Medco Health Solutions, Inc. Q3 2007 Earnings Call Transcript

Nov. 4.07 | About: Medco Health (MHS)

Medco Health Solutions, Inc. (NYSE:MHS)

Q3 2007 Earnings Call

November 1, 2007, 8:30 AM ET

Executives

Valerie Haertel - IR

David B. Snow, Jr. - Chairman, CEO and Director

JoAnn A. Reed - CFO and Sr. VP of Finance

Timothy C. Wentworth - President and CEO, Accredo Health Group, Inc.

Analysts

David Macdonald - SunTrust Robinson Humphrey

Arthur Henderson - Jefferies & Co.

Thomas Gallucci - Merrill Lynch

Ricky Goldwasser - UBS

Lisa Gill - J.P. Morgan

Kemp Dolliver - Cowen & Company

Charles Boorady - Citigroup

Michael Baker - Raymond James

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

Operator

Good morning my name is Crystal and I will be your conference operator today. At this time I would like to welcome everyone to the Q3 2007 Medco Health Solutions Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session. [Operator Instructions].

At this time, I would now turn the conference over to Ms. Valerie Haertel. Please go ahead Ma'am.

Valerie Haertel - Investor Relations

Thank you very much, Crystal. Good morning everyone and thank you for joining us on Medco's third quarter earnings conference call. With me are Dave Snow, Chairman and Chief Executive Officer and JoAnn Reed, Chief Financial Officer. Tim Wentworth, CEO of Accredo Health Group; Rich Rubino, Chief Accounting Officer; and David Machlowitz, General Counsel, are also on the call for a question and answer session.

Please note that if you have not received a copy of our earnings release, it is available on the Investor Relations section of our website at medco.com. Before I turn the call over to Dave Snow, I would like to remind you that in light of SEC's Regulation FD, management will be limited in responding to increase from investors and analysts in a non-public forum. Therefore, we encourage you to ask all questions of a material nature on this call.

During the course of the call, we will make forward-looking statements as that term is defined in the Private Securities Litigation Reform Act of 1995. These statements involve risks and uncertainties that may cause results to differ materially from those set forth in the statements. No forward-looking statement can be guaranteed, and actual results may differ materially from those projected. We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise.

Forward-looking statements made on this call should be evaluated together with the risks and uncertainties that affect our business, particularly those disclosed in the risk factor section of the Company's annual report on Form 10-K, Form 10-Q and other reports and registration statements filed from time to time with the Securities and Exchange Commission. Copies of Medco's filings are available from the SEC, the Medco website or from the Medco Investor Relations department. The copyrights for the contents of this discussion and the written materials used on the earnings call are owned by Medco Health Solutions, Inc. 2007.

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

David B. Snow, Jr. - Chairman, Chief Executive Officer and Director

Thank you Valerie. Good morning and thanks to all of you for joining us. I am pleased to report strong third quarter earnings driven by solid execution across all of our key strategic growth drivers. Our GAAP diluted earnings per share was $0.78, an increase of 25.8% from $0.62 per share in the third quarter of 2006. Excluding the amortization of intangibles that existed when Medco spun off in 2003, third quarter diluted EPS was $0.88 representing a 23.9% increase over Medco's third quarter 2006 results.

We achieved net income in the quarter of $214.7 million, up 15.6% from the third quarter of 2006. Our stronger than expected results reflect the benefit of record generic dispensing rates. This is in part due to the early releases of generics in the quarter for two popular branded medicines, Coreg and Toprol XL.

We also saw a continuation of strong mail order volume. Our ongoing share repurchase program also contributed to our EPS growth this quarter and JoAnn will provide further details on each of these.

Net revenues were $10.9 billion, an increase of 4.4% from the third quarter of 2006 reflecting higher business volumes and our increased generic penetration which reduces revenue but increases our income while also lowering costs for our clients and members. In fact year-to-date we've seen over $1.9 billion in incremental generic savings for our clients and members.

Total gross margin increased 70 basis points to 6.4%, compared to 5.7% reported in the third quarter of 2006. Again the increase in gross margins was primarily driven by a record high generic dispensing rate combined with higher mail order volumes. EBITDA per adjusted script of $2.61 increased 13.5% from $2.30 in the third quarter of 2006. Yesterday, we closed the previously announced $1.5 billion acquisition of PolyMedica and we welcome all of PolyMedica's valued employees to Medco.

When combined with Medco's current book of patients with diabetes, this acquisition creates one of the world's largest diabetes care practices serving nearly 4 million members with this chronic disease. Although, diabetic patients comprise just 5% of the total population, they account for more than 15% of total drugs spend with the rate of spend increasing at 15% annually.

It is estimated that diabetic patients generate 4 to 6 times the drugs spend of an average pharmacy patient, providing a significant growth opportunity for us since we can now offer both medications and supplies with the convenience of one stop shopping. This is also an opportunity to help our clients to better manage this increasingly critical area of pharmacy care.

This acquisition is consistent with our overall strategy to use our therapeutic resource centers as platforms to expand our portfolio of disease specific value-added services, by treating patients using deep knowledge domains at the disease level, we will more effectively care for our members with chronic and complex conditions to achieve better clinical and financial outcomes.

Patients with chronic and complex conditions have the greatest need for member engagement. They create the greatest potential for health care improvement and they represent the greatest financial burden for our clients. Additional clinical initiatives that are built upon our new therapeutic resource center platforms include two research collaborations. The first is our previously announced Mayo Clinic collaboration focused on the drug Coumadin within our coagulation resource center.

We are assessing the benefits of genetic testing to more precisely set to dosing for Coumadin, a medicine that leads to hospitalization 22% of the time in the first six months of taking the drug due to today's trial and error dosing methods.

The second collaborative research effort announced just two weeks ago is with LabCorp on the drug to Tamoxifen within our oncology resource center. We are quantifying the extent to which genetic testing can improve breast cancer outcomes for women whose treatment regiment includes this widely prescribed drug. Tamoxifen is prescribed to prevent the recurrence of breast cancer, however, it is not effective for approximately 10% of women because of variations in their CYP2D6 genes causing them to under metabolize or not metabolize the drug.

In short, for those patients there is little chance Tamoxifen can be effective leaving them with false expectations and loss time. In both cases Medco is now at the forefront of advancements in genomic testing to encourage the precise dosing and proper prescribing of medications that treat life threatening conditions with greater precision.

With Medco's involvement at point of care, we can increase member and physician awareness of genomic test availability and increase the effectiveness of the prescribed treatment to drive better health outcomes and lower the total cost of care. As you can see our unique approach to pharmacy provides specialized care for chronic and complex diseases today and ushers in a new era of personalized medicine. At our Analyst Day on November 16th, our Chief Medical Officer, Dr. Rob Epstein will elaborate on both these research efforts and what they mean to Medco and our clients.

Now I'd like to review the third quarter in terms of our key growth drives beginning with generic. Generic utilization was the most significant contributor to earnings growth in the third quarter. Our third quarter generic dispensing rate was a record 60.3%, up 4.3 percentage points from the third quarter of 2006. We benefited this quarter from the early releases of generic Coreg and Toprol XL as I noted previously, which resulted in higher generic utilization.

We also experienced a full quarter impact of Ambien and Lotrel both of which were at least in the second quarter and contributed to the increased generic dispensing rate. We are continuing to benefit from a compounding effective 2006 generic introductions of blockbuster medications, especially now that they have all passed the 180-day exclusivity period. As a reminder, after the 180 days when more generic competition enters the market, prices drop significantly improving our profitability while increasing the savings to our clients in their members.

Our mail order penetration rate on an adjusted prescription basis increased by 1.3 percentage points from the third quarter of 2006 to 38.4% and our mail volume reached 23.5 million prescriptions, up from 22.3 million. We expect to see continued growth in mail volume in future quarters driven by significant new client wins, the programs we have in place to encourage plans and members to take advantage of the savings possible through mail and generics and the clinical support available through our specialized pharmacists.

Total prescription volume for the quarter was a 136 million, up 0.7% from a 135 million in the third quarter of 2006. Total prescription volume adjusting for the difference in days supply between mail order and retail was 182.7 million prescriptions, up 2.0% from third quarter of 2006. Retail prescriptions remained flat, while mail order prescriptions grew 5.4%, compared to the same quarter in 2006.

In specialty pharmacy, we continue to see strong revenue from increased mail order volume. Net revues in the third quarter totaled nearly $1.5 billion, up 11% from $1.35... a 1.35 billion in the same period of 2006. Third quarter gross margin for Accredo Health Group was 7.8%, up from 7.6% in the third quarter of 2006. The year-over-year operating income increase was 18.8% and 16.5% year-to-date. Clearly our specialty unit is performing extremely well.

On the acquisition front, Accredo has signed a definitive agreement to acquire Critical Care Systems, Inc. or CCS, one of the nation's largest independent and most successful providers of home-based and ambulatory specialty infusion services. Although an immaterial transaction from an earnings perspective, it is an important strategic asset that will expand Accredo's capabilities and market presence related to in field [ph] agents, which are important today and will grow even more important with infusion drugs accounting for approximately 40% of the specialty drug pipeline.

Critical Care Systems is a privately held firm with 42 branches in 29 states, serving approximately 38,000 patients. Specialty infusion is not their side business. It's their primary business and their track record is one of growth and excellence, which we believe makes them a premium asset in this market and an excellent complementary asset to Accredo, to build additional client and shareholder value.

We expect this acquisition to be slightly accretive in 2008. We look forward to leveraging the combined entity strengths, which include payer relationships, purchasing synergies, a skilled nursing staff and the many growth opportunities that will result from this combination. We also look forward to welcoming a talented group of executives, managers, clinical care staff and support employees from Clinical Care Systems to the Medco family. This transaction requires the customary Federal Trade Commission, antitrust review under Hart-Scott-Rodino act and we expect it to close later this quarter.

In the third quarter, we announced three new Medicare prescription drug plan offerings for 2008 designed to provide more choice and better value to seniors. Our competitive offerings have qualified Medco to receive dual eligible patients' assignments in 26 geographic regions across the country next year.

For our PDP, our generic dispensing rate grew to a record 64.5% and our adjusted mail penetration was 30.6%. This demonstrates that with the appropriate plan design, education and service support we can with great success help seniors find the lowest cost, highest value choices, which in the long run reduces the cost of the Part D program to patients and tax payers and improves our results.

Turning to sales. Given that the 2007 selling season is essentially over and our time and attention around 2008, I will focus my remarks on how sales are shaping up for next year. Annualized new name sales currently stand at $4.5 billion and drugs spent for 2008, which includes the previously announced wins of FEP and the State of New York, both of which start on January 1st. For 2008, we have renewed $4.8 billion or more than one-third of the client drugs spend that we expect to renew, which is a great start to the season. Our client retention rate is currently at 96.3% unchanged from last quarter and continues to represent what we believe is the highest retention rate in the industry.

In summary, we have delivered performance that exceeds expectations primarily due to the early introduction of some significant generics. All of our key business drivers are performing well and continue to provide opportunities that are aligned with the interest of our clients and members. We have now completed the roll out of our advanced pharmacy practice with our therapy resource centers as the corner stone of our clinical strategy.

Our clients understand the power of our unique specialized approach to pharmacy in the chronic and complex disease categories of care to fundamentally improve clinical and financial outcomes. At our Analyst Day on November 16th, we will provide additional details regarding the early returns on our therapeutic resource center model and our efforts in the personalized medicine space. We will also provide you with some insight into how we view the evolution of pharmacy and how we are preparing now to capitalize on the numerous growth opportunities available to us.

In light of our very strong third quarter 2007 financial and operational performance and our continued confidence in our future. We are again raising our 2007 guidance and updating our 2008 guidance.

On our second quarter earnings call, we provided 2007 GAAP earnings per share guidance in a range of $3.11 to $3.15 per share. This quarter we are raising our GAAP earnings per share guidance to a range of $3.16 to $3.21 for the year representing a growth rate of 31% to 33% over 2006 excluding the effect of the first quarter 2006 legal settlement charge.

Excluding the amortization of intangibles, the 2007 guidance we provided in the range of $3.50 to $3.55 per share in the second quarter, is being raised to a new range of $3.55 to $3.60 per share, representing a growth rate of 28% to 29%. In the first quarter of 2007, we forecasted our 2008 GAAP earnings per share growth rate to be at least 20% over 2007. At that time, we did not anticipate the early releases of a few generics that actually raised the bar for us. Nonetheless, we are now expecting GAAP EPS for 2008 to be in the range of $3.89 to $4.01 representing a growth rate of 21% to 27% over our new 2007 guidance.

Diluted earnings per share in 2008 excluding the effect of amortization on other intangibles that existed with Medco became a public company is projected to be in the range of $4.29 to $4.41 resulting in a growth rate of 19% to 24% over 2007. Our confidence in our ability to deliver sustained strong double digit growth reflects the continued strength of our business model in the key core performance drivers; generics, mail, net new business, specialty and the opportunities in the seniors' market.

Additionally, we anticipate that our new specialist pharmacy model to our therapeutic resource centers will continue to drive appropriate member behavior and enable us to deliver best-in-class care. Our therapeutic resource centers also create an exciting new platform upon which we will continue to innovate for the benefit of our members, clients and shareholders.

With that I will turn the call over to our CFO, JoAnn Reed who will discuss the details behind our third quarter financial performance and our increased expectations for earnings per share growth in 2007 and 2008. JoAnn.

JoAnn A. Reed - Chief Financial Officer and Senior Vice President of Finance

Thanks Dave. Good morning everyone. I am very pleased to report another quarter of strong financial performance. I will begin by taking you through the details of our quarterly performance and then take some time at the end to discuss our increased 2007 guidance along with our full year 2008 guidance.

Third quarter 2007 net revenue exceeded by $10.9 billion, product net revenues were nearly $10.8 billion and were comprised of $4.3 billion from mail and $6.5 billion from retail. Service revenues were $136 million. Overall revenues increased by 4.4% as a result of higher and new client volumes and price inflation by pharmaceutical manufacturers on brand-name drugs partially offset by a reduction of $570 million from the effect of lower cost generic drugs and to a lesser extent prior transition.

Our overall generic dispensing rate was a record 60.3%, an increase of 4.3 percentage points from the third quarter of 2006 and a 1.4 percentage point increase from the second quarter of 2007. The generic dispensing rate at mail was 50.9%, an increase of 4.6 percentage points from the third quarter of 2006 and a 1 percentage point sequential quarterly increase. At retail, the generic dispensing rate of 62.2% increased 4.3 percentage points, compared to the same period last year with a 1.4 percentage point sequential quarter increase.

In mid 2006, the blockbuster chronic medications, Zocor and Zoloft became available in generic form and are therefore included in the generic dispensing rate for the third quarter of 2006. The mail generic dispensing rate increased over last year primarily reflects increased penetration of the generic forms of Zocor and Zoloft in addition to the generic introduction in 2007 of Norvasc at the end of March, Lotrel at the end of May and the earlier releases of various strengths of Toprol XL in July and August, and Coreg in September. Note that Toprol XL 50 milligram which was released in August generates the highest mail prescription volume of all the Toprol strength in our mail order book.

These early introductions combined with higher than anticipated generic substitution posted our third quarter results by approximately $0.04 per share, compared to our previous guidance. Total prescription volume in the third quarter adjusting for the difference in day supply between mail and retail increased 2% from the third quarter of 2006 to 182.7 million prescriptions. Mail order volume increased to 5.4% over the third quarter of 2006. We dispensed 23.5 million mail order prescriptions this quarter consistent with the second quarter and higher than the 22.3 million in the third quarter of 2006.

The number of members in our retail refill allowance program also known as mandatory mail has grown from approximately 8 million in 2006 to more than 9 million in 2007. This reflects adoption of this as a program among our clients and the positive impact of new clients with a higher than expected average mail penetration, now at 38%.

Retail prescription volume was a $112.5 million, down a slight two-tenths of 1% from the third quarter of 2006 and down 3.4 million prescriptions or 2.9% from the second quarter of 2007, reflecting client transitions such as Blue Cross Blue Shield of Florida and declines in cough and cold medications.

Third quarter adjusted mail order prescriptions as a percentage of total adjusted volume increased to 38.4%, 1.3 percentage points over the same period last year. Sequentially over the second quarter of 2007, this metric increased 70 basis points. Total rebates earned in the quarter were $856 million, up 5.9% from $808 million in the third quarter of 2006, reflecting enhanced formulary compliance at mail with continued improvements in market care performance, but down $62 million from the second quarter of 2007 due to seasonality.

The total amount of rebates retained in the quarter was 12.8%, down from 18.3% a year ago and also down from the 15.6% we reported in the second quarter of 2007. The decline in rebates retained reflects changes in client rebate sharing terms associated with a significant volume of successful renewals and new business wins we have been experiencing and our leadership in financial transparency. This obviously has not affected our overall profitability.

Our total gross margin for the quarter of 6.4% increased 70 basis points over the third quarter of 2006 margin, up 5.7% and is consistent with the second quarter of 2007. The margin increase over last year reflects the increase in generic dispensing rates and higher mail order volumes. The components at the 6.4% third quarter margin, includes product margin of 5.6% and service margin of 74.5%.

Our specialty pharmacy segment revenues were nearly $1.5 billion for the quarter, an increase of 11% from the third of 2006 and consistent with the second quarter of 2007, this includes $17 million in service revenues. Operating income increased 18.8% to $52.5 million, compared to $44.2 million in the third quarter of 2006. Gross margins for specialty pharmacy were 7.8%; reflecting an improvement over the 7.6% margin reported in the third quarter of 2006. This margin expansion reflects increased mail order volume.

Accredo Health Group contributed an incremental $0.02 per share to our third quarter 2007 EPS, compared to the third quarter of 2006 in line with our expectations. We continue to see a meaningful improvement in the Medicare Part D populations used at mail and generic. The mail penetration rates for our PDP in the third quarter of 2007 was approximately 30.6% significantly higher than the 18%, for the third quarter of 2006 and up 60 basis points from the second quarter of 2007, largely due to the 2007 decrease in dual eligible members who had no financial incentive to use mail service and generic.

The generic dispensing rate in our Medicare Part D, PDP was a record 64.5% for the third quarter of 2007; 4.2 percentage points higher their book of business average and 3.7 percentage points higher than the 60.8% for the third quarter 2006. Both the generic dispensing rate and the mail penetration rate across our Medicare products are in line with our expectations for 2007.

While I am on the subject of Medicare, I would like to report that in conjunction with the CMS reconciliation process, Medco had previously reflected in its balance sheet the published $25 million liability to CMS for 2006 as well as for the 2007 impact to-date. SG&A expenses amounted to $263.2 million in the third quarter, an increase of 18.1% or $40.3 million from the third quarter of 2006. This increase primarily reflects $18 million in employee related cost, which includes $4 million in stock-based compensation and the 200 recent hires associated with business growth across the Company.

SG&A also includes $12 million for higher performance bonus expenses as well as client and product support activity. Net interest and other expense amounted to $25.5 million reflecting increases of $4.6 million from the third quarter of 2006 and $3.6 million from the second quarter of 2007. The increases reflect higher borrowings from our debt refinancing that took place at the end of April. As we've reported previously, we refinanced our $1.5 billion bank credit facility into a new $3 billion facility that includes $1 billion senior unsecured term loan and $2 billion senior unsecured revolving credit facility.

The higher debt levels under the new credit facility and the previously increased borrowings under our accounts receivable financing facility are being used for our share repurchase program, general corporate activity, working capital requirements, capital expenditures and acquisitions.

Net interest expense for the third quarter of 2007 was lower than our expectations due to higher than anticipated cash balances resulting in $0.01 EPS improvement to our quarterly expectations. Note that as a result of closing PolyMedica transaction we are capping our $2 billion revolving line of credit, which will create higher interest expense in the fourth quarter.

The anticipated closing of Critical Care Systems in the fourth quarter may result in further borrowings under our revolver. EBITDA in the quarter was $476.7 million, an increase of 15.5% or $63.8 million as compared to the third quarter of 2006. Our EBITDA per adjusted prescriptions for the quarter was $2.61, a 13.5% increase over the $2.30 in the third quarter of 2006 and a slight sequential increase over the $2.55 from last quarter. The effective tax rate was 39.9%, 2.9 percentage points higher than in the third quarter of 2006.

The third quarter of 2006 rate included a non-recurring benefit associated with the IRS approval of a change in the timing of deductibility for certain rebates passed back to clients and other favorable tax adjustments. Also note that we have experienced some increases in state income tax rate in the course of 2007.

Net income in the quarter was $214.7 million, a 15.6% increase over the $185.8 million reported for the third quarter of 2006 and consistent with second quarter of 2007. GAAP diluted earnings per share was $0.78 an increase of 25.8% from $0.62 in the third quarter of 2006, excluding the $0.10 per share in amortization of intangible assets that existed when Medco became a publicly traded company, EPS was $0.88, up 23.9% from the same period in 2006. We continue to make progress on our $5.5 billion share repurchase program.

In the third quarter of 2007, we repurchased 6.4 million shares with an average cost per share of $80.48. Since the program's inception in August 2005 through the end of the third quarter we repurchased 55.7 million shares at a cost of $3.5 billion with an average cost per share of $63.11.

We have not repurchased any shares to-date in the fourth quarter. We will again review our guidelines with the Board at our December meeting. Our weighted average fully diluted share count for the third quarter was 274 million shares, compared to 298.7 million for the third quarter of 2006, and 282.1 million for the second quarter of 2007. The reduced weighted average diluted share count contributed $0.06 per share to the third quarter 2007 EPS, compared to the third quarter of 2006. We finished the third quarter of 2007 with 267.2 million basic shares outstanding plus a diluted equivalent of approximately 5 million additional shares bringing the total fully diluted share count to approximately 272.2 million on September 29, 2007. This fully diluted share count becomes the entry point for the fourth quarter.

Now, turning to the balance sheet. The close of third quarter of 2007 was $629.5 million of cash, compared to $458.8 million at the end of the third quarter of 2006 and $983.7 million at the end of the second quarter of 2007. The higher cash balance reflects cash proceeds from the debt refinancing at the end of April combined with strong operating cash flows. Cash flow from operations for September year-to-date was $816.4 million, compared to $361.8 million for the same period of 2006 reflecting the underlying strength of our balance sheet and continued earnings growth.

As Dave mentioned, today we have again raised our guidance for 2007 primarily as a result of very positive long-term trend in all key areas of our business. Guidance for 2007 GAAP diluted earnings per share is now $3.16 to $3.21, up from the previous range of $3.11 to $3.15 per share as provided on our second quarter call. This represents growth in earnings per share of 31% to 33% over 2006 when excluding the effect of the third quarter 2006 legal settlements charge.

Excluding the amortization of intangibles related to our spin-off in 2003, we are increasing our 2007 guidance to a range of $3.55 to $3.60 per share, up from the previously provided range of $3.50 to $3.55. This represents growth in the range of 28% to 29% from 2006 excluding the first quarter 2006 legal settlement charge. What I would like to do now is to identify the updated guidance components to clarify what we expect for the remainder of the year. Of course, since we are three quarters through the year the math would indicate that we expect a range of $0.67 to $0.72 per share on a GAAP basis for the fourth quarter. The fourth quarter diluted earnings per share range excluding intangible amortization is expected to be in a range of $0.77 to $0.82 per share.

First, I would like to review the full year 2007 guidance assumptions that remain unchanged from those provided on our second quarter call. We expect to deliver a record of approximately 95 million mail order prescriptions, have similar Medicare Part D guidance and incremental contribution of up to $0.08 per share from Accredo Health Group. SG&A excluding PolyMedica of $1.05 billion to $1.07 billion, an effective tax rate in the range of 39% to 39.5%, a weighted average diluted share count for the full year in the range of $278 million to $282 million and finally maintenance capital expenditures of approximately $150 million.

Now I will review some changes to our guidance assumptions directed specifically to the fourth quarter. Net interest expense is expected to be approximately $40 million for the fourth quarter as a result of higher debt levels associated with the funding of our recent acquisitions and higher interest rates. In addition, we expect to incur our fourth quarter start up costs and expenses of approximately $30 million to $35 million associated with new clients, including FEP and the State of New York, new product offerings and the 2008 Medicare plan.

I would also like to add, that we will incur cost associated with the PolyMedica acquisition. We expect up to $0.02 per share dilution related to the PolyMedica acquisition, which closed on October 31st. To-date, we have hired an incremental 2700 employees for Medco's new business.

Moving on to the subject of client renewals in 2007, I wanted to take this opportunity to provide more color on where we stand for the year. The 2007 total drug spend for all client renewals, for scheduled an early renewal, now amounts to approximately $16.5 billion; approximately 93% of the 2007 renewals are in effect as of the end of the third quarter. Including seven of the eight signed accounts in excess of $500 million in drug spend expected this year.

Our EPS excluding intangible amortization for the fourth quarter of 2006 amounted to $0.86 per share, compared to our fourth quarter 2007 guidance range from $0.77 to $0.82. This reflects the impact of the aforementioned start up costs and expenses, dilution related to the PolyMedica acquisition, higher interest rates and the fourth quarter of 2006 benefit from the strategic purchasing of a short-lived generic.

These items are partially offset by fundamental improvements in our profitability this year. As a final note on this quarter's results, as is our practice, I would like to note that there will no one-time non-recurring item in the third quarter contained in our third quarter 10-Q which will be filed later today.

Now I would like to walk you through some of the details behind our 2008 guidance. We are projecting our 2008 GAAP EPS to be in the range of $3.89 to $4.01 representing growth in the range of 21% to 27% over the new 2007 guidance. Diluted EPS guidance excluding the intangible amortization that existed when Medco became a public company is projected to be in the range of $4.29 to $4.41, for year-over-year growth of 19% to 24%.

This 2008 guidance includes the following key assumptions: approximately 105 million mail order prescriptions, which includes the new volumes from FEP as well as the erosion related to client transitions primarily in Ohio. Approximately $0.20 per share in additional EPS resulting from new scheduled 2008 generic introduction, the largest of which is Fosamax and please note that our guidance only includes scheduled generic releases as it is impossible to accurately predict earlier unanticipated releases. Accredo year-over-year growth have another $0.06 to $0.09 per share reflecting higher revenue and operating profit contribution in 2008, offset by a lower gross margin percentage from the significant FEP win which has deep discounts due to its size.

SG&A excluding PolyMedica in the range of a $1.80 billion to a $1.100 billion. We still project that PolyMedico will be slightly accretive in 2008. We expect that our base capital expenditures will be in line with our historical investments of $150 million per year. As a result of the anticipated construction of our third automated dispensing facility and the build out of further service offerings, total capital expenditures in 2008 are expected to reach up to $270 million. We still anticipate the new automated dispensing facility to be operational in 2009, an effective tax rate of approximately 39% to 39.5%, a weighted average diluted share account of $255 million to $275 million.

We will not provide specific quarterly guidance for 2008, there are a few points I would like to make particularly relative to the first quarter of 2008. When you model 2008, remember that the first quarter of 2007 was very strong as a result of the non-recurring strategic generic products that benefited that quarter. The first quarter of 2008 will include start up costs associated with the large client installation including higher customer service costs. The majority of our renewals in 2008 are effective January 1, 2008.

Finally, I wanted to note briefly what I know is of interest to many investors. The 2009 selling season. For Medco 2009 is expected to be an average renewal year based upon our average contract term of approximately 4.5 years. At this point in time, while it is still very early, we expect scheduled client renewals to total approximately $9 billion.

As we head into the last quarter of 2007, we are very pleased with our success to-date and our ability to generate strong earnings growth. We are able to raise our guidance throughout 2007 by over $0.40 per share, mainly the result of both early releases and unanticipated new generic introduction. Our strong earnings results reflect our ability to retain our valued clients through excellent customer service, win important accounts who are differentiated and value-added clinical offering and deliver significant value to our shareholders.

Now Dave and I would like to open the line for your questions. Crystal, would you please do that?

Question And Answer

Operator

[Operator instructions]. Your first question comes form the line of David Macdonald with SunTrust.

David Macdonald - SunTrust Robinson Humphrey

Good morning guys. Congratulations. One question I've got can you give a little bit more detail on CCS, I know that you guys have talked about the oncology space being an important one for you on a go forward basis. You now have the infusion capabilities here. Can you talk a little bit about what you think that does for you strategically and can you also talk about the early reaction of PolyMedica and the potential cross selling opportunity there within your book?

David B. Snow, Jr. - Chairman, Chief Executive Officer and Director

Yes, let me take the second part of your question first, David and then I am going to ask Tim Wentworth who is the CEO of our Accredo business to talk about the other acquisitions, since that's his baby. Relative to PolyMedica, the reception has been extremely positive from multiple advantage points. First of all, the end to end capability that we've created for diabetes, the chronic disease, is something that our clients fundamentally get and they are very interested in working with us to actually drive patients with that disease to this new clinical model because fundamentally here's the goal; 7% of diabetics in this country today properly manage their blood sugar. The big cost of diabetes to society comes from unstable diabetes. So clients are very motivated to work with us if we can fundamentally move the needle on that number and we believe we can.

The other exciting things about this acquisition that we have talked about and people understand are that PolyMedica brings us a fantastic Medicare brand B2C through liberty which we think is really important. They also have a CLIA certified lab, CLIA certified in 48 states which fits in perfectly with what we are doing in the personalized medicine space. So all of these pieces are fantastic and the last thing that we like a lot is that PolyMedica's fundamental business is in Medicare Part D. That is not Medco space, that is a brand new market. So PolyMedica gets us into the Medicare Part D with our solutions and then we bring PolyMedica into the commercial space. So, the synergies... across revenue synergies particularly are really fairly powerful here. This acquisition I personally like an awful lot and strategically it's a great fit for where we are going. Tim can you talk a little bit about the other acquisition.

Timothy C. Wentworth - President and Chief Executive Officer, Accredo Health Group, Inc.

Sure, we are really excited about that the CCS. We have been looking in this space for about three years and actually it was not driven by our oncology strategy, which has several components, which I won't go in to detail about now, but when you breakdown oncology you have got the orals, you have got the supported medications both of which we have a leadership position in and then you have obviously got the infused drugs which continued to grow out of the pipeline.

We do think that the... one of the side benefits of the CCSI acquisition is the fact they have an infusion ambulatory footprint which we can look at and grow a lot of therapies through, certainly it could become a corner stone to moving further into oncology, but understand that was really almost a side benefit to the great payer and therapy mix and management team that they have brought to the table.

The other piece was after looking for three years, we had a very good sense of which assets we were most excited about and the kind of price to pay. And as you've heard this is immediately in 2008 going to contribute to our earnings, not reduce them and we think it's a great platform for a lot of things moving forward.

David Macdonald - SunTrust Robinson Humphrey

And guys just one other point on CCS, in terms of timing of the deal you know with a Medicare home infusion benefit probably more than eventuality you know did that kind of tie in here in terms of another service that you think you'll eventually be able to sell to Medicare seniors?

Timothy C. Wentworth - President and Chief Executive Officer, Accredo Health Group, Inc.

We certainly think that, that's an opportunity here. It wasn't factored into our acquisition financials at all, but it's certainly an opportunity. What I'll remind you as well is Accredo has a large home infusion business already. So and you can see its performing extraordinarily well. So we get a lot of leverage from our existing nurses. We think this acquisition allow us for a huge amount of synergy there because they've got a wonderful core of nurses as well. And so we think that the Medicare piece would be great frosting and on our already are very good cake.

David Macdonald - SunTrust Robinson Humphrey

Okay.

David B. Snow, Jr. - Chairman, Chief Executive Officer and Director

I want to take you one notch up strategically and we'll talk more about this at Analyst Day later in this month. What we have now built with our TRC is a really fundamental new platforms where we can start putting pieces of the puzzle together to drive fundamental changes and outcomes clinically and financially across the disease spectrum. This asset is particularly important within the Accredo portfolio of therapeutic resource centers because so many of the drugs that Tim's group deal with are either infused today or going to be infused tomorrow. And we need to make certain work creating end-to-end solutions for these diseases with clinical services on top of them.

So now, as we move forward, you will see us continue to look at potential acquisitions that still are our capabilities across each of the key chronic and complex diseases. You will also probably see us continue to look at other advances maybe through joint ventures or affiliations such as, what you have seen with us for Mayo Clinic as well as LabCorp on the personalized medicine front, which we think hold huge potential future opportunity for us down the road.

David Macdonald - SunTrust Robinson Humphrey

Okay, thank you.

Operator

Your next question comes from the line of Art Henderson with Jefferies & Company.

Arthur Henderson - Jefferies & Co.

Hi, good morning, just a follow-up, Tim, did you guys have infusion presence out in field that you think is adequate to address the needs that are out there or do you expect to see more acquisitions in that space going forward?

Timothy C. Wentworth - President and Chief Executive Officer, Accredo Health Group, Inc.

The answer to your first part may not equal to second, in other words, I think that we have got a great footprint now that we can built from, it may or may not require acquisitions than we are going to be very thoughtful about how we spend our shareholder's money.

Arthur Henderson - Jefferies & Co.

Can you just... how many locations do you have out in the field now that are infusion... home infusion capable?

Timothy C. Wentworth - President and Chief Executive Officer, Accredo Health Group, Inc.

We actually haven't release that but its with the two together now, its going to be north of 60 and again I would remind you, that in lot of those we don't need more physical facilities because we do know how to manage nurses in a way that profitably allows us to serve those patients and take care of the payers needs there.

Arthur Henderson - Jefferies & Co.

Okay, that's helpful, and then one question, Dave the UnitedHealthcare contract, is that coming up for renewal any time soon and sort of give us some perspective on that?

David B. Snow, Jr. - Chairman, Chief Executive Officer and Director

The contract right now calls for a price check at the end of 2009 effective for January 1, 2010. So we have ways to go in that regard.

Arthur Henderson - Jefferies & Co.

Okay, great, thank you.

Operator

Your next question comes from the line of Tom Gallucci with Merrill Lynch.

Thomas Gallucci - Merrill Lynch

Good morning. I just wanted to first confirm some thing that you had said JoAnn in your remarks the $0.04 additional versus the guidance just wanted to make sure I understood where that was coming from?

JoAnn A. Reed - Chief Financial Officer and Senior Vice President of Finance

That's from the early releases in 2000... in the third quarter such as Toprol and Coreg that we had planned on for the fourth quarter.

Thomas Gallucci - Merrill Lynch

Okay. And then another question maybe for Tim potentially here. I think JoAnn you had mentioned that some of the improvement in the specialty margin was driven by increased penetration on the mail side of that business. Could you maybe put in perspective a little bit, where does the mail penetration of that business stand versus what the few radical potential could be. And then also just maybe more broadly, where does the penetration of the use of your specialty services stand relative to the use to the book of business... to your book of business. So we can sort of get an idea maybe where the moving parts of the growth opportunities are?

Timothy C. Wentworth - President and Chief Executive Officer, Accredo Health Group, Inc.

Sure Tom and we will talk a little bit more about that on Analyst Day. So I am actually totaling the latest numbers right now for that presentation. But what I tell you is on the pharmacy side, we have largely penetrated the opportunities in the Medco book of business. We have got over 42 million lives now that are... have access to our program, a great number of those have not only access to it but have a strong incentive of overall effect required by their plans to use our program.

What we're seeing though is we know that about between to 40% and 60% of the spend sits on the, the non-pharmacy side right now. And we are working with a large number of clients to go after key therapies on that side. It's not going to be equal to yet another sort of 100% of what we currently have. But we think probably over half of what's out there is ultimately something that we can work with individual clients can move over. So, I think we are probably only 60% penetrated the way I would like to be if I had to throw a wild number at you.

David B. Snow, Jr. - Chairman, Chief Executive Officer and Director

Yes let me just remind everybody on the call that when it comes to specialty spend, rough numbers it varies by agent benefit design, but rough numbers half the total specialty spend for any client is on the drug benefit side. Half the spent is buried in the medical benefit under miscellaneous J-codes where clients are truly spending too much money they are not taking advantage of the scale of specialty business like ours. So it's a huge opportunity, it's in its infancy really in terms of penetration and natural we are very focused on right now.

Timothy C. Wentworth - President and Chief Executive Officer, Accredo Health Group, Inc.

Yes the last color I give you on that is the real... the drug that really has created a dialog has been the red blood cell drugs because clearly clients are looking at that and not only were they being dispensed at times for things that they won't actually prove for but more importantly there was less consistent, making sure the patients were being monitored from a test standpoint which is something that we have the platform and ability to do, our clients understood that and that has driven a lot of conversation and we have a very large number of clients now who have either already moved those drugs to Accredo, either to be shifted patient or to the physician's office, or in the process of doing so and that dialog extends very nicely past those therapies once you start the conversation.

Thomas Gallucci - Merrill Lynch

Are there any key sort of benefit design changes that you can highlight as we enter '08 and sort of new benefit designs starting in January for a lot of clients or is this sort of more of an ongoing process?

Timothy C. Wentworth - President and Chief Executive Officer, Accredo Health Group, Inc.

It is both and this is an area where lot of the summary planned descriptions of our clients already kind of allow them to do this so it becomes more a question of when they sit down with their health plans, and have the conversation about moving certain therapies out term, but also I can tell you that we have a good sized, bigger than a hand full of clients who for one-one either mandating certain drugs we pulled out and moved on to the pharmacy side or are putting in very strong co-pay incentives if you will or maybe this incentives depending on how you look at it to make sure that those numbers move over.

Where we have seen those co-pays work very effectively. We get 80% to 85% conversion without forcing a patient to pick a particular provider. They just come to us by virtue of the co-pay and then the client gets the savings from the visible transparent purchase discount that they get from us.

Thomas Gallucci - Merrill Lynch

Thank you for the color.

Timothy C. Wentworth - President and Chief Executive Officer, Accredo Health Group, Inc.

You bet.

Operator

Your next question comes from the line of Ricky Goldwasser with UBS.

Ricky Goldwasser - UBS

Good morning.

David B. Snow, Jr. - Chairman, Chief Executive Officer and Director

Hi Ricky.

Ricky Goldwasser - UBS

Couple of questions. Firstly, you started about $30 million in additional start up costs in the fourth quarter. Can you compare that to a more normalized level that you usually see in a normal year and then '09 is expected to be an average renewal year, but if you can just talk a little bit about the opportunity for new contracts i.e. compared contracts that should be offering you into '08, '09 season? Thank you.

JoAnn A. Reed - Chief Financial Officer and Senior Vice President of Finance

Hi Ricky. In terms of start up costs I would say an average fourth quarter would be more in the range of $5 million and the reason the number is so much higher this year is of course because of our large client win. That have programming that we have to do specifically for them as well as al the member mailing. And then also we are getting ready for the new product offerings that we have on the Medicare side of the business. So there is a lot of work to be had and as I said we hired over 2700 people in the field in our pharmacy and customer service centers in order to handle all this incremental volume. That's a huge number for us as you can see from our headcount historically.

So that is really the right accounts for the higher numbers and all of that fourth quarter is higher than we had originally expected when we gave you guidance last quarter. So it's coming in higher because of the additional people requirements that we have. And then on the renewal side of the business for 2009 for us right now it's looking about $9 billion and renewals that we'll be working on for the 2009 year.

Ricky Goldwasser - UBS

And what about the new contracts not renewals but contracts that are coming up and might go to market?

David B. Snow, Jr. - Chairman, Chief Executive Officer and Director

You are talking about prospect opportunities Ricky?

Ricky Goldwasser - UBS

Correct.

David B. Snow, Jr. - Chairman, Chief Executive Officer and Director

The way I would think about that is its certainly there aren't as many big opportunities as you saw this year for January 1, '08, but I would call it an average year in terms of opportunity at this point now, but these things change still fairly early and sometimes you're surprised by companies going out to bid that are not on your radar but right now I would call it a normal year.

Ricky Goldwasser - UBS

Are there any kind of like notable contracts that you know of already that are going to be that have an RFP out for 1/1/09?

David B. Snow, Jr. - Chairman, Chief Executive Officer and Director

The biggest that I am aware of is AT&T.

Ricky Goldwasser - UBS

Okay. Thank you.

David B. Snow, Jr. - Chairman, Chief Executive Officer and Director

Thank you.

Operator

Your next question comes from the line of Larry Marsh with Lehman Brothers.

Unidentified Analyst

Good morning, this Adam Tussard [ph] calling in for Larry. I was just wondering if you could elaborate on how you guys are thinking about the auto sector these days kind of with the creation of VEBAs, and could you remind us of those kind of relationships? How that is structured and of the kind of the length of those contracts?

David B. Snow, Jr. - Chairman, Chief Executive Officer and Director

Here's how we're thinking about VEBAs right now. First of all, I would like to point out we've served the VEBAs today. This isn't a new idea. We have customers that are VEBA trust today. In the auto's case the best date we have right now where these could be up and running and ready to go is Jan 1, 2010. So there is some time between now and then.

I think the way I would think about that is for 2010, this is a customer that we will need to talk to and sell through as part of... it is just basically you are taking one company and turning it into two. That's how we look at it. We have had a very good relationship with both the United auto workers as well as management of the auto and we are certainly are going to try to meet their needs as they define what it is they want and it is very early to know what they want at this point.

Unidentified Analyst

Okay thanks. And just one clarification on that $4.5 billion that was mentioned earlier is that a new annualized number or net new number?

David B. Snow, Jr. - Chairman, Chief Executive Officer and Director

That's the $4.5 billion is new name... I am sorry, new name, yes.

Unidentified Analyst

And what was the net new for the --

David B. Snow, Jr. - Chairman, Chief Executive Officer and Director

You have that one JoAnn.

JoAnn A. Reed - Chief Financial Officer and Senior Vice President of Finance

Net new, I do have that --

David B. Snow, Jr. - Chairman, Chief Executive Officer and Director

Hang on.

Unidentified Analyst

Okay.

JoAnn A. Reed - Chief Financial Officer and Senior Vice President of Finance

$3.9 billion.

David B. Snow, Jr. - Chairman, Chief Executive Officer and Director

You get that Adam? $3.9 billion.

Unidentified Analyst

All right, thanks a lot.

David B. Snow, Jr. - Chairman, Chief Executive Officer and Director

You're welcome.

Operator

Your next question comes from the line of Lisa Gill with J.P. Morgan.

Lisa Gill - J.P. Morgan

Thanks very much and good morning. Dave, while we think about 2009, are you showing us all about new carve out opportunities we are trying to hear a little bit from the consultants that many players are kind of big corporations that perhaps had part of their business carved out with the PBM but part of it was under a managed care type of offering are now looking the taking the whole piece. Are you starting to see that in the marketplace at all?

And then, well it sounds like follow-up but you can answer it all together. And then secondly as we think about the selling season for this year as it nears completion. Can you just talks about little about any kind of plan design changes, expectation is around mail. I know we've talked a lot about specialty pharmacy today. But, it seems that mail is something that such a growth drive in a last couple of years. Clearly you guys will have a great year at next year with the big mail contract you feed on. But may be just talk about some others trends as well.

David B. Snow, Jr. - Chairman, Chief Executive Officer and Director

Sure in terms of carve outs, yes, I wont say it's an overwhelming volume but we are seeing certain strategic big names, accounts who have articulated their desire to take at least the drug part out from... many big national accounts have helped plans signed up embedded that compete against the companies plan. And the challenge with that is the drugs spend when it is HMO side by side offering, also goes through the HMO it's broken up. And many clients are saying I want all the drug under one roof and we're going to work to... and there are couple specifically that I can't name that are actually. I have made very specific steps to do this where they are going to start pulling and carving out drug completely and not letting the drug pieces get sliced out of the business.

What I call that a mega trend yet? No. But what it... what I do thing it signals is customers understanding that they like complete end-to-end visibility around drugs spend. And understanding that if in fact you can have a consistent approach with the drug side of the business, if you consider the drugs the first line defense you want to manage that as tightly and as consistently as you possibly can and I actually believe that with our movement to the specialized practice of pharmacy, I think clients are seeing the value of that being the first line of defense, before you get into the more expensive medical side of the benefit.

So will this grow, I think it might, but I can't be sure yet, you should ask me that question by the middle of next year, I think I'll have better visibility into it.

Lisa Gill - J.P. Morgan

Well you know I will ask you.

David B. Snow, Jr. - Chairman, Chief Executive Officer and Director

I know I'm extending the offer.

Lisa Gill - J.P. Morgan

And then also I mean as you talked about earlier if you think about specialty pharmacy in that 50% is still on the medical side of the benefits, I mean we've clearly have seen the trends over the last few years, more of a bit more... more and more products moving to the pharmacy side, do you think its just the complexity of the product on the medical side today and therefore, as you move forward with TRC and some of the other programs that Tim has talked about, I mean is that the opportunity now to extract that from the medical side of the benefit or is it more have to do with the way that an individual company is actually looking at reimbursing these components?

David B. Snow, Jr. - Chairman, Chief Executive Officer and Director

No it's more the first... the reality is when you run a health plan, these incremental drug expenses that are buried in miscellaneous J-codes are fundamentally unmanaged and they're growing, it is an alarming rate and a health plan that has much more of its total premium expenditure going to other parts of the medical equation, they're not really building the intellectual properties necessary to manage end-to-end, this... the expense and they're also not... they don't have the scale to drive the pricing.

So clients are saying look we want all drugs managed end-to-end under one benefit with complete visibility to one vendor. And it makes logical sense if you think about it and I just think that's the perspective, it's in no way denigrating the performance of the health plan, it's just the harsh reality that relative to total premium that medical expense buried inside J-codes is very small and you are not going to get the time, attention or you're not going to see the capital expenditures to fix the problem.

Lisa Gill - J.P. Morgan

Okay great, that's very helpful.

David B. Snow, Jr. - Chairman, Chief Executive Officer and Director

Now on the plan design, just you asked about plan design, Tim talked about on the specialty side, plan design changes. More generally, I do see an increased interest in mail around specific diseases where we have a profound benefit clinically. It's a... I think it's, we're creating a brand new reason beyond, expense and convenience. We now have a... we are building a profound clinical reason for certain chronic or complex diseases to lever the mail channel and we're going to continue to build upon that.

So, we're seeing, 6% growth in our mail year-over-year, next year it will be slightly greater because of the big mail business we brought in, for Medco specifically we are building on that mail franchise, we are building proprietary brandable assets that I think will continue to grow mail, and I'm hopeful that with this additional leg, it is still it's additional value prop we're actually going to see growth in the rate, the change in the rate of growth upwards over time.

Lisa Gill - J.P. Morgan

Yes, I mean that would be my question, it's just that when you think about the plan design I understand that when you speak you're saying from the therapeutic side, and why it makes sense to go through mail. But are they... are you actually seeing plan design changes where you're incentivising a member to have to go through mail, I mean are we seeing shifts back towards some kind of mandatory mail programs because of these programs or is it just going to be more incentive... economic incentive on behalf of the members to utilize these programs and therefore utilize mail.

David B. Snow, Jr. - Chairman, Chief Executive Officer and Director

I think it's going to be both, I think you're going to see economic incentives to a bigger extent early on as we start publishing the data you know we're going to publish data on the mail study with Coumadin. We'll publish data around the Tamoxifen study with LabCorp. We'll publish data around our moving the needle around diabetes. As we get tangible benefits for our way of clinically managing care, I think you're going to see it move from just financial incentive to more mandatory, this is where we want patients cared for, you know, down the road. So it's going to start financial incentive, it will move toward I think. We might not go to a client now and go all members mandatory mail all chronic, but I can see us doing it disease specific based upon the data we produce from this new model.

Lisa Gill - J.P. Morgan

Very helpful, thank you very much.

David B. Snow, Jr. - Chairman, Chief Executive Officer and Director

Thank you.

Operator

Your next question comes from the line of Kemp Dolliver with Cowen and Company.

Kemp Dolliver - Cowen & Company

Hi thanks. I was curious about your thinking on Part D next year and I think that your I guess renewed interest in dual eligibles given that you had backed away from them for the '07 season?

David B. Snow, Jr. - Chairman, Chief Executive Officer and Director

Sure we don't have renewed interest in dual eligibles, it just happened Kemp. The reality is we filed rates tied to what we saw, you know, tied to our underwriting process. We filed rates tied to our new benefit designs and you have no visibility to what the others are going to do in the marketplace and it turned out that we came under that average and therefore we are back on the list, it wasn't a conscious thing, it was, we're just fundamentally running our business and it turned out that way.

We're not certain about what we might add back in dual eligibles, but our kind of you know guess at this point is maybe around 30,000 lives, which isn't huge. It just so happens that our performance on and our premium structure just that the fundamental performance became very competitive and we didn't know it till the results were announced.

Kemp Dolliver - Cowen & Company

I guess congratulations anyway.

David B. Snow, Jr. - Chairman, Chief Executive Officer and Director

Thank you Kemp, I think --

Kemp Dolliver - Cowen & Company

What... and just quickly on Q4 in generics what are your thoughts on say the, any highlight generic launches you're expecting this quarter?

JoAnn A. Reed - Chief Financial Officer and Senior Vice President of Finance

No we're not expecting any new big drug.

Kemp Dolliver - Cowen & Company

Thank you.

David B. Snow, Jr. - Chairman, Chief Executive Officer and Director

Thanks Kemp.

Operator

Your next question comes from the line of Charles Boorady with Citi.

Charles Boorady - Citigroup

Thanks good morning. Hey congrats on closing PolyMedica, how are your diabetes strategy and capabilities speak communicated to your existing clients and is this a sort of freebie to boost retention or is there a new top line opportunity?

David B. Snow, Jr. - Chairman, Chief Executive Officer and Director

Well I think you know if you recall we often talk about the... we're going to do this year 95 million scripts at mail, there are another 90 million prescriptions at retail that are chronic and with this capability a lot of those are diabetes, we want them and we're going to give you a lot of more, a lot more detail about this, as on our Analyst Day, we'll show you by therapeutic resource center, the split of scripts between retail and mail by disease. And I think you'll see immediately what we're talking about in terms of opportunity disease by disease.

It is significant and remember in the past we only looked at it around the drugs. Now we're also looking at it in terms of the scripts, the meters, the insulin pumps and all those other things that PolyMedica brings to the table. So we are creating an end to end service for creating a huge reason to go to mail. The end-to-end service now, it's not just to drugs and you've got specialized pharmacists who can help you with your chronic disease. And as I said earlier, the fundamental number we want to move is those people who adequately manage their blood sugar because that is the number one factor when you determine whether a diabetic is stable or unstable. And unstable is where enormous amounts of money are spent. We can keep them stable, significantly better than the average out there today, mail will be driven I can guarantee that.

Charles Boorady - Citigroup

So to make sure I understand is, another... is an additional sale actually required to your existing relationships or is the opportunity here really to grow within the context of your existing contract?

David B. Snow, Jr. - Chairman, Chief Executive Officer and Director

No, I would... it's not another sale. It basically most of our clients today favorably price mail over retail because of the benefit, it's simply teaching, it's communicating the additional services we have to offer at the member level. So its communication, it's talking about these new services, it's driving this new clinical care model having members understand it.

The clients really do get it. They are very supportive, I think that if you want to talk about what client sale will be involved down the road, it's when we have the data to show, we might want them mandate at the disease level use of mail tied to those clinical services that really do measurably change the outcomes clinically and financially.

Charles Boorady - Citigroup

I see. And in terms of next steps in future M&A prospects is there going to be a period during which you approved out this strategy with diabetes before moving on to this kind of end-to-end strategy with other disease states, and are there other pieces of the puzzle you're looking to fill in for diabetes or do you feel like you have all the capabilities you need there?

David B. Snow, Jr. - Chairman, Chief Executive Officer and Director

I think in diabetes, we have most of everything we need to put together something that's very powerful. We probably won't run out and buy another big asset in the space immediately, but not for the reasons you suggested. It's really... I'm very, very confident in what results we will deliver with the PolyMedica asset. But you do want to make absolutely certain, you don't run ahead of your ability to execute on these acquisitions, you want to make sure you thoroughly integrate them and get them running and if you spread your management team out too thinly you won't execute and that's the number one thing I want to pay attention to.

Charles Boorady - Citigroup

Last question from me, you had expected previously some softness I forget the exact wording, in the second half of '07 from a couple of large July 1 contracts and I'm wondering if the impact from those contracts specifically was as great as you expected, but they were offset by other things going better than you thought in the quarter or was the affect of those large contracts for July 1 not as, not as bad as you previously thought they might be?

JoAnn A. Reed - Chief Financial Officer and Senior Vice President of Finance

So before we thought we would be done with 95% of our renewal through the end of the third quarter, and we're currently done with 93% of them. So one account moved into the fourth quarter.

Charles Boorady - Citigroup

Got it.

JoAnn A. Reed - Chief Financial Officer and Senior Vice President of Finance

So that was one reason for the improvement and then the other real reason for the improvement is really those unanticipated early generics that came into the third quarter versus us thinking it was going to be in the fourth quarter.

Charles Boorady - Citigroup

I got it, okay. Great thanks so much.

David B. Snow, Jr. - Chairman, Chief Executive Officer and Director

Thank you.

Operator

Your next question comes from the line of Michael Baker with Raymond James.

Michael Baker - Raymond James

Thanks, hearing from some consultants that they're pushing for a WAC-based pricing benchmark for 2009 first half, I was wondering if you could confirm that? And then secondly, if that is the case, can you give us a sense to how that might change the optics around generics firstly, and then secondly, whether you anticipate any change in competitive pricing because when I've looked at some contracts and competitive dynamics, I've noticed that historically most cases the Big Three have been really tight in terms of how they price relative to one another, just wondering if that's still the case?

David B. Snow, Jr. - Chairman, Chief Executive Officer and Director

I'll answer this, the last part but I'll ask JoAnn answer the WAC-based question.

JoAnn A. Reed - Chief Financial Officer and Senior Vice President of Finance

On the WAC-based, what we're hearing more is that it's going to AMP not to WAC, but the consultants are just making estimates. Right now no one has come up with the new benchmark, so we don't know where it's headed but for us as you know it's really no real impact to us because of our contractual language and there has been talk that it might happen in the latter part of 2008.

David B. Snow, Jr. - Chairman, Chief Executive Officer and Director

And then relative to pricing Michael I would say it's pretty much the same. The reality is as you see more and more generics you see the pricing changing at an individual company, but relative to other companies in this competitive space it's very competitive, it continues to drive similar pricing discipline and clients are getting excellent pricing largely because of the generics and the generics looking down for the next four years. We take that into account and they're seeing fabulous pricing. So people are moving, I would say in sync with what's happening with generics on the pricing side.

Michael Baker - Raymond James

Thanks and then just one other quick question I was wondering if you could give us an update on the benefits you're seeing from the Healthways JV?

David B. Snow, Jr. - Chairman, Chief Executive Officer and Director

Yes we've had some sales on that and I don't know, are we doing an update on that Valerie at the Analyst Day, are we talking about that?

Valerie Haertel - Investor Relations

We are going to --

David B. Snow, Jr. - Chairman, Chief Executive Officer and Director

So we'll give you some actual numbers, but we're pretty pleased with the, where it's... it's really ramping up nicely, clients understand again how Medco with it's pharmacists who practice have teachable moments that Healthways doesn't have and how by preserving those teachable moments we can do a better job in total management. We do therapy management, they do disease management and combined we can really move to total cost equation for chronic and complex disease which again is where most of the money is spent. So we are happy with that, it's ramping up the sales cycle is really about the same as it is in the PBM business. These decisions are made once a year and it takes about a year to get customers to sign up, but we've had some very nice wins together and I feel good about where we're heading.

Michael Baker - Raymond James

Thanks for the update.

David B. Snow, Jr. - Chairman, Chief Executive Officer and Director

Thank you.

JoAnn A. Reed - Chief Financial Officer and Senior Vice President of Finance

Crystal we'll take one last question.

Operator

Thank ma'am. Your final question comes from the line of John Kreger with William Blair.

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

Hi thanks very much, JoAnn thanks for all the clarity on expectations for '07 and '08. Can you give us your latest thinking on operating cash flow for those two years? And then David you mentioned PolyMedica integration. Can you just be a little bit more specific, how long do you think that will take and what sort of issues are involved? Are you going to try to migrate their systems to yours and to what are you going to run that business independently versus trying to forward it into Accredo or your other businesses?

David B. Snow, Jr. - Chairman, Chief Executive Officer and Director

Okay

JoAnn A. Reed - Chief Financial Officer and Senior Vice President of Finance

No, on the operating cash flow we expect the increases that we're seeing and net income to flow through to operating cash flows also, so same kind of growth rate.

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

Okay thanks.

David B. Snow, Jr. - Chairman, Chief Executive Officer and Director

And then on the PolyMedica integration, it's not identical to Accredo's. In Accredo's case, they truly were the experts on the specialty line of business and we actually moved our specialty business under Accredo. We've preserved the culture, they are know-how, we've learned a lot from them as a company and it actually was a big stimulus in our learning lessons that led to the development of therapeutic resource centers.

In the case of PolyMedica, fabulous company, fabulous innovations around compliance for what they do, it is completely part of taking care of patients with diabetes and it will be integrated into our TRC total care approach at the member level. So it is going to be... we've appointed one of my executive officers, Laizer Kornwasser to head up the company and to lead the integration. What we ultimately want to do is innovate in diabetes with these combined assets using specialized pharmacist and the compliance models of PolyMedica.

I will tell you that the integration I think is going to be a very smooth one and again with PolyMedica, we've worked with them under a joint venture for a year. We integrated systems, we fulfilled for them as a vendor to them, the drugs for the diabetics that they serve. So we know their systems inside out, we've already done integration there. So that's been taken care of already, which is often one of the hardest parts of an integration. So this will be smooth. I don't think it will take us much more than a quarter to get this thing really humming and have everyone singing from the same page, you know we feel good about this one, this is a perfect fit for us.

With that I'm going to close. I want to thank all of you for taking time with us today and we look forward to talking to you again next quarter and we look forward to seeing you at Analyst Day on the 16th of November. Thanks for listening.

Operator

Ladies and gentlemen, thank you for you time today. This concludes the conference call. 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!