Medco Health Solutions Q2 2009 Earnings Call Transcript

| About: Medco Health (MHS)

Medco Health Solutions Inc. (NYSE:MHS)

Q2 2009 Earnings Call

July 29, 2009 8:30 pm ET

Executives

Valerie Haertel - Vice President, Investor Relations

David B. Snow, Jr. - Chairman of the Board, Chief Executive Officer

Richard J. Rubino - Chief Financial Officer, Senior Vice President, Finance

Steve Fitzpatrick - President of Accredo

Analysts

Lisa Gill - JP Morgan

Ross Muken - Deutsche Bank

Lawrence Marsh - Barclays Capital

Thomas Gallucci - Lazard Capital Markets

Robert Willoughby - Bank of America

Randall Stanicky - Goldman Sachs

Charles Boorady - Citi

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

Operator

Good morning, ladies and gentlemen. My name is Amanda and I will be your conference operator today. At this time I would like to welcome everyone to the Medco Health Solutions Second Quarter 2009 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session. (Operator's Instructions) Thank you. I would like to turn the call over to Valerie Haertel, Vice President of Investor Relations. Please go ahead, ma'am.

Valerie Haertel

Thank you, Amanda. Good morning and thank you for joining us on Medco's Second Quarter 2009 Earnings Conference Call. With me today as speakers are Dave Snow, Chairman and Chief Executive Officer, and Rich Rubino, Chief Financial Officer. Also joining us from Franklin Lakes for our question-and-answer session are Kenny Klepper, President and Chief Operating Officer, Tom Moriarty, General Counsel, Secretary, and Senior Vice President of Pharmaceutical Strategies and Solutions, Steve Fitzpatrick, President of Accredo, Tim Wentworth, Group President of Employer Accounts, and Brian Griffin, Group President of Health Plans.

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 statement 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 enclosed 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 nonpublic 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 earning 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, are currently available in the events section of the investor relations site on www.medcohealth.com. Additionally, please note that our 10-Q will be filed after the close of the market today.

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

David B. Snow, Jr.

Thank you, Valerie, and thanks to all of you for joining us this morning. Today we're reporting strong top line and bottom line second quarter 2009 results. In addition we are raising and narrowing our earnings guidance for full year 2009.

For the second quarter of 2009 our GAAP diluted earnings per share reached a record $0.64, representing 25.5% growth over second quarter 2008. Our diluted earnings per share excluding the amortization of intangible assets from our 2003 spinoff reached $0.69, a 23.2% increase from the second quarter of 2008.

Our second quarter revenues reached a new record of $14.9 billion, a growth rate of 16.9% over second quarter 2008. This strong top line growth is a direct result of our continued success of winning new customers while retaining the vast majority of our existing customers.

Our 2009 selling season is a clear record breaker. Annualized new name sales now total $10.1 billion, up from the $8.6 billion we reported last quarter. Our 2009 net new sales, which take into affect new name accounts one in the competitive marketplace net of lost accounts and erosion, now total more than $8 billion, another new record up from the over $7 billion we reported to you last quarter.

We have now completed virtually all of our planned 2009 client renewals which total $23 billion. It's still early in the 2010 selling season, but even so, we are pleased with our progress from both a new business and client retention perspective. We have sold $2.8 billion 2010 annualized new-name business, up from the $2 billion we announced last quarter.

In this new name business number we include the newly won Chrysler retirees who will be part of the new created UAW Retiree Medical Benefits Trust for the American Auto Industry, also known as the VEBA Trust, starting January 1, 2010.

Our client retention rate for 2010 is currently better than 98% and includes the renewal of the Ford and General Motors' retirees who will remain with Medco as they move into the new UAW Retiree Medical Benefits Trust next year.

Looking at other key performance metrics, our total prescriptions adjusted for the difference in dates applied between mail and retail increased from the same quarter last year by 13.5% to $224.9 million. Our mail volume was in line with our expectations of 25.9 million prescriptions, a 1.5% decline from second quarter 2008.

Our retail volumes continue to grow at a strong pace largely fueled by our 2009 business win. Retail prescription volumes grew 23.4% to $147.6 million. The strength in retail volumes and stability in mail volumes brought our adjusted mail penetration rate to 34.4% from 39.7% in second quarter 2008, and brought our gross margin percentage to 6.8% from 7.3%.

This quarter, our generic dispensing rate increased 3.6 percentage points to a record 67.3% compared to 63.7% for the second quarter 2008. The year-over-year improvement in our overall generic dispensing rates delivered incremental savings for our clients and members of approximately $620 million in the quarter.

For the second quarter, EBITDA increased 14.1% to a record $689.4 million. EBITDA for adjusted scripts increased to $3.07 from the $3.05 in the second quarter of 2008. This is strong performance considering our higher mix of retail prescriptions in 2009.

Turning to our specialty pharmacy segment, Accredo posted record sales results this quarter with net revenues growing 20.3% to $2.4 billion. Operating income grew at an even higher rate achieving 30.5% growth and reaching $88.5 million for the quarter.

Switching gears briefly, I discussed the topic of healthcare reform at length during our last quarter call. There have been many headlines since then, however our thinking about the probably outcomes remain unchanged. We continue to believe we are part of the solution in any healthcare reform initiative. Likely specifics include e-prescribing initiatives that drive physician adoption, the establishment of a pathway for biosimilars which will allow us to create new sources of value for our clients, and some form of government sponsored benefit for the uninsured, however modest, which would represent a new market opportunity for us.

We also believe that our clinical leadership in pharmacogenomics, combined with our therapeutic resource centers which focus on chronic and complex therapy management, represent a unique strength in the context of any likely healthcare reform provision.

We will remain actively engaged in the reform debate and the implementation process in Washington, D.C. for the foreseeable future, since many of the contemplated changes have implementation dates that extend as far out as 2013. Today we are raising and narrowing our 2009 earnings guidance. Our 2009 GAAP diluted earnings per share guidance is now in the range of $2.54 to $2.59, representing year-over-year growth of 19 to 22%. Our previous GAAP diluted earnings per share guidance was $2.45 to $2.55.

Excluding the amortization of intangible assets from the spinoff, we now expect diluted earnings per share to be in the range of $2.76 to $2.81 for an 18 to 21% growth rate. You will recall that our previous guidance was $2.67 to $2.77 per share.

In summary, 2009 is turning out to be yet another strong year for Medco. We have a highly motivated and dedicated group of employees who put the interest of our clients and our 60+ million members first. Earlier this year we were recognized by Fortune magazine as a leader in people management. Through a recent employee opinion survey our employees confirmed that our approaches to motivating and engaging our workforce is the right approach.

As a result, Medco was just added to the hey groups list of high performing companies, a benchmark group of companies with strong financial performance, coupled with high levels of employing engagement

I'd like to take this opportunity to thank everyone of our 22,000 employees for their strong commitment to our noble cause. Our marketplace success as a result of our team's ability to provide clients with a customized solution and the transparency they require, along with a set of products and services tailored to lower prescription costs, lower total healthcare costs, and enhance health outcome. We call this making medicine smarter, and it's working.

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

Richard J. Rubino

Thank you, Dave. Good morning. I'll be taking you through our balance sheet and income statement highlights and will also provide further details behind our newly raised and narrows earnings guidance. As Valerie mentioned, the slides on our website should be helpful to you in following along with my commentary.

We closed the second quarter with $2.1 billion of cash in our balance sheet, going beyond the $1.8 billion on hand at the end of March. This is after repurchasing shares at a cost of $791.5 million during the quarter. We expect our cash balance to grow even further by the end of 2009.

Our cash flow from operations for June 2009 year-to-date amounted to $2.27 billion, an eleven-fold increase over the same period last year, and eclipsing our full year 2008 cash flows which totalled $1.64 billion.

This increase reflects our continuing efforts to improve working capital. For full year 2009, we now expect cash flows from operations to be in excess of $3 billion, a near doubling over our record 2008 performance.

Our inventory levels declined from June 2008 by over $590 million, a 28% reduction, to under $1.5 billion. The last time our inventory was this low was the first quarter of 2006 when our mail volumes were considerably lower than today.

We achieved this reduction through efficient inventory management, never impacting our ability to dispense prescriptions to members in a timely and efficient manner.

We are also focused on improving the terms on our manufacturer rebates receivable. While our earned rebates have grown 25.3% over the second quarter of 2008, our receivables have increased only 6%.

As a result of our working capital management progress to date, and our plans for the remainder of 2009, we now expect at least a four percentage point improvement in our return on invested capital for 2009, up from the previous guidance of a three percentage point improvement.

Out total debt remains at $4.6 billion, consistent with the balance for the past 12 months. One last comment on the balance sheet, Our June year-to-date capital expenditure totalled $98.1 billion, reflecting investment across the business. We currently expect capital expenditures of approximately $235 million for the full year of 2009. This is up slightly from our previous injection of $225 million, primarily the result of the significant new account wins.

With regard to our income statement performance, as Dave mentioned, our second quarter EPS results were quite strong. Second quarter 2009 GAAP diluted EPS of $0.64 increased by 25.5%. Diluted EPS, excluding the amortization of intangibles from the 2003 spinoff of $0.69, increased by 23.2%.

Turning to revenues, net revenues for the second quarter were $14.9 billion, representing growth of 16.9%. Product revenue grew 16.8% while service revenue grew 19.9%. Product revenue growth represents 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 include administrative fees in our significant retail volumes, clinical program revenues, and Medicare Part D service fees. Our mail order revenue for the second quarter grew by 2.7% to $5.6 billion, while the very strong retail volumes from our new accounts led to a retail revenue increase of 27.6%, reaching $9.1 billion.


Dave already walked you through our strong retail volumes and our stable mail volumes of 25.9 million prescriptions. Our other mail order volumes not counted as prescriptions which include OTC items and diabetes supplies, totalled 1.7 million units, 13% higher than our second quarter 2008 volume of 1.5 million units. The increase reflects growth from the acquisition of a majority stake in Europa Apotheek Venlo's in April 2008, plus continued growth in diabetes supply volumes from our Liberty medical brand, and volumes from a newly introduced Medco health store which is available to our members on www.medco.com.

Turning to rebates, we earned a record of $1.33 billion for the second quarter, representing the 25.3% growth rate I mentioned earlier, which is attributable to new client wins and continued improvements in formulary contracting.

Our second quarter 2009 rebate retention rate was 13.6% compared to 18.7% for second quarter 2008. We expect rebate retention to balance out for the year at approximately 13%. 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 6.8% compared to 7.3% for the same period of 2008. Our record gross margin dollars of $1.02 billion reflects almost 9% growth over second quarter 2008. All components of our portfolio contributed to this growth.

Sales and general and administrative expenses of $370.7 million for the quarter were essentially flat compared to the $368.4 million reported in second quarter 2008. We are pleased with this performance, especially given the dramatic expansion of our client base that we have experienced this year.

Our total EBITDA for second quarter 2009 grew 14.1%, reaching a record $689.4 million. Our adjusted script line grew 13.5% to 224.9 million scripts. Our EBITDA for adjusted scripts increased slightly to $3.07 in second quarter 2009 compared to $3.05 for the second quarter of 2008.

Our intangible amortization of $75.9 million in second quarter 2009 increased from $70.6 million in second 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 $41.2 million for the quarter decreased from $57.5 million in second quarter 2008, a result of lower interest rates in our debt and increased cash balances.

Our effect tax rate for the second quarter 2009 was 40.9% ,a point higher than second quarter 2008. This 40.9% rate is slightly higher on a sequential basis, but is expected to decline, particularly in the fourth quarter of this year.

Net income increased 18.8% to a record $312.1 million from the $262.7 million reported for the second quarter of 2008.

Moving on to share repurchases, under a $3 billion authorization we repurchased a total of 18.3 million shares during the second quarter of 2009 for $791.5 million and an average per share cost of $43.32 which was funded entirely from free cash flow.

Our weighted average fully diluted share count of 488.0 million shares for the second quarter decreased 29.6 million shares compared to 517.6 million for the second quarter of 2008, reflecting share repurchases made throughout the period and the effect of employee stock options.

We finished the second quarter of 2009 with 473.4 million shares outstanding plus a dilutive equivalent of approximately 8.6 million additional shares, bringing the total fully diluted share count to approximately 482.0 million shares on June 27th, 2009. This fully diluted share count becomes the entry point for third quarter 2009.

Moving onto Accredo, the success in our specialty segment continues. The strong second quarter revenue growth of 20.3% reflects higher volumes from new business. Accredo's second quarter growth margin of 7.4% is below the 8.0% experience in the second quarter of 2008, reflecting changes in channel mix. Importantly, Accredo's operating income grew at a very strong 30.5%, reflecting significant productivity gains. Accredo has become an increasingly important contributor within Medco's business portfolio.

Our Medicare success also continues. As we reported previously, the number of Medicare lives Medco covers increased 300% over last year, primarily from our new health plan sales in 2009. Our own PDP, though relatively small in the context of Medco's broader Medicare offerings, is demonstrating strong growth as well. Medco's PDP revenues in the second quarter increased over 72% to almost $283 million. Generic dispensing rates for our PDP grew to 71.2% with adjusted mail order penetration of 25.5%.

As Dave discussed we are raising and narrowing our guidance for GAAP diluted earnings per share to a range of $2.54 to $2.59 from the previous $2.45 to $2.55, a represented growth of 19 to 22% over 2008. Excluding the amortization of intangibles form the 2003 spinoff, we expect our diluted EPS to be in the range of $2.76 to $2.81. From the previous guidance, that's $2.67 to $2.77, and representing growth of 18 to 21% over 2008.

Now I will provide you with an update to the components of the detailed full year 2009 EPS guidance that support our increased and narrowed range. We now expect new generic introductions to contribute $0.13 to 2009 earnings per share, $0.02 higher than our previous guidance. We recognized $0.01 in the first quarter, about $0.035 in the second quarter, and expect $0.04 in the third quarter and about $0.045 in the fourth.

The increase reflects earlier than expected generic releases for some lower volume product and slightly higher yields on scheduled product introductions. Our EBITDA for adjusted script is now expected to be in line with our full year 2008 performance of $3.09.

We now expect mail prescription volume for the year to approximate 103 million prescriptions, slightly below the low end of the previous range. Very importantly, the volume of generic mail order prescriptions in our revised guidance is unchanged from the volume of generic mail order prescriptions in the midpoint of our previous guidance of 106 million prescriptions. The total volume reduction is generated from brand name scripts, a direct outgrowth of the recession and the resultant prudent use of benefits by members.

As we have stated in the past, Medco recognizes that brand name drugs represent a significant financial pain point for clients and members, and in alignment with client interest, generally prices these branded drugs to break even.

Our adjusted mail order penetration rate for the full year is expected to be consisted with the 34.4% reported for the second quarter of 2009. We expect that our gross margin percentage for the full year will be consistent with the 6.6% experience for the first half of 2009. SG&A expenses of 2009 are still projected to be essentially flat with 2008 and approximately $1.4 billion.

Net interest expense for 2009 is expected to be on the low end of the previous range of $170-190 million, at the $170 million level reflecting lower interest rates in our debt and higher cash balances. Intangible amortization expense is expected to be on the high end of the previous guidance range of $295-305 million, at the $305 million level.

The effective tax rate for the full year is now expected in the rate of 39.0-39.5%, which represents a narrowing towards the high end of the previous range of 38.5-39.5%. We continue to expect the lowest rate in the fourth quarter of the year.

The weighted averaged diluted share count is expected to be approximately 490 million shares, compared to our previous guidance of 485 to 500 million shares.

For our Accredo specialty business we currently expect 2009 revenues of over $9.3 billion, higher than the previous guidance of over $9.2 billion. Accredo operating income is now expected to exceed $350 million, higher than the previous guidance of over $325 million.

We expect Accredo's full-year growth margin percentage to be in the mid-7% range. We look forward to our third quarter call when we plan on taking you through our guidance for 2010. In addition to the update on the 2010 sales year that Dave already provided, I would like to report that our renewals for 2010, including schedules and a preliminary view of early electric renewal, are expected to be in the $15-20 billion. As reference points, we renewed $15 billion in 2008 and as Dave already mentioned, we renewed $23 billion worth of business in 2009.

The success of our business and financial strategies is evident in our second quarter result, and our new earnings guidance, it's a testament to our confidence in full year 2009. Now Dave and I would like to open the lines for questions. Amanda?

Question-and-Answer Session

Operator

(Operator's Instructions) Your first question is from Lisa Gill, JP Morgan.

Lisa Gill - JP Morgan

Thanks very much and congratulations, guys, in doing it in less than 30 minutes this morning. (Laughter) We appreciate that. Dave, I guess just a couple questions for you and then a followup for Rich. There was an article back a few weeks ago in the Wall Street Journal that talked about manufacturers paying co pays for some of the more expensive drugs. One, can you talk about if you're seeing any of that, especially in your specialty business? And two, if they do that on some of the chemical compounds that have a generic equivalent, what do you think that does to your business model? And just secondly my question would be that we know you've been spending a lot of time in Washington, can you maybe just talk about other than prescribing and bio generics, is there anything else that you're lobbying for on behalf of the PBMs when we think about healthcare reform?

David B. Snow, Jr.

Yeah, bunch of good questions. I think relative to pharma and the subsidization of a co pay, just from a healthcare form perspective, not a Medco perspective, a healthcare reform perspective is a really bad thing to do because it fundamentally takes some of the benefit design that's meant to create consumer driven behavior, prudent buyer behavior, out of the system. And it just, generally speaking, I think should not be allowed. And by the way it's caught the attention of Congress.

Relative to how it affects Medco is it really hasn't affected Medco because for the most part these programs are being offered in the biotech space more so than the chemistry space where the real generic wave is occurring. And as you know there are no generics in the biotech space so this would undermine formularies to the extent lots of clients had formularies, but that's a relatively new concept and there aren't a lot of formularies to date. But I think it's a problem as you go forward as it might undermine formularies.

And I actually think Congress may address this because it's on their radar and it's talked about a lot. But to date we're not terribly concerned about it.

Relative to activities in Washington, I kind of went through the things I think that are likely to happen. The one place in my prepared comments I didn't give a lot of granularity is this whole thing about how important the pharmacogenomics and the therapeutic resource centers are to root cause, reform relative to our healthcare problems in this country.

And what we are trying to do is work very hard to get a better approach to managing chronic and complex disease on the table and we obviously use, as an example, our therapeutic resource centers, because it's pretty much widely accepted. A conservative number is we waste about $350 billion on the poor management of chronic and complex disease, and we spend a lot of time educating Congress about how we can do a better job since drugs are the first line of defense in almost 90% of all chronic and complex diseases. And the truth is, the drug part of the system is wider today. And we show them the numbers and the methodologies used to create accountability around better outcomes on chronic and complex disease and we even have data that shows a real strong correlation between compliance and reduction and total healthcare costs.

So that data is down in Washington. We'd like to see some at least on pilot programs in that regard, which I think would prove themselves very useful, especially in the Medicare population where 70% of the total population has a chronic or complex disease.

So that's the one thing I didn't talk about. I would say — I think you've been reading the headlines. I would say that there isn't going to be a public health plan. I really don't think that's going to happen, but I do think we'll make some incremental reforms and many of them are in the right place. I think one of the things I'd like to see is I do believe there will be a pathway for a biosimilar. I don't like as much the 12-year exclusivity and there is still a very significant debate going on and we'd like to see a shorter period of time, but we'll take tier at this point.

Lisa Gill - JP Morgan

And are you recommending to them — I mean if we think that there's no national plan, are you recommending though that pharmacy, a you think about pharmacy, should be carved out in some way? I mean it looks like if we move forward it will be the existing insurance companies that will take care of the increased number of insured now. What are your thoughts about carve in versus carve out? Do you think that the government needs to step in and say that we think the standalone PBMs, we've had conversations with Medco, they do it so much better. We want to make sure that these people are really truly managed and this is what we're going to do. I mean is that what you're hope is?

David B. Snow, Jr.

Well what we're trying to do is be politically sensitive and so what we're really talking a lot — we're not going to talk about who's capable of doing it. I think that comes out in the wash, but what are the criteria for appropriate management of chronic and complex disease? What capabilities must you have, and the rest will sort itself out.

So we really want the concept understood. We believe you're more likely to get something done if you stick to what are the criteria verus pushing policies that excludes a channel or excludes specific participants. We really want to talk about how the system can get better and clearly there are men who can play in that new system and that's been our approach down there.

Lisa Gill - JP Morgan

Okay, great. And obviously Davis, but if Aetna and others start selling their PBMs to the likes of Medco, that probably won't be an issue. And then just a second followup, Rich, on your guidance of the mail order volume, should we be assuming that generic utilization in your mail book goes up even though as the mail volumes come down a little bit, just based on your comments?

Richard J. Rubino

Yes. By definition that's what you'd have to assume.

Lisa Gill - JP Morgan

Okay great. Thanks very much.

Operator

Your next question is from Ross Muken with Deutsche Bank.

Ross Muken - Deutsche Bank

Dave, I wanted to dig into a little more of what you just commented on. There was a lot of talk about sort of this oversight panel trying to drive towards something like protocol-based medicine which you talked a lot about historically. Now with these sort of powerful datasets that you guys are coming up with, what sort of new business opportunities does that possibly suggest could come about? I know this is something that's sort of futuristic, but it just seems like you guys kind of are in the sweet spot of what should probably happen from sort of developing a cost-benefit way of approaching healthcare and I think that's one of the key things that's coming out is we're talking about utilization going up and covering more people, but the real thing we need to talk about is sort of the right type of care at the right costs and it feels like you're sort of in the sweet spot. So I'm sort of curious as sort of what you guys have thought around that and sort of if there's anything else from a longer-term business perspective that you've thought about that makes sense to address that.

David B. Snow, Jr.

Yeah, Rob. We do believe we're in the sweet spot and we're not just talking about it, we're actually doing it today. It's already been publicly disclosed previously that we do have a contract with the FDA to do the equivalent of comparative effects in the study. And you're right we are big believes in protocol-driven practice and we're big believers in comparative effectiveness, and that whole conversation has real legs down in Washington.

The people who argue against it are most frightened that it will turn into the NICE program that exists in the UK where comparative effectiveness is really used as an excuse for financial management of a system, regardless of what the clinical data shows. But I believe we can do it properly and I believe implicit in a wired healthcare system, it's better analytics and regarding what's effective and what's not effective. So I think we're heading in the right direction, you know that the stimulus package still has that $20 billion earmarked for health IT and the wiring of a system. That all lends itself beautifully to better information about what works and what doesn't work and I think that because 96% of all the drug money goes to chronic and complex disease, 75% of the medical money, and drugs are the first line of defense — the learning's there, the opportunities are huge, and Medco definitely has a place.

We're still on track this year to publish landmark studies — more than 12. And these are things that change the practice of medicine and I think this is just the beginning and it's a huge opportunity. Where it will go in terms of additional business opportunities monetarily is yet to be determined, but I think it's very powerful and nobody in the country has a larger longitudinal database around this than Medco. So I'm pretty excited about it.

Ross Muken - Deutsche Bank

Dave, it all makes so much sense that probably unfortunately that won't happen because D.C. doesn't always sort of do what makes sense. What degree is sort of your customer-base understanding of this? Because it seems like look, the new business momentum is still quite good, do you feel like the customers sort of appreciate this now more so than they did historically? Not just sort of the TCRs, but sort of some of these more futuristic approaches than maybe some of your peers are necessarily focused on?

David B. Snow, Jr.

I believe that our customers understanding completely the power of the therapeutic resource centers, the power of using integrated data, the power of protocol driven practices at the pharmacy level. They understand that completely and I think the sales numbers are a testament to that fact. If you were to ask me where I need to go next I think we need to focus on even more granular reporting to show how Medco at the client level's moving the needle around the activities that these — now that we've built this capability, the reporting out will be the next, I think, milestone that we're going to work on and actually we have some new technologies we're deploying to make that possible and I think it's pretty exciting.

Ross Muken - Deutsche Bank

And quickly, Rich, you have sort of the CFO dream problem of having so much cash generation now you have to figure out how to deploy it. Obviously you have some left on the buyback, buy as we look at the ROIC come up significantly this year, how are you thinking about other external opportunities and what that would have to look like on a returns perspective relative to this sort of new hurdle rate of sorts that you've created for yourself?

Richard J. Rubino

Well there's no guarantee that any acquisitions going forward would be immediately Accredo from an ROIC perspective. In fact it's highly likely that they wouldn't be so you'd really have to balance out the longer-term value from an ROIC perspective of an acquisition, recognizing that there will be likely shorter term dilution.

At the end of the day we have $1.8 billion left as you alluded due on a $3 billion authorization. We are always looking at opportunities. We look at them on a risk-adjusted NPV basis and in the mean time we are sitting on a lot of cash. And now that the credit markets have opened up somewhat there's perhaps an opportunity down the road to pay down some of our securitization since we're comfortable that we'd be able to draw back down on those if needed, in the case of an acquisition or whatever.

Ross Muken - Deutsche Bank

That's helpful. And then one last thing, where are we on share count as of today?

Richard J. Rubino

I said that in my —

Ross Muken - Deutsche Bank

Oh I must have missed it, sorry.

Richard J. Rubino

It's okay. I can get that for you. It won't take but a minute. Okay, so essentially what we've got is we're looking at approximately 490 million shares in guidance, but I also said what the entry was going to be for the next quarter and that is — if I can find that — it's easy for you to ask and me to — (laughter). Here we go, finished the second quarter with 473.4 million shares outstanding.

At the end of the day when you add in the diluted shares we're at about 482.0 on June 27th.

Ross Muken - Deutsche Bank

Okay. So we're roughly around that today?

Richard J. Rubino

Exactly.

Ross Muken - Deutsche Bank

Okay. Thank you.

Operator

Your next question is from Larry Marsh with Barclays Capital.

Lawrence Marsh - Barclays Capital

Thanks and good morning, a couple of quick things; first, congratulations on the continued new business momentum as that is really great. On the consolidated auto VEBA, is there anything that will be different in this new contract that would potentially change the mix or on product or mail, and has the length of that contract been disclosed?

David B. Snow, Jr.

No, it hasn't been disclosed, Larry, and we're not at liberty to talk about the details around the benefit design. That's constrained by the client.

Lawrence Marsh - Barclays Capital

Okay. So that would be totally their call on what they'd want to talk about. Okay, great. Secondly, I know you get asked about Cigna now Aetna just about every day. You've been, I think, very clear in your view of the value you can bring here, but is there anything in the questions you're getting around values, pricing terms, timing these days, that strikes you as off base, or is the general buzz still reasonably accurate in your view?

David B. Snow, Jr.

Well I can't speculate on the rumors around other assets being on the market, but I can comment on the Wellpoint transaction because that's the one public transaction that's been completed with actual numbers, and that one made all the sense in the world financially. I mean I can tell you that that, when you do the math around it, makes sense.

Lawrence Marsh - Barclays Capital

Right, okay. Two other things, Part D I know you've highlighted that as a big driver for success of your new business as you talked about increasing your penetration for your customers MAPD business, but in our recent customer review it still strikes us how many PBMs still service that business. I mean is there still a lot of green field out there for you given your ability to save costs, and are there any bigger opportunities still for 2010?

David B. Snow, Jr.

Well, here's how to think about it because the bulk of that growth is ASO-based growth, where the health plan is the underwriter and we're serving the health plan. So in connection with that, sure there are still some opportunities out there with some relatively large players starving that population in both MAPD as well as PDP.

Lawrence Marsh - Barclays Capital

Okay. And then finally on Accredo, for the past six months you've taken up your profit expectations here by about 50 million, it is about $0.06 a share. And I know you suggest a big part of that is increasing customer penetration, but is there anything around product mix that's also helping to drive that profit increase? And then as we think about 2010 with this business — heavier Medicaid exposure in other states, is there any reimbursement challenges that you're highlighting over the next year or two?

David B. Snow, Jr.

Sure. Just looking at the profitability, and we do have Steve Fitzpatrick here so he'll probably add to what I'm saying — from a profitability perspective we continue to see high rates of product inflation in this product line. Of course we saw last year, significant increases on a per unit basis, as I recall of 11.8% and that was recorded on a drug trend report last year. So we do continue to see price inflation that will buttress profitability. Tremendous growth in lives — of course the majority of the business that we win includes a specialty component. You also see continued strength in the non-Medco customer piece of the Accredo business. I'll turn it over to Steve with regards to any observation on medical and reimbursements.

Steve Fitzpatrick

Yeah. I think as we look forward we are watching the medical in California and some of the other states very carefully, but I think we're pretty well positioned there and we've had a good impact. And the other question is the mix has not changed dramatically over the past couple of years.

Lawrence Marsh - Barclays Capital

Okay. I see, thanks.

Operator

Your next question is from Tom Gallucci with Lazard.

Thomas Gallucci - Lazard Capital Markets

Good morning, everybody, just a couple of followups. On the specialty, since we were just talking about that, can you just remind us where the penetration of your existing PBM base of business is and sort of what you're expecting that to go to over the next few years in terms of them using your specialty capabilities?

David B. Snow, Jr.

Yeah. Roughly speaking we have had over 50 million members of our over 60 million covered through an Accredo specialty program and we would expect to see continued increased in that penetration over time because as I mentioned earlier, most of the wins that we've been gaining in recent history have included a specialty component.

Thomas Gallucci - Lazard Capital Markets

And then just to look back on the VEBA, I understand you can't give a lot of the details, but I've heard some different things about the start date, just when will that new business be implemented for you?

Richard J. Rubino

As I said in my formal comments, it's 110.

Thomas Gallucci - Lazard Capital Markets

It is 110. And then I guess just a broader question about benefit design sort of given the state of the economy, maybe as it pertains to the selling season, but also with existing customers, are there any inflection points or trends in terms of customers getting more aggressive as they look out to benefit design for next year?

Richard J. Rubino

I would say that the tools that we've talked about in the past are still the most popular tools that are being deployed. The only comment, and I've made this one before, is that certain clients have been reluctant in the past to take advantage of those tools, but this recession has made them more open to implement the tools that others did long ago.

So for example, we had many clients who still were not on a three-tiered formulary because of their own preference and this recession has driven them to implement things like that. So we're seeing just more uptake on the existing products that help control costs.

David B. Snow, Jr.

Further to that point, recognizing there are many tools — mandatory mail lives have actually increased so mandatory mail lives at the end of 2007 were about 9 million and at the end of '09 were about 10 million and at this point about 10.5 million.

Thomas Gallucci - Lazard Capital Markets

Okay, great. Thanks for the color.

Operator

Your next question is from Robert Willoughby with Bank of America.

Robert Willoughby - Bank of America

Hey, Rich, at some point I think you're going to have to explain to me how any acquisition would be immediately accretive to your ROIC. I think your people should talk to my people, but that's not my question. I guess my question would be is there anything other than the kind of profile on the new business that would contribute to any concern over your ability to raise that profitability, and what kind of swing factor do you ultimately think you can get out of the current enrollment base?

Richard J. Rubino

Well first of all I think you misunderstood what I said because I said the exact opposite of how you just quoted me. I said that it is highly likely that any acquisition would in fact be dilutive to our return on invested capital certainly in short run, albeit not over the longer run.

Robert Willoughby - Bank of America

Got you. I did mishear you.

Richard J. Rubino

So I think we're on the same page there so that's okay. With regard to the profile of the new business and prospective profitability opportunities, well as I've said before, when you win a lot of business at 9% mail pen as we have, the ability to drive that mail penetration higher is significant. And particularly when you consider the great success we've had recently in increasing generic dispensing rates, not just the function of the new products coming on board, but very strong performance in ongoing generic substitution rates combined with the Accredo components thereof, I think there's a lot of additional profit generation potential in this new quiet base.

Robert Willoughby - Bank of America

And you would characterize the margin level they're on as more material than the new business opportunity for next year from an EPS-driver standpoint?

Richard J. Rubino

Well I'll give further clarity on that when we give our guidance for 2010.

Robert Willoughby - Bank of America

Okay. And I guess a question on the capital deployment. In the first quarter we didn't see much in the way of share repurchases with one PBM deal out there and the second quarter here you've stepped it up with two deals seemingly in the market, who knows? But why would we not see a more share repurchase trend than what we've seen to date?

Richard J. Rubino

Well each quarter we discuss with our board the proper level of share repurchases and the associated target stock prices and so forth. And as you saw this quarter, we were able to repurchase a significant amount of shares, but we still kept plenty of cash at the ready if in fact there were acquisition opportunities out there, not to mention the fact that if there are acquisitions in the future, it's not really a function of the cash that we would have on hand because as I mentioned earlier, the credit markets, as you know, have opened. So with our strong balance sheet we should have access to a relatively low cost debt if we needed it.

Robert Willoughby - Bank of America

And did you indicate, Rich, if you'd been active since the end of the quarter?

Richard J. Rubino

I did not.

Robert Willoughby - Bank of America

Will you indicate that or is that to be announced?

Richard J. Rubino

At this point with regard to share repurchases thus far, into this quarter there really hasn't been anything to speak of.

Robert Willoughby - Bank of America

Okay. Thank you.

Operator

Your next question is from Randall Stanicky with Goldman Sachs.

Randall Stanicky - Goldman Sachs

Thanks for the question. Rich, just a followup, and I don't want to beat a dead horse, but should we expect more stable deployment on share buyback going forward? And then secondly maybe can you guys comment, you talked about mail pen at 34.4% for the year, can you maybe give us some of the thoughts around your ability to drive penetration or what you're factoring in for some of the newer business that has a lower pen rate including maybe UNH?

Richard J. Rubino

Sure. So at this point if you look at the share repurchase that we've got on the second quarter which were significant and at a relatively low average per share price relative to where we are today, we're getting ourselves pretty close to the share range I gave you for the year. So I'm not going to tell you to expect that there's going to be stability or a repeat of the second quarter in the third or the fourth.

So I'm not necessarily looking right now to have any stabilization over the next several quarters. That's just not the current expectation. I'll give you more of an update of course when we carry you into 2010 guidance next quarter.

With regards to the ability to drive penetration, I can tell you that the opportunity certainly remains. We are, at this point, with the new united deal as well as the new clients we added this year, we're not seeing massive increases in mail penetration at this point, we are though seeing improvements in generic dispensing rates and so forth which are, in many respects, more important than just your raw mail penetration rates.

I'll also tell you that as I've said recently, we do earn a profit on retail as well and you can see that in our strong service revenue growth this year. And as a result of us having balanced pricing with our clients, we are, in fact, earning client fees on those retail claims and that is certainly supporting our profitability prospects as well.

David B. Snow, Jr.

And let me add to Rich's comments, Randall. There's no question that Medco's mail conversion programs are actually working better this year than any other year in the past so that part of our machine is working extremely well. The interesting thing, and it was the conundrum we faced at the beginning of the year, was how would the consumer behave in this very significant recession relative to their overall purchases of drugs broadly? And so getting the right number at mail was hard because we really didn't know how the consumer would behave, we'd have no history to look at to predict the future at that time.

Rich gave something really fascinating that I just want to repeat because it is fascinating. What we've now learned from a consumer perspective is that in fact we have seen a drop-off in prescript use, but only in the branded side of it now. So what you see is this prudent buyer behavior occurring where people are up taking on the generics, they've slowed down on the brand affecting total mail volume, but not the generic part of our projections relative to the year, so that's really, really good news for us because as Rich mentioned, we aligned with our clients and we price brands at mail at cost. So this is just an interesting learning experience. So the degradation in volumes have been — we've been moving people to mail very effectively, but you see a lower growth expectation simply because of the brand effect in this recession. And I think it's really interesting and from a financial perspective that mix change is very meaningful in a positive way for us.

Randall Stanicky - Goldman Sachs

And, Dave, you've been pressed a lot on the economy and whether or not you're factoring a 10% unemployment rate. As you look back now, I mean has it had that much of the impact on the overall business? And clearly there's some signs of improvement going forward so as you reflect, has it had as big of an impact as you would have thought?

David B. Snow, Jr.


I say it did. Obviously Rich and I have communicated that we were fully planned in at a 10% unemployment rate and the effect that that would bring, and we also tried to factor in even if someone was still employed what they might do as a consumer relative to out of pocket costs and so the pleasant news here is that the generic volumes were very definitely maintained. It was brand volume where the consumer changed which means our bottom-line economics were not smooth the way our planning said it might be.

Randall Stanicky - Goldman Sachs

Great. Thanks, guys.

Operator

Your next question is from Charles Boorady with Citi.

Charles Boorady - Citi

Hi thanks, good morning. I am wondering if you can talk a little bit more about the selling season for 2010 and first just a minor question on the VEBA, I know you can't talk about the dollar amounts on VEBA, but is the VEBA impact for 2010 reflected in the net 2010 sales figure that you gave?

Richard J. Rubino

Yeah. Remember GM and Ford are simply considered in our accounting renewals and the Chrysler piece is considered new names. So it is a piece of that quarter-over-quarter addition in our total sales.

Charles Boorady - Citi

Got it. And then I'm wondering if you could speak qualitatively, since you've given us the numbers already in terms of the net new sales and how you'd characterize the business opportunities looking forward to 2010 versus previous years in terms of things like the number of customers going out for a bid, and any changes in customer preferences. For example, are they adding things to the RFP that would impact your revenues or ability to win business because or your therapeutic resource centers. If there's any change in the customer preference for a focused standalone PBM versus a drugstore owned or a health plan owned PBM that you're seeing.

Richard J. Rubino

I would say broadly speaking, recognizing that 2009 is just an off the chart sales year — I mean off the chart in terms of $10 billion in new-name sales. That's just a very big number. But I say 2010 is a very good year. Our $2.8 billion in new names this early in the year bodes well for us so we like the way the year is shaping up. There is opportunity in 10 that's meaningful and I'm hoping that we can continue to give you updates as the quarter's perceived — by the way, a $2.8 billion sales year on a standalone basis is historically a very good year. I think we've been spoiling in the past Q because our sales have been so strong, but they continue to look great in 2010. And I would tell you generally speaking the RFPs as they come over to (inaudible), haven't changed much, however we have seen in some cases added by consultants, added in some sections on the clinical management of care. I'd say that's the newest thing we're seeing more often and that's great. It plays right to our strengths.

Charles Boorady - Citi

Do you have preference for drug-store owned versus pure play versus health-plan owned? Are you getting any more customer feedback on that?

Richard J. Rubino

I just think you have to watch the sales numbers across the spectrum and draw your own conclusions.

Charles Boorady - Citi

Alright, thanks.

David B. Snow, Jr.

Okay. We have time for one more question.

Operator

Your final question is from Helen Wolk with Sanford Bernstein.

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

Hi, thank you for taking the question — a couple of questions. First on the TRC question, I know you mentioned earlier that the value proposition is resonating as sort of measured by your sales. Could you tell us a little bit about how clients are thinking about it from an outcomes or performance metrics perspective? And then are you sort of guaranteeing or willing to guarantee around those metrics?

Richard J. Rubino

Yeah. So the way we're guaranteeing today is we call it closing gaps in care. So the big problem in chronic and complex disease, our customers understand that that's where all of their money is spent when it comes to taking care of their employees, it's chronic and complex disease. And they understand that closing these gaps in care, patients not doing what the doctor tells them to do or doctors not being up to date on the landmark evidence around how to manage specific chronic disease, lead to $350 billion of waste nationally. That breaks down to each of our customers wasting enormous amounts of money in the proper management of chronic disease.

So what they look for from us in the early stages right now is guarantees around closures of gaps in care and right up front we can show clients by disease how many gaps they have in care for all the people in their population with diabetes, all the people in their population with asthma, et cetera and so forth, and we can measure and show how we close those gaps in care with the fundamental belief and the data supporting that as you close those gaps in care your total healthcare costs come down. I see us as part of this reporting I talked about earlier, our elevating our gain there as we have integrated data. We believe over time, and you got to remember, close the gaps the first year you start seeing an improvement in total healthcare costs in the second year — we need to do a good job reporting out at the disease level in an aggregated way for their populations what that looks like. Our actions result in what reaction, financially and clinically? But that's what they're looking for, that's what we're delivering, and we're just going to get better and better at how we parse that data and actually improve our services to drive that fundamental value prop of lowering total healthcare costs tied to therapy management.

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

Great. And then a second question on generics and generic pricing. We've heard a lot about pricing stability in the market, maybe seen it in some of the generic manufacturers' reports. Any sort of color on how that impacts in terms of the margin opportunity for PBM or pharmacy?

Richard J. Rubino

Well on the purchasing side, of course as we continue to grow, our purchasing power increases and so too does our ability to get steeper discounts. As we've said before as a result of some of the consolidation on the generic manufacturing side, we haven't really seen any harm to us as a result of those consolidations. So when you're as large as Medco is, and as long as we're growing as we are, and as long as our members continue to prefer generics as we're saying, I think there are good prospects going forward and I think our clients are really enjoying the benefits of this in the form of very significant savings to them. So all in all there's a promising future there.

David B. Snow, Jr.

Okay. We appreciate that you joined us for our second quarter earnings call and we look forward to talking to all of you after third quarter call or if we have any conferences in the meantime I'm sure we'll see you there. So thanks again for listening to Medco.

Richard J. Rubino

Thank you.

Operator

Thank you for participating in today's conference call. This concludes the call. You may now disconnect.

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