IMS Health Q4 2005 Earnings Conference Call Transcript (RX)

IMS Health (RX)
Q4 2005 Earnings Conference Call
January 31st 2006, 8:30 AM.

Executives:

Darcie Peck, Vice President, Investor Relations
David Carlucci, President and CEO
Nancy Cooper, CFO and Sr. VP

Analysts:

Larry Marsh, Lehman Brothers
Steve Unger, Bear Stearns
Eric Coldwell, Robert W. Baird & Co.
John Kreger, William Blair
James Kumpel from FBR
Duane Pfennigwerth, Raymond James
Steve Halper, Thomas Weisel Partners
Larry Marsh, Lehman Brothers

Presentation

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the IMS Health Fourth Quarter and Full Year 2005 Earnings Conference Call. Operator Instruction. I would now like to turn the conference over to Darcie Peck, Vice President, Investor Relations. Please go ahead.

Darcie Peck, Vice President, Investor Relations

Thank you Susan and good morning to everyone. Welcome to our fourth quarter 2005 earnings conference call. With me today are Dave Carlucci, our President and CEO; and Nancy Cooper, our Chief Financial Officer. Dave and Nancy will discuss highlights from our fourth quarter and full year 2005 results, and discuss our guidance for the full year and the first quarter of 2006. We posted slides and highlights of our 2005 performance and our ’06 guidance on our website and I encourage you to view these during Dave and Nancy’s prepared remarks this morning. A question and answer session will follow our prepared remarks.

And now the standard procedure let me read out the Safe Harbor provision. Certain statements we make today are forward-looking within the meanings of the US Federal Securities laws. These statements include certain projections regarding the trends in our business, future events, and future financial performance. We would like to caution you that these statements are just predictions and the actual event or results may differ. They can be affected by inaccurate assumptions, or by known or unknown risks or uncertainties, consequently no forward-looking statement can be guaranteed.

We call your attention to our fourth quarter 2005 earnings release, which we issued earlier today, and our 2004 Annual Report on Form 10-K, we have set forth important factors that could cause actual results to differ materially from those contained in any such forward-looking statements. Our forward-looking statements represents our views only as to date they are made and the company undertakes no obligation to correct or update any forward-looking statements, whether as a result of new information, future events or otherwise.

The financials we’ll talk to you today are on an adjusted basis. Adjusted results are those used by management for purposes of global business decision-making, including developing budgets and managing expenditures. Adjusted results exclude certain U.S. GAAP measures to the extent that management believes the exclusion will facilitate comparisons across periods and more clearly indicate trends. Although IMS discloses adjusted results in order to give the full picture to investors of its business as seen by management, these adjusted results are not prepared specifically for investors and are not a replacement for the more comprehensive information included in our US GAAP results.

Adjusted results should be read in line with the detailed reconciliation to results on an SEC reported basis, which is in our press release and I encourage you to review the notes in our press release further describing these adjusted results. As it relates to our comments on guidance today, in accordance with Sarbanes-Oxley, it is important that you understand the basis of our guidance to you. Going forward, as in the past, our guidance excludes certain items such as the one Nancy will describe in our full year results, because we feel it is more reliable way to give you guidance in our core operational performance. Now, let me turn the call over to Dave Carlucci. Dave?

David Carlucci, President and CEO

Thanks Darcie. I am pleased to be with all of you this morning to review the performance for 2005 and discuss our outlook for the future. 2005 was an excellent year, constant dollar revenue grew 12% at the high end of our guidance range, and constant dollar and revenue growth accelerated every quarter. Reported revenue grew 12% from $1.8 billion. Operating income on a constant dollar basis grew 14%. If you exclude the year-to-year benefit from the restructuring charge we took at the end of 2004; constant dollar operating income grew 4%. We are very pleased with this excellent operational performance, 4% operating income growth is the strongest full year operating income growth we had in three years. Operating margins for the year were 25%. So we are on track with the stabilization of our operating margins we talked to you about in July.

Adjusted EPS grew 17% to $1.38, $0.03 better than the high end of our range. Adjusted net income grew 14% to $321 million, and preliminary free cash flow was $315 million. We’ve converted 98% of adjusted net income into free cash. Given the strong fundamentals of our business, we certainly have a leadership position in the cash conversion area. We capped off this great year with excellent results in the fourth quarter. Constant dollar revenue growth was 12%. Reported revenue grew 8% to $478 million. Adjusted earnings per diluted share improved 18% year-over-year to $0.40. I am very proud of what we have accomplished in 2005. Our teams weren’t distracted by the failed merger attempt with VNU and remained very focused on our clients.

As far our clients, they experienced increased pressure to realize significant gains in their sales and marketing productivity. And in anticipation we positioned ourselves to deliver high-value solutions through our expanded offerings and growing capabilities in consulting and services. In fact in 2005, our top 20 accounts had 17 of those accounts growing their spending with us and over seven or seven of them, I should say, grew over 20%. In total, our revenue from top 20 accounts grew 10%. Our medium-size accounts grew 11% and our small and emerging biotech accounts grew 15%. Our clients are taking advantage of our global footprint and are looking to fewer and stronger global partners to help them identify opportunities to improve their overall performance.

A year ago, when we gave you our guidance for 2005, we’ve said we had to deliver on some important operational initiatives. First, we have to grow our business in Japan. As you know, we’ve launched our new sales force effective this offerings in the second quarter as planned and we accelerated the growth of our consulting and services business. While we expected to achieve double-digit growth only in the second half of the year, we have constant dollar double-digit revenue growth in Japan for the full year.

Second, we set a goal to capitalize on the excellent work we had done to achieve productivity and efficiency gains in our business. In 2005, we completed our restructuring plans and eliminated about 490 physicians. At the same time, we increased our customer facing resources by about 20% from 2004 and we developed and acquired critical skills to continue to support the growth of our consulting and services business around the world.

Today we have over a 1000 billable consultants and services colleagues up from around 600 at the beginning of 2005. And we are just beginning to rescale advantages in a few of our larger countries. We also continued our strong track record relative to our competition. In addition we acquired 10 companies, four of which were in the US, where we extended our capabilities in anonymous patient-level data, R&D, competitive benchmarking and added new offerings targeted to the government.

We also improved our gains significantly in other parts of world around health, economics, and outcomes research. This is a very important area that has become increasingly important as regulators and healthcare payers demand real world proof about the value of new drugs. We continue to expand our capabilities here and this is an important space for us in 2006. We have great confidence in our business, and our ability to execute, and our growth prospects for the future. We are barely scratching the surface of the huge opportunity ahead of us, and we want our shareholders to share in that confidence.

For these reasons, we announced today the repurchase of approximately $750 million of our shares primarily through an accelerated share repurchase program. In addition, we are increasing our annual dividend by 50% from $0.08 a share to $0.12. This is a balanced approach to return cash to our shareholders, as our business performance is sustainable, and our financial performance is accelerating. Over the past 10 quarters now, constant dollar revenue growth has been 10%. Adjusted EPS growth has been 13%. Free cash flow conversion has been over 100% and return on invested capital has been very strong.

From the regional perspective, our teams remained focused on our clients throughout 2005, and we delivered strong financial results every single quarter and we had an excellent fourth quarter results with double-digit constant dollar growth in every region as we had in the third quarter. The Americas grew 12% constant dollar and 12% as reported in the fourth quarter. For the full year, the America has delivered 9% constant dollar growth, 10% growth as reported. These strong results reflect the region’s growing ability to demonstrate our unique value of combining information assets with consulting and services capability.

We had several large competitive wins in the fourth quarter as a result of the greater breath of our data assets especially in the long-term care area, and our consultants’ deep understanding of our clients’ business. Because of the success of these new engagements we are reaching more senior executives, and as a result new growth opportunities exists for precision targeting, sales force optimization, and promotional effectiveness across more therapeutic classes and brands.

Our Asia Pacific region continues to perform very well. In the fourth quarter, Asia Pacific grew 23% constant dollar, 15% as reported. And 14 out of 15 countries reported double-digit constant dollar growth. Our Asia Pacific team secured some significant wins including several engagements to help our clients evaluate licensing opportunities and analyze generic market trends. For the year, Asia Pacific grew 15% on a constant dollar basis, 15% as reported with double-digit constant dollar revenue growth in Japan.

Turning to EMEA, once again this region delivered reporting its 10th consecutive quarter of double-digit constant dollar growth. In the fourth quarter, EMEA grew 10% constant dollar, 1% as reported. EMEA bore the brunt of the currency impact from the strengthening dollar, which had a significant negative impact on reported growth in the fourth quarter. This is the third year in a row of double-digit constant dollar growth in this region however. For the full year, EMEA grew 13% on a constant dollar basis, 12% as reported. Among our key client wins was a multi-brand engagement with a large company to help them understand messaging and positioning for several upcoming product launches across Europe.

While we are talking about the EMEA region let me spend a moment on a key executive announcement we just made. Last week I announced that Gilles Pajot, who has been running our Europe, Middle East, and Africa operation for the past eight years will be taking on a new and extremely important role for IMS. In his new role as IMS Executive Vice-President, and President of Global Business Management, Gill will run our business lines and consulting and services worldwide.

Our global footprint is a key differentiator and a competitive advantage for our company. And Gill will increase our ability to execute on a constant and a consistent basis with our global clients. He is an industry expert with more than 30 years of global experience and has an incredible track record for helping both our clients and IMS succeed. Succeeding Gill as President of EMEA is Kevin Knightly with over two decades of experience in IMS, including last four years working closely with Gill in Europe, Kevin brings a wealth of experience in leadership to our European team.

Turning to our business lines our performance was strong in 2005, all performing well, and the largest sales force effectiveness is back on track as a result of the acceptance of our new offerings in Japan. In consulting and services, which now represents 16% or $275 million of our overall business, we delivered 50% growth for the second year in a row.

Now let me move on to our outlook for 2006. Our operational performance in 2005 was very good, and the better news is that it improves going forward. Over the last few years we have been investing in the growth drivers of our business and we have delivered accelerating revenue growth and strong EPS and cash flow growth. Our performance is accelerating in environment perceived as very challenging and uncertain for our customers. Customers all around the world have validated their offerings, our high value and delivered insights to their most important business issues.

As I meet with investors most of their questions center around our ability to sustain growth in a challenged US pharmaceutical market. And while we are very comfortable taking about the US pharmaceutical industry and our prospects for growth in the US market, our business is global, with 64% of our business coming from outside the US and that’s about the same level it was in 2004.

As a result, we are expecting a strong year in 2006. Constant dollar revenue growth of 11% to 13%; constant dollar operating income for the full year is 9% to 13%; and our adjusted EPS guidance was $1.45 to $1.51. Both our EPS and operating income guidance exclude the impact of equity based compensation expense. And this guidance takes into account the several factors including the positive effects from the share repurchase program and the negative impact of foreign exchange.

Finally, our free cash flow guidance for 2006 is $265 million to $300 million. Now, I am going to turn the call over to Nancy, who will walk you through the details of our guidance and give you a bit more on our 2005 results, Nancy?

Nancy Cooper, CFO and Sr. VP

Great, thanks Dave. Let me get right to the guidance for 2006. As Dave mentioned our full year 2006 guidance in constant dollar revenue growth of 11% to 13%. We do see operating margins stabilizing. So, we are comfortable with constant dollar operating income growth of 9% to 13%, and this just before the expensing of options, and I will get to that impact in a moment. This is the first time we have introduced operating income guidance to you. So to put this in perspective our constant dollar operating income growth in 2003 was a negative 5%. In 2004, it was flat and in 2005 it grew at 4%. So, 9% to 13% operating income growth is a significant improvement for our business.

We also expect more stability in our margins in 2006. However, various factors including the seasonality of our business and new acquisitions will cause some quarter-to-quarter variability. For example, our first quarter typically has the lowest operating margin of the year. Now, let me spend some time on how currency affected our business in 2005 and how it will impact 2006. It’s important that you have a right starting point for absolute revenue and net income as you build your models.

Now lets get to revenue. In 2005, we all know that the dollar strengthened throughout the year with a large move in the fourth quarter. Essentially, our dollar denominated company the same local currency revenue and operating income in 2005, what we were at fewer dollars in 2006. Based on the foreign currency rates at the beginning of 2006, we estimate that reported revenue growth will be about three percentage points lower than constant dollar revenue growth rate.

Similarly, local currency operating income in 2005 will be worth fewer dollars in 2006. Of course this differential will change as exchange rates change during 2006. In addition, as the dollar strengthens during 2005, it reduced operating income. But this reduction was offset by hedge gains. We realized 24 million in hedge gains in 2005, which are recorded in the other income line. To sum up currencies impact for you, the year-to-year impact of the strengthening dollar is a negative $0.11 on an adjusted EPS in 2006. Our effective tax rate in 2006 will be 30%, this is a point for us in our tax rate in 2005. And as you recall in 2005, we benefited from a one-time favorable tax audit resolution in Japan. We estimate that the change in the tax rate will reduce the EPS by about $0.02.

Our adjusted EPS guidance also takes into consideration the share repurchase program we announced this morning. The program reduced shares outstanding by about 12% and with the additional leverage will increase our net interest expense for the year. Net interest expense for 2006 will likely to be higher than $40 million. In total, the reduction in share account coupled with the additional interest expense will have about $0.05 accretion to EPS in 2006. With all these factors combined excluding stock-based compensation expense, our adjusted EPS guidance for 2006 is $1.45 to $1.51. Now let me walk you through the impact of stock compensation expenses on our guidance.

In 2006, we will include stock compensation expense in our results consistent with FAS 123R. The total amount of options expense in 2005 was $30 million after-tax and would have had $0.11 impact on EPS. We will not restate 2005 results for that, so EPS for year-to-year will be distorted.

The dollar value of our stock-based compensation in 2006 is expected to be about the same as for 2005. However, principally due to the lower share count in 2006 from our share repurchase program, the impact is about $0.13 rather than the $0.11 in 2005. Stock-based compensation expense will reflect in each quarter in our cost and expense and this will have a negative effect on operating margin of about 2 percentage points. I realize there are lot of moving parts necessary complicated.

So let me summarize guidance for the full year 2006. Constant dollar revenue growth of 11% to 13%. Constant dollar operating income growth of 9% to 13%, excluding the impact of stock-based compensation expense. For adjusted EPS, excluding the impact of stock-based compensation expense, our full year guidance is $1.45 to $1.51 and stock-based compensation expense will reduce EPS by about $0.13 and reduce operating margin by about two points. Free cash flow guidance for the year will be $265 to $300 million, adjusted net income in 2006 is impacted by the higher interest expense associated with our share repurchase, so too will free cash flow be reduced. However, the share repurchase is accretive to EPS and will improve our free cash flow per share.

Turning over to guidance for the first quarter, we expect constant dollar revenue growth of 13% to 15% and excluding stock-based compensation expense, adjusted EPS of $0.30 to $0.33. Stock-based compensation expense will reduce EPS in the first quarter by about $0.03. We expect revenue growth to be higher in the first half of 2006 versus the second half and this is due to the phasing of revenue from the acquisitions we completed in the second half of 2005.

Our strong operating performance in 2005 gives us confidence in our 2006 guidance. Now, let me give you a little more detail on our 2005 results, specifically our capital structure, our balance sheet and our SEC results. In 2005, as you know, we completed the repatriation of $647 million as part of the American Jobs Creation Act. As part of this program, we increased debt in countries outside the United States with strong operating profits and cash flow and with lower borrowing cost. This action had the effect in the fourth quarter of significantly lowering our debt and our related interest expense. We spend about $200 million on the acquisitions in 2005 and more than half of that was in the US.

Going forward, we expect to continue to acquire company at about half the rate we did in 2005. And as you saw on our press release this morning, we have already executed an approximately $750 million share repurchase program and announced that we are increasing our annual dividend by 50% to $0.12 per share. Let me set a few minutes on the repurchase program.

The first $100 million of the program we executed through regular open market purchases that we’ve already completed earlier in January. The remaining share repurchase will be down to an accelerated share repurchase program or ASR, which we signed after the market closed yesterday and executed this morning. The total number of shares that we bought back under these program should be about 12% of our outstanding share base. Our total debt will be approximately $1.1 billion with a plan to retire about 10% of that in the first year. After this transaction IMS will continue to be positioned as the solid investment grade credit with a two-time debt to EBITDA ratio. Even with the share repurchase and an increase in our dividends, we have sufficient flexibility to continue to invest in the growth areas of our business. This is all incorporated in our guidance for 2006, which I just took you through.

And turning over to the balance sheet. We ended the year with $363 million in cash and short-term marketable securities, which is a decrease a $97 million over 2004. Total debt was $611 million, a decrease of $15 million over 2004. The income for the full year was 61 days and that’s consistent with what we had in 2004 and we had excellent performance in the fourth quarter at 56 days. Preliminary free cash flow for the year was $315 million and that includes the proceeds of the sale of our interest in TriZetto. Following these proceeds of $37 million preliminary free cash flow was $278 million. Also included in our cash flow in 2005 is $24 million of spending for the restructuring plan we announced in fourth quarter 2004.

For the full year 2005, we repurchased 10.2 million shares for a total amount of $247 million. We repurchased 4 million shares in the fourth quarter. Total shares outstanding at the end of the year is 228 million shares.

Now turning to our SEC results for the full year. On a SEC basis, we reported $1.22 EPS for the full year of 2005. Our full year SEC financial statement, which is on Table 2 in the press release reflect the inclusion of few gains and charges, which we have excluded from adjusted results in our for items. The first is a pre-tax net gain of $1.7 million on our enterprise assets portfolio. The second is in our SEC results include $17.9 million of the related cost associated with our agreement to merge with VNU, which was announced last July and terminated in November. The third, the payment from VNU on termination of the merger agreement of $15 million, and the fourth and largest $40 million tax charge on the repatriation. Now let me turn this call back to Dave to wrap-up.

David Thomas, Executive Chairman

Thanks Nancy. We covered a lot with you on our call today. Clearly we had a great year in 2005 and as we enter 2006, our revenue growth remains strong. Our operating income has begun to grow and we see strong acceleration into this year and we have already re-capitalized our company to optimize shareholder value. As we think about 2006 and our future, we are committed to improve our operating income growth in line with revenue growth, our margins will stabilize and we will continue to have strong cash flow.

We are very pleased to serve a strong and growing customer set. We got a sound strategy and we are well positioned to expand our global capabilities to help our clients. You will hear more about all of this and how we plan to deliver accelerating operational performance at our Investor Day on February 13th in New York City. I hope to see you all of you there. So thanks for spending the time with us this morning and now let me turn it over to the operator to open it up for questions.

Questions & Answers

Operator

Thank you. Operator Instructions Our first question comes from the line of Larry Marsh from Lehman Brothers. Please proceed with your question.

Q – Larry Marsh

Thanks and good morning. Nancy, if I can get you to elaborate a little bit on the impact of currency, is most of the $0.11 impact you are talking about coming from your EMEA operations, which is Euro denominated?

A – Nancy Cooper

Good morning Larry. Let me talk to you about that. Really if you had looked at the results in the fourth quarter we had a major strength sitting in the dollar and for us, you know, we are principally in four currencies that were significantly impacted by rate changes, they are not just to Euro. If you looked on the Euro and it is very important for you to also look at the Yen and the Swiss Franc and the British Pound. You would see those currencies depreciated in value against the dollars somewhere between 10% and 15% and so we’re really getting impacts from all of those and as Dave mentioned on his call, on this call earlier 64% of our revenue comes from offshore. So, you can see that the combination of those is what we are taking about in $0.11.

Q – Larry Marsh

Okay, are you quantifying what benefit you’ve got in the last several years with the weakening dollar and you know would you anticipate I mean that shifting in ’07?

A – Nancy Cooper

Of course I can’t predict currency. The things I can tell you Larry is we did get about a $0.03 benefit from currency in 2005 and more than that, close to $0.09 in 2004. The thing to remember is once we entered the year, so when we give guidance for 2006, we have fully hedged the operating income going into this year and we don’t feel good but we can guess which way the currency is going to go.

Q – Larry Marsh

I understand, right okay. So, again now you communicated once a year you would show some benefit or negative impact with currency?

A – Nancy Cooper

We really give you that as we do our quarterly results, as we discuss the hedge gain and the hedge gain phasing.

Q – Larry Marsh

Well, I understand that. Okay, thanks, second question would be the impact of acquisitions. How much of your constant dollar revenue growth came from acquisitions in Q4 and specifically in the SFE side area?

A - Nancy Cooper

Let me give you the impact of acquisition for full year 2005 we had four clients for out of the 12, we grew organically eight points, which is two points up from 2004 and SFE we are not breaking out acquisitions by business lines and the SFE really was Japan coming back.

Q – Larry Marsh

Okay, I got it. So, you didn’t spend any money on acquisitions in the fourth quarter as I would hear it. I guess of the 11% to 13% constant dollar revenue growth, which you are communicating obviously very good, how much is that coming from acquisitions?

A - Nancy Cooper

It will be slightly less than what we saw this year before we do any acquisitions in 2006. If you remember my comments, we said we are going to cut the level of acquisitions we are doing in 2006, of course, you know, there is a flow through effect in the first half of ’05 because of large of what we did in 2005.

Q – Larry Marsh

Right, I am sorry, so of the 11% to 13% financing you are seeing how much is that yours from acquisitions?

A - Nancy Cooper

3% to 4%, something like that in that range.

Q – Larry Marsh

Okay, 3% to 4% and again you are communicating operating margin stability for ’06?

A - Nancy Cooper

Yes I am.

Q – Larry Marsh

Very good, thank you.

A - Nancy Cooper

Thank you.

Operator

Our next question comes from the line of Steve Unger from Bear Stearns, please proceed with your question.

Q – Steve Unger

Hi good morning. Just my first question, David, what do you expect the regions of the world, the individual regions of the world to grow on a constant dollar basis in 2006 and what are the key drivers of growth in each of those regions?

A – David Thomas

Well, it’s hard to break it down how each one of them will grow in the quarter. As you see our guidance calls for very healthy double-digit growth to continue on a constant dollar basis and I think we will see the continued drivers of growth being the new areas we invested in, particularly in launching brand but from a raw growth dollar number you are going to see you know significant growth in portfolio and SFE also with the investments we made in both of those areas, particularly in the resource optimization around sales force targeting. So, I think we will see again fairly balanced growth in all the geographies, we don’t have a situation like we had with Japan. Things have stabilized across the board. So I see continued consistent levels of growth across all three major regions.

Q - Steve Unger

You are expecting then in 2006 double-digit constant dollar growth in each of the regions?

A – David Thomas

I don’t know how it will flow quarter-to-quarter. It’s always very hard to tell, but to get to an 11 and 13 the laws I have to carry their way in 2006.

Q – Steve Unger

Okay I understand, and then you mentioned health outcomes as an important growth driver for the company in 2006, could you, you know, quantify the overall opportunity that you see in health outcomes on a global basis, and what you are doing to capitalize on that opportunity?

A – David Carlucci

Sure, what I did say Steve is that we continue to invest for growth in that arena. We acquired several companies, which are very local by nature five countries. So we have a presence in the UK, in Australia, in Germany, in France, as well as the Pharmetrix acquisition, the United States provides insight of the outcomes level. We just see a trend for more and more need for evidence-based evaluation of the efficacy of new drugs and it’s certainly pervasive with payers as well as certainly the government’s evaluation in the role as payer. So we think this is an area where it’s very fragmented on a global basis. Our footprints and our base data assets give us a certain level of insights and adding outcomes data to the research analysis. We think it will be something that will be very significant both to our pharma clients as well as to payers that provide us those data assets

Q – Steve Unger

Okay and then in Japan the uptake of the reinstalled products seems to be growing better than expected. Have you studied exactly where that uptake is there in terms of saturating the customer base there?

A – David Carlucci

Sure, I think the most positive aspect of it is that the number of DDD customers that we obtained in 2005 exceeded our expectations, but if you look at it from a therapy class penetration point of view, we still have a long way to go. So we have significant opportunity now, where we have entrenched DDD in a broader number of customers than we anticipated in ’05. So I think that goes well for our continued growth in ’06. In the meantime, we also built up our consulting and services business. I think that’s part of the reason we are able to accelerate the number of DDD licenses that where installed with our clients, and it will give us the ability, I believe, to also expand to more therapy classes.

Q – Steve Unger

Okay and then two quick financial questions if I might, Nancy, could you breakdown the $0.11 foreign exchange impact on EPS by the hedge gained from 2005, and then what would be the impact from just the year-over–year change in the dollar, and then what was the interest rate you are expecting on the debt?

A – Nancy Cooper

Sure, your first question Steve, the hedge gain was approximately $0.08 of the $0.11 impact and then starting the year with a start point, which is my comment that reported will be we are started around 3 points below constant is a another 3 penny.

Q – Steve Unger

And then the interest rate on the new debt?

A – Nancy Cooper

Yes, the debt, as you may remember from our third quarter call we have been able to point a portion of our debt in Japan at extremely low interest rate. So we will be funding that Steve on your 4%.

Q – Steve Unger

Okay, great job, thanks guys.

A – Nancy Cooper

Thank you.

A – David Carlucci

Thanks Steve.

Operator

Our next question comes from the line of Eric Coldwell, from Robert W. Baird & Co., Inc. Please proceed with your question.

Q – Eric Coldwell

Okay, thanks very much, nice performance. Nancy, just big picture question here, last quarter there was some debate and concern over the mix of SG&A cost and gross margin. This quarter that you reversed in gross margin was a big driver of the upside, can you just give a sense on what factors would play there and how we should think of these numbers as we look at 2006?

A - Nancy Cooper

Well on the gross margin, first I think you can see it as resume, kind of, historic levels so it was more in the pattern. I would call third quarter more on the aberration and as we said in the third quarter, you know, we had done a lot of acquisitions. We always know when we first acquire these that these smaller companies, and their cost and expense but it is not perfect. So we think we found a lot of that cleaned up. And we really in the fourth quarter we had great operational performance, I mean we’ve exceeded guidance, we really did well. And on the SG&A side, let me be candid with you, you know, as we saw the quarter coming in very strong, we took the opportunity to accelerate few things in fourth quarter.

Q – Eric Coldwell

Makes sense and so for this year maybe SG&A recoups a little bit from the high in the fourth quarter in gross margin with some variability stays, higher than what we saw in the third quarter of ’05.

A - Nancy Cooper

Yeah, but we can’t get to that, you know.

Q – Eric Coldwell

Okay, fair enough. Just a big picture question, you know, I am pleased to see the repurchases, the ASR, Nancy, you mentioned that you are comfortable with debt-to-EBITDA of around two times as you did your modeling on potential scenarios for capital structure and repurchases what was the kind of in terms of comfort zone. What was the maximum range of that EBITDA you were willing to go to and just how important is the investment grade status to you?

A - Nancy Cooper

I think we have a full turn a lot of comfort level on that to EBITDA, which is like to point about we have kept ourselves with a lot of flexibility. We thought this was appropriate for where we are now and gives us plenty of room to continue what we view is investment in the company, which we think is critical, with all the opportunities you heard Dave articulate. So, it’s really a balancing point with room to be able to do more.

Q – Eric Coldwell

That’s great, thanks very much.

A - Nancy Cooper

Thank you.

Operator

Our next question comes from the line of John Kreger from William Blair. Please proceed with your question.

Q - John Kreger

Thanks very much. Can you just explain a bit more on your expectations for operating margin, you have communicated that you are expected be essentially stable in ’06. Can you just talk about some of the key underlying drivers in both directions, what areas of the company do you expect to have improving margins and where are you still looking at incremental investment?

A - Nancy Cooper

Sure John, I think it will come to no surprise as to people that we actually this year we will get operating income growth from Japan. We also has recently moderate acquisition the downward effect on those will be moderated. We did do a large restructuring in 2004 and we put a lot of those resources back in the business but that basically gave us some more efficient structure for our whole production organization. So, that helps and we are getting scale in our C&F now. Those are all the full credit we will continue to invest in this business. There will be new data assets that we want to have, we will want to keep rolling out consulting and services. Those are the growth drivers of our business, so what you are hearing I’d say we are in a balance point where we can invest where we also have things that are paying off so we can stabilize.

Q - John Kreger

Right thanks and Nancy or Dave, your European results while still double-digits, the growth is certainly below what we’ve seen in the last couple of years. Can you talk about what has caused that trend to moderate a bit?

A - David Thomas

Well John, we had a couple a very aggressive acquisition years in Europe and as you know that shifted more prominently to the US in ’05. So, I think that’s probably the biggest single factor in that, although ten quarters of double-digit growth is still very, very strong. We have not seen any underlying issues in any of the business lines or in the growth of our consulting and services business in fact we have very good growth in Europe and very strong organic growth in consulting and services.

Q - John Kreger

Okay great, and then one last question, can you give us an update on PharMetrics and where that stands in terms of turning that into a cost that you can take the clients and grow?

A - David Thomas

As you know they already have a number of offerings that are significant to our clients today and we have made a good deal of progress with putting our teams together to drive a more integrated view from the rich prescription or prescribe our level data along with the anonymous patient-level data. We continue to plan to introduce new offerings, we already launched in the last quarter a cost to care offering that allows pharma and managed care companies to assist the cost of care. So, it helps pharma sell the value of their offerings and it helps the payers manage the cost. We also have in development for launch in ’06 to add diagnosis to our rich prescription information and also to improve our offerings in the non-traditional dispensing areas like clinics, doctors, offices and outpatient facilities.

Q - John Kreger

Great thank you.

Operator

Our next question comes from the line of Duane Pfennigwerth, from Raymond James. Please proceed with your question. Mr. Pfennigwerth your line is open. We will proceed to the next question, our next questions comes from the line of James Kumpel from FBR. Please proceed with your question. James Kumpel your line is open.

Q – James Kumpel

Yes, can you tell me what, what kind of fee would be paid to you should VNU get sold imminently?

A – David Thomas

Well, I think we announced at the time we broke the merger agreement of that we would get $15 million for recovery of expenses upfront and that if there was a change of control within 12 months that we would receive an additional $45 million.

Q – James Kumpel

Okay, okay, can you - maybe Nancy, you can provide some for historical perspective on Japan. Japan, before the product withdrawal I think was at or around 10% of your revenues, and maybe you can walk us through where was before the product withdrawal in terms of margins and revenue mix for the company, where was the made or and where about that is at this point?

A – Nancy Cooper

I don’t think we have ever gone through an individual countries characteristics quite like that but let me try to give you a flavor. We lost the product in 2002 and as we said at the time we thought Japan and certainly Japan is a very important market for pharma. So we did not reduce the expense base, in fact we have been growing that to increase their capabilities. So we went through a period where we had a downward impact in ’02, ’03 and ’04 and second half of this year we launched DDD as Dave mentioned we got more clients than we had forecasted and we are very encouraged about them going forward. So we believe we positioned Japan in a much better place for the future and the opportunity we see there.

Q – James Kumpel

Okay and in terms of stock-related expenses, I know a number of companies are moving towards restricted stock as opposed to options related expense – options related incentive. So, can you talk about your strategy there and if the executive team feels sufficiently centered towards shareholder interest with your levels of stock-based competition?

A – David Thomas

Sure, we are looking at restricted and stock appreciation rights as an alternative option, as you know the top level executives in the company, all of the incentives are performance based. So, with the performance based incentive approach we think that, you know, is very positive as compared to an options incentive.

Q – James Kumpel

And then finally Nancy on the free cash flow, actual free cash flow excluding TriZetto was 278, right, by your preliminary estimates. So in fact your free cash flow guidance for 2006 is in cash, isn’t necessarily an absolute reduction if this kind of bracketed around that 278 million going forward right?

A – Nancy Cooper

That’s right and if you look at our per share basis, it’s a double-digit increase.

Q – James Kumpel

Okay great, thank you.

Operator

Our next question comes from the line of the Duane Pfennigwerth, from Raymond James. Please proceed with your question.

Q - Duane Pfennigwerth

Hi, can you hear me?

A – Nancy Cooper

Yes, we can.

Q - Duane Pfennigwerth

Sorry about that, just with respect to the accelerated share repurchase, can you tell me when your partner would be done purchasing shares in the open market, is there an expiration when the repurchasing needs to be done?

A – Nancy Cooper

Now we have plenty of time to do it but you know we have a lot of liquidity in the market and we should be able to get this done we think within six months or so.

Q - Duane Pfennigwerth

Great thank you. And you mentioned in terms of some of your customers reducing the number of vendors that they worked with and doing more strategic relationships. I wondered if you could just provide some anecdotes for us about, you know, how many vendors, you know, maybe one of your customers work with, what areas you were able to expand into and how that sort of expanded your opportunity and margin potential?

A – David Carlucci

Sure, it really starts Duane with having a broader portfolio capabilities to be more relevant to your client and as they look at their challenges and trying to look at sales and marketing end-to-end, and deliver more effectiveness and efficiency with it. Certainly, if someone can play a much broader role and they can play that across multiple geographies on a consistent basis, there is a cost advantage to that. So when they look at having integrate data from us and several other vendors and working with a multitude of consulting organizations to give them advice, but certainly is a scale advantage to being able to look to a global provider to perform those activities for them. Secondly, we have differentiated ourselves both from data suppliers, and from consulting and services companies by having this evidence based approach and actually having a lot more accountability in the recommendations based on the fact that they are made of our data and information assets primarily. So we have seen several instances where both the end-user executives, as well as procurement have been pushing the envelop with how broad a base of opportunity can we fulfill to have a win-win type of situation, where they can reduce their overall cost, and we have an opportunity to compete for a broader base of business. So that’s what we are seeing, we’ve seen it in our clients’ desires to look across Europe on a more consistent basis specifically and we are seeing similar phenomenons in the other regions.

Q - Duane Pfennigwerth

Of your top 20 how broad based would you say the conversion has already been?

A – David Carlucci

I’d say it really depends on the pharmaceuticals view of how centralized or how common set of systems they want to run. As you know, pharma in general is a fairly decentralized industry but you are starting to see some significant trends with the pressure on growth in cost and expense of doing things on a more consistent basis globally and so it would be hard to characterize it by the top 20, but I think you have a fairly good understanding of how they have run in the past and some of the changes they’re making going forward to improve their efficiencies.

Q - Duane Pfennigwerth

Great, thank you. And then just last, I was just wondering your ’06 forecast, what assumptions you are making on the sort of domestic new drug approval front, and you know, is there any chance there we could get some, you know, better news as you look into 2006? Thanks.

A – David Carlucci

Yeah, I would just say we have consistently said, we don’t see a direct correlation between the number of new launches and the trajectory of our business, obviously we all feel that the healthier the industry is the better and the more drug launches that at some point we will see increased levels of activity. But we don’t see any direct correlation in ’06 although we do see projections to pretty healthy pipeline from our clients.

Q - Duane Pfennigwerth

Thank you.

A - Nancy Cooper

Operator, I think we have time for just two more questions.

Operator

Our next come from the line of Steve Halper from Thomas Weisel Partners, please proceed with your question.

Q – Steve Halper

Hi, Nancy, could you just repeat what you said about the non-operating income or the interest expense guidance that you gave us for 2006?

A – Nancy Cooper

Sure, I said that you could expect interest expense in 2006 to be over $14 million and that if you remember we are, you know, we are doing this large share repurchase that we financing it with them. So that is what’s causing the difference.

Q – Steve Halper

Great, and in the guidance that you provided for adjusted EPS, you assume that the ASR is completed within six months?

A – Nancy Cooper

Yeah, approximately Steve.

Q – Steve Halper

Okay, great thanks for the clarification.

A – Nancy Cooper

Thank you.

Nancy Cooper

Okay I think we have just time for one more question Susan.

Operator

Yes we do have a follow-up question from the line of Larry Marsh from Lehman Brothers. Please proceed with your question.

Q – Larry Marsh

Yeah, just very quickly, I just want to make sure I am reading this right, your full year CapEx in capitalized software you are showing $52 million of CapEx for the full year is that right, Nancy?

A – Nancy Cooper

Yeah, let me go through that Larry, you know, we have a expensive capital, I also call the plan and what we decided in 2005 is we travel offshore on that quite a bit and we needed to technologically upgrade the plan. So what you see in CapEx is you got with the two lines this time, in CapEx there is $30 million for the plan. So, you see when you take that out well within on historic CapEx ranges, and the third line below that you will see proceeds from the sale of the plan. So, you really need to add about $15 million in there as the plain, so and that’s the two and that’s the net effect of upgrading our plain.

Q – Larry Marsh

Okay alright and then are you - did you breakout the dollar amount that you showed from the standalone consulting and services division for the full year?

A – Nancy Cooper

Yes, that number is broken out, its $275 million of revenue, which is the 51% constant dollar growth.

Q – Larry Marsh

Right, and did you comment about what kind of growth would you anticipate for consulting and services on a standalone basis and that you incorporate those in the other divisions?

A – Nancy Cooper

Yeah, we are not going to start breaking out our guidance, but let me explain, you know, obviously, we had two years of an excess of 50% growth. We are now almost like $300 million business. We have a great opportunity in the area, we have great growth but its could be the law of larger numbers that the growth will not be quite as large.

Q – Larry Marsh

Very good, thank you.

A – Nancy Cooper

Thank you

Dave Carlucci, President and CEO

Thank you Larry, and thank you all for spending the time with us today. I think the most important message we want to send is that the operational performance of the company is excellent and it continues to improve and we hope you’ll take some time with us on February 13th as we take you through the strategy of the business as well as the fundamental drivers of the growth going forward. So, we look forward to seeing you then. Thank you very much.

Operator

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and I ask that you please disconnect your lines. Have a great day everyone.

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