Medco Health Solutions, Inc., Q3 2009 Earnings Call Transcript

Nov. 3.09 | About: Medco Health (MHS)

Medco Health Solutions, Inc., (NYSE:MHS)

Q3 2009 Earnings Call

November 3, 2009 at 8:30 AM ET

Executives

David B. Snow, Jr. - Chairman and Chief Executive OfficerRichard J. Rubino - Chief Financial OfficerKenneth O. Klepper - President and Chief Operating Officer

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

Steve Fitzpatrick - President of Accredo

Timothy C. Wentworth - Group Pres of National AccountsValerie Haertel - Vice President, Investor Relations

Analysts

Ross Muken - Deutsche Bank Securities

Thomas Gallucci - Lazard Capital Markets

Charles Boorady - Citi

Lisa Gill - J.P. Morgan

Robert Willoughby - Banc of America-Merrill Lynch

Lawrence Marsh - Barclays Capital

Alex Beckler - Goldman Sachs

Operator

At this time I would like to welcome everyone to the third quarter Medco Health Solutions earnings call. (Operator Instructions). I would now like to turn the call over to Valerie Haertel, Vice President, Investor Relations.

Valerie Haertel

Good morning everyone and thank you for joining us on Medco’s third quarter 2009 earnings conference call. With me today 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 Tom Moriarty, General Counsel, Secretary, and Senior Vice President of Pharmaceutical Strategies and Solutions, Steve Fitzpatrick, President of Accredo, and Tim Wentworth, Group President, Employer Accounts.

During the course of this call we will make forward-looking statements as that term is defined in the Private Securities Litigation Reform Act of 1995. No forward-looking 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 disclosed in our SEC filings. Copies of Medco’s filings are available from the SEC, the Medco Investor Relations Department, or the Medco website. Medco intends to use the investor relations section of its website as a means of disclosing material 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.

David B. Snow, Jr.

Thank you all for joining us this morning. Today we’re announcing strong third quarter 2009 results, improved full-year 2009 expectations, and robust earnings guidance for 2010.

For the third quarter of 2009, our GAAP diluted earnings per share reached a record $0.59, representing 19 % increase over third quarter 2008. Our diluted earnings per share excluding the amortization of intangible assets from our 2003 spin-off reached $0.75, also a 19% increase. You may recall that in the third quarter of 2008 we recorded an EPS benefit of $0.05 per share associated with state income taxes. As a result, third quarter 2008 was the strongest quarter of last year. When that benefit is excluded from third quarter 2008, our apples to apples third quarter 2009 comparable GAAP EPS increase grows an even more impressive 30%.

Our third quarter revenues reached $14.8 billion, a growth of 17.8% over third quarter 2008. Our performance continues to be driven by the most comprehensive and scalable clinical capability in the pharmacy industry. Medco’s clinical innovations are delivering improving health outcomes today that lower total healthcare costs for both our clients and our members. Our unique value proposition to client and prospect continues to drive high retention rates with existing clients and strong top line growth from new customers. With the 2009 sales year close to completion, our annualized 2009 new name sales stand at a record of over $10 billion and 2009 net new sales stand at over $8 billion. Our 2010 sales year is actively underway with annualized new name sales at $4.1 billion, up from the $2.8 billion announced last quarter. Net new sales for 2010 currently stands at over $4 billion with a record 99% client retention rate.

Additionally, as was reported in a separate press release yesterday, we’re delighted that the mail order and specialty business we currently have at the Blue Cross/Blue Shield Association Federal Employees Program, more commonly known as FEP, has been extended through the end of 2011. We have generated over $20 billion in new name sales since 2008 on a revenue base that is approaching $60 billion this year, clear proof of the unique and powerful value proposition we’re building for the customers we serve.

Looking at other key performance metrics. Our total prescriptions adjusted for the difference in days supplied between mail and retail increased from the same quarter last year by 14.1% to $220.2 million. Our mail order volume was in line with our expectations at 25.5 million prescriptions, a 2.3% decline from third quarter 2008. As we pointed out on our second quarter call, the decline in mail scripts has been with brand name scripts only while our generic volumes at mail remained strong. Specifically, within the 2.3% overall mail volume decrease, brand mail volumes declined 7% while generic mail volumes increased by 1.4%.

Our retail volumes continue to grow as a result of our 2009 business win. Retail prescription volumes grew 25.4% to 144.3 million. The strong retail mix in our new business brought our adjusted mail penetration rate to 34.5% from 40.4% in the third quarter 2008 and brought our gross margin percentage to 7.0% from 7.4%. This quarter our generic dispensing rate increased 3.3% points to a record 67.7% compared to 64.4% from third quarter 2008. The year-over-year improvement in our overall generic dispensing rate delivered incremental fading to our clients and members of approximately $560 million in the quarter. For the third quarter EBITDA increased 16.7% to a record $719.3 million. EBITDA for adjusted script increased to a record $3.27 from the $3.19 in third quarter 2008.

Turning to our specialty pharmacy segment, Accredo posted record sales results this quarter with net revenues growing 19.2% to over $2.4 billion. Operating income grew 19.5% and reached a record $93.2 million for the quarter.

Turning to healthcare reform; while we’re still far from a final bill, we continue to believe that some form of healthcare reform public policy will pass by the end of this year. We believe that any new bill will most likely present Medco with opportunities to demonstrate that we’re well positioned to be part of the solution. Specifically, our therapeutic resource center platform which better manages patients with chronic and complex disease, is designed to reduce the $350 billion of waste in this country linked to noncompliance and omissions in care associated with products in complex disease. Additionally, our pharmacogenomics or personalized medicine efforts hold the ultimate promise of moving our healthcare system from shotgun medicine to precision medicine.

We believe comparative effectively research will be funded and encouraged in any final bill. We are uniquely equipped to play a leadership role in comparative effect of this research given our enormous longitudinal data resources. This is evidenced by our published Plavix PPI study covering 17,000 patients, our recently presented tamoxifen and 2D6 enzyme inhibitor study at ASCO, and our recently announced 14,000 light-perspective comparative Plavix Effient study to determine the role of genetics in the effectiveness of these two competing drugs. We will discuss more details on our groundbreaking research at Analyst Day later this month.

Additionally, we anticipate that e-prescribing as an option among physicians will continue to accelerate tied to already approved provision and funding in the brief of stimulus package. Higher absorption rates will drive efficiencies in how we communicate with physicians, improve formulary compliance, and channel management and ultimately yield meaningful savings for customers and members. We believe a pathway for biosimilars is eminent. Once biosimilars enter the market there will be increased competition and therefore lower costs for what are now very expensive medicines.

Finally, we expect that funding for the uninsured with become a reality creating a new market for Medco to serve. It is important to point out that legislation is passed later this year much work will be required to draw legislative rules that support all policies. Many of the contemplated policies would not be implemented until 2013. As a result we must remain actively involved in Washington D.C. for the foreseeable future.

Today, we’re once again raising and narrowing our 2009 earnings guidance. Our revised 2009 GAAP diluted earnings per share guidance is now in the range of $2.58 to $2.60 representing year-over-year growth of 21% to 22%. Our previous 2009 GAAP diluted earnings per share guidance range was $2.54 to $2.59. Excluding the amortization of intangible assets from the spin-off, we now expect 2009 diluted earnings per share to be in the range of $2.80 to $2.82 or a 20% to 21% growth rate. You will recall that our previous guidance range was $2.76 to $2.81 per share.

Looking forward to 2010, we expect full year 2010 GAAP diluted earnings per share in the range of $3.05 to $3.15 representing growth of 17% to 22% over the 2009 revised guidance. Full year 2010 diluted earnings per share excluding intangible assets from the spin-off is projected in the range of $3.28 to $3.38, representing 16% to 21% growth over our revised 2009 guidance.

In summary, Medco’s growth strategy is working to the benefit of our clients, members, and shareholders. We believe that the model we’ve built addresses a real need in the marketplace, is an example of how regardless of what happens in Washington, working with our clients, Medco can affect meaningful healthcare reform. I plan to expand upon this statement in some detail at our upcoming Analyst Day later this month. With that, I’ll turn the call over to our CFO, Rich Rubino who will discuss additional details behind our third quarter 2009 financial performance and provide you with additional information regarding our 2009 and 2010 guidance.

Richard J. Rubino

Thank you and good morning. Please note that as I walk you through our third quarter results, I will also point you to any line item updates to 2009 full year guidance. I will cover 2010 guidance separately at the end of my prepared remarks. As Valerie mentioned, the slides on our website should prove helpful in following along with my commentary. The slides include all of the elements of guidance that I will be providing.

We closed the third quarter of 2009 with $2 billion of cash in our balance sheet, consistent with the June balance. This is after paying down $400 million of our $600 million short-term securitization debt facility. This pay-down saves more than $3 million annually in interest expense. Our cash flows from operations for year-to-date September 2009 amounted to $2.5 billion, a threefold increase over the same period last year. This already exceeds our full year 2008 cash flows which totaled $1.64 billion. The increase reflects our continuing efforts to improve working capital. For full year 2009, we now expect cash flows from operation of approximately $3.2 billion, about two times our record 2008 performance.

Our inventory levels have been managed further downward, from $1.5 billion as of June 2009 to $1.3 billion as of September 2009. This now represents a decrease of almost $750 million from June 2008, a reduction of over one-third. As a result of our working capital management progress to date and our plans for the remainder of 2009, we now expect a 5% point improvement in our return on invested capital for 2009, up from the previous guidance of a 4% point improvement. Excluding the Merck acquisition effects from 1993 that was pushed down to our balance sheet, Medco’s return on invested capital this year is expected to be 25%, up from 20% last year. Our total debt declined from $4.6 billion as of June to $4.2 billion as of September 2009 reflecting the pay-down I mentioned earlier.

Our September year-to-date capital expenditures of $154.3 million reflect investments and cost to business. We continue to expect capital expenditures of approximately $235 million for full year 2009. With regard to our income statement performance, as Dave mentioned, our third quarter EPS results were quite strong with 19% growth. Looking at revenue composition, our product revenue grew 17.8% and service revenue grew 20.9%. Product revenue growth reflects significant new business and price inflation on brand name drugs, partially offset by a higher representation of lower-cost generics. Service revenue growth reflects the expansion of our overall client base and includes administrative fees in our significant retail volumes and Medicare Part D services.

Dave already walked you through our strong retail volumes and our stable mail volumes at 25.5 million prescriptions which importantly included increased generic mail prescription volumes over 2008. We continue to expect 103 million mail order prescriptions for full year 2009 along with continued year-over-year growth in generic mail prescriptions. We also expect adjusted mail order penetration for the full year 2009 at approximately 35.4%.

One other point in our third quarter 2009 retail volume growth rate of 25.4% over third quarter 2008, which was driven primarily by new client wins. This does include a 10% volume increase in the anti-viral drug category associated with the 2009 flu season. Our other mail order volumes not counted as prescription which include OTC iodine and diabetes supplies reached 1.8 million units, 12.5% higher than our third quarter 2008 volume of 1.6 million units. The increase reflects growth from the acquisition of a majority in Europa Apotheek Venlo in April 2008, continue growth in diabetes supply volumes from our Liberty medical brand, and volumes from our newly introduced Medco Health Store, which is available for our members through medco.com.

Turning to rebates, we earned a record of $1.35 billion for the third quarter representing a 20.3% growth rate over third quarter 2008. This is the result of new client wins, continued improvements in formulary contracting, and higher levels of formulary compliance, particularly at mail. Our third quarter 2009 rebate retention rate was 14.1% compared to 18.2% for third quarter 2008. We expect rebate retentions to balance off for the year at approximately 13.5%. Although fluctuations reflect client mix and client preferences regarding the rebate sharing aspects of their overall pricing structure. Today, the gross margins, as Dave mentioned, with strong retail volume in the quarter, reduced our consolidated gross margin percentage by 40 basis points to 7.0% compared to 7.4% for the same period in 2008. We expect our full year 2009 gross margin percentage to be approximately 6.7%. Note that this does not close the effect of $0.01 to $0.02 per share on start-up expenses expected in fourth quarter 2009 associated with our significant January 1 new business installation.

Our gross margins include the beneficial for new generic introductions in 2009 which as previously guided contributed $0.04 per share in the third quarter and will contribute $0.13 per share on a full year 2009 basis. This includes a $0.045 per share contribution expected in the fourth quarter of 2009. Our record gross margin of just over $1 billion for the quarter reflects 12.5% growth over third quarter 2008, all components of our portfolio contributed to this growth. Selling, general, and administrative expenses of $369 million for the quarter increased $21.8 million or 6.3% over third quarter 2008 while declining slightly from the $370.7 million we reported for second quarter 2009. The increase over third quarter 2009 reflects bonus compensation expense plus a strong company performance and depreciation expense from investments we have made across the enterprise including software depreciation associated with our significant client wins.

On a September year-to-date basis, the SG&A growth rate is 3.4%, and we now expect SG&A expenses to increase on a full year basis over 2008 levels by approximately 2% to the range of $1.45 billion to $1.46 billion. This is a strong testament to our disciplined management team company wide especially when considering the record volume of business we have won and the significant strategies we are executing. As Dave mentioned, we achieved a record EBITDA for adjusted script this quarter of $3.27. For the full year 2009, we continue to project EBITDA for adjusted script in line with the $3.09 we achieved in 2008. Note that this is an average for the full year and includes the first quarter 2009 EBITDA for adjusted script of $2.86 in addition to the fourth quarter start-off expenses I mentioned previously.

Our intangible amortization of $78.4 million in the third quarter 2009 increased from $71.1 million in third quarter 2008 including PolyMedical intanglible. For the year 2009 intangible amortization is currently projected in the $305 to $310 million range. Total net interest expense of $39.9 million for the quarter decreased from $58.2 million in third quarter 2008, the result of lower interest rates on our debt and increased cash balances. We now expect full-year 2009 net interest expense of approximately $165 million to $170 million. Our effective tax rate for third quarter 2009 was 39.3% compared to 34.0% in third quarter 2008. As Dave mentioned and as we disclosed last year, we recorded a state income tax benefit in third quarter 2008 that drove down the effective tax rate for that quarter. We continue to expect the lower effective tax rate in fourth quarter 2009 bringing our full year 2009 effective tax rate to the previously guided range of 39.0% to 39.5%.

Record net income of $335.6 million in third quarter 2009 increased 13.5% over third quarter 2008. Moving on to share repurchases; we did not repurchase any shares in third quarter 2009. You will recall that in the first half of 2009 we repurchased 23.6 million shares at a total cost of just over $1 billion using an average cost per share of $42.71. Thus far, we have spent $1.21 billion under the $3 billion share repurchase authorization we announced in 2008 which authorizes repurchases through November 2010. As you will note from the 2010 share guidance that we will provide shortly we clearly intend to repurchase additional shares going forward under the remaining authorization.

Our weighted average fully diluted share count of 484.7 million shares in the third quarter decreased 28.7 million shares compared to 513.4 million for the third quarter 2008 primarily reflecting the effect of share repurchases made year to date. We finished the third quarter of 2009 with 477.1 million shares outstanding plus a dilutive equivalent of approximately 9.5 million additional shares bringing the total fully diluted share count to approximately 486.6 million as of September 26, 2009. This fully diluted share count becomes the entry point of fourth quarter 2009. We continue to expect our full year 2009 weighted average diluted share count to be approximately 490 million shares.

Turning to specialty, Accredo posted another strong quarter with revenue growth of 19.2% reaching a new record of over $2.4 billion, and operating income growth of 19.5%, another new record at $93.2 million. Accredo’s gross margin percent was 7.4% which compares to 8.1% for the same period last year as a result of changes in channel mix from significant new business wins. Once adjusted, the third quarter was the strongest quarter of 2008 for Medco; it was also the strongest quarter of 2008 for Accredo.

Our 2009 full year guidance for Accredo revenue is increasing from over $9.3 billion to approximately $9.5 billion and operating income guidance is increasing from over $350 million to approximately $355 million with the gross margin percentage still expected in the mid 7% range. Our Medicare PDP has demonstrated strong growth as well. Medco’s PDP revenues in the third quarter increased over 72% to $270 million. Generic dispensing rate through our PDP grew to 71.5% with adjusted mail order penetration of 24.5%.

Now, let’s more on to 2010 guidance. To recap, our full year 2010 GAAP diluted EPS is projected in the range of $3.05 to $3.15, representing growth of 17% to 22% over 2009 revised guidance. Full year 2010 diluted EPS excluding amortization of intangible assets from the spin-off is projected in the range of $3.28 to $3.38, representing 16% to 21% growth over revised 2009 guidance. Here are the detailed components of our guidance. We currently expect to renew approximately $15 billion of business in 2010 including scheduled and early elective renewals with approximately 75% of renewal pricing in effect in the third quarter of 2010 with the remainder primarily in the third quarter. Note that the SEC expansion is included in our guidance.

Mail order volumes are expected to grow to a range of 107 million to 109 million prescriptions. The mail order penetration rate of a new named account is estimated at 25% and the mail order volume growth in 2010 is expected to be primarily comprised of growth in generic prescriptions. The impact of new generic introductions on 2010 EPS is expected to be $0.25 with the estimated quarterly spread to be $0.03 in the first quarter, $0.06 in the second quarter, $0.08 in the third quarter, and $0.08 in the fourth quarter. SG&A expense for 2010 is expected to be approximately $1.5 billion, representing an estimated 3% growth rate over 2009.

Net interest expense for 2010 is projected in the range of $170 million to $180 million. The 2010 intangible amortization is expected to range from $280 million to $290 million. The full year 2010 effective tax rate is expected to be in the range of 38.5% to 39.5%. Weighted average diluted shares for 2010 are estimated in the range of 465 million to 480 million. For Accredo, the success is expected to continue with full year 2010 revenue expected to exceed $11 billion and operating income expected to exceed $450 million. EBITDA for adjusted script for 2010 is expected to increase by 5% to 10% over 2009. Capital expenditures are expected to be approximately $215 million, reflected lower expenditures related to the new pharmacy partially offset by growth across the business and new compliance requirements, particularly associated with HIPAA and the stimulus package.

On cash flows from operations, we made material improvement to our working capital of 2009, but there is more progress planned for 2010. Our current plan is to take the cash flows from operations for 2010 at the $2.3 billion level. This is lower than 2009 because the working capital improvement in 2009 was quite significant and the residual working capital opportunity for 2010 is not as great. Return on invested capital performance remains a key component of our financial plans for 2010, and we’re expecting yet another strong increase in 2010. We’re currently targeting an increase in this important gauge of shareholder value from 25% in 2009 to well over 30% for 2010.

In concluding our prepared remarks, we are confident in the strength of Medco and excited about our prospects for continued earnings growth. Now, Dave and I would like to open the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Ross Muken - Deutsche Bank Securities.

Ross Muken - Deutsche Bank Securities

In terms of the net new business wins, another great year for Medco; Dave, can you give us some highlights of what you saw in the selling season that surprised you, and in terms of some of the new programs that you’ve rolled out or some of the new strategies, what really do you think were some of the key drivers of another very successful year?

David B. Snow, Jr.

Ross, I would tell you that the selling season has not surprised me. We are seeing continued pricing stability in the marketplace and decisions are primarily being made around the value propositions that companies deliver on top of that fundamental pricing; so, I would say the sales year would be characterized as another very strong and successful one largely because of our clinical innovations and the promise of really bending the curve in a positive direction when it comes to total healthcare cost, and the clients are now starting to see real results and I think the word of mouth is starting to get out there; so, if you talk to our group presidents responsible for the various markets we serve, I think you’d hear unanimously and you will hear at Analyst Day that as we get better and better at what we’re doing with the therapeutic resource centers and with pharmacogenomics, clients are starting to actually see the results and it’s very encouraging. So, the renewals are very positive, we saw 99% retention rate expected in 2010, that’s because we have very satisfied customers; obviously we’re meeting their expectations on pricing and on service, but the clinical value proposition on top of this is really starting to take hold. Just for the record, I think they may have misspelled when I referred to the 2009 adjusted mail order penetration rate, I think I may have said 35.4% expected, it’s actually 34.5% expected; my apology.

Ross Muken - Deutsche Bank Securities

And Rich, you’ve said for some time that given the cash flow, you certainly would like to deploy it but it’s not burning a hole in your pocket, but given the guidance for 2010, it seems like you need some new pants because it’s quite an impressive number again; I think clearly the guidance sort of lays out the plan from a share repurchase perspective, but in terms of the other potential uses and what you’re seeing in the M&A market and what you’re looking to do in terms of internal investments, what else should we be focused on for next year?

Richard J. Rubino

You’re exactly right, Ross, with regard to the share repurchases; so, we do expect in this guidance to use the majority of the $3 billion authorization that expires at the end of next year. We are keenly focused on building the growth engine for 2015 and beyond. We are making significant internal investments in that regard, we are also looking constantly at acquisition opportunities, many of them will be small but they are sparks that will fuel that future growth. I can tell you that we are keenly focused on differentiating our sales over the future. We are going to talk a lot about this Analyst Day, but I am going to tell you one thing and you’re right, I’m not going to let the cash burn a hole in my pocket, we are not going to go out there and make an investment just for the sake of investing our cash. There are a lot of investments out there that on day 1 may not be accretive to our very very sizable return on invested capital, but we’re not using that as an investment gauge, we realize that there will be acquisitions on day 1 that will in fact yield a lower ROIC than our impressive 25%, but we have our eyes open, there could be both on acquisitions out there that are consistent with our theme which ultimately is generating shareholder value by driving additional value and savings for our clients.

Operator

Your next question comes from the line of Thomas Gallucci - Lazard Capital Markets.

Thomas Gallucci - Lazard Capital Markets

Rich, can you talk a little bit about some of the key drivers in 2010, I think the $0.25 contribution from new generics is fairly sizable, so maybe if you give a little bit more color there, and then, how do you think about some of the other key drivers over and above generics within the company?

Richard J. Rubino

I’ll start by saying that we still happen to be very focused on operational excellence so to yield the kind of nominal SG&A growth that we are projecting for next year, it’s a pretty going good accomplishment when you consider the way we’ve grown, we’ve made a new business of over $20 million, but generics are clearly a strong driver for next year; of course, we do have a mail order growth in the $107 to $109 million script range and that is fueled by meaningful growth in generics; we see not only that the benefit of the $0.25 from new generic introductions next year, but we also see continuation of increased generic substitution rates for the older generics; the simvastatins of the world continue to do very well along with other, what I’ll call, legacy generic products; many I suspect will be surprised by the new generic contribution for next year because when you look at the slide that you see all the time that talked about new generic introductions in 2010, it’s slightly slow, however, as we settled along, there were a couple of things to consider; one is the calendarization effect, but very importantly, you have to look at those drugs relative to their representation in Medco’s book of business and their associated mail order penetration; so let me give you a couple of statistics. The new generics in 2009 that yielded $0.13 contribution, in Medco’s book, they had an average mail penetration rate of just over 30%. When you look at the new generic introductions in 2010, you’re actually saying approximately 50% mail order penetration rate; so, drugs like Flomax, Cozaar, and Hyzaar, they’re very strong mail penetrated accounts in our book; so, clearly the primarily drivers to the growth next year, not to mention of course the profits yielded from our additional top-line growth, and then Accredo continues to knock the cover off the ball; so, to achieve over $11 billion in revenue next year and another year of operating income growth that is higher than the revenue growth, it is because of the excellent job the Accredo management team has done and also the power of leveraging Medco’s overall lives base in growing Accredo.

Thomas Gallucci - Lazard Capital Markets

Just one followup, you mentioned seeing more higher generic substitution rates than older generics, and David, you might have mentioned inside mail, where the number of brands were down 7%, generics were up a percent or a percent and a half, I’m curious, is there benefit design changes that have driven that for this year or for next year you’re seeing any change in benefit design or is it just simply the sensitivity that the people have to money at this point given the economy?

David B. Snow, Jr.

I think primarily the difference is the economy; the recession has driven more prudent buyer behavior on the part of our patients as they try to save every dime they can from their out-of-pocket expenses; so, the recession has driven the right choices that benefit both Medco and our clients.

Operator

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

Charles Boorady - Citi

I just like to ask if you can be a little more specific on the trends that you’re seeing in the procurement process of your clients, and how the 2010 selling season was different from other selling seasons; I know you’re not surprised by the strength of the season but there were a lot of factors that raised concern during the year, I’m curious how they played out for you such as the impact of the ESI NextRx and the maintenance choice program success by CVS Caremark and how those factored in, if they created headwin at all for you?

David B. Snow, Jr.

I’ll start and I’ll ask Ken to add his comments in, but honestly the NextRx acquisition had absolutely no influence whatsoever on our selling season, I would say that the competitive landscape between us and CVS Caremark is the same, it is really the same, we’re not seeing any changes, we’re seeing relative to the opportunities out there, we’re continuing to have a very strong close ratio tied to the RFPs that are outstanding; so, if there was anything different from the 2009 selling season, I would say something, but honestly it is identical, it really hasn’t changed and Tim, I don’t know if you have a different pop there.

Timothy C. Wentworth

No, I will never disagree with you, Dave. The only thing I can say is it is slightly overlaying on ESI NextRx because it is very early; we have started to see a little bit more activity in the middle market, we are going to go through a PDM change anyway and have shown increased interest in what we’re doing, and we certainly enjoy the good win rate there. I think the other thing there is the differentiating message getting it out to the endpoints of our market place consistently and every point both with renewals as well as more importantly per this conversation new business wins has been very powerfully received, and I think what we hear from consultants and clients is, it’s never been a more differentiated message out in the market place and what clients want to hear about it is exactly what we’re talking about and doing which is, one, enabling healthcare outcomes through the real-time nature of pharmacy and, two, which has been the biggest surprise for me the interest across the employer groups in particular in helping drive a broader healthcare strategy that they’re trying wire up. They don’t want to wait for Washington to wire it. We can help them wire it and enable a broader strategy with our extended enterprise open architecture, and so we’ve seen that what we have built with Healthways is not only selling strongly on its own, but that same model is selling with other providers that our clients may want us to empower, and it’s very powerful to show we’re doing it today and we can do it for them.

Charles Boorady - Citi

Have you seen that manifest in more carve-outs of the PBM by large employers as well?

Kenneth O. Klepper

That’s a great question. This year more than any year that I’ve seen in my time with Medco we had significant wins from the captive PBMs, major wins who had longstanding carve-in relationships.

Operator

Your next question comes from the line of Lisa Gill with J.P. Morgan.

Lisa Gill - J.P. Morgan

Dave, as you spend time down in Washington, can you just maybe give us some of your thoughts around when we have healthcare reform if there is a public option, what do you think happens with the PBMs? I mean do they now go out and if there is public option are they going to be negotiating with the PBM like Medco to handle the pharmacy benefit or will they do it themselves? Can you maybe give us some thoughts because there is a lot of concern around if there is a public option, one, and then, two, should we be concerned about the Cantwell Amendment around transparency?

David B. Snow, Jr.

Relative to the public option, I’ve mentioned it before we are relatively neutral on the concept, although I don’t really think it really reforms healthcare, but from a Medco perspective, there is no question if the government decides through either consortiums or state-specific public plans or even a national public plan, they will outsource or contract to the private sector to administer that benefit. The truth is there isn’t a single public plan today, I don’t care if you look at Medicaid or Medicare or DOD, they all use the private sector to administer their plans. So there’s no way they could build this themselves. You know how much we spend in CapEx each and every year to do what we do. The fundamental technologies, the infrastructure, the computer systems, they’re all things that the government is not going to build, and they’re not really readily available at the scale that would be needed at a federal level. It’s not available commercially, so they would have to contract with the private sector to do that. So I’m feeling very comfortable with that. If you were to ask me what the ultimate public plan might look like, if there is one at all, I really can’t tell you right now. If there is one very hostile debate going on in Washington, it’s over this public plan, and my whole point in this debate is that it’s too bad we’re spending so much political capital on the public plan because even if we get one, it doesn’t get at those root cause things that are so important to real healthcare reform, which again ties back to what Medco is doing and the fact that Medco is actually delivering real healthcare reform, and it’s a very interesting model that I think will continue as it generates the data to support it. It’ll provide I think a real catalyst as something that’s more meaningful. It solves the problems in this country when it comes to how we manage care.

Relative to the Cantwell Amendment, we are not terribly concerned with it as it is currently structured because as you know if you go through it in more detail you’ll see that the things that the Cantwell Amendment ask for Medco already does. We do it on our quarterly earnings calls. We do it in our filed 10-K. We also do it in our quarterly filings. We give rebates. We break out volumes. All the specific things that are talked about in that legislation, Medco has led the way and is already doing, so again we’re not terribly concerned about the current form of that proposal.

Lisa Gill - J.P. Morgan

I have one followup question for Tim. Tim, as Walgreen’s and Wal-Mart talk about this Caterpillar program and we hear a lot about it from them but not so much about it from individual clients or plan sponsors, are you seeing them at all? Do they ever make it to a best in final with this program that they’ve tried to together?

Timothy C. Wentworth

I haven’t seen them make it to one best in final, Lisa. I think they’ve got one client that has a unique set of circumstances, and they’re trying very hard to build off of that base, but quite frankly when the marketplace which is very sophisticated analyzes the economics as well as frankly the results, they’ll just know they’re there.

David B. Snow, Jr.

Let me add to that because a lot of people don’t understand what the Caterpillar arrangement really is all about. It’s simply the plan sponsor direct contracting with certain retail networks. Caterpillar still uses a PBM. They still use someone else for mail. It’s not a PBM model that they’re contracting for. It’s a direct contract with certain retail chains that is then administered by the PBM. Quite honestly, we have certain health plans which are strong in their local markets which contract their networks and we administer it, so it’s not a revolutionary concept and it’s not really a PBM concept. It’s a direct contract retail model.

Timothy C. Wentworth

The other thing we do see is Walgreen’s is very interested in trying to drive a workplace clinic sort of model with employees which we actually are positioned to help empower in terms of driving patients through there. I think the Wal-Mart piece which has been out there now for three years since they launched their first generic list, what clients see is that what Medco has been doing for over 30 years is exactly what Wal-Mart does for its customers except we happened to be larger in our space than they are in our space, and that is we create competition amongst suppliers, that’s both manufacturers as well as retailers, we bring the benefits of that lower cost through the marketplace in a highly competitive way, and we keep what we can for our shareholders. That’s exactly what Wal-Mart does in the popcorn space and the toilet paper space and so forth. We happened to do it in the pharmacy space, and we do it very well, and when we get to see an apples to apples comparison, particularly given the 85% spend is still on brand drugs and management of overall patient outcomes is as important in the market if not more so than unit costs, Wal-Mart is left very far from us.

Lisa Gill - J.P. Morgan

And that’s really what they care about at the end of the day—the dollar spent, so what they’re trying to do is go line by line and say we can save you dollars here and that may be a lot of the prescriptions but not a lot of the cost.

Timothy C. Wentworth

Exactly. Right now, the numbers have actually changed a little. 85% of total gross spend now is brand, 15% is generic, even though almost of the scripts are generic.

David B. Snow, Jr.

The transformational thought here Lisa is that we call our members patients; they call them customers.

Operator

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

Robert Willoughby - Banc of America-Merrill Lynch

Rich, you answered the capital deployment question, but I guess I’m still rolling the dice on what you’re going to do any quarter, whether you hoard cash or buyback stock or pay down some debt, and I would’ve thought with a company of your size there would be a bit more consistency and balance on these fronts, and I guess in the absence of that, it kind of tells me maybe a bigger deal is coming and that you do have to maintain a lot more dry powder, and that’s really my only risk factor, so why no more discipline on the capital deployment front or balance, I guess?

Richard J. Rubino

I would tell you that I’m not maintaining dry powder for any specific purpose, and I’m not going to invest for the sake of an investment. I don’t think you would like it if we did that either. The reason why we pay down the securitization facility or most of the securitization facility this quarter is because it was renewed and the rates were higher and the carrying cost was higher, so it did not make good economic sense for us to keep that fully drawn. So that was a one-off decision that we made since obviously did have the cash. With regard to how you should project share repurchases going forward, as I mentioned earlier, we do have probably about $1.8 billion to go in the authorization. You will probably the majority of that activity toward the every end of this year and toward the very beginning of next year. Beyond that, I’ll just say stay tuned just as we are because at the end of the day, we’re going to deploy our cash in a way that drives long-term shareholder value. That is an imperative.

Robert Willoughby - Banc of America-Merrill Lynch

What drives the decision to front-end share repurchase versus back-end? Is it just the valuation here or why not space that out over 4 quarters?

Richard J. Rubino

There is a number of considerations, but valuation is certainly one consideration, and I can tell you that with $2 billion of cash on our balance sheet and with nothing imminent on the front with regard to significant acquisition, I think it’s a good thing to do right now.

Operator

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

Lawrence Marsh - Barclays Capital

On Tom’s earlier question, to me one of the big takeaways is that mail penetration on generic launches as opposed to just thinking about generic launches, and Dave I know you’ve highlighted in the past even bigger opportunities for 2011 and 2012, etc., and so just directionally, is it premature to think about a healthy contribution for 2011 and 2012 versus 2010, and if it is premature, what is the street missing in that assumption?

David B. Snow, Jr.

Healthy contribution from what, Larry?

Lawrence Marsh - Barclays Capital

For incremental generic launches again versus the $0.25 for 2010, and I know you don’t want to give guidance, but I’m just saying directionally are there incremental opportunities for the consequent two years?

David B. Snow, Jr.

I think there continue to be some opportunities. You’ve seen a trend more recently of negotiation between brand and generic manufacturers such that we’ve seen fewer releases than we did in 2006 and 2007, but there is that possibility. We had a few smaller ones this year that were good news and surprises. Since Tom Moriarty is here and he is responsible for all of our manufacturer contracting, I’ll ask him what he thinks about the environment right now.

Thomas M. Moriarty

Obviously, we monitor this on an almost daily basis and keep very much in tune with Rich, but Dave I would agree with your comments that in terms of where our projections are that’s a fairly good estimate, and are there potential opportunities? Yes, but it’s too early to tell.

David B. Snow, Jr.

A couple of other points—of course the $0.25 is based purely on scheduled generic releases next year, and when you look at the 2009 performance, we originally guided to $0.11 in contribution. That has since been increased to $0.13. About a penny of that increment was the result of earlier than expected generic introductions, actually focused on the product CellCept, and the other penny was really just higher penetration on the scheduled new generics.

Lawrence Marsh - Barclays Capital

Dave, in your prepared remarks, you specifically called e-prescribing as an opportunity. I know it’s a mandate I guess for electronic health record funding. How specifically should we think of your opportunity there? Will it show up in increased generic penetration rates, and are there other ways you can participate which should be a substantial migration to e-prescribing here in the next couple of years?

David B. Snow, Jr.

Relative to e-prescribing volumes, we’ve seen a doubling year over year in e-prescribing volumes, albeit on very small numbers, so you’re seeing the early signs of adoption and acceleration, so it’s an encouraging sign, but we’re in the infancy. So between the Medicare bill passed under Bush that creates a reward early on for e-prescribing and a penalty later for if you don’t e-prescribe, plus the stimulus package which says very specifically any government monies that go to health IT have to include use of e-prescribing. We think the acceleration should pick up even further. So how does that e-prescribing result in numbers for Medco? First of all, you have to think of administrative cost reduction, and it’s approximately $2 a script on new scripts in mail where our administrative costs go down. Why do they go down? Because a lot of the work in processing a new script is calling a physician because you can’t read their handwriting, calling the physician because they forget to fill out an important thing like the dose of the drug, calling about a drug’s drug interaction, calling about formulary compliance. These are all labor intensive activities that require sometimes multiple phone calls and re-work of a script. So you can get that all right upfront reducing pharmacists’ time, making a much quicker and more accurate transaction without the constant phone calling. So that’s the reduction in administrative costs. On top of that, remember about 40% of all mail scripts are considered new scripts. So 40% of our volume if it was all e-prescribed is $2 a script, so it’s a meaningful number. On top of that, we also believe if e-prescribing is structured properly, you will see better generic uptake, you will see better mail channel use because it’s a more cost-effective channel, you will see better automatic formulary choices, and ultimately Medco vision is we want to push to the doctor who is connected, the protocols and where that patient is performing relative to protocol, so they will close gaps in care, which again will drive down total healthcare costs for our clients and will save administrative dollars for us. So, lots and lots of really positive benefit when the system gets wired, and we’re encouraged by the early volumes we see today.

Richard J. Rubino

Just to give you some math behind that, 40% of mail scripts, so let’s use round numbers, 100 million scripts, that’s 40 million scripts at $2 saving per script is $80 million of potential annualized savings which is about $0.10 a share. That’s just to give you an order of magnitude, which to Dave’s point does not even include the power of higher formulary compliance, generics, and so forth.

Lawrence Marsh - Barclays Capital

That’s a big opportunity as you said because it sounds like e-prescribing penetration rates could get to 70-80% under this mandate. Is that a fair assumption?

David B. Snow, Jr.

It absolutely is, Larry. The one variable I cannot give you an answer to is the rate of adoption. So 100% is very realistic. The question is what is the trajectory. Is it over 5 years, is it over 10 years? I just don’t know yet, but I think once the stimulus bill, the HIT funding, really does get deployed, we will have a better sense and we will be able to update you with a much more accurate projection of the rate of adoption.

Lawrence Marsh - Barclays Capital

2010 selling season, are you seeing anymore focus on limited retail networks from your clients, or not really?

Thomas M. Moriarty

We’ve seen a bit more. One of the byproducts of the Walgreen’s and Wal-Mart sort of being out there talking is that we’ve been able to at least have conversations with clients to say hey listen we’ve shown you before, let’s show you again how to create some competition and improve your rate here. I wouldn’t say it’s a major move, Larry, but it’s certainly a continued dynamic.

Operator

Your final question comes from the line of Alex Beckler – Goldman Sachs.

Alex Beckler - Goldman Sachs

You recently announced the Plavix Effient comparative effectiveness study. As we get closer to the goal of improved generic conscious in 2011 and 2012, should we expect you to get involved in more of these head to head studies?

David B. Snow, Jr.

Yes. I think one of the powerful things that Medco has been doing and I think it’s going to continue is with our longitudinal database, we’re beautifully positioned to do these sorts of things to drive the best value possible for our clients which we view as our job, and honestly this is not just about cost savings. This is about safety. So many of the studies we’ve done are clearly about how do you keep the patient safe, how do you make sure the patient is on the right drug so that they don’t get harmed and they actually are cured or kept stable, and we have over 20 additional studies going on right now, and the list is growing, and we’re really pleased with how the FDA has taken some of our studies and changed the labels on drugs according to what we’ve learned. So we think this is very important. We think this ability to do comparative effectiveness and the way we immediately integrated it into our protocols for the way we dispense is really powerful, and you can see real results which we’re going to show you on analysts’ day, and also we’re big believers in evidence-based protocols when it comes to the practice of pharmacy, and just that ability to close gaps, get it right, have the technology and the systems that help with decision support to make a clinician that much better is just very powerful in a healthcare system, and stay tuned on that. We’re going to talk about it and show you more about that at analysts’ days later this month.

Alex Beckler – Goldman Sachs

That’s a great call. Thank you.

David B. Snow, Jr.

Thanks to all of you for your questions. In closing, I would like to remind you that our analysts’ day will be held on November 20, 2009, in New York City. The majority of our senior leadership team will be there to present our multi-prong strategy to continue growth. We will focus on the core drivers contributing to our success today and those that we believe will extend and propel the growth of our enterprise far into the future. Our strategy grounded in delivering smarter medicines through continuous innovation and best in class clinical care is both specialized and precise and one that has global appeal. We hope you can join us in person or on the webcast to learn more. For additional information about our analysts’ days, please contact Investor Relations. Thanks again for joining us.

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