Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

MedcoHealth Solutions (NYSE:MHS)

Q4 2010 Earnings Call

February 22, 2011 8:30 am ET

Executives

Valerie Haertel - IR

Glenn Taylor - Group President of Health Plans

Timothy Wentworth - Group President of Employer and Key Accounts

Richard Rubino - Chief Financial Officer and Senior Vice President of Finance

Steven Fitzpatrick - President of Accredo Health Group Inc

David Snow - Chairman and Chief Executive Officer

Analysts

Lisa Gill - JP Morgan Chase & Co

Ricky Goldwasser - Morgan Stanley

Ross Muken - Deutsche Bank AG

Steven Valiquette - UBS Investment Bank

Lawrence Marsh - Barclays Capital

Thomas Gallucci - Lazard Capital Markets LLC

Randall Stanicky - Goldman Sachs Group Inc.

Operator

Good morning. My name is Vanessa. And I will be your conference operator today. At this time, I would like to welcome everyone to the MedcoHealth Solutions Fourth-Quarter 2010 Earnings Call. [Operator Instructions] I would now like to turn the call over to Ms. Valerie Haertel, Vice President of Investor Relations. Please go ahead, ma'am.

Valerie Haertel

Thank you, Vanessa. Good morning. And thank you for joining us on Medco's fourth-quarter and full-year 2010 earnings conference call. With me today as speakers are Dave Snow, Chairman and Chief Executive Officer; and Rich Rubino, Chief Financial Officer. Also joining us for our question-and-answer session are: Kenny Klepper, President and Chief Operating Officer; Tom Moriarty, General Counsel, Secretary and Senior Vice President of Pharmaceutical Strategies and Solutions; Steve Fitzpatrick, President of Accredo Health Group; Dr. Rob Epstein, President of Advance Chemical Science and Research; Tim Wentworth, Group President of the Employer and Key Accounts; and Glenn Taylor, Group President Health Plans.

During the course of this call, we will make forward-looking statements as that term is defined in the Private Securities Litigation Reform Act of 1995. No forward-looking statement can be guaranteed, and actual results may differ materially from those projected. We undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future events or otherwise. Forward-looking statements made on this call should be evaluated together with the risks and uncertainties that affect our business, particularly those disclosed in our SEC filings.

Copies of Medco's filings are available from the SEC, the Medco Investor Relations Department or the Medco website. Medco intends to use the Investor Relations section of its website as a means of disclosing material non-public information and for complying with its disclosure obligations under Regulation FD. The copyrights for the contents of this discussion and the written materials used on this earning call are owned by MedcoHealth Solutions, Inc. 2011.

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 medcohealth.com. Additionally, please note that we expect to file our 10-K after the close of the market today.

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

David Snow

Thank you, Valerie. And thanks to all of you for joining us this morning. Medco is pleased to report record fourth-quarter and full-year 2010 earnings, reflecting strong financial and operating performance at the high end of our previously increased guidance. Today, I will focus my remarks on full-year 2010 results and 2011 guidance, while Rich will focus on our balance sheet, our fourth-quarter results and details surrounding our 2011 guidance. At our Analyst Day in November, we shared with you our expectations for Medco and our business strategy that is designed to continue delivering strong growth through 2020. We outlined our portfolio of growth drivers that will advance our mission to make medicines smarter for our clients and the more than $65 million members we serve. Today, we remain confident in our expectations and are pleased to provide you with the details of our performance for 2010 and expectations for 2011.

Let's begin with our year-over-year 2010 financial and operational performance. For the year, we delivered record GAAP diluted earnings per share of $3.15 representing growth of 21.1%. Our diluted earnings per share excluding the amortization of intangibles from the 2003 spin-off grew 20.1% to a record $3.40. Our net revenues reached a record $66 billion, up 10.3% from 2009 despite the higher volumes of lower-cost generics that reduced our net revenues by nearly $3.7 billion and correspondingly resulted in record client and patient savings.

Within net revenues, our higher margin-generating service revenues grew 28% to a record $1.08 billion, fueled by our United BioSource acquisition and service revenue growth across the company. We achieved record total gross margin of $4.3 billion, an increase of 7.7% over 2009.

Our EBITDA increased 8.1% to nearly $3 billion and our EBITDA per adjusted script increased 1.6% to a full-year record of $3.11. And finally, our net income increased 11.5% to a record $1.4 billion. With respect to the operating metrics that contributed to our strong financial results, overall prescription volumes adjusted for the dates applied between retail and mail grew a strong 6.5% to a record 957 million prescriptions.

Mail-order prescriptions for the year grew at a strong 6.5% to 109.8 million, which exceeded the high end of our guidance of 109 million prescriptions and set a new record. Importantly, we experienced continued strength in generic mail-order volumes, increasing a substantial 13.4% to 67.6 million prescriptions as patients continued to choose lower-cost generic medications.

Growth of generics [ph] for the fourth quarter was even greater at 15.1%. Our overall generic dispensing rate rose 3.5 percentage points to 71% and within that, our mail-order generic dispensing rate component increased an even greater amount by 3.7 percentage points to a record 61.5%. For the full year, our Medicare Part D PDP revenues achieved a record, increasing 33.5% to well over $1.4 billion. We are proud to have been the first and only national PDP to be awarded five stars by CMS and believe this world-class recognition operationally not only validates our investments in our agile enterprise but also enables continued strength in our Medicare business going forward.

Moving on to our Specialty business, Accredo's performance remained strong with revenues increasing 19.1% to a record $11.3 billion and operating income rising 22.7% to a record $438.2 million. Turning to sales and client retention results, Medco delivered another solid year of performance. Our 2010 annualized new-named and net-new sales each remained strong at $5.3 billion, and our client retention rate remained over 99%. For 2011 to date, our annualized new-named sales stand at $1.7 billion and our net-new sales are currently $1.5 billion, up from the $1.4 billion previously disclosed on our third-quarter earnings call. We have now completed over 80% of our 2011 scheduled and early elective client renewals, up from the over 50% we reported on our third-quarter call, and our 2011 year-to-date client retention rate remains at over 99%.

This past year, we continued to invest in our enterprise by expanding our expertise in genomic and personalized medicines with the acquisition of DNA Direct. We also entered the market for post-approval Phase IV safety, economic evaluation and outcomes research through our acquisition of United BioSource. We are very pleased with the results to date for both of these acquisitions. DNA Direct's genomic services are gaining traction in the marketplace. Just a few weeks ago, we announced the addition of four new community hospital clients to DNA Direct genomic medicine hospital network, extending web-based physician support and genetic expertise to their physicians and their patients.

We also announced the addition of four new health plan clients who are implementing DNA Direct's Policy & Benefit Support Program for molecular diagnostic and genetic tests. This program enables payers to determine coverage for more than 800 molecular diagnostic and genetic tests and provides real-time access to the DNA Direct team of genetic counselors for clinical guidance and counseling on the more than 2,000 genetic tests available today. We are encouraged by the level of market interest in these new service offerings.

We are very pleased with the acquisition of UBC, which has been enthusiastically embraced by more than 100 Medco clients, representing more than 40 million lives volunteering to be part of the Medco research consortium to participate in UBC research study. This is up from the previously disclosed 89 clients and 33 million lives. As we noted at Analyst Day, both our clients and biotech drug manufacturers have common interests to ensure the safety and efficacy of new drugs coming to market. On top of that, Medco and its clients are fully aligned to pursue better outcomes and lower total healthcare costs, the essence of Making Medicine Smarter.

As we move forward, we anticipate UBC will continue to realize strong growth from its impressive pipeline of opportunities, including safety surveillance where UBC holds the market-leading position globally. Additionally, we expect to leverage UBC's, Medco's and Accredo's capabilities to the benefit of our clients and patients as we fundamentally change the way drugs are introduced, delivered and monitored for both safety and economics.

Turning to guidance, we are reaffirming our full year 2011 GAAP diluted earnings per share guidance of $3.53 to $3.66 reflecting a growth rate of 12% to 16% over 2010. Diluted earnings per share excluding all intangible amortization, our new pure cash EPS measure, is reaffirmed to be in the range of $3.99 to $4.12, reflecting 12% to 16% growth over 2010 earnings per share. Please note that the growth rate change for GAAP and pure cash EPS was 12% to 17% previously, but has narrowed due to the fact that we achieved the high end of our 2010 guidance range.

In closing, we remain confident in our ability to generate strong EPS growth well into the future. In the weeks since we shared our long-range plans with you, I have been asked how we can be so confident over such an extended horizon. There are two primary reasons, the first is the rigor and granular detail behind our 10-year strategic financial plan. As we shared on the Analyst Day last November, we have a very detailed roadmap for growth that is reasonable and logical based upon the many compelling opportunities we foresee over the next 10 years and a realistic view of the risks we may have encountered along the way. I believe that our growing portfolio of capabilities with leaders who are dedicated and accountable for each one of them will enable us to offer a comprehensive suite of solutions that will likely remain unmatched in the marketplace.

The second is our people. Our employees are united to a greater good, a noble cause that fuel the passion around Making Medicine Smarter in a world-class manner. While a common vision is important, our people also have proven ability to execute with unparalleled excellence. Our CMS five-star rating is a testament to this, further evidence can be found in our January 1 install, which were virtually flawless despite the record number of complex changes required by CMS in the recent healthcare reform mandate.

As we continue to make progress in advancing our capabilities through our agile enterprise initiative, we expect to achieve unprecedented improvements in the way we deliver operational excellence to the benefit of our clients and members. Yet another example of our operational excellence is the recent final approval we received from the Indiana Board of Pharmacy for our new third-generation automated pharmacy located in Whitestown, Indiana.

In the testing phase that ran from September through mid-January, the board found that the pharmacy filled every prescription of the tens of thousands tested with 100% accuracy. I would like to take this opportunity to thank each and every one of our over 24,000 Medco employees now spanning the globe for their continued efforts on behalf of clients, patients and shareholders resulting in another great year and strong, long-term prospects. They are delivering everyday for our clients, members and shareholders.

With that, I will turn it over to Rich Rubino, who will take you through our balance sheet, the fourth-quarter 2010 financials and further details on our guidance for 2011. Rich?

Richard Rubino

Thank you, Dave. Good morning. We are pleased to deliver another quarter and full year of strong financial and operating performance. As Valerie mentioned, the slides on our website will prove helpful in following along with my commentary.

Starting with our balance sheet, we closed the fourth quarter with a cash balance of $853 million, and our cash flow from operations for full-year 2010 totaled over $2.34 billion. While our mail-order prescription volumes set record highs in 2010, our inventory balances represent a record year-end low of just over $1 billion at the end of 2010, a $272 million reduction from year-end 2009 on top of the $571 million reduction we generated during 2009.

Our capital expenditures at full year 2010 were in line with our guidance at $250 million, reflecting investments in our business to drive agility and enhance efficiency across the organization, prepare for healthcare reform implementation and to fund the future growth. We achieved the full year 2010 return on invested capital of 35%, excluding 2010 acquisitions such as UBC. A meaningful increase over the 2009 return was 27%, which was already seven points higher than 2008.

Our fourth quarter 2010 EPS results were records, with GAAP diluted EPS of $0.88 representing 25.7% growth over fourth-quarter 2009 and diluted EPS excluding the amortization of intangibles from the 2003 spin-off of $0.94 representing 23.7% growth over 2009.

Total fourth-quarter 2010 net revenues reached a record $16.9 billion, representing growth of 11.1% over fourth-quarter 2009. Our product revenue grew 10.4%, reflecting our new business wins as well as higher prices charged by brand name pharmaceutical manufacturers, partially offset by a higher representation of lower-priced generics, in fact, a record generic effect of approximately $1.1 billion on fourth quarter's revenue alone.

Service revenue continued to be a very meaningful growth driver, increasing 58.7% over fourth quarter-2009. This strong performance reflects a full quarter of service revenue contribution from UBC, which closed on September 16, 2010, as well as the expansion of our overall client base at our Medicare Part D service fees.

Turning to rebates, we earned nearly $1.5 billion for the fourth quarter and $5.8 billion for full-year 2010, both records, even though we are dispensing fewer brand-name medications and more generics. These earned rebate levels represent 7% growth for the quarter and 8.1% growth for the year attributable to new client wins and continuous improvements in formulary contracting. Our fourth-quarter 2010 rebate retention rate was 13.0% compared to 14.1% in fourth-quarter 2009 as we continue to drive significant value to clients in a highly transparent manner. For the full year, our rebate retention rate of 12.5% compared to 13.7% in 2009.

In terms of claims volumes, total fourth-quarter prescriptions adjusted for the difference in days supply between retail and mail reached a record $244.3 million, an increase of 7.4% over fourth-quarter 2009. Retail prescriptions in fourth-quarter 2010 grew 7.5% to a record $161.4 million. Mail-order volume remains strong as clients and members continue to choose the lowest cost and most clinically effective channel.

Our mail-order prescriptions reached a record $27.9 million in fourth-quarter 2010, a 7.3% increase from fourth-quarter 2009. The adjusted mail-order prescription volumes for fourth-quarter 2010 comprised 33.9% of the total adjusted prescriptions, in line with the 34.0% mail penetration rate in fourth-quarter 2009.

Within the record fourth-quarter 2010 mail-order prescription volume total, generic prescription volume increased 15.1% to a record $17.5 million, reflecting new generic introductions and continued growth in previously released generics, while brand-name prescription volumes decreased 3.7% to 10.4 million prescriptions. The strength in our generic mail-order prescription volumes was an important driver of our fourth-quarter gross margin, which increased 13.1% over fourth-quarter 2009 to a record of $1.16 billion.

Our consolidated gross margin percentage of 6.9% for the quarter held steady with what we reported at third-quarter 2010, and on a year-over-year basis, increased 20 basis points from the 6.7% in fourth-quarter 2009, again a result of the strong fourth-quarter 2010 mail-order generic prescription volumes and our strong service gross margins.

Selling, general and administrative expenses of $428.5 million for the fourth quarter increased over fourth-quarter 2009 by $53 million or 14.1%, reflecting the addition of UBC as well as higher professional fees and other expenses associated with strategic initiatives. Excluding UBC, SG&A for the fourth quarter was up $32.2 million or 8.6% from fourth-quarter 2009.

The expenses we incurred in 2010 for strategic initiatives are critical to our transformation into a world-class agile enterprise focused on speed, accuracy, efficiency and providing the highest levels of client and patient care. We invest in ourselves because we are a growth company, with many exciting components of our expanding portfolio of businesses. These investments, whether in the form of expense or capital, are designed to proactively drive unparalleled levels of client and patient service on top of what we believe is already a world-class service model.

Our total EBITDA for fourth-quarter 2010 reached a record $786.5 million, representing growth of 13.2%. EBITDA per adjusted prescription for the quarter increased 5.2% to $3.22, a fourth-quarter record. Our intangible amortization of $75 million in fourth-quarter 2010 decreased slightly from $75.5 million at fourth-quarter 2009. The full-year amortization of $287.4 million decreased in 2009 by 6.0% or $18.2 million, primarily reflecting lower intangible amortization from PolyMedica and Accredo, partially offset by the addition of UBC and DNA Direct intangible assets.

Total net interest and other expense of $50.4 million for the fourth quarter of 2010 increased $10.5 million from the $39.9 million in fourth-quarter 2009, reflecting the new debt we added to finance the UBC acquisition last September. For the full year, total net interest and other expense of $163.1 million was slightly higher compared to the $162.6 million for 2009, reflecting this new debt, offset by lower interest rates associated with floating-rate debt.

The fourth-quarter 2010 effective tax rate was 37.7% compared to 36.3% in 2009, primarily reflecting a 2009 benefit from state-related income tax items. Our effective tax rate for full year was 38.9%, in line with the 39.1% in 2009. Net income for the quarter increased 10.8% to a record $378.5 million from the $341.5 million reported for the fourth quarter of 2009. For the full year, net income increased 11.5% to a record of over $1.4 billion from the $1.3 billion reported for 2009.

Moving on to share repurchases. During the fourth quarter of 2010, we repurchased 15.8 million shares for $963.3 million at an average per-share cost of $61.05. For full-year 2010, share repurchases totaled 69.9 million at a cost of $4.1 billion with an average per-share cost of $58.97. Since share repurchases commenced in 2005, we repurchased a total of 256.2 million shares, at a total cost of $11.1 billion, with an average per-share cost of $43.18.

For 2011 to date, we repurchased 7.0 million shares with an average per-share cost of $62.06. In January 2011, we completed the remaining $437 million of the $3.0 billion authorization that was approved in May 2010. By February 2, 2011, our board authorized a new $3 billion share repurchase plan. We continued to complete approximately $2 billion in share repurchases in 2011, driving meaningful value to our shareholders. We expect to commence share repurchases under the new authorization later this quarter.

Turning to our Specialty segment, Accredo achieved record revenues of $3.0 billion for fourth-quarter 2010, an increase of 21.3% over the fourth quarter of 2009. Consistent with our guidance, Accredo's gross margin percentage for the quarter amounted to 6.5% compared to the 7.0% in fourth-quarter 2009. This Accredo gross margin decline reflects product channel and new client mix. The 2010 product mix reflects significant growth in our multiple sclerosis, rheumatoid arthritis, oncology and pulmonary arterial hypertension patients with product volumes. Accredo's operating income for fourth-quarter 2010 increased 30.7% to $109.9 million.

Moving on to Medicare, we continued to experience growth in our Medicare PDP. For fourth-quarter 2010, Medco's PDP revenues increased 27.7% to $331.7 million. As Dave discussed, we are reaffirming our guidance for 2011. To briefly repeat our reaffirmed 2011 guidance, diluted GAAP EPS is expected to grow 12% to 16% over 2010 in the range of $3.53 to $3.66. As we noted last quarter, the non-GAAP diluted EPS measure change commencing in 2011 to exclude all intangible amortization. Diluted EPS excluding all intangible amortization remains in the guidance range of $3.99 to $4.12, representing growth of 12% to 16% over the 2010 full-year equivalent of $3.55.

While this measure will not be used in 2011, diluted EPS, excluding intangible amortization from the 2003 spin-off would be guided to increase to a range of $3.80 to $3.93, also representing growth of 12% to 16% over 2010. The detailed components of our 2011 guidance are as follows. We currently expect to renew approximately $15 billion of business in 2011, including scheduled and early elective renewals, representing less than 1/4 of our business. As Dave mentioned, we have over 80% of our 2011 renewals already completed. As I've previously guided, approximately 75% of the renewal pricing is in effect in the first quarter with the majority of the remainder effective in the third quarter of 2011.

Our guidance for mail-order prescription volumes for 2011 remains in the range of $107 million to $109 million, demonstrating solid growth in our base business considering the 3 million script offset I discussed at Analyst day. You may recall the expected reduction of approximately 2 million mail-order scripts from the contribution of Europa Apotheek to the Medco Celesio joint venture and another 1 million scripts associated with the conversion of generic Allegra known as fexofenadine to OTC status in early 2011. These expectations remain intact.

As you can see from our slides on the Web, the vast majority of our detailed 2011 guidance components remain consistent with those we provided at our Analyst Day including, as example, the $0.09 incremental contribution from new generics and expectations for stability or probable expansion in gross margin percentage and EBITDA per adjusted script performance in 2011. There is one guidance point that is changing. As I alluded to on Analyst Day, we are narrowing our guidance for 2011 SG&A expense from a range of $1.7 billion to $1.8 billion to a narrower range of $1.7 billion to $1.75 billion.

Now let's focus specifically on the first quarter of 2011. Our first-quarter 2011 pure cash EPS is expected to increase over the first-quarter 2010 equivalent of $0.76 by approximately 16% to 17%. This first-quarter 2011 guidance includes a planned $0.04 benefit to earnings associated with changes to various employee benefit plans across the company. This item reflects the financial effects associated with the prior service credit for our employee post-employment benefits plan that was in place before our 2003 spin-off. This benefit, which equates to approximately 1% full-year EPS guidance, was included in our internal operating plan upon which guidance was based and was ultimately approved by our Board of Directors in January 2011.

For the first quarter of 2011, we expect improvement in gross margin and EBITDA per script compared to first-quarter 2010, even when excluding the $0.04 benefit I just mentioned of which 3/4 flows to cost of sales and 1/4 flows to SG&A expense. Now let me provide some pointers to help you model the remaining quarters of 2011.

You may recall that I indicated on Analyst Day, when you look at earnings progression for the year, EPS in 2011 will be even more back-end loaded than we experienced in 2010. When excluding the $0.04 first-quarter benefit I just mentioned, EPS is expected to be fairly consistent in the first two quarters of 2011 and improve progressively in each of the last two quarters, in part the result of the incremental contribution from new generics, with zero, $0.01, $0.02 and $0.06 EPS contributions, respectively, for each of the four quarters.

Let me now discuss an item that is not included in guidance at this time as the net effect is currently indeterminable. The contribution of Europa Apotheek Venlo or EAV to the Medco Celesio joint venture is now expected to take place in March 2011. We still expect to record a foreign exchange loss upon contribution. We are awaiting the final fair market valuation of the EAV asset we are contributing. At this point, we believe the exchange loss will likely equate to approximately $20 million and it remains too early to quantify any gain or loss on the fair market valuation of EAV. This will be a onetime transaction that we will call out in our first-quarter 2011 results that, again, was not and is not included in our quarterly or full-year guidance.

As we reported during the quarter, the Medicare Part D business of Universal American, a current Medco client, is planned to be acquired by one of our competitors. As a result, it is expected that their business will no longer be serviced by Medco beginning in 2012. The termination of this business will not impact 2011 financial results and will not have a material impact to 2012 earnings since this account is very heavily weighted towards particularly low-margin dual-eligible business.

I know many of you on the call are interested in our expected renewals for 2012. At this point, we estimate our 2012 renewals in the range of $16 billion to $17 billion, approximately 25% of our book. One last point, we look forward to Lipitor's scheduled availability late in the fourth quarter of 2011 and the many other blockbuster brand-name drugs that lose their patent protection and become available in generic form in 2012. As we stated at our Analyst Day and on many other occasions, our clients, members and shareholders all stand to benefit from what we expect in 2012, the highest level of generic savings generating in our company's history.

That concludes my prepared remarks, and now Dave and I would like to open the lines for questions. Vanessa?

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Tom Gallucci from Lazard Capital Markets.

Thomas Gallucci - Lazard Capital Markets LLC

I guess first question, Rich, there has been obviously lot of focus on gross margin trends throughout the course of 2010, so maybe could you just highlight for us sort of where you came in relative to your expectations in the quarter and what some of the moving parts might have been?

Richard Rubino

Well, we came in right in line with our expectations. As you saw, we had stability going from third quarter to the fourth quarter, which we were, of course, pleased with. The generic prescription volume mail came in stronger as we expected. UBC also contributed nicely to our service margin expansion. So I'd have to say that we're on track to delivering what we expect for 2011 as well. So with confidence, I can point to the fact that we do expect this momentum to continue with stability and the likelihood of growth, both in gross margins as well as EBITDA per script.

Thomas Gallucci - Lazard Capital Markets LLC

And then Dave, if I could just sort of ask more of a strategic question, you mentioned in the Medco Oncology Therapeutic Research Center that opened up during the year, can you maybe talk a little bit more about what you're doing there, and maybe also with respect to drugs there that are in the drug benefit versus the medical benefit on the oncology side of the business maybe and how you're getting more of those drugs on the medical side?

David Snow

Yes, sure. As you know, at a strategic level, many people are talking about oncologic issues moving from catastrophic to chronic in nature tied to the innovations in the drug world. And we've also mentioned to you many times, but we highlighted in the Analyst Day, that when you look at the pipeline of biotech drugs coming to market, 50% of them are oncologic in nature, and the vast majority of them have a biomarker associated with the drug, which obviously we've been building around now for years. This state-of-the-art oncologic TRC that opened up in Whitestown, Indiana is really gorgeous, and it has capacity for 130 pharmacists who do nothing but manage patient care to protocols around various tumor types. We have actually sub-stratified capabilities tied to evidence-based protocols, working with physicians and patients to drive better outcomes for this -- what is now becoming chronic disease. So our clients clearly love the concept of therapeutic resource centers. It's highly applicable to the oncology space. Our clients also do want us to bring the medical spend, which is half the specialty spend, that is on the medical side over to the pharmacy side to be better managed. So we are doing many things. One of them, we highlighted at Analyst Day, which is many of the drugs on the oncology space are infusible. And one of our nurses got up and demonstrated to all of you the iPad technology that we've developed to manage total patient care in the home that goes well beyond the infusion they're delivering. And we find out, we can actually, at the point of care, manage the source of the drug, get that drug sourced at a better price, mail environment for our client. We also can take care of the other drug needs and the drug gaps in care around that patient in that home setting, and we have well over 1,000 nurses, who do nothing but manage patient care in the home around all of these infusibles. And by the way, in the pipeline, well over 30% of the drugs in the pipeline are infusible. So we're going to see that trend grow as a major part of our arsenal at the point of care to change how these drugs are managed. In addition, we are working, especially with our health plan clients, to isolate those specialty drugs that are hidden under what people call J-Codes under the medical coding. J-Codes to me are, by definition, 100% unmanaged. They are mystery codes that allow payers to pay AWP plus a dispensing fee plus a mark-up, which is just grotesquely inefficient, and clients are becoming more and more aggressive around pulling that out and managing it properly, levering scale and everything else that we as PBM bring. And we do that today, and we're actually looking at some more highly scalable models in the future that we can rollout to do an even better job there but that's -- literally, we could double the size of Accredo simply by taking all of the spend that's buried on the medical side of the business and moving it to the managed environment, we create for specialty drugs within Accredo. So we consider that an enormous opportunity and our clients are motivated to work with us.

Thomas Gallucci - Lazard Capital Markets LLC

And then just to confirm, Rich, you mentioned Lipitor estimates are still good there that you had talked about previously for the EPS contribution?

Richard Rubino

Yes, that's confirmed.

Operator

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

Lawrence Marsh - Barclays Capital

Dave, there's been a lot of discussion, it seems like recently, as I've noticed it around pass-through transparent pricing at FEP and other customers, obviously, one of your competitors just talked about a big margin impact with that change. Now you have mentioned great customer satisfaction with FEP -- pricing extension already in your guidance. So what's the difference here, maybe educate us and then how do we think of pricing in the future for this contract and others around this pass-through pricing?

David Snow

Larry, I can't really talk about our competitor. I really can't talk specifically about FEP's renewal, but let me talk more broadly. I think you know we've been a leader in transparency. Our definition of transparency has fit very nicely with most of the definitions out there of transparency, including government transparency. So we're comfortable with this environment. We also had one-year renewals with FEP. And you haven't heard the same sorts of comments from us. So I think you might want to think about that as unique to a specific PBM and not apply it to the industry. That would be my best advice.

Lawrence Marsh - Barclays Capital

And then I guess just a follow with Rich, just help me make sure I've got my numbers straight on the two comments about EBITDA and Q2. So you're suggesting EBITDA per adjusted script for Q1 will be above last year's number?

Richard Rubino

That's right.

Lawrence Marsh - Barclays Capital

I've got it like $2.85, is that the right ballpark for EBITDA per adjusted script for last year's Q1?

Richard Rubino

Yes, I think that's about right, yes.

Lawrence Marsh - Barclays Capital

And then just the wording about Q2 being about the same as Q1, if I do the math, that's in the mid-80s, I guess, in cash earnings. And if I compare that to my cash earnings of last year, that would be down year-over-year. Am I thinking of that right, or are we talking about earnings growth versus actual earnings?

Richard Rubino

At this point, I'm just giving you some high-level guidance here. Don't be overly precise with regard to the second quarter in particular. But the most important point is, we're going to see a meaningful acceleration of growth in the back half of the year. It's difficult for me to be very specific with regard to second-quarter performance at this point. But more importantly, I want you to have the earnings in the right part of the year.

Operator

Your next question comes from the line of Lisa Gill from JPMorgan.

Lisa Gill - JP Morgan Chase & Co

Dave, maybe we could just talk a little about Accredo and your comments around mix, basically product channel, et cetera. When we look at the gross margin in that business, can you maybe talk about over time, what you expect that to look like? Is there pressure on the gross margin aspect, the fact that a lot of it is still going through retail? And can you maybe talk about -- maybe you want to talk about specific numbers, but the margin opportunity as you bring that book into Accredo's book of business?

David Snow

Lisa, let me kind of give you the way we think about what's going on in the specialty space. I would tell you that margins, generally, are quite stable. But what we try to explain in our formal comments is that mix is something you just need to be aware of. So for example, hemophilia as a category, has been a higher-margin business. But the disease and the growth pattern of that disease among the population is far slower than the growth of many of the other specialty drugs tied to the disease patterns in the population. So, Rich, in his comments pointed out things like rheumatoid arthritis, things like pulmonary arterial hypertension. Those are stable margins, margins that we like, and when you just do the math and they grow dramatically, they change the weightings of margin across the drug products and that simply changes the overall margin perspective. But I wouldn't want investors think about this as declining margins for specialties, that's really not the story. It's just the relative growth across the product lines. So that's how I would think about it. Steve Fitzpatrick is here with us. Steve, do you want to add anything to that?

Steven Fitzpatrick

That's a good point. I think the other piece of that is, when we talk about channel mix and client mix, it actually drives us. So as we add more Medco clients at typically higher volumes of the multiple sclerosis, rheumatoid arthritis, oncology [ph] and on to it [ph] those therapies, you're also getting new indications of those drugs coming out that ultimately drive that growth even greater that you don't have in some of our core infused therapies that are very strong on the medical side that we've always penetrated and been strong on the medical side, it's just that we’ve been growing in the pharmacy side.

Lisa Gill - JP Morgan Chase & Co

And wouldn't it also be the channel though, right? I mean, Steve, if you think about this, when you're actually have it go through your mail-order facilities or you're going out and infusing a product, my understanding is that, that margin is much better than if you're just adjudicating a claim or you still have some aspect to the book that you're doing that, right?

Steven Fitzpatrick

That's correct. Our retail volume has continued to grow fairly steadily and to the degree that's actually higher, that is a lower margin.

Lisa Gill - JP Morgan Chase & Co

Are you comfortable giving us some -- I'm really looking at this as a future opportunity, right? So the more of that, that you can bring into your book, the better the margin's can look over time. Is that 25% of the book, 40% of the book? Can you give us some range of where the opportunity is to bring that into the Accredo book of business?

Richard Rubino

Well, right now, if you look at the level of penetration of our current clients that currently have Accredo specialty, it's actually between 85% and 90%. So we made great progress over the past few years. You might recall, when we started out probably two years into the acquisition in the maybe 60% to 70% range. So we’ve had a very meaningful success over the past few years.

Lisa Gill - JP Morgan Chase & Co

And then just one follow-up question, Dave, can you maybe just give us any of your thoughts around -- I know that the selling season hasn't really started yet this year, but as we look at the 2012 selling season, first off, the amount that you have up for renewal was a little bit less than we had anticipated. One, have things shifted around at all? And secondly, as you look at the RFPs for 2012, are you seeing anything unusual as far as requests go in the RFP process?

David Snow

No. The number Rich gave relative to the renewals for '12 is pretty much just how the contracts fall in our selected early renewals. It's just the way it fell. And I would say that relative to RFPs we're seeing, I can't comment on anything special that we've noticed, but Tim is here in the room. I don't know, Tim, if there's anything special you want to mention relative to the RFPs we're seeing and coming through the pipeline right now?

Timothy Wentworth

Nothing particularly special. I think perhaps a bit more general clinical focus, a bit more focused on understanding what we're doing to manage specialty, wellness and workplace health. Those sorts of things are getting a bit more focused in certain RFPs than we've seen in other years. But other than that, I would say nothing unusual. We are very pleased with the pipeline right now, I've got to say.

Operator

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

Ross Muken - Deutsche Bank AG

Just off of Lisa's comment on -- as we think about this upcoming selling season, now that you've had some time, is there still some of the nice wins that you had and look at the high renewal retention rate, as you dug into some of the specific clients, what were some of the two or three things that you felt like in this last selling season that sort of stood out to you that finally, we've either gotten a lot of traction with X, Y or Z or is one, two or three kind of really push the needle and kind of either helped us retain business or helped us increase our market share?

David Snow

This isn't going to be a new ah-ha to you, Ross, but I would tell you that there is no question that clients when they're buying are looking for an overall value prop. I say that and I think sometimes, it's discounted because people think it's just about price, and it's just not the case. It's, overall, value prop relative to total healthcare cost, and there is no question that clients are looking for the company that can optimize their spend driving better outcomes at lower cost. The things we're doing around Therapeutic Resource Centers, the things we are doing around pharmacogenomics, even the things we're now introducing tied to post FDA approval research are all things that resonate with clients because they feel as though we're putting their destiny in their hands by creating an ability to drive from shotgun medicine to precision medicine and optimize the value of every dollar they spend. And we're able to do this even in competitive pricing situations because on top of the fundamental ticket to entry, which is price, it's about what else you're doing to drive a better outcome. And it's really working for us, and it's just confirmed again in 2010. It was a fantastic year, and we're really happy with the way it's run. Glenn, I don't know if you have any thoughts about that question, but feel free to comment.

Glenn Taylor

Dave, I'd say there's a couple of other things. The clients are really interested in using technology, so the iPad example we used earlier is just one of many of how do you get the members more connected mobily (sic) or with apps. So I think that's a big thing that it resonated well and also clients like the idea that we can connect them or connect to other providers with theirs. So we call it extended enterprise. But that has been a huge positive in the health plans space.

Ross Muken - Deutsche Bank AG

I just want to -- and I don't mean to belabor the point, but I'm just getting a lot of questions in my inbox, so I just want to make sure everyone's sort of understanding sort of the EPS progression. If we think about, Rich, obviously, the progression throughout the year, vis-à-vis when you originally provided guidance relevant to the management model and then what we’re seeing today, one, is that relatively consistent and then two, as we think about progression throughout the year isn't the key two deltas, the amount of generics obviously coming in per quarter which continues to be back-end weighted and then, two, the impact of the share repo, which typically has more of an impact to earnings growth in the back half? Is that the right way to think about it?

Richard Rubino

Yes, absolutely. And I'll remind you again, Ross, of the incremental EPS effect of new generics. It really doesn't do much in the first half at all. It's nothing in the first quarter. It rounds to $0.01 in the second quarter. So you're really not getting any meaningful fuel first-to-second quarter at all. Of course, it's all about the fourth quarter with a $0.06, half of which is from Lipitor.

Operator

Your next question comes from the line of Randall Stanicky from Goldman Sachs.

Randall Stanicky - Goldman Sachs Group Inc.

Just a couple other, Dave or Rich, can you just give us an update, I'm not sure if you commented on UNH and possible timing or maybe collectively, can you let us know when we should expect to hear about an update on both FEP and UNH?

David Snow

As I said before, Randall, UNH, typically, its history is a predictor of the future. Typically, conversations with an account this size start 18 months prior to, which means puts us beginning the serious conversations in the summer. So you really shouldn't expect information from us, really –- so I'd say in the fall potentially, depending on whether or not history is that accurate predictor. So we, as I've said before, feel very good about our relationship with United, and I'm optimistic we will have a fruitful conversation, but the serious conversations, don't even expect them to really start till summer time. FEP is in flight now, and I really can't say much about a bid process that's in flight now. But you should be hearing about that I would assume just given the timeframe set out by the client, probably by next quarter at the latest.

Randall Stanicky - Goldman Sachs Group Inc.

Okay, so it sounds like no change on either front there. Just one more question, we've gotten a lot -- more so in the specialty pharma side, but can you just -- we've had a lot of questions here on co-pay assistant cards. You and I have talked about this before, should we expect to see anything in terms of action from Medco or the industry in general to push back and obviously, what could be a big source of cost savings for clients?

David Snow

Here's the way to think about this. We are not seeing the co-pay couponing, let's call it influencing our volumes. You heard our volumes, they are robust, they are moving to mail, they're moving to generics, all the things the plan designs are encouraging. So today, I can tell you that we're not seeing any meaningful influence by coupons. However, let me be clear, to the extent couponing drives the wrong behavior, so what I mean by that, if couponing, in fact, takes the prudent buyer behavior out of the consumer by eliminating their out-of-pocket responsibility, which means they go to the most expensive drugs, which end up going to the payer's pocket. We have a series of things that we can easily do to shut that down very quickly. So we monitor, we make sure what's going on, is in the clients' best interest, and we are fully prepared, and we work with our clients all the time so they can see and have visibility to what's going on. To the extent it's not in the payer's best interest, we have benefit designs, plan designs and strategies ready to go that can shut couponing down overnight. So we're very comfortable with it, and we certainly have plans to help clients respond.

Randall Stanicky - Goldman Sachs Group Inc.

Are clients asking about this or is it on their radar screen yet?

Timothy Wentworth

Yes, it is, and what we find the conversation leaning toward and if you saw the Times article, it was interesting because it ended with the same concept. Recently there was a Times article about this phenomenon, is that clients are coming back and revisiting their decisions around preferred drugs step therapy, which really takes the issue pretty much off the table, because to the extent that a drug is on formulary is couponed and the member takes it because they fail the generic is the first step, and that's actually in everybody's best interest. So clearly, what plans are looking at is our ability to put those programs in place and the great news is those programs create no member noise. We are black belts at doing it, and we are well invested in driving it.

Operator

Your next question comes from the line of Ricky Goldwasser from Morgan Stanley.

Ricky Goldwasser - Morgan Stanley

Couple of questions, first on the UBC contribution. So what percent of the growth -- and I assume it was in the services line, what percent of the growth in services came from UBC of the $92 million?

Richard Rubino

If you look at the change in run rate from say the second quarter, which was the last pure quarter in service without UBC to the fourth quarter, the majority of the dynamic is a contribution from UBC.

Ricky Goldwasser - Morgan Stanley

So if we try to back it out of EBITDA, we get to core growth for the business of about 3% year-over-year, are we in the ballpark there?

Richard Rubino

So I can just tell you, I don't have the EBITDA math in front of me. But I can tell you the pretax contribution in the fourth quarter from UBC was nominal. We're talking about low-single – well, single-digit millions.

Ricky Goldwasser - Morgan Stanley

No, but when you think about it on an EBITDA per adjusted script, just if we add to the EBITDA and given that there's no script associated with the business, we assume higher contribution there?

Richard Rubino

Yes, that's correct.

Ricky Goldwasser - Morgan Stanley

So, this is kind of like -- backing into around 3% year-over-year growth for just the core business, is that a reasonable estimate?

Richard Rubino

You're talking about just growth in the EBITDA per adjusted script?

Ricky Goldwasser - Morgan Stanley

Correct.

Richard Rubino

Which is currently in the fourth quarter? On a fourth-quarter basis, 5.2%, you're saying about 3% of is...

Ricky Goldwasser - Morgan Stanley

Is core, i.e., once we back out UBC?

Richard Rubino

I'm doing the math in my head. It's probably -- the core should be stronger than that.

Ricky Goldwasser - Morgan Stanley

And then on the 2012 renewal season of the $16 billion to $17 billion, I don't know if you'd comment on it, but what percent are early renewals versus scheduled?

David Snow

I can tell you that the majority of that number is scheduled.

Ricky Goldwasser - Morgan Stanley

And does that imply that you had some of the early renewals in 2011 really came from 2012 renewals?

Richard Rubino

No, I wouldn’t say that. I gave you the 2011 renewal number, it's $15 billion.

David Snow

Ricky, I would tell you that in any given year, the vast majority of renewals are scheduled renewals, and I would say that consistently, we're very selective about what we early renew and that was true for 2010. It continues to be true for '11 and it will be true for'12.

Operator

Your final question comes from the line of Steven Valiquette from UBS.

Steven Valiquette - UBS Investment Bank

I guess first, just to clarify, so the $16 billion to $17 billion, does that include or exclude UNH, just to make that crystal clear. There seems to be some confusion around that.

Richard Rubino

It does not include United. United is not up for renewal in 2012.

Steven Valiquette - UBS Investment Bank

And then you commented on the timing of that. Could UNH drag into 2012? Or should at least assume that whatever is going to happen there, will happen sometime in calendar 2011? Just trying to get a little more color on that. Unless [ph] unclear.

David Snow

I think it's easily conceivable it can drag into '12 [ph].

Steven Valiquette - UBS Investment Bank

Just quick final question here on SG&A, kind of more of a general question, I think for the PBM sector, we're all kind of trained to think about start-up expenses for new business wins occurring in the first quarter of each calendar year. But I'm just curious, with Medicare becoming a larger part of the mix, is it more prevalent now to assume more startup costs, renew business wins in 4Q? I mean, without getting too granular. I'm just trying to get a general sense that the split between 4Q and 1Q for startup expenses is generally speaking?

David Snow

I think the way you should think about it is that is from a software development point of view, to benefit modifications or account set up, that's primarily fourth-quarter expense. Service expense is first quarter tied to volumes of calls when you go live. And I would say, historically, with us the expense has been more heavily weighted to the fourth quarter relative to the coding of the benefits in getting the accounts set up versus first quarter.

Richard Rubino

One further point on that, Steve, the majority of our startup expenses this year and last year had been in cost of sales when they effect gross margin. They generally have not been an SG&A expense.

Steven Valiquette - UBS Investment Bank

As far as the lower SG&A expense expected for 2011, any additional color on that? I think you lowered the range there by $50 million or so?

Richard Rubino

Well, the range was very, very broad. It was almost too wide when we first give guidance, which is why on Analyst Day, I promised that I would narrow it.

David Snow

Thanks to all of you for joining us today. And look forward to speaking with you again in the not-too-distant future.

Operator

This concludes today's conference call. Thank you for your participation. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: MedcoHealth Solutions' CEO Discusses Q4 2010 Results - Earnings Call Transcript

Check out Seeking Alpha’s new Earnings Center »

This Transcript
All Transcripts