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Express Scripts Inc. (NASDAQ:ESRX)

Q3 2009 Earnings Call

October 29, 2009 10:00 am ET

Executives

David Myers - VP of IR

George Paz - Chairman and CEO

Jeff Hall - CFO

Analysts

Charles Boorady - Citi

Ross Muken - Deutsche Bank

Tom Gallucci - Lazard Capital

Randall Stanicky - Goldman Sachs

John Kreger - William Blair

Robert Willoughby - Bank of America

Lisa Gill - JPMorgan

Welcome to the Express Scripts third quarter 2009 earnings call. At this time, all participants are in a listen-only mode. Later we’ll conduct a question-and-answer session and instructions will be given at that time. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to Vice President of Investor Relations, Mr. David Myers.

David Myers

Welcome to our third quarter conference call. With me today are George Paz, our Chairman and CEO; and Jeff Hall, our CFO. Before we begin, I need to read the following statement. Statements or comments made on this conference call may be forward-looking statements and may include but are not necessarily limited to financial projections or other statements of the company's plans, objectives, expectations or intentions. These matters involve certain risks and uncertainties. The company's actual results may differ significantly from those projected or suggested in any forward-looking statements due to a variety of factors which are discussed in detail in our filings with the SEC. In addition, the reconciliation of EBITDA to net income can be found in our earnings release which is posted on our website.

At this point, I will turn the call over to Jeff, who will provide details on our third quarter results.

Jeff Hall

Thanks, David. As most of you know we had another strong quarter with adjusted EPS of $0.81. This excludes non-recurring items, but includes $0.18 of financing costs related to the NextRx transaction. On an apples-to-apples comparison of the base business, we are up 22% over last year due to strong underlying financials.

Gross profit percentage for the quarter continued to strengthen at 10.9%, up 140 basis points from last year. Total adjusted scripts were up over 2% due to some mid-year starts and increased utilization patterns, and Home delivery claims were up again sequentially as our behavioral economic tools continue to show positive results for our clients.

As I mentioned last quarter, due to our strong operating performance, we’ve increased our investments in the core business. We expect these initiatives to drive increased member and client satisfaction, higher levels of productivity and to enhance our intellectual property and extend our lead in the application of behavioral economics to the pharmacy benefit. As a result of these investments SG&A, excluding non-recurring items was up about 10% in the third quarter over last year.

Despite these investments, adjusted EBITDA per script was $3.38, an increase of 18% over last year and 6% better than last quarter, which further demonstrates the power of our aligned business model.

Cash flow from continuing operations was also strong as we generated over $395 million in the quarter which is a 62% increase from last year. We are [hitting] the home stretch in the pre-closed work on NextRx and we now expect to close in the next four to six weeks. The time we have taken pre-close will help us to ensure that we have a smooth transition and will put us in a position to integrate WellPoint's members onto our systems on the lower end of the 12 months to 18 months we have told you about before.

All things considered, we are happy with the progress we have made so far and remain excited about the long-term prospect of this acquisition to create significant shareholder value for us while lowering costs and improving health outcomes for WellPoint and their members.

Moving on to our 2009 guidance; again because we have not yet closed the transaction, our guidance is only for our existing business. So for 2009, we are now expecting core EPS in the range of $3.76 to $3.82. This excludes any non-recurring costs and financing costs related to funding the acquisition. Table four in our press release provides further details.

Finally, we have been getting a few questions on why we decided to give 2010 guidance with our Q4 earnings. It's really pretty simple, so let me walk you through our thoughts on this. First, we don't have new information that would lead us to change our view on the expected accretion from the acquisition. Second, as we have been saying, we will only give guidance for the combined company and we will wait until we’ve had a chance to validate our assumptions after the close to do this. These factors and the expected timing of the close would have led us to provide guidance in late September or early January.

Given that, we decided it would be more useful and quite frankly more efficient to wait a few extra weeks, so we’d be able to not only more fully validate our expectations but also see how membership for NextRx is changing in 2010 and therefore guide to a more precise range. Just to be clear, we are waiting to give 2010 guidance, so that we can give a more precise range, not due to any changes in our expectations or any new information.

With that, I will turn it over to George.

George Paz

As you know, we have wrapped up the signature account season. Clearly this is our strongest selling season in recent history. We won eight new signature accounts which we define as those accounts with a million or more annual scripts. We won roughly half of the signature accounts that changed PBMs this year.

Overall, we've won 238 new accounts and we anticipate driving that number even higher as we wrap up the middle market season. Even with the warrants of a major managed care client which was acquired earlier in the year, we still anticipate positive script growth in 2010. Equally as important we have retained 98% of our current book of business. We attribute these results for our business model of alignment coupled with outstanding service levels and client relationships.

Also, we deployed next-generation reporting tools that our clients and prospects are enthusiastically adopting. These tools enable our clients to manage their benefit more efficiently and unlock [tailored] saving opportunities.

Finally, our clinical offerings enabled by advanced understanding of human behavior, provided unparalleled value position in the marketplace. Yesterday we hosted a conference at the University of Chicago to explore the convergence of behavioral economics in healthcare. The 150 claims sponsors in attendance have reinforced a growing sentiment that cost-cutting edge PBMs will need to bring an advanced understanding in consumer behavior and decision making to drive better healthcare outcomes.

Consumerology is the tool which improves existing clinical program performance to increase member engagement. We’re leading this movement and are seeing results that are surpassing our initial expectations. This will continue to differentiate us in the marketplace. The time, energy and resources invested in consumerology could not have been more timely or relevant, and certainly the experience and the knowledge we've gained are not solely applicable to the pharmacy benefit.

We are looking forward to the potential application of this knowledge and to other areas of healthcare. Through our relationship with WellPoint we are committed to changing the delivery of healthcare in order to improve health outcomes while driving out waste.

While it is difficult to predict the ultimate outcome of the healthcare debate, one thing is certain, reform will bring that change. We have a proven track record for capitalizing on change. We believe that any reform provides opportunity for us to demonstrate our evidence-based value proposition.

Throughout our history, we have demonstrated thought leadership and the creation of value for clients and our members. Our business model of alignment coupled with our behavior-centric approach is a template for the solutions that Washington is seeking.

At this point, we are happy to answer any questions.

Questions-and-Answer Session

Operator

(Operator Instructions) We will begin at the line of Charles Boorady with Citi.

Charles Boorady - Citi

Thanks for those comments regarding the 2010 guidance, recognizing the nature of the transaction warrants waiting. If we put the transaction aside though, looking at 2010 just on an organic basis, you talked about a very strong selling season. How would you characterize the outlook for 2010? Is it consistent with your outlook for ’09 last year this time, better or worse?

George Paz

Let me just take at stab at this and I'll ask Jeff to comment if he has anything further to add. 2010 has a lot of things going on in it. Obviously we’ve had a very strong selling season. We have actually been redeploying some of our capital into our base business to actually position us well for the future. We believe investing in the future. I suspect there will be some level of healthcare reform for change. We need to be prepared for that.

I think we are very well positioned to take advantage of that. Probably one of the more positive things is utilization trends have picked up some, but when we go back to historic levels, we’re still trailing historic levels fairly broadly, on a pretty big margin. So that is something that still needs to get better in line. I think the fact that we've turned the corner and are showing increases in script accounts is definitely positive.

Keep in mind how our business works. When you add a lot of new accounts, there is a significant amount of new start-up costs as we have to convert those claims (inaudible) and take all the calls and convert all the mail order files over. There are usually some higher costs associated with that.

There is a lot of headwind, but we’ve got a lot of tailwinds. So we feel very good about where we're positioned. As far as giving any more specific than that I think it would be better for us to wait until we can give you a complete picture after we get some time with the WellPoint data and see where they are at.

Charles Boorady - Citi

Finally, in terms of a jumping off point for modeling 2010, is it fair to just rollback in the financing costs related to the transaction and exclude the one-time items? Can you talk about what do you see as a real run-rate 2009 number to use as we model our 2010?

George Paz

Obviously the financing costs are going to continue, but the way we look at it is the base business here is 376 to 382. The financing cost is going to continue. So, certainly you would have to factor that in. Then to take a look at, what the addition of NextRx is going to add and what we've said is moderately accretive to that.

Operator

We will now go to the line of Ross Muken with Deutsche Bank.

Ross Muken - Deutsche Bank

The commentary on the selling season was obviously very encouraging, particularly on the signature accounts. I know this is sort of a big focus of yours, for this selling season versus some of the success you've had in the past in the mid-market. What do you think was sort of the key element to drive the hit rate that you had which was quite good on the business that changed hand? Was it the behavioral economics and the consumerology efforts that were really starting to resonate? Was it any other sort of differentiation in the approach, the way you went about things this year?

George Paz

Everything in our business, probably similar to yours is based on relationship. For us to win a new account means you can't just meet them for the first time at the [finalist] presentation. So we had to be focused on being out in front and starting to build relationships and talking about what we do. At the end of the day, we’re selling to various businessmen and what they’re looking for is to better manage their healthcare trends.

So what we have to do is to be able to demonstrate that we are better than our competitors in managing those trends. When you get right down to it, the backbone of any PBM that’s going to add new claims and grow has to be around clinical services.

The most important thing you can deliver is clinical services that drive out waste while not disrupting the members. That's a big statement because when you run step-therapy programs, prior-authorization programs, mail order campaigns and other things, there is member involvement. And what we have to make sure we do is drive those members to the lowest cost products while not causing them to become upset or feel like they are limiting access or anything else. So, we have invested a lot of money in that. How do we do it?

Our approach is through consumerology. So consumerology is an enabler. It's a tool that we use to get our clinical programs to gain better traction. That resonates extremely well in the marketplaces. I think you've heard us say in the past, when you look at healthcare we've got a lot of accountants and medical people that are trying to influence a population at large. At the end of the day the proven companies that know how to market to individuals, the Anheuser-Busch’s and the P&Gs and on and on really know how to get to those members. I think that's the approach we're taking, that you just can't come in with a stick-and-carrot. The members today want to better understand their healthcare. When we're successful, we want to take out stronger footholds in managing their healthcare. So we need to provide that medium and those tools for them to do that, and once we get them bought in, then we can move them in the right direction. Our approach is paying [spades] for us.

At the end of the day though, the other thing you have to have is you have to have the tools for the client. We've invested heavily this year and rolled out a new reporting package for our clients. So we are focused on the ember because you have to take care of trend member by member, one member at a time, but at the end of the day, it all aggregates up to a composite trend.

So the client needs to be able to see what is happening in their underlying business, where their high cost patients are and what's happening with those people from an adherence perspective, from compliance, from just overall perspective of how those numbers are the cost and healthcare of those members. So we’ve got a new program that I believe is best-in-class at allowing the client to look at very broad data and then drilldown into specific areas, specific therapy classes, whichever way they want to cut their data to better manage their trends, and I think the combination of all those things together to gain clients. So it’s really not any one thing, but as you said, it has been a focus of ours and I think it paid off for us in spades this year.

Ross Muken - Deutsche Bank

As we look at the guidance now as it stands for this year on an apples-to-apples basis with ’08, it looks like earnings growth will come in something like 20%, 22%. That's without a whole lot of cash flow deployment. That is certainly a lot better than sort of what the initial take was when we started the year. If you sort of had to rank where you were most pleasantly surprised on execution and where profitability came in better than the original expectation, what would the top three things be?

Jeff Hall

Sure. I think first of all, we had some nice mid-year starts. So we delivered some nice wins here which has gotten script guidance up. I think at the beginning of the year we said forecast for scripts were going to be down 2% to 3%. We now expect it to be better than that. Along those same lines as I said in my prepared remarks, utilization has come up. Certainly the uptake in our behavioral economics programs has worked out well for us. We do have a very aligned business model.

As we deliver more savings for our clients we make more money. Certainly in this economic environment, our clients have been looking to save more money. So that gets to the power of the aligned business model, and certainly, the team here is great and the focus on execution has been good and we are driving productivity and we're making investments we are excited about. So things have moved nicely through the quarter.

Operator

We will now go to the line of Tom Gallucci with Lazard Capital.

Tom Gallucci - Lazard Capital

George, you mentioned with the good selling season there's some start-up costs there. Is the bulk of those sort of Q4 or Q1, or how should we think about that?

George Paz

Yes. They come in towards the end of Q4, so that's clearly anticipated in our guidance. We have to get the people out and head for the call centers and all those things that actually [load] the eligibility. All of those things are happening as we speak, but there is always a significantly higher call volume and a lot more work that goes into the start-up of a client. As you probably know, a lot of the mail order drugs don't necessarily get transferred to us very smoothly from other providers. Some of the C2s and C3s, those type of drugs can't be transferred, so we have to get new scripts. There is a lot of work that goes in when we sign up a new account and all that takes place in the first quarter.

Tom Gallucci - Lazard Capital

I think you mentioned, Jeff, investing in the core. I think you had some IT investments if I heard you correctly, that were sizeable. Could you maybe just give us a little color on the types of things that you are working on in that area?

Jeff Hall

At the end of the day, a lot of the investments are around IT. So we have been doing a lot of work to get our Department of Defense. As you know, we have a new contract coming on line there. So there's been a lot of IT work to get those systems up and running and very efficient. We've also continued to invest in our behavioral economics initiative, which is people and systems and just new ideas and building out what I refer to as intellectual property. So a lot of what is showing up on SG&A is really pretty close to R&D in a lot of these things. So, as we build up barriers to entry around consumerology and behavioral economics and continue to extend our lead in that space, we are investing a fair amount of money there.

Just a continuing improvement of systems to build out better and better systems, this is certainly a culture of continual improvement. We are driving our teams to keep looking for new ways to drive incremental costs out of the business to keep improving profitability. We are seeing lots of opportunities to make solid investments there.

Tom Gallucci - Lazard Capital

Last question, if I could. Just wondering if there is anything that stood out during the selling season are your designing benefits with your existing clients, if clients are more willing to be aggressive in certain areas, as you think about the economy and benefit design for 2010.

George Paz

That's a great question. As Jeff said earlier, some of our better than expected financial results are attributable to the fact that companies, CFOs, CEOs, are really becoming focused on taking costs out of their own equation to meet their own SG&A targets. That really lends itself well to what we do and who we are.

If you go back three or four years ago and you saw trends that moderated down to the low single digits. That wasn't an issue for most HR directors. Today, no cost can be left unturned. Everybody has to focus on how do I take more costs out of the equation to meet my profitability goals. Those things worked really well for us. It allows our clinicians and our account management teams to work closely with the clients. I was out on a trip a few weeks ago with a bunch of other CEOs and it (inaudible) of their list on other ways that we can help. There wasn’t a CEO in the group that wasn’t talking about looking at productivity measures, looking at efficiency measures and looking to figure out other ways to take out cost. So to the extent we could come in and drive trends from low single-digits to zero to negative is very well received today.

Operator

We will now go to the line of Randall Stanicky with Goldman Sachs.

Randall Stanicky - Goldman Sachs

George, given what's soon to be an enhanced footprint with your market position with NextRx, anything different that you are hearing from your clients with respect to the integrated PBM retail model? Secondly, for Jeff, obviously good cash flow this quarter, any update that you can provide us on the capital structure and debt repayment target as you think about 2010.

George Paz

I will be honest with you. I don't hear a whole lot about a retail-centric model. I do believe that there are different clients with different expectations. And probably if you are looking for that type of a focus then Caremark is your answer. I mean I think you probably would go to them and that's going to be your choice as a PBM.

We don't really hear that in our prospect meetings at the finalist presentations. I don't hear a whole lot of push for that. I think the concern is always that once you start filling at retail you run the risk of those being converted back to 30-day scripts. At the end of the day, a 90-day script is a huge money saver for the client and they realize that. And I don't think anybody wants to take those risks of losing the savings.

I'm certainly not saying anything negative about Caremark. I think it is a great company and they have got lot of great things going for them. I think they are a fine competitor but our approach is different. Our approach certainly resonated this year as we had a significant win in the selling season. I like where we sit and really not hearing; none of my clients have come to me and told me to give me a 90-day option at retail.

Jeff Hall

Randy, overall on capital structure, our position hasn't changed. We think optimal for us is strong investment-grade credit which means one to two-times leverage. We think after the close, we are just about there. We certainly feel like we've got the cash flow expectations to be able to pay down the debt that is coming due here over the next several quarters out of operating cash flow and certainly, that gets repaid. We will look at what the right capital structure is. It is going to depend on what the debt markets look like and what the rest of the economy looks like and how our business is shaping up at that point, but at this point we feel pretty good about our capital structure and certainly good about our cash flow.

Operator

We will now go to the line of John Kreger with William Blair.

John Kreger - William Blair

George, another question about the type of discussions you are having with clients. When you sit down with them does the NextRx transaction come up all that much. And if so, do you see it helping those discussions or hindering them?

George Paz

I think it doesn't come up very much to be honest with you because it's a big consortium of those plans. I think the beauty of the transaction quite honestly is, as you know, we do a lot of [Blues] plans already. And so since they all have segregated territories and states, there is not really a competitive threat by doing the WellPoint transaction. So I think it really aligns nicely with our business model.

What it does do for us is it puts us on the roadmap as a major player in the space. I always believed we were there, I think our leverage over the supply chain as you've seen in our numbers in the past really spoke for themselves. We are now tied right up there with the big three. That is really catapulted us to a higher position, but quite honestly, from the employer perspective, there's been three out there. So I don't see that a whole lot. I do think one of the things it does do for us though is I believe there is a tremendous opportunity for us and WellPoint to change the delivery of healthcare. I have said this many times.

If you go back to our history and you look at all of our acquisitions, they weren't just done for pure economic reasons. They all added something. [GPS] got us in the managed care space. [Priority] really did cap out our need to get some much needed exclusive drugs to meet the needs of our marketplace. And all of our acquisitions provided tremendous strategic opportunities for us and WellPoint takes us to a whole new level.

I think that, I know that Angela at WellPoint is committed to changing the way healthcare is delivering and taking out the waste and improving healthcare outcomes. The things that healthcare reform should really be about, is what I think we are both focused on. I am excited about that. I think it can provide a whole new opportunity for us in the future. I talk about that with our clients and I think they get excited about it because they see some of the inefficiencies that exist today in the healthcare delivery system. So I think that as we look out to the future, there is a great a paradigm for us.

The other side quite honestly from an internal perspective is keep in mind, the WellPoint transactions over a 10-year period and we are hopeful it is a permanent situation for us. In addition the DoD is a five-year contract with two options, and last time they always exercised those options. So again, just to reiterate what we've said on previous calls, we’ve got 50% of our book of business, more than that, all locked up for seven to 10 years. That's a pretty good place to be that most companies don't find themselves in that situation.

John Kreger - William Blair

A quick follow-up for Jeff, given that it's been a more quiet year for generics, could you give us some perspective on that 18% profit per script number that you were able to report in the quarter? If you were to rank the key drivers of that improvement, what would you put at the top of the list?

Jeff Hall

We don't really get into the details in a real discreet way, but certainly, it’s been a lower than average generic here in 2009, and quite frankly, 2010 looks to be also lower than average. The other thing going on as I alluded to earlier, certainly our clients are looking for us to help them save money and as we do that through a whole host of tools that we can do, which isn't just about generics. There's also just getting to the right place in the formulary. So a lot of times, we can move from brand to brand where it makes sense or to lower cost brands.

We can realize this is just as big savings for our clients as we can on moving to generic in some cases. So there are certainly lots of tools that we pull here. And we are expanding our toolkit pretty much every day with the investments we are making in behavioral economics and other spaces.

Operator

We will now go to the line of Robert Willoughby with Bank of America.

Robert Willoughby - Bank of America

George or Jeff, I believe you gross up the TRICARE contract in the fourth quarter. Can you offer some guidance on the boost in revenues and hit to gross margin that we should see there.

Jeff Hall

Sure. I think we talked a little bit about this last quarter. I think it is a good question because we want to make sure that nobody is surprised by this. At the end of the day, the accounting for the DoD contract is changing. It was on a net basis and it is going to a gross basis because we are doing so much more work for the DoD in the new contract. The net impact for that from an accounting standpoint is that for the full-year it's about an $8 billion increase in revenue.

Again, just to be clear, no change to gross margin, but it is an $8 billion increase in revenue. For Q4, we are going live next week on this, so we are going to get about two months of this gross up. So one-sixth of $8 billion is going to hit in Q4. And then obviously as the revenue goes up, the gross margin as a percentage of revenue will go down. I don't have the precise numbers in front of me, but I think you are all capable of dividing that by a bigger number.

Robert Willoughby - Bank of America

Maybe, George, just on the thought process around the WellPoint guidance that you ultimately will provide, is there anything that you can say or do to put some parameters around the contribution when the deal closes, because it strikes me as somewhat difficult here waiting for the next Express Scripts press release for sometime in early February, potentially. Did you not run the risk that consensus starts to run on you here as expectations continue to build?

George Paz

Bob, at the end of the day, I am an accountant by education and I prefer to be. I don't like to just throw numbers out there that are not grounded. We don't know anything more today than we knew when we closed this deal. As a matter of fact you could argue we know less because the information has become stale. We haven't closed. I can't look at the profitability of those accounts. They don't give us changes in membership. We don't see what has happened inside the company. We have made a lot of guesstimates and we still feel very good about those. I think we do a very good job of due diligence, but our focus hasn’t been over the last six months to confirm due diligence. That doesn't do anything for us.

Our focus has been on enabling a smooth transition and making sure that there is no number disruption. And most important of all, it is about changing their ability to sell in the mid-market and large market employment space so that they can grow their membership, so WellPoint can add new lives which in turn gives new lives to us. We are very well equipped, we've got teams on the ground that are ready to go out and start helping them. Learn how to sell PBM better and give them the tools to make their offering better. Quite frankly, there is just really nothings happened since we announced this deal that caused us any concern nor causes us to deviate from where we were at. If we are going to close the deal, so what happens?

At closing, all of a sudden now we start doing a lot of conversions. We are taking a lot of things from their systems, but we still don't really have it until the first month closes. So we might as well see what that looks like. We'll see all the [one-one] changes that come through and so in February when we are ready to give guidance, we'll feel really good about where we sit and the guidance we can give. I am sorry if that is not quite meeting your needs, but I really do believe that's the best we can do at this time.

Robert Willoughby - Bank of America

I guess the other issue George, you are for better or worse for years have been genetically wired as a company to give 20% to 25% sort of earnings growth as the guidance range. Clearly you have been able to comfortably exceed that in the past. I can really get to some numbers well above that guidance range quite easily just by backing out things like the WellPoint dilution this year. How do you philosophically think about putting out the high EPS growth rate for next year which has been against the company's [brain] for fear of upsetting some of the clients that you deal with? Is that something you are wrestling with currently?

George Paz

If you trying to get in the back door my guidance number, I am not going to do that. I think what I would tell you is that if my profitability is going up; it’s usually because my clients are doing better. I don't get challenged too often, I won't say always, but too often from my clients that I make too much money.

At the end of the day, if you take my total script counts and divide it into my after-tax net income; I don't make a lot of money per script. It’s just not a lot of money, and look at all we do. We do step therapies. We do mail order. We do prior authorizations. We consult with our clients on best ways to manage their membership through very difficult times as they make tough decisions.

We are not taking a bunch of money. Do the same thing for CVS or Walgreens. Take their total income and divide it by their script count. Now again, they've got some front-end, but if you can back up some thoughts there, we don't made what they make, and they're at the end of the day dispensing pharmacy when we are a pharmacy benefit manager adding tremendous amount of value into the supply chain process. So I don't feel like we need to apologize for the money we make. I think we do great things for that money, and at the end of the day, we will give guidance at the end of the fourth quarter.

Operator

We will go to the line of Lisa Gill from JPMorgan.

Lisa Gill - JPMorgan

George, as we look at the new business one for 2010, I had a couple of questions. One, can you may be talk about where it came from. Did it just come from your other two big competitors or did you see any carve-in business this year. Secondly, you've talked about the success of your mail program, Select Home Delivery. Can you talk about the number of clients or potential scripts for 2010 around this program, and was that a key driver to winning some of these signature accounts.

George Paz

I think the whole concept of consumerology which included better ways to manage generic fills, move people towards better adherence. Although companies are trying to save money, Lisa, they are still very focused on making sure their diabetics take their diabetic medication. That they want their hypertensives taking their high blood pressure medicine, on and on. That is still their focus, because the first line of defense is medication in any healthcare treatment.

People have become very focused on wellness, and very focused on making sure for that 50% of their membership that’s taking acute medications, chronic medications, that they are getting what they need to take, and that sells well our whole approach.

The whole way that the mail program works, it really depends on what their mail penetration rates are. Those clients that are with an existing PBM that have a mail order offering and that vendor has done a very good job driving mail. They are probably less likely to choose Select Home Delivery because they already have strong mail penetration rates. So there's not a lot of up-side to that, and so the focus is more around generic penetration, clinical programs, other ways to drive costs out of the equation.

Those that have low mail penetration rates, it’s been a huge home run for us, because it allows clients to go to the mail order program without making it mandatory. What it really does is it forces that member to call in or to go on line. Hopefully, on line because we can handle a lot more that way to understand what the mail benefit is all about. This way, they can still opt out.

But the conversion rate it is quite significant, at one phase see how easy it is how we will do everything for them to keep those drugs coming to their house on a regularly scheduled basis, and that’s a very nice option for many clients.

As far as what are the [membership] comes from, I still a tremendous amount of carve-out occurring. As the brokers and the consultants are basically the Fortune 500, for that matter the Fortune 1,000, have chosen where they want to carve in and carve out. Those decisions are made. Some of them are still moving more towards carve out.

But as you look at the consultants, they need to grow their revenues and they need to stay in front of clients as well to meet their earnings need, and so they are going further and further down the line and looking at and talking to clients.

We have seen clients with as few as 5,000 and 10,000 numbers coming to us through a consultant these days. Not direct but jump through a process, and often these would be joining consortiums or going through TPAs when they get smaller, and more and more of these people are going direct as they are looking.

It really depends on how much they have deployed with respect to HR support as to whether or not they want to carve out or not.

Lisa Gill - JPMorgan

How about the eight signature accounts? Was that just primarily competition amongst the big three or are we seeing big signature accounts with more than a million claims carving out that hasn't carved out before. I think that's really what my question is.

George Paz

It’s both, Lisa. It's some from the others and some from carve out. There was a combination of both.

Lisa Gill - JPMorgan

As we think about these and we think about the potential profitability around these accounts, did they have a lot of mail, when you picked them up as we think about what that mail penetration looks like for that book of business for 2010? Is it similar to your existing book, is it greater than your existing book, or are there opportunities to improve that over the next couple of years.

George Paz

Without speaking to any significant client, let me just bucket them all together and just speak to the overall. Overall the mail penetration is lower than the book of business. So you will see that in the first quarter when those numbers come through that will drive mail penetration levels lower. But, obviously, that's a great opportunity for us.

Lisa Gill - JPMorgan

It goes back to the first part of my question, which is that did they sign up for programs that they give you the visibility to see that the mail order is going to improve, especially as we get into 2011, 2012 which are big generic years.

George Paz

Some of them have and some of them haven't. It just depends on why they are coming to us. If they had a terrible service issue, right now they are just trying to get away from a problem. Keep in mind our business is like every other business out there. There's a relationship person at the front. If the relationship person screws up a relationship, the client wants to leave.

They may not be concerned about their benefits at that point, they are more concerned about getting someone that is going to take care of them, and then we'll sell those people after we get in and build the right relationship. But a lot of them came to us certainly for our mail order capabilities and our ability to move generic drugs. So again, you can't, every client is different. Every need is different. They are not all the same.

Lisa Gill - JPMorgan

Just one last question that pertains to all this. How would you characterize the 2010 selling season from a competitive perspective. Do you think that the players are rational, are you finding that any of the competitors are irrational in the market as we've seen in the past?

George Paz

My perspective last year, and you heard me say this last year, there was a couple of deals that traded hands that I couldn't understand how in the world people priced at those levels. Again, I didn't necessarily say they were irrational. They may have been smarter than us, they may have seen something we didn't see, they may have seen an opportunity to drive something that would really help the client and help them as well.

Majority of the business last year was not priced irrationally from my perspective. This year is like that, except, well it’s different. I didn't see any big deals that were changing hands that had what I saw as crazy pricing.

I think it was more of, again, when you get crazy on the pricing; you're really trying to eat away at a very small margin of our business. There is a much better answer by driving trend in the right programs to get much bigger savings for the clients. So if you're successful at doing that, we're selling our capabilities and not giving away our little bit of margin. I haven't seen any price irrationality this year to be quite frank.

I appreciate all of you joining us this morning for our call. We were really excited about where we are positioned. We're looking forward to closing our NextRx transaction, and we will keep you posted as things develop. Thank you very much. Have a great day.

Operator

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

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