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Medco Health Solutions (NYSE:MHS)

Q3 2011 Earnings Call

October 26, 2011 8:00 am ET

Executives

Thomas M. Moriarty - President of Global Pharmaceutical Strategies, Secretary and General Counsel

Valerie Haertel - IR

David B. Snow - Chairman and Chief Executive Officer

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

Frank J. Sheehy - President of Accredo Health Group

Glenn C. Taylor - Group President of Health Plans

Analysts

Michael Cherny - Deutsche Bank AG, Research Division

Thomas Gallucci - Lazard Capital Markets LLC, Research Division

John Kreger - William Blair & Company L.L.C., Research Division

Steven Valiquette - UBS Investment Bank, Research Division

Ricky Goldwasser - Morgan Stanley, Research Division

Lawrence C. Marsh - Barclays Capital, Research Division

Eugene Goldenberg - BB&T Capital Markets, Research Division

Charles Rhyee - Cowen and Company, LLC, Research Division

Robert M. Willoughby - BofA Merrill Lynch, Research Division

David Larsen - Leerink Swann LLC, Research Division

Operator

Good morning. My name is Andrea, and I will be your conference operator today. At this time, I would like to welcome everyone to the Medco Health Solutions Third Quarter 2011 Earnings Call. [Operator Instructions] I would now like to turn the call over to Vice President of Investor Relations, Ms. Valerie Haertel. You may begin.

Valerie Haertel

Thank you, Andrea. Good morning, everyone, and thank you for joining us on Medco's Third Quarter 2011 Earnings Conference Call. With me today as speakers are Chairman and Chief Executive Officer, Dave Snow; and Chief Financial Officer, Rich Rubino. Also joining us for our question-and-answer session are: Kenny Klepper, President and Chief Operating Officer; Tom Moriarty, General Counsel, Secretary and President of Global Pharmaceutical Strategies; Frank Sheehy, President of Accredo Health Group; Tim Wentworth, Group President of the Employer and Key Accounts; and Glenn Taylor, Group President of Health Plans.

During the course of this call, we will make forward-looking statements as that term is defined in the Private Securities Litigation Reform Act of 1995. No forward-looking statement can be guaranteed, and actual results may differ materially from those projected. We undertake no obligation to publicly update any forward-looking 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 these 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 Medco Health 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-Q after the close of the market today. At this time, I would like to turn the call over to Dave Snow. Dave?

David B. Snow

Thank you, Valerie, and thanks to all of you for joining us this morning. Today, we are reporting strong third quarter 2011 earnings and narrowing the range of our full year 2011 earnings per share guidance to the high-end of previous guidance. GAAP diluted earnings per share for third quarter 2011 reached $0.90 or $0.96, excluding merger-related expenses incurred in the quarter, representing solid 12.9% growth over third quarter 2010. Even when including the merger-related expenses, our GAAP EPS is a record. Our diluted earnings per share, excluding all intangible amortization and the merger-related expenses, reached a record $1.07, reflecting a 12.6% growth rate over third quarter 2010. Importantly, our gross margin percentage was consistent with third quarter 2010 at 6.9%, up meaningfully from the 6.5% in second quarter 2011. And our EBITDA per script, excluding the merger-related expenses, also reached a record level at $3.43. Our mail volumes continue to be strong at this stage of the year. We are now confident that we will meaningfully surpass the high-end of our previous mail volume guidance range of 108 million to 110 million script.

Our Accredo business also delivered strong results with revenue growth of 16.7% and operating income growth of 33%, all at a 6.8% gross margin, consistent with third quarter 2010. The company is performing well across the board and we narrowed our a 2011 diluted earnings per share guidance excluding merger-related expenses and all intangible amortization to a range of $4.08 to $4.12, which represents 15% to 16% growth over 2010. Our previous guidance of $4.02 to $4.12 reflect the growth of 13% to 16% over 2010.

For the 2011 selling season, our annualized new-named sales totaled $3.2 billion, up from the $3 billion we previously reported. We have completed 98% of our 2011 renewals amounting to $16 billion client-drove spend. Our 2012 annualized new-named sales currently stand at approximately $1.6 billion, double the $800 million reported last quarter as our clinically focused model continues to have strong appeal in the marketplace.

Now, I would like to share some thoughts on the pending merger with Express Scripts. As you saw in the recently filed S-4, after an extensive review of numerous strategic alternatives through an exhaustive planning process, we determined that combining with Express Scripts was the best strategy to maximize value for our clients, members and shareholders. The merger is a solution to control escalating healthcare costs in America, costs that are undermining the U.S. competitiveness in the global economy. In 2010 alone, U.S. spending for prescription drugs reached $307.4 billion. Our aging population and an increased prevalence of chronic disease are projected to drive a 50% increase in prescription drug spending to well over $450 billion by 2019.

At Medco, we have lowered the cost of prescription medications for our clients by enabling greater use of generics, driving a savings of $3.7 billion to Medco's clients in full year 2010, and $2.7 billion year-to-date in 2011. We have expertly managed the challenges associated with the rising costs of care, including specialty medications, and we have improved efficiencies my enabling clients to make effective use of the highest value channels of distribution, including mail-order delivery for chronic medication. The combined organization is well positioned to advance the quality and cost goals set forth in America's healthcare reform legislation by combining 2 innovative approaches, Medco's advanced clinical services that utilize an evidence-based protocols and Express Script Services which focus on behavioral science to increase medication adherence. As you can see from this year's performance and our projections included in the S-4, we are planning to merge from a position of strength. Combining forces with Express Scripts positions us to deliver what our nation needs now, high-quality care at even lower cost to our patients and clients. And we can do this much more effectively together.

Many of you have asked where we are in the regulatory review process and what will be the likely outcome. As I have said previously, and most recently at a hearing in Washington DC, we would not have announced this combination if we were not confident in our ability to obtain the necessary regulatory approvals. As we stated when the deal was announced, we anticipated that the transaction will close in the first half of 2012, and we remain confident in that projection for a number of reasons. First, the opponents of this proposed mergers are not customers. Our proposed merger is receiving very positive reaction from our customers who understand that the combination of Medco and Express Scripts can mean to them and their members. This combination includes over $1 billion in savings as it's expected to be delivered to customers after closing.

Second, the PBM marketplace is highly competitive and will remain highly competitive after the deal closes. There are at least 10 PBMs serving the largest employers in the Fortune 50 and over 15 serving the Fortune 500 alone. In addition, these and many other PBMs also serve large government accounts and health plan. In fact, today, our competitors include over 40 PBMs with household names like Aetna, CIGNA, CVS Caremark and others who may not be as well known, but continues to make major investments such as Prime Therapeutics, Catalyst and FXP. Additionally, in specialty drugs, hundreds of different firms compete including PBMs, pharmacy chains and independents, wholesalers, managed-care organizations, as well as stand-alone specialty pharmacies. Also, and very importantly, UnitedHealth Group has announced its plans to bring in-house the 14 million lives previously served by Medco and combine that business with a substantial Medicare and other national employer lives it already directly services through its own PBM known as OptumRx. With this, United Health Group will be one of the nation's largest PBMs.

The merger with Express Scripts provides us with the opportunity to reduce our acquisition costs for medications and pass on additional savings for our clients and patients. The SEC's concern is protecting consumers, not competitors. That means ensuring competition remains healthy in the marketplace and consumers are not harmed by price increases resulting from fewer competitors. We firmly believe that this combination will benefit consumers.

To conclude my remarks on this topic, the proposed merger, in our view, embodies the spirit of the new healthcare reform legislation that promotes innovation to solve America's healthcare burden. As I have said previously, we are confident that this merger will receive SEC approval in the first half of 2012. We are an important part of the solution and we remain dedicated to providing our clients with quality care at the lowest possible cost. Not only does this merger promise to serve our clients well, it will create substantial value for our shareholders.

Before I turn the call over to Rich, who will cover the 2012 guidance more thoroughly, I would like to highlight a few observations for next year. First, as you saw in the S-4 and in our earnings release, revenue is expected to decrease to approximately $58.9 billion in 2012, equating to a $10 billion or 14.5% decline. This decline contains many moving parts, including clients that are transitioning from Medco due to acquisitions by competitors and other reasons. Also, contributing to the decline in revenues is the generic wave in 2012, which is projected to reduce our net revenues next year by approximately $6.5 billion. If you look at this from the other side of the ledger, this is value that accrues to clients and patients, a massive win to the consumer.

The last point I will make on guidance is regarding our EBITDA, which at the high-end is expected to grow by as much as 9.5% in 2012 as a function of the generic wave and continuously improving business efficiencies. And looking at EBITDA as a percentage of revenue, what is known as EBITDA margin, we expect this measure to increase from approximately 4.5% in 2011 to as much as 5.8% at the high-end in 2012, which would represent a Medco record. We expect meaningful increases in our gross margin percentage and EBITDA per script for 2012 as well. Resulting not only from the generic wave and business efficiencies I just mentioned, but also from the fact that the large retail clients that will be transitioning in 2012 carries extraordinarily low profit margins.

With that, I'll turn the call over to our CFO, Rich Rubino, who will discuss additional third quarter 2011 financial performance details, and provide you with additional color regarding our 2012 guidance. Rich?

Richard J. Rubino

Thank you, Dave. Good morning. As Dave mentioned, our third quarter EPS results were strong, with record GAAP diluted EPS of $0.90. The record gets even more impressive when you exclude the $0.06 of merger-related expenses, bringing that number to an equivalent of $0.96, a growth of 12.9% over third quarter last year. Diluted EPS, excluding all intangibles and merger-related expenses of $1.07 for this quarter is also a record, representing a 12.6% increase. This $1.07 is a meaningful $0.08 higher than our previous EPS record of $0.99 set in the fourth quarter of 2010. The merger-related expenses, which primarily include bankruptcies, legal fees and employee retention-related expenses, totaled $36.6 million or $0.06 per share. And that of course, was for the third quarter of 2011, with $35.6 million flowing to SG&A expense and the remaining $1 million flowing to cost of sales. We currently expect the fourth quarter 2011 amount of merger-related expenses to be slightly less than the third quarter at $0.05 per share, bringing full year 2011 estimated merger-related expenses to $0.11 per share.

Total third quarter 2011 net revenues reached $17.0 billion, representing growth of 4.1% over third quarter 2010. Our product revenues grew 3.4% over third quarter 2010 to $16.6 billion, reflecting our new business wins, as well as higher prices charged by brand-name pharmaceutical manufacturers, partially offset by a higher mix of lower-priced generics. On that generics point, our clients and members saved approximately $700 million this quarter compared to third quarter 2010 from increased utilization of generics. For 2011, we expect these savings to total approximately $3.7 billion. If you look at how much Medco clients and members have saved from generic drug utilization since 2006, when the first blockbuster drug started losing their patents, it is a very substantial number, $16.7 billion. Add to that the expected record 2012 year for generic savings that Dave already mentioned, contributing another expected $6.5 billion in savings, and the cumulative savings since 2006 rose to over $23 billion.

Service revenue continue to be a significant growth driver, increasing 46.9% over the third quarter 2010 to a record $379 million. This strong performance reflects the service revenue contribution from UBC, as well as growth in our client service offerings across the company.

Turning to rebates, we earned $1.5 billion for the third quarter, an increase of 5.6% over the same period last year, even though we are dispensing fewer brand-name medications and more generics. This year-over-year growth is attributable to continuous improvements in formulary contract. Our third quarter 2011 rebate retention rate was 13.0%, consistent with the 12.8% in the third quarter 2010 as we continue to drive significant value to clients in a highly transparent manner.

As Dave mentioned, mail-order volume remains strong as clients and members continue to choose this lower cost and clinically effective channel. In third quarter 2011, our total mail-order prescription volume is 27.4 million. Within this, generic prescription mail-order volumes increased 3.5% to 17.7 million, just 100,000 scripts shy of our record experienced last few quarter. Brand name prescription volumes decreased 4.9% to 9.7 million prescriptions. Mail-order volumes are on their way to exceeding the high end of the previous guidance we provided of 110 million scripts. We now expect 2011 mail-order volumes of approximately 112 million prescriptions.

Our generic dispensing rate at mail increased 2 full percentage points from third quarter 2010 to a new record of 64.8%. The strong generic mail-order prescription volumes and our increased service gross margin drove our third quarter gross margin to a new record of $1.17 billion, a 4.3% increase over third quarter 2010. The total gross margin percentage of 6.9% is consistent with third quarter 2010, which you may recall was an important quarter for 2010, it reflected a significant gross margin percent recovery from where we were earlier in that year.

Selling, general and administrative expenses for third quarter 2011 totaled $455.6 million. When reduced by the $35.6 million in merger-related expenses I explained earlier, SG&A expenses declined to $420 million. When adjusted further for the effective UBC, which was acquired on September 16, 2010, our SG&A increased only 1.7%. This reflects efficiencies across the enterprise while we continued to invest in our clinical and strategic programs and new technologies to drive even higher levels of service to our clients and members.

The EBITDA and EBITDA per script performance I'm about to explain excludes the merger-related expenses. Our total EBITDA for the third quarter 2011 marks yet another record at $800.9 million, representing growth of 3.9% over third quarter 2010. EBITDA per adjusted prescription for the third quarter 2011 also represents a record, increasing 4.6% to $3.43 from the $3.28 in the third quarter of 2010, which was our previous record. Our intangible amortization of $73.2 million in third quarter 2011 increased 2.8% from $71.2 million in third quarter of 2010, primarily reflecting the UBC intangible assets. Total net interest and other expense of $49.6 million for third quarter of 2011 increased $8.8 million from the $40.8 million in third quarter 2010, reflecting the new debt we added to finance the UBC acquisition last September. Third quarter 2011 effective tax rate was 39.6% compared to 39.3% in the third quarter 2010.

Net income in the third quarter of 2011 of $355.4 million included $22.0 million in merger-related expenses. This essentially being the tax effective equivalent of the $36.6 million pretax number I described earlier. Excluding these expenses the results of net income of $377.4 million represents a 1.6% increase in the third quarter 2010.

Moving on to share repurchases. During the third quarter of 2011, we repurchased 6.3 million shares for $350 million at an average per share cost of $55.89 through our pre-authorized trading plan. This third quarter repurchase allotment under the pre-authorized plan was completed on July 15. Future repurchases have since been suspended as a result of the pending merger with Express Scripts. We have always viewed share repurchases as an effective tool in enhancing value to shareholders. On an inception-to-date basis, since we started our first share repurchase program in 2005, we have repurchased 285.5 million shares at a cost of $12.85 billion and an average per share cost of $45 even.

Our year-to-date cash flow from operations is $1.086 billion compared to $1.365 billion for the same period in 2010, with the largest driver being the approximately $200 million payment from the IRS in 2010 related to its tax receivable in prior years. Our inventories reached a record low of $788 million. You may recall that in June 2008, our inventory balance closed at nearly $2.1 billion. We have since then reduced inventory by over 60% to the lowest it has been since 1999, the year when our mail volume was about 60 million prescriptions. All of that impacting patient service level.

We closed the third quarter with a cash balance of $161.5 million, and we expect our quarterly cash balances to build for the remainder of 2011 and into 2012 due to the suspension of our share repurchase program. Our total debt for the third quarter has remained consistent since third quarter of 2010 at $5.0 billion.

Turning to our specialty segment. Accredo achieved record revenues and operating income with growth of 16.7% and 33.0%, respectively, and sustained a strong margin of 6.8%. This strong performance reflects our clients preference to the Accredo service model, as well as, more generally, to grow the utilization of specialty drugs. To be more specific, the product categories driving the growth in specialty include rheumatoid arthritis, multiple sclerosis, immune disorders and oncology. With new drug introductions also driving growth in the hepatitis class.

As Dave mentioned, we are narrowing our 2011 EPS guidance to the high end of the previous range. Our 2011 full year GAAP diluted EPS, including the merger-related expenses is expected in the range of $3.54 to $3.58. Excluding the merger-related expenses, 2011 guidance is $0.11 stronger as I discussed earlier. When adding back the $0.11, this guidance represents a range of $3.65 to $3.69 for a growth rate of 16% to 17% over 2010. Our full year 2011 diluted EPS guidance excluding all intangible amortization and merger-related expenses is now in the range of $4.08 to $4.12, reflecting growth of 15% to 16% over 2010. We essentially updated what was previously at $0.10 guidance range and narrowed it to the high end with a much tighter $0.04 spread, reflecting confidence in our strength for the remainder of the year. I'm not going to walk you line by line through 2011 guidance since our current expectations are consistent with what we have previously communicated.

Our fourth quarter is expected to be the strongest quarter of 2011, as I have guided in the past. Included in the fourth quarter is an expected lift in the incremental EPS effect in new generics led by Lipitor, with an approximate $0.03 contribution. We also expect our fourth quarter tax rate to be lower, bringing the full year effective tax rate to the lower end of the previous guidance range or approximately 38.5%.

You may recall that when I first gave guidance for 2011 on our third quarter 2010 earnings call, I pointed to an expectation for stability or possible expansion in gross margin percentage and EBITDA per script. Looking back to September 2011 year-to-date, excluding this year's merger-related expenses, gross margin is consistent at 6.5% through '11 and '10, and our EBITDA per adjusted script has, in fact, expanded to $3.16 in 2011 compared to $3.07 in 2010. Again, these are all year-to-date specific. Additionally, one measure that is very important to this company, return on invested capital was projected to exceed 30% this year, even when fully including the invested capital associated with the UBC acquisition in September 2010.

Now this leads me to a discussion of our expected 2012 performance. This is an unusual year in that the Form S-4 recently filed by Express Scripts under the name Aristotle Holding Inc. on October 6, includes Medco forecast for 2011 through 2014 for net revenues, EBITDA and net income. You can find these forecasts on Page 123 of that document. The S-4 forecasts do not include merger-related expenses or any other onetime costs that may be incurred. They are meant to reflect Medco's expected operating performance on a stand-alone basis. For those of you who don't have the S-4 handy, the 2011 forecast presented includes revenues of $68.951 billion, EBITDA of $3.113 billion and net income of $1.473 billion. These 2011 forecasts should be viewed as a reflection of the midpoint of our recently narrowed guidance range or about $4.10 in diluted EPS, excluding all amortization and merger-related expenses. The amounts included in the S-4 for 2012 include revenues of $58.931 billion, EBITDA of $3.408 billion and net income of $1.626 billion. These 2012 amounts represent our internal operating plan. You should consider these forecasts as reflecting the high end of the 2012 guidance range with the 4% reduction representing the low end of the range, consistent with ranges provided the previous years.

Revenue for 2012 is expected to decline by $10 billion or 14.5% from 2011. This decline includes the effect of clients that were required by competitors or transitioned in the normal course of competitive activity, all as previously announced. It also includes the $6.5 billion generic affect discussed earlier, which decreases our revenues, and very importantly, increase the savings to clients and patients.

The EBITDA growth from 2011 to 2012 using the forecast presented in the S-4, amounts to 9.5%. Our EBITDA growth from 2010 to 2011 amounts to 4.7%. As you can see, our 2012 EBITDA growth rate is expected to more than double by 2011 EBITDA growth rate. The 2012 growth rate reflects improved profitability, largely because 2012 is the peak year of the generic wave. In addition, we expect to yield efficiencies commensurate with what our business will now require. We have various alternative plans in place to yield these business efficiencies. And you must realize that the large majority of our cost and expense base is, in fact, variable and manageable.

The 2012 net income growth of 10.4% follows the growth I explained for EBITDA. One statistic that becomes critical with these forecasted amounts being presented is the relationship with EBITDA to revenue, which for the S-4, would be 5% in 2011 and 5.8% in 2012. Recognizing from earlier comments, the 5.8% reflects the high end of the range, we may end up with a record EBITDA margin year in 2012. With EBITDA margin expansion, gross margin percentage and EBITDA per adjusted script expansion are also expected to follow. You will note that the S-4 disclosures do not include any EPS projections for Medco as our share count is uncertain due to the suspension of repurchases while the merger is pending. At this point, I do not expect to give any further guidance detail for 2012 beyond what I just provided.

In conclusion, we delivered another strong quarter of operating results and EPS. We remain confident in our future prospects for continued growth well into the future and I do believe the value we can drive to clients and members will be even greater with a combined Medco and Express Scripts. Now Dave and I will like to open up the lines for questions. Andrea?

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Larry Marsh with Barclays Capital.

Lawrence C. Marsh - Barclays Capital, Research Division

In your S-4, which you addressed this morning, you talked about the 2012 and you showed numbers through 2014. I'm assuming that disclosure doesn't include the loss of United beginning in 2013. And then you talked about net new business being negative because of acquisitions and such, do you have a net new number, a business number for 2012 that you can share?

Richard J. Rubino

Well, I would say that -- to answer your second question first, the net new number for 2012 pretty much equates to the net change in revenues that you see for the year, because we have many puts and takes in that revenue dynamic. You have the effect of the lost clients. You have the effect of the generic wave, but you have offsetting effects, also, from expected AWP inflation, et cetera. But when you look at the net new number, it's -- coincidentally ties to the reduction in the net revenue in the S-4.

Lawrence C. Marsh - Barclays Capital, Research Division

Right. And just for Rich, I mean you say all of this has been previously disclosed. Because when I add up all the previously disclosed information, I don't quite get there but maybe I'm underestimating something.

Richard J. Rubino

Yes. You won't -- well, we never gave revenue amounts for clients. Of course, we've never disclosed the amounts to Universal American nor for Bravo, as example, which are large accounts. So we of course disclosed the FEP because of its profit contributions but not the others. So the reason why you're not getting there is probably because you don't have the proper estimates for some of those other accounts, which is completely understandable. Regarding 2013, while many have assumed that United is actually in our 2013 numbers, it is not. One point you have to understand is this business is living and breathing and healthy, and we expect to continue to win business and don't take one year as a trend. We have a long history of winning clients and we don't plan on stopping at any time soon. And that revenue number that you see is not a guess, we have underlying assumptions that are actually quite detailed, and that's all I can say for obvious reasons. But it does, in fact, exclude United.

Lawrence C. Marsh - Barclays Capital, Research Division

So just to confirm, the 2013 and '14 numbers exclude United both in revenues and obviously in your assumed EBITDA, so it's obviously reflecting some offsets to your cost structure that you allude to in your prepared remarks?

Richard J. Rubino

That's exactly right, Larry. I mentioned the high proportion of variable expenses and our total cost base, just to give you some color on that. It's over 60% in some cost categories. It's over 70% in certain expense categories. So there is quite a bit of variable expense in the base unlike some reports have indicated. And by definition, therefore, quite manageable.

Lawrence C. Marsh - Barclays Capital, Research Division

So you must be assuming about an $8 billion incremental increase in net new business for 2013? Is that about right?

Richard J. Rubino

Well, you should be thankful that you got the 2000 numbers out there from a revenue perspective. I'm not going to get into the puts and takes on what's net new versus how much is inflation and the rollover of generic effect, and so forth. But ultimately, you can assume that there is certain net new growth in 2013. That's all I'm going to say.

Operator

Your next question comes from the line of Tom Gallucci with Lazard Capital Markets.

Thomas Gallucci - Lazard Capital Markets LLC, Research Division

I guess 2 quick questions. One, your Lipitor expectations have remained very consistent. From the outside looking in, it seems to be sort of a fluid situation. So I was wondering if you can give us any color on why you've got that visibility at this point? And then number 2, just wondering if you got any commentary or anecdotally that you can offer from your clients on the Walgreens-Express situation or their view toward narrower retail networks in general, given the potential implications for your business depending on how the merger turns out?

Richard J. Rubino

Okay. I'll answer the first question and Dave will take the second. Interestingly, we had visibility to Lipitor a year ago at $0.03. And a year later, it's still $0.03. And as I've said many times in the past, we are not going to disclose our sources or the basis for our confidence other than, as you would imagine, we are more confident again than ever before in that $0.03. And I know that there are various press reports and I know it is fluid, but from a Medco perspective, again, very confident in the $0.03.

David B. Snow

Yes. And Tom, regarding clients questions about WAG, we get many of them. We actually have a regional Drug Trend Symposium that we conduct each and every year, one in the West Coast, one on the East Coast. So a total of, I'd say, 400 or 500 customers between the 2. And that was a universal question, asking us what was behind the activity between WAG and ESI. And we've made it clear to them we don't really have insight into the details of the arguments between WAG and ESI. But independent of that, I can tell you that many of our clients are looking at restructured networks to get optimal value and pricing. And they also understand, when you look at a network across the country of 65,000 retail pharmacies and when you do geo-access for many, many, many of our customers and see that there's literally no disruption in terms of travel distance to exclude parts of that network to get significant changes in pricing, they're all looking at it. And that's an independent activity that's been going on at Medco for quite some time. And as the pressures mount tied to this economy, I would tell you they are looking harder at that option now than they ever have before, and I expect that to continue.

Operator

And your next question comes from the line of Ricky Goldwasser with Morgan Stanley.

Ricky Goldwasser - Morgan Stanley, Research Division

I have a couple of thought questions here. So first of all, on the 2012 selling season, at this point, what percent of the season is completed in terms of renewals in your business?

David B. Snow

So I can say regarding 2012 renewals, we've made very good progress. And the renewal number for 2012 is quite consistent with the renewal number for 2011. And we're over 2/3 completed with the renewals for 2012.

Ricky Goldwasser - Morgan Stanley, Research Division

Okay. And should we assume that the remaining business is more skewed to the lower, mid to small accounts?

David B. Snow

Yes.

Ricky Goldwasser - Morgan Stanley, Research Division

Okay. Great. And then you talked about rebates and how you continue to see improvement in kind of like from your management and what the branded manufacturers are willing to pay. When you think ahead to 2012, with all the patent expirations, do you think that we're going to continue to see kind of like that same kind of like strategy from the pharma companies?

Richard J. Rubino

Let me turn it over to Tom Moriarty.

Thomas M. Moriarty

Sure. So I do and I think you will see it. We obviously have a multipronged approach that deals at a client level that match their needs. And as we look to different formulary strategies, those formulary strategies thought drive value for the clients. And then ultimately, the pharma companies want to stay in that, and the way they participate is through [indiscernible].

Ricky Goldwasser - Morgan Stanley, Research Division

Okay. And do you anticipate -- because you talked about kind of like some of the assumptions for AWP pricing that's factored into your 2012 revenues. Do you anticipate manufacturers like Pfizer and Lipitor will continue to raise prices post the patent expiration?

Richard J. Rubino

I'm not going to talk about specific drugs or specific manufacturers. I can tell you, in 2011, we experienced a brand inflation rate that's well over 10%, one of the highest inflation rates we've seen in recent years. Our assumptions actually assume that, that gets down a bit to between the 5% and 10% range in 2012.

David B. Snow

And Ricky, just to be sure everybody understands why, I mean this is predictable. When you look at the tax that pharma needs to be pay tied to healthcare reform, you knew that was a pass for you. You knew that was going to come from somewhere and that's exactly what's going on. And you also have the additional pressure tied to this generic wave that these brand manufacturers are dealing with. So I think it's reasonable to think that you will continue to see inflation. Although, you're going to see a lot of people fighting to prevent that rate of inflation, I think there's a real tug-of-war going on that will continue.

Operator

And your next question comes from the line of Steven Valiquette with UBS.

Steven Valiquette - UBS Investment Bank, Research Division

So the generic launches for 2012 are obviously positive. But I'm just kind of curious, that $6.5 billion number and it's close to 10% of 2012 revs, it kind of seems like a fairly large number. So I guess I'm just curious, is there anything unique about maybe your mail versus retail mix or some other internal factor? And maybe read that to have a larger impact on Medco than maybe other pharma services companies? Or would you just kind of assume that maybe everybody in this industry would kind of have a similar 10% drag on the top line?

Richard J. Rubino

Okay. So let me give you some statistics, Steve. If you look at our book of business mail penetration rate for this quarter, it's 34.8%. When you look at the big drugs that are going to affect that generic effect we mentioned earlier, you have Lipitor which is at, the last time I checked, about 60% mail-order penetration rate. You have Lexapro that's at 35%, Plavix at 50%, Singulair at 45%, Actos at 50%, Diovan at 50%. Those are all numbers that I gave at last year's Analyst Meeting on Page 16 of my presentation. Even though there've been some client puts and takes, those numbers are still good reference points. You can see that the majority of the drugs, and these are very high drug spend molecules here, are way beyond our book of business average mail penetration rate.

David B. Snow

And just to make it clear. This is always been in our line of sight and always been limited within our 5 and more recent 10-year plan. And this has been well known.

Steven Valiquette - UBS Investment Bank, Research Division

Okay. That's helpful. And then just a quick follow-up on specialty, hitting a lot of questions on that. I'm wondering the size of the market is kind of wide open to interpretation, but do you have an approximate number for how you guys define the size of the specialty markets, I mean, you have roughly $13 billion of revenues this year mainly to Accredo. But where do you give your approximate market share within specialty in terms of how the discussion might be going with the FTC, et cetera?

Richard J. Rubino

We don't have a number going. We focus on what our actual performance. I think, the market is very, very broad, as Dave mentioned in his prepared remark, and there are many, many providers. And the specialty market is very likely much greater than what you would see in the disclosures of the respective PBMs, which is just a small piece of the broader market.

Steven Valiquette - UBS Investment Bank, Research Division

Okay. And then just real quick, 2 second follow-up on that UNH, is that spread across 2013 and 2014? Or was just that 2013 that you're assuming the loss of UNH within that 5-year, or 4- or 5-year projection?

David B. Snow

It's assumed out 1/1/13.

Operator

And your next question comes from the line of Ross Muken with Deutsche Bank.

Michael Cherny - Deutsche Bank AG, Research Division

It's actually Mike Cherny in for Ross. So just quickly, on the closing of the 2 JVs with Celesio and the United Drug, can you talk about the cash flow impact there if there has any changes to your outlook and any financial terms you can provide above and beyond what was already discussed?

David B. Snow

No. It's all quite immaterial so it's really -- nothing to worry about, nothing that will meaningfully change models going forward.

Michael Cherny - Deutsche Bank AG, Research Division

Perfect. And then you mentioned in terms of the rationale for the deal, Dave, talking about customer response so far and how they are excited about the savings that can be provided to them. I guess, as you went to the later stage of the selling season and talking about the fiscal '12 selling season as well, can you talk about, I guess, client reaction from that perspective in terms of both going out and winning new deals, what the thought process was on how you're going to change the approach once the merger with Express Script was completed and kind of what kind of service levels and other added benefits they'd beginning in terms of planned design post the merger?

David B. Snow

Yes. Sure. First of all, I'd love to point out the fact that just in our Systemed Group alone, they closed over 70 deals post-merger announcement and they're still extremely busy right now. From the point of view of a client, they understand how the combination creates better financials for them and it was just critically important. So that beyond the financials, the questions they're asking is, what will the combined company look like? How will it operate? Will we still get the same services that we got from Medco as a stand-alone company? As George and I talked about what this combined company will look like, we have this concept of best-of-breed and best of both worlds. So my feeling is, our clients are likely to experience continued innovation, combinations of best-of-breed assets to get even better service and better options. And obviously, part of that is in execution, and we're still in integration planning process so we have a lot of work to do still, but conceptually, we do know where we want to end up. I think both companies know where they want to end up and I think it's safe to say both companies have the client and the clients' need squarely in their focus is the #1 priority. Because at the end of the day, we still want to delight and retain customers and win new customers. So I'm very comfortable that as we look at the capabilities of both companies, we will get to something we call best-of-breed between the 2. And I think that makes clients comfortable. I think that's what they're looking for and obviously, they're going to watch that over time.

Operator

Your next question comes from the line of John Kreger with William Blair.

John Kreger - William Blair & Company L.L.C., Research Division

Dave, you mentioned a few minutes ago that clients are showing a greater interest in some of these narrow networks. What sort of savings are you able to offer to them and are you finding that the savings is big enough to sort of assume the hassle factor?

David B. Snow

It varies by client because it ties with the geographic dispersion of their people. But I can tell you in a range, it's very meaningful and very worthwhile considering, especially when you're a jumbo account, which Medco has a lot of. It's extremely meaningful. You can see 2 points easily and sometimes more.

John Kreger - William Blair & Company L.L.C., Research Division

Great. And Rich, you made the comment that your cost structure is flexible. Can we infer from that, that your starting down the path of cutting some costs as you've had some losses or should we assume that, that's a process that's going to potentially be held up by the merger?

Richard J. Rubino

Well, if you look at our SG&A numbers, given this quarter, you can see that the inherent growth rate is quite low so we've been, I think, doing a great job in managing our expenses and just all the course of business. But ultimately, the efficiencies need to be yielded on a stand-alone basis or in a merged scenario. So we have to do what we have to do.

Operator

Your next question comes from the line of Robert Willoughby with Bank of America Merrill Lynch.

Robert M. Willoughby - BofA Merrill Lynch, Research Division

Just a quick one, the European joint ventures, you guys have bought back, I guess a couple of them. These were growth drivers for you for 2014 and beyond. And what's the plan there? Are you bringing them off-line or are you hoarding the economics? What's the strategy there?

David B. Snow

It's more the latter than the former, Bob. We are still very committed to Europe. We like the opportunities. As we fine tune what Europe needs and want, we feel we're incredibly well prepared to deliver it without a joint venture partner. And so now we've learned a lot in these seeds we planted. And as we refine and focus on what we want to do and how we want to approach it, taking it all in-house made sense for us. And if Brian Griffin, who's running our international operations were here today, he would tell you that this is something that he is excited about now that he has full control and he is able to focus upon the market without the distractions of managing a JV.

Robert M. Willoughby - BofA Merrill Lynch, Research Division

And how do we think about the profit profile and the future investment needed for them?

Richard J. Rubino

Well, I would say, over the next few years, the investments will be relative to the broader company, nominally material. The growth profile remains the same. We never expected it to be material in '12, 13. But certainly, when you get to the back half of this decade, our thinking is consistent that the it will in fact start to become meaningful contribution to our profitability.

David B. Snow

And I'll just add, Brian Griffin and his team have had some nice wins recently and we're very encouraged that the trajectory is going to be something like what we originally envisioned. So we're feeling very good about his progress there.

Operator

Your next question comes from the line of Charles Rhyee with Cowen.

Charles Rhyee - Cowen and Company, LLC, Research Division

Just one more question on Celesio. If I recall at the beginning of this year, you made an adjustment for the JV and a bunch of the mail volume went -- it was part of the JV, so it wasn't counted in your mail volume. How should we think about treating that, I think it was almost like 10 million mail scripts. Should we think that's coming back on to the income statement again?

Richard J. Rubino

Well, the mail scripts are -- you're way off by a multiple factor with regards to the volumes. It's actually more like a fraction of that. The mail volumes came from Europa Apotheek Venlo. And Europa Apotheek Venlo has been in our volumes because it was never contributed for the joint venture in the first place. So that just continues in our run rate and will continue as it grows through the next several years.

Charles Rhyee - Cowen and Company, LLC, Research Division

Okay. So there's really no then change to how we should be looking at the go forward mail volumes other than some of the announced contracts?

Richard J. Rubino

That's correct.

Charles Rhyee - Cowen and Company, LLC, Research Division

Okay. And then a quick question maybe on FEP, we're obviously looking at -- when you look at the '12 numbers, does the change that we're seeing also include any sort of purchasing leverage you might be losing because, clearly, your mail revenues drop and a chunk definitely does come from branded. Now how should we think about that part of the contribution?

David B. Snow

I'll let Rich answer that. But I think -- I just want to remind you because we've said this before, that the loss of FEP has literally no impact on our leverage and our ability to contract at competitive prices. This change in volume on our side has literally no impact on our leverage.

Richard J. Rubino

Yes. There is no leverage effect in today's point. And we have a very clear line of sight into our purchasing leverage for 2012 and of course, that's baked into what you see in the S-4.

Charles Rhyee - Cowen and Company, LLC, Research Division

Okay. That's helpful. And then just one last question on Accredo. Obviously -- I think a couple of years ago, we saw some margin pressure on the gross margin line, it's clearly stabilized here. What has really changed here now and then shall we think about the margins being pretty stable at this -- a high 6.8% range going forward?

David B. Snow

I'll start with that and then I'll ask Frank Sheehy to add anything that he wishes to. The thing I will add is that, what's changed is Frank Sheehy. He's gone in there. He's looked at the operations. He's done a very, very, very good job working with our clients and also working with the operations to get the costs in line and to make us more efficient. And what's great about Frank is he came from the customer side of our business in the core, knows these customers, knows what they're looking for, and he's made some great changes to, I think, be better aligned with what our clients need and serve them better and more cost-effectively. And I don't know if you want to point anything specific at this point, Frank, but I'm giving you the opportunity.

Frank J. Sheehy

Yes. I think to Dave's point, working aggressively with Tim Wentworth and Glenn Taylor and their team and putting programs out there that are aligned with our clients interest are definitely resonating, combined with the differentiating service model that we've bought there have create a great opportunity for Accredo and our clients.

Operator

Your next question comes from the line of Eugene Goldenberg with BB&T.

Eugene Goldenberg - BB&T Capital Markets, Research Division

Can you just provide any additional commentary around some of the chatter that we're hearing of Pfizer getting a little bit or actually a lot more aggressive on the rebate strategy when it comes to Lipitor? I think they recently raised the rebate on Lipitor to about 50% and have been offering it to some PBMs. Can you provide a little bit of color on that?

David B. Snow

I'll ask Tom if he has any insight into that?

Thomas M. Moriarty

Well, obviously, they have a multipronged strategy for the market around Lipitor and what you cited obviously about the marketplace. We've obviously chosen our strategy and are quite comfortable with that. So that's all I can add to it.

Operator

And your last question comes from the line of David Larsen with Leerink Swann.

David Larsen - Leerink Swann LLC, Research Division

Has the 2013 selling season started off for large health plans?

David B. Snow

I'll ask Glenn Taylor, who runs our Health Plan Group to indicate what's going on there.

Glenn C. Taylor

Yes. I would say, yes, there's RFP activity related to 1/1/13 business. But we haven't had any finals and haven't gone through the full process yet. It's a little bit early.

David B. Snow

It is in the sale cycle for that type of account though.

David Larsen - Leerink Swann LLC, Research Division

Okay. So that sort of process is not necessarily having an impact on that 2013 revenue on the S-4 statement, right? It's not like you have great clarity on '13. Okay. And then also in terms of the EBITDA growth rate for 2014 in the S-4, it looked pretty good to me be and like maybe 14% year-over-year. Is there anything in '14 in particular that would drive that?

Richard J. Rubino

Well, you might recall again from Analyst Day last year that we show that famous generic EPS contribution slide. It had a wave going through it. And you might recall that 2014 and 2018, were both strong years. Actually 2014 was the strongest after 2012 and that includes some pretty large drugs going generic. And for our book, at the time at least, they averaged about 45% mail-order penetration rate. They include, in order expected introduction, Asacol; Evista; Nexium, which of course is a very large drug; Telebrix and Actonel. So those were important drivers for '14.

David Larsen - Leerink Swann LLC, Research Division

Okay. And then for new members coming on through the exchanges in '14, that's not a big driver of that growth rate. Is that correct? It's more the generics?

Richard J. Rubino

That is correct.

David B. Snow

Yes. You're going to be seeing the exchange growth come through health plan partners given the way the rates are written right now.

David Larsen - Leerink Swann LLC, Research Division

Okay. And then just my last question, Dave, assuming this merger does go through, do we get any clarity on sort of what your role is going to be or what your plans are?

David B. Snow

We don't have complete clarity now. But remember, we are the company being acquired. So I think you can think about it from that point of view.

Operator

Are there any closing remarks, sir?

David B. Snow

No. I think we're done. And I just want to thank everyone for dialing into our call and joining us. And we look forward to continuing, updating you as we make progress with the FTC. Thanks.

Operator

Thank you, ladies and gentlemen. This concludes today's conference call. You may now disconnect.

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