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Express Scripts (NASDAQ:ESRX)

Q2 2010 Earnings Call

July 29, 2010 10:00 am ET

Executives

David Myers - Vice President of Investor Relations

Jeffrey Hall - Chief Financial Officer and Executive Vice President

George Paz - Chairman, Chief Executive Officer and President

Analysts

Lisa Gill - JP Morgan Chase & Co

Ross Muken - Deutsche Bank AG

Garen Sarafian - Citigroup Inc

Lawrence Marsh - Barclays Capital

Glen Santangelo - Crédit Suisse AG

Thomas Gallucci - Lazard Capital Markets LLC

Robert Willoughby

Randall Stanicky - Goldman Sachs Group Inc.

John Kreger - William Blair & Company L.L.C.

Ann Hynes - Caris & Company

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Second Quarter 2010 Earnings Call. [Operator Instructions] I'd now like to turn the conference over to David Myers, Vice President of Investor Relations. Please go ahead.

David Myers

Thank you, and welcome, everyone to our second 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 Safe Harbor 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 statement due to a variety of factors, which are discussed in detail in the company's filings with the Security (sic) [Securities] and Exchange Commission.

For clarity purposes, all numbers we talk about today will be on an adjusted basis. Please refer to the tables in our press release for the reconciliation of GAAP to the adjusted numbers we will be discussing. The reconciliation of EBITDA to net income can also be found in our earnings release. The earnings release is posted on our website at express-scripts.com

At this point, I'll turn the call over to Jeff, who will discuss our second quarter results.

Jeffrey Hall

Thanks, David. We plan to keep our prepared comment brief as we've already published a lot of data, and we believe the question-and-answer session provides a better opportunity to address your questions and our thoughts and strategies.

In summary, we had another strong quarter. All of our metrics are positive and moving in the right direction. Earnings and margins were up, cash flows were strong, we're raising the bottom end of our guidance, and we now have more than 50% of the WellPoint live migrated on to our system. Given this strong performance, we remain confident in both the short- and long-term prospects for our core PBM business and our ability to realize more than $1 billion of incremental EBITDA from NextRx.

Moving on to a few more details in the quarter. We reported second quarter adjusted earnings per share of $0.60, an increase of 33% over last year. This increase was driven by EBITDA, which grew 46% from the prior year and 6% sequentially as a result of strong operating performance in the core business and the NextRx acquisition.

Metrics for the quarter were solid across the board. Adjusted claims grew over 51%, reaching $189 million, mainly reflecting the addition of NextRx, but also the results of a successful selling season. Gross profit was up 31% over last year and gross profit for Rx increased 7% sequentially to $4.11. Going forward, we expect our strong performance in the core business and the realization of synergy will result in improving gross margins for the remainder of the year and into 2011.

As expected, SG&A spending increased from Q1 levels, as we continue to invest in our future. We continue to expect that SG&A, excluding amortization and nonrecurring items, will be between $865 million that $881 million for 2010. EBITDA for adjusted Rx reached $3.10, up sequentially from $2.92 last quarter. Cash flow from operations was up 197% from last year to $688 million. Cash flow was in line with our forecast and is on track to exceed $2 billion for the year.

As a result of our strong operating fundamentals and positive outlook, we are raising the low end of our EPS guidance range for the year. 2010 EPS is now expected to be in the range of $2.45 to $2.50, representing growth of 25% to 27% on an adjusted basis.

We expect to give initial 2011 guidance with the release of Q3 earnings later this fall. Until then, let me reiterate what I said at the beginning of the call. Given our strong performance year-to-date and the market factors we are seeing today, we remain confident in both the short- and long-term prospects for our business, our ability to grow margins throughout the year and into 2011, and that we will realize more than $1 billion of incremental EBITDA from NextRx.

And with that, I'll turn it over to George.

George Paz

Thank you, Jeff, and good morning, everyone. Our second quarter financial results reflect the strong fundamental performance of our core PBM business. We remain on track to complete the integration of NextRx in the lower end of 12 to 18 months with over 50% of our members already migrated on to our system. In addition to our integration activity, we have begun working with WellPoint on cultivating our alliance and deploying next-generation strategies and innovative programs to enhance the healthcare value we deliver to our members.

Although the selling season is not yet complete, I will give you a preliminary indication of our progress. In 2010, we have seen high retention rates by incumbent PBMs for signature accounts. We define signature accounts as those with 1 million or more adjusted prescriptions per year. However, we also see significant opportunities that gain share in the smaller to middle market.

Consistent with previous years, we have made decisions not to bid or renew certain accounts. We focused our efforts towards those clients that share our commitment to take the waste out of healthcare, while improving health outcomes for their members.

With our unique tools and aligned business model, we can significantly reduce client expense, improve patient healthcare and create value for our shareholders. We accomplished this with our clients when we are aligned, both clinically and economically.

For example, we chose not to renew a few NextRx direct clients, including a major retailer. Because of their preference for management and the pharmacy benefit was not consistent with our approach, we made this decision. Our past experience have taught us that these types of arrangements do not deliver value for our client. It can also hinder our ability to leverage economies of scale and dilute the value of our overall offerings to the rest of our book of business.

I should point out in the early 2000s, this retailer was a client of Express Scripts. When they came up for renewal back then, we also elected not to renew it. When we perform due diligence on NextRx, we specifically evaluated all the direct contracts. We knew a few of these contracts were managed in a manner that did not align with our approach and philosophy. As such, we assume these clients would terminate them. And when we calculated our purchase price and run rate EBITDA, we calculated those terminations in those numbers.

Although we decided not to renew certain clients, to date, we made substantial progress with our overall renewal efforts. At this point, we are more than halfway complete with our 2011 renewals. We anticipate by the end of the year, we will have client retention consistent with our historical norms of about 95%.

Today, we're having another strong sales year. We're ahead of last year's pace and have added over 140 clients, including two new signature wins. As a result of the strong selling season so far and strong operating performance in all aspects of our business, we currently expect 2011 claims to be flat to slightly up compared to the 2010 claims. We also expect EBITDA per claim to increase through 2011. We will continue to update you as the selling season progresses.

In the midst of a tough economy and the effect of high drug trends, our tools are more in demand than ever before. Throughout our history, we have identified and tackled inefficiencies in healthcare. From the early days, where our primary tools were rebates and retail network management, we evolved with innovative tools to drive greater use of generics and low-cost brands and increase the use of home delivery. We will continually evolve by focusing on those issues which are driving up the healthcare costs for our clients, both today and in the future. Namely adherence and specialty management are the focus of their needs today and our focus of our clinical programs.

Our ability to manage trend, coupled with our expertise in Consumerology, provides us with the ability to drive outlays for our clients, improve outcomes for patients and deliver increased earnings to our shareholders. As Jeff stated earlier, we remain positive on the underlying trends and opportunities in our space and remain confident in our ability to improve health outcomes and drive outlays, meeting the needs of our clients, lowering costs and generating exceptional value for our shareholders.

At this point, I'd like to open it up to questions.

Question-and-Answer Session

Operator

[Operator Instructions] And we will begin with the line of Lisa Gill with JPMorgan.

Lisa Gill - JP Morgan Chase & Co

George, as you talked about last quarter around pricing, can you maybe just give us an update if anything has changed in your mind over the last couple of months on the pricing front? Number one. And then number two, as you talk about the new clients that you've signed, maybe can you just give us some indication as to what plan design looks like, if we're looking at scripts roughly flattish, but you're saying EBITDA per script is going to up? Are you seeing people do more step therapy, more mail, et cetera, in your new book of business?

George Paz

From a pricing perspective, and we did talk about this last quarter. You know I've been at this business since I came in at the end of 1997 then here to '98 and forward, pricing has always been extremely aggressive. And I remember back in 1998 addressing this question, I think in those days our EBITDA per script was about $0.70. And when you think about where he sat then and clients need to take cost out of the equation, there's two ways you can go about it. If you have a business model, which is ineffectual, that doesn't deliver needs to the clients, then effectively what you have to do is you have to give up your price because you don't have the clinical tools and the expertise to take out costs. On the other side of that equation, though, if in fact, you have clinical tools and you have the ability to drive out costs to a much better item, is it safe, is to keep people in the generics and to home delivery and to lower-cost brand, where we can share rebates back with our clients to drive down their costs, and everybody wins in that equation. The clients save money, the patients save money and we make more money. And that's again, around our model of alignment. We put our profits into those second-tier branded products that save money for our clients are more most efficacious. We put our profits and greater levels of our profits into the generic products. And of course, mail, which is the winner for everybody in the equation as you get better health outcomes and lower costs is also our highest profit margin items. So as long as we keep that model strong, the best way we can take out cost is not to focus on our pricing, but instead to focus on the clinical programs that drive those prices. We've got over 95% retention with our book of business. The reason I believe that exists is because we can win year in and year out and effectively show our clients that we hold ourselves accountable to a scorecard, where we show what overall drug trends are doing across the industry, what drug trends are in their specific industry and then what it is for them. And when we're doing our job right, their trends are lower than other companies in their industry and are lower than the overall PBM industry. So I do believe that approaching pricing properly does not mean it's a win-lose situation, the client versus the PBM. It's a win-win. When you have an effective model, such as ours, that focuses on the economic behaviors of our members and behavioral economics to save more appropriately, we can drive out those costs and we can have it a win-win for all three constituents: the members, the plan sponsors and for us. As far as our wins, keep in mind, we're saying that we're going to be flat to slightly up on claims next year. But that takes into consideration the loss of a major retailer and another client, another direct client that was part of the deal that came over with us that we also knew. The way they approach it was not in line with us. Just talking about the retailer for a moment. Keep in mind, the way that one works. It's adjudication only, and 95% of the volume only goes to their stores. With that situation, where's the leverage? What value do you get in signing up a client like that? Obviously, they don't want clinical programs, they want everything dirt cheap, they don't want any intrusion by us in driving better health outcomes. That's not the way our company is put together. That's not the way we manage, and that's not the way we train our employees. So to try to carve-out and do one-offs for clients like that creates tremendous, tremendous inefficiency inside of our operations and technology components of our business and it's just not worth it, especially just to adjudicate a client. So what we do is we are willing to jettison those types of clients and sign on clients that looking at either to have strong three-tier systems, that have a passion for trying to drive out costs, we sent up clients that have two tiers. But the management team is dealing with a tough labor situation where they're confined by a labor contract, which doesn't allow them to go to three-tier or make big differentials between generics and brand. Well, we have the tools to Consumerology to go in and without changing claim designs to drive higher generic bill rates, to drive higher mail penetration and the unions buy in to that. And they allow us to take costs out for our clients and meet their need, and therefore, drive our profit. When we get clients lined up like that, our scale grows. Scale, in and of itself doesn't matter, unless it's a lined scale going after the right metric in order to drive overall profitability.

Lisa Gill - JP Morgan Chase & Co

So what you're saying is that it's just more of the same for 2011, you're not really seeing much as far as changes go, George, and what people are looking for from plan design? So that they're basically looking to Express Scripts for all the things you just talked about, rather than making big plan design changes?

George Paz

I would say, every client is different, Lisa, so what we see in some situation is the client will have -- that's taken on a step therapy program. And once we get huge utilization in the preferred product, then what a client may do in the following year is eliminate a drug off the tier in order to get even better economics. So we see people constantly, and that's our job, is for our account management team and our clinical pharmacists to sit down with those clients and help them work with their book of business in a situation they're in and tweak it. So hopefully, for all of our clients, we are constantly tweaking plan design with them in order to drive the desired benefits and minimize employee disruption. Especially in today's environment where HR departments have been cut back, they don't want employee noise. And so I think our tools are designed to get into those results while minimizing that noise. And I think that's the reason that works. And again, if drug trends are running 7%, 8%, and we can deliver 0% to minus 1%, we've done a pretty effective job. And therefore, price concessions are nearly as important. Having said all that, keep in mind, no client has ever called me on the phone and offered me more money the following year. The increase, to walk away from discount. So our job is to figure out how do we drive those discounts and drive those costs and still do what we do each and every quarter for our shareholders, which is drive up our profitability.

Lisa Gill - JP Morgan Chase & Co

And then just one follow-on, Jeff, did I hear you correctly that now you expect free cash flow for the year to be north of $2 billion?

Jeffrey Hall

Yes, that's correct. We expect cash flow to be above $2 billion. But to be fair, I think we say, it's definitely the same thing last quarter.

Operator

Next, we will go to the line of Robert Willoughby with Bank of America.

Robert Willoughby

George, on some of those NextRx clients that you've walked away from, how does this jive with the guaranteed claims number that you have with WellPoint? Have these clients been excluded from day one?

George Paz

Obviously, we're looking for strong relationships with our partners, and we believe that WellPoint is a great partner. And so when we went in, we knew this would go away. So we never wanted to include them in the calculation. That wouldn't be fair to them and it wouldn't be fair to do in general. So we excluded them.

Robert Willoughby

And just you've obviously bought stock back at some higher levels here than where the stock is today, might share repurchases going forward take a different form, more front-end loaded or overnight repurchases of some sort or any changes on how you're going about that?

George Paz

We've always had the same philosophy towards the use of our cash flow, strategic opportunities will always come first, but we weigh those against the options. So once we look at those, we then look at investing in ourself. But as you know, our business is not all that capital intensive. And then the third option is share repurchase and you've seen our behavior for the last 12 years. So I think that speaks for itself.

Operator

And next, we will go to the line of Tom Gallucci with Lazard Capital Market.

Thomas Gallucci - Lazard Capital Markets LLC

So just to be clear, George, when you're talking about not renewing, obviously, these are things that you didn't even bid on, is that right?

George Paz

Yes. Well, the one big retailer, we didn't bid on that. There was no sense in bidding on that. I think, I don't know if you've ever been a part of a PBM or seen what a proposal looks like, but we're talking thousands of drugs and a lot of the plans have multiple divisions and so you have different claim designs for different division. It's a lot of work. And I don't believe in spending money that doesn't make sense. So in that situation, we could see the pricing. We knew where it was at. We knew the client well, and we elected not to bid it.

Robert Willoughby

Maybe just changing gears, your volume for the year is sort of in line with what you've talked about in the past so far. But obviously, there's been issues that have been discussed out there about physician office visits and pressures on an overall industry script volume, or maybe some shifts in mix versus what people are looking for. Can you just maybe make a comment toward the macro environment and how it's shaping up versus what you've been expecting?

George Paz

Jeff, may want to chime in here as well, but our focus is not just what the environment evolved. We had to be a major player in the environment. So when we see members, diabetic, people on look to lowering drugs, hypertensive, hence, hypertensive drugs, we see that they're not filling their scripts. We don't just say, "Okay, it's a bad economy." We reach out to those members and with our clinicians and our pharmacists, and we try to make sure they understand the impact of non-adherence and we do a pretty good job. Year-to-date, we're actually seeing trends close to 3% to slightly under that in our book of business. Utilization trends, we see it both in new prescriptions being filled, as well as in renewals. I can't speak to some of the comments made by others and why they're not seeing the same thing we are, but maybe because our Consumerology or because probably, because our Consumerology approach really does work and our messaging to our members really is effective. And it does drive behaviors, and we are getting those better clinical outcomes. And I 100% believe it that it's working and we're seeing the numbers come through. Jeff, do you have anything you'd like to add?

Jeffrey Hall

I think that's exactly right. We look in detail at our utilization yesterday again, after our comments were made and our utilization is exactly where we forecasted it for the year and adherence remains very strong in our book.

Thomas Gallucci - Lazard Capital Markets LLC

Any differences in mix, retail, mail, et cetera?

George Paz

Yes, mail is always stronger. And again, I think, it only make sense, right, if you're an Express Scripts' mail user, a call comes into your house or a text message comes to your phone or whatever your appropriate means of communication is and its got Express Scripts on. If you're a mail user and you're using our pharmacy on a regular basis, chances are you're going to open it and read it and see what we have to say. And so we reach out to the individuals when they -- in the scripts, if we see that their renewal is due and they haven't refilled it yet, we'd send out a reminder notice to them. They can sign up for automatic renewals if they would -- so it could just show up automatically, if they want. So we give them a lot of tools and a lot of opportunities. We got our pilots going with our ball caps. So that's giving us some very positive results as well. So we constantly look for ways to evolve our programs to make sure our member use the first sign of defense, which is prescription drug to maintain their better healthcare outcomes. And I think we're very effective at it.

Operator

Next, we will go to the line of Glen Santangelo with Crédit Suisse.

Glen Santangelo - Crédit Suisse AG

One of the questions I think that's been on a lot of people's minds, post reform, is maybe whether the insurance companies might decide to claw their PBM businesses back in house based on the new MLR rules or ultimately decide to outsource those businesses. We obviously had the WellPoint data point last year. And then this week, we had Aetna. George, I don't know if you kind of have a view on potentially the direction of those captive PBMs? And maybe if you think there's more opportunity down the road potentially what you see given within the reform rules?

George Paz

Quite frankly, I think it works to our advantage. When you have pressure and you got to figure out how do I maximize profits, keep in mind, that a health plan selling an insured product, when that drug costs comes in to them, that drug is going to be included in that premium costs so it's already in the number. When we pay the drug on their behalf, it becomes part of their cost of goods sold. So the drug cost is embedded into their MLR. So that's in there, whether they do it internally or externally. Now the question becomes how do you make profits of this? And how do you get the best outcomes? So our job is to make sure that we are better than the alternative in-sourcing and I think it speaks for ourselves. WellPoint saw our expertise in this area. They have a tremendous expertise on the medical side, by them allowing us to manage the drug side for them, their focus on the medical side. I believe they can drive their overall loss ratios to the right level to meet their clients' needs and allow them to maximize their profit levels within their book of business. And I think that's what it's all about. So our focus on the drug side, they're focused on the medical. And then our joint focus on overall health outcomes, I think, is a winning combination that you'll see in both of our results as we go forward.

Thomas Gallucci - Lazard Capital Markets LLC

So with kind of that being said, you would expect to see that trend towards outsourcing continue. Is that a fair way to characterize that?

George Paz

I'm pretty biased with this, obviously. So you're asking me, I would think it's the right answer. We provide outsource benefits to many, many Blues claims around the country, plus other managed care organizations. I think we are considered by most, if not all of them, as their right hand in helping them manage their overall cost. I think it's the right answer. I think it's transparent. From their perspective, they're getting the best of all worlds. They're getting the value of a $40-plus billion revenue company that can make the investments in the drug side that they need to be competitive. And at the same time, they're getting very good pricing in the proper clinical outcomes for their members. It's a great combination for all the parties, I mean, while we can create value for our shareholders. So I think it works and I think it works great.

Glen Santangelo - Crédit Suisse AG

George, maybe if I could just ask one other follow up. If I listen to kind of your call and then CVS and then ultimately Medco, it kind of sounds like each quarter you guys are sounding more and more different from each other and your models are kind of evolving further and further away from each other. How is that being perceived with the client base out there? Do you think the bigger clients are starting to view you guys more and more differently over time? And will that ultimately impact pricing in either direction as maybe you're viewed potentially less as a commoditized business over time?

George Paz

I've always believed that. I've always believed that we were different and our approach was different. We have a very strong focus on that number. Pat and Gary, operations and IT, Ed from sales to account management, their whole mission is to treat each of those 65 million members as an individual and to give the right tools and the right offering to not just worry about the 5% of the patients we spend 80% of the drug costs, but instead to focus on every member. Because if you're one of those other people that just have episodic care, you don't care. If you know that you're taking really good care of that other 10% or 15%, you want to know that you're taking care of, and that's our approach. We treat each member with a tremendous amount of respect and a passion for their situation and try to solve it. I do think that makes us different in at least at my view. I can't speak to Medco or Caremark view. You got to ask their CEOs. Their approaches and what their doing. But I do think that each of us have a different approach to the marketplace. I like the things that they are all different. Again, as I started in my prepared comments, I don't believe that the answer is just the drop price. If you just got to drop price to get business, that speaks for the quality of your service and your offering. I think you got to be able to just go in there and show that you can drive better health outcomes, while lowering costs. And if you can do that, you can maintain your profitability. If you don't have a model that can deliver that, then you can only deliver on costs, and that's not what we're going to be.

Operator

And next, we will go to the line of Ann Hynes with Caris & Company.

Ann Hynes - Caris & Company

Have you ever disclosed how much of the $1 billion incremental synergies you have included in guidance for 2010? And if you haven't, will you do that?

George Paz

I'll let Jeff answer this. But from my perspective, I think, you also have to understand that WellPoint has many, many, what we call, dope [ph], and that's different plain designs by -- they have 14 different Blues plans in each of those fill a myriad of different products. They have come on to our systems. We can calculate the synergies that we're going to gain from where we stood a year ago when we closed the deal or before we close the deal. Once you put all the companies together, it all gets commingled. We buy drugs at mail order. We negotiate discounts from the retail drugstore chain. We don't negotiate discounts and rebate. That's why it's so important that we have a homogeneous approach to the marketplace, and we no longer focus. I know many of you look and try to focus on how much is coming out of WellPoint and how much is coming out of this. For us, it's a lot of allocation, and we feel very, very confident in the numbers and the trends that we have. But we just don't break those out. We don't talk about client-specific economics, and we're not about to now.

Ann Hynes - Caris & Company

And just a follow-up, Jeff, you made a comment that SG&A will be going up to invest in the future. Can you discuss some of the projects that you're working on?

Jeffrey Hall

Sure. We've spent a lot of effort here. As George was just talking about, building out better and better systems to make sure that we're well serving every individual client out there, and providing just absolutely flawless care for our clients, for our members and along those lines. You'll also hear us talk a lot about behavioral economics, and we're spending a lot of time and effort there in building out new programs, new systems that really led us continue to build our lead there, continue to build our intellectual property. So that we can continue to deliver better health outcomes and lower cost to our clients and members along those fronts.

Operator

And next, we will go to the line of John Kreger with William Blair.

John Kreger - William Blair & Company L.L.C.

Another question about the progress around the WellPoint integration. It seems like you gained some speed recently. Given that, are you starting to feel comfortable that perhaps in 2011 you could start transitioning to the next phase where you can drive more mails, specialty and some of your more clinical programs? Or should we view that more as an opportunity for 2012?

George Paz

The first thing we want to do is get everybody on the same platform, and that's appropriate. As they come on to our platforms, we now have the tool in our operations centers to actually start effectuating and driving, especially from the generic side. That's already starting to happen. It becomes full force though with a real drive behind it in 2011. So we're not waiting for 2012. What I'd hope what we're doing in 2011 is try driving their generic penetration. We are where it is today, as well as the mail order. And we also, simultaneously, through Dr. Miller, we have a focus on what is that next-generation. Those groups already meeting, and we hope to start delivering on some combined new approaches to the delivery of healthcare throughout 2012 and '13.

John Kreger - William Blair & Company L.L.C.

And then George, just a follow-up question on health care reform, based on what you know now, when do you think you might start to see some additional competition within the Specialty business through biosimilars?

George Paz

We've been meeting, both Jeff and myself and many of my senior management team have been meeting with several representatives and senators. It's great we got in what we got in. We fought hard for that, but we're still fall far short of where we need to be. I think the big question for pharma today is they try to use the pipeline and the pathway or did they just go about it in the new -- just try to introduce new products. And I think that you're going to start seeing some come into the market because of the receptivity. But I think that congress, as they look at new ways to drive down healthcare costs, because keep in mind, through this bill, what we've done is were given coverage, but we really haven't tackled the tough problems of costs. And as we start tackling those problems, I think there's room for that component of the bill to be amended and made more easier for pharma to introduce products. So I think under the current rate, a couple of years out, we should see some biosimilars. We really like to see some biogenerics coming in the market, and we're going to need some more legislation for that.

Operator

And next, we will go to the line of Ross Muken with Deutsche Bank.

Ross Muken - Deutsche Bank AG

I want to build off of something that one of the earlier callers talked about. And there's been a lot of you who recently kind of on the healthcare reform front, but really across the service complex on sort of core growth and the sustainability of earnings, and the sustainability of capital returns. As you look at your business and then you look at the next several years, which we've known for sometime, we're going to be quite good and think about the various threats on the horizon. I mean, is there anything different today than versus six months ago or 12 months ago or even before in terms of how you thought about things that you could even perceive as a potential threat to any of those metrics as we go forward?

George Paz

Well, of course. There's always threats, right? I mean, anybody that's a business man is going to be looking for threats. My job is not just to look for threats, though, it's how do you mitigate those threats and then take advantage of the opportunity. When I look out through 2017, I see a tremendous amount of Blue Sky. Think about what we were about to embark on. The government has just opened up coverage to over 30 million more, and it's probably more than that based on the state of economy today. It's more than 30-plus million people are going to now have access to coverage. In addition to that, who's got the tools that work? The PBMs have a proven pathway and track record of showing that we can reduce costs, while improving health outcomes. Think about all the statements that were made by the administration about what they needed to have in health outcomes, and it's a blue print for the way the PBM was designed. So you got millions and millions of individuals come into the market. You've got a proven model that does what it needs to do to take costs out. I think we're sitting at an incredibly good space right now. I think we have -- sure, there's pricing pressures. But keep in mind, we have tremendous inflationary impact of drug costs. When drugs are going up at 7% to 10% a year, you got specialty products that arise, going up at double digits 14%, utilization trends and specialty that are driving overall specialty drug trends at 20% or more. Those things are all opportunities for us. So when you have those kinds of increases, you can actually give part of it back to your clients as price concession and still have profit for yourself, especially if you can show that you're driving people to the cheaper alternatives. With all of the headwinds that we have as a nation and healthcare inefficiencies, I see the PBMs as a great, great tool to continue to grow, to innovate and to change the way healthcare is delivered and take advantage of the opportunities that are out there. I think we are part of the solution. And being part of that solution provides us runway for better years to come.

Ross Muken - Deutsche Bank AG

I certainly tend to agree with you there, George. Maybe one for Jeff, we have the maturities coming due, I believe in October on one of the term loans, you have the interest rate you're paying there is pretty de minimis. As you sort of think about where leverages is today on the balance sheet and putting that in the context of the interest rate environment, you sort of appetite for maybe rolling that over or maybe keeping more leverage, I guess, would be the way I'd put it on the business, and then to a degree that you might do that. You obviously have a pretty attractive stock price. I think someone hinted earlier to kind of the desire and appetite for that. What sorts of things would be possible in that context?

Jeffrey Hall

Certainly, there are lots of possibilities. I mean, you're exactly right. We've got about $980 million of debt that's due in October. Our expectations, same thing we said last quarter, expectation remain the same at this point that we will pay that off when it indeed come due. When we do that, we're going to beat about 1x EBITDA, debt to EBITDA. And we've said many times in the past that our goal for -- or the correct range for us to leverage is 1x to 2x EBITDA. So we're certainly going to be at the low end of that range. So being at the low end of the range, along with the strong cash flows that the business is producing, really opens us up to a lot of different opportunity. And our view of how we want to use that cash hasn't changed over time. We still think the best use is reinvesting in our business. And second is solid, accretive acquisitions like the NextRx acquisition. And to the extent that we still see offered excess cash beyond that, then we use it to do share buybacks. And George said earlier on the call we're buying stock back at higher prices earlier in the year. So certainly if the stock stays at a level it has been recently, that's certainly in a very attractive price to us as well. So I'm not really ready to give any more detailed guidance than that today. But certainly, we have lots of opportunities and have historically done the right thing for our shareholders.

Operator

And next, we will go to the line of Lawrence Marsh with Barclays Capital.

Lawrence Marsh - Barclays Capital

First, a clarification for Jeff. I'm assuming a little over 1% script growth in '11. I know back in February, you guided to, I think, $740 million to $760 million adjusted claims. It seems to me you're on a run rate to do kind of a higher end of that. Is there any way to clarify that? Is it fair to say that's kind of the right base?

Jeffrey Hall

Yes, I don't think we want to tighten up that range at this point. We still think that $740 million to $750 million is the right range for scripts for the year.

Lawrence Marsh - Barclays Capital

George, you've mentioned another direct client from WellPoint that you assume was leaving, it is. I know you don't talk about specific customers, but can you give us any clarification even via industry group?

George Paz

No, I prefer not to. The only thing I mentioned the retailers is because that's been in the press release that somebody else put out. I don't take a greater pride in jealousing a client. I mean, you do it because it's the right economic answer. But I would rather have them conform. I would rather have them look for more than just adjudication. For me, purely adjudicating a claim for a couple of pennies a script, that doesn't do anything for me. Unless it's adding scale and size, as we've talked about earlier, and doing things that are benefiting the entire book. It just doesn't make sense. So singling clients out to talk about, it's not something whether we win them or lose them. It's something I've ever really wanted to do.

Lawrence Marsh - Barclays Capital

I guess to that point, George, you make an interesting observation at some customers, understanding your system and some not, and we step back and say Aetna. They used to be a customer of yours. They chose some years ago to go on their own way, and start their own PBM, build on facilities. Obviously, they've chosen to partner with another competitor. So in terms of that, is it fair to say you are not necessarily in agreement with how they're thinking about running their business relative to your customer? Or are you not in a position to comment on their strategy?

George Paz

I'd rather not talk about other people's strategy because that's their business, and what they've elected to do to get a deal done. But I would tell you again, from my perspective, if a big company comes to us, and let's say it's a health plan and they own their own PBM and they want to carve out that PBM and partner with Express Scripts, we are going to be -- there's two ways to be competitive on that deal. One is we can do it for no value, i.e., no shareholder value, give all the economics to the client and have them do whatever they want to do, whether manage their own formularies, whether they manage their own networks, whether they want to take in all the back office stuff. We can do that, but the value just isn't there. If we can convince them, which is what we do, that they should align their formularies with ours. At the end of the day, we have a P&T Committee. Most health plans have a P&T Committee. Yet when you look at our formularies, sales were at lapped 99% of the time, or somewhere in that range, because we can get them to understand how we make our selections. We can show them the economics of it. So we can find clients that want to conform to our ways, and I believe it's the right clinical answers. And they want to go after the things we want to go after. They want to drive generics. They want to pay me more for my generics, and maybe lose money on my brands or make money on my generics. As I can drive more, they win, I win. Those are the clients we want. Those are the clients we line up with. Same thing with getting the rebates on the branded products. Again, going back to conformity of formularies. So if a client comes to us and none of those things are lined up, they just don't line up well, we, quite frankly, don't waste our time even bidding the account. It's not worth it. We can spends thousands, thousands of dollars, a lot of man hours, kill a lot of trees. At the end of the day, we're not going to get it anyway. So why?

Lawrence Marsh - Barclays Capital

Finally, back for Jeff and maybe George, I know you've been very consistent in suggesting $1 billion of incremental EBITDA to enterprise when integrated. I know you've communicated, you've just paid the integration, being completed the low end of 12 to 18 months. I know your partner suggested yesterday and just made integration to be completed by the end of 2010. Is there reason to think then that $1 billion of incremental value should accrue fully into 2011 or you're not willing to say that?

Jeffrey Hall

I think it's a -- I think we haven't really gone there. I would say that if you'd assume that everything -- if we are indeed completely done by the end of the year, then I think it's reasonable to assume that $1 billion would all accrue in 2011.

George Paz

Larry, what we'd like to do is at the end of the third quarter, we will have, for the most part, keep in mind the small employer comp, the TPA business, a lot of the small Brokerage business, it's still out there, a very profitable business by the way. So it's something that we really do focus on. But having said all that, the majority of the big accounts have been selected. Retention was pretty much done. And so when we disclose our third quarter earnings, as Jeff said earlier, we will give full year guidance for 2011 at that time.

Operator

Next, we will go to the line of Randall Stanicky with Goldman Sachs.

Randall Stanicky - Goldman Sachs Group Inc.

George, first, a follow up, a lot of cash flow being generated. As you think about the longer-term picture, what's your strategic appetite to add businesses or diversify away from the core PBM offering or add tangential businesses to what you currently have?

George Paz

I looked at our business, and I see growth rates. I think Jeff talked about 25% to 27% growth for this year. We've got the value of NextRx coming in. I have a lot of confidence in the WellPoint management team and where they're headed. I have a lot of confidence from either Blues plans and managed care partners that they want to do, what we want to do in driving out the waste of costs. And we've got hundreds and thousands of clients that are aligned with us. And I looked and I asked, what are the industries do you own or do you have that since 1992 have grown in excess of 20% in each and every year. And then I have to ask myself what would I diversify out of that? What do I add into that mix that can supplement that growth rate and not be a drain on the ROIC, which, I'm the x-CFO here. Jeff is 100% behind it. The management team believes in ROIC. I can't think of why we would want to diversify, when we got a business model that's in demand, that's needed by America, and we can deliver exceptional value for our patients, clients and shareholders. It just doesn't make a lot of sense to me.

Randall Stanicky - Goldman Sachs Group Inc.

As you look forward to 2015 plus, I mean, do you think that growth rate that you're putting up right now, which is obviously significant, do you think you can sustain that growth rate through that period?

George Paz

You're talking 2015, its 2010. We do three-year plans. The third year is always a bit of a challenge because what's going to happen in three years? I can't speak unequivocally that 2015 is going to continue on the same path. But I think the answer to that question resides in the management team that you entrusted to run your capital here at Express Scripts. Our job is to make sure we don't give up on that growth rate. My people, my management team is absolutely focused on maximizing our growth rate, and we don't take that lightly. And I don't think -- it's not like we come to work every day and we just switch somebody to a generic. Our whole idea is to innovate, improve and change the way we administer. If you were to walk into Express Scripts in 1998, if you were to walk in 2002, 2005 and now in 2010, our approaches, our reporting, what we do for our clients, is far different than each one of those different intervals. We don't want to sit still and wait to get commoditized. We innovate, change and come up with new ideas and new approaches to tackle the myriad of problems and inefficiencies that existed in healthcare. Our job is to stay on top of that. 2015 is a long way out. I feel really good about where we sit today. We talked about what healthcare reform can do for us. I think there's a lot of Blue Sky out there. Our job is to make sure we capture our share of the value.

Operator

With the line of Garen Sarafian with Citigroup.

Garen Sarafian - Citigroup Inc

First, on the selling season and your two new signature wins. Can you just elaborate a little bit more as to what in particular resonated with these two new clients that their current vendor wasn't providing?

George Paz

He sent me an e-mail yesterday which was a debrief. Every time we renew a client or we win a client, I think, we have a very high track record of winning in a jump ball situation. But quite frankly, there's times when the client renews with the existing, incumbent. And so what we do is we just say, okay, we take that apart and understand, could have done something different. Was it merely the client trying to get a better price from their existing vendor or was it just effectively doing a market check or they actually going to change hands? So we take it apart. Rod sent me an e-mail yesterday, and look at three major wins we've had this year and what was the driver. And I would tell you, Consumerology was a very important component in all three of those wins, two of those signature wins, where in fact, they pointed to the fact that we were addressing their need and hitting the market with opportunities that they don't otherwise have access to get the best pull-through without massive planned design changes, which could cause employee disruption. Our approach here is resonating, it's working and it's good for us and our clients and our members. So I think that is the driver.

Garen Sarafian - Citigroup Inc

And then in your prepared remarks, you made some comments about you seeing some opportunities in the small to mid markets, which I thought was interesting because I would have thought that with the acquisition of NextRx, using your jump ball analogy, you're totally, probably going over it in a more formidable competitor with the Fortune 100. So is the small to mid market more of a focus this year? Or am I just reading too much into it?

George Paz

No, its been a focus every year since we went public in 1992. It's always been an area that we really go after. Let me make sure I'm clear, though. In those states where NextRx has a dominant position and there's a small client opportunity, we would rather work through them than go direct. So we want to partner with our Blues plans. We have Blues plans throughout the country. We have managed care organizations throughout the country. And so we were actually caught our sales to people on our clinicians into their shops to help them secure clients and growth. So we do it in two different ways. We do it either through our existing managed care book of business or we do it direct in those areas where we don't have a managed care partner, or if a client wants to carve out and no longer offer an insured benefit. And they just want to go purely ASO, and they want us to bid, and we would bid on those two. But that's always been a big focus of ours.

Garen Sarafian - Citigroup Inc

And then just lastly, it's clear that we can see our progress in migrating the NextRx lives onto the Express Scripts' IT platform. But can you maybe discuss a little bit as to what you've started to do with these lives and now that they've migrated? Are there any metrics you can share those very low mail penetration, for example? Anything you could share on that would be great.

Jeffrey Hall

The focus, as we said earlier, the focus this year is really getting all the lives migrated. While we started to explore potential ways to increase mail and generic bill rates and those things, we are spending a lot of effort on that this year. The primary effort is to get the lives migrated. And then just to be clear, integration doesn't end with migration. There's a lot of other things we have to do that are also related to integration. But as we go through the integration, once that's complete in early next year, we would expect them to spend a lot of effort mapping out new mail plans, new generic plans and really starting to second order drive the integration and the synergy. Certainly, both WellPoint and Express Scripts, in keeping with our model of alignment, are both very highly motivated to increase mail and increase generics, and we're confident were going to be able to do that over time.

George Paz

Well, again, I thank everyone for joining us this morning. We do have tremendous confidence in our space, and we feel very good about our position in the marketplace. We believe our clinical tools are second to none. Our Consumerology approach, coupled with those clinical tools, allows us to compete extremely effectively in the market to maximize shareholder value while delivering value to our clients and our patients. So again, we appreciate your attendance on our call this morning. We look forward to talking with you all soon. Thank you.

Operator

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

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Source: Express Scripts Q2 2010 Earnings Call Transcript
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