Express Scripts Holding (ESRX) Timothy C. Wentworth on Q2 2016 Results - Earnings Call Transcript

| About: Express Scripts, (ESRX)

Express Scripts Holding Co. (NASDAQ:ESRX)

Q2 2016 Earnings Call

July 26, 2016 8:30 am ET

Executives

Benjamin Bier - Vice President-Investor Relations

Timothy C. Wentworth - President, Chief Executive Officer & Director

Eric R. Slusser - Chief Financial Officer & Executive Vice President

David A. Queller - Senior Vice President-Sales & Account Management

Analysts

Lisa Christine Gill - JPMorgan Securities LLC

Eric Percher - Barclays Capital, Inc.

Robert Jones - Goldman Sachs & Co.

Garen Sarafian - Citigroup Global Markets, Inc. (Broker)

John C. Kreger - William Blair & Co. LLC

Charles Rhyee - Cowen & Co. LLC

Robert Willoughby - Credit Suisse Securities (NYSE:USA) LLC (Broker)

Brian Gil Tanquilut - Jefferies LLC

Ricky R. Goldwasser - Morgan Stanley & Co. LLC

George R. Hill - Deutsche Bank Securities, Inc.

David M. Larsen - Leerink Partners LLC

Steven J. Valiquette - Bank of America Merrill Lynch

Operator

Welcome to Express Scripts Second Quarter 2016 Conference Call. All lines have been placed in listen-only mode until the question-and-answer session. Today's call is being recorded. If anyone has any objections, you may disconnect.

I would now like to turn the call over to Ben Bier, Vice President of Investor Relations. Sir, you may begin.

Benjamin Bier - Vice President-Investor Relations

Thank you. Good morning. With me today are Tim Wentworth, Chief Executive Officer and President; Eric Slusser, Executive Vice President and Chief Financial Officer.

Before we begin I need to read the following Safe Harbor statement. Statements or comments made on this conference call may be forward-looking statements and may include financial projections or other statements of the company's plans, objectives, expectations or intentions. These matters involve certain risks and uncertainties. The company's actual results may differ materially from those projected or suggested in any forward-looking statements due to a variety of factors, which are discussed in detail in the company's most recent Form10-K filed with the Securities and Exchange Commission. We do not undertake any obligation to update or otherwise release publicly any revisions to our forward-looking statements.

For clarity purposes all financial numbers, except where indicated, that we talk about today will be on an adjusted basis and are attributable to Express Scripts, excluding non-controlling interest representing the shares allocated to members of our consolidated affiliates.

This presentation will be posted on our website and includes an appendix with footnotes and the reconciliations of GAAP to adjusted numbers. Please also refer to tables included in our earnings press release for a reconciliation of GAAP to the adjusted numbers that we will be discussing. This press release is posted on the Investor Relations section of our website at www.express-scripts.com.

At this point, I will turn the call over to Tim.

Timothy C. Wentworth - President, Chief Executive Officer & Director

Thank you, Ben, and good morning, everyone. As you've seen this past week, the healthcare environment remains unpredictable and volatile. At Express Scripts we are not distracted. Indeed, our focus has never been sharper, and that focus is being rewarded. Demand for our services continues to be high, our unique model is resonating and we are competing well. This is leading to a strong client retention year for 2017.

On the call today I will briefly discuss why we are positioned for growth, how we will deliver value to clients, patients and shareholders, important differentiators of our approach to specialty, our clients number one pain point and our unique attributes that fuel our momentum. Then I will turn it over to Eric who will discuss our solid financial performance and outlook for the remainder of the year.

Having a singular focus and a steadfast alignment with clients differentiates us. Plan sponsors today face a harsh environment filled with threats, but also with promise. We have an unprecedented level of innovation in the pharmaceutical industry. There are more drugs in the pipeline now than ever before and the majority are for specialty products treating chronic and complex conditions.

Without our leadership, in collaboration with our clients, this rich pipeline of high-cost therapies has the potential to profoundly impact healthcare costs. There have never been so many drugs coming out of the pipeline that are high-priced, prices once only seen in orphan conditions are now seen for conditions that affects millions of people, in diseases such as cancer, high cholesterol and hepatitis C. We are relentlessly focused on the patient, delivering the right drug at the right cost and creating a more rational net pricing environment.

Central to this in the long term will be competition from biosimilars. However, legal and regulatory challenges are impeding progress. We are working every day with regulators and biotech manufacturers to help them realize there is a market for these products. We have the assets that will ensure patients get on the appropriate therapy and remain adherent.

In addition to cost and complex regulations, payers are facing a population that is growing older, demanding more healthcare and wanting a greater say in how that care is delivered. We uniquely tackle these challenges and increasingly plan sponsors are turning to us, to control client costs, improve patient care and help plan sponsors maintain their pharmacy benefits, and do this through our innovative solutions, a single digital platform that integrates medical and pharmacy data, and specialized care delivered by compassionate people with deep expertise.

Now let me turn to how we deliver value through our independent focused model and our ability to practice pharmacy smarter. Being independent means being fully aligned with our clients' best interest. Alignment has never been more important than it is now. Our independent PBM model puts our patients and clients first and we tirelessly focus on lowering healthcare costs while delivering healthier outcomes. We are not encumbered by any specific drug delivery channel, we are not beholden to any specific pharmaceutical partner, we are not part of a bigger business. At Express Scripts our focus is simply on pharmacy benefit and management. That allows us to align fully and flexibly with the clients, do what's best for patients as we redefine the member experience, and work across the supply chain to drive out waste and create real value.

Next week, we will unveil our 2017 National Preferred Formulary. By aligning with our clients, we have been able to change the dynamic in pharma/payor relations, reining in costs while sustaining access to drugs. Our approach has saved clients billions of dollars while delivering superior clinical outcomes. When you look at our 2015 drug trend report, I would point out that clients who tightly manage the benefit at a trend of 3.3%, in fact that represents nearly 57% of those clients. Plan sponsors are increasingly using a broad range of cost-effective innovative solutions to manage plans, and there is plenty of room to run across our book of business.

We advocate for what matters most to our clients. As I referenced earlier, in the past few weeks two biosimilars were approved by the FDA, yet today they are not available to patients. We continue to champion for biosimilars and for increased generic utilization. It will create the headroom payers need to afford breakthrough innovation.

Capitalizing on biosimilars will take the same kind of bold action we took when high-priced hepatitis C drugs threatened to decimate payer budgets. We stood with our clients and worked with pharma to lower the cost of care and expand access. We drove the treatment costs down by nearly 66% and delivered adherence and cure rates on par with both the clinical trials and the competing product in the marketplace.

Now the key to achieving this outcome in hepatitis C as well as outcomes across therapeutic classes is our Accredo Specialty Pharmacy. As most of you know, I am very familiar with our specialty business having previously served for three years as the CEO of Accredo. I recognize then what is still true today. Specifically, the difference that specialized care through our Therapeutic Resource Centers can make for patients and how our company will be rewarded for getting this area right for our clients. As specialty spend is expected to soon comprise 50% of total drug spend by 2018, we continue to enhance the high-touch service model we offer through Accredo while leveraging our scale and expertise to control costs.

No one is better positioned than we are to provide specialized care for patients with complex and chronic diseases. As I mentioned earlier, our specialty model is poised to get biosimilars to market and further accelerate our ability to manage specialty spend and trend. Our success in specialty is based on focused clinical management. Our continued growth is the result of our differentiated innovative offerings in the specialty space, which not only increases PBM client adoption but helps us win direct business from payers, physicians and patients.

Our SafeGuardRx suite of products is designed to better manage specialty spend, establishing a higher standard for patient outcomes. Payer's greatly improve their specialty utilization trend and overall spending by taking advantage of our cost management and patient care programs, seeing as much a 50% reduction in trend compared to those who do not apply our solution. In fact, I would point out the 3.3% drug trend for tightly managed clients, I mentioned a moment ago, is inclusive of specialty trend for those clients.

When you put it all together, Express Scripts is driving better retention, delivering strong sales performance, and building upon a diverse client portfolio by addressing payer challenges like no one else can. Therefore, we expect another excellent retention year. Because of our singular focus, consistent operational excellence, flexibility and our innovative practice of pharmacy, we expect 2017 retention rate of 96% to 98%, up 1% at the midpoint of the range when compared to this same time last year.

Additionally, I am pleased with our selling season. With our new suite of products including SafeGuardRx and our ability to meet the demands of today's complex healthcare environment, we are well positioned to drive new sales. We have changed conversations for the better. Our bold actions, specialized care, data insights and innovative solutions have created a deep connection with clients, and our success provides more proof of the value of our independent PBM model. Putting patients and clients first truly works.

I will now turn the call over to Eric to discuss our solid second quarter financial performance and the full year 2016 guidance.

Eric R. Slusser - Chief Financial Officer & Executive Vice President

Thank you, Tim, and good morning, everyone. For the second quarter of 2016, we reported adjusted earnings per diluted share of $1.57, representing growth of 9% over last year and in line with the midpoint of our guidance range. Consistent with recent years, this quarter includes approximately $107 million of incremental revenue related to a client contract payment.

Other key metric highlights for the quarter include: adjudication of 315.3 million adjusted claims; decreased adjusted SG&A of 1% versus the prior year; EBITDA generated of approximately $1.8 billion; and finally, excluding the impact from the previously mentioned client contract payment, EBITDA per adjusted Rx would be $5.36, up 4% over last year.

Throughout my first year with Express Scripts, we've been focused on expense management and efficient use of capital. This includes our capital structure initiatives and our intentions to maintain an approximate 2 times debt-to-EBITDA leverage ratio and an investment grade rating.

As discussed in our press release, we executed a bond offering and concurrent tender offer to minimize our near-term debt repayment obligations, lengthen our portfolio's duration and to lock in attractive longer-term interest rates. Overall, we are very pleased with the outcome of this transaction.

Let's now turn to our 2016 updated guidance. Let me first touch on the adjusted claims guidance. For the full year, we are maintaining the midpoint of our current claims guidance at approximately 1.275 billion adjusted claims but narrowing the range. For adjusted SG&A, we are maintaining our guidance range. Cost efficiency is a priority for our leadership team. We continue our efforts to streamline our processes and make changes toward more automation. With our focus on technology, digital tools, home delivery and specialty, we expect to see operational cost improvements, a reduction in SG&A year-over-year and an increase in patient satisfaction.

We are maintaining our EBITDA guidance range at a range of $7.2 billion to $7.4 billion, which represents growth of 3% to 5% over 2015 adjusted EBITDA. As we stated in the first quarter, while the growth expected in the back half of 2016 is similar to previous years, we are expecting a slightly higher ramp up in EBITDA throughout the third quarter and fourth quarters as a result of several factors.

First, the Q1 roll-off of business due to acquisitions was a headwind we had to overcome. And second, the growth over prior year in the second half of the year is largely driven by higher utilization of our cost savings programs along with generic launches, supply chain initiatives and higher Medicare Part D revenue, driven by the benefit design and reinsurance payments from the government.

We are also narrowing our adjusted earnings per diluted share guidance to a range of $6.33 to $6.43, increasing the bottom end of our guidance range by $0.02. This range raises the previously guided midpoint and represents growth of 14% to 16% year-over-year.

With respect to the third quarter of 2016, we expect adjusted earnings per diluted share to be in the range of $1.72 to $1.76, up 19% to 21% year-over-year.

We are pleased with our financial performance year-to-date and continue to execute on our strategy to lower costs and improve health outcomes while generating shareholder value.

Thank you and now we'll be happy to take your questions.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. Our first question comes from the line of Lisa Gill. Ma'am, your line is open. You may proceed.

Lisa Christine Gill - JPMorgan Securities LLC

Great. Thanks very much and good morning. Tim, just wanted to follow up on your questions, I'm sorry, around your comments on this year's selling season. You talked about retention, but can you talk about specifically on the sales side, is there a number that you're comfortable giving us? Are you net positive as you move into 2017, would be my first question.

And then secondly, you talked about a number of different value offerings that you have in the market, can you talk about what people are buying for 2017?

Timothy C. Wentworth - President, Chief Executive Officer & Director

Sure, Lisa. Thank you for your question and good morning. I'll start by talking just a little bit about the net positive question. So, as you know, we still have a range of retention out there. Our goal is to be net positive. In fact, our goal is to offset even the loss of Coventry next year, which again, as you saw in the release, there is still a little bit of that. But it's too early to declare that.

But you just need to know we're having a strong selling year. Things that we're winning don't happen to be the ones that you see out being announced, but we're very pleased with the way that we're selling. And a big piece of the reason that we're winning, as well as obviously retaining our existing clients, is exactly the point that you make, which is that we've got a number of things that we're out in the market with that are giving clients hope in terms of both some cost certainty, holding down their trends, keeping their patients on the products that are the most correct products, given the value they create. And so what I'll do is, actually Dave Queller is here, who heads up our Sales and Account Management. I'll let Dave speak specifically as it relates to the marketplace and kind of what you see in terms of uptake of the products.

David A. Queller - Senior Vice President-Sales & Account Management

Thanks, Tim, and good morning, Lisa. Lisa, we've had a very strong selling season this year, we're very pleased with where we are to-date at this point. As Tim mentioned, the clients are very focused on cost and adherence, and so we're leading in the marketplace with our SafeGuardRx programs, and very focused on what we have put in the marketplace to-date as it relates to the hep C programs and the cancer programs and our inflation protection. So that's got a lot of good headwinds for us, or a lot of help for us I should say, going forward.

The other piece, I would say, is that management of specialty has been critical and use of the TRCs, we see a very positive reaction in the marketplace as it relates to our management of the care and also getting patients the right drugs at the right time.

The last piece I'll talk about is the 90-day programs, we are focused on that and we've seen health plans have a larger uptake recently in 90-day programs, whether that be at the retail or more importantly, the home delivery. And so we've been really pleased with that too. And...

Lisa Christine Gill - JPMorgan Securities LLC

Is there a way, Dave for you, or Tim or even Eric, because this is kind of a numbers question, to maybe just help us to quantify the percentage of your customers that are buying these today and what the white space, or market opportunity is? So would you say that when you think about each of the buckets, you think about specialty or SafeGuard, or any of those, would you say you're in the early innings or would you say a lot of clients have already adopted these kinds of programs? How do we think about that?

David A. Queller - Senior Vice President-Sales & Account Management

I'll take it, Lisa. I actually think for most of these, we're in the fairly early innings. I mean, SafeGuardRx represents a great chassis as do the programs that we launched in cardiovascular and in hep C, to build off of. We've already announced for next year diabetes and we're in the final stages of refining that exact program with our clients and with some supply chain participants, as well as the inflammatory conditions.

So we see this as still probably in the third inning of a game that could go into extra innings, quite frankly, because we don't see the dynamics changing dramatically that create the opportunity for us to uniquely work with the supply chain leveraging our book of business to create those outcomes.

So I think there's a lot of white space in condition management that bring a number of our tools together differently. So when you talk about Mail, for example, in the old days, this business, because of the generic wave largely, you drove the value of Mail because Mail was so much more effective at converting generics. Today the question is how do we work not only with Mail but with the retail channel, with 90-day channel, to drive the overall outcome in these condition management programs that we're launching.

Lisa Christine Gill - JPMorgan Securities LLC

And just one last one follow up, would just be, you noted that you're going to come out next week with the National Preferred Formulary for 2017. I think in the past, Tim, Express Scripts has talked about the value of the incremental savings that you can bring to your clients. Is there a number to think about for 2017 and the incremental drugs that you will be taking off of the formulary?

Timothy C. Wentworth - President, Chief Executive Officer & Director

So, I'm not going to tell you that this week because we are literally still working through it. Believe it or not, these negotiations can take you straight to the brink sometimes. But I can tell you this: we target a material amount here, as you know. We try to do it with as few drugs. So I think that the big headlines are how much can we actually help drive out waste and how little can we actually disrupt patients in order to do that? We have been very good at that and I think what you'll see next week is, again, we're going to thread that needle very effectively.

Lisa Christine Gill - JPMorgan Securities LLC

Great. I appreciate the comments. Thanks, everyone.

Operator

Thank you. And our next question comes from the line of Eric Percher. Sir, your line is open. You may proceed.

Eric Percher - Barclays Capital, Inc.

Thank you. I might move to a financial question for Eric. As I look at our model, our chief concern is relative to SG&A, and I know you spoke to some of the elements that are helping you control SG&A, but could you speak a bit more with more specificity to how much are we seeing benefits today from actions taken over the last year or two when you speak to cost efficiency? And as a priority, how much has been done this year? Because I know in the last two years we've seen second half SG&A higher than the first half. You really need to see a pretty large reduction to meet your full-year goal.

Eric R. Slusser - Chief Financial Officer & Executive Vice President

Sure. So let's talk about a couple of things. One of the things that just to comment on last year, just as a reminder, in the second half of the year, a large part of that third quarter and fourth quarter was driven by incentive programs and in seeding our targets around performance of the business. So you have incremental incentive in there and we talked about that at year-end.

As you look at this year, particularly this quarter and if you look at the guidance for the year, the second half, a couple of things. One, we're still very focused on cost management. This company historically has always been and that is not going to change under Tim and my watch. So very, very focused. The front half of this year, we've continued to make investments around some of the things we've talked about, automation.

And so the other thing I'd point out in the second quarter is we had a few one-time items that won't repeat in third quarter and fourth quarter this year, particularly around a couple of one-time incentive programs, and then also increased legal fees around Anthem litigation. So that will certainly bring down the run rate and then we're going to continue to manage across the board our programs into the third quarter and fourth quarter, doing the things that we've previously talked about.

Eric Percher - Barclays Capital, Inc.

Okay. And so it sounds like we've got a couple of one-time items. But you would characterize much of this as efforts that have been put into place since the beginning of the year more so than long-term benefits from prior cost reduction efforts?

Eric R. Slusser - Chief Financial Officer & Executive Vice President

Well, it'll be both and we're not going to talk about 2017 until towards the end of this year, but we're very focused on both near-term/short-term cost savings and longer-term cost savings management, and we'll talk more about the latter later this year.

Timothy C. Wentworth - President, Chief Executive Officer & Director

Yeah. And I would just add, as you can appreciate and Eric said it, but the back half of last year we took the opportunity to incrementally invest in things that we knew would drive out costs this year. And so that, a) was part of the ramp up last year, and b) is the kind of thing that's providing benefit in an increasing level, things like elective prior authorizations, for example, for the back half of this year.

And I have to point out that this team is, Eric said it, we are not losing our focus on cost. We're going to achieve the results that Eric has shared with you. And as you've seen, we've put zero dollars; zero, in any integration expense, because as we committed to you, we are done with that. And so we knew that was coming this year, we invested smart last year, we've got the management team that's got a lot of discipline this year and we feel very confident that we're positioned to deliver the back half strongly.

Eric Percher - Barclays Capital, Inc.

Thank you for that.

Operator

Thank you. And our next question comes from the line of Robert Jones. Sir, your line is open. You may proceed.

Robert Jones - Goldman Sachs & Co.

Great. Thanks so much. Yeah. Tim, just going back to some of your comments around biosimilars and your position to drive better adoption. I'm just trying to get a little bit more clarity on, are there things you can do near term with the formulary for next year to drive adoption of biosimilars that have been approved for the FDA? Or should we be taking your comments to be more of a longer-term goal?

Timothy C. Wentworth - President, Chief Executive Officer & Director

I appreciate the question, Bob. First of all, what I'd say is, unfortunately, and I think that's probably the best word for both our clients and for us, it's unlikely that we're going to see anything next year. And my comments were made very much more to frame what we believe the longer-term opportunity is going to be and the position that we sit to be able to grab that opportunity and help deliver it for our clients and for the patients.

But understand also that my point would be the mechanisms by which we will deliver those are the mechanisms that are delivering value today because we recognize that we're working at the state level as well as at the federal level to help folks understand that we will get these products to market, that we will do it safely, that they can create a significant amount of headroom for payers.

And so when we go in and we have these conversations, we recognize the timing may not be until 2018 or 2019 or even beyond, but I'm reminded of when I joined this business in 1998, we were looking at the front-end of the generic wave and we were at 40-some-percent generic dispensing rates and we're at 90% now and it was back then that we needed to be able to begin to educate the marketplace, make sure we were aligned with clients to deliver that value and have a business proposition. We're very much in that position now.

Robert Jones - Goldman Sachs & Co.

Got it. And I guess just a follow up, one of the areas you guys talked about contributing to improvements this year and I think even more so in the back half was the digital initiatives. And I guess one area that we would've thought would see some improvement in as a result would have been the mail penetration. Obviously in the quarter down about 180 basis points year-over-year, down slightly sequentially. How are you thinking about your ability, given some of the ongoing initiatives, to drive better mail penetration going forward? And how important is driving better mail penetration to the full-year expectations you guys have?

Eric R. Slusser - Chief Financial Officer & Executive Vice President

So the good news for us is we're very committed to the digital transformation of our member experience, because that's how members want to work with us. It's how we drive down costs. And what you'd see if you were inside the company is a couple things: one, you'd see significantly increasing net promoter scores on the part of members who work with us; two, you would see that that's a big piece of how we're driving down costs and waste from taking out phone calls that members, frankly, don't want to make to us because they want to self-serve, and we're seeing that. That is the sort of leading result of those investments.

The lagging results of those investments, as members experience it and work with us, particularly as we put our omni-channel 90-day programs with clients that are both mail and retail is we've been able to contract with the supply chain and the retailers in such a way as to make that something that works for us and our clients and our patients is that over time we're going to see it grow.

In the quarter what you would've seen, or frankly his year what you would see is the roll-off of Coventry was largely their commercial book of business which did have mail penetration and that's largely the driver that was actually creating what you saw in the numbers that you put out there. So we're very confident in the long term.

I remember the old days when we used to say that a generic at mail was three times as profitable as anything else, at least in the company I was working for at the time. I can tell you now, that dynamic has leveled out to a far greater deal. We have a much more balanced approach to how we actually are paid in alignment with our clients to do our job. And so we are committed to mail. We believe it's a channel that members want to use, but it's not a channel that we are solely dependent upon for the kind of growth that you would expect from us.

Robert Jones - Goldman Sachs & Co.

Got it. Thanks for taking my questions.

Operator

Thank you. And our next question comes from the line of Garen Sarafian. Sir, your line is open. You may proceed.

Garen Sarafian - Citigroup Global Markets, Inc. (Broker)

Good morning, guys. Thanks for taking the questions. I wanted to take the selling season from a different perspective. Given the M&A activity within managed care and the recent announcements by the DOJ, I'm wondering what changes you've noticed in the selling cycle heading into this year, so we can see what it might revert to as the recent views get digested by clients, even if they're still not entirely resolved. So have clients been holding back on certain RFPs that may now go out sooner than anticipated? Or were they lengthening or shortening the duration of their contracts? Any comments on that front would be great.

Timothy C. Wentworth - President, Chief Executive Officer & Director

That's an interesting question. What I would tell you as I sit here and think about it is, no, we have not seen clients – clients are so focused on managing things right now year to year and evaluating the marketplace for the best solutions, that they don't have the luxury of sitting and waiting for the DOJ to make a set of decisions. I think that as I think about our position in the selling season this year and next year, in my opening comments that's why I sort of referred to our singular focus and our ability to innovate now rather than – we went through our merger and acquisition 4.5 years ago, right. And you saw what we went through. It's hard. Looks as if at least those may not happen, but I can tell you that the payers are focused on what you can do today for them, and we've not seen any of them holding back or sort of changing their approach to creating a very competitive market for us to play in.

Garen Sarafian - Citigroup Global Markets, Inc. (Broker)

Okay. That's useful. And then on Accredo, one of the opportunities I thought I've heard mentioned in the past is to better sell Accredo as a standalone specialty pharmacy, which could be used even if Express Scripts wasn't the PBM. Could you elaborate on that aspect of selling season and how that's progressing versus prior years? And, of course, quantifying it as much as possible?

Timothy C. Wentworth - President, Chief Executive Officer & Director

Sure, so as you know, we don't really give the separate result there, and even when we used to in the old days, we didn't break it out by direct versus PBM. What I would say is this, we continue to compete well in what we call the direct marketplace, where essentially Accredo is either the specialty pharmacy for someone who is packaging that with other offerings to the market or in network as one of two or maybe one of three. Typically that's what we see. We continue to see both the retention of that business as well as new opportunities there, good bolt-on, in some cases for singular therapies where we have deep expertise or across therapies. And so I'll tell you it's an important part of our business, particularly in the more rare disease space where we have just a commandingly excellent service model for those patients, PAH, hemophilia, designs and so forth. And it continues to be an important part of our overall strategy for growth.

Garen Sarafian - Citigroup Global Markets, Inc. (Broker)

Got it. Thank you.

Operator

Thank you. And our next question comes from the line of John Kreger. Sir, your line is open. You may proceed.

John C. Kreger - William Blair & Co. LLC

Hi. Thanks very much. Just to come back to the SafeGuardRx programs, Tim, on the inflation front. What are you seeing in the market now, not in your own managed products, but just curious are you seeing any changes in inflation across generic, traditional brand and specialty brand?

Timothy C. Wentworth - President, Chief Executive Officer & Director

What I'd say is pretty much what you've seen is what we've seen, which is generic inflation has been very low to next to zero. Our clients have experienced good generic results over a lot of years because of our ability to negotiate on the mail side and then bring that into our retail negotiations. But in the brands, what you're seeing is continued – and you really have to dig in and look at it product by product and manufacturer by manufacturer to understand the overall dynamic and what's inside of it. But we're certainly still seeing inflation that has our clients focused, that has us with a job to do, and close to, I would say, the double-digit rate again this year, probably between 10% and 12%. And probably, right now at least, it looks like at the high side, recognizing we've still got quite a bit of the year left.

John C. Kreger - William Blair & Co. LLC

So when you sit down with prospective clients and talk about your inflation guaranteed products, what sort of differential do you think you can deliver?

Timothy C. Wentworth - President, Chief Executive Officer & Director

It's multiple percentage points. The real point is we can take the lid off of that and, again, recognizing depending on the client's mix of business, mix of products, what kind of patients they have and so forth, it varies from client to client, and that's how we write the program, in terms of the value it creates. But it's multiple percentage points of difference. As you heard me say in my prepared remarks, we hit 5.5% across the book of business on our Drug Trend Report roughly and 3.3% for the highly managed clients. And what we've defined as highly managed is clients that are taking four of our programs and inevitably one of those programs is for the upcoming year and the results that we put out, which we think are going to be very strong again are going to be those that are in that Inflation Protection Program.

John C. Kreger - William Blair & Co. LLC

Great. Thanks, and one last one, Eric. Can you just talk to the operating cash flow metric. It was down year-over-year. Just what drove that? And have your full-year expectations for cash flow changed at all? Thanks.

Eric R. Slusser - Chief Financial Officer & Executive Vice President

Yes, so certainly full year has not changed as we've maintained that guidance range. If you look year-to-date, I believe, we're just slightly above last year. You have to go back to the first quarter when we were well ahead of expectation. And I commented on the call in the Q&A, a lot of this is around timing of payments and receipts and we had receipts in the first quarter that came in just a little bit ahead of time and would've otherwise been second quarter items. So it's kind of hard to look at it quarter-to-quarter. I would stay focused on the year-to-date, which we're right in line with expectations and again our annual number, same thing, right on line with our previous expectation.

John C. Kreger - William Blair & Co. LLC

Thank you.

Operator

Thank you. And our next question comes from the line of Charles Rhyee. Sir, your line is open. You may proceed.

Charles Rhyee - Cowen & Co. LLC

Yes, thanks. Thanks for taking the question here. Tim, you talked about the changing value of mail over time, and clearly as you mentioned earlier, the real driver in the past was generic conversion. As we really kind of approach the tail end of this big wave of small molecule generic drugs, is the specialty portion really the main driver in the mail channel? And how do you view the rest of the traditional mail business in the small molecule space going forward?

Timothy C. Wentworth - President, Chief Executive Officer & Director

Look, first of all, there's no question that as our clients look down the barrel of specialty being half of their spend that it's a critical part of how we're going to maintain both the trends in spend and adherence and outcomes and everything else that the clients need from that channel.

But what I'd say is mail still has an important role to play. By the way, there is still some pretty terrific generics coming forward, as you know, in mail. Obviously retail has done a much better job in the last few years than they did back in the day in terms of converting those patients. But mail begins to add to its allure, the fact that people just like getting things by mail.

And so we've got a great clinical benefit there. We think our therapeutic resource centers continue to be important differentiators. We continue to see mail achieving outcomes that are differentiated even from 90-day retail channels, and so we are still committed to that. But I think it's one thing in terms of what you're paying in the markets, another in terms of how big is the problem that it's solving in contrast to the overall problem? And simply put, specialty is an increasing opportunity for the work that we need to do, and therefore relative to mail, has become more important.

Charles Rhyee - Cowen & Co. LLC

And just a follow up, you talked a little bit earlier about some digital initiatives and things like that. Can you talk about the patient experience, the user experience right now with dealing with mail? I think in the past people have often commented that mail is a little difficult to get started. Once you're started, it's fine, but getting signed up can be a little bit cumbersome. Can you talk about how things have changed here in terms of getting people signed up earlier? And what's the average turnaround time for the first fill, typically? Thanks.

Timothy C. Wentworth - President, Chief Executive Officer & Director

Yes, first of all, interestingly enough, the turnaround time for the first fill is a really important vector. When we look at net promoter score and break down what are the key drivers of net promoter score, and so that's a piece where we've lopped off over half a day and we continue to lop off time for that first script coming from mail.

We're also absolutely trying to make it easier to do. Obviously, we're in a highly-regulated business, both at the state level and the federal level. So there are certain things that you might be able to do in other businesses that we have to figure out that not as easy, in terms of, for example, taking a picture of a script, which you can do certainly if you're then going to go into retail because you're going to present the paper script. But we have to have the physical script or the electronically prescribed script before we mail it. So e-prescribing very important part of our strategy. We continue to see that grow.

Digitally, we've started using our digital welcome kits, which means it's a time that a member enrolls with us and we already have their data, we can actually present opportunities to them through that enrollment process in our welcome kit that used to be a paper thing that everyone threw out. And so while it's early days and we're going to wind up re-versioning that, doing what you would expect us to do in terms of digital A/B testing and seeing the things that work best to help members navigate to mail, we see in the long run that that's a channel strategy with members ought to at least present the opportunities to them in an easy-to-use way, so that those that want to use it will access it.

Charles Rhyee - Cowen & Co. LLC

That's helpful. You say you've lopped off about half a day in terms of turnaround time. So what would be the average number of days for the first fill typically now in mail?

Timothy C. Wentworth - President, Chief Executive Officer & Director

Well, the challenge – so your question implies challenge, which is it depends. As you know, more and more prescriptions come with prior authorizations today because that's how both the Medicare plans are managing and the commercial plans are also managing on top of more narrow formulary management. And so it depends is the answer. Where we're able to get the script electronically, do an e-prior authorization and so forth, the patient can expect that script in probably three to four days.

And, by the way, part of the goal as well is patients are happier when they know where the script is than when they don't. And so one of the things we've done is opened up a black hole that if you'd ordered from us four years ago, you'd know that we got your order and that's all you'd know until you receive it. And now, we've become much more communicative with our members in whatever channel they want us to communicate to actually keep them informed of that. And so the timing is important, but managing of expectations is equally important and that's what we're seeing.

Charles Rhyee - Cowen & Co. LLC

Great. Thank you.

Operator

Thank you. And our next question comes from the line of Mr. Robert Willoughby. Sir, your line is open. You may proceed.

Robert Willoughby - Credit Suisse Securities (USA) LLC (Broker)

Great. Tim, is there a rule from the United experience or otherwise just in terms of helping us think about Anthem possibly transitioning away? Is there any type of rule how much business, like employer carve-out business you think you could retain in that eventuality?

Timothy C. Wentworth - President, Chief Executive Officer & Director

You know, the short answer is there's not because you have to look at the book of business that one had versus the other, how much of it was likely to be carved out. What we've been more likely to do, Robert, when we've seen some churn in the marketplace is try to help our health plan clients win lives and carve them back indirectly. And obviously, that overlap is something that we have not looked at yet, if I'm honest with you, because all our energy has been spent on servicing Anthem's members and positioning ourselves to be their best choice when they reach the point of needing to make a choice in pharmacy. Obviously, the question was would they or wouldn't they be integrating another pharmacy into their own or into us or into something else. And that's still all to be played out. So the short answer is I wouldn't bet a large amount of the pie on that, and I frankly have been spending my time thinking about, again, what are other things we can do to help them win and grow.

Robert Willoughby - Credit Suisse Securities (USA) LLC (Broker)

You obviously had some challenges with the integration of the Medco business. Was there an experience with United as they transitioned a lot of their business back? Or that was just Medicare business, I guess. We can't really point to any success retaining accounts?

Timothy C. Wentworth - President, Chief Executive Officer & Director

No. I would agree. I wouldn't point to anything there that would be material.

Robert Willoughby - Credit Suisse Securities (USA) LLC (Broker)

Okay. Thank you.

Operator

Thank you. And our next question comes from the line of Brian Tanquilut. Sir, your line is open. You may proceed.

Brian Gil Tanquilut - Jefferies LLC

Hey, good morning. Tim, in your prepared remarks, it sounded like you were explaining to us the value of independence. So as we've seen some of the contract changes that have happened with United winning a lot of business or a decent amount of business for CVS, what are you seeing in terms of the traction that you're getting with that message that there is value to the independence of the model?

Timothy C. Wentworth - President, Chief Executive Officer & Director

Yes, it's showing up in our retention obviously. It's showing up for us in our sales. I've read several reports that also spoke to the fact that the market is looking for a competitive PBM offering that delivers value. In this business, one of the constants over my 18 years has been that the independent model has been very successful. Obviously, I was part of one that wasn't and then when we became independent, it unleashed us to be able to do our job really, really well. And I think it just makes our conversation very, very straightforward and, more importantly, all the assets of the company that come to the table in the form of our account rep or our sales rep are aligned around this one thing. And it really just drives a very, very deep singular conversation. Our clients see when we're in Washington, D.C. or at the state level advocating things, we're only advocating things that are in their interest in pharmacy. We aren't advocating anything else. We aren't talking about anything else. But all of that makes us feel good. Our job is to make it come to the table in terms of retention and new business wins.

Now, the other thing I'd say is there's always been folks that like certain models. There are certain PBMs that are small that you look and you think on a pure scale basis they shouldn't win a single case, but they find a marketplace for themselves. There are buyers who will choose based on different criteria. What I can say is the buyers that are choosing on criteria around aggressive management, around taking care of their members and trying to continue to provide the benefit to help their members through a consumer experience as it relates to the plan design and navigating the choices that are being thrust onto those "consumers" as it relates to plan design, those buyers, which are a significant number in the marketplace, like our model a lot, because we really are aligned to them. There is no question that we are creating competition in parts of the supply chain including retail and pharma, and so from our perspective it's a great unencumbered model.

Brian Gil Tanquilut - Jefferies LLC

And, Tim, as a follow up to that, shifting to the Health Transformation Alliance, it's something that was written up obviously this weekend and some of your investors are looking at. So how do you envision that alliance of employers and you're offering basically co-mingling or co-existing in the market?

Timothy C. Wentworth - President, Chief Executive Officer & Director

Well, I think that actually there's a lot we can do to work with those clients in the Health Transformation Alliance. In fact, many of those clients know what we can do and have brought that to the table. We actually are engaged with them. We have a very good dialog with the HTAs directly as well as importantly, our clients that are in there. It's been out there for a while, as you know.

Again, it's one of those things where if you go back to 2005, there was the Transparency Coalition that got started. We adapted our model to that and it's been extraordinarily successful for us and for that coalition, and those clients that wanted that sort of a model. That's again, from our perspective, the ability to be flexible, the ability to create value for clients. I think as I told a client around that, if all of the clients we have in HTA are willing to do certain things together, that only gives us more ability to create value for them, whether that's around indication or outcomes-based pricing, whether that's around a different rebate model, or anything else.

This business has always adapted and we see things like the HTA to the extent that it gains true traction in working with those clients. And of course they have a number of things they're going after, but we love the fact they want to be data driven, we love the fact that they want to really drive outcomes that are good for their clients and keep their clients in business. I think the big story that didn't come out of that is those clients want to stay in the business of providing benefits. That's right down our strike zone.

Brian Gil Tanquilut - Jefferies LLC

Got it. Thanks for the comments, Tim.

Operator

Thank you. And our next question comes from Mr. Ricky Goldwasser. Sir, your line is open. You may proceed.

Ricky R. Goldwasser - Morgan Stanley & Co. LLC

Yeah. Hi. Good morning. A couple of questions, but first starting with the big picture. One, Tim when you took on the CEO helm, you talked about taking a fresh perspective, it expresses strategic assets. So can you maybe share with us a little bit when you look at your assets portfolio, what do you think you still need to add to it?

Timothy C. Wentworth - President, Chief Executive Officer & Director

Thank you for the question, Ricky. First of all, I think one of the things that that we started even before George left, but on my watch, with the team that is so terrific at my table, is this notion of really rethinking how we engage with the supply chain to create value, and leverage our clinical focus.

And so this notion of condition management programs, with an umbrella of inflation protection over it, is extraordinarily innovative. We don't see anybody else doing it at scale the way we are and taking on those challenges.

We started it by launching it in front of 600 clients and Dr. Miller standing up and essentially signing them up to empower us to go out and do something that hadn't been done before around sort of an indication-based pricing model in oncology. And we built off that and it is transformational as it relates to the conversations we have with pharma, with manufacturers and with our clients.

That being said, and so we like and think we have the assets to get it done in terms of continuing to create that value. But as we look out, we see areas of waste and so forth in areas like worker's compensation, we see that there continues to be more we can do in specialty to broaden our footprint. We see healthcare information technology, particularly for payers in assessing risk and managing risk and potentially for providers, as areas that would naturally leverage our DNA.

And so those areas that we're now looking at, and what I would tell you is we are much more engaged than we were while we were integrating, as it relates to looking at opportunities outside of our four walls to bring additional solutions to our clients in those areas.

Ricky R. Goldwasser - Morgan Stanley & Co. LLC

And when we think about how you think about balancing that in additional buybacks, is that sort of a formula you're thinking about it?

Timothy C. Wentworth - President, Chief Executive Officer & Director

So what I would tell you is, it is not either/or. We have enough flexibility and enough ability to do both that I'm not concerned. And certainly, obviously, the share buybacks right now have a very high return to us, so they create certainly a high standard for any acquisition to hit in terms of our strategic thinking around that acquisition. But let me be really clear that we are not doing share buybacks at the expense of otherwise taking advantage of diversifying somewhat our EBITDA base and solving problems for our clients that go outside of our current core. So in that respect, I guess our capital priorities are not changed at all and, again, they are not either/or.

Ricky R. Goldwasser - Morgan Stanley & Co. LLC

Okay. And then just one follow-up – and thank you, Tim, for that. One follow-up for Eric on the SG&A in the second half of the year. I mean obviously an important part of the earnings trajectory, but are there additional swing factors in the second half that we should be thinking about outside SG&A?

Eric R. Slusser - Chief Financial Officer & Executive Vice President

I guess, within SG&A really none other than the things I've talked about before. So it's managing our costs, managing the trends. There's no big items that are going to drive that. It's across the board, across all of our organization. If you're referring to outside of SG&A, it was in same things in my prepared comments that are going to drive the ramp in EBITDA in the second half.

Ricky R. Goldwasser - Morgan Stanley & Co. LLC

Okay. Thanks very much.

Operator

Thank you. And our next question comes from the line of George Hill. Sir, your line is open. You may proceed.

George R. Hill - Deutsche Bank Securities, Inc.

Hey, good morning, guys and thanks for taking the question. Tim, I have a question about alignment in specialty. You guys talk a lot about how well you're aligned with the clients. A piece of feedback that we get sometimes is that the PBM is still incentivized to fill these high-cost specialty scripts and payers seem more concerned about appropriate utilization. I guess, so can you just talk about straddling the line between kind of the script filling in here and managing utilization appropriately? And I guess, can you give us an example of how you contract around that alignment such that you're getting paid and creating value whether or not you fill the script? That would be helpful. Thank you.

Timothy C. Wentworth - President, Chief Executive Officer & Director

Sure. I mean, first of all, it's clear. The way we report to clients, they have a front row seat for the job that we do in specialty. And I would just point out that the vast majority of patients, in fact, that are on specialty scripts need to be on those scripts. There's value that is created. The question is are they on the lowest-cost and most appropriate script and that's why we've been able to move formulary into specialty as aggressively as we have, which was not something that was being done largely in the industry as recently as three years ago, and certainly not at scale.

And so number one, making those formulary decisions and contracting with manufacturers to create and bring to our clients real value around that, contracting in such a way as to allow the price to be rational and allow us to do our job. So let me give you an example: PCSK9s. When you take a look at PCSK9s, to your point, as just a retail pharmacy or a fulfillment pharmacy, we're incented to fill every script we get in PCSK9s. That's not the way it works. And what we've shown our clients and where we sit today is in the first year while those products have been out, we have basically taken the majority of the scripts that came to us, let me use that number, and wound up actually speaking with the physician and moving the patient out of the PCSK9 class in terms of their therapy because of the fact that we managed it to the label, we managed to the indication, we got the tests that were fairly sophisticated in terms of the kind of data that we needed to get, and we managed it. And we've shown our clients that.

We put it in a program called the Cardiovascular (sic) [Cholesterol] (52:13) Care Value Program and we basically guaranteed the PMPM cost that they were going to experience for PCSK9s and then we hit it. And we didn't just do that recklessly because patients that should be on those drugs – those are fabulous drugs – are drugs that we want to get and keep those patients on. But again, in the early days, the docs really were not writing in such a way as to target those patients highly effectively and we've helped train those physicians through those conversations while making sure that the patients that needed them got them. That's probably the best and most recent example I can give you, but I can tell you across the piece that we contract with these companies to create value for our clients and then we deliver it.

George R. Hill - Deutsche Bank Securities, Inc.

If I follow-up on that example, Tim, can I ask the question, between the prior auth, the contacting the doctor and then moving that patient, let's say, off the PCSK9 to generic Crestor, can you guys make more money through the prior auth process and that whole redirection process to the generic than you would have on the PCSK9?

Timothy C. Wentworth - President, Chief Executive Officer & Director

Nope. We don't actually. So what we – I couldn't charge that much for the prior auth, I wish. But we are paid for that. But again, we work with our clients to make sure that we get paid the way they want us to be paid and there are a number of ways in specialty that that happens. But that's part of doing our job. We can't make money on – it's not about dispensing a drug every time it's being sent to us. It's about getting it right and, over the long term, that's what drives our retention, that's what drives uptake of our other products and services, and it's what creates a total envelope of value that we're able to participate in with our clients.

George R. Hill - Deutsche Bank Securities, Inc.

I appreciate the color. Thank you.

Operator

Thank you. And our next question comes from the line of Mr. David Larsen. Mr. Larsen, your line is open. You may proceed.

David M. Larsen - Leerink Partners LLC

Hey, Tim. Can you talk a bit about your relationship with Anthem? Has the dialogue or the relationship improved in any way now that the DOJ has apparently blocked the deal with Cigna?

Timothy C. Wentworth - President, Chief Executive Officer & Director

So thanks for the question. What I would say, David, is that that just happened last week, and I'm sure that there are whole bunch of things that Anthem naturally is going through. As I said before, we're not going to do a blow-by-blow or play-by-play sort of our conversations with Anthem. What I would say is this. We're working really effectively with Anthem to help them put in programs that help manage cost and drive their business. We're providing really strong service to them. Our teams are working well together. I don't have anything more to report than that at this point. Obviously, we still have a lawsuit between the two firms that they filed and that we've counter filed on, and we are in the very early innings of that game, barring any change of position on their part, of which I'm hopeful and which, again, I believe the best way to position ourselves for that is to just to continue to really drive great value to them through these programs that we're putting in place as well as taking great care of their members.

David M. Larsen - Leerink Partners LLC

Great. Thanks very much.

Timothy C. Wentworth - President, Chief Executive Officer & Director

Okay. Operator, we have time for one more call, please. This will be the last question.

Operator

Thank you. Our last question comes from the line of Steven Valiquette. Sir, your line is open. You may proceed.

Steven J. Valiquette - Bank of America Merrill Lynch

Thanks. Good morning, Tim and Eric. So I guess for me, I think every key topic has been touched on at this point, but just to follow-up on that Health Transformation Alliance. It wasn't really clear from the article just the mechanics of how that alliance is going to create savings in pharmacy and it sounded like from your comments they're not really intending to bypass PBMs or go into the PBM business themselves. Are they just trying to pool together their buying of PBM services? Is that kind of the essence of it?

Timothy C. Wentworth - President, Chief Executive Officer & Director

I mean, I really would say you need to talk with them to go deeper. It wouldn't be right for me to speak on their behalf. What I would say based on the interactions both with our clients and with them that we've had, is they are – and what they've said publicly, they're agnostic as to providers. They recognize the need for providers to sort of enable whatever it is they want to bring to life. I think we've worked with different coalitions for years and years. How this one plays out, we'll follow their lead. We'll show them sort of some ideas that we can do. I agree with you though that even in the article, which was really a stew of interesting sort of different, sort of mostly previously written things that were being brought together to form a theory that, frankly, doesn't exist, was very much around this notion that these plans are focused on maintaining coverage, using data to get smarter, understanding how the dollars flow. Those are all things that we do really well.

And I can tell you, we've been willing for years to write deals and many, many of our contracts, for example, have rebates of 100% flow-through, completely auditable. The article implied that that doesn't exist. And so again as the Healthcare Transformation Alliance focuses on their pharmacy pillar, of which they have four pillars based on my understanding, we look forward to working with them because it would appear what they want to do is work with the marketplace to drive additional innovation, and that's our DNA. And so I actually think we can find some very interesting ways to help them achieve their goals.

Steven J. Valiquette - Bank of America Merrill Lynch

Okay. The other real quick piece in the article, it just talked about that the members of the alliance can control drug benefits by separating PBM services of like claims administration, mail order and specialty pharmacy. It seems like to me unbundling that would lead to more costs, not less. I'm curious to get your quick thoughts just on that blurb in the article as well, if you've got an extra second on this.

Timothy C. Wentworth - President, Chief Executive Officer & Director

Yeah, sure. I mean, I think it remains to be seen, but generally speaking, I agree with you. I mean, I think that what you've found in the marketplace generally and it's true both in our channel as well as health plans as well as other businesses, right, is I just bought my wife a car. They bundled a bunch of stuff together and it was a lot cheaper than me going through the pick list and it put together something that was what we wanted. That's our job in the case of HTA and with every other client is to bundle together what they need us to do. It doesn't mean they have to buy everything. It means that we believe that we can configure our model in a way that's good for us and helps the client meet their needs. And if they want to, for example, internalize some small piece of what we do because they'd like to do that, we have clients today that do that, in the health plan space for example.

What I would say though is, most of the HTA – well the HTA's clients are employers, they've got a lot of things to do, they got businesses they're trying to grow and focus on. And from our perspective, typically what employers have found is even when they have asked us to respond to bids that had discrete lines of business, almost inevitably they've come back, and this article actually spoke to that, they've come back and moved back into a more integrated model.

But then they understood sort of what the individual cost pieces were and got comfortable with the bundle. And I fully believe that we're going to continue to see the market, particularly the employer market, continue largely down that path for the foreseeable future.

Steven J. Valiquette - Bank of America Merrill Lynch

Okay, got it. Okay, thanks.

Timothy C. Wentworth - President, Chief Executive Officer & Director

Okay, I think with that last question I want to thank everyone for dialing in today. We appreciate you calling in. Look forward to talking to you next quarter as we share our results in the marketplace and in running our business. Thank you.

Operator

And that concludes today's conference. Thank you for participating. 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!