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Express Scripts, Inc. (NASDAQ:ESRX)

Q4 2008 Earnings Call

February 26, 2009 10:00 AM ET

Executives

David Myers - Vice President of Investor Relations

Jeffrey L. Hall - Vice President and Chief Financial Officer

George Paz - Chairman, President and Chief Executive Officer

Analysts

Charles Boorady - Citigroup

Ross Muken - Deutsche Bank

Robert Willoughby - Bank of America

John Kreger - William Blair

Randall Stanicky - Goldman Sachs

Lawrence Marsh - Barclays Capital

Glenn Garmont - Thinkequity

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Fourth Quarter 2008 Earnings Conference Call. At this time all participants are in a listen-only mode. Later we will conduct the question-and-answer session. Instructions will be given at that time. (Operator Instructions). As a reminder this conference is being recorded.

I'd now like to turn the conference over to our host, Vice President of Investor Relations, David Myers. Please go ahead.

David Myers

Thank you. Good morning everyone and welcome to our conference call. With me today are George Paz our CEO, and Jeff Hall our CFO. Before we begin, I need to read the following statements.

Statements or comments made on this conference call may be forward-looking statements that may include but are not necessarily limited to, financial projections or other statements for the company's plans, objectives expectations or intentions. These matters involve certain risks and uncertainties that company's actual results may differ significantly from those projected or suggested in forward-looking statements due to a variety of factors which we discuss in detail in our SEC filings.

In addition a reconciliation of EBITDA to net income and the net cash provided by operating activities can be found in our earnings release which is on our website. At this point, I'd like turn the call over Jeff Hall who will discuss our fourth quarter results.

Jeffrey L. Hall

Thank you, David. As most of you already know, Express Scripts had another strong quarter and year. Earnings per share were up 30% for 2008 and we have guided to 19% growth at the midpoint of our range for 2009.

Cash flow from operations was $1.1 billion, up 29% from 2007 and return on invested capital was 26.8% up from 23.7% in 2007. We attribute this success to the continued focus on our model of alignment. We only make money when our clients save money. We are expanding the differentiation of this model through our behavior-centric approach, that is, the application of human behavior theory and behavioral economics to the pharmacy benefit.

By using technology to tailor our offerings and interactions to each individual, we can increase therapy adherence and lower cost of care, delivering lower cost and better health outcome. And in this economic environment, saving money is more important that ever to many of our clients.

Now let's take a look at our results in a little more detail. Earnings per share were $0.83 for the quarter, a 20% increase over the prior year and $3.10 for the year, a 30% increase. Our industry-leading generic fill rate reached a record of 67.3% in the fourth quarter, up 3.6 percentage points from last year. This increased draws both savings for our clients as well as contributing to our gross profit, which was up 19% from last year's fourth quarter. We believe there are significantly more rooms to grow use of generics and low-cost brands and increase the savings for our plan sponsors and members.

We've also had encouraging results in home delivery this year. They can be directly attributed to our behavior-centric model. As we've mentioned in the past, we made a strategic decision to our several low margin male fulfillment clients to roll off over the past several quarters. Excluding the effect of this decision, our home delivery clients grew almost 5% in 2008.

In the fourth quarter, we also continued to invest heavily in growth initiatives, as well as prepare for the implementation of 226 new clients for 2009. As a result of these investments and the $11 million of spending related to security incident, SG&A was up $23.6 million sequentially. In Q1 and over the course of 2009, we expect SG&A spending to return to 2008 average levels. Even with this increase level of investment our EBITDA per RS for the quarter was $2.90, up 16% from the prior year.

The December quarter also marked the fourth consecutive quarter of earnings growth for our SAAS segment earnings for the segment grew 32% sequentially and 84% for the year. As you know, we have many different businesses in this segment but one of the primary drivers of this improvement is the success we have had in integrating our pharmacy operations with the operations of our core PBM. These units are becoming one world-class organization driving better service and outcomes for our clients and members and keeping with our model of alignment, increased profit for our shareholders.

Looking in to 2009, we still expect our diluted earnings per share will be in the range of $3.63 to $3.73, growth of 17 to 20% from 2008. This strong outlook for 2009 continues our history of improving profitability by lowering costs for our clients. This performance is driven by our differentiated model of alignment with the behavior-centric approach.

Finally although we do not provide quarterly guidance, consistent with our prior experience, we expect Q1 earnings per share to be flat to slightly down compared to the $0.83 in Q4. Also in Q1, SG&A and net interest expense are expected to return to Q3 levels. We look forward to delivering another year of savings for our clients and earnings growth for our shareholders. And at this point, I will turn the call over to George.

George Paz

Thank you, Jeff and good morning everyone. Before I comment on our prospects for 2009, I'd like to briefly reflect on the success we have achieved in 2008.

As a result of the tough economy, clients were more motivated than ever to lower their pharmacy spend, a trend that will continue throughout 2009. The timing couldn't be better. Our business model alignment along with the differentiated behavior-centric approach, what we refer to as consumerology, is significantly improving our ability to deliver better health and value to our clients and to our patients.

Clients are eager to adopt our new and innovative methodologies to promote the benefits of generics, home delivery and specialty management. We assisted our clients in driving out wasteful spend and the pharmacy benefit through the greater use of generics, which is evidenced by industry-leading generic fill rates. We're driving toward an all-time low trend for our clients and a decrease in our members co-payments for the second year in a row.

This is especially important, because the decrease in average member co-payment was driven by a more cost effective behavior of members, not reductions in co-payments by our clients. In short, we are helping plan sponsors and members via our behavior-centric approach. Complementing our business models is strong service offering, confirmed by JD Powers and Associates ranking our home delivery customer satisfaction ahead of our two largest PBM competitors.

As we enter 2009, the continued turbulence in the broader economy provides the backdrop for Express Scripts to do... to continue to do what we do best. Now more than ever, our clients need us and we have been working tirelessly to produce solutions that will help drive out the ways in the pharmacy benefit, while improving health outcomes and keeping employees productive and satisfied. Our confidence for 2009 and beyond is based on a clear understanding what plan sponsors are looking for and that is greater control of costs alongside optimal health outcomes.

Our distinct business model alignment positions us ahead of our competitors to deliver with greater focus, objectivity and evidence-based recommendations. We have a proven track record with our industry-leading generic fill rate, which by the way is still at the top of every plan sponsor's priority list. If it is wasteful spend we are after in these economic times, then it is imperative that we seek out the right balance of generics and low-cost brands. Combine this with the benefits of home delivery and a comprehensive specialty offering, and you can see how our value proposition is in greater demand than ever before.

But the fact is the appropriate clinical programs and services are the foundational capabilities of all major PBMs. The key to success is not just having the proper clinical programs, but the challenge for us and in healthcare in general, is the engagement of individuals' adoption of these programs that adherence to protocols; in other words patient behavior. No longer are we willing to sit on the sidelines hoping that financial incentives and more education can get the job done. That is the reason we are taking an innovative behavior-centric approach to better management of the pharmacy benefit.

The early results as Jeff mentioned, are encouraging and quite frankly fascinating. This type of innovation is empowering. This is innovation that matters today. It allows us to take on our clients' key challenges win a new set as tools. We are continuing to cross-fertilize these proven, indisputable psychological principles and applying to develop solutions that are intuitive, effective and innovative. And as we can all understand, our clients thirst for innovation is considerable.

As we stated previously, we've a significant number of pilot programs already in production around the application of some of these key physiological principles. While it is still too early to report on many of them, I can share with you that we expanded beyond home delivery and we're aggressively exploring the areas of therapy adherence and specialty. Our advisory board of thought leading academics is motivated to develop new innovative solutions for these two particular suicidal challenges.

And finally, there has been a lot of conversation around the PBM's rolling healthcare reform. With our proven track record of managing the way several pharmacy benefits, we believe we are well positioned to take advantage of the opportunities on the horizon. For example, we'll benefit from more individuals gaining coverage, accelerated adoption of e-prescribing and the swift development of our biologic... biogeneric pathway. All of these will benefit us in the future.

We are excited about our position in the PBM industry and opportunity to deliver value to our clients and stockholders in the future. That concludes our prepared remarks and we'll now be happy to open it up for questions. Operator?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). We'll go to the line of Charles Boorady with Citigroup. Please go ahead

Charles Boorady - Citigroup

Hi, thanks. Good morning. I am wondering if you can comment on recent legislation of stimulus bill and what's in the Obama budget, to the extent you'd a chance to look at it. And I saw something biogenerics related. And just comment generally how we should think about the impact of the all the change taking place in Washington on your long-tern growth prospects. And is there anything we need to worry about near term that would have a positive or negative impact on you?

George Paz

Sure. Thank you for the question. Clearly it's very early a from a budget perspective, was introduced. The great news, we have been working tirelessly in Washington to try to influence a biogenerics pathway that makes sense for the population at large. And we are very pleased that what we have seen so far comes to the legislation and that looks like it's more of five-year period and it looks like it's got all the right components to it and obviously, we're a long way from actual introduction to the bill. But it is certainly the right start for both our trade association and Express Scripts on its own. Dr. Miller and our folks in DC have worked, as I said earlier extensively on.

I think overall, you know to be that an economy and a country with such profound wealth help me to define it that way in these times, not to have so many uninsured is not a good thing. And I think we are moving in the right path. I think it's going to be tough try to control the budget during this process. But each of these... each of the steps the government is taking to try to provide healthcare especially to children, to those in need is at the end of the day a good thing. A lot of which we see in the stimulus program is around getting the electronic records and cost-effective solutions for healthcare. Those are very important.

There is a tremendous amount of protocols out there today which is part of my prepared remarks, that are just not being followed and the protocols around diabetes, asthma and many other disease states that we have done a tremendous amount of research on, could be better followed. Healthcare would go up significantly in this country. It's very hard to do without worrying all the providers of healthcare. As we move down that path, I truly believe healthcare will become better. And I think Express Scripts in particular and PBMs in general are very well positioned to take advantage of the opportunity that lay in front of us.

Charles Boorady - Citigroup

When would it ready for specific dollar amounts in terms of the profit potential, revenue potential from biogenerics legislations and another changes enacted or that are likely to be enacted?

George Paz

We're closing monitoring that. And we will provide that information once we see a final bill. There's going be a lot of lobbying going on obviously around this. We work hard to try to keep it in the best interest of our plan sponsors and our members and there will be other people with different agendas that'll be working at some cost purposes and certain situations. And so, we'll keep you posted but we'll provide that information once we see what it is we have to work with.

Charles Boorady - Citigroup

Thank you.

Operator

Thank you. And next we go to the line of Ross Muken with Deutsche Bank. Please go ahead.

Ross Muken - Deutsche Bank

Good morning gentlemen. So can you talk a bit about sort of the utilization trends you're seeing in the business and certainly obviously there is so much talk about the tough economy and increases in the unemployment rate. One, obviously as we sort of approach 10% unemployment, what does that mean for your business? Are there certain areas that were impacted more than others?

And then relative to the previous comment with Obama's sort of clear support of generics, does that potentially provide some offsetting in certain pieces in a business where may be doing stem therapy or more aggressive formulary control could move the needle to offset maybe some of the volume weakness?

George Paz

Thanks Ross. That's a great question and observation. You know there is clearly opportunities and Jeff you can chime in here around to illustrate. You know utilization turns are down. They are down from prior years and that's a bit alarming when you consider the aging of population and the trend and diabetes of DCD, high blood pressure on and on. And so the declining utilization rates long time can not be good for us as a country.

The other side of that though which is I think your observation is what we're really seeing today is of more of a thirst for the member to conserve their own personal network, and we have seen you know just unbelievable adoption of the step therapy programs in a positive manner and people going online and reaching at our people reaching out to them and advising them of cost savings opportunities.

At the end of the day we refer to waste as a dollar spend for no additional clinical value, and there is a lot of that in healthcare, whether it's very expensive brands or it is a cheaper brand alternative or whether it's a generic alternative. And what were we are seeing, because the way we align our business with our members and our plan sponsors, is as those members move away from the least effective cost... higher cost products to the more cost effective product and better products their co-pays come down. And obviously, the plan sponsors save money and our shareholders make money and that is giving a tremendous amount of traction.

In addition to that, the plan sponsors on the other hand are reaching out again, top of everyone's list, is lets get the waste out of the pharmacy spend. And even though it maybe zero for many of our clients; negative for many, many clients, 1 % or 2% for some of our other clients, every dollar you can save, one thing I refer to is every $20,000 you save out of the pharmacy benefit ex-waste you can keep an employee or drive more value to your bottom line. And I think people are really understanding that and they are moving in that direction.

So we are seeing tremendous amount of support in our clinical programs and movement to mail and specialty and certainly biogenerics pipeline when you consider the costs of many of the biogenerics that are... many the specialty products that are out there, there is a tremendous opportunity for all of our... all the PBMs and I think Express Scripts in particular to take a lot of lot of cost and add a lot of value to the healthcare system. Jeff if you want to comment.

Jeffrey Hall

Sure just I mean specifically on unemployment, the way we think about it here is as we prepare for year and to give guidance, we actually go through client by client, bringing the account teams, the account team talked about specifics about clients. And then we make assumptions about what gain or loss of employees ensure to that client will be. And then we roll that all up into our plan for the year.

So what we don't do is try to extrapolate that into total U.S. unemployment rate. We think our book of business is not necessarily exactly equal to the U.S. mix. But certainly, we feel pretty good that we've done a detailed job on what unemployment would do to our book of business. And at this point still look very comfortable with our guidance for the year.

Ross Muken - Deutsche Bank

That's really helpful. And just quickly Jeff, relative to the guidance, you guys are generating that kind of cash, we have seen some cash build up on the balance sheet. I know these are times when capital is certainly at a premium, and you guys have obviously shown phenomenal returns on your capital. Could you talk about one, sort of the degree to which share repurchase, rather utilizations of the free cash are kind of contemplated in guidance and if to some degree, there is less so contemplated, what's the current thought process on where you feel like the capital structure is?

Jeffrey Hall

Sure. So, we have... I would say an average amount of share repurchase contemplated in our guidance although, it is certainly more towards the backend of the year. We are... we've been locked up all of first quarter so far from buyback. So anything we do will start... what really start to impact P&L and earnings, until really the third and fourth quarter. But really our look for cash hasn't changed; I would much prefer to do zero buybacks and use that money to either invest in growth opportunities internal to the business or to invest that money in solid external M&A opportunities.

Ross Muken - Deutsche Bank

And just quickly as a follow-up, just in terms of way you are focused there. I mean, is it continuing to beef up the specialty side of the business? Are there assets available in that space or are there kind of other sort of broad growth initiatives that you see opportunity in that maybe you don't currently play in?

Jeffrey Hall

There are a lots of opportunities. At the end of the day it comes down to... is the price that people want equal to the value that we see. And we obviously have very high expectations of value creation on deals we do, but it's around what we do today. But I am not for obvious reasons going to go into specifics about what the targets might be.

Ross Muken - Deutsche Bank

Yeah, no, I didn't expect you to. Thank you very much, gentlemen.

Jeffrey Hall

Thank you.

George Paz

Next question. Operator?

Operator

Right. And Robert Willoughby of Bank of America, please go ahead.

Robert Willoughby - Bank of America

Thanks. I must have missed that. I guess George, if you still look at the start performance here, it's certainly not nearing the operating results that you just reported or your vision of the future. And I guess it's just guilt by association with the managed care names which maybe more in the cross-hairs from the Obama reform issues. But, what strikes you of everything you've seen and heard as particularly offensive about any of these reform initiatives? I know you are positive on generics' and need for the services, but what are people focusing on in your view that creates this concern?

George Paz

Well, I believe that one of the biggest concerns is just purely the uncertainty. When we talk about picking up millions and millions of uninsured into the rolls, and again, I think we do need to cover children. But at the end of the day, when we don't explain how we can pay for it, when we're facing, staggering debt levels as a country, and we don't have a whole lot of clarity around how we're going to normally provide the coverage, but also how low we're going to fund that coverage. I think that causes a tremendous amount of unrest.

And you know this better than I do, Robert. But I think uncertainty, puts the risk to your stock price. And I do believe that the underlying trends are incredibly positive for PBMs in general and for us in particular. But, I think that peer uncertainty is still something that's pushing on our stock price and to your point lot of the cutbacks in Medicare reimbursement rates, certainly affects a lot of the managed care players that has had a disproportionate effect on our stock prices as well.

Robert Willoughby - Bank of America

Okay, and I just saw from the K you cut headcount by a 1000 lives year-over-year. I know you did an acquisition, I know you have get Stifton in there, but what the other 999 guys that you let go, what areas?

George Paz

Well Just to be clear Ed Stifton was an incredibly smart guy but I think Conrad (ph) is one. So there was... we sold off our infusion business and so that was a lot of the headcount change, Pat McNamee, who runs our operations and technology has actually done a superb job of redeploying technology to take out unneeded useless, steps that aren't really adding value to our clients or our members.

So there's been a real focus around that keeping headcount... actually driving headcount down in operations, in IT and those some of the back-office type areas. But overall, we're still investing, our account management side, our CPMs and our sales people we've actually grown that side of business with headcounts. So I think to Jeff's earlier point, we're very cognizant of what drives value and we invest heavily in those areas that where believe value can be created but try to cutback in those areas that aren't adding value.

Robert Willoughby - Bank of America

Okay. Thank you.

Operator

Thank you. Your next question is from John Kreger with William Blair. Please go ahead.

John Kreger - William Blair

Hi thanks very much. Two unrelated questions, Jeff behind the guidance that you reiterated, has your thinking changed at all over the last couple of months about the balance between underlying claims and improving profitability per claim that underpins that guidance? And then the second question, George another kind of healthcare reform question, could you help us size your Medicare Part D and PDP business? And just how big and how important are the growth driver, how is that been in recent years?

Jeffrey Hall

John on the first question, the simple answer is no. The underlying assumptions around share growth and EBITDA RX growth have not changed. As we look at we've guided 19% growth. I mean what's interesting this year is that of the 19% growth at the midpoint, almost 17% of it's coming from profitability improvements and EBITDA for RX growth, which is a lot higher percentage of the total than in past years.

As you know we stopped our share buyback, back in July timeframe as we discussed earlier. And as a result we aren't seeing the kind of capital structure improvements that we normally see. So we are actually achieving all the growth this year based on EBITDA for RX. A lot of programs in here, George was talking about productivity improvements, other efficiency improvements things we're just doing better and better as time goes and that's what's driving the growth. But again the underlying assumptions have not changed from when we guided.

John Kreger - William Blair

Okay thanks.

George Paz

From a Medicare perspective, we decided early on we weren't going to compete directly against our clients. We try very hard to avoid conflict and enforce our model of alignment. So, we work closely with our clients. Many of our managed care clients are in the Medicare business and our job is to help them be competitive and to grow that book of business. Ed Ignaczak and Larry Zarin on the sales and marketing side work closely with those clients to put the right products in front of them, but also from a Larry's perspective, he goes out and helps our managed care clients in selling the prescription benefits to their ultimate client, and helping their sales force understand the new answers of pharmacy. And I think that's paying big dividends for us. Roughly 10% of our total volume is that of the Medicare side of the business. But again that's not direct through us, that's through our manage care programs.

We don't take the reimbursement risk if you will. That's not our expertise. We don't have people that do that. But we do what we understand and we are sympathetic to the situation that our managed care clients face. So we stay very closely with them from our pricing and underwriting individuals to help them figure out ways to stay competitive, as government looks actually now reimbursement rates and what have you. So they can stay competitive by taking waste out of the pharmacy benefit area.

John Kreger - William Blair

Thanks, George.

George Paz

Absolutely.

Operator

Next question is from Randall Stanicky Goldman Sachs. Please go ahead.

Randall Stanicky - Goldman Sachs

Hi, thanks, just a couple of quick questions. One, related to healthcare reform, just a quick for George. Any disproportionate impact relative to you versus your peers from any reform that we could or may see? And then secondly, for Jeff, you have the Generic Pharmaceutical Association Conference this week, saw some more discussion around pricing in generics, firming up or stabilizing. So, on that topic, any impact you are seeing or any way that we should be thinking about rather the impact to your business or your sourcing decisions on that front?

George Paz

From a disproportionate side, the only thing I can tell you is that I believe, we are second to none, from a clinical approach. Again, it's built into our DNA, if you will that the whole concept of taking waste out of the system. And so our programs, our systems, our call center associates, everybody in our company understands the drive is to go after the generic opportunities where appropriate and then convert people to some mail or specialty where appropriate.

And so, I just think that we are very well positioned to take care of the opportunities that come down, it's not like we have to reinvent or put new programs in place. We've got the programs, we've got the opportunities and now we just have to conform them to whatever drugs come to market. So, I don't... on its face, there is no clear opportunity. I think our industry leading generic fill rate probably gives us a tremendous opportunity to take that to the next level. Jeff, you want to speak to...

Jeffrey Hall

Sure. On generics overall; generic industry is a highly competitive commodity business. And as such, it is incredibly price competitive. We haven't seen any change at all in the price competitive nature of that industry, nor do we expect to see any change in the price competitive of that industry. So, I mean I put the rumors, but we're just aren't there.

Randall Stanicky - Goldman Sachs

And you are not seeing any impacts from many of the manufacturing issues that we're seeing across some of the smaller manufacturers out there, that's unpacking or sourcing decision?

Jeffrey Hall

Certainly, we spend a lot of time looking at quality control and analyzing our vendors, and making decisions by which vendors are going to use, based on quality, based on manufacturability, based on the controls they have in their plans. So, the simple answer is, we aren't seeing any big issues. But we're also spending a lot of time and effort making sure we don't.

Randall Stanicky - Goldman Sachs

Fair enough. Okay. Thanks, guys.

George Paz

Thank you.

Operator

Thank you. Your next question is from Larry Marsh with Barclays Capital. Please go ahead.

Lawrence Marsh - Barclays Capital

Thanks, and good morning. George, now you may have said this, surprised if I've missed it, but on the last call you gave us an update on number of new accounts you'd want for '09, I think it's like 226 of 1.4 million realized. Do you have an update on that today?...

George Paz

Yeah we...it was basically that same number of range.

Lawrence Marsh - Barclays Capital

Okay Got it and with consumerology, obviously a lot of detail about change in the consumer behavior. Do you think about the mail business and you've done a great job of growing your profit per script in your business over last five years though you'd see mail script have been fairly stable. I know you say some customers are more profitable than others. Do you think of as you think about 2010 and 2011, do you see that mail script number going reaccelerating for you or besides the fact that you can still grow your margin, as you drive on your customer costs or do you just take away as a broader, look under the covers to think about which customers are more profitable than others?

George Paz

We clearly I think our ROIC speak to our focus on profitability. And because we align our business, our focus on profitability isn't at the cost of our members or our plan sponsors. Our focus on profitability complements where our plan sponsors are trying to accomplish in driving out the costs and the waste. So we do look at that closely.

I'll be quite honest with you, Larry. I don't really want to just put pills in bottles, that doesn't do a whole lot, doesn't excite me a whole lot. So when we have a mail-only opportunity and they really don't want anything more than us... from us but to put pills in bottles. Unless it's going to be at a pretty decent margin, I don't unnecessarily want to tie up our people on that. I would rather, I think our whole business model is running around alignment, taking out the waste and the beauty of it is because that's what we focus on and that's what we do, that's it's easy to keep our employees focused on what they need to do. And if all there is, is an external adjudicator that handles the script and we put the pills in the bottle, then we're not really doing anything there.

I mean just fulfilling an order. And so what we've seen over the last couple of years and just been a big part of this is to really help us focus on those clients where we can take our offering to the next level and add more value to our clients in total.

So what we've seen and Jeff referred to, was the fact that we've lost some of our mail-only clients. In the early days when we were pretty small, we looked at the scale as a pretty important component to try to be competitive in the marketplace. I think we have enough scale to be competitive in the marketplace. So the question now is how do you make sure that you take that scale to the next level. I mean and that is use that scale to influence the supply chain. And again if you don't have any control over formula, if you have no control over step therapies or clinical programs then that scale can actually dilute your overall value proposition of the supply chain.

So we're really focused on ROIC and profitability, adding units for the sake of units but destroying shareholder value is not something we are excited about or interest event. So our growth will come as Jeff said in his comments, if you take out the clients that have gone off the book over the last couple of years, mail would have grown by 5%. I will tell you I am not happy by 5% mail order growth rate and that's the whole idea behind consumerology. The financial incentives have got us to the mail penetration rate we have. The next question is, how do you get that number to ultimately get more involved in their healthcare, overall healthcare situations that they are controlling both, the outcomes of the their healthcare and the costs associated with those outcomes and that's why we're dealing with our consumer-centric model.

Lawrence Marsh - Barclays Capital

Very good. And then just a quick follow-up; speaking of ROIC, you mentioned consistently the idea about not competing with your customers on Part D. I certainly understand that, you said that about 10% your business Medicare servicing and your customers obviously now directly. But how do you think about that? First customers are under margin variability because of reimbursement. Do you still feel like there is a good opportunity for you to drive that debt value and you do that through various programs, or are they are suffering under margin pressure or you're concerned about that spilling back down to you at some point?

George Paz

The people that offer these programs... it's a great question by the way, Larry.

Lawrence Marsh - Barclays Capital

Thanks.

George Paz

The people that offer these programs are very sophisticated buyers. So they are constantly looking at us and trying to figure out, how do we help them compete in an extremely competitive marketplace. I think that's where we are again, second to none. Our account management team has dedicated resources to each of those clients that go out and visit them, on a regular basis, some daily, some monthly. Sometimes they sit in the client's offices. But the whole idea there is to make sure that we stay in front of them not with opinions with, but with facts, so that we can show them, what's actually taking place and help them fight for new lives and growth, because as we tell them, their growth is our growth. So, I do think there is constant pressure, which at the end of the day Larry, that we only make after tax, after all of the capital and everything else, and now whole lot over dollars or scripts. So there is only so much value you can take out of a PBM.

The other side to that is, there is a lot of value that we gain by driving up the generic fill rate by 400 basis points, or driving up the amount penetration rate by 400 basis points. The dollars saved there as far exceeds our profitability. So, the idea is to make sure that we've given those answers to help them implement solutions that can be sold to their clients, not disrupting the members from their work activities, but driving out the waste. And so that remains a big focus for us.

Last thing here is keep in mind that Medicare reimbursement is somewhat cyclical, it comes and it goes. What happens is they keep cutting their providers reimbursement rates. People start dropping out, coverage isn't there. All of the sudden you got to start increasing it again, the doctors lobbying then starts to work, hospital lobbying starts to work. So these things all come and go over time, and the ideas we have to be the constant for those clients that has a constant message of taking out that waste and try to help them fight through those cyclical cycles.

Lawrence Marsh - Barclays Capital

Okay. Very good. Thanks.

Operator

Thank you...

Jeffrey Hall

Operator. This would be the last question.

Operator

Okay. That comes from Glenn Garmont with Thinkequity. Please go ahead.

Glenn Garmont - Thinkequity

Thanks, good morning. Two quick ones, if I could. George, you've made some... obviously, some very nice progress, improving the profitability of your specialty segment. I know there is a lot of different things in there, but should we expect any additional mix changes in that business? Are there business is you're in that you want to get out of? Are there businesses that you are not in, that you would like to get in to? And then secondarily, Jeff, you sort of mentioned in your prepared remarks that there is... sounds like there is plenty of opportunity to continue to move the generic dispensing rate higher. I just want to understand; I mean, is that based on the schedule of upcoming generic introductions or are you suggesting that you can move that number higher even just given the current availability of generics?

George Paz

I will address the first part, and obviously, Jeff will take the second piece. I think for specialty, here is one of the problems with specialty just to be totally frank. If you look at our numbers and we try to segment this and as Jeff said earlier when you look at specialty it's really in our book, we have a small distribution business. We have what we call Heathbridge of course for pharmaceutical companies and some reimbursement services and go on for days there is a whole hodge-podge the difference stuffed in there. Some of it being very adversely affected by changes in such as our PAP programs or patient's assistance programs. As more and more individuals becomes eligible for Medicaid and/or for Medicare, those people fall out of the PAP programs, still good programs still very profitable, but they are declining. So it has a negative impact on profitability for that segment.

The other side of the equation is specialties are very important component of the pharmacy benefit management. We bought CuraScript followed by the Priority acquisition to position us to be able to still compete on what we need to do and that is control trend. Although specialty spend is relatively small, the fastest component of drug inflation or trend expansion is still around specialty. It's growing at fairly fast clip and if you look at the pipeline that's where the big drugs are, that's where the big dollars for the future are and here is where its gets complicated. I believe that offering needs to be integrated with the overall pharmacy benefit management.

It's not like I can send out an account manager to work with your company on specialty and then have some totally different working with you on the pharmacy side. If you do that, then you got still work for the same plan designs, you still got to work with the same opportunities. You got to make sure that if there is a step therapy program we try oversize (ph) before we move over to the more expensive specialty therapies...want to control trend and that's where that's important or appropriate.

So I think that these lines are becoming very blurred. One of the things we do and I am not sure how our competitors do it but all of our especially runs through our retail and there is a fair amount of that its still reported in our PBM. All the specialty goes though our mail order so that's where we don't actually have high touch hands on clinical values around specialty. So its been the spends one of our mail order pharmacy's because all they want to do this client, is to deliver the specially product. That's been driven though mail order operations and that's reported in our PBM segment or in our PBM component.

Rebate, we view rebate as something we manage on the behalf of our clients. So all of our client rebates are reported in our PBM segment and all of course to the extend we keep our share that will go straight down to the bottom-line and operating profits. So there is ...the lines are very-very blurred when it comes to specialty. I would tell you specialty is very important component of our current PBM as well as our future in controlling drug trends?

Jeffrey Hall

Okay. So on generics where it 67% today, you think that number can go a lot higher and the answer to your question is really both. We have clients today with the current mix of generic drugs have generic fill rates that approach 80%. Certainly, there is a lot of effort on our part to move people along that curve. Certainly in the economic environment we are facing today we are seeing a lot of interesting clients to move on the more step therapy programs and to move on the other programs that we have that drive generic fill rate up.

The other side of that is of course new generics come out every year. 2009 actually ends up being a pretty light year, down about 30% I think from 2008 and in that generic impact and pretty backend loaded with two-thirds of the benefit from new generics really coming in the second half of the year. But over time we're going to we got some really big years out in the future that we're going to see a lot of new generics come on and that's going to drive up the generics fill rate. And then of course biogenerics we talked about earlier today. As we see biogenerics come in that's going to be a third leg really on this for additional leverage to grow generic fill rates.

Glenn Garmont - Thinkequity

Very helpful. Thank you.

George Paz

Thank you. So this concludes our call for today. We appreciate everyone sharing the last 45 minutes with us. And we look forward to continue to drive profitability, what we derived on our client costs and everyone have a great day.

Operator

Thank you. Ladies and gentlemen that does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.

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