Medco Health Solutions Inc., Q1 2009 Earnings Call Transcript

Apr.29.09 | About: Medco Health (MHS)

Medco Health Solutions Inc. (NYSE:MHS)

Q1 2009 Earnings Call

April 29, 2009 8:30 am ET

Executives

David B. Snow - Chairman and Chief Executive Officer

Kenneth O. Klepper - President and Chief Operating Officer

Richard J. Rubino - Chief Financial Officer

Thomas M. Moriarty - General Counsel Secretary and Senior Vice President of Pharmaceutical Strategies and Solutions

Timothy C. Wentworth - Group President, Employer Accounts

Valerie Haertel - Vice President, Investor Relations

Analysts

Lisa Gill - J.P. Morgan

Ross Muken - Deutsche Bank Securities

Lawrence Marsh - Barclays Capital

Charles Rhyee - Oppenheimer & Co.

Charles Boorady - Citi

Robert Willoughby - Bank of America-Merrill Lynch

Helene D. Wolk - Sanford C. Bernstein & Co.

Operator

Good morning. My name is Brandi and I will be your conference operator today. At this time, I would like to welcome everyone to the Medco Health Solutions first quarter 2009 earnings conference call. (Operator Instructions). I would now like to turn the call over to Valerie Haertel, Vice President of Investor Relations.

Valerie Haertel

Good morning everyone, and thank you for joining us on today’s first quarter 2009 earnings conference call for Medco. With me as speakers are Chairman and Chief Executive Officer, Dave Snow; Chief Financial Officer, Rich Rubino; and joining us for the question-and-answer session are President and Chief Operating Officer, Kenny Klepper; our General Counsel Secretary and Senior Vice President of Pharmaceutical Strategies and Solutions, Tom Moriarty; and Tim Wentworth, Group President, Employer Accounts.

During the course of this call, we will make forward-looking statements as that 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 a 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 Investor Relations Department, or the Medco website. Medco intends to use the Investor Relations section of its website as a means of disclosing material non-public information and for complying with its disclosure obligations under SEC regulation FD. 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.

David B. Snow

Thanks all of you for joining us this morning. Today, we are reporting solid first quarter 2009 performance. GAAP diluted earnings per share reached $0.58 representing 16% growth over first quarter 2008. Our diluted earnings per share excluding the amortization of intangible assets from our 2003 spin-off reached $0.53, a 14.5% increase over first quarter 2008. Our continued strong net new sales growth drove our first quarter revenues to over $14.8 billion, a new record, representing a substantial 14.4% growth rate over first quarter 2008. Our 2009 selling season has set a new Medco record of $8.6 billion in annualized new name sales, up from the previously reported $8 billion. Our net new sales number for 2009 now stands at over $7 billion, up from our previously reported $6.1 billion.

Our sales success extends beyond health plans and across all areas of our business. This is particularly true for our Systemed business which provides tailored solutions for the middle market. Systemed is experiencing a record 2009 sales year. Clients of all sizes are recognizing the value of our model and they understand the powerful clinical value delivered through our therapeutic resource centers and our pharmacogenomic initiatives. Although it is still early in the 2010 selling season, we’re pleased to report that we have added to our win lift for January 1, 2010, installation, the commercial and workers’ compensation business of Coventry, bringing our annualized new names sales today to $2 billion for 2010.

We believe that the Coventry win is an outgrowth of our nearly flawless installation of their Medicare business on January 1, 2009, and the excellent service we’ve delivered to Coventry and their members since that time. We have now completed over 97% of our planned 2009 client renewals. All accounts with drug spend over $500 million have been renewed. Our 2009 client retention rate stands at over 96%.

Looking at other key performance metrics are total prescriptions adjusted for the difference in day supply between mail and retail increased from the same quarter last year by 9.4% to $226.1 million. Our mail volume was on target with the guidance Rich gave on our last call at 25.7 million prescriptions, a 3.4% decline from the first quarter of 2008. Our retail volumes were very strong; in fact, they exceeded our expectations. Bolstered by volumes from our significant new business wins, our retail prescriptions grew by 17.5% to a record $149.4 million.

The strength in retail volumes and stability in mail volumes drove our adjusted mail penetration rate to 34% from 38.4% in first quarter 2008 and brought our gross margin percentage to 6.4% from 6.9%. This quarter our generic dispensing rate increased 3.5% to a record 66.8% compared to 63.3% for first quarter 2008. The year-over-year improvement in our overall generic dispensing rate drove incremental savings to our clients and members of approximately $650 million in the quarter.

For the first quarter EBITDA increased by 5.7% to a record $647 million. EBITDA for adjusted script declined slightly to $2.86 from $2.96 in the first quarter of 2008, again reflecting the heavier mix of retail volume in the denominator for this calculation from the new business we installed in January.

Turning towards Specialty Pharmacy segment; Accredo posted record results this quarter. Net revenues reached $2.3 billion representing growth of 21% over the $1.9 billion in the first quarter of 2008. Accredo generated a 7.8% gross margin, up from 7.7% in the same quarter last year due to drug mix. Operating income grew by 43.3% and $91.3 million for the quarter.

Now, I’d like to briefly discuss healthcare reform and its relevance to Medco. It’s a topic many of our investors and analysts are asking about. From a Medco perspective we believe the administration has recently released 10-year budget plans that strategically sound good for America, good for our clients, and because Medco is part of the healthcare reform solution, good for Medco. More specifically, the healthcare reform proposals and budgets include government subsidies for laid off employees covering 65% of their monthly COBRA costs. COBRA coverage enables laid off workers to maintain their Medco benefits. It includes additional funding to fully wire healthcare which is a fundamental enabler for any meaningful reform.

EPrescribing is an important component of a wired healthcare system and is a big win for Medco, our clients and their members, when widely adopted by physicians. It includes funding to cover $47 million uninsured Americans. Investors should view this as a new market for Medco to enter should the administration’s efforts prove successful.

The President proposes that a pathway for biosimilars or biogenerics be developed. Medco has been a strong advocate for this pathway and supports it as a way of creating competition and lowering costs. The plan would prohibit manufacturers from reformulating products to extend brand patent. This means generics will come to market faster, positive to Medco and our clients.

The budget will increase Medicaid rebates to 22% of AMP from 15%. This is a positive for Medco because by law drug manufacturers are required to ensure that the Medicaid program receives the best price when purchasing branded drugs. This has historically placed limitations on the discounts that can be achieved by the private sector. It is in fact a floor that we often bump against. Increased Medicaid rebates would improve Medicaid’s best price allowing Medco to reengage to negotiate more favorable pricing for its high-volume branded drugs.

The proposed budget would also allow states to collect rebates provided through Medicaid managed care organization. This has no impact on Medco because our model provides for the pass-through of rebates today.

Additionally, many of you would ask how a government sponsored public health plan would affect Medco. The simple answer is that the impact would be neutral to positive for us. If you look at US history, for government sponsored healthcare programs, the government generally hires the private sector to administer the plan on their behalf. Therefore, there is a possibility that new business opportunities could be created for Medco. It is clear that the Obama administration has three main priorities; to provide choice keeping the private sector plans in place, to continue to cover the insured population, to create a competitive offering mainly for the uninsured, and to lower costs. The administration understands that PBMs consistently take costs out of the healthcare system and are part of the solution.

The government is focused not on taking apart what is working but rather on fixing what does not work today. There are not any visible or measurable negatives for Medco in the Obama budget as we read it for there are evidences in the many discussions we have had in Washington D.C. Medco will continue to spend significant time in Washington participating in the reform debate while Congress promulgates the policy details that support the principles of the Obama reform plan.

Today we’re again reaffirming our 2009 diluted GAAP earnings per share guidance of $2.45 to $2.55 which represents growth of 15% to 20% over 2008. Excluding the amortization of intangible assets from the spin-off we expect diluted earnings per share to be in the range of $2.67 to $2.77, a 15% to 19% growth rate. As we noted last quarter, we believe that the range of earnings per share guidance we’re reaffirming today takes into account both the opportunities and the challenges posed by the current economic environment including rising unemployment rates that may reach 10% by year end. While the relationship between unemployment rates and attrition in our member base is not linear, we believe that we’ve reasonably analyzed and forecasted the potential impact to our earnings.

In summary, our highly scalable clinically driven model continues to provide a strong brandable difference in the marketplace. Our portfolio of products and services provide the needed solutions to help our clients and members during this time of economic uncertainty. Medco’s industry-leading transparency to its shareholders makes us especially proud to have been recognized in Forbes as one of the most trustworthy companies in America based on corporate accounting and management practices. We’re even more delighted by the confidence our clients have placed in us as their trusted advisor.

With that, I’ll turn the call over to our CFO, Rich Rubino, who will discuss additional details behind our first quarter 2009 financial performance and provide you with additional color regarding our 2009 guidance.

Richard J. Rubino

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 second quarter and full year 2009. We closed the first quarter with nearly $1.8 billion of cash in our balance sheet, well over three times the $541 million at the end of the first quarter 2008 and almost double the $938 million at the close of the last quarter. There is always an element of timing in cash balances from quarter to quarter, but we do expect our cash balance to grow even further by the end of 2009 far beyond our original guidance.

Our cash flow from operations for first quarter 2009 increased 7-fold to $1.170 billion compared to $166 million for first quarter 2008. This increase reflects our efforts to improve working capital and again includes an element of timing. For full year 2009 we now expect cash flow from operation to be in excess of $2.5 billion, representing greater than a 50% increase over our record 2008 performance.

Our total debt remained at $4.6 billion and we currently expect to hold that level of debt through the end of 2009 inherently lowering our debt-to-EBITDA ratio as our EBITDA grows. Our inventory levels declined for year end 2008 by over $180 million to $1.676 million. We have reduced our inventory levels by more than $400 million or 20% since the high point at the end of the second quarter of 2008. As a result of our working capital management progress today and our plans for the remainder of 2009, we now expect at least a 3% point improvement in our return on invested capital for 2009, up from the previous guidance of 2% points.

One last comment on the balance sheet, our capital expenditures for first quarter 2009 totaled $35.4 million reflecting investments across the business. We still expect capital expenditures of approximately $225 million for full year 2009 as we complete construction of the Indiana Pharmacy later in year.

With regard to our income statement performance, as Dave mentioned, our first quarter EPS results were solid. First quarter 2009 GAAP diluted EPS of $0.58 increased by 16%, diluted EPS excluding the amortization of intangibles from the 2003 spin-off of $0.63 was higher by 14.5%.

Turning to revenues, net revenues for the first quarter exceeded $14.8 billion representing growth of 14.4%. Product revenue grew 14.1% while service revenue grew 39.5%. 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 diminished rate of fees and our significant retail volumes, clinical program revenue from the multitude of programs we offer to generate substantial savings to our clients and Medicare Part D service fees.

Our mail-order revenue for the first quarter grew by 1.9% to $5.5 billion while the very strong retail volumes from our new accounts led to an increase of 23% for retail revenue to a record $9.1 billion. Dave has already walked you through our strong retail volumes and our stable mail volumes of 25.7 million scripts which were in line with the guidance of 25.5 million to 26.0 million I provided on our last call. Our other mail-order volumes not counted as prescriptions which include OTC items and diabetes supplies totaled 1.7 million units. The increase from the 1.2 million units in first quarter 2008 reflects the acquisition of the majority stake in Europa Apotheek Venlo in April 2008 plus continued growth in diabetes supplies volumes from our Liberty Medical brand.

Turning to rebates, we earned a record of over $1.3 billion for the first quarter representing 24% growth which is attributable to new client wins and continued improvements in formulary contracting. Our first quarter 2009 rebate retention rate was 12.8% compared to 20% in the first quarter 2008 and 15.9% last quarter. As always, fluctuations reflect client mix and client preferences regarding the rebate sharing aspects of their overall pricing structure.

Turning to gross margins, as Dave mentioned, the strong retail volume in the quarter reduced our consolidated gross margin percentage by 50 basis points to 6.4% compared to 6.9% for the same period in 2008. Importantly, our gross margin dollar is up over $944 million, grew almost 5% over first quarter 2008. While we make higher margins with mail which is where we drive the greatest savings to client numbers, it is important to note that we also earn service days and other margin on retail prescriptions as an important component of our overall profitable business portfolio. Of course, the significant growth in retail volumes today represents the mail conversion opportunity for tomorrow.

Selling, general, and administrative expenses of $340.3 million for the quarter reflects 3.6% growth over first quarter 2008. Sequentially, SG&A expenses declined 10.7% or $40.7 million from $381 million last quarter. Our total EBITDA for first quarter 2009 grew 5.7% reaching a record of $647 million.

The good fortune of having significant new client wins with very strong retail volumes also has the effect of reducing EBITDA per adjusted script which decreased 3.4% to 286 from 296 in the first quarter of 2008. We estimate that if the retail volumes were in line with our visible expectations, EBITDA per adjusted script would not have declined when compared to first quarter 2008.

Our intangible amortization of $75.9 million in first quarter 2009 increased from $69.5 million in first quarter 2008 reflecting PolyMedica intangibles and those intangibles stemming from the Europa Apotheek Venlo majority stake acquisition in April 2008.

Total net interest expense of $41.6 million for the quarter decreased from $54.3 million in the first quarter 2008 and $57.6 million last quarter as a result of lower interest rates and increased cash balances. In addition, you may recall that in the first quarter of 2008 we had spent $9.8 million associated with the ineffective portion of the hedge relating to the senior notes issuance. Our effective tax rate for the first quarter 2009 was 40.2% in line with the guidance I provided on our year end call. This compares to 39.7% in first quarter 2008. Net income increased 7.7% to $291 million from the $270.2 million reported for the first quarter of 2008.

Moving on to share repurchases; under our $3 billion authorization, we repurchased a total of 5.3 million shares during the first quarter of 2009 for $215.6 million at an average per share cost of $40.59 which was funded entirely from free cash flow. A weighted average fully diluted share count of 501.2 million shares for the first quarter decreased 36.6 million shares compared to 537.8 million for the first quarter of 2008 reflecting share repurchases made throughout the period and the effective employee stock option. We finished the first quarter of 2009 with 490.4 million basic shares outstanding plus a dilutive equivalent of approximately 7.5 million additional shares taking the total full diluted share count to 497.9 million on March 28, 2009. This fully diluted share count becomes the entry point for second quarter 2009.

Moving on to Accredo; the success in our specialty segment continues. The strong first quarter revenue growth of 21% reflects higher volumes to new business and a favorable product mix. Accredo’s first quarter gross margin increased to 7.8% from 7.7% in the same period last year reflecting new product mix. Of particular note was the significant 43.3% growth in first quarter operating income to $91.3 million. There were benefits recorded in cost of sales in the first quarter largely associated with the timing of inventory purchases that are not expected to be repeated in the course of the year. For the full year 2009 we expect top and bottom line growth for Accredo that is more balanced than what was experienced in the first quarter.

We continue to experience profitable growth in the Medicare marketplace as a direct provider to our own PDP, as a partner with our health plan clients, and in collaboration with our employer clients. As we reported previously, the number of Medicare alliance Medco coverage increased 300% from last year. While the majority of that growth is from our health plan success, our own PDP is demonstrating strong growth as well. Medco’s PDP revenues in the first quarter increased over 80% to almost $275 million. Generic dispensing rates for our PDP grew to 70.3% with adjusted mail-order penetration of 26.8%.

As Dave discussed, we’re reaffirming our guidance for GAAP diluted earnings per share in the range of $2.45 to $2.55 representing growth of 15% to 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% to 19% over 2008.

Now, I’ll provide you with an update to the detailed full year 2009 guidance components that supports the reaffirmation of our overall EPS guidance. Our 2009 scheduled and early elective renewals amounting to approximately $20 million are over 97% complete with well over 90% of the revised pricing in effect in the first quarter of 2009. We continue to expect new generic introductions to contribute $0.11 to 2009 earnings per share with $0.01 already realized in the first quarter, $0.03 expected in the second and third quarters, and $0.04 in the fourth quarter. This is all consistent with our previous guidance.

Our EBITDA per adjusted script is now expected to essentially flat or slightly under 2008 full year number of $3.09 reflecting the higher-than-projected retail volumes. We continue to expect full year mail-order prescription volumes in the range of $105 million to $107 million. This assumes an uptick from the current run rate for the end of 2009 as our various mail order programs gain further traction offset by the expected effect of this weak economy including increasing unemployment. This trajectory is consistent with what we’ve provided previously. Our adjusted mail order penetration rate for the full year is expected to be slightly higher than the 34% reported for the first quarter of 2009.

We expect that our gross margin percentage for the full year will be slightly higher than the 6.4% reported for the first quarter of 2009. SG&A expenses for 2009 are still projected to be flat with 2008 at approximately $1.4 billion. Net interest expense for 2009 is expected to be lower than the previous range of $220 million to $230 million and is now projected in the $170 million to $190 million range reflecting lower interest rates and higher cash balances.

The previously provided intangible amortization guidance range of $295 million to $305 million for 2009 remains unchanged. Expectations for the effective tax rate for the full year remains unchanged at 38.5% to 39.5%. As I indicated on our previous earnings call, the first three quarters of 2009 are expected to be consistent at approximately 40% with a lower rate anticipated in the fourth quarter. The weighted average diluted share count expectations for the 2009 full year are also unchanged at 485 million to 500 million shares.

For our Accredo specialty business, we currently expect 2009 revenue of over $9.2 billion and operating income in excess of $325 million with a gross margin percentage in the mid to high 7% range. This is stronger performance than our previous guidance.

On looking to the second quarter specifically, I would like to make the following observations. The second quarter overall performance is not expected to differ materially from the first quarter other than the slight uptick in new generic contribution from $0.01 in the first quarter to $0.03 in the second. Also, please keep in mind that the Accredo operating income growth in the second quarter is expected to be in line with top line growth. The first quarter operating income is relatively stronger because of the items I mentioned earlier on this call.

In conclusion, we are confident in our ability to continue to drive substantial earnings growth. We’re very pleased with our financial performance that we delivered this quarter and now Dave and I would like to open the line for questions.

Question-and-Answer Session

Operator

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

Lisa Gill - J.P. Morgan

Just a couple of quick questions; Dave, would you give us your thoughts on the WellPoint transaction and what you think it means overall for the PBM industry. Secondly, can you talk about the opportunity to convert some of these retail claims over to mail; the number of retail claims obviously coming in much higher, so maybe just give us an explanation as to why it is higher; number one, and number two, where the opportunity is.

David B. Snow

On the WellPoint transaction, I think I’ve been saying Lisa since 2003 that I always felt the independent PBMs were far more efficient than inhouse PBMs simply because it is our center of the desk focus and I’ve also always said that we rarely if ever see an inhouse PBM at best and finals when we’re in the competitive mode, and it’s largely because they don’t have the scale, they don’t invest in the technologies that make mail the most efficient way to dispense drugs. So, it does not surprise me that WellPoint did the transaction they did, and it would not surprise if other health plans with inhouse PBMs started rethinking their strategy to drive better value for their customers and shareholders. Medco’s position relative to any of these opportunities is that we’ll continue to be opportunistic. We think that enormous value can be delivered to health plan clients who seek to do this and we also believe at the right price it also could be the right thing for Medco to do relative to creating shareholder value.

Lisa Gill - J.P. Morgan

Do you want a handicap whether we’ll see another transaction this year or not; do you think it’ll happen that quickly that the others have to say, “We’ve got an awful lot going on since we have healthcare reform, maybe we should be thinking about this today?”

David B. Snow

I believe that there is added pressure to health plans generally in this time of recession as they look for ways to create earnings for shareholders. So, I do think this recession has added to a pressure on them that would make them more likely to consider it now than at a time when there’s less economic pressure on health plans. So, I can’t tell you specifically whether I expect another transaction this year, but I do think the environment is favorable for strong consideration of that option. Relative to retail claims conversion, I can tell you that so far this year our team is doing a fabulous job moving retail scripts to mail tied to the therapeutic resource centers, initiatives and the things we do for our clients. In addition, many of these heavy retail accounts that picked up picked up because of our expertise at mail because they see the enormous value that mail brings to them in their bottom-line. So, benefit designs are aligned for a lot of this new business and we’re probably the best at moving from retail to mail. So, I’m very bullish on that. The unknown here and the thing you need to factor in as you think about a full year is this recession and the layoffs you read about every day because as we convert retail to mail there is also a counteracting vector which is the layoff that makes the hole deep that we have to fill with these conversions, and where that ends up at the end of the year, as Rich said in his comments, we believe we analyze it and we projected properly, but I don’t think anyone has a crystal clear prediction model here. This recession is something that takes twist and turns that surprises all every week.

Lisa Gill - J.P. Morgan

Just so I understand this, it’s actually filling the hole where you had a number of layoffs, for example, some of the big auto workers, etc., that are having layoffs where there was a lot of mail utilization, those people are going away, you brought in a lot of retail business that will take some time to convert, so the conversions are what we see this year and it may very well take a little bit more time than this year, obviously based on where mail penetration will be at the end of the year; is that the right way to think about it or we should be thinking about how Medco is going to look at that over the next couple of years and that conversion opportunity to fill the hole?

David B. Snow

Absolutely, again, last time we talked about this, we said that last year we did 105 million mail scripts and there’s another 110 million mail equivalent scripts for chronic and complex disease still going to retail; that is our opportunity, in fact, in the new business we brought on, that number has gone significantly higher in terms of opportunities. So, it’s a long-term mining opportunity, it isn’t a one quarter or one year opportunity; it’s something we can re-benefit from for a long time to come, and in fact, we get better and better at doing it, and you will see benefit this year, but it does get masked by the erosion type of layoffs. Now, one of the things that’s interesting and it went into effect April 1st is the COBRA subsidy that actually subsidized 56% of the cost of COBRA, and so we’re hoping that the erosions actually are smaller as more people opt. Especially if they have chronic or complex disease, they opt to pay out of pocket for COBRA because the cost of it at least for the first 9 months is reduced by two-thirds to the individual member who has been laid off aside to the Obama budget change; so, I think that’s good news.

Lisa Gill - J.P. Morgan

Rich, are you still expecting roughly 10% unemployment in that bottom end of your guidance range, is that correct?

Richard J. Rubino

That’s right.

Operator

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

Ross Muken - Deutsche Bank Securities

Relevant to the selling season that obviously is now underway, what differences have you seen in terms of customers and then how have the conversations been given that this is kind of the first time we’ve been in the midst of this economic situation; I think companies have far more appreciation for may be the duration and the severity of the downturn and in turn may be look to you more so than they have historically to really help deliver even more savings. So, I’m just kind of curious about some of the types of conversations you’re having and what really the customer base has been focused on?

David B. Snow

Ross, I’ll give you a 30,000-foot view just based upon across all of our market groups that we have and have been in attendance with us, and so, I’ll ask Tim to add on at a more granular level what you’re seeing in the marketplace, but generally speaking, corporate America is suffering, there’s no question about it; this recession is taking its toll with our clients. So, the conversations I’ve been and across the board has been extremely positive because the clients are seeking the solutions we offer and they are more willing to adopt some of the solutions we have offered in the past that they chose not to do in the past, but now they’re pushed to do it because of the real need to drop earnings to their bottom-line; so there’s been nothing but positive conversation relative to what we are continuing to develop that bring brandable difference and brandable value to our clients each and every year, and Tim, you’ve been out there a ton lately, why don’t you give your view on market.

Timothy C. Wentworth

To add to what Dave said, we clearly see a strong bias to clients looking at programs around formulary choice, so we have webcast where our clients talk with each other, hundreds of them, and we have seen significant uptake this year in step therapy rules, in the key areas where there are major opportunities for us to drive generic and then drive the preferred brands in those categories. So, very significant uptake there; also has a very high base to start with. So, we’re closing a lot of those opportunities. The other thing we see is our mail co-pay waiver programs and other programs that can help drive members into the channel that clients increasingly see the clinical total healthcare cost tied because our PRC message is resonating incredibly well and has been significant; so, mid year changes which would never have been contemplated before, we’re seeing clients put in routinely, and I guess the third piece is even clients who have potentially a little bit more challenge making full-scale changes are signing up for disease specific programs where perhaps we take a diabetes population and manage it separately even though they may not put up a full mandatory mail program in place this year. So, very strong alignment between our solutions and the clients, and it’s resonating fairly well.

Ross Muken - Deutsche Bank Securities

Thanks to both of you, and then just one quick followup to some of the comments Dave that you made on the healthcare reform side, I know a lot of the investors are sort of struggling to understand kind of the ramifications of different industry participants; I think clearly it seems like most of what’s coming out of government hopefully will be relatively favorable to you; I mean, if we were to see something that would be not favorable, what are you focused on in terms of the one thing that if that happens that potentially would make you nervous about the business or that the government has sort of leaned in a certain direction and maybe the sort of slippery slope ramifications are something that we need to be aware of, because I think everyone kind of wants to know that 2% probability, if it’s that or if it’s lower, but if there’s really nothing that gets you that nervous that would also sort of be helpful.

David B. Snow

I’ll tell you that, here’s what I worry about relative to healthcare reform; I have outlined for you at a policy level or a principal level what the Obama administration is trying to accomplish and it makes sense, but the devil is always in the detail, so there are two things that we at Medco are being vigilant around, one is, I don’t believe big boom reform will work, and by that I mean you cannot fit everything at once, you need to go building block by building block and make meaningful reform occur. The challenge right now is that, let’s take wiring healthcare; on top of that, one member of Congress might want to tag on a bill that says, we want to negotiate directly with pharma, which means you create resistance to that element of reform from pharma who says, I don’t want you to do that, so they try to trash the fundamental, very important building block; then you say, I want to have a public health plan compete against the private side for the uninsured; well, then you get the health plans to be very negative about the reform, and then you as you kind of tag on these incremental things, the resistance increases, and we’ve seen this happen many times; so, the worry would be, you get nowhere because you try to tag too many things to the incremental reform to the point of resistance that’s too high, so that’s number 1.

Number 2, and I do worry about this is you’ve got a vision now that’s been articulated, and I would say, now Congress is trying to turn that vision into policy and things can go wrong when you translate a vision into policy because members of Congress, many of them if not most of them, do not understand how healthcare works, so that translation can really turn out poorly and hurt many great companies. So, that’s why we need to stay vigilant.

I want to give you one example, it happened, it’s over now, but this is just a great example. The stimulus bill had a $20 billion funding number for wiring healthcare, for health IT; however, as the stimulus package went through the house, the house tagged on to the bill HIPAA rules that were so onerous, healthcare would have taken 20 steps backwards relative to the use of data to create transparency to do a better job taking care of patients; in fact, it was so onerous you might as well put the $20 billion back in your pocket because you couldn’t use the data even if the system was wired. Now, Medco, Medco’s Washington office plus a lot of other healthcare companies scrambled, they educated, and they got the onerous language changed to a point where you can deal with it, but this will happen a lot; these twists and turns around how you activate or make actionable these policy ideas, a lot of details are involved and people can make honest mistakes and you just need to be there to educate and to make sure this thing comes out at the policy level and it reflects what was originally intended. That’s always a danger in healthcare reform, and finally, to tie to that, I would say the other worry I always have and I have had it since I’ve been here in 2003 is headline news because someone makes a wrong turn, the headlines are big; even if they are not ever going to happen, it does create headline news and that means volatility from time to time as the debate goes through the summer and you can expect that.

Ross Muken - Deutsche Bank Securities

I really appreciate that, I know it’s a tough question, thanks again and congratulations.

Operator

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

Lawrence Marsh - Barclays Capital

First of all, wanted to clarify on guidance; between interest and Accredo I guess you’re calling out $65 to $75 million of upside versus what you suggested back in February; guess you’re saying EBITDA per script is now flat to down with greater retail, are you saying your EBITDA will be lower versus your earlier expectations or not, and if this is not, why wouldn’t we see some upside in your guidance range?

Richard J. Rubino

No, it’s just the EBITDA per adjusted script and that’s really a function of the higher retail volumes that we originally expected. So, when you make the adjustment for the higher retail volumes, the EBITDA per adjusted script guidance and the gross margin percent guidance and so forth; this is all consistent honestly with the previous guidance we gave. So, all of those alterations to some of those statistics are a function of the very strong retail volumes.

Lawrence Marsh - Barclays Capital

Okay, so you’re suggesting no change in your general view, Rich, of EBITDA for the year?

David B. Snow

That’s exactly right; and I have to tell you that, and I said this on Analyst Day, to quote Rich for being Analyst Day, “I love all clients,” and because even though they may be significantly retail oriented today, they do represent mining opportunities with regard to increasing mail in the future. So, I think the top-line growth, the record top-line that we demonstrated this quarter is very important because that’s going to be the fuel for mail growth going forward. EBITDA per adjusted script will go up and down in the next several quarters or may be years as we layer in significant chunks of new business that will have different mail penetration lines.

Lawrence Marsh - Barclays Capital

Just one more followup on Express WellPoint, was there anything coming out of that announcement around those substantial at your drug cost saves that was at all surprising to you; and if there’s continued momentum around that consolidation, is there any thought from your standpoint as to where we would run into any potential anti-trust concerns?

David B. Snow

No, our council is not concerned about that; there isn’t a single independent PBM who could roll up all of the in-house PBMs under their roof, that wouldn’t happen, but there is not a concern at this point in time, there’s enough room for these things to happen pretty easily.

Lawrence Marsh - Barclays Capital

And any surprises on sort of the suggested drug cost saves, is that just confirming the idea there’s still lots of opportunities out there?

David B. Snow

It honestly confirms what I have been saying since 2003. I also see that lots of opportunities for savings and greater efficiency have been there. In fact, Larry, those numbers really kind of reflect that spreadsheet difference I’ve always told you about that seems to occur when consultants manage a bit, and you find that the in-house PBMs don’t make it to the best and finals; there’s a correlation there between the lack of spreadsheet value and the value that you’re finding tied to one of these deals.

Lawrence Marsh - Barclays Capital

In your net new business, looking out for this year and next year, are you sizing Coventry either in revenues or mail scripts?

David B. Snow

Not at this point.

Lawrence Marsh - Barclays Capital

And then just, I know in the proxy, you talked about that one of the things that Medco executives get compensated on is retention goals, obviously the one thing that you didn’t quite hit last year was the retention target of 96, it sounds like you’re in a good position; can you confirm you are at or above your target for this year at over 96% currently?

David B. Snow

If you notice, our 2009 executive compensation grid looks a little different than 2008 because quite honestly I made a mistake in 2008 where I counted retention twice technically. Net new by definition is a measure for retention and then we had a separate retention number. So, even though in 2008 we blew away the net new numbers we also had the standalone retention number that didn’t make a lot of sense. So, net new is a measure of both your organic sales for new names minus losses, so you really wrap it all up in one measure, and this year you can see ours is a net new number without a standalone retention number, but I can tell you that we’re very much within our own parameters tied of what we expect relative to retention in a given year.

Lawrence Marsh - Barclays Capital

Makes sense, and finally, any particular update on the previously discussed auto VEBA bid for 2010, is that still in the mix?

David B. Snow

Obviously, it’s still being talked about and there’s been a lot of press about it lately. The big thing to watch as we are going to watch is there have been a more recent published concerns about the increased portion of the VEBA funding that is tied to stock, and obviously, as some of these companies contemplate structured bankruptcy, it’s not a terribly secure feeling for the unions and they look at how that whole health benefit is going to be financed. So, I would keep an eye on that; I would assume for now that everyone’s plan is to carry forward with their VEBA plan but there is some question at least about the financing of the VEBA.

Operator

Your next question comes from the line of Charles Rhyee - Oppenheimer & Co.

Charles Rhyee - Oppenheimer & Co.

Dave, I wanted to go back maybe to the topic of health reform and obviously all the comments you gave are very helpful, but you talked about sort of the government plan being sponsored, how that could be sort of neutral to positive for you guys, and with the idea that the government likes to subcontract, can you give us a sense on how you would envision something like that working in the market today and how the pharmacy benefit would fit into that, particularly given that where you have a Medicare part D plan in existence?

David B. Snow

Medicare part D is a standalone drug benefit to the extent, for example, the government wanted to have a drug benefit type of Medicare fee for service that was more designed and owned by the government, this is an example; my only point is that the government wouldn’t go out and build a mail order facility, they wouldn’t go out and create the software necessary to adjudicate claims, they wouldn’t go out and wire that new entity to retail pharmacy, they would hire someone to do the work for them; so when you hear about the debate and you talk to members of Congress, what they’re really saying is when they talk about a government program, they would like to have some control in the benefit design and how they approach the market relative to the individual choices private sector plans make. So, it’s a competing product and it would be in my view outsourced, and it is what they do pretty much generally for any of the government sponsored programs. Medicare fee for service on the medical side is all outsourced to the private sector today.

Charles Rhyee - Oppenheimer & Co.

But Dave, is this that sort of the issue you hear from providers that they complain about Medicare rates being sort of lower and not really covering the costs that they need and the concern being that as the government becomes more involved, they are going to put a lot of pressure on price, and so I can understand how you are saying that they are going to contract out the delivery functions and the fulfillment, but as they enter the market, can you give us a sense how, at least on the PBM side of the equation, how you fit in there and how you would think that is still at least neutral to positive here?

David B. Snow

I would administer the plan that they described; you’re talking about stake holders who may be concerned because they are at the end of the reimbursement, but honestly, that’s why I would say having a public health plan competing as to private health plan is going to create more constituency against overall reforms, because you’re going against potentially doctors who don’t want it; from our point of view, for what we do, it would work for us, but I do from an overall health reform point of view, don’t think it’s a great idea because I don’t think it brings much incremental value to the table and it does raise a lot of stake holders who will be against this idea when they might be very supportive if they left it alone. So, it really is neutral to us. It’s not something that concerns us. There will be private health plans, and the new health plan is one we could administer just like we administer other federal program today.

Charles Rhyee - Oppenheimer & Co.

One last question, in regards to really trying to manage the price of drugs and clearly the budget outlines increase in the Medicaid rebate and you mentioned how that could benefit you as you negotiate with drug manufacturers, in your discussions with people closer to government, do you get a sense that they understand the benefits that the overall drug spending environment as generics have really entered the market, do you think there’s a good understanding of how the dynamics are working between brand and generics and the role that you guys play?

David B. Snow

Absolutely, no question in my mind.

Operator

Your next question comes from the line of Charles Boorady - Citi.

Charles Boorady - Citi

Just on the topic again of health plans and PBMs, in light of the uncertainty in Washington this year and I agree with your views, Dave, in terms of what the upshot is likely to be, but in light of the uncertainty of the risk of a government run part D plan, how would you think of the value of PBM focus just on Medicare versus one focus just on commercial, would there be any discount for the risk that might be greater in the Medicare book versus the commercial book this year?

David B. Snow

Good question Charles, the truth is we would look at commercial book differently than a Medicare only book and when there’s a blended mix between Medicare and commercial, we would isolate the two and then blend it to come up with what makes sense because there are many different considerations when you look at Medicare book; so, for example, mail pen tends to be lower especially if there are a lot of dual eligibles, mail pen is extremely low and also there are certain federal rules around term of contract that would potentially shorten the time it takes to get a return on your investments; so, yes, there are lots of different considerations, so you have to isolate and price differently to two components of the business.

Charles Boorady - Citi

Just a followup on ePrescribing incentives, have you noticed any uptake in either new scripts or higher mail penetration or better formulary compliance from prescriptions that come electronically, and can you quantify for us any increase in electronic scripts you’ve seen as a result of the government’s initiatives to promote more ePrescribing?

David B. Snow

Yes, we have seen an uptake, it’s actually encouraging. We saw the uptake start with the Medicare bill passed last summer. We also, based upon dialogues and what not, know that a lot of attention is focused on getting a piece of the HIP funding that’s in the stimulus package, so that I think will accelerate ePrescribing. I would actually say we’re actually starting to see a turn and it’s looking a little more like a hockey stick approach to adoption. I don’t have the numbers in front of me right now but I certainly can come prepared at our next quarter call and give you some more color on what we’re seeing relative to the adoption of ePrescribing, but it is encouraging. I will also tell you that as the adoption takes place, there’s more money in the system for the vendors who create ePrescribing software and one of the big things is there wasn’t enough money in the system coming from doffered use to see the technical product evolve and get better and better, and there’s been a need for that. Now that there’s money flowing through the system, we’re seeing much better user friendly electronic devices for ePrescribing which I think will in itself also help catalyze that adoption. So, we are encouraged it is early and I will give you color next quarter.

Operator

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

Robert Willoughby - Bank of America-Merrill Lynch

Dave or Rich, the SG&A line item is vastly better than where I though it would be, is that a good run rate going forward or do you still see some fat in there to cut?

David B. Snow

Well, I wouldn’t say there’s necessarily fat in there to cut; we’re actually running pretty mean and lean. I reiterated the guidance for 2009, we expect to be flat. When you look at the first quarter compared to the first quarter, we were up a bit, I think it was 3.6%; in the course of the year, we expect to flatten that out. So, we do have further efficiencies to yield but I can tell you that we are running pretty lean and very efficiently right now, a little bit more to go for the year.

Richard J. Rubino

One of the things to point out is we’re projecting flat SG&A but we added 5 million members, so, that in and of itself is real cost containment.

Robert Willoughby - Bank of America-Merrill Lynch

Anecdotally can we point to anything operationally going forward, is there a synergy or anything I could focus on that’s bigger than a breadbox there or just a lot of small things?

David B. Snow

A lot of blocking and tackling; I may have mentioned in the past that we’ve done some organizational changes to create centers of excellence where there are pockets of activities, say in, PolyMedica and created one in Medco that we’re combining to get synergies and efficiencies, those sorts of things and we’re doing pervasively across the business.

Robert Willoughby - Bank of America-Merrill Lynch

And I guess if I look at the cash generation, the higher goals there, what you have on the balance sheet in the absence of the larger share repurchase in the quarter, you did something great but in the absence of a larger one, don’t I have to worry about a fairly sizable acquisition coming down the pipeline?

David B. Snow

Well, we take one step at a time. The share repurchases that we’re doing at this point are pretty much consistent with what we had anticipated in our plan and what’s inherent in the guidance that we gave yielding 485 million to 500 million shares, we said that last time, we say it this time. We are building cash for reasons that we discussed earlier, which is we got a right size of working capital, and as a result of doing that, we are yielding a lot of cash and I am delighted with the rate at which we have been generating cash. Don’t view it necessarily as pointing to anything imminent. I am very comfortable having that dry powder available as I have said before, we always look at opportunities and we’ll take advantage of opportunities that generate the right level of return based no our return of invested capital guidelines and requirements.

Richard J. Rubino

And I think worry is the wrong word, Bob, because the deals we tend to do are creative right out of box for shareholders.

Robert Willoughby - Bank of America-Merrill Lynch

Okay, I guess I worry that a year ago’s buy and capital isn’t effectively re-deployed, so it’s just a slippery slope where you’re going to do the right thing versus not doing anything…

Richard J. Rubino

I would assume we’re going to do the right thing. I think that’s a safe assumption.

David B. Snow

I agree.

Operator

Your final question comes from the line of Helene Wolk - Sanford C. Bernstein & Co.

Helene D. Wolk - Sanford C. Bernstein & Co.

I have two questions, first on the gross margin dynamics, may be you can help in terms of just providing a little bit more information around the moving parts like the retail component, generics, anything else that we may not be seeing that may be contributing to the change in the gross margin expectations.

Richard J. Rubino

When I gave original guidance I said that the gross margin percentage was going to decline slightly, and as a result of the strong retail volumes, the gross margin declined. Looking at the spread in bids from last year, it was probably about twice what I originally expected.

David B. Snow

I want to make sure everybody understands when we talk about strong retail volumes, it’s because a number of the clients we won for 01/01 effective this year actually won more membership than we had logged when we originally won them. They brought on more membership on their own, and so it wasn’t in our numbers because they did have very successful one-one selling seasons; that just added to the numbers of members we have as we happen to be heavily oriented to retail.

Richard J. Rubino

Adding to Dave’s point, the mail penetration from the new accounts which we had pointed to as being 9% on that Analyst Day is still 9%. So, the good news is the mail penetration rate remained consistent, but because the mail penetration rate is lower by definition you see much more of an amplified uptick in retail. Another point I’d like to make is take a look at our service margins. Our service margins were stronger and the service revenue is quite strong and that’s in large part because our administrative fees on the retail business have really been driven upward by the higher volumes. Aside to the point I made in my prepared remarks which is we earn a profit on retail claims as well as mail claims and look to that service margin line to demonstrate good growth in the course of this year as a result of that elevated service revenue stream that we expect to see continuing throughout 2009.

Helene D. Wolk - Sanford C. Bernstein & Co.

A second question on the balance sheet; we’ve seen strong cash flows from both inventory and accounts payable management. Can you give us a sense of going forward what you might be doing in those efforts as well as what opportunity may remain going forward?

Richard J. Rubino

The accounts payable is more a function of timing and management per se. I can tell you that from a management point of view we continue to look at further opportunities in driving inventory down. We’re also working to increase our rebate receivable turns in the course of this year. I expect to see some nice improvement there in the course of the second quarter and third quarter of 2009.

David B. Snow

Thanks everybody. That was our last question and we appreciate your joining us today, and we look forward to talking to you next quarter.

Operator

This concludes today’s Medco Health Solutions first quarter 2009 earnings conference call.

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