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Express Scripts, Inc. (NASDAQ:ESRX)

Q3 2007 Earnings Call

October 25, 2007, 10:00 AM ET

Executives

David Myers - VP, IR

Edward J. Stiften - CFO and Sr. VP

George Paz - Chairman, President and CEO

Analysts

Lawrence Marsh - Lehman Brothers

Glen Santangelo - Credit Suisse First Boston

Tom Gallucci - Merrill Lynch

Robert Willoughby - Banc of America Securities

Lisa Gill - JPMorgan

Randall Stanicky - Goldman Sachs

John Kreger - William Blair & Company

Kemp Doliver - SG Cowen

Charles Boorady - Citigroup

Operator

Ladies and gentlemen, thank you for standing by, and welcome to Express Scripts’ Third Quarter 2007 Earnings Release. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions].

I would now like to turn the conference over to Vice President of Investor Relations, Mr. David Myers. Please go ahead.

David Myers - Vice President, Investor Relations

Thank you, and welcome everyone to Express Scripts’ third quarter conference call. With me today, George Paz, our CEO and Chairman, and Ed Stiften our CFO.

Before we begin, I need to read the following statement. Statements or comments made on this conference call may be forward-looking statements and may include, but are not necessarily limited to financial projections or other statements of the company's plans, objectives, expectations, or intentions. These matters involve certain risks and uncertainties. The company's actual results may differ significantly from those projected orsuggested in any forward-looking statements due to a variety offactors, which we’ve discussed in detail in our SEC filing. Inaddition, the reconciliation of EBITDA to net income and the net cash provided by operating activities can be found on our earnings release, which is posted on our website.

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

Edward J. Stiften - Chief Financial Officer and Senior Vice President

Thankyou, David. Today, I am pleased to discuss Express Scripts’ thirdquarter performance. We reported record adjusted earnings per share of $0.60, representing a 43% increase over the $0.42 reported for the third quarter last year. For the quarter, we generated $247 million of cash flow from operations compared to $158.8 million last year. And we expect to be in the upper half of our previous guidance range of $750 million to $850 million for the year. During the quarter, we repurchased 6.1 million shares of common stock for $313.6 million. And year-to-date, we repurchase 23.1 million shares for $1.1 billion.

Our strong operating results were driven by record generic utilization andlower drug producing costs in the PBM segment. This strong performancein our PBM segment more than offset less-than-expected results in ourSpecialty and Ancillary Services segment. We recorded $18.5million of non-recurring charges at the SAAS segment, the majority ofwhich pertains to a charge to bad debt expense resulting from theinsolvency of our specialty distribution client. This charge is uniquebecause over the last three years bad debt write-offs had averaged only$0.5 million per year on revenues that have average of $1.3 billion an year. In fact, over the last decade bad debt expense in this business unit has averaged less than 0.1% of revenues.

Excludingthese charges, SAAS operating income declined $1.3 million sequentiallyfrom the third quarter. This decline is attributable to our infusionbusiness, which had an operating loss of $6.8 million for the quarterand has lost $12.5 million year-to-date. We recently announced plans toclose six under-performing infusion sites and reduce overhead toimprove operating performance of this business unit. While George willbe providing further commentary on our SAAS segment, we believe we'repositioned to deliver Specialty Pharmacy solutions for our clients anddrive long-term growth for our stockholders.

Our comprehensive Specialty offering was also one of enablersof the strong operating performance of our PBM segment, which had anoperating increase... operating income increase of 39% over theprevious year. The savings we're generating for our clients through ourPBM and Specialty business units resulted in a record high adjustedEBITDA, and on a per adjusted claim basis was $2.44, a 33% increaseover last year. As a result of strong underlying PBM trends, we'reraising our 2007 earnings guidance. Excluding non-recurring items,we're increasing guidance from a range of its $2.23 to $2.29 to a rangeof $2.28 to $2.32. The mid-point of our range reflects growth of 39%over 2006 on an adjusted basis. Our plans are to provide 2008 guidancelater in November.

At this point, I would like to turn the call over to George Paz.

George Paz - Chairman, President and Chief Executive Officer

Good morning, everyone and thank you Ed. As we near thecompletion of another outstanding year, I want to take a few minutes toreview some of the success we’ve achieved as well as opportunities forthe future.

We're clearly disappointed with the performance of our SAASsegment. However, the disappointment is primarily related to theinfusion business unit and our patient assistance programs. As wepreviously stated, patient assistance programs are declining due to theMedicare Part D. I've mentioned some near-term changes we're making toimprove the performance of the infusion business. We'll continue toevaluate the strategic bit of this business.

Looking at our Specialty Pharmacy business, we continue torealize significant successes in selling specialty pharmacy services toour PBM clients. Specialty drugs are one of the largest drivers of drugtrend and our Specialty Pharmacy business provides a cost-effective,single-source solution for our client. We believe our SpecialtyPharmacy platform is the key to our recent successes in retaining aswell as leaning new PBM business. In addition, much of our success inwinning as well as retaining our book-of-business is attributable toour business model, which is based on alignment of interest withplanned sponsors and their patients. This longstanding business modelalignment has positioned as a trusted advisor to our clients. Thishelps us to promote the use of generics and lower cost preferredbranded drugs.

Our industry-leading generic fill rate, which had a record62.2% this quarter, demonstrates our value proposition. Our messagethat mix matters is ringing true to consultants and PBM clients whofocus on the tools we offer to drive to lower cost solutions. We aremoving to the next stage of alignment. We believe that there istremendous opportunity to enable better health and value at theconsumer level. We are learning how to unlock this value at the levelof the individual consumer and unlocking that value means greatersavings for our planned sponsors and better savings and health outcomesfor our members.

Our recent acquisition of ConnectYourCare, one of thenation's leading consumer directed health plan account administratorsis an example of our commitment to take our business model of alignmentto the next stage. Our success in encouraging consumers to increase theuse of generic drugs demonstrates that empowered, educated consumers,given convenient state-of-the-art tools can unlock great value in actively managing their health.

We are pleased with our overall results for the third quarterand excited about the opportunities to continue generating savings forour clients and patients, and strong growth for our investors.

That concludes our prepared remarks, and I will be happy to answer any questions. Operator?

Question and Answer

Operator

[Operator Instructions]. Our first question will come fromthe line of Larry Marsh with Lehman Brothers. Please go ahead.

Lawrence Marsh - Lehman Brothers

Thanks, George and Ed. I certainly can’t complain about thePBM business, another great quarter, so I will ask about infusion. Areyou giving us any sense of how big that business is now from a revenuestandpoint? And towards the end of the last quarter, you mentioned thatyou thought the infusion business was interesting, given the number andtypes of drugs in the pipeline. What's causing you to maybe change yourview here? And do you just see this as company specific issues or isthere anything industry-wide now that would cause you to re-evaluatethe infusion exposure?

George Paz - Chairman, President and Chief Executive Officer

As you probably know, Larry, the infusion business is a veryfragmented business and there are many, many providers in almost everygiven regional location. And therefore, a lot of the leverage exists onthe side of the manage care plans and it's very difficult to gain theleverage that we need in order to drive our value proposition for ourshareholders.

I do believe that there is a role for infusion as you lookout in the future. I am not sure though that you have to have thenurses that actually go to the homes to ultimately have the solutionfor the specially drugs that are in the pipeline. We are currentlyevaluating that. It's painful believe me to watch our high-growthbusiness being pulled back by our results from our infusion business.There is a very strong pipeline of infusible drugs, and a lot of thesedrugs are going to be more like the dialysis situation where you can goto an infusion suite and the people aren’t bedridden at home and haveto have nurses come to their house. They can in fact just go to suitesand have this business taken care of.

The infusion business today is very difficult because youspend a tremendous amount of time and cost and non-value addedactivities such as traveling to the patient's own, down time as you getthe patients in from the clinics and the hospitals. So, there is a lotof administrative burden and costs that make this business verydifficult. What we hope to do is continue to evaluate this over thenext quarter or two and come back to our shareholders with a solution.We are not ruling things out, but we are actively analyzing what moveus in the best interest of our shareholders.

Lawrence Marsh - Lehman Brothers

Okay. Are you giving us any size or a range for how big that is for you now?

George Paz - Chairman, President and Chief Executive Officer

Just what’s in there, just what we have disclosed in our Qs and Ks and the press releases.

Lawrence Marsh - Lehman Brothers

So, is it fair to say it's about $100 million of revenues or are you getting any more specific?

George Paz - Chairman, President and Chief Executive Officer

I don' t believe we have made any statements in that regard.

Lawrence Marsh - Lehman Brothers

Okay, and just another quick clarification. I know, Ed, lastquarter you gave us some sort of a sense of update on sequential trendsin scripts, you pretty much hit that. Is there any update in terms ofwhat we should expect for full-year adjusted script growth or mailgrowth this year?

Edward J. Stiften - Chief Financial Officer and Senior Vice President

Yes. For the full year, we would expect it to be to approximately 2%, give or take a few tenths of a percent.

Lawrence Marsh - Lehman Brothers

Okay. All right. Very good. And then finally, I guess alongthat line, just bigger picture, and I know at the analyst day youtalked about kind of vision of the benefit of Specialty and reallygrowing your EBITDA per adjusted script and how you sort of see thatopportunity… substantial opportunity I think as you defined it over thenext 5 to 10 years. Does the re-evaluation of the infusion businesschange that? Are you going to try to replace that with other thingswhere you can generate a reasonable return? Is that kind of the messagehere, take something our and maybe put something in here the next yearor so?

George Paz - Chairman, President and Chief Executive Officer

It certainly doesn't change it and we are always open to waysof adding to our SAAS segment or our Specialty business if we can findbusinesses that are good complementary fits with what we have, we wouldhappy to add those. We don't really feel like we have major holds rightnow, but we are constantly looking for opportunities to improveshareholder value through acquisitions if we can. But certainly, whatwe’ve presented in investor day is still what we believe.

Lawrence Marsh - Lehman Brothers

Okay, and finally just a clarification. Are you stillanticipating to give '08 guidance in mid-November like last year orsometime later in the month?

Edward J. Stiften - Chief Financial Officer and Senior Vice President

We are going to give in November. We will put out someprobably towards the second half of the month, but we will give youample notice.

Let me also just clarify with respect to the Specialtybusiness. When we bought Priority, it was one of the last remaininglarge specialty providers that were out there. As you know, Larry, whenwe bought CuraScript, it was a huge home run for us. We grew revenuesby 300% during a fairly short period of time. But the problem we hadquite honestly was CuraScript is a very small company and we aredeficient in many key therapy classes. The Priority acquisition wasincredibly important to us to round out our therapy classes. We nowhave product offerings, and 97% of the drugs that are out, there isonly a handful of drugs that we don't have and these are very small,often orphan-type situations where it doesn't make economic sense tohave multiple providers. So, our offering today is very robust and veryfull. I think the message we’re trying to say here is that we’ve got acouple of businesses that came with that and those businesses are a bitof an albatross. We are evaluating those and we're looking at them.

Keep in mind that the PAP programs are not part of thatacquisition. It was part of our… of Express Scripts’ build-out. Thatwas a very useful program before Medicare Part D in that it servedpeople very much in need. Usually, there is a Means Test that occurs,and once you fail those Means Test, you’re under poverty levels or somemultiple of that. And the access to very expensive drugs, theseprograms are life sustaining for people who need those drugs. We werethe largest player, we continue to be the largest player in thoseproducts, but anybody that goes over 65 now has access to Medicare PartD. So, the pharmaceutical manufacturers have created an opportunity totheir benefit… or the government is created an opportunity for them tomove these people [inaudible] used to give the drug away and pay us anadministrative fee. So, a product where now the person buys the drug,you may get paid for by the federal government and the individual stillgets their drugs, but it comes… we are not part of that transaction.So, just to be clear, our Specialty business doing is doing quite well.

Lawrence Marsh - Lehman Brothers

Okay. Very good. Thanks.

Operator

And our next question comes from the line of Glen Santangelo with Credit Suisse. Please go ahead.

Glen Santangelo - Credit Suisse First Boston

Yes, thanks. Hey, George, I just want to quickly follow-up onthe selling season for next year. You obviously gave a lot of detailsat the analyst day, but is there a sort of any update there? And inparticular, I think you said at that analyst day that next year was arelatively light renewal season. But from my records, I think the bigrenewal you have on tap is TRICARE. And so, maybe if… given that it’sless that six months away, maybe if you could just give us an update onthat situation that will be helpful?

George Paz - Chairman, President and Chief Executive Officer

Sure. At the analyst day, we said that many of the Fortune500 companies have made their decisions, and Ed went through thenumbers in the managed-care plans, most of the big employer groups haveto have. Open enrollments is occurring as we speak for a lot ofcompanies. So, those decisions have had to be made by now or are closeto now.

The other piece of our business, which is the legacy ExpressScripts business, is that small to medium-size of employer groups, thatbusiness often gets made and is done often through brokers and TPAs,and those decisions are being made as we speak and they’ll be… continueto be made all the way up till the end of the year. So, I don't havereal good visibility to where that’s going to come in yet. When youare… it's usually the TPAs are out moving people to better offerings intheir own portfolio. They may offer several PBM options. And so, wewould hard with the TPAs and with the brokerage to get our message outin front of those smaller clients. What we will do is maybe as a partof the earnings guidance call, we will give you some more color onwhere that is. To be quite frank though, some of those decisions getmade all the way into the very end of December and we find out about itin early January and we’re loading up eligibility files. So, that'smore of a touch-and-go market.

Glen Santangelo - Credit Suisse First Boston

And you have that with respect to TRICARE?

George Paz - Chairman, President and Chief Executive Officer

TRICARE is a... they’ve postponed the bidding process. Wehaven't… we believe that the RFP is going come out sometime thisquarter. There is no… we won’t know that for sure until we actually getit. So, they are still looking at that. The whole idea of AWP andpricing of drugs was a big issue as well as a few other things in theprocess and they’re trying to evaluate how to handle their programgoing forward. Keep in mind that the program doesn't start for… I thinkit is '09... I believe it’s--.

Edward J. Stiften - Chief Financial Officer and Senior Vice President

Yes, I think whether we’re renewed or whether there’s someoneelse, that it would take effect approximately the middle of '09.

George Paz - Chairman, President and Chief Executive Officer

Yes, the middle of '09. So, it still ways out there. But wewill probably be working on that over the winter and in the springgetting ready for our bid on that program.

Glen Santangelo - Credit Suisse First Boston

Okay. Thanks for the update.

Operator

And our next question comes from the line of Tom Gallucci with Merrill Lynch. Please go ahead.

Tom Gallucci - Merrill Lynch

Good morning. Thank you. I guess first, just a follow-up onthe infusion business. You are going to close some facilities there andreduce some overhead. Any color on the magnitude of the savings thatyou might see there or really how much can we save in terms of thelosses that we have seen because of those efforts?

Edward J. Stiften - Chief Financial Officer and Senior Vice President

Yes. Tom, it's a little bit preliminary, but we think theactions that we're taking should improve the picture by roughly $0.5million a month or $6 million a year but that is pretty preliminary.And so, what we're trying to do is get this thing down to a profitablecore, but if we can’t get it to a profitable core then we wouldevaluate other strategic alternatives. But so far, what we haveidentified gets us sort of most of the way there. We're still lookingat other things, but again it is pretty preliminary.

Tom Gallucci - Merrill Lynch

Sure. Okay. That helps. And then, you also mentioned… youhave talked about in the past lower retail and mail drug purchasingcosts and I think in your investor day you covered some of the dynamicsthere. Is that a pretty persistent theme through for a while? Can yougive us an idea of where you think we are in sort of that revolution?Is there a lot of room to run as you look out into the future, justgenerally speaking, or have a lot of the opportunities been for reasonsthat may be behind us?

George Paz - Chairman, President and Chief Executive Officer

Couple of ways to answer that. I think it is our job tocontinue to drive down costs. That is what our plan sponsors pay us todo. If you think about AWP inflation on the branded side going up at 6%or 7% a year, flat-to-up in the generics side depending upon the drugitself, there is inflationary pressures that alone drives up the costtrends for our clients. We have got to try to recoup as much of thosedrug trends back on an annual basis for our clients or we are not doingour job, there is no reason for us to exist. So, our focus internallyis to contribute to drive supply chain economics for the betterment ofour patients and our clients.

Tom Gallucci - Merrill Lynch

Okay. Thank you for the color.

Operator

Our next question will come from the line of Robert Willoughby with Banc of America Securities. Please go ahead.

Robert Willoughby - Banc of America Securities

George, your trade association really only seems to pushinge-prescribing on its agenda. I don't see many other issues that they’rereally advocating at the moment. And as yet, we haven't really heardany of the individual PBMs say anything. Are you just not perceivingthis as a near-term opportunity? Is this something that followsbiogenerics in terms of economic advantage for you?

George Paz - Chairman, President and Chief Executive Officer

Couple of things, Robert. First of all, Dr. Miller is on ourstaff as you probably know and he is one of… he is probably the leadingexpert on biogenerics, spends a lot of time in Washington DC working onthis issue. A lot of the support for that program, obviously, ExpressScripts is a big leader in this program, but it does come from PCMA asa group. So, to the extent that all the PBMs work together to opencertain doors and we get Dr. Miller in front of them is a bigopportunity for us as a group. I think one thing you really need tounderstand is that the retail pharmacists, especially the independentretail pharmacists, often have an agenda. Our economics, the value youare seeing that we are handing of our clients often comes out of thehands of the pharmacies and they don't like that. There is a lot ofpushback. So, every year as we start the legislative cycle, there isconstantly introductions of anti-PBM legislation that occurs, anti-mailorder, any willing provider statutes, which of course eliminatescompetition. If everybody can play how do you get competition. So, theywant free rein and they don't want competition obviously. So, thosekinds of bills our PCMA groups up very hard to open up both at thestate level to defeat that legislation as well as at the federal levelto allow us access to make sure that we get the PBM message out anddrive…. help sustain our business.

Robert Willoughby - Banc of America Securities

Are you assuming then that any prescribing opportunities justcan help you near term, that it is much further out, and that likely areality would be the biogenerics?

George Paz - Chairman, President and Chief Executive Officer

Well, yes. I think the problem is we’ve got two basic issues.I am going to go out on limb a little bit here, but I think that whenyou look at the retail drug store chains with the CuraScript and thenyou look at PBMs with Rx hub, you’ve got two different people trying toprovide a solution. And then on top of that, you've got the doctors whoare resistant to the whole process or program. So, there is a lot ofobstacles that come down. Again, Dr. Miller works extremely hard andtirelessly to try to get this through the Medicare Part D program andthere are some trial measures and things that exist. But we need to getthis through Congress.

The reason the PBM business works so well is because as youprobably recall, there was going to be legislated a drug benefit backin the ‘90s, early ‘90 and that got all the pharmacies to get online.We need either a threat of legislation or actual legislation to getthis to work as way too many vendors… too many different processes areout there. You need a consistent standard to get something to work. Ido believe that the value of e-prescribing is huge. There is noquestion about it, that if you look at all the hard work we do tryingto contact doctors and form formularies, drive savings, withe-prescribing then think about prescriptionnaires. One of the hardestthings to do is read a prescription. I don’t know if you’ve ever lookedat one, but try to read that handwriting, it's terrible. And if wecould get that all done into an electronic format that gets e-mailed toeither a retail pharmacy or into our mail order, it’s electronicallyadjudicated, we take out a tremendous amount of the cost, add savingsand more importantly add safety to the whole equation. So, this is abig opportunity for us, but we need a lot of stars to line up.

Robert Willoughby - Banc of America Securities

Yes, another question. Just one of your competitors struck aninteresting deal one of the lab companies just to work together herepromoting formularies with greater clinical integrity I guess. Where doyou stand on some of those issues? Who are you interacting with on thediagnostics side, if anybody?

George Paz - Chairman, President and Chief Executive Officer

As you know, Tom Mac Mahon is on our Board. He is theChairman of LabCorp., so we've pretty good relationships. We certainlyknow the people at Quest than the others and I think that often themthere is dialog. I think that it’s clearly… in today's day and age, ifyou could put on a statin [ph], you go back a month later, two monthlater, supposed to be a month later, but since a lot of people don't doit, and you get your check done to make sure that your things are goingright. Those are all important tests. I think it is in the futurethough that might hold a bigger promise, as we look out to the futureand see that specialty drugs and the ability of the body to metabolizebecomes key. The real question is, can you... does it help to link thetwo together or do you work just with everyone to make it happen,because you've to look at the customer base overlap, but we're activelyinvolved in this space.

Robert Willoughby - Banc of America Securities

Okay, thank you.

Operator

And our next question will come from the line Lisa Gill with JP Morgan. Please go ahead.

Lisa Gill – JPMorgan

Thank you. Ed, I was wondering if maybe you could just touchon a couple of things for me. First, on the reserve for AWP, if Iremember correctly, it was going to come out this third and fourthquarter. Can you just talk about it from an accounting perspective? Didit ever go into the numbers or was it only in guidance and thereforewas it reversed or was it not?

And then, secondly, when we look at the EBITDA per scripts, Ithink last quarter you raised the expectations to 225 to 235. Can you give us an idea what your expectations are now going into the fourth quarter around that?

And then just lastly, on Specialty Pharmacy, can you justtalk a little bit, either George or Ed, about the kind of growth ratesthat you're seeing in your core book of business? I think, George, youtalked about the fact that this is an important component of youwinning business and maintaining business. So, therefore, are youseeing it grow pretty much in line with industry, slower, faster, ifyou can just directionally tell us how it is going? Thanks.

Edward J. Stiften - Chief Financial Officer and Senior Vice President

Okay. Lisa, I'll start with the first one, and thanks for theopportunity to clarify, because I think there still might be just alittle bit of confusion out there on the AWP. The AWP risk has neverbeen a reserve on the balance sheet. It has always been a restraint inour guidance. So, our guidance would have otherwise been much higherhad we not been concerned about that AWP risk. So, we have never putanything on the balance sheet, and of course since we never putanything on we never pull anything off. So, it's never been a reserveon the balance sheet.

With respect to the EBITDA per adjusted script for the fullyear now, we would bump it up just a little bit. We will probablytighten the range and move the bottom end of the range up. So, we wouldright now call it 228 to 235, so kind of the low 230s is where wethink. So, it has bumped up just a little bit.

And then with respect to the core specialty growth, I thinkwe will see an improvement there. We are getting better and betterreceptivity from PBM clients. We’ve put in some new initiatives and newproducts and new tools there. We're seeing some traction that wehaven't seen inside the last 24 months. It is early, but we see somepositive momentum building there. And maybe, George, you want to add tothat or so forth, but--.

George Paz - Chairman, President and Chief Executive Officer

Yes. I think that there is two pieces to the Specialtybusiness. When we bought CuraScript and Priority, keep in mind, they’vesold just managed care plans because they were… they didn’t have a PBMper se. So, to the extent that we either retain or slowly over timelose that business, I think what we seeing mostly in the large employergroup business and to some extent the labor unions and the mediumemployer group business is that the Specialty business is becoming abundled offering into that business.

Now, there are still a lot of managed-care players out thereand we are trying to upsell our Special solution into managed care. Thegrowth rate we are achieving, the strong growth that we have inSpecialty is part of our PBM component. We are upselling to our PBMclients to the extent that it was third party, like mail-only business,remember back in the late ‘90s and early 2000s, there used to be a lotof mail-only business and a lot of formulary-only businesses and peopleused to cut up their offerings into components, that doesn't exist toomuch any more. The economies of scale are better by bundling thosepieces together. But similar to that, the specialty-only business wasoffered by those two independent companies before we bought them. Thathasn't shown a lot of growth. I mean that piece is pretty stagnant.Once in a while, we win a new client, but most of our wins come fromupselling to our PBM clients. Since we have 55 million members I thinkthere's a lot of growth and a lot of opportunity for us inside of ourbook.

Lisa Gill - JPMorgan

George, are you actually seeing any of the business actuallyshift from the managed-care side to where… from they are shifting itfrom the medical side of the benefit to the pharmacy side of thebenefit and therefore we call it stagnant or flat, is it actuallydeclining and therefore the growth on the PBM side is actually evenbetter than what we would think?

George Paz - Chairman, President and Chief Executive Officer

On the manage-care side, it is pretty flat on the third-partyonly business. I say that with the exception of one. We had a large,large client that… it was probably about two years ago we signed up andthey stuck with us for a year, and then they pulled the business andthey decided to do it on their own. So, it’s one of the top four managecare players of the country. So, that came out of our… we only hadjacked up our revenues and our sales for a year and then it came backup. But other than that, the rest of business is pretty flat, but we'reseeing significant growth on the PBM side.

Lisa Gill – JPMorgan

And then, if I can just ask one last question on 2008 plandesign, are you seeing any changes from a mail perspective? Clearly,your mail scripts grew or penetration grew by 20 basis points in thismost recent quarter. And I think that over the longer term yourexpectation is that kind of 1% to 2% per year. Is there any way thatyou think that we could see that accelerate in the next couple of yearsbased on what people are doing with plan design?

George Paz - Chairman, President and Chief Executive Officer

I think that there is some opportunities, I think it's got tobecome more at the consumer level though. We've got to do a better jobof informing the consumer about the savings and the opportunities, andthe value of the convenience of mail. And I don’t think we as a PBMhave done very good job of that and so we need to focus on doing abetter job of that in the future.

Lisa Gill – JPMorgan

Great. Thanks for all the comments.

Operator

And our next question will come from the line of Randall Stanicky with Goldman Sachs. Please go ahead.

Randall Stanicky – Goldman Sachs

Great, thanks. Just two cash-related question. The first, nowthat you've trended above where you’ve talked about in terms ofbuyback, I think it was $1 billion plus an additional $100 million to$200 million, maybe just as a comment on thought process around buybackgoing forward. And then, secondly George, given your view on captivePBMs, are you hearing anything or seeing… I should say seeing anythingin the marketplace that will lead you to believe that there may be someacquisition opportunities for you going forward here near-term?

George Paz - Chairman, President and Chief Executive Officer

Let me do the latter one first. Obviously, we can’t talkabout M&A activity. So, you’re better off talking with the bankersabout that one.

Edward J. Stiften – Chief Financial Officer and Senior Vice President

On the share buybacks, in the revised guidance for '07, we donot assume my additional share repurchases for the balance of the year.We wouldn't until guidance was out, and given that that will be fairlylate we wouldn't be planning on doing much. So, I think in our guidancewe’ve assumed zero. I think in your planning you should assume eitherzero or very negligible, because as you pointed out we're going to do$1 billion and then I think we mentioned that we might add another $100million to $200 million of that and we've added a $140 million of thatextra $100 million to $200 million already. So, we've pretty muchaccomplished what we wanted to do this year.

With respect to '08, again normal strategy for us, we'll tryto find accretive acquisitions. Failing that, the vast majority of ourfree cash flow would likely go to share repurchases.

Randall Stanicky – Goldman Sachs

Got it. That's helpful. Thank you.

Operator

And our next question comes from the line of John Kreger with William Blair. Please go ahead.

John Kreger - William Blair & Company

Hi, thanks. One quick follow-up question on infusion. Itseems like the losses have got a bit larger as you’ve progressedthrough this year. Can you just talk about why that is?

George Paz - Chairman, President and Chief Executive Officer

There is a couple of things, and I’ll let Ed chime in here aswell. First of all, when we took over the business, we'd very highstandards around compliance and process. And there were… some of thestandards around process weren’t as strong as I would have liked. So,we actually tightened down some of the screws. What we did is in theold days, often they would accept the patients without having… in orderto bill it you had to have a prior authorization code. There is a listof things that you have to have before you can actually bill andcollect on a patient. Well, often what would happen is that we’dcollect a couple of the pieces, they would go put the person onservice, once you start servicing a member there is no way you can turnthem off. And then the health plan doesn’t necessarily pay if you don'thave a clean client. And so, now you spend the next several monthstrying to get the data for those clean clients together. So, we'vereally screwed that down. So, if we don't have all the data we needupfront then we’re not willing to put the member on service. So, wehave been trying to manage fixed cost side of this as we’ve got ourarms around the servicing process. And of course, as we were doing allthese we’re realizing some bad debts on some of the previous sales thatwe made where we weren’t as clean as we should have been. I don’t know,Ed, if you want to add anything else.

Edward J. Stiften - Chief Financial Officer and Senior Vice President

I think George said it well. The biggest reason second andthird quarter were worse than first quarter has been just a moreaccurate assessment of bad debt exposure, but in addition you mayrecall that we’ve closed six sites and we’re reducing overhead, and weobviously are going to engage a consultant to help us with some ofthose analyses. So, there's a little bit of non-recurring consultingexpense in there, but it's small, it’s a fraction of a penny a share.So, that's a little bit of it is well.

John Kreger - William Blair & Company

Great, thanks. A different question, I realize that in thisenvironment generics are really your client savings. But curious, areyou seeing anything change in the branded rebate side of the business,any interesting trends in terms of your ability to get larger rebatesfrom your clients? And also, are you seeing a trend and how much ofthose rebates are being passed along to your customers?

George Paz - Chairman, President and Chief Executive Officer

Rebates are a functional of quality or the ability of the PBMto drive trend and share. So, if the PBM is good at moving people intothose second tier products, which are cost savings for our members,then we should realize higher rebates. So, we are excited about what wedo for our clients because we often talk about generics, but what wetry to throw into the messaging is really about generics and lower costbrands. Keep in mind that on a lot of branded products there could be ahuge differential in the cost of the products between a third-tier anda second-tier product. So, we have seen some things, some clients thatwanted to be more proactive can put like a flat solid co-pay on asecond-tier product and a percentage co-pay on third-tier product, sothat more of that what we call waste, extra costs on a less efficaciousdrug ends up not being borne by the plant, but instead by the personwho is making maybe not as good a decision. And so, we have seen drivestowards getting better formulary compliance and consequently drivingrebates.

As far as the sharing perspective, that's a little bit of amixed bad. Some of the clients… we see a lot of pass-through clientsnow where they pick a 100% of the rebate. Our other clients realizethat to really get things to work there should be a sharing of economicarrangement. In other words, if… what’s the incentive of the PBM totake all the work of driving somebody from a third-tier product to asecond-tier product if we don't realize any economic benefit out of it.[inaudible] we’ll do that and everybody else will say they are going todo it, but if you actually have a financial incentive to do it thenthere is a lot of value. So, a lot of our compliance still want toshare the rebates with us, maybe on a smaller percentage of a largernumber, but there is still a lot of that going. We still have clientswe take a 100% of the rebate. For whatever the reason, the clientdoesn't want that, they’d rather have discounts at the pharmacycounter. So, there is a whole spectrum of solutions out there that wecan offer, provided we are competitive with the pricing.

John Kreger - William Blair & Company

Great. Thank you very much.

George Paz - Chairman, President and Chief Executive Officer

You are welcome.

Operator

And our next question comes from the line of Kemp Doliver with SG Cowen. Please go ahead.

Kemp Doliver - SG Cowen

Hi. Thanks and good morning. First question is, when you allinitially discussed the outlook for the third quarter, you havementioned that generic launches were going to be pretty minimal. Yetthe generic mix sequentially went up over 100 basis points, which isquite a nice move. Did anything change with regard to your expectationsregarding launch or is there some underlying increase in generic mixthat occurs even absent the availability of new generic products?

George Paz - Chairman, President and Chief Executive Officer

Hey, Kemp, that is a great question. At Express Scripts, weare totally focused on the generic solution. You met Pat McNamee at ourinvestor conference and you met Ed Ignasiak who is… Pat is Head ofOperations and Technology and Ed is in charge of product development,sales and marketing, and those two gentlemen work hand in glove inorder to try to drive down the costs. At the end of the day, we havestandard in front of our clients and explain to them what drug trendsare overall versus what are the drug trends that they realize. Theytake that job very seriously as we all do here. And so, it is about thetechnology and the tools we give our call center associates and thework we do to actually drive those trends down. So, what you are seeingis the fruit of the labor of our investments and technology and callcenter associate training and development in order to… once you call inor you go online and there is a savings opportunity, you get popups,you get information sent to you about the savings opportunity thatexist. If you like, we connect you to a pharmacist who will make theoutbound calls to you doctor to help you fluctuate those cost savingchanges. It’s always the doctor’s decision if it is a therapeuticinterchange. So, we take those things very seriously as well, but Ithink it is the business model.

Kemp Doliver - SG Cowen

All right. And this is somewhat an academic question, but ifthere were no new generics out… I mean what is the generic opportunitywithin the existing book. Would you say you are 80% penetratedeffectively, 40%, any sense of that?

George Paz - Chairman, President and Chief Executive Officer

As you may recall from our investor conference, Ed showed aslide where we have clients in the 75 to 80 range or a little top of80, but we should be able in theory, pure theory, there is no reasonyou could… a plan couldn’t meet its needs with close to an 80% genericfill rate. So, we are at 62%, so you see there is a significant amountof opportunity there. There is lot of issues that come into play here,some plans still have two level co-pays, not big differentials betweenthe first and the second level, so there is a lot of things that causeus to have difficulty making those moves happen. But I think ascompanies look at their ever-increasing cost of healthcare and theylook at trying to compete in a global market, they are taking the bullby the horns and we still need more and more planned sponsors activelymanage this drug and allowing us to help them actively manage theirdrug benefits to drive down their costs without ever compromisinghealth outcomes.

David Myers - Vice President, Investor Relations

We only have time for one more question.

Operator

And that question will come from Charles Boorady with Citigroup. Please go ahead.

Charles Boorady - Citigroup

Hi. Thanks, good morning. Most were answered, but on the… tofollow on the generic conversation, in addition to increasing thepenetration with generics, what do you see as the long-term opportunityon pricing? Has it been going down in an 8% to 10%? Can that continuefor a while?

George Paz - Chairman, President and Chief Executive Officer

Well, I think that there is… and I’ll let Ed chime in herewhen I get done, but I think obviously penetration is a big issue. Asfar as our pricing perspective is concerned, I think that this is avery competitive market. Ed showed some slides out there that showedthe ROICs of the generic drug manufacturers and the profit margins thatare being hedged throughout the space, whether it be retail or othergeneric manufacturers. But I think there is still room to run. We havedisclosed any percentages or what we think those opportunities mightbe, but it certainly fits into our guidance and the information we giveto our plan sponsors and to you as the shareholders.

Charles Boorady – Citigroup

And then just a question. Aetna had an earnings call todayand they talked about the value of an integrated health benefitincluding an integrated PBM. And I'm wondering, Express Scripts, canyou be integrated with the health plan, say the way, not a perfectanalogy, but the way an Intel chip is integrated into an Applecomputer, or is there some way that you'd be deficient in a partnershipwith a health plan versus what a health plan can accomplish by holdingthe PBM, and how?

George Paz - Chairman, President and Chief Executive Officer

We obviously… probably 40%, roughly of our book is managedcare today. And I would tell you that we're very integrated. We doeverything from plane label to use our name with those clients and itseamless, it’s very integrated. But let’s go to the other side, theFortune 500 companies that choose to work with a big health plan,whether it’s United, CIGNA, Aetna, WellPoint, on and on and on, andthey use us as their PBM. There, the plan sponsor has to be allowed tomanage their overall health care costs and where appropriate manage thehigh utilizers. All that information exists very easily. Many of thehealth plans are out in the marketplace trying to sell the virtues ofan integrated benefit.

I would tell you, the biggest thing you do, the best valueget is to choose the best in breed in every class. There is greatwellness programs out there, there is fantastic CDHC solutions outthere, there is fantastic medical plans out there, there is great PBMsout there, and I think that to maximize your benefit the interchange isvery easy today. You know what it’s like on the Internet and how easyit is to send an information around, all you got to do is to get thevendors to agree, and that's easy to do because it’s your data, to makesure that they interchange the data and you can get it. I don't thinkbeing owned by a medical plan offers any benefits that you can get bybeing a standalone PBM. As a matter of fact, our focus, our sole focus,our only focus is to drive drug trends down.

On the medical side, 85% of the costs are coming out of themedical side, where are they going to put their best people and theirresources when they have issues. Our focus is clear. So, I think we'revery well positioned to compete in this ness space and to continue togrow.

David Myers - Vice President, Investor Relations

Thank you very much for the questions. I thank everyone foryour participation this morning. We’re excited about our third quarterresults. We're very optimistic about the future of the prescriptiondrug benefit programs. We look forward to talking to you in a few weeksabout our guidance for 2008. So, thank you very much.

Operator

Ladies and gentlemen, we want to thank you for yourparticipation and for using AT&T Executive Teleconference Service.You may now disconnect.

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Source: Express Scripts, Inc. Q3 2007 Earnings Call Transcript
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