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Executives

David Blair - CEO

Mike Donovan - CFO

Analysts

Brooks O'Neil - Dougherty and Company

David McDonald - Suntrust

David Toung - Argus Research

Eugene Goldinberg - BB&T Capital Markets

Tony Perkins - First Analysis

Michael Baker - Raymond James

Robert Willoughby - Banc of America

Mark Arnold - Piper Jaffray

Larry Marsh - Lehman Brothers

Glenn Garmont - Broadpoint Capital

Michael Minchak - JPMorgan

Dan Lazard - Magnatar

HealthExtras Inc. (HLEX) Q1 2008 Earnings Call May 7, 2008 10:00 AM ET

Operator

Welcome to the HealthExtras’ First Quarter Investor Conference Call. Today’s conference is being recorded.

This conference will contain forward-looking statements. Forward-looking statements are made pursuant to the Safe Harbor Provisions of the Private Securities Litigation Act of 1995. Forward-looking statements may be significantly impacted by certain risks and uncertainties described in the company’s filings with the Securities and Exchange Commission.

With that said, I would now like to introduce the Chief Executive Officer of HealthExtras, Mr. David Blair. Please go ahead, sir.

David Blair

Good morning and thank you for joining our first quarter conference call. Also with me is Mike Donovan, our Chief Financial Officer. Overall, it was a solid quarter for us. There are a couple items I’d like to run through with you, before turning the call over to Mike to discuss financial results.

On the sales front, clearly we're pleased with the results from the first quarter. As noted in press release, we sold business representing 300,000 lives with midyear client implementations. In round numbers that should equate to $120 million to $150 million in annualized revenues. And at this point the vast majority of our focus is on sales opportunities with 1/1/09 effective date, for pursuing health plans, large employer groups, state and local governments and Union business.

We typically get asked to quantify the sales pipeline, of course that's always difficult for us to quantify. Perhaps the best way to describe it is, based on RFP activity and client proposals; we expect to exceed last year’s sales results, which equated to $700 million. These expanding opportunities come from the opportunity to pursue larger accounts, different types of clients as well as businesses in new geographies.

Next, let me comment on M&A activity. Clearly, we were pleased to announce the acquisition of HospiScript last month. This transaction has not closed yet, so I will keep my comments somewhat limited. From an industry perspective, we like the hospice base. There are over 4,000 hospices across the country which can benefit from our pharmacy benefit management services, whether it be at the access to our network of pharmacies, our clinical expertise, or a data reporting and analytics.

Second, as many of you know, we have been the claim's processor for HospiScript for the last several years. So in that respect, we know the management and we know the business model well.

Clearly, we believe Shannon Spear, the President of HospiScript and her team will be a great addition to our organization, and not only do we expect the see growth in the hospice business, we also anticipate HospiScript will pursue other complimentary lines of business.

Our expectation is that this transaction will close in the next several weeks. We continue to evaluate the other M&A opportunities, mail order is an area we expect to be in. Acquiring a mail facility will better position us to provide our clients with a differentiated level of service, and specifically will support our initiatives to provide clients with acquisition based pricing of mail. And then also from a service, we'll be able to provide our clients with higher level of customization.

Overall, acquiring a mail facility should be simply as a continuation of our commitment to be the leader in pricing transparency, and innovative programs to drive patients to most care effective, cost effective drugs.

I'm also looking at both regional and national pharmacy benefit. Management companies which could be integrated with our existing business structure, and we continually evaluate other complimentary business lines in the healthcare services arena.

All that being said, we are under no pressure to pursue any acquisitions. Revenues were up 45% and that's all on strong organic growth. And so as I mentioned, the pipeline for new sales is strong. We expect 2008 sales to exceed last year's totals, so we are under no pressure to pursue a transaction, we will do so only when we are confident that the long-term interest of our shareholders is being well served.

Another key area I'd like to comment on briefly is client retention. Typically, we realize annual client retentions in excess of 98%, and we would expect this year to be no exception. At this point in the year, over 95% of our existing business is contracted for 2009 and that number should continue to increase as we secure additional client renewals and client contract extensions.

Last month we announced that Hai Tran will be joining the company as CFO effective July 1st. We are thrilled to have Hai join the organization, not only does he bring a high level of energy and experience, but also a commitment to build on our track record of growth. I look forward to introducing you to Hai during our next quarterly conference call. The addition of Hai reflects the larger initiative of ours to expand the depth of our senior management team, and you can look for us to make additional key hires throughout the year.

Mike isn’t going anywhere and he will continue to pursue business development opportunities for us. And so with that I will turn it over to Mike to discuss the financials.

Mike Donovan

Thanks David. Good morning everybody. To review the highlights in the press release, basic and diluted earnings per share were $0.27 in the quarter. For comparison purposes earnings were $0.23 a share in the first quarter of last year. Excluding the contributions from the terminated supplemental benefits business, the year earlier quarter earnings were approximately $0.19 a share. Accordingly, on a comparable basis, earnings were up over 40% year-over-year in the first quarter.

Also on a year-over-year basis, revenue was up from 45% from $406.3 million to $588.6 million. On a sequential basis revenue was up 10.7% from $531.9 million to $588.6 million. Gross margins were $31.2 million in the quarter and up year-over-year by $3.6 million and sequentially by $1.3 million. Again, I would ask everyone to remember that the supplemental benefits margin contribution in the fourth quarter of last year was approximately $3 million.

As referenced in the press release, operating profitability per prescription was up sequentially by approximately $0.20 a transaction, which when combined with increased transaction volume, more than made up for the loss of the overwhelming majority of that $3 million gross of profit from the supplemental benefits segment in the prior quarter.

Year-over-year claim count increased to $12.8 million from $9.7 million and also grew sequentially by $1.4 million scripts from the $11.4 million processed in the fourth quarter of 2007.

Year-over-year generic utilization increased from 58.1% to 62.3% and was also up sequentially by 1.9 percentage points from the 60.4% reported in the fourth quarter of 2007. Unadjusted mail order claims were $403,000 in the quarter and flat sequentially. Average net revenue per script was $45.84, and up about a nickel on a sequential basis.

SG&A expenses were up sequentially by approximately $700,000 reflecting several factors including out of market expenses related to strategic initiatives and a full quarter of operating expenses related to our one business additions.

Capital expenditures for the quarter were $1.4 million. During the quarter non-cash charges totaled $3.3 million, including $1.2 million in non-cash compensation expense and $2.1 million in depreciation and amortization.

Days in AR were down sequentially by almost 10% to 35 and our working capital management was solid with operating cash flow for the quarter coming in at $34.8 million. We ended the quarter with a negative working capital balance of approximately $27 million. We had approximately $145 million of cash on the balance sheet at the end of quarter.

And also just so you know, we'll be filing the 10-Q, we expect, on Thursday, so that will give everybody all the other detail on cash flow on a line by line basis.

David with that I will turn it back to you.

David Blair

Before opening the call for your questions, let me just reiterate the based on current business volumes we remain comfortable with the current financial guidance. Specifically we expect revenue to be approximately $2.5 billion and net income to range between $50.5 million to $54 million and that equates $1.17 to $1.25 earnings per share.

And so with that operator, we'll open up the call for their questions.

Question-and-Answer Session

Operator

(Operator Instructions). We'll have our first question from Brooks O'Neil, Dougherty and Company.

Brooks O'Neil - Dougherty and Company

Good morning. I have a couple of questions and I confess that I had to drop off at the beginning of the prepared remarks, so if I ask something you've commented about already, I apologize. Do you think you could just tell me what the contribution of supplemental benefits was this quarter, Mike or David?

Mike Donovan

Brooks, as we mentioned, we think for the full year the supplemental benefits produces a penny, may be a little bit more share in the first quarter, and was pro rata with that.

Brooks O'Neil - Dougherty and Company

So you'll think, you will keep the business during the balance of the year, is that what I am hearing you say?

Mike Donovan

I think we mentioned before that the disposition of that business is not material one way or the other and that the overwhelming majority of revenue and margins were terminated with the relationship we described at 12/31/07.

Brooks O'Neil - Dougherty and Company

Yes, okay that's helpful. And then, I heard David say specifically that mail was strategic opportunity for you. Did you comment at all about the specialty opportunity, whether that ties directly to the mail situations you're looking at, or whether you consider that a separate opportunity in any way?

David Blair

Brooks, we do view that as a separate opportunity and it is something that we're looking at for our clients. As you know that's an increasingly important part of the pharmacy equation and thus we look at specialty. Not only we focus on distribution, but just as importantly, the care management side that and making sure that there is consistent reimbursement, regardless of whether the patient is acquiring a drug.

Brooks O'Neil - Dougherty and Company

Okay that's good. And then lastly I'll just ask you, if either of you would be willing to comment on the gross margin percentage trend? Obviously that continues to come down a little bit. Do you think we'll see that begin to stabilize as a percentage of revenue sometime this year, or should we expect that to continue to slide a little bit?

Mike Donovan

Brooks, I think if you look at quarter-over-quarter. Again extra supplemental benefits business. I think we saw some modest improvement in margins in the current quarter and I think you'll continue to see that through the year.

Brooks O'Neil - Dougherty and Company

Okay that's very helpful. Thank you very much.

Operator

We'll have our next question from David McDonald, Suntrust

David McDonald - Suntrust

Good Morning guys. Can you guys give kind of for modeling purposes, a little detail on the HospiScript deal in terms of ballpark revenue, what type of contribution you'd be expecting?

Mike Donovan

Dave, as David mentioned in his prepared remarks, we have been the claims processor for HospiScript for a number of years. That's in fact, how we got to got to know the management team there. So we will be reporting that business on a net basis, going forward, and the incremental business. So, in that respect, we are not going to get a whole lot of revenue -- significant margin lift. I think from a valuation perspective, the view that we have given folks is that $0.12 to $0.15 accretive when fully integrated, which is a calendar '09 target for us and the management team at HospiScript, I think, reflects well on the valuation. And also, we didn't look at it strictly in sort of the academically accretive view of things. That's a business that we think can grow materially over the next couple of years and so we are real confident in the management team and the growth prospects in that specific market segment.

David McDonald - Suntrust

And then Mike, one other question, obviously a big cash flow number in the quarter. Is pretty much the working capital benefit, I would assume that's tied to some new folks that came on at the beginning of the year. Should we expect working capital to be more of a push throughout the balance of the year?

Mike Donovan

We certainly got out of the gate fast from a cash flow standpoint this year. You are absolutely right, David. What we are doing there, is managing timely billing. We are managing the left side of the balance sheet aggressively. But I would expect again, that by the end of the year, the guidance that we have given, which is net income adjusted for non-cash items, and the difference in the cash tax rate, probably ought to be a proxy for cash flow. So I think somewhere in that $70 million range is probably a realistic target for all of calendar '08.

David McDonald - Suntrust

Thank you.

Operator

We will have our next question from David Toung, Argus Research.

David Toung - Argus Research

Yes Good morning. Thank you for taking the call. Hello.

David Blair

Yes.

David Toung - Argus Research

First of all on generics. I think there's some variability on the timing on some of the introductions of some of the generics. Is there variability to your guidance from that?

Mike Donovan

Less so for us than for our PBMs that operate mail order facilities of their own; because for us, a significant portion of our business is predicated on pass-through pricing at retail and at mail. So for us, we want to take advantage of those opportunities. We've continued to increase our generic utilization consistently quarter-to-quarter. But the cost of goods sold impact, if you will, on us, from the variability of the timing, and occasionally the introduction and subsequent withdrawal of some of these products does not have the same impact that it does on the retailers, if you will, regardless whether they are mail or brick and mortar retailers.

David Toung - Argus Research

So when you do acquire a mail order facility, you should expect a greater impact from generic?

Mike Donovan

Yes. We will be faced with some of that variability that historically we haven’t had. But again I'd defer to some of our other competitors' comments on that, but it’s a not a huge swing vote, in terms of profitability.

David Toung - Argus Research

Right. I have a follow-up. There seems to be a fair amount of activity among accounts, fairly large accounts shifting consolidation because of M&A activity at the managed care level. Can you talk about what you see, what opportunities you might be able to pick up, because of what I'm seeing as an increase in that level of activity in this shifting of accounts?

David Blair

Sure. From a sales perspective, I don’t know that our target accounts have changed that much as a result of that dynamic. The employer groups, state, local governments, managed care plants, are still attracted to us because of the local commitment, that we're willing make. And that pricing transparency and collaboration. Specifically with the health plan clients, in some respects, we offer almost a hybrid model between doing it all in-house or kind of outsourcing it to a PBM; because we allow the health plan to control critical functions, whether that be formulary design, rebate management, those types of things. But yes, we can provide all the administrative support as it relates to IT or clinical data analytics, that type of things. So the dynamic that you are referring to, I don’t know that it has necessarily changed our value proposition, perhaps it has created more opportunities for us than we would have seen historically otherwise.

David Toung - Argus Research

Okay thank you.

Operator

Our next question comes from [Newton Jung, BB&T Capital Markets].

Eugene Goldinberg - BB&T Capital Markets

Good morning guys, this is Eugene standing in for Newton. Just wanted to get a little more on clarity on the HospiScript and kind of the composition of their customer base. I guess, I am kind of more interested on the business that's associated with Vista Care, I think Vista is one of their larger clients. Can you just give us an idea of perhaps the size of the Vista Care relationship with HospiScript?

David Blair

Well, we haven't disclosed that. Clearly, Vista Care is one of the larger players in the hospice market segment. HospiScript is specialized in, what I will call that mid tier markets, where you are talking about the 100 to 200 bed hospice operators. The institutional end of marketplace if you will in today's environment is large served by OMNI care and one thing is that we is a great opportunity for us, is that the models that we've used in PBM business for the commercial side has I think we're going to be able to use some of that play book to go after the larger market segments, clearly HospiScript, I know, an excellently run company. It doesn’t have the balance sheet and the visibility and the other things that we bring to the equation. So I think there is both an opportunity to increase profitability in the middle market in the HospiS business, but also to reach out to the more institutional end of the business and to gain market share there.

Eugene Goldinberg - BB&T Capital Markets

Thank you for that. Would you want to comment on the side effect, 5%, 10% of revenue, any number behind that or?

David Blair

No

Eugene Goldinberg - BB&T Capital Markets

Okay. And one more question, can you just comment on any impact that you guys are seeing or you guys expect to see from Wal-Mart's recent expansion of the generic plant?

David Blair

Sure. This is David. It is terrific for our client. I mean it is one of the things we have been pushing through our generic advantage program which is to drive to the low cost provider of generic drugs. That's something we encourage our clients to promote. We think it drives savings for both the member to the extent they have co-insurance they have co-insurance or high deductible plans or even an HSA type arrangement so it is terrific and we would like to see more of the retail chains come out with some more programs.

Eugene Goldinberg - BB&T Capital Markets

Great, thank you very much for your comments guys.

Operator

We go next to Tony Perkins, First Analysis

Tony Perkins - First Analysis

Good morning. First question, did you experience significant drug price increases potentially weight on gross margin, mainly as a result of some pressure the manufacturers are seeing from generic competition?

David Blair

I wouldn't say that was a material factor in the quarter for us at all. I think the cycle of price increases and for us, again operating and primarily a pass through environment and not being a direct purchaser of product in the wholesale channel kind of insulate us from some of that so I would say, I wasn’t anything that was particularly influential in terms of Results for the quarter.

Tony Perkins - First Analysis

And then just a follow-up on the mail distribution capability. Should we continue to assume an acquisition in that space? I know there has been some talk about building it but sounds like on today's call it is still continuing with the acquisition strategy.

David Blair

That’s right Tony. Our preference would be to acquire an existing facility.

Tony Perkins - First Analysis

Okay. That's all. Thank you.

David Blair

Thank you.

Operator

We will go next to Michael Baker, Raymond James.

Michael Baker - Raymond James

Thanks. Just wanted to follow-up, David, in terms of your optimism as it relates to the selling season. Sounds like you are looking for a better selling season in '09 or related to '09 than last year. And we’ve heard some competitors indicate business is stickier than this year than we saw last year. So I just wanted to get some sense of what's driving your optimism along those lines and if there's any particular segment of the market that appears more attractive?

Mike Donovan

Sure. And that stickiness that's maybe referred to when drug trend is in the single digits, there's perhaps less of a reaction to move business, perhaps if they're focusing on other areas of health care component. But for us, the reason that we are optimistic is because there's more; more opportunities this year than there have been historically. When we brought on in the Blues plans, Wellmark 1.5 years, 2 years ago that opened up a lot of doors. So now we have that under our belt for 1.5 years. We have demonstrated the ability to service 1 million plus group control their drug trend and this year we are seeing more activity than we have ever seen before or maybe a 500 or 600,000 life group which wouldn't have considered us in 2006 is now looking to us as a viable alternative. That stickiness has been more than offset by doors been opened for us, whether it's larger accounts and clearly were in more parts of the country than ever before. So we have a better name recognition and then just also the ability to go after different types of accounts. We brought on our first group a year and a half ago, and so that again a huge market opportunity where historically if you don’t have an existing client, its hard to demonstrate that you can service that account and now we have those references. So with the past two months have been fast and furious for us flying around on the country for best and finals bringing clients in here for onsite business etcetera. So we are confident that this build on the 300,000 miles that were bringing on mid year and next year sales should exceed that $700 million number.

Michael Baker - Raymond James

And can you just give us a sense that how you think the composition might shape up for instance last year there weren’t a lot of named ones, but still up a good numbers that some similar dynamic we could see this year or what are your thoughts along those lines?

David Blair

My guess is you will see prior one or two larger accounts of a north of 200,000 to 300,000 lives with to get to us to that end point. But then our bread and butter which is the smaller groups will continue to add.

Michael Baker - Raymond James

And then just along that the last point you make, can you update us on how in California coalition shaping up?

David Blair

Sure. If we've at this point, there is as some of you know this 44 different entity that comprise that coalition at this point we have now which is all of those groups, we have on office in California and this is a opportunity to bring kind of one group on at a time. And so it has gone slower than we have expected. But we are, we have a dialogue with these groups now about bringing on business on the first of the year but candidly there's no business from that coalition that's baked in our current guidance or the 300,000 lives that I've mentioned earlier.

Michael Baker - Raymond James

Thanks a lot for the update.

Operator

We'll go next to Robert Willoughby, Banc of America.

Robert Willoughby - Banc of America

Good morning, Mike or Dave, you did mention some key hires potentially over the course of the year, could you possibly give us an update there and what in terms of what you may be looking for and secondarily I guess given some the unique kind of cash flow dynamics of your model negative working capital very low PP&E and your balance sheet, why is now the time to actually lever up meaningfully and do something a little bit larger or more aggressive, I mean something above and beyond the smaller transactions we have seen today, is there a potential to see something that could be more landscape changing for you?

David Blair

Sure, Robert. Let me address the first quarter part of your question relate to key hires, as we watch this company over the past couple of year and we're twice the size that we were just 2.5 years ago and so an ongoing initiative of ours if that continually recruit the best and greatest professional to support that growth and I think you can look for us add additional personnel whether would be on the sales and marketing side certainly government services is becoming a increasingly bigger part of our business, as well as, client services in clinical support. So we will continue to recruit those types of professionals and, they are mention on previous phone calls we're an attractive organization for folks who join we're growing dynamic organization and we had a lot of success on the recruitment front.

Mike Donovan

And Bob, the comment on the balance sheet certainly we have a track record of successful acquisition in integration discipline here, I would may be echo David's earlier comments in his prepared remarks I think 2008 is a year in which is more likely than ever that the size of that transaction to easier terms the landscape altering transaction is certainly something that we've actually had an opportunity to look at several of those in the last six months, none of which were ones that we felt from protecting the interest and enhancing the interest of our shareholders with transactions that we were committed to. But there are a number of them under evaluation today which I would say meet the definition of landscape changing as you described. And whether the question of how best to use the balance sheet from the standpoint of leverage we certainly have significant untapped borrowing capacity in our own cash flow and we would expect that a target or targets would bring comparable levels of cash flow so that we would look to make a judicious use of leverage in a situation where we felt like we were getting a high quality asset with a lot of good earning.

Robert Willoughby - Banc of America

Is there no aversion to debt financing, I mean, is there a point you wouldn't push it past though in terms of a capitalization ratio or does that kind of depend on the deal that presents itself?

Mike Donovan

I think it depends on the deal and also in the current environment, the availability of credit and the pricing in which it can be that is correct we can take it down, I think it changes day to day, certainly it is not the same market it was 12 months ago. But I think we've always had the view that leverage judiciously employed is an important way to increase shareholder returns. That's what we will try to do.

Robert Willoughby - Banc of America

And is there any sense also kind of a tougher question, I mean, how many deals can you manage at one particular time does it just the management challenge if there is three or more things in the offer too much or is it kind of a annual thing we will see one deal a year?

David Blair

That’s a good question. I mean its going to depending complexity of the deal that we are looking at. Two or three transactions at any time is probably about how we max out right now. But that goes again to the earlier question you had about key hires, and we are trying to our bench strength so that we have an opportunity to pursue more transactions than we do now.

Robert Willoughby - Banc of America

Okay thank you.

David Blair

Thank you.

Operator

We will have our next question from Mark Arnold, Piper Jaffray.

Mark Arnold - Piper Jaffray

Thanks Most of my questions have been answered but a couple of follow ups here, on the HospiScript acquisition, you said you are comfortable with your guidance for the rest of the year. I assume that any contribution from HospiScript would be outside of that guidance range, is that a fair statement?.

Mike Donovan

I think what we have communicated is that with integration costs related to conforming systems and hiring some folks there to pursue the sales strategy we would expect it to be a neutral number for the back half of 2008. As David said, we realistically believe that is a couple of weeks away. So that sort of kicks off the integration time line. But the accretion numbers we have given are looking at calendar ’09.

Mark Arnold - Piper Jaffray

Okay and then I guess the one thing that is surprising about the Q1 results I think going back to the commentary in the last earnings call I guess I was expecting a little bit higher script count in Q1. Did any, can you comment at all about that? I think you guys talked about being on a run rate in late February of 55 million scripts per year and the run rate here in Q1 was a little bit lower than that. Is there anything specific there about the Puerto Rico business or anything that would add a little bit more color there about the script count in the quarter?

Mike Donovan

Clearly, the script count for the back half of the quarter after our conference call was lighter than we expected 12.8 million scripts was probably at the low end of our expectation for the quarter. But it's not unusual when you bring on new business and you are looking at historical utilization files, historical eligibility files trying to maybe get not an entirely accurate picture of a sort of a normalized run rate to claims. So I wouldn’t want to one specific contributor to that. I think script cap industry wide was soft in the back end for the quarter and we saw perhaps more than our fair share of that softness.

Mark Arnold - Piper Jaffray

And then just as you talked about that in the industry side, what would account for that or do you have any idea of what would account for that?

Mike Donovan

Not particularly, and I think if you read the headlines in the Wall Street Journal and elsewhere that gas prices and food prices are crowding out doctor visits and so I think we've seen perhaps less sort of routine retail claims being generated by doctor office visits. But that's beyond us from a policy standpoint to sort of comment on an economy wide issues. But I think it’s a fact.

Mark Arnold - Piper Jaffray

Okay.

Mike Donovan

Certainly, we have also seen at the margin for us, some of our employee groups have been experiencing implementing headcount reductions and the like which hurts eligibility at the margin. Again not a material contributor but in some large markets, people are familiar with business in Las Vegas and the economy in Las Vegas has been soft over the last six months.

Mark Arnold - Piper Jaffray

Great. Thank you very much.

Operator

We will go next to Larry Marsh, Lehman Brothers.

Larry Marsh - Lehman Brothers

Thanks. Just a couple a couple of quick ones. Mike I just want to make sure I'm clear here you are saying if you back up the supplemental business and I know we are getting the details in the queue, you are saying the margin went year-over-year in your PBM business, is that what you said or am I misstating that?

Mike Donovan

You have it right, except year-over-year. I was speaking sequentially. Larry.

Larry Marsh - Lehman Brothers

Sequentially, okay, right, that's what I'd thought. And so then to that point, would you define that year-over-year decline strictly a function of customer mix or would you define it as front end price competition, where you not able to fully offset that with back end pricing leverage I guess, things you've talked about in the past.

Mike Donovan

Overwhelmingly before.

Larry Marsh - Lehman Brothers

Okay.

David Blair

We brought on, as I think we talked about on a couple of calls in a row, the significant volume of business that added in Q3 of 2007 was public sector business specifically three large pools of state employees, which is the most competitive segment of the market and it is competitive in that way because the state government as you know cannot be utilize of mail order services in any significant way so what we're really doing is running a retail network and price competition there whether MetCo express ourselves CareMark, it's a very competitive and there as you know a very transparently competitive marketplace. So I think we got a pick up in the back half of the year on 1-1 with some more managed care business and some more commercial business tend not to be quite as aggressive fore a price standpoint.

Larry Marsh - Lehman Brothers

Okay, great, thank you for reiterating that. On the point of May, you talked sequential flatness there, what is, if the question is, is there specific incentive for you to try to structure your benefit design to aggressively shift a nail or to at this point just do whatever is right for the customer and might any of those financial synergy ultimately accrue to the customer change when you add your own capacity.

David Blair

For us Larry, it’s all about cost savings and convenience for our members and our clients and so, we want to get the member the right prescription at the lowest price. And then whether they want to buy through mail or retail, that's really, should be the member's decision if they want that level of convenience and if there is a price savings with mail, we should be in a position to pass that one. But conversely we don’t want to be in situation where they are incentivizing them to go to a high cost provider or disincentivizing them to not go to the low cost provider. So, for us it is about convenience and choice for the member and then consisting reimbursement whether its retailer mail and we feel like if we own a facility, we will be at better position to accomplish that goal.

Larry Marsh - Lehman Brothers

Okay. To the point then, the continued aggressiveness in prize at mass merchant marketing generics, as you said, does that give you a customers even better even a better deal and more incentivize to drive five a retail versus mail, is that really not a statement around channel.

David Blair

No, I think its terrific opportunity for our clients. The more programs that come out like this, like the Wal-Mart program, and I think there is eight or nine chains out there that have low cost generic options available. That‘s a terrific opportunity and let’s get our members to go there or incentivize them. And if they can go there, I want to be in a position where I can sell them those generic drugs at the same cost that those discount retailers are selling for. So, we have plotted those efforts and we encouraged them.

Larry Marsh - Lehman Brothers

Okay.

Mike Donovan

Well, I just going to add, if I might that, may be two or three years ago we tended to think of retailing and mail sort of black and while you understood the advantages of one versus the others. And I would describe the market as sort of grade from end to end, which is where products are the least expensive is not something that you can know with certainty. So, going back to David’s observation increasing use of 90 days of retail where retailers have been willing to close the gap on the economic of brain drugs, has been a meaningful factor. If you compound that with, as David commented, the Wal-Mart initiative target matching that dollar for dollar, product for product, that fact in many respects, Costco is the low cost provider across the full continuing of generic products, even benchmark again Wal-Mart, suggest that it’s market where there has to be a little bit more number in terms of planned design so that may be the blunt instrument of a waive a co-pay to get somebody to go to mail, may not be something that hasn’t same financial returns that they did three years ago and so, not having a huge investment in the sort of status quo profitability of mail is important. Mail done right is important, but we also think that competition is coming across all of those retail outlets regardless of where they are.

Larry Marsh - Lehman Brothers

And I guess to that quick point, your generics advantage, marketing program is at the heart channel agnostic or is it more retail driven given the, it’s good deals that we are seeing in the market

David Blair

It's providing the members and the clients with information to make smart decisions. So and if that’s going to Wal-Mart for one drug and going to mail for another drug or whatever the case maybe its just providing the members and the clients with that information when they can get the lowest cost drug.

Larry Marsh - Lehman Brothers

Two quick things and the tax rate for the year. You've probably already said this or may you've stated it you need to change in general expectations for the full year Mike?

Mike Donovan

I think I would expect somewhere between where we were for the quarter and maybe 38 depending on jurisdiction of [mix].

Larry Marsh - Lehman Brothers

Okay. Now the interest income was the payment to HospiScript that we would anticipate. Those were reductions I guess starting in Q2, are you in a position to quantify a range or just say yes, it's definitely coming down.

Mike Donovan

I just say it will be coming down Larry and I as we've talked to people before our interest income yield when you sort of reverse engineered it is an indication that our overnight investment balances tend to be materially higher and our quarter end reported cash balance. So that in clearly is a $100 million in today's interest rate environment assuming that we close in the timeframe that Dave alluded to will necessitate a reduction in interest income for beginning in Q2 potentially and certainly the back half of the year. Somewhere offset by good cash management.

Larry Marsh - Lehman Brothers

Very good, okay, thanks.

Operator

We will have our next question from Glenn Garmont, Broadpoint Capital.

Glenn Garmont - Broadpoint Capital

Thanks, good morning. I apologize if you sort of touched down this already, Mike. But I just wanted to get some comfort around sort of the SG&A, it was bit higher in the quarter and we are modeling and stepped up pretty meaningfully on a sequential basis, the mid fourteens, that sort of good run rate, and how should we think about may be some incremental SG&A in Q2 as you prepared to bring on that 300,000 lives? Thanks.

Mike Donovan

The answer to your first question yes, but if we think forward to Q2 and results at the end of July will have HospiScript SG&A in that number for some period of time as well. So that will be something it will a sequential comparison a little muddy and then we would have a full quarter of not only the SG&A associated with the 71 ads, but a full quarter HospiScript in Q3. So I think from a run rate standpoint sort of claim volume index, I think it sort of good run rate number, but there will be some changes to that mix of the two reasons I just described.

Glenn Garmont - Broadpoint Capital

And what kind of sort of magnitude SG&A would HospiScript do you expect to add?

Mike Donovan

I don’t think we've disclosed that. Part of it will be timing. But if you look at the neutral sort of implications for guidance for the back half of the year, that's rally I think the more important issue.

Glenn Garmont - Broadpoint Capital

Okay, yeah, I was just asking on a run rate basis externally for Q2, that's helpful thanks.

Operator

We'll have our next question from Michael Minchak, JPMorgan.

Michael Minchak - JPMorgan

Thanks and good morning. You talk a little bit about the generic advantage program, are you getting a lot of interest in it from current and perspective customers and do you think its specifically help you win some of the new that you signed in first quarter?

David Blair

It has. It's getting a lot of interest I mean in particularly because over the past five years there is being such a big push to mail that folks are waking up, I think have 30% mail over utilization and when they look at the cost they are paying through mail as compared to may be what's some low cost retail options might be. They leave a lot of money in the table and so that's something that is driving our sales and it's just another step in our progress towards kind of complete transparency and innovative programs to drive savings to declines the numbers.

Michael Minchak - JPMorgan

Great and then can you comment on the competitive landscape where they might be seeing any additional opportunities based on the recent M&A activities in some of the small periods.

David Blair

We haven't seen any change from a competitive perspective and this is a highly competitive business where we're perceiving business and there is a handful of other PBMs that are aggressively fighting for the same block of business. So there is no material difference between, what we saw historically and what we see today.

Michael Minchak - JPMorgan

And going back to the HospiScript acquisition, do you see additional opportunities out there for consolidation in that market segment?

Mike Donovan

There certainly are other opportunities smaller Hospi PBM operators and certainly the management at HospiScript's Shannon Speir is familiar with those opportunities. And though they would probably be smaller in size than the things that we would do organizationally in the PBM business. To the extent they again compliment geography or service offerings in the HospiS business. We would not be reluctant to fund that type of acquisition specific to that market segment.

Michael Minchak - JPMorgan

Great thanks for the comments

Operator

(Operator Instructions). We'll go next to [Dan Lazard, Magnatar].

Dan Lazard - Magnatar

Hi guys thanks for taking my call. I disrupt the question on your supplement of benefits, If you guys could break out for us what the operating cost of that business or at least how much of that gross margins flows the pre-tax line because it looks like from the comment you made about core PBM EPS being $0.19 last year about 90% of that gross margin flowed through?

Mike Donovan

That’s correct.

Dan Lazard - Magnatar

Is that a fixed cost that flows through consistently or is it that ratio that should continue?

David Blair

Given where we are today we have shed the majority of those other operating costs. I would say it is, if numbers are small enough now if you have an FTE and a half they probably don't get to the 90/10 ratio anymore but they're de minimus operating costs.

Dan Lazard - Magnatar

Alright and then just comment but I am seeing what looks to be quite a big level of excitement on part about the future growth prospects of the business so I am curious if you guys would consider canceling your 10-b-5 sales since it appears to me those sales in your stock price don’t reflect that excitement?

Mike Donovan

Yeah. I think if you look at the couple years of trading here and I won't comment on David. So I think David's plan has changed if that we have tried to work off options granted in some cases 8, 9 10 years ago in an orderly fashion prior their exploration date and I think that’s something that we have got an input from the board on as to been a prudent way to go about doing then.

Dan Lazard - Magnatar

Thanks.

Mike Donovan

Thank you.

Operator

And we have no further questions in the queue at this time. I will turn the conference back over to management for additional or closing remarks.

David Blair

Thank you for your participation today and we look forward to speaking with you during the next conference call.

Operator

That concludes today’s conference. You may disconnect at this time. We appreciate your participation.

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Source: HealthExtras Inc. Q1 2008 Earnings Call Transcript

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