plan design and the spectrum of plan design, the most popular thing right now has been benefit design to drive mail and drive generics. That’s the number one focus of most of the major changes we made in plan design year over year.

Relative to guarantees, I just want to make sure everybody understands. You asked about guarantees around gaps in care. Medco always has made guarantees around elements of our service, whether it be phone answer time, whether it be rebate levels, whether it be generic dispensing rates. There’s an assortment of things we do. What we’ve seen since the implementation of our therapeutic resource centers is a desire to shift the guarantees to some extent from some of those administrative things that we do extremely well to closing gaps and care clinically, and so the way that works is we put a set amount of money up as we would for other service parameters around closing gaps in care, and let me just explain that for a minute.

I’ve mentioned this before but what Medico has done now that we practice the specialized practice of pharmacy and our therapeutic resource centers is that our pharmacists are actually looking at data at the member level versus national protocol about how to best treat a disease, and when we see gaps in care, whether it be patients not doing what the doctor told them to do or the doctor not ordering what the protocol says you should order or do, we make intervening calls with the physicians and/or the members. The clients who want us doing that and most do, we are very comfortable guaranteeing closures in gaps in care, and it is very easy to measure for us, so it’s a service standard, it’s a set amount, and it depends on the size of the account, but we have been doing this now for about a year, and we are very comfortable with managing that to drive client expectations, and as we close, we don’t guarantee financial outcome here, we guarantee closing gaps is care. The corollary is though that to the extent you mange these gaps in care, you keep people with chronic and complex disease stable, they are less likely to end up in the emergency room, they are less likely to end up in the hospital, and total healthcare cost for the client goes down. That’s theory behind it, but we only guarantee our service around closing the gaps.

Lisa Gill – J.P. Morgan

So there is no financial tie to it then. Do you feel like this is helping you to win business? As we hear what some of the consultants are saying and some of the things that Medco is trying to be differentiated in the marketplace, this is one of the things we are hearing about, and that is through therapeutic resource center, by working with the disease management and wellness programs within the existing entity, Medco is coming to the table with offerings that are really trying to drive this, and our understanding was that there was some kind of financial tie in some way with some incentives for Medco if you’re able to do that. Do I understand that incorrectly?

David Snow

Yes, I think you do, if I understand what you said correctly. We simply put X amount of money on the table tied to the gap in care, so let’s take the disease diabetes. Let’s say that there are 60% compliant with national standard around complex diabetes. We would make guarantees around getting that 60% closer to the national standard which is 100%, and we wouldn’t say we are going to get it to 100%, but we would certainly work to move at the point of care improve those gaps in care, so what we’re finding and what the clients love is that they’ve been investing for years in disease management and medical management services, but it is always retrospective. It’s not at point of care, but with drugs, with what Medco is doing in our TRCs, we do it at point of dispensing, and we are finding that our ability to move the needle, and we showed this at analysts’ day, is spectacular, and those truly do result in major savings for the clients, but the guarantees around the percentage of gaps in care closed, not around the total healthcare cost to the client, but there is a definite correlation that everybody understands. The final question you asked me is about layoffs and how we see that. Well, we do watch the same data you watch, but we also are in dialogue all the time with our customers and clients, and we typically know what they are planning to do within a reasonable timeframe, and often they even coordinate with us relative to COBRA and other things, and with retirees, we often work with them to help create a smooth transition for retirees, so we are involved with our clients, so we do have, I think, more information relative to our book than you might have from the more general information.

Lisa Gill – J.P. Morgan

If you have any update for us as to anything you see that that’s changing in anyway. Clearly you’ve reiterated the guidance but your guidance also assumes some element of unemployment, so just based on what you are hearing right now, has anything changed as far as the outlook goes based on that specific data point?

David Snow

No. We are still very comfortable with the range we gave and our guidance, and in that, we told you that we did accommodate a level of unemployment in this country. We are still below that. We still very much feel the same way as we did on our third quarter call regarding that.

Operator

Your question comes from the line of Ross Muken with Deutsche Bank Securities.

Ross Muken – Deutsche Bank Securities

Rich, obviously on the cash flow, the improvement continues to be pretty astounding in this kind of a market environment, and you are building up the liquidity. I know you have the share repurchase in place, but as you are looking at some of your other efforts that you are doing either on the TRCs or around pharmacogenomics or potentially even around wellness because that was something that’s been discussed at length and also came up in a lot of what Obama is going to speak about in terms of healthcare reform, are you still actively looking out there for little tuck ins to kind of enhance the business and continue the differentiation or do you think you have enough of the internal capabilities today to go after that, and if you don’t, I would assume pricing of those sorts of assets or IP, etc., is somewhat attractive today.

Richard Rubino

Currently the majority of that strategic pursuit is managed internally, and it is in fact largely inherent in our SG&A projection for 2009 for example. What I have said in the past though is as we build cash, and I believe we must build cash in this environment, there will occasionally be an opportunity, and we of course proceed in life with our eyes wide open, but at this point I can tell you that there is nothing on the immediate radar screen, but eyes are always wide open.

Ross Muken – Deutsche Bank Securities

Could you also talk a little about the ex-US business? I know it is relatively small, but you continue to push in to the different European markets. We are watching the economies over there. They are obviously struggling mightily and probably even more so than the US, and there is significant pressure on corporations and on the governments there to manage their pharmacy costs better. Now that you have sort of dipped your tail in, are you seeing any increased interest amongst different other countries in the region after you started your initial efforts there?

David Snow

We are pleased with the traction are getting over in Europe. As we told you on the last call, we did deliver the software solution to Sweden, and now we are looking at what next steps might be. Germany is still relatively young in the relationship with us, so I would not say we have established the reputation that I know we are going to establish in Germany; however, there is no question to your point that health plans in Germany are trouble. Their inflation rates are actually worse than the United States. They are having financial problems. They are desperately looking for solutions. Medco has those solutions, and we are having very robust dialogues right now, so I would tell you that it’s still early. I would use Rich’s terminology, “it is still a seed that we’ve planted;” however, I would also tell you that between our conversations with sick funds, our conversations with worldwide pharma, as a result of what we doing in Europe, we are very pleased with what this new opportunity promises for our future, and so we are very much on track with original plans, and there is no question if you think healthcare needs to be reformed in this country, it’s a global problem, it isn’t a US problem, and so if you have a solution that helps reform healthcare, it applies to more than just the United States.

Ross Muken – Deutsche Bank Securities

Just because you mentioned it, I’m just going throw in one quick other thing. In terms of health reform, Dave, you’ve obviously been at the forefront pushing for a bunch of changes in our system. There is a big conference in summit going on in next week in Washington to discuss what is likely going to be the eventual Obama healthcare plan. Can you talk a bit about in terms of what’s already been proposed regarding increased coverage, etc., how you are thinking about what they are initially going after and targeting, and if you think it’s enough, and in turn what it means for Medco?

David Snow

Yes. We have less clarity today than we had on our third quarter call because we thought Tom Daschle would be running the show, and he wrote a book on what he planned to do, so we actually had the roadmap, and now that Daschle is out of the picture and we still don’t really know how this will shake out, I could say that we know little less, but I will still say that I’ll be down in Washington later this week as a matter of fact, but there is no question that solving the uninsured problem is still very high priority, and as I said before to the extent they solve for that, that creates a new market for Medco. It’s a market we do not serve today, so like with Medicare part D, the uninsured, if they are a funded benefit, is another $47 million people Medco can serve, so we think that’s nothing but positive for us. Relative to health IT, that is in the stimulus package, you know how I feel about wiring healthcare. It’s a fundamental building block to doing some very exciting things. You know drugs are wired today and that’s what enables Medco to do what we do on a protocol-driven level, managing disease. We think that holds a lot of promise for the future. E-prescribing is a huge benefit to Medco, and we’re hoping that last mile to the doc’s office does get covered as part of a stimulus package. I think biogenerics are still very much on the radar, and I’m still optimistic that we will get a pathway for biogenerics in this country, and that’s very positive for Medco and Medco’s Accredo division, so nothing’s changed relative to the need for healthcare reform in this country and Medco’s feelings about how it is positioned in a world of healthcare reform, and we are actively engaged to your point Ross, and we hope that something will get done because this country desperately needs something to be done in healthcare reform.

Operator

Your question comes from the line of John Kreger with William Blair & Company, L.L.C.

John Kreger – William Blair & Company, L.L.C

David, could you just talk a little bit more about how pricing is holding up as you move into the selling season for the coming year, and also how is the profitability of generics holding up, especially in some of the older generics that came to market a few years ago.

David Snow

I would tell you that pricing has been extremely disciplined this year. I’d call 2008 a very reasonable year relative to pricing discipline. I would say that 2009 is even more disciplined, so the competition honestly is really focused on the brandable differences after price. It really is, and so it is a great position to be in. That’s where we’ve always wanted to the competition to be. You scale to get an entry level pricing capability, and then let’s compete on the other things we can do to improve a client’s performance, and that’s really where it is right now, and as you can see from our year to date 2009 sales numbers, we are doing extremely well when we compete on brandable differences, and I believe that we can continue that kind of performance shift based upon the needs out there and the solutions Medco has to offer. Relative to generic pricing, it’s held up extremely well. Tom Moriarty is here with me. I don’t know Tom if you want to make a comment on generic pricing.

Tom Moriarty

No. I think from a macro perspective, if you look at where branded and generic pharma is today, it creates a number of different opportunities for us as we go out from a purchasing strategy to continue to drive value.

Rich Rubino

If you look at the relative profitability of generics, it’s fairly consistent over the past few years and the pattern on a generic introduction by introduction basis is consistent as well which is you go from a brand in mail which is less profitable to the 6-month period until the first generic is introduced which is more profitable again and then even greater profitability once we are past that specific period and more manufactures come into the fold.

Operator

Your next question comes from the line of Robert Willoughby of Bank of America- Merrill Lynch.

Robert Willoughby – Banc of America-Merrill Lynch

Rich, what’s the barrier to taking that down quicker? I guess you are down about $100 million or so sequentially, but you know your options, you know what scripts they are on. Why can’t you bring that inventory balance down quicker?

Rich Rubino

You will be seeing an accelerated pace in the course of 2009, and that’s probably the single largest contributor to our increase in cash flow from operations plan for 2009, so I would just say stay tuned.

Robert Willoughby – Banc of America-Merrill Lynch

But why isn’t it a two-quarter phenomena, it’s a four quarter phenomena? Is there some safety stock or some issue that you hold more?

Rich Rubino

Well, there’s a lot of underlying analysis that needs to take place as well, so you don’t just make unilateral safety stock decisions across the product line. You really have to look at it on a product by product basis because you need to understand what the future sourcing capabilities are and so on so forth, so we have to be careful because if we take too draconian approach, we can end up with a situation that would not provide optimal service to our members.

Dave Snow

The logistics, Bob, are very complex. You are not just talking about the two big back ends in Las Vegas and in Willingboro. You’ve also got the specialty logistics across the country, and in the middle of the year, you have the logistics of adding a third big back-end with big volume, so making sure you don’t have shortouts, making certain that you can serve your customers’ needs, making certain that you can make the purchasing decisions and the right volumes to get the kind of discounts you need to get are all important considerations, so you need to be very careful with this. It’s not as simple as it might sound.

Robert Willoughby – Banc of America-Merrill Lynch

You cannot put your distributor at risk for any of this or take any of that specialty on consignment, those aren’t options?

Rich Rubino

The current arrangement we have with our distributors, and as I have said in the past, has worked out quite well, so we are doing phenomenally well with regards to them providing next day shipments and so forth, so just from an inventory management perspective, we’ve found our relationship with them to give us the capabilities to significantly reduce our days supply in the course of ’08 an further into 2009.

Robert Willoughby – Banc of America-Merrill Lynch

On the EBITDA line item, the administrative spending, for the businesses that you’ve added, can you remind us what are the opportunities to bring costs of the acquired operations down? What tangible things do you have to do?

Richard Rubino

One of the items we are pursuing is what is I call national support organizations. As a matter of fact, I have one of them reporting to me, where we took reimbursement activities from CCS and Polymedica and Accredo, combined with the accounts receivable activities here at Medco and combined them under one roof, and in doing that and finding other areas where we can create centers of excellence, if you will, we’re able to grow the business without further increasing SG&A because you get a whole new perspective on scale, and utilizing pockets of capacity throughout the previous organizations.

Robert Willoughby – Banc of America-Merrill Lynch

But are there tens of millions of dollars of opportunities to cut the expenses for the acquired businesses or just maintaining them flat while getting the growth is delivered, we’ll see.

David Snow

At the current point, looking at 2009, we said that we’re going to hold SG&A at around $1.4, so it’s going to be more over the future couple of years hopefully continuing to grow on the topline and managing that SG&A base to zero to very low growth, so it’s going to more containing growth. You’re going to see however probably single digits to into the $20 million efficiency range in the course of the year to year and a half.

Operator

Your next question comes from the line of Larry Marsh of Barclays Capital.

Larry Marsh – Barclays Capital

I want to address the same question, Dave, as the last quarter, which is the healthy increase in net new business. It looks another 1.1 billion as you mentioned. At analysts’ day, you cited the great work Brian Griffin and his team on health plans, providing more services for their MAPDs in ’09. Is that where a lot of this incremental is coming from, or is it a broader mix, and do you still see that, the MAPD opportunity, as a big opportunity for you over the next couple of years?

David Snow

I won’t go beyond this year. I think this year the big story has been a lot of Medicare business health plan specific coming our way because of the track record we’ve established operationally to take a very big complex piece of business and run it relatively smoothly. I will also tell you that our Systemed business continues to do extremely well. National Accounts is actually having a very nice run right now. Our Key Accounts Group is I would say doing as well as they did in 2008, but they also have some very interesting opportunities still in the pipeline for 2009, so when I look at where the sales are coming from, they’re not limited to Medicare, and they’re not limited to health plans. There are lots of interesting things going on right now that spell opportunity for Medco.

Larry Marsh – Barclays Capital

Dave, as you think it what would be the biggest benefits concerns you would have if you were able to significantly expand your exposure to the health plan market, and indirectly Part D, either internally or through acquisition opportunities in the next year or so? Is there anything of note that stands out?

David Snow

Are you talking about MAPD, Larry, or are you talking PDP?

Larry Marsh – Barclays Capital

Let me get you to respond to both, I guess, Part D directly and MAPD indirectly, if you could.

David Snow

I would tell you that I don’t think we have any interest in doing MAPD direct at all. We will serve health plans to do MAPD. I like my relationship in the MAPD world to be as administrative services only basis, not a fully insured basis. I’m sure you saw what happened yesterday, and I don’t think that’s a place we need to be or want to be. We want to be the Intel Inside serving the health plan customers who want to serve that business. On the PDP side, I think our strategy remains the same, and that is we like serving health plan business on the PDP side. On an ASO basis, we’re very good at it. We bring a lot of value to the health plans who hire us; however, we do keep a national PDP of our own simply because it gives us enormous flexibility to design one-off solutions for our employer customers who want to change the way they handle their retirees, and that’s been a very successful strategy for us, so we like to do that. We consider the health plan part of our business a very important part of our business, and I don’t necessarily want to go out and compete against them. I’d rather partner with them.

Larry Marsh – Barclays Capital

To be clear though, if you had the opportunity to meaningfully expand your servicing as an Intel Inside with a health plan market around some of your capabilities with Part D, you would see that as a good opportunity?

David Snow

Absolutely, and we’ve been doing that significantly as you’ve seen in our numbers, so yes, we like that opportunity.

Larry Marsh – Barclays Capital

Just to follow up for Rich, I know you’ve confirmed your guidance on net interest expense that’s a bit higher than this year despite a stellar Q4 cash flow figure and an increase versus my expectations for ’09. Why should we think of interest expense being higher this year than ’08 given all the cash you’re generating? Is that just a conservative view of the year, or is there something that I’m not thinking about?

Rich Rubino

I would say at this point it’s clearly conservative, and what I’ll do on the next quarter call once we’ve got the quarter under our belt is that I will probably making an adjustment there with whatever adjustments are necessary, but more importantly, you’re in the zone with all of the line item guidance and certainly with regard to the bottomline EPS guidance.

Larry Marsh – Barclays Capital

You’re very good at giving some triangulation around some of the components of the year. Obviously, a little bit higher tax for the first three quarters, and I know you try to avoid being too specific on quarterly guidance, but directionally, is there any comment about how we think of the first quarter, say, versus the fourth, or you’re not wanting to be that specific at this point?

Rich Rubino

I will jus reiterate some of the specific guidance I did provide at the end of my prepared remarks, and I did point to 25.5 million mail scripts to 26.0 million mail scripts for the first quarter, indicating that you’d see increases in the latter part of the year, so that’s one key pointer, and the other one really is effective tax rate which of course is significant from a dollars perspective, so those are really the two most important elements along with the news you already had from our third quarter call which is the new generic spread. That gives you enough pointers to do a reasonable job in modeling quarter to quarter.

Operator

Your next question comes from the line of Helene Wolk of Sanford Bernstein.

Helene Wolk – Sanford Bernstein

I’m curious if you can give us an outlook perhaps for 2010 selling season maybe in regard to the percent of the book up for renewal and/or any outlook on the market relating CVS Caremark early renewal action.

Dave Snow

I’ll let Rich give what we have up for renewal in ’10. I can just tell you that you will start hearing from us probably next quarter about our 2010 selling season. We usually don’t talk about it when we’re talking about wrapping up our ’08 year, but I will tell you that ’10 is an interesting year, and you can expect in our first quarter call an update on ’09 and ’10 selling season. I will tell you that there is quite a bit of opportunity for the 2010 selling season, and we’re feeling pretty good about it at the moment.

Rich Rubino

From a renewal perspective and it’s very early to tell of course, but you’ll probably a renewal here in 2010 that’s at this point somewhere in the range of what we saw in 2008 and 2009, which is in the $15 to $20 billion range. I think that’s safe for now.

Helene Wolk – Sanford Bernstein

A second question about the SG&A projections and any impact in terms of the Indiana facility coming on line or anything else we should expect from that facility later this year.

Rich Rubino

Indiana really doesn’t affect SG&A because our pharmacies are included in cost of sales, and because the pharmacy is going to be primarily in test mode this year once it’s constructed, you don’t have a significant cost effect. That really will be to a great extent humming more in 2010.

Operator

Your next question comes from the line of Charles Boorady of Citigroup.

Garen Sarafian – Citigroup

This is Garren sitting in Charles. If you could comment about progress in findings ways to collaborate more with health insurers running their in-house mail order and other PBM opportunities to drive down their drug spend and, two, if you could update us on your bid for the commercial side of the business of a large hearth insurer that’s expiring later this year.

David Snow

I’m not really going to comment on your second. On your first, I’ll tell you the opportunities are interesting, and they’re there. That’s about all I can tell you at this point.

Operator

Your next question comes from the line of Ricky Goldwasser of UBS.

Ricky Goldwasser – UBS

What are your assumptions for 2009 in PDP growth rates? I think I heard you saying the PDP revenue grew 25.9% in the fourth quarter, so just curious what are you assuming for ’09. In addition, to follow up on the 2010 season, I know obviously it’s very early, but I think Rich, you talked about 15 to 20 billion of renewal business. Can you quantify to us what could be the opportunities for new business?

Dave Snow

We don’t like to do that Ricky because what happens is people take our percentage and book it, and it doesn’t create anything but trouble, so we’re probably not going to quantify the universe of opportunity, but suffice it to say that the opportunity is strong as you saw both in ’08 and it’s materializing in 2009. That’s what we can tell you relative to the sales opportunity. Relative to the PDP, there’s one big enrolment period each and every, and we’ll give you more details about that enrolment in our next quarter’s call.

Ricky Goldwasser – UBS

On the Indiana facility, you said testing mode in 2009. In 2010, should we assume that you’re going to continue with the three full operational facilities, or are we going to see some consolidation from the other facilities?

Dave Snow

No, Ricky, we need the third facility because of our rate of growth, so Las Vegas stays in place, Willingboro stays in place, and what you will see us do though is we won’t fully equip the Indiana facility. We will equip some lines, and we will build out but we’ll invest in the lines of equipment as the script volume grows, so you will see us ramp up on the inside of the building as the script volume grows, but the other two facilities are in complete operations. We didn’t build the third facility to shut one down. We really need this for our own growth.

Operator

Your next question comes from the line of Glen Garmont of Thinkequity.

Glen Garmont – Thinkequity

Dave, with respect to the increment net new business, I know when you’re talking about the $4.9 billion number, that was heavily skewed toward plans with a very low mail penetration rate, and now that you’re up in sort of the low 6’s, is that still a fair characterization of your net new business, in terms of should we continue to think about maybe a high single digit mail penetration rate? Secondarily, related to mail, I know it’s still very early, but can you give us maybe some sense as to what you’re seeing with United contract and whether or not the revised terms there are enabling you to maybe grow the mail penetration rate there?

Dave Snow

Relative to your first question, I would say for your assumptions and modeling you should still think lower mail penetration for the business that’s come on board, so the 9 to 10 is good. Relative to UNH, as we’ve said in the past, we’re very pleased with the new arrangement, and we’re optimistic that it will be positive relative to mail, but I would tell you it’s early to confirm that mail is doing what we want it to, but we feel good about it.

Operator

Your next question comes from the line of Randall Stanicky of Goldman Sachs.

Alex Beckler – Goldman Sachs

It’s Alex Beckler for Randall. I wanted to follow up on the generics margin discussion. What trend are you anticipating in terms of your generic margins in 2009?

Rich Rubino

The relative profitability should be consistent with what we’ve seen in the past. The only new news is what I already discussed with regard to the impact of new generic introductions. You don’t have a lot of significant generics in mail that were introduced in the back part of 2008, so you’re not going to see much of a carryover effect. The biggest generic impact for us in 2008 was of course from Fosamax which was very early in the year in February, so it’s essentially consistent with what we’ve seen in the past.

Alex Beckler – Goldman Sachs

Secondly, just wondering if you could be a little bit more specific with regards to your assumptions that you’ve made in your outlook with regards to what’s going on with the automakers.

Dave Snow

The automakers really are a 2010 phenomenon, so I would say that it’s premature to talk about because we haven’t given any 2010 numbers, but the VIBA trust is at 1/1/2010 effective date, so we’ll give more clarity to that when things actually start to happen there.

Operator

We have reached the allotted time for questions and answers. I will now return the call to management for any final remarks.

Dave Snow

Thank you all of you for joining us! I’m going to say one more time we’re very pleased with the 2008 performance we just presented to you, and I will also tell you that we’re very pleased with the way 2009 is already beginning to develop. We appreciate the time you’ve spent with us, and we look forward to updating you at our next quarterly call.

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